Operational Assets: Acquisition, Disposal and Exchange

OPERATIONAL ASSETS n Basic characteristics – Actively used in primary operations – – Expected to benefit future periods (long-term) – Generally not held for resale n Grouping of operational assets – Tangible = have physical substance – Intangible = value not tied to physical substance

OPERATIONAL ASSETS n Classification – Property, plant, and equipment Buildings Machinery, furniture and fixtures Land Land improvements – Natural resources – Intangibles

ASSET ACQUISITION n With cash n On credit n In exchange for equity securities of the acquiring company n Through donation from another entity n Through construction n In exchange for nonmonetary assets

ACQUISITION COST General Rule “The historical cost of acquiring an asset includes the costs necessarily incurred to bring it to the condition and location necessary for its intended use.” SFAS No. 34

ACQUISITION COST BUILDINGS l Architectural fees l Cost of permits l Excavation costs l Construction costs l Purchase price

ACQUISITION COST MACHINERY, FURNITURE & FIXTURES n Net purchase price n Transportation costs n Installation Costs n Modification to building necessary to install equipment

l Purchase price l Real estate commissions l Title search l Title transfer fees l Title insurance premiums Land is not depreciable. ACQUISITION COST LAND

ACQUISITION COST LAND IMPROVEMENTS nDriveways nParking lots nFencing nLandscaping

PURCHASE ON CREDIT The asset acquired is recorded at the Cash equivalent price (market value) or Present value of future cash payments using the prevailing market interest rate Whichever is more objective and reliable (APB Opinion No. 21)

Purchased With Equity Securities nAsset acquired is recorded at the fair market value of the asset or the fair market value of the securities, whichever is more objective and reliable. nIf the securities are actively traded, fair market value can be determined. nIf no objective and reliable value can be determined, board of directors assigns a “reasonable value.”

DONATED ASSETS nMunicipalities may donate land and/or buildings to induce a company to locate in the area. nSFAS No. 116 defines a contribution as nonreciprocal transfer “an unconditional transfer of cash or other assets to an entity or a settlement or cancellation of its liabilities in a voluntary nonreciprocal transfer..”

LUMP-SUM PURCHASE nSeveral assets may be acquired for a single lump-sum price that may be lower than the sum of the individual asset prices. nPortions of the lump-sum directly attributable to particular assets are assigned to those assets. nThe remainder is allocated on the basis of relative value of the assets.

SELF-CONSTRUCTED ASSETS nCapitalize all costs directly associated with the construction including materials, labor and overhead. nIn certain cases a company can capitalize –General overhead –Interest expense

SELF-CONSTRUCTED ASSETS never exceed nThe asset’s recorded cost must never exceed its fair market value. nIf costs actually incurred exceed fair market value, a loss must be recognized.

INTEREST CAPITALIZATION nIn some cases a company may capitalize “avoidable interest” incurred on “qualifying assets.” –Avoidable interest -- interest that could have been avoided if the asset were not self-constructed and the money used to retire debt.  Key questions to be answered –What are “qualifying assets?” –What is the capitalization period? –What amount should be capitalized?

PP&E - val - 17 INTEREST CAPITALIZATION  Qualifying assets –Self-constructed and required a period of time to “get them ready for use”  Capitalization period –Begins when all following conditions exist Expenditures have been made Asset is being prepared for use Interest cost is being incurred –Ends when asset is ready for intended use  Amount capitalized –Lower of “actual interest incurred” or “avoidable interest”

PP&E - val - 18 AVOIDABLE INTEREST  Computation of amount –Interest rate x Weighted-average accumulated expenditures (WAAE)  Appropriate interest rates –For WAEE < or = to amount actually borrowed for construction --- Use actual rate on specific borrowings for construction –For portion of WAEE > than amount actually borrowed for construction --- use weighted average rate for all other outstanding debt during the capitalization period

DISPOSAL OF PLANT ASSETS nUpdate depreciation to date of disposal. nOriginal cost of asset and accumulated depreciation are removed from the accounts. gain or loss nThe difference between book value of the asset and the amount received in the disposal process is recorded as a gain or loss.

NONMONETARY EXCHANGES General Principle Accounting for the exchange of nonmonetary assets should be based on: Market value of assets transferredor Market value of assets acquired Whichever is more readily determinable

PP&E - val - 21 NONMONETARY EXCHANGES Exchange situation Accounting  Fair values determinable &  Assumes commercial substance Record new asset using FMV & recognize gain or loss  FMV of either asset received or given up is not determinable OR  Lacks commercial substance OR  Exchange to facilitate sales Record new asset using BV & no gain or loss recognized

PP&E - val - 22 NONMONETARY EXCHANGES Commercial Substance  Exchange has “commercial substance” if the entity’s future cash flows are expected to change significantly as a result of the transaction –Configuration of future cash flows changes –Value of assets received differs from value of assets transferred

POST-ACQUISITION EXPENDITURES nMaintenance and ordinary repairs. nImprovements (betterments), replacements, and extraordinary repairs. nAdditions. nRearrangements and other adjustments.

expense Normally we debit an expense account for amounts spent on: Maintenance and Ordinary Repairs Concept: keep assets in proper working order. POST-ACQUISITION EXPENDITURES

asset Normally we debit the asset account for amounts spent on: Improvements, Replacements, and Extraordinary Repairs Concept: increase useful life or productivity of the original asset. POST-ACQUISITION EXPENDITURES

asset Normally we debit the asset account for amounts spent on:Additions Concept: expansion of an existing asset. POST-ACQUISITION EXPENDITURES

other asset Normally we debit an other asset account for amounts spent on: Rearrangements and Other Adjustments Concept: increase efficiency of operations. POST-ACQUISITION EXPENDITURES

INFORMATION GLUT!