Property, Plant, and Equipment: Acquisition and Disposal C hapter 10 COPYRIGHT © 2010 South-Western/Cengage Learning Intermediate Accounting 11th edition Nikolai Bazley Jones An electronic presentation By Norman Sunderman and Kenneth Buchanan Angelo State University

2 Characteristics of Property, Plant, and Equipment 1.The asset must be held for use and not for investment. 2.The asset must have an expected life of more than one year. 3.The asset must be tangible in nature. To be included in the property, plant, and equipment category, an asset must have three characteristics:

3 Acquisition of Property, Plant, and Equipment Determination of Cost Devon Company purchases a machine with a contract price of $100,000 on terms of 2/10, n/30. The company does not take the cash discount and incurs transportation costs of $2,500, as well as installation and testing costs of $3,000. Sales tax is $7,000 on the purchase. During installation, uninsured damages of $500 are incurred. What is the cost of the machine?

4 Determination of Cost Contract price$100,000 Discount not taken(2,000) Transportation cost2,500 Installation and testing3,000 Sales tax 7,000 Cost of machine$110,500 Contract price$100,000 Discount not taken(2,000) Transportation cost2,500 Installation and testing3,000 Sales tax 7,000 Cost of machine$110,500 Acquisition of Property, Plant, and Equipment

5 Machine110,500 Repair Expense500 Discounts Lost2,000 Cash113,000 The company does not include the $500 of damages because it was not a necessary cost. Acquisition of Property, Plant, and Equipment

6  Contract price  Costs of closing the transaction, obtaining title, including commissions options, legal fees, title search, insurance, and past due taxes  Contract price  Costs of closing the transaction, obtaining title, including commissions options, legal fees, title search, insurance, and past due taxes Acquisition of Property, Plant, and Equipment Cost of Land  Costs of surveys  Cost of preparing the land for its particular use, such as clearing, grading, and razing old buildings when such improvements have an indefinite life  Costs of surveys  Cost of preparing the land for its particular use, such as clearing, grading, and razing old buildings when such improvements have an indefinite life

7  Landscaping  Streets  Sidewalks  Sewers Cost of Land Improvements Acquisition of Property, Plant, and Equipment

8  The contract price  The costs of remodeling and reconditioning  The costs of excavation for the specific building  Architectural costs and the costs of building permits  Capitalized interest costs  Unanticipated costs resulting from the condition of the land  The contract price  The costs of remodeling and reconditioning  The costs of excavation for the specific building  Architectural costs and the costs of building permits  Capitalized interest costs  Unanticipated costs resulting from the condition of the land Cost of Buildings Acquisition of Property, Plant, and Equipment

9 Leasehold Improvements  Revert to the lessor unless exempted in lease agreement  A lessee capitalizes the cost of a leasehold improvement, such as the interior design of a retail store  Amortizes the cost over its economic life or the life of the lease, whichever is shorter Acquisition of Property, Plant, and Equipment

10 Lump-Sum Purchase Under the lump-sum purchase method, the value of each asset is based on the proportion of its market value to the total market value of the group of assets being purchased. Acquisition of Property, Plant, and Equipment

11 A company pays $120,000 for land and a building. The land and building are appraised at $50,000 and $75,000, respectively. Appraisal Relative Fair Total Allocated Value Value × Cost = Cost Land$ 50,000 $50,000/$125,000 × $120,000 = $ 48,000 Building 75,000 $75,000/$125,000 × $120,000 = 72,000 Total$125,000$120,000 Acquisition of Property, Plant, and Equipment

12 A company pays $120,000 for land and a building. The land and building are appraised at $50,000 and $75,000, respectively. Acquisition of Property, Plant, and Equipment Land48,000 Building72,000 Cash 120,000

13 Deferred Payments Antush Company purchases equipment by issuing a $10,000 non-interest-bearing five-year note. A $2,000 payment will be made at the end of each year. The market rate for obligations of this type is 12%. Equipment7,210 Discount on Notes Payable2,790 Notes Payable10,000 ($2,000 × ) Acquisition of Property, Plant, and Equipment

14 Assets Acquired by Donation The city of Julesberg (a governmental unit) donates land worth $20,000 to the Klemme Company. Land20,000 Donated Capital20,000 Acquisition of Property, Plant, and Equipment

15 The CEO of Hrouda Company donates a building worth $50,000 to the company. Building50,000 Gain from Receipt of Donated Building50,000 Acquisition of Property, Plant, and Equipment The gain is reported in the other items section of the income statement. Assets Acquired by Donation

16 Start-up Costs GAAP requires that a company expense the costs of start-up activities as incurred. Start-up costs are costs related to one-time activities for opening a new facility, introducing a new product, etc.

17 The general principle is that the cost of a nonmonetary asset acquired in exchange for another nonmonetary asset is the fair value of the asset surrendered. Nonmonetary Asset Exchanges

No Cash Included in Exchange Arnold CompanyCarbon Company Cost $100,000 Accum. depr.54,000 Fair value40,000 Cost $60,000 Accum. depr.32,000 Fair value40,000 Assets Acquired by Exchange of Other Assets 18

Arnold Company Cost $100,000 Accum. depr.54,000 Fair value40,000 Equipment40,000 Accum. depr.54,000 Loss6,000 Building100,000 Book value$46,000 Fair value 40,000 Loss$ 6,000 Assets Acquired by Exchange of Other Assets No Cash Included in Exchange 19

Arnold Company Equipment40,000 Accum. depr.54,000 Loss6,000 Building100,000 Cost $40,000 Book value$46,000 Fair value 40,000 Loss$ 6,000 Assets Acquired by Exchange of Other Assets 20 No Cash Included in Exchange

Cost $60,000 Accum. Depr.32,000 Fair value40,000 Building40,000 Accum. Depr.32,000 Equipment60,000 Gain12,000 Book value$28,000 Fair value 40,000 Gain$12,000 Carbon Company Assets Acquired by Exchange of Other Assets 21 No Cash Included in Exchange

Cost $40,000 Book value$28,000 Fair value 40,000 Gain$12,000 Building40,000 Accum. Depr.32,000 Equipment60,000 Gain12,000 Carbon Company Assets Acquired by Exchange of Other Assets No Cash Included in Exchange 22

Cash Included in Exchange Arnold Company Cost $100,000 Accum. depr.54,000 Fair value40,000 Cash received5,000 Cost $60,000 Accum. depr.32,000 Fair value35,000 Cash paid(5,000) Assets Acquired by Exchange of Other Assets Carbon Company 23

Arnold Company Cost $100,000 Accum. depr.54,000 Fair value40,000 Cash received5,000 Equipment35,000 Accum. depr.54,000 Cash5,000 Loss6,000 Building100,000 Assets Acquired by Exchange of Other Assets Book value$46,000 Fair value 40,000 Loss$ 6, Cash Included in Exchange

Arnold Company Equipment35,000 Accum. depr.54,000 Cash5,000 Loss6,000 Building100,000 Cost $35,000 Assets Acquired by Exchange of Other Assets Cash Included in Exchange 25

Cost $60,000 Accum. Depr.32,000 Fair value35,000 Cash paid5,000 Building40,000 Accum. Depr.32,000 Equipment60,000 Cash5,000 Gain7,000 Assets Acquired by Exchange of Other Assets Book value$28,000 Fair value 35,000 Gain$ 7,000 Carbon Company Cash Included in Exchange 26

27 Exceptions to the General Rule 1.Neither the fair value of the asset received or given up is reasonably determinable. 2.The transaction is an exchange of inventory to facilitate sales to a third party; for example, when a company exchanges its inventory with another company in order to sell the newly acquired inventory to a third company. A company would not recognize a gain or loss when: ContinuedContinued

28 Exceptions to the General Rule 3.The transaction lacks “commercial substance.” A nonmonetary exchange does not have commercial substance if the company’s future cash flows are not expected to change significantly. Messenger Company exchanged a used truck and $2,000 cash for another used truck. Truck32,000 Accumulated Depreciation20,000 Truck50,000 Cash 2,000

29 The cost of materials, labor, and overhead used in the self-construction of property, plant, and equipment intended for a firm’s production process are added to the cost of the asset. Self-Construction

30 Capitalization of Interest A company is required to capitalize interest on assets that are either constructed for its own use or constructed as discrete products for sale or lease to others.

31 Capitalization of Interest—Qualifying Assets  Must be built for the company’s own use, or be constructed as discrete projects for sale or lease to others.  Qualifying expenditures were made.  The amount to be capitalized is the actual interest incurred, not imputed.  Activities that are necessary to get the asset ready for its intended use are in progress.

32 Interest cannot be capitalized for the following types of assets: 1.Inventories that are routinely manufactured. 2.Assets that are in use or ready for their intended use. 3.Assets that are not being used in the earning activities of the company and are not undergoing the activities necessary to get them ready for use. Capitalization of Interest

33 There are three alternatives for a company to include fixed overhead costs in the cost of a self- constructed asset. 1.Allocate a portion of total fixed overhead to the self-constructed asset. 2.Include only incremental fixed overhead in the cost of the self-constructed asset. 3.Include no fixed overhead in the cost of the self-constructed asset. Fixed Overhead Costs

34 Costs Subsequent to Acquisition  Extending the life of the asset  Improving productivity  Producing the same product at lower cost  Increasing the quality of the product  Extending the life of the asset  Improving productivity  Producing the same product at lower cost  Increasing the quality of the product The future economic benefits of a productive asset or product can be increased by:

35 The cost of an addition represents a new asset and therefore is capitalized. Additions

36 Rearrangement and Moving  The costs of rearranging the facilities within a building or moving them to a new location are capitalized and expensed over the period expected to benefit.  Many companies expense such costs immediately, which is an acceptable procedure if the difference is immaterial.

37 Repairs and Maintenance  Routine repair and maintenance costs should be expensed in the period incurred.  If incurred unevenly during the year, the amount of repair costs in each interim period may be averaged by using an allowance account.

38 Asset Retirement Obligations  The acquisition of some assets automatically creates a legal obligation related to the retirement of the asset. –Power plants –Mines –Industrial manufacturing sites  The usual method of measuring the fair value is the present value of the future cash flows that will be paid by the company.

39 IFRS vs. U.S. GAAP  IFRS allow a company to write the value of its property, plant, and equipment up to fair value if fair value can reliably be measured. Increases are credited to stockholders’ equity as a revaluation surplus.  IFRS require that the cost of relocating or reorganizing property, plant, and equipment be expensed.  Under U.S. GAAP, companies can elect to either capitalize or expense these expenditures.

40 Disclosure of Property, Plant, and Equipment GAAP requires a company to disclose the balances of its major classes of depreciable assets by nature or function.  Land  Building and leasehold improvements  Machinery and equipment

41 Successful- efforts approach? Full-cost method? Appendix: Oil and Gas Properties

42 Expense dry wells immediately? Capitalize all drilling efforts? Appendix: Oil and Gas Properties

43 C hapter 10 Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc.