HIGHLIGHTS OF CHAPTER 10: Operational Assets Acquisition & Disposition April 2004 April 2004

SIGNIFICANT ISSUES  Types of OA  Costs included in OA  Allocation of lump-sum purchase  Cost under deferred payment contract  Exchange for stock & donations  Dispositions & exchanges  Self-constructed assets  Interest capitalization  Costs of purchased & internal intangibles

CHARACTERISTICS OF PPE  For use & not resale  Long-term  Subject to depreciation  Physical existence

CHARACTERISTICS OF INTANGIBLE ASSETS  Lack physical substance  Not financial instruments  Long-term  Subject to amortization... or not?

COSTS INLUDED  Historical cost  Desired location and condition for use

COSTS INLUDED  Equipment  Land  Buildings  Natural resources

NATURAL RESOURCES  Acquisition costs  Exploration costs  Development costs  Asset retirement obligation

IDENTIFIABLE INTANGIBLE ASSETS  Patents  Copyrights  Trademarks, tradenames  Franchises, license  Goodwill  Customer related (customer lists, backlogs)

CONCEPT OF GOODWILL  Value of existing business in excess of value of individual assets  Products  Brand names  Employees & management  Customer base  Structure

RECORDING GOODWILL  Can’t record internally generated goodwill  Capitalize only purchased goodwill

RECORDING GOODWILL  Revalue acquired assets & liabilities  Goodwill is “excess of cost over fair value of net assets acquired”

NEGATIVE GOODWILL  Unusual situation  “excess of fair value of net assets acquired over cost”  Record in income as an extraordinary gain

GOODWILL Amortize or record impairment in value...?

OTHER VALUATION ISSUES  Lump sum purchase  Issuance of stock  Donations of assets  Deferred payment contracts (Notes payable)  Net cash discounts  Exchanges of nonmonetary assets

FIXED-ASSET TURNOVER RATIO Net Sales Fixed-asset turnover ratio = Average fixed assets Average fixed assets

DISPOSING OF OA  Gain/loss on disposal  OA held for sale  Impairment loss  Not depreciated or amortized  Involuntary conversions (Extraordinary gain/loss?)

EXCHANGES OF NONMONETARY ASSETS  Dissimilar - Recognize gains/losses  Similar - Defer gains/Recognize losses  Similar assets with cash(“boot”) - Partial recognition of gains/Recognize losses

SELF-CONSTRUCTED ASSETS  Direct costs  Fixed overhead  How far should you go?

INTEREST CAPITALIZATION  Qualifying assets  Construction period  Amount to capitalize  Lower of actual or avoidable  Weighted average expenditures  Interest rate - specific or average?

INTEREST CAP EXAMPLE WEIGHTED-AVERAGE EXPENDITURES Weighted Weighted Amount Average Amount Average Date Paid Period Cost__ 1-1 $210,000 12/12 $210, $210,000 12/12 $210, ,000 10/12 250, ,000 10/12 250, ,000 8/12 360, ,000 8/12 360, , __ , __ $1,500, ,000 $1,500, ,000

INTEREST CAP EXAMPLE WEIGHTED-AVERAGE INTEREST RATE Principal Interest Principal Interest 15% construction loan$750,000 $112,500 15% construction loan$750,000 $112,500 10% 5-year note 550,000 55,000 10% 5-year note 550,000 55,000 12% 10-year bond 600,000 72,000 12% 10-year bond 600,000 72,000 $1,150,000 $127,000 $1,150,000 $127,000 Weighted-average rate = 127,000/1,150,000= 11.04%

INTEREST CAP EXAMPLE AVOIDABLE INTEREST COMPUTATION Weighted Average InterestAvoidable Average InterestAvoidable Cost Rate Interest Cost Rate Interest $750,000 15% $112,500 $750,000 15% $112,500 _70, % 7,728 _70, % 7,728 $820,000 $120,228 $820,000 $120,228

INTEREST CAP EXAMPLE MAXIMUM INTEREST CAP ALLOWED Principal Interest Principal Interest 15% construction loan$750,000 $112,500 15% construction loan$750,000 $112,500 10% 5-year note 550,000 55,000 10% 5-year note 550,000 55,000 12% 10-year bond 600,000 72,000 12% 10-year bond 600,000 72,000 $239,500 $239,500 Avoidable interest $120,228 < $239,500

OTHER INTEREST CAPITALIZATION POINTS  Disclosure of interest capitalized  Net interest income

RESEARCH & DEVELOPMENT COSTS  Generally expense as incurred  Alternative future use, then capitalize (amortize or depreciate)  R&D performed for others  Purchased R & D

COSTS SIMILAR TO R&D  Start-up costs  Initial operating losses  Computer software costs

COMPUTER SOFTWARE COSTS  External use Expense until technologically feasible Expense until technologically feasible Alternative use - capitalize Alternative use - capitalize Amortize based on greater of % of revenue or straight-line Amortize based on greater of % of revenue or straight-line Value at lower of amortized cost or net realizable value Value at lower of amortized cost or net realizable value

COMPUTER SOFTWARE COSTS  Internal use SOP 98-1 SOP 98-1 Expense preliminary project costs Expense preliminary project costs Capitalize application development costs Capitalize application development costs Expense training & application maintenance costs Expense training & application maintenance costs

OIL & GAS ACCOUNTING  Successful efforts  Full-cost