Prepared by: Gabriela H. Schneider, CMA; Grant MacEwan College INTERMEDIATE ACCOUNTING INTERMEDIATE ACCOUNTING Sixth Canadian Edition KIESO, WEYGANDT, WARFIELD, IRVINE, SILVESTER, YOUNG, WIECEK

C H A P T E R 11 Acquisition and Disposition of Tangible Capital Assets

Learning Objectives 1.Describe the major characteristics of tangible capital assets. 2.Identify the costs included in the initial valuation of land, buildings, and equipment. 3.Describe the accounting problems associated with self-constructed assets. 4.Describe the accounting problems associated with interest capitalization.

Learning Objectives 5.Understand accounting issues related to acquiring and valuing plant assets. 6.Describe the accounting treatment for costs subsequent to acquisition. 7.Describe the accounting treatment for the disposal of property, plant, and equipment.

Acquisition and Disposition of Tangible Capital Assets Costs Subsequent to Acquisition Additions Improvements and replacements Rearrangement and reinstallation Repairs Other “Cost” Issues Cash discounts Deferred contracts Lump sum Share issuance Nonmonetary exchanges Contributions Investment tax credit Other valuation methods Acquisition Acquisition costs: land buildings, equipment Self-constructed assets Interest during construction Disposition Sale Involuntary conversion Donations Miscellaneous problems

Examples: property, plant, and equipment plant assets fixed assets Major characteristics are: 1.acquired for use in operations and not for resale 2.long-term in nature and usually subject to amortization 3.possess physical substance Tangible Capital Assets

Acquisition Cost Historical cost is the basis for determining cost Historical cost includes: the asset’s cash or cash equivalent price the cost of readying the asset for it’s intended use Costs incurred after acquisition are: added to asset’s cost, if they provide future service potential expensed, if they do not add to service potential

Cost of Land Land costs include: purchase price closing costs, land title fees, legal fees, and recording fees costs of getting land ready for use (removing of old buildings, clearing, grading, etc.) special assessments for local improvements assumption of liens or encumbrances additional improvements with an indefinite life Sale of salvaged materials reduce cost of land

Land Improvements, Building, and Plant Improvements with limited lives are recorded as Land Improvements (and not as Land) Building cost includes: costs of materials and labour and overhead professional fees and building permits Cost of equipment includes: purchase price freight and handling charges insurance while in transit costs of special foundation, assembly and installation trial runs

Self-Constructed Assets These are assets constructed by the business for use in operations The cost of self-constructed assets includes: cost of direct materials cost of direct labour variable manufacturing overhead a pro rata portion of the fixed overhead actual interest costs incurred during construction (with modification)

Interest Capitalization Interest costs incurred during construction of capital assets Accepted approach to interest capitalization: Capitalize only the actual interest costs incurred during construction - follows historical cost concept, with only actual costs recorded - disclosure of capitalized interest must be disclosed

Interest Capitalization CICA Handbook, par (b) professional judgement is appropriate in determining interest to be capitalized. Following FASB Statement 34, three questions must be answered: What are the qualifying assets? What is the capitalization period? What is the amount of interest to be capitalized?

Qualifying Assets List includes: –assets under construction for company’s own use –assets intended for sale or lease produced as discrete projects Non-qualifying assets include: –assets in use or ready for intended use –assets not be used in company’s earnings activities

Capitalization Period Capitalization period begins when three conditions are present: 1.Expenditures for the asset have been made 2.Activities for readying the asset are in progress 3.Interest cost is being incurred Capitalization continues for as long as these three conditions exist Capitalization ends when asset is substantially complete and ready for use

Amount to Capitalize Amount of interest to be capitalized is the lesser of: the actual interest cost incurred on debt the avoidable interest for construction of asset Avoidable interest is the amount that could have been avoided, if expenditures for the asset had not been made Weighted-average accumulated expenditures calculation required

Computing Avoidable Interest: Steps Determine weighted-average accumulated expenditures 1 Avoidable interest Appropriate interest rate (see page 501) 2 Capitalize, if less than actual interest Multiply by

Interest Capitalization: Example Given: Bridge construction project – time line 17 months Payments made to Contractor: March 1$ 240,000 July 1$ 480,000 November 1$ 360,000 Total$1,080,000 Year-end: December 31 st Compute the Weighted-Average Accumulated Expenditure at December 31 st.

Weighted-Average Accumulated Expenditure (WAAE) DateAmountCapitalization WAAE Period Capitalization period: time between the expenditure date and the date interest capitalization stops or year-end (whichever comes first) March 1$240,00010/12 months$200,000 July 1$480,0006/12 months$240,000 Nov. 1$360,0002/12 months$ 60,000 December 31 st – WAAE =$500,000

Interest Capitalization – Special Issues: Land Expenditures Amount of Capitalized Interest based on the intent of the land purchased Intent Capitalized Interest Cost Attached to: Lot Sales Developed land Specific Purpose Land Structure Site Structure Investment Interest costs should not be capitalized

Interest Capitalization – Special Issues: Interest Revenue When funds borrowed for asset acquisition are not immediately used May be temporarily invested Should the interest earned be netted out against the capitalized interest cost? Current treatment is to treat the interest earned as a revenue item

Interest Capitalization – Special Issues: Interest Capitalization Significance Capitalized interest increases net income for the period Impact on EPS can be significant Two main arguments on the treatment of interest and capitalization 1.Interest should be capitalized on all “pre- earning” assets 2.No interest should be capitalized; interest is an expense of the period

Other Cost Issues Cash Discounts –The Net-of-Discount Method is the preferred method Deferred Payment Contracts –Assets, purchased through long-term credit, are recorded at the present value of the consideration exchanged Lump Sum Purchase –Cost of assets, acquired at a single lump sum price, is allocated to assets on the basis of their relative fair market values

Other Cost Issues Issuance of Shares –Market value of publicly-traded shares serve as the cost of the acquired asset –When shares have no determinable market value, use the market value of the acquired asset Nonmonetary Exchange of Assets –Transaction is nonmonetary where cash is 10% or less of the total fair value given up or received Dissimilar Assets Similar Assets

Exchange of Nonmonetary Assets The basic rule is that the exchange must be based on: –the fair value of the asset given up, or –the fair value of the asset received whichever is clearly more evident. The rules for gain / loss recognition depend upon whether the assets exchanged are: –dissimilar assets or –similar assets

Accounting for Exchanges Types of AccountingRationale Exchange Guidance Dissimilar Recognize gainEarnings process Assets and losses is complete Similar Assets Recognize loss;Earnings process (Cash Gain up to bootis partially Received ) (partial gain)complete Similar Assets Recognize loss;Earnings process (No Cash Defer gainis not complete received) Non- Recognize gainEarnings process Monetary and lossesis complete (Similar or Dissimilar Assets exchanged)

Dissimilar Assets Amber Company exchanges a number of trucks for land from Becktel company. Fair value of trucks:$ 49,000 Book value of trucks:$ 42,000 (Cost, $64,000; Accum. Amor., $ 22,000) Cash paid to Becktel (boot):$ 17,000 Record the purchase in Amber’s books. Land 66,000 Accumulated Amortization 22,000 Trucks 64,000 Cash 17,000 Gain on disposal 7,000

Similar Assets (Loss) Amber Company exchanges a used machine for a similar machine from Becktel company. Fair value of used machine:$ 6,000 Book value of used machine:$ 8,000 (Cost, $12,000; Accu. Amor., $ 4,000) Cash paid to Becktel:$ 7,000 Record the purchase in Amber’s books. New Machine 13,000 Accumulated Amortization 4,000 Loss on disposal 2,000 Machine (old) 12,000 Cash 7,000

Other Cost Issues Contribution of Assets –Nonreciprocal transfers: transfer of assets where nothing is given up in exchange (e.g. donations, gift, grants) –Asset’s fair market value used as cost of the asset –Two approaches to valuing and recording such transfer: 1.Capital Approach: credit contributed surplus account (donated capital) 2.Income Approach: credit represents income and the gain is deferred over the life of the asset (exception being land) a)Cost Reduction Method: credit the respective asset account b)Deferral Method: credit Deferred Revenue

Other Cost Issues Investment Tax Credit (ITC) –Governed by tax legislation –Income is reduced in the year of acquisition by a prescribed percentage of the cost of eligible capital assets –ITCs are accounted for following Accounting Standards Board policy: taken into income using either: Cost Reduction Method, or Deferral Method

Costs Subsequent to Acquisition If costs incurred increase future benefits, capitalize costs (Capital Expenditure) If costs maintain a given level of services, expense costs (Revenue Expenditure) Costs incurred after acquisition can be: Additions: increase or extension of existing assets Improvements and replacements: substitution of an existing asset for an improved one Rearrangement and reinstallation: moving asset from one location to another Repairs: costs that maintain assets in operating condition

Improvements and Replacements Capitalize costs, if They increase future service potential ImprovementsReplacements or Substitution of a better asset for present asset Substitution of a similar asset for present asset

Capitalization Approaches Carrying value of asset is known Carrying value of the asset is unknown Substitution approach Capitalize the new asset (without removing the old asset from the pool), or Debit accumulated amortization (when expenditures extend useful life of asset)

Dispositions of PP&E Plant assets may be: –retired voluntarily, or –disposed of by sale, exchange, involuntary conversion Amortization is recorded up to the date of disposal before determining gain or loss Gains or losses from involuntary conversion are often reported as extraordinary items

COPYRIGHT Copyright © 2002 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by CANCOPY (Canadian Reprography Collective) is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his / her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.