1. 1 Investments in Noncurrent Operating Assets-- Acquisitions

2. 2  Identify those costs to be included in the acquisition cost of different types of noncurrent operating assets.  Properly account for noncurrent operating asset acquisitions using various special arrangements, including deferred payment, self-construction, and acquisition of an entire company. Learning Objectives

3. 3  Separate costs into those that should be expensed immediately and those that should be capitalized, and understand the accounting standards for research and development and oil and gas exploration costs.  Discuss the pros and cons of recording noncurrent operating assets at their current value. Learning Objectives

4. 4  Use the fixed asset turnover ratio as a general measure of how efficiently a company is using its property, plant, and equipment. EXPANDED MATERIAL  Evaluate the different ways to compute capitalized interest and properly incorporate midyear loans into the capitalized interest calculations.

5. 5 Time Line of Business and Accounting Issues Involved With Long-Term Operating Assets

6. 6 EVALUATE possible acquisition of long-term operating items

7. 7 ACQUIRE long-term operating assets

8. 8 DISTINGUISH between those items to be expensed and those to be capitalized

9. 9 RECORD long-term operating assets at appropriate amount

10. 10 ESTIMATE and RECOGNIZE periodic depreciation

11. 11 MONITOR asset value for possible decline

12. 12 DISPOSE of asset

13. 13 Valuation at Acquisition Initially record asset at cost; cost is actual cash price. Cost includes all expenditures required to obtain asset and place it in use.

14. 14 Purchase price, commissions, legal fees, and escrow fees. Clearing and grading costs. Cost of removing unwanted structures. Assessments for water lines, sewers, and roads. Acquisition Costs of Tangible Noncurrent Operating Assets

15. 15 Landscaping. Parking lots. Interior sidewalks. Light structures (for parking and sidewalks). Fencing. Acquisition Costs of Tangible Noncurrent Operating Assets

16. 16 Purchase price. Taxes, freight, and insurance during shipping and installation. Special foundations or reinforcing of floors. Installation and testing. Note: Any expenditure incurred in preparing the asset for its intended use is charged to Equipment. Acquisition Costs of Tangible Noncurrent Operating Assets

17. 17 Purchase price. Commissions, legal fees, escrow fees, survey fees. If ready for use: Contract price. Legal fees If newly constructed by outsider: Acquisition Costs of Tangible Noncurrent Operating Assets If a building is self- constructed, the cost of materials, labor, and overhead establishes the cost of the asset.

18. 18 Acquisition Costs of Intangible Noncurrent Operating Assets Patent: Purchase price, filing and registry fees, cost of subsequent litigation to protect right. Does not include internal research and development costs. Copyright: Same as Patent. Trademark and Trade Name: Same as Patent. Franchise: Expenditures made to purchase the franchise. Legal fees and other costs incurred in obtaining the franchise. Organization Costs: Expenditures to organize the corporation--cost of stock certificates, underwriting costs, state incorporation fees, legal fees. continuedcontinued

19. 19 Acquisition Costs of Intangible Noncurrent Operating Assets Software Development Costs: Expenditures made after software is determined to be technologically feasible but before it is ready for commercial production. Goodwill: Portion of purchase price that exceeds the sum of the current market value for all identifiable net assets.

20. 20 Acquisition Other Than Simple Cash Transactions  Basket purchase  Deferred payment  Leasing  Exchange of nonmonetary assets  Issuance of securities  Self-construction  Donation or discovery  Acquisition of an entire company

21. 21 Methods of Acquisition Basket purchase: Allocate cash price to individual assets based on percentage of appraised or fair market value. Land, buildings, and equipment are acquired for $160,000. The appraisal values at the acquisition date are: land, $28,000; buildings, $60,000; equipment, $12,000.

22. 22 Methods of Acquisition Basket purchase: Allocate cash price to individual assets based on percentage of appraised or fair market value. Land$ 28,000 Buildings60,000 Equipment 12,000 $100,000 $28/$100 x $160,000 = $ 44,800 $60/$100 x $160,000 =96,000 $12/$100 x $160,000 = 19,200 $160,000

23. 23 Deferred payment Record asset at face value of note, plus any cash paid. Record note at fair market value of acquired asset if note’s value is not determinable or is unreasonable. Deferred payment Record asset at face value of note, plus any cash paid. Record note at fair market value of acquired asset if note’s value is not determinable or is unreasonable. Methods of Acquisition Land is acquired on January 2, 2002 for $100,0000; $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%.

24. 24 Methods of Acquisition June 30, 2002 Interest Expense3,250 Notes Payable5,000 Cash8,250 $65,000 x 0.05% Deferred Payment Illustration

25. 25 Methods of Acquisition Leasing: A capital lease is economically the same as a purchase. The acquiring company records the asset and liability at the present value of future lease payments. Exchange of nonmonetary assets: The new asset is valued at its fair market value or at the fair market value of the asset given up, whichever is more clearly determinable.

26. 26 Methods of Acquisition Issuance of securities: Record the asset at the fair market value of the securities issued. Self-construction: Recorded at cost, including all expenditures incurred to build the asset and make it ready for its intended use.

27. 27 Interest Capitalization Capitalization of interest is required for assets that are being self- constructed for an enterprise’s own use and 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.

28. 28 Interest Capitalization-- Qualification  Projects are discrete.  Costs are separately accumulated.  Construction covers an extended period of time.  Construction costs are substantial. When assets are acquired by self-construction, interest incurred on funds borrowed to finance construction can be capitalized if the following conditions are met:

29. 29  Maximum capitalization equals actual interest incurred during the period.  Interest capitalization is calculated on average amount of accumulated expenditures.  Interest rate used is (1) actual rate on debt incurred specifically for the project, then (2) weighted average interest rate on all borrowings not specifically for the project.  If the construction period covers more than one fiscal period, accumulated expenditures include prior years’ capitalized interest. Interest Capitalization-- Requirements

30. 30 Interest Capitalization-- Example: Scenario Bee Wood, Inc., a construction company, decides to build a new warehouse. The following information is applicable to the project:

31. 31 Construction will begin January 1, 2001, and is expected to end December 31, 2002. Construction costs are estimated at $640,000. A 12%, 2-year loan of $200,000 has been obtained and will become effective on January 1, 2001. Interest Capitalization-- Example: Scenario

32. 32 Bee Wood, Inc.’s other debts are: –5-year, 10% notes payable$ 75,000 –9% mortgage120,000 2001 Expenditures were: –January 1:$ 100,000 –July 1: 100,000 –October 1:100,000 In 2002, expenditures of $340,000 occurred evenly throughout the year. Interest Capitalization-- Example: Scenario

33. 33 Maximum Interest Capitalization DebtAmountRateInterest Loan$ 200,00012% $24,000 Note 75,00010% 7,500 Mortgage 120,000 9% 10,800 Maximum interest capitalization $42,300 Interest Capitalization-- Example: Solution

34. 34 Weighted Average Rate: DebtAmountRateInterest Note $ 75,00010% $ 7,500 Mortgage 120,000 9% 10,800 $195,000$18,300 Interest Capitalization-- Example: Solution Weighted Average Rate = 9.4% ($ 18,300 ÷ $195,000 = 0.0938) Weighted Average Rate = 9.4% ($ 18,300 ÷ $195,000 = 0.0938)

35. 35 1/1/01 $100,000 12/12 $100,000 7/1/01 100,000 6/12 50,000 10/1/01 100,000 3/12 25,000. $300,000 $175,000 Weighted Average Expenditures--2001: Weighted Date Amount Ratio Average Interest Capitalization-- Example: Solution Interest Capitalization--2001: $ 175,000 x 12% (loan) = $ 21,000 Interest Capitalization--2001: $ 175,000 x 12% (loan) = $ 21,000

36. 36 Weighted Average Expenditures--2002 Acc. exp. 12/31/01$300,000 2001 interest capitalized 21,000 Adjusted acc. exp. 12/31/01$321,000 2002 expenditures 340,000 Acc. exp. 12/31/02$661,000 Weighted average expenditures, 2002$491,000 Interest Capitalization-- Example: Solution ($321,000 + [$340,000 ÷ 2])

37. 37 Interest Capitalization--2002: $200,000 x 12% = $24,000 $291,000 x 9.4% = 27,400 Total interest$51,400 Maximum interest$42,300 Interest Capitalization-- Example: Solution Interest Capitalized, $42,300

38. 38 Acquisition of an Entire Company --Business Combination There are two ways to account for a business combination-- pooling of interest and purchase. The purchase method raises a problem in how to allocate the purchase price to the various assets acquired. Compared to pooling of interest, the purchase method records assets at their fair market value, which results in lower earnings in subsequent years due to higher depreciation charges. Despite opposition from the business community, the FASB has taken steps to eliminate the pooling of interest method.

39. 39 Goodwill Defined: “The excess amount paid for a company in a business combination over the fair market value of the company’s identifiable assets.” Recording Goodwill 1.Write identifiable assets up to FMV. 2.Record excess purchase price over net assets at FMV as goodwill. 3.Amortize goodwill over its economic useful life -- not to exceed 40 years.

40. 40 Expense/Asset Continuum Oil and Gas Exploration Land and Buildings Software Development Supplies Used Repairs Research and Development Expense Asset

41. 41 Postacquisition Expenditures Expenditures to keep plant and equipment in good operating condition are referred to as maintenance. Expense as incurred

42. 42 Postacquisition Expenditures What about expenditures that do not extend the useful life or increase future cash flows? Expense as incurred

43. 43 Postacquisition Expenditures If the cost of the old component is known, remove its cost and accumulated depreciation. Next, record cost of the new component and recognize a gain or loss.

44. 44 Postacquisition Expenditures What if the cost of the old component is not known?

45. 45 Then the cost of the new component is deducted from accumulated depreciation. Postacquisition Expenditures

46. 46 Research and Development Research and development costs include those costs of materials, equipment, facilities, personnel, purchased intangibles, contract services, and a reasonable allocation of indirect costs that are specifically related to R & D activities and that have no alternative future use.

47. 47 Research and Development Examples  Research aimed at discovery of new knowledge.  Search for applications of research findings.  Search for possible product or process alternatives.  Design, construction, and testing of preproduction prototypes.  Design, construction, and operation of a pilot plant.

48. 48 Development of Successful Software R & D Costs (Expense) Deferred Costs (Intangible Assets) Inventory Costs Software project initiated Technological feasibility established Software available for commercial production Software sold

49. 49 Sales Average Fixed Assets Fixed asset turnover = Fixed Asset Turnover Lamberson Company’s sales for 2001 totaled $46,381,530. Its beginning and ending Property, Plant, and Equipment balances were $9,678,233 and $10,088,997, respectively. Average fixed assets = ($9,678,233 + $10,088,997) 2 Average fixed assets = $9,883,615 $46,381,530 $9,883,615 = 4.69

50. 50 The End