COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Investments in Noncurrent Operating Assets - Acquisition Chapter 10 S t I c e | S t I c e | S k o u s e n Intermediate Accounting 16E Prepared by: Sarita Sheth | Santa Monica College

Learning Objectives 1.Identify those costs to be included in the acquisition cost of different types of noncurrent operating assets. 2.Properly account for noncurrent operating asset acquisitions using various special arrangements, including deferred payment, self- construction, and acquisition of an entire company.

Learning Objectives 3.Separate costs into those that should be expensed immediately and those that should be capitalized, and understand the accounting standards for research and development and oil and gas exploration costs. 4.Recognize intangible assets acquired separately, as part of a basket purchase, and as part of a business acquisition.

Learning Objectives 5.Discuss the pros and cons of recording noncurrent operating assets at their current values. 6.Use the fixed asset turnover ratio as a general measure of how efficiently a company is using its property, plant, and equipment.

What Costs are Included in Acquisition Cost? Initially record asset at cost. Cost includes all expenditures required to obtain asset and place it in use. Most costs associated with internally- generated intangible assets are expensed. The cost of externally purchased intangibles is generally recorded as an asset.

Tangible Assets- Land Purchase price, commissions, legal fees escrow fees, surveying fees Clearing and grading costs Cost of removing unwanted structures Assessments for water lines, sewers, roads

Tangible Assets- Land Improvements Landscaping Paving parking lots On-property sidewalks Light structures (for parking and sidewalks) Fencing

Tangible Assets- Building If ready for use: –Purchase price –Commissions, legal fees, escrow fees, reconditioning costs If newly constructed by an outsider: –Contract Price –Legal Fees If self constructed: –Cost of materials, –Labor –Overhead

Tangible Assets- Equipment Purchase price Taxes, freight, insurance during shipping and installation Special foundations or reinforcing of floors Reconditioning and testing costs Note: Any expenditure incurred in preparing the asset for its intended use is charged to Equipment.

Intangible Assets Patent : Purchase price, filing and registry fees, cost of subsequent litigation to protect right. Does not include internal research and development costs. Copyright : Same as Patent. Trademark : Same as Patent. Franchise agreement : Expenditures made to purchase the franchise. Legal fees and other costs incurred in obtaining the franchise. Acquired customer list : Purchase price when acquired from another company. Goodwill : Portion of purchase price that exceeds the sum of the current market value for all identifiable net assets. ™

Acquisitions Other than Simple Cash Transactions Basket purchase Deferred payment Leasing Exchange of nonmonetary assets Acquisition by issuance of securities Self-construction Acquisition by donation or discovery Acquisition of an asset with significant restoration costs at retirement Acquisition of an entire company

Methods of Acquisition Leasing: A capital lease is economically the same as a purchase. The acquiring company records the asset and liability at the present value of future lease payments. Exchange of nonmonetary assets: The new asset is valued at its fair market value or at the fair market value of the asset given up, whichever is more clearly determinable.

Methods of Acquisition Issuance of securities: Record the asset at the fair market value of the securities issued. Self-construction: Recorded at cost, including all expenditures incurred to build the asset and make it ready for its intended use.

Interest Capitalization Capitalization of interest is required for assets that are being self-constructed for an enterprise’s own use and assets that are intended to be leased or sold to others that can be identified as discrete projects. Interest should not be capitalized for inventories manufactured or produced on a repetitive basis.

Interest Capitalization When assets are acquired by self- construction, interest incurred on funds borrowed to finance construction can be capitalized if the following conditions are met: –Projects are discrete. –Costs are separately accumulated –Construction covers an extended period of time. –Construction costs are substantial.

Interest Capitalization Interest charges begin when the first expenditures are made on the project and continue until the asset is completed. Interest capitalization is calculated on average amount of accumulated expenditures. Interest rate used is: (1) actual rate on debt incurred specifically for the project (2) weighted average interest rate on all borrowings not specifically for the project. If the construction period covers more than one fiscal period, accumulated expenditures include prior years’ capitalized interest.

Acquisition by Donation or Discovery Property acquired through donation should be appraised and recorded at its fair market value. Land400,000 Buildings1,500,000 Revenue or Gain1,900,000

Asset with Significant Restoration Costs at Retirement Bryan Beach Company purchases and erects an oil platform at a total cost of $750,000. Oil Platform 750,000 Cash 750,000

Asset with Significant Restoration Costs at Retirement The oil platform will be in use for 10 years, at which time Bryan Beach is legally obligated to ensure that the platform is dismantled (at a cost of $100,000).

Asset with Significant Restoration Costs at Retirement The oil platform will be in use for 10 years, at which time Bryan Beach is legally obligated to ensure that the platform is dismantled (at a cost of $100,000). Oil Platform46,319 Asset Retirement Obligation46,319 FV = $100,000 i = 8% N = 10 years

Postacquisition Expenditures Expenditures to keep plant and equipment in good operating condition are referred to as maintenance… Expenditures that do not extend the useful life or increase future cash flows… Expense as incurred

Postacquisition Expenditures If the cost of the old component is known, remove its cost and accumulated depreciation. Next, record cost of the new component and recognize a gain or loss. If the cost of the old component is not known, then the cost of the new component is deducted from accumulated depreciation.

Research and Development Research and development costs include: –Costs of materials –Equipment –Facilities –Personnel –Purchased intangibles –Contract services –A reasonable allocation of indirect costs that are specifically related to R & D activities and that have no alternative future use.

Oil and Gas Exploration Costs Full cost method- all exploratory costs are capitalized. –Reasoning: The cost of drilling dry wells is part of the cost of locating productive wells. Successful efforts method- exploratory costs for dry wells are expensed, and only exploratory costs for successful wells are capitalized. wells.

Accounting for the Acquisition of Intangibles Five General Categories of Intangible Assets: 1. Marketing-related - trademarks, brand names, and internet domain names. 2.Customer-related - customer lists, order backlogs, and customer relationships. 3.Artistic-related - items protected by copyright. 4.Contract-based - licenses, franchises, and broadcast rights. 5.Technology-based -patented and unpatented technologies as well as trade secrets.

Valuation of Assets at Current Values In IFRS 16, concerns about permitting upward revaluations of noncurrent operating assets is reflected in the rules laid out: –If a company revalues its noncurrent operating assets to fair value, it must do so on a regular basis and must revalue entire classes of assets rather than just picking and choosing certain assets. –Downward revaluations are recorded as a loss. –Upward revaluations are recorded as a debit to the asset and a credit to a special “revaluation” equity account.