10-1 Prepared by Coby Harmon University of California, Santa Barbara Intermediat e Accounting Prepared by Coby Harmon University of California, Santa Barbara Westmont College INTERMEDIATE ACCOUNTING F I F T E E N T H E D I T I O N Prepared by Coby Harmon University of California, Santa Barbara Westmont College kieso weygandt warfield team for success

10-2 ► “Used in operations” and not for resale. ► Long-term in nature and usually depreciated. ► Possess physical substance. Property, plant, and equipment are assets of a durable nature. Other terms commonly used are plant assets and fixed assets. Property, Plant, and Equipment LO 1 Describe property, plant, and equipment. Includes:  Land,  Building structures (offices, factories, warehouses), and  Equipment (machinery, furniture, tools).

10-3 Historical cost measures the cash or cash equivalent price of obtaining the asset and bringing it to the location and condition necessary for its intended use. LO 2 Identify the costs to include in initial valuation of property, plant, and equipment. Property, Plant, and Equipment Acquisition of Property, Plant, and Equipment Main reasons for historical cost valuation:  Historical cost is reliable.  Companies should not anticipate gains and losses but should recognize gains and losses only when the asset is sold.

10-4 Includes all expenditures to acquire land and ready it for use. Costs typically include: Cost of Land LO 2 (1)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. Acquisition of PP&E

10-5 Improvements with limited lives, such as private driveways, walks, fences, and parking lots, are recorded as Land Improvements and depreciated.  Land acquired and held for speculation is classified as an investment.  Land held by a real estate concern for resale should be classified as inventory. Acquisition of PP&E LO 2 Identify the costs to include in initial valuation of property, plant, and equipment. Cost of Land

10-6 Includes all expenditures related directly to acquisition or construction. Costs include:  materials, labor, and overhead costs incurred during construction and  professional fees and building permits. Cost of Buildings LO 2 Identify the costs to include in initial valuation of property, plant, and equipment. Acquisition of PP&E

10-7 Acquisition of PP&E Cost of Equipment Include all expenditures incurred in acquiring the equipment and preparing it for use. Costs include:  purchase price,  freight and handling charges,  insurance on the equipment while in transit,  cost of special foundations if required,  assembling and installation costs, and  costs of conducting trial runs. LO 2 Identify the costs to include in initial valuation of property, plant, and equipment.

10-8 Exercise 10-1 A. A. Other accounts, accounts pay B. B. Building C. C. Land D. D. Land E. E. Buildings F. F. Buildings G. G. Buildings H. H. Land I. I. Land

10-9 J. Land Improvements K. Land L. Land M. Building N. Land Improvements O. Land P. Building

10-10 Self-Constructed Assets Costs 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. LO 3 Describe the accounting problems associated with self-constructed assets. Acquisition of PP&E

10-11 Three approaches have been suggested to account for the interest incurred in financing the construction. Interest Costs During Construction LO 4 Describe the accounting problems associated with interest capitalization. Capitalize no interest during construction Capitalize all costs of funds GAAP $ 0$ ? Increase to Cost of Asset Illustration 10-1 Acquisition of PP&E Capitalize actual costs incurred during construction

10-12  GAAP requires — capitalizing actual interest (with modification).  Consistent with historical cost.  Capitalization considers three items: 1.Qualifying assets. 2.Capitalization period. 3.Amount to capitalize. Interest Costs During Construction Acquisition of PP&E LO 4 Describe the accounting problems associated with interest capitalization.

10-13 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. (Ships or real estate) Qualifying Assets LO 4 Describe the accounting problems associated with interest capitalization. Interest Capitalization

10-14 Capitalization Period LO 4 Describe the accounting problems associated with interest capitalization. Begins when: 1. 1.Expenditures for the asset have been made Activities for readying the asset are in progress Interest costs are being incurred. Ends when: The asset is substantially complete and ready for use. Interest Capitalization

10-15 Amount to Capitalize LO 4 Describe the accounting problems associated with interest capitalization. Capitalize the lesser of: 1. 1.Actual interest costs. 2.Avoidable interest - the amount of interest cost during the period that a company could theoretically avoid if it had not made expenditures for the asset. Interest Capitalization

10-16 LO 4 Describe the accounting problems associated with interest capitalization. Special Issues Related to Interest Capitalization 1.Expenditures for Land  Interest costs capitalized are part of the cost of the plant, not the land. 2.Interest Revenue  In general, companies should not net or offset interest revenue against interest cost. Interest Capitalization

10-17 WORK EXAMPLES

10-18 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. Valuation of PP&E LO 5 Understand accounting issues related to acquiring and valuing plant assets.

10-19 Cash Discounts — Discount for prompt payment. Deferred-Payment Contracts — Assets purchased on long-term credit contracts at the present value of the consideration exchanged. Lump-Sum Purchases — Allocate the total cost among the various assets on the basis of their relative fair market values. Issuance of Stock — The market price of the stock issued is a fair indication of the cost of the property acquired. Valuation of PP&E LO 5 Understand accounting issues related to acquiring and valuing plant assets.

10-20 Valuation of PP&E LO 5 Understand accounting issues related to acquiring and valuing plant 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 clearly more evident. Exchanges of Nonmonetary Assets Companies should recognize immediately any gains or losses on the exchange when the transaction has commercial substance.

10-21 Exercise 10-3 Trucks13, Cash13,900 Trucks14,727.26* Discount on Notes Payable1, Cash2,000 Notes Payable14,000 *PV of 10% for 1 year = $14,000 X = $12, $12, $2, = $14,727.26

10-22 Trucks15,200 Sales Revenue 15,2000 Cost of Goods Sold12,000 Inventory12,000 Trucks13, Common Stock10, Paid-in Capital in Excess of Par – Common Stock3, (1,000 shares X $13 = $13,000)

10-23 Valuation of PP&E LO 5 Understand accounting issues related to acquiring and valuing plant assets. Meaning of Commercial Substance Exchange has commercial substance if the future cash flows change as a result of the transaction. That is, if the two parties’ economic positions change, the transaction has commercial substance. Illustration * If cash is 25% or more of the fair value of the exchange, recognize entire gain because earnings process is complete.

10-24 Valuation of PP&E LO 5 Understand accounting issues related to acquiring and valuing plant assets. 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. Exchanges—Loss Situation

10-25 Valuation of PP&E LO 5 Understand accounting issues related to acquiring and valuing plant assets. Exchanges—Gain Situation Has Commercial Substance. Company usually records 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.

10-26 Valuation of PP&E LO 5 Understand accounting issues related to acquiring and valuing plant assets. Exchanges—Gain Situation Lacks Commercial Substance—No Cash Received. Now assume that Interstate Transportation Company exchange lacks commercial substance. Interstate defers the gain of $7,000 and reduces the basis of the semi-truck.

10-27 Costs Subsequent to Acquisition LO 6 Describe the accounting treatment for costs subsequent to acquisition. 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. In order to capitalize costs, one of three conditions must be present: 1.useful life must be increased, 2.quantity of units produced must be increased, and 3.quality of units produced must be enhanced.

10-28 BRIEF EXERCISE 10-8 Equipment3,300 Accum Depr—Trucks18,000 Trucks20,000 Cash500 Gain on Disposal 800

10-29 BRIEF EXERCISE 10-9 Equipment ($3,300 – $800)2,500 Accum Depr—Trucks18,000 Trucks20,000 Cash500

10-30 BRIEF EXERCISE Equipment5,000 Accum Depre—Machine3,000 Loss on Disposal of Mach4,000 Machinery9,000 Cash3,000

10-31 Costs Subsequent to Acquisition LO 6 Describe the accounting treatment for costs subsequent to acquisition.

10-32 Brief exercise a) Capitalize b) Capitalize c) Expense d) Capitalize e) Capitalize

10-33 Brief Exercise Depreciation Expense ($2,400 X 8/12)1,600 Accumulated Depreciation1,600 Cash10,500 Accumulated Depr ($8,400 + $1,600)10,000 Machinery 20,000 Gain on Disposal of Machinery500

10-34 Brief exercise Depr Exp ($2,400 X 8/12)1,600 Accum Depreciation1,600 Cash5,200 Loss on Disposal of Machinery4,800 Accum Depr—Machinery 10,000 ($8,400 + $1,600) Machinery20,000

10-35 Costs Subsequent to Acquisition Summary Illustration 10-21

10-36 Disposition of PP&E LO 7 Describe the accounting treatment for the disposal of property, plant, and equipment. 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.

10-37 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. Involuntary Conversion LO 7 Describe the accounting treatment for the disposal of property, plant, and equipment. Disposition of PP&E

10-38 Exercise Depreciation Expense (8/12 X $60,000)40,000 Accum Depreciation—Machinery40,000 Loss on Disposal of Machinery470,000 ($1,300,000 – $400,000) – $430,000 Cash430,000 Accum Depreciation—Machinery400,000 ($360,000 + $40,000) Machine1,300,000

10-39 Depreciation Expense (3/12 X $60,000)15,000 Accumu Depreciation—Machinery15,000 Cash1,040,000 Accum Depreciation—Machinery375,000 ($360,000 + $15,000) Machine1,300,000 Gain on Disposal of Machinery115,000* *$1,040,000 – ($1,300,000 – $375,000)