1. Investments in Noncurrent Operating Assets—Acquisition
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Intermediate Accounting,17E
Investments in Noncurrent Operating Assets—Acquisition
PowerPoint presented by: Douglas Cloud Professor Emeritus of Accounting, Pepperdine University
© 2010 Cengage Learning

2. What Costs Are Included in Acquisition Cost?
Initially record noncurrent operating assets at cost.
Cost includes all expenditures required to obtain asset and place it in use.
Most costs associated with internally-generated intangible assets are expensed.
The cost of externally purchased intangibles is generally recorded as an asset.

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6. Tangible Assets—Land
Costs assigned to land should be those costs that directly relate to the land’s unlimited life.
Purchase price, commissions, legal fees, escrow fees, surveying fees, and government assessments for water lines, sewers, and roads are charged to Land.
Clearing and grading costs, including the removal of unwanted structures, are also part of the cost of land.

7. Tangible Assets—Land Improvements
Land improvements include:
Landscaping
Paving parking lots
On-property sidewalks
Light structures (for parking and sidewalks)
Fencing

8. Tangible Assets—Building
If the structure is purchased ready to use, charge Buildings for:
Purchase price
Commissions, legal fees, escrow fees, and reconditioning costs
If newly constructed by an outsider:
Contract price
Legal fees

9. Tangible Assets—Equipment
Equipment costs include:
The purchase price
Taxes, freight, and insurance during shipping and installation
Special foundations or reinforcing of floors
Reconditioning and testing costs

10. Intangible Assets
Intangible assets are those assets (not including financial assets) that lack physical substance.
The most important distinction in intangible assets for accounting purposes is between those that are internally generated and those that are externally purchased.

11. Trademark
A trademark is a distinctive name, symbol, or slogan that distinguishes a product or service from similar products or services.
The cost of a trademark includes the purchase price, filing and registry fees, and the cost of subsequent litigation to protect rights. It does not include internal research and development costs.

12. Franchises
A franchise is the right received (usually purchased) by a business or individual to perform certain functions or sell certain products or services.
The cost of a franchise includes expenditures made to purchase the franchise, legal fees, and other costs incurred in obtaining the franchise.

13. Order Backlog
The order backlog is the amount of orders the company has received for equipment that has not yet been produced or delivered.
These orders do not constitute sales because they do not satisfy the revenue recognition requirement.

14. Goodwill
Goodwill represents the business contracts, reputation, functioning systems, staff camaraderie, and industry experience that makes the company more than just a collection of assets.
The portion of the purchase price that exceeds the sum of the current market value for all identifiable net assets is considered goodwill.

15. Basket Purchase
A number of assets may be acquired in a basket purchase for one lump sum.
When part of a purchase can be clearly identified with specific assets, such a cost assignment should be made and the balance allocated among the remaining assets.
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16. Basket Purchase
When no part of the purchase price can be related to specific assets, the entire amount must be allocated among the different assets acquired.

17. Deferred Payment
The acquisition of real estate or other property frequently involves deferred payment of all or part of the purchase price.
Land is acquired on January 2, 2011, for $100,000; $35,000 is paid at the time of purchase, and the balance is to be paid in semiannual installments of $5,000 plus interest on the unpaid principal at an annual rate of 10%.

18. Deferred Payment
Jan. 2, 2011—Purchased land for $100,000, paying $35,000 down, the balance to be paid in semiannual payments of $5,000 plus interest at 10%.
Land 100,000
Cash 35,000
Notes Payable 65,000
June 30, 2011—Made first payment.
Interest Expense 3,250
Notes Payable 5,000
Cash 8,250
$65,000  0.05

19. Deferred Payment
On January 2, 2011, equipment with a cash price of $50,000 is acquired under a deferred payment contract. The contract specifies a down payment of $15,000 plus seven annual payments of $7,189 each (a total cost of $65,323). The present value of the seven payments at 10 percent is $35,000.

20. Deferred Payment
January 2, 2011—Purchased equipment with a cash price of $50,000 for $15,000 down plus seven annual payments of $7,189 each.
Equipment 50,000
Discount on Notes Payable 15,323
Notes Payable 50,323
Cash 15,000

21. Deferred Payment December 31, 2011—Made first payment of $7,189.
Amortization of debt discount:
$50,323 – $15,323 = $35,000; $35,000  10% = $3,500
Journal entries:
Notes Payable 7,189
Cash 7,189
Interest Expense 3,500
Discount on Notes Payable 3,500

22. Deferred Payment
December 31, 2012—Made second payment of $7,189 and amortized debt discount.
Notes Payable 7,189
Cash 7,189
Interest Expense* 3,131
Discount on Notes Payable 3,131
$31,311  0.10 = $3,131
*$50,323  $7,189 = $43,134 Notes payable
$15,323  $3,500 = 11,823 Discount on notes payable
$31,311 Present value of notes payable at the end of first year

23. Leasing
A lease is a contract whereby one party (the lessee) is granted a right to use property owned by another party (the lessor).
Rental leases are operating leases and arrangements that are equivalent to a sale of leased assets are capital leases.
Capital leases are recorded on the acquiring company’s records as assets, with a related liability at the present value of the future lease payments.

24. Exchange of Nonmonetary Assets
In some cases, an enterprise acquires a new asset by exchanging or trading existing nonmonetary assets.
Monetary assets are those assets whose amounts are fixed in terms of currency, by contract, or otherwise.

25. Acquisition by Issuing Securities
When a fair value for the securities can be determined, that value is assigned to the asset acquired.
In the absence of a fair value for the securities, the fair value of the asset acquired is used. This may require the services of an independent appraiser.

26. Self-Construction
Like purchased assets, self-constructed assets are recorded at cost, including all expenditures incurred to build the asset and make it ready for its intended use.
There is a difference of opinion regarding the amount of overhead properly assignable to construction activity.

27. Savings or Loss on Self-Construction
When the cost of self-construction of an asset is less than the cost to acquire it through purchase or construction from outsiders, the difference is not a profit.
When the cost is greater than the cost to acquire it through purchase or construction from outsiders, the asset should be recorded at cost (with some exceptions).

28. Interest Capitalization
Capitalization of interest is required for assets that are being self-constructed for an enterprise’s own use and for assets that are intended to be leased or sold to others that can be identified as discrete projects.
Interest should not be capitalized for inventories manufactured or produced on a repetitive basis.

29. Interest Capitalization
When assets are acquired by self-construction, interest incurred on funds borrowed to finance construction can be capitalized if the following conditions are met:
Projects are discrete
Costs are separately accumulated
Construction covers an extended period of time
Construction costs are substantial

30. Interest Capitalization
Interest charges begin when the first expenditures are made on the project and continue until the asset is completed.
Interest capitalization is calculated on the average amount of accumulated expenditures.
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31. Interest Capitalization
The interest rate to use is the actual rate on the debt incurred specifically for the project.
If the construction period covers more than one fiscal period, accumulated expenditures include prior years’ capitalized interest.

32. Interest Capitalization Example
Cutler Industries, Inc. has decided to construct a new computerized assembly plant.
Construction will take about 18 months.
Construction costs are estimated at $6.4 million.
A 12%, $2 million loan is obtained and will become effective on January 1, 2011.
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33. Interest Capitalization Example
Cutler Industries, Inc.’s other debts are:
5-year notes payable, 11% interest $3,000,000
Mortgage on other plant, 9% interest 4,800,000
The weighted-average interest rate on the general nonconstruction debt is computed as follows:
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34. Interest Capitalization Example
The following expenditures were incurred on the project during 2011.
January 1, 2011 $1,200,000
October 1, ,800,000
In the previous slide we noted that the weighted-average rate was 9.8% (rounded).
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35. Interest Capitalization Example
Computation of the amount of interest to be capitalized for 2011 follows:
The firm borrowed $1,800,000 on October 1
In Slide 10-33, the weighted-average rate was determined to be 9.8%
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36. Interest Capitalization Example
The amount of interest capitalized cannot exceed total interest incurred during the year. Total interest during 2011 was as follows:
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37. Interest Capitalization Example
The actual interest was $1,002,000 and the calculated interest was $192,500. Thus, the entry is as follows:
Construction in Progress 192,500
Interest Expense 809,500
Cash 1,002,000
$1,002,000  $192,500
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38. Interest Capitalization Example
FASB Statement No. 34 requires disclosure of the total interest expense for the year and the amount capitalized. This disclosure can be made either in the body of the income statement or in a note to the statements.
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39. Acquisition by Donation or Discovery
Property acquired through donation should be appraised and recorded at its fair market value.
Land 400,000
Buildings 1,500,000
Revenue or Gain 1,900,000

40. Asset with Significant Restoration Costs at Retirement
To illustrate the initial recognition of an asset retirement obligation, assume that Bryan Beach Company purchases and erects an oil platform at a total cost of $750,000. At the end of ten years, the platform must be dismantled and removed from the site at an estimated cost of $100,000. Using an 8% interest rate, the present value of $100,000 for ten years is $46,319.
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41. Asset with Significant Restoration Costs at Retirement
The journal entries to record the purchase and the asset retirement obligation follow:
Oil Platform 750,000
Cash ,000
Oil Platform ,000
Asset Retirement
Obligation ,000

42. Postacquisition Expenditures
A component is a portion of a property, plant, or equipment item that is separately identifiable and for which a separate useful life can be estimated.
Expenditures to keep plant and equipment in good operating condition are referred to as maintenance.

43. Postacquisition Expenditures
Expenditures to restore assets to good operating condition upon their breakdown or to restore and replace broken parts are referred to as repairs.
Maintenance and repairs are charged to expense accounts immediately.

45. Renewals and Replacements
Expenditures for overhauling plant assets are frequently referred to as renewals. They should be expensed immediately.
Substitution of parts or entire units are referred to as replacements. Treat the removed part similar to removing any plant asset.

46. Additions and Betterments
Enlargements and extensions of existing facilities are referred to as additions.
Changes in asset design to provide increased or improved services are referred to as betterments.
Capitalize the cost of additions and betterments.

47. Research and Development
Research (discovering new knowledge) and development (formulation, design, and testing of products) costs include:
Costs of materials
Equipment
Facilities
Personnel
Purchased intangibles
Contract services
Reasonable allocation of indirect costs that are specifically related to R&D activities and that have no alternative future use
Research and development expenditures are expensed in the period they occur.

48. International Accounting for R&D: IAS 38
IAS 38 requires research costs to be expensed and development costs to be capitalized.
Research costs are those R&D costs incurred before technical and commercial feasibility has been attained.
Development costs are those incurred after technical and commercial feasibility.

49. Oil and Gas Exploration Costs
Full cost method—all exploratory costs are capitalized.
Reasoning: The cost of drilling dry wells is part of the cost of locating productive wells.
Successful efforts method— exploratory costs for dry wells are expensed, and only exploratory costs for successful wells are capitalized.

50. Intangibles Acquired in a Basket Purchase
A company pays $700,000 to purchase a patent along with a functioning factory and special equipment used to produce the patented product. The estimated fair values are allocated as shown next.

51. Intangibles Acquired in a Basket Purchase

52. Five General Categories of Intangible Assets
Marketing-related—trademarks, brand names, and Internet domain names
Customer-related—customer lists, order backlogs, and customer relationships
Artistic-related—items protected by copyright
Contract-based—licenses, franchises, and broadcast rights
Technology-based—patented and unpatented technologies as well as trade secrets

53. Estimating the Fair Value of Intangibles—Traditional Approach
Intangible Asset A is expected to generate $1,000 in royalty payments at the end of each of the next five years. The risk-adjusted interest rate is 12%. The fair value of the patent is calculated as follows:
Table Value (n = 5; I = 10)  $1,000 = PV(annuity)
3.605  $1,000 = $3,605

54. Estimating the Fair Value of Intangibles—Expect Cash Flow Approach
Intangible Asset B is a secret formula that is expected to have the following probabilities of happening:
10% probability of cash flows of $5,000 at the end of each year for 10 years
30% probability of cash flows of $1,000 at the end of each year for 4 years
60% probability of cash flows of $100 at the end of each year for 3 years
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55. Estimating the Fair Value of Intangibles—Expect Cash Flow Approach

56. Goodwill
Goodwill is a residual amount, the amount of the purchase price of a business that is left over after all other tangible and intangible assets have been identified.
In a basket purchase, each identifiable asset is recorded at an amount equal to its estimated fair market value; any residual is reported as goodwill.

57. Goodwill Illustration
Airnational Corporation purchases the net assets of Speedy Freight Airlines for $1,500,000 in cash. The book value of Speedy Freight at the time of purchase is shown below.
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58. Goodwill Illustration
Analysis between the costs and market values of the assets acquired reveal a difference of $513,300 ($1,266,500  $753,200).
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59. Goodwill Illustration
The difference between the purchase price of $1,500,000 and the net asset book value of $767,200 ($1,036,700 – $269,500) is $732,800.
The market value of the noncash assets (inventory, land, building, patents, etc.) is $1,266,500. The difference between the cost of these items ($753,200) and the market is $513,300.
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60. Goodwill Illustration
Subtract $513,300 (step b) from $732,800 (step a) gives us the amount of Goodwill, which is $219,500.
(at book value)
(at market)

61. Bargain Purchase
When the amount paid for another company is less than the fair value of the net identifiable assets, this is a bargain purchase.
Assume that the Speedy Freight acquisition was for $1,000,000 instead of $1,500,000. The acquisition would be recorded as shown next.
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62. Bargain Purchase
Note that a gain is recognized

63. Valuation of Assets at Current Values
In IFRS 16, concerns about permitting upward revaluations of noncurrent operating assets is reflected in the rules laid out:
If a company revalues its noncurrent operating assets to fair value, it must do so on a regular basis and must revalue entire classes of assets rather than just picking and choosing certain assets.
Downward revaluations are recorded as a loss.
Upward revaluations are recorded as a debit to the asset and a credit to a special “revaluation” equity account.

64. Fixed Asset Turnover Ratio
General Electric’s manufacturing segments had sales for 2006 totaled $102,481. Its beginning and ending property, plant, and equipment balances were $16,504 and $12,675, respectively.
($16,504 + $12,675) 2
Average fixed assets =
= $14,590
$102,481
Sales
Average fixed assets
Fixed asset turnover ratio =
= 7.02
$14,590

65. Fixed Asset Turnover Ratio
General Electric’s manufacturing segments had sales for 2007 totaled $115,595. Its beginning and ending property, plant, and equipment balances were $12,675 and $14,590, respectively.
($12, $14,590) 2
Average fixed assets =
= $13,409
$115,595
Sales
Average fixed assets
Fixed asset turnover ratio =
= 8.62
$13,409