Ch10 - Intermediate Accounting Chapter 10 Acquisition and...

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Unformatted text preview: Intermediate Accounting Chapter 10 Acquisition and Disposition of Property, Plant, and Equipment Learning Objectives Learning 2 Describe property, plant, and equipment Identify the costs to include in initial valuation of property, plant, and equipment Describe the accounting problems associated with self­constructed assets. Describe the accounting problems associated with interest capitalization. Understand accounting issues related to acquiring and valuing plant assets. Describe the accounting treatment for costs subsequent to acquisition Describe the accounting treatment for disposal of property, plant, and equipment Property, Plant, and Equipment Property, Property, plant, and equipment includes land, buildings, and equipment (machinery, furniture, tools. Major characteristics include: 3 “Used in operations” and not for resale Long­term in nature and usually depreciated Possess physical substance. LO 1: Describe property, plant, and equipment. Acquisition of PP&E Acquisition Valued at Historical Cost, reasons include: 4 Historical cost is reliable Companies should not anticipate gains and losses but should recognize gains and losses only when the asset is sold LO 2: Identify the costs to include in initial valuation of property, plant, and equipment. Acquisition of PP&E Acquisition Cost of Land Includes all costs to acquire land and ready it for use. Costs typically include: (1) the purchase price; (2) closing costs, such as title to the land, attorney’s fees, and recording fees; (3) costs of grading, filling, draining, and clearing; (4) assumption of any liens, mortgages, or encumbrances on the property: and (5) Additional land improvements that have an indefinite life. 5 LO 2: Identify the costs to include in initial valuation of property, plant, and equipment. Acquisition of PP&E Acquisition Cost of Buildings Includes all costs related directly to acquisition or construction Costs typically include: (1) materials, labor, and overhead costs incurred during construction and (2) professional fees and building permits. 6 LO 2: Identify the costs to include in initial valuation of property, plant, and equipment. Acquisition of PP&E Acquisition Cost of Equipment Include all costs incurred in acquiring the equipment and preparing it for use. Costs typically include: (1) purchase price, (2) freight and handling charges (3) insurance on the equipment while in transit, (4) cost of special foundations if required, (5) assembling and installation costs, and (6) costs of conducting trial runs. 7 LO 2: Identify the costs to include in initial valuation of property, plant, and equipment. Acquisition of PP&E Acquisition Self-Constructed Assets Costs typically include: (1) Materials and direct labor (2) Overhead can be handled in two ways: 1. Assign no fixed overhead 2. Assign a portion of all overhead to the construction process. Companies use the second method extensively. 8 LO 3: Describe the accounting problems associated with self­constructed assets. Acquisition of PP&E Acquisition Interest Costs During Construction Three approaches have been suggested to account for the interest incurred in financing the construction. $ 0 Capitalize no interest during construction Increase to Cost of Asset Capitalize actual costs incurred during construction (with modification) GAAP 9 LO 4: Describe the accounting problems associated with interest capitalization. $ ? Capitalize all costs of funds Acquisition of PP&E Acquisition Interest Costs During Construction GAAP requires – capitalizing actual interest (with modification) Consistent with historical cost – all costs incurred to bring the asset to the condition for its intended use Capitalization considers three items: 1. Qualifying assets. 2. Capitalization period 3. Amount to capitalize. 10 LO 4: Describe the accounting problems associated with interest capitalization. Acquisition of PP&E Acquisition Qualifying Assets Require a period of time to get them ready for their intended use. Two types of assets: • Assets under construction for a company’s own use. • Assets intended for sale or lease that are constructed or produced as discrete projects. 11 LO 4: Describe the accounting problems associated with interest capitalization. Acquisition of PP&E Acquisition Capitalization Period Begins when: 1. Expenditures for the asset have been made. 2. Activities for readying the asset are in progress. 3. Interest costs are being incurred Ends when: The asset is substantially complete and ready for use. 12 LO 4: Describe the accounting problems associated with interest capitalization. Acquisition of PP&E Acquisition Amount to Capitalize Capitalize the lesser of: 1. Actual interest costs 2. Avoidable interest – the amount of interest that could have been avoided if expenditures for the asset had not been made. 13 LO 4: Describe the accounting problems associated with interest capitalization. Acquisition of PP&E Acquisition Interest Capitalization Illustration: KC Corporation borrowed $200,000 Interest KC Corporation borrowed $200,000 at 12% interest from State Bank on Jan.1 2011, for specific purposes of constructing special­purpose equipment to be used in its operations. Construction on the equipment began on Jan. 1, 2011, and the following expenditures were made prior to the project’s completion on Dec. 31, 2011: Actual Expenditures: January 1, 2011 $100,000 April 30, 2011 150,000 2011 300,000 100,000 $650,000 14 Other general debt existing on Jan. 1, 2011: November 1, $500,000, 14%, 10­year bonds December 31, 2011 Totalpayable expenditures $300,000, 10%, 5­year note payable LO 4: Describe the accounting problems associated with interest capitalization. Acquisition of PP&E Acquisition Step 1 – Determine which assets qualify for capitalization of interest. Step Determine which assets qualify for capitalization of interest. Special purpose equipment qualifies because it requires a period of time to get ready and it will be used in the company’s operations. Step 2 – Determine the capitalization period. Step Determine the capitalization period. The capitalization period is from Jan. 1, 2011 through Dec. 31, 2011, because expenditures are being made and interest cost are being incurred during this period while construction is taking place. 15 LO 4: Describe the accounting problems associated with interest capitalization. Acquisition of PP&E Acquisition Step 3 – Compute weighted­average accumulated expenditures. Accumulated Expenditures Jan. 1 Actual Capitalization Date Expenditures Period Weighted Average $ 100,000 12/12 $ 100,000 Apr. 30 150,000 8/12 100,000 Nov. 1 300,000 2/12 50,000 Dec. 31 100,000 0/12 ­­ $ 650,000 $ 250,000 A company weights the construction expenditures by the amount of time (fraction of a year or accounting period) that it can incur interest cost on the expenditure. 16 LO 4: Describe theaccounting problems associated with interest capitalization. Acquisition of PP&E Acquisition Step 4 – Compute the Actual and Avoidable Interest. Compute the Actual and Avoidable Interest. Selecting Appropriate Interest Rate: 1. For the portion of weighted­average accumulated expenditures that is less than or equal to any amounts borrowed specifically to finance construction of the assets, use use the interest rate incurred on the specific borrowings. the 2. For the portion of weighted­average accumulated expenditures that is greater than any debt incurred specifically to finance construction of the assets, use a use weighted average of interest rates incurred on all other outstanding debt during the period. outstanding 17 LO 4: Describe the accounting problems associated with interest capitalization. Acquisition of PP&E Acquisition Step 4 – Compute the Actual and Avoidable Interest. Debt Specific Debt General Debt Rate $ 200,000 Interest Actual Interest Interest 12% $ 24,000 500,000 14% 300,000 300,000 $ 1,000,000 1,000,000 Avoidable Avoidable Interest Interest Accumulated Expenditures Expenditures 10% $ 1 0 0 ,0 0 0 = 1 2 .5 % $ 8 0 0 ,0 0 0 70,000 70,000 30,000 $ 124,000 124,000 Interest Avoidable Avoidable Rate Interest $ 200,000 200,000 12% $ 24,000 50,000 50,000 12.5% 6,250 $ 250,000 18 We ig h te d ­a ve ra g e inte re s t ra te o n g e ne ra l d e b t LO 4: Describe the accounting problems associated with interest capitalization. $ 30,250 30,250 Acquisition of PP&E Acquisition Step 5 – Capitalize the lesser of Avoidable interest or Actual Step Capitalize the lesser of Avoidable interest or Actual interest. Avoidable interest Actual interest $ 30,250 124,000 Journal entry to Capitalize Interest: Equipment Interest expense 19 30,250 30,250 LO 4: Describe the accounting problems associated with interest capitalization. Acquisition of PP&E Acquisition Special Issues Related to Interest Capitalization: Expenditures for Land Interest Revenue 20 LO 4: Describe the accounting problems associated with interest capitalization. Valuation of PP&E Valuation Companies should record property, plant, and equipment: at the fair value of what they give up or at the fair value of the asset received, whichever is more clearly evident. 21 LO 5: Understand accounting issues related to acquiring and valuing plant assets. Valuation of PP&E Valuation Cash Discount – whether taken or not – generally considered a reduction in the cost of the asset. Deferred-Payment Contracts – Assets, purchased through long term credit, are recorded at the present value of the consideration exchanged. Lump-Sum Purchases – Allocate the total cost among the various assets on the basis of their fair market values. Issuance of Stock – the market value of the stock issued is a fair indication of the cost of the property acquired. 22 LO 5: Understand accounting issues related to acquiring and valuing plant assets. Valuation of PP&E Valuation Exchanges of Nonmonetary Assets Ordinarily accounted for on the basis of: the fair value of the asset given up or the fair value of the asset received, whichever is more clearly evident. Companies should recognize immediately any gains or losses on the exchange when the transaction has commercial substance. See Illustration 10-10 23 LO 5: Understand accounting issues related to acquiring and valuing plant assets. Valuation of PP&E Valuation Exchanges – Loss Situation Companies recognize a loss immediately whether the exchange has commercial substance or not. Rationale: Companies should not value assets at more than their cash equivalent price; if the loss were deferred, assets would be overstated. See Illustrations 10-11 & 10-12 24 LO 5: Understand accounting issues related to acquiring and valuing plant assets. Valuation of PP&E Valuation Exchanges – Gain Situation Has Commercial Substance. Companies usually record the cost of a nonmonetary asset acquired in exchange for another nonmonetary asset at the fair value of the asset given up, and immediately recognizes a gain. See Illustrations 10-13 and 10-14 25 LO 5: Understand accounting issues related to acquiring and valuing plant assets. Valuation of PP&E Valuation Exchanges – Gain Situation Lacks Commercial Substance—No Cash Received If the transaction lacks commercial substance (that is, the economic position of the company does not change significantly as a result of the exchange) and NO cash is received, then recognition of the gain is deferred. See Illustrations 10-14 and 10-15 26 LO 5: Understand accounting issues related to acquiring and valuing plant assets. Valuation of PP&E Valuation Exchanges – Gain Situation Lacks Commercial Substance—Some Cash Received. When a company receives cash (sometimes referred to as “boot”) in an exchange that lacks commercial substance, it may immediately recognize a portion of the gain. See Illustration 10-16 for the formula for See partial gain recognition partial 27 LO 5: Understand accounting issues related to acquiring and valuing plant assets. Valuation of PP&E Valuation See Illustration 10-20 for a Summary of See Gain and Loss Recognition on Exchanges of Nonmonetary Assets of 28 LO 5: Understand accounting issues related to acquiring and valuing plant assets. Valuation of PP&E Valuation Accounting for Contributions Companies should use: • the fair value of the asset to establish its value on the books and • should recognize contributions received as revenues in the period received. 29 LO 5: Understand accounting issues related to acquiring and valuing plant assets. Costs Subsequent to Acquisition Costs In general, costs incurred to achieve greater future benefits should be capitalized, whereas expenditures that simply maintain a given level of services should be expensed. To capitalize costs, one of three conditions must be present: Useful life of the asset must be increased Quantity of units produced from asset must be increased Quality of units produced must be enhanced. Quality of units produced must be enhanced. 30 LO 6: Describe the accounting treatment for costs subsequent to acquisition. Costs Subsequent to Acquisition Costs Major Types of Expenditures • Additions • Improvements and Replacements • Rearrangement and Reinstallation • Repairs •See Illustration 10-21 31 LO 6: Describe the accounting treatment for costs subsequent to acquisition. Disposition of PP&E Disposition A company may retire plant assets voluntarily or dispose of them by sale, exchange, involuntary conversion, or abandonment Depreciation must be taken up to the date of disposition. 32 LO 7: Describe the accounting treatment for the disposal of property, plant, and equipment. Disposition of Plant Assets Disposition Involuntary Conversion Sometimes an asset’s service is terminated through some type of involuntary conversion such as fire, flood, theft, or condemnation. Companies report the difference between the amount recovered (e.g., from a condemnation award or insurance recovery), if any, and the asset’s book value as a gain or loss. They treat these gains or losses like any other type of disposition. 33 LO 7: Describe the accounting treatment for the disposal of property, plant, and equipment. Disposition of Plant Assets Disposition Miscellaneous Problems If a company scraps or abandons an asset without any cash recovery, it recognizes a loss equal to the asset’s book value. If scrap value exists, the gain or loss that occurs is the difference between the asset’s scrap value and its book value. If an asset still can be used even though it is fully depreciated, it may be kept on the books at historical cost less depreciation. 34 LO 7: Describe the accounting treatment for the disposal of property, plant, and equipment. ...
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This note was uploaded on 02/28/2012 for the course ACC 3313 taught by Professor Humphrey during the Spring '08 term at Texas State.

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