Property, Plant and Equipment: Acquisition and Disposal C hapter 10 An electronic presentation by Norman Sunderman Angelo State University An electronic presentation by Norman Sunderman Angelo State University COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Intermediate Accounting 10th edition Nikolai Bazley Jones

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 taxes total $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 damage because it was not a necessary cost. Acquisition of Property, Plant, and Equipment

6  Contract price  Costs of closing the transaction, obtaining the title, options, legal fees, title search, insurance, past due taxes  Contract price  Costs of closing the transaction, obtaining the title, options, legal fees, title search, insurance, past due taxes Acquisition of Property, Plant, and Equipment Cost of Land  Cost of surveys  Clearing and grading property to get it ready for its intended use  Razing old buildings (net of salvage)  Cost of surveys  Clearing and grading property to get it ready for its intended use  Razing old buildings (net of salvage)

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

8  Contract price  Remodeling and reconditioning  Excavating for the specific building  Architectural and building permit costs  Capitalized interest  Certain unanticipated costs  Contract price  Remodeling and reconditioning  Excavating for the specific building  Architectural and building permit costs  Capitalized interest  Certain unanticipated costs Cost of Buildings Acquisition of Property, Plant, and Equipment

9 Deferred Payments Antush Company purchases equipment by issuing a $10,000 non-interest-bearing 5-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 x ) Acquisition of Property, Plant, and Equipment

10 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 (by a governmental unit) Acquisition of Property, Plant, and Equipment

11 Assets Acquired by Donation The CEO of Hrouda Company donates a building worth $50,000 to the company. Building50,000 Gain from Donation of Land50,000 (by a nongovernmental unit) Acquisition of Property, Plant, and Equipment The gain is reported in the Other section of the income statement.

12 Start-up Costs SOP No requires that a company expense costs of start-up activities incurred. Start-up costs are costs related to one-time activities for opening a new facility, introducing a new product etc.

13 The general exchange 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

14 Recognize Portion of Gain End YES NO Gain Recognize Losses End NO YES Assets Similar End Recognize Gains NO YES Boot Received Gain Not Recognized End NO Recognize Gains & Losses End YES Exchange of Assets Boot > 25% of value of exchange Determine Gain or Loss

15 Assets Acquired by Exchange of Other Assets Dissimilar Company ACompany B Cost $100,000 Accum. depr.54,000 Fair value40,000 Cost $60,000 Accum. depr.32,000 Fair value40,000

16 Dissimilar Company A 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 value40,000 Loss$6,000 Assets Acquired by Exchange of Other Assets

17 Dissimilar Company A Equipment40,000 Accum. depr.54,000 Loss6,000 Building100,000 Cost $40,000 Book value$46,000 Fair value40,000 Loss$6,000 Assets Acquired by Exchange of Other Assets

18 Dissimilar Company B Cost $60,000 Accum. Depr.32,000 Fair value40,000 Building40,000 Accum. Depr.32,000 Equipment60,000 Gain12,000 Assets Acquired by Exchange of Other Assets Book value$28,000 Fair value40,000 Gain$12,000

19 Dissimilar Company B Cost $40,000 Book value$28,000 Fair value40,000 Gain$12,000 Assets Acquired by Exchange of Other Assets Building40,000 Accum. Depr.32,000 Equipment60,000 Gain12,000 Gain on tractor given and building (dissimilar asset) received, recorded.

20 Dissimilar with Boot Company ACompany B Cost $100,000 Accum. depr.54,000 Fair value40,000 Cash received5,000 Cost $60,000 Accum. depr.32,000 Fair value35,000 Cash paid5,000 Assets Acquired by Exchange of Other Assets

21 Dissimilar with Boot Company A 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 value40,000 Loss$6,000

22 Dissimilar with Boot Company A Equipment35,000 Accum. depr.54,000 Cash5,000 Loss6,000 Building100,000 Cost $35,000 Assets Acquired by Exchange of Other Assets

23 Dissimilar with Boot Company B 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 value35,000 Gain$7,000

24 Dissimilar with Boot Company B Building40,000 Accum. Depr.32,000 Equipment60,000 Cash5,000 Gain7,000 Cost $40,000 Assets Acquired by Exchange of Other Assets Book value$28,000 Fair value35,000 Gain$7,000

25 Exchange of Similar Assets Company ACompany B Cost $100,000 Accum. depr.54,000 Fair value40,000 Cash received5,000 Cost $60,000 Accum. depr.32,000 Fair value35,000 Cash paid5,000 Boot Paid by Company Incurring a Gain

26 Boot Paid by Company Incurring a Gain Company A Cost $100,000 Accum. depr.54,000 Fair value40,000 Cash received5,000 Equipment35,000 Accum. Depr.54,000 Loss6,000 Cash5,000 Equipment100,000 Exchange of Similar Assets Book value$46,000 Fair value40,000 Loss$6,000

27 Boot Paid by Company Incurring a Gain Company A Equipment35,000 Accum. Depr.54,000 Loss6,000 Cash5,000 Equipment100,000 Cost = $35,000 Exchange of Similar Assets Book value$46,000 Fair value40,000 Loss$6,000

28 Company B Cost $60,000 Accum. depr.32,000 Fair value35,000 Cash paid5,000 Boot Paid by Company Incurring a Gain Equipment33,000 Accum. Depr.32,000 Equipment60,000 Cash5,000 $28,000 + $5,000 Book value$28,000 Fair value35,000 Gain$7,000 Exchange of Similar Assets

29 Company B Boot Paid by Company Incurring a Gain Equipment33,000 Accum. Depr.32,000 Equipment60,000 Cash5,000 $28,000 + $5,000 Book value$28,000 Fair value35,000 Gain$7,000 Exchange of Similar Assets Cost = $33,000

30 Boot Received by Company Incurring a Gain Company ACompany B Cost $100,000 Accum. depr.80,000 Fair value30,000 Cash received3,000 Cost $60,000 Accum. depr.32,000 Fair value27,000 Cash paid3,000 Exchange of Similar Assets

31 Gain Recognized When Boot Received X Total Gain = Boot Boot + FMV of Asset Received Amount of Gain Recognized

32 Gain = ($30,000 - $20,000) =$1,000 $3,000 $3,000 + $27,000 Book value$20,000 Fair value30,000 Total gain$10,000 X Total Gain = Boot Boot + FMV of Asset Received Amount of Gain Recognized Company A

33 Equipment18,000 Accum. Depr.80,000 Cash3,000 Equipment100,000 Gain1,000 Company A Cost $100,000 Accum. depr.80,000 Fair value30,000 Cash received3,000 Boot Received by Company Incurring a Gain Exchange of Similar Assets

34 Equipment18,000 Accum. Depr.80,000 Cash3,000 Equipment100,000 Gain1,000 Company A Boot Received by Company Incurring a Gain Exchange of Similar Assets Cost = $18,000

35 Company B Cost $60,000 Accum. depr.32,000 Fair value27,000 Cash paid3,000 Boot Paid by Company Incurring a Loss Equipment30,000 Accum. Depr.32,000 Loss 1,000 Equipment60,000 Cash3,000 Exchange of Similar Assets Book value$28,000 Fair value27,000 Loss$1,000

36 Company B Boot Paid by Company Incurring a Loss Equipment30,000 Accum. Depr.32,000 Loss 1,000 Equipment60,000 Cash3,000 Exchange of Similar Assets Book value$28,000 Fair value27,000 Loss$1,000 Cost = $30,000

37 1.Are dissimilar productive assets exchanged? 2.Does the boot equal or exceed 25% of the value of a similar asset exchange? 3.For exchanges of similar productive assets, is there a loss? 4.For exchange of similar productive assets between two dealers or between two nondealers in which there is a gain, is cash received or paid? Four Issues Summary of Productive Asset Exchanges

38 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

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

40 Capitalization of Interest- Qualifying Assets  Must be built for the company’s own use, or be constructed as discrete projects  Must require a period of time to get them ready for their intended use. If land is to be used as a building site, the interest becomes part of the building cost.  Qualifying expenditures were made.

41 Capitalization of Interest- Qualifying Assets  The amount to be capitalized is the actual interest incurred.  Construction and related activities occurred for substantially the entire period.  Interest cost was incurred, not imputed.  Interest earned on idle funds does not offset capitalized interest.

42 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

43 Costs Subsequent to Acquisition  Extending the life of the asset.  Improving the productivity.  Producing the same product at lower cost.  Increasing the quality of the product.  Extending the life of the asset.  Improving the 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--

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

45 Improvements and Replacements A company decides to replace its oil furnace with a gas furnace. The oil furnace is carried on the books at a cost of $50,000 with an accumulated depreciation of $30,000. The scrap value of the old furnace is $5,000, and the new furnace costs $70,000. Furnace70,000 Accumulated Depreciation: Furnace30,000 Loss on Disposal of Furnace15,000 Furnace50,000 Cash65,000 Substitution Method

46 A capital expenditure of $60,000 is incurred in replacing a roof on a factory building. Accumulated Depreciation60,000 Cash60,000 Reduce Accumulated Depreciation Improvements and Replacements

47 A capital expenditure of $80,000 is incurred to enlarge a factory. Factory80,000 Cash80,000 Increase the Asset Account Improvements, Replacements and Additions

48 Disposal of Property, Plant, and Equipment Bean Company has a machine that originally cost $10,000, has accumulated depreciation of $8,000 at the beginning of the current year, and is being depreciated at $1,000 per year. On December 30, the company sells the machine for $600. Depreciation1,000 Accumulated Depreciation1,000 To bring depreciation to point of sale.

49 Cash600 Accumulated Depreciation9,000 Loss on Disposal400 Machine10,000 To record disposal of machine for $600. Disposal of Property, Plant, and Equipment Bean Company has a machine that originally cost $10,000, has accumulated depreciation of $8,000 at the beginning of the current year, and is being depreciation at $1,000 per year. On December 30, the company sells the machine for $600.

50 Disclosure of Property, Plant, and Equipment APB Opinion No. 12 requires a company to disclose the balances of its major classes of depreciable assets by nature or function.

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