Transcript Slide 1
CHAPTER 10
ACQUISITION AND DISPOSITION
OF PROPERTY, PLANT AND
EQUIPMENT
Sommers – Intermediate I
Types of Operational Assets
Long-lived, Revenue-producing Assets
Expected to Benefit Future Periods
Tangible
Property, Plant,
Equipment & Natural
Resources
General Rule for Cost Capitalization
The initial cost of an operational asset includes the
purchase price and all expenditures necessary to bring the
asset to its desired condition and location for use.
Costs to be Capitalized
Land (not depreciable)
• Purchase price
• Real estate commissions
• Attorney’s fees
• Title search
• Title transfer fees
• Title insurance premiums
• Removing old buildings
Equipment
• Net purchase price
• Taxes
• Transportation costs
• Installation costs
• Modification to building
necessary to install
equipment
• Testing and trial runs
Costs to be Capitalized
Land Improvements –
Separately identifiable costs
• Driveways
• Parking lots
• Fencing
• Landscaping
• Private roads
Buildings
• Purchase price
• Attorney’s fees
• Commissions
• Reconditioning
Natural Resources
• Acquisition costs
• Exploration costs
• Development costs
• Restoration costs
Self Constructed Assets
• Materials
• Direct Labor
• Overhead
Discussion Questions
Q10–4 Indicate where the following items would be shown on a
balance sheet.
(a) A lien that was attached to the land when purchased.
(b) Landscaping costs.
(c) Attorney’s fees and recording fees related to purchasing land
(d) Variable overhead related to construction of machinery.
Discussion Questions
Q10–4
(e) A parking lot servicing employees in the building.
(f) Cost of temporary building for workers during construction of
building
(g) Interest expense on bonds payable incurred during construction of
a building.
(h) Assessments for sidewalks that are maintained by the city.
(i) The cost of demolishing an old building that was on the land when
purchased.
Example 1: Continued
Semtech Manufacturing purchased land and building for $4
million. In addition to the purchase price, Semtech made the
following expenditures in connection with the purchase of the
land and building:
Title insurance
$ 16,000
Legal fees for drawing the contract
5,000
Pro-rated property taxes for period after acquisition 36,000
State transfer fees
4,000
An independent appraisal estimated the fair values of the land
and building, if purchased separately, at $3.3 and $1.1 million,
respectively. Shortly after acquisition, Semtech spent $82,000 to
construct a parking lot and $40,000 for landscaping. Determine
the initial valuation of each asset Semtech acquired in these
transactions.
Example 1: Continued
Purchase price
Title search and insurance
Legal fees
State transfer fees
Total cost
Land
Building
Land
Building
Land improvements:
Parking lot
Landscaping
Fair Value
$3,300,000
1,100,000
$4,400,000
$4,000,000
16,000
5,000
4,000
$4,025,000
% of Total
75%
25%
100%
$3,018,750
1,006,250
82,000
40,000
Valuation
$3,018,750
1,006,250
$4,025,000
Example 1: Continued
Semtech Manufacturing purchased land and building for $4 million. In
addition to the purchase price, Semtech made the following
expenditures in connection with the purchase of the land and building:
Title insurance
$16,000
Legal fees for drawing the contract
5,000
Pro-rated property taxes for period after acquisition 36,000
State transfer fees
4,000
An independent appraisal estimated the fair values of the land and
building, if purchased separately, at $3.3 and $1.1 million, respectively.
Shortly after acquisition, Semtech spent $82,000 to construct a parking
lot and $40,000 for landscaping.
Now assume that immediately after acquisition, Semtech demolished
the building. Demolition costs were $250,000 and the salvaged
materials were sold for $6,000. In addition, Semtech spent $86,000
clearing and grading the land in preparation for the construction of a
new building.
Example 1: Continued
Cost of land:
Purchase price
Title search and insurance
Legal fees
State transfer fees
Demolition of old building
Less: Sale of materials
Clearing and grading costs
Total cost of land
Land improvements:
Parking lot
Landscaping
$4,000,000
16,000
5,000
4,000
$250,000
(6,000)
244,000
86,000
$4,355,000
$
$
82,000
40,000
Example 2
Tristar Production Company began operations on September 1, 2011.
Listed below are a number of transactions that occurred during its first
four months of operations. Prepare journal entries to record each
transaction.
1. On September 1, the company acquired five acres of land with a
building that will be used as a warehouse. Tristar paid $100,000 in
cash for the property. According to appraisals, the land had a fair
value of $75,000 and the building had a fair value of $45,000.
Asset
Land
Building
Fair
Value
Percent
of Total
Fair Value
Initial
Valuation
Example 2: Continued
Tristar Production Company began operations on September 1, 2011.
Listed below are a number of transactions that occurred during its first
four months of operations. Prepare journal entries to record each
transaction.
2. On September 1, Tristar signed a $40,000 noninterest-bearing note
to purchase equipment. The $40,000 payment is due on
September 1, 2012. Assume that 8% is a reasonable interest rate.
Example 2: Continued
Tristar Production Company began operations on September 1, 2011.
Listed below are a number of transactions that occurred during its first
four months of operations. Prepare journal entries to record each
transaction.
3. On September 15, a truck was donated to the corporation. Similar
trucks were selling for $2,500.
4. On September 18, the company paid its lawyer $3,000 for
organizing the corporation.
Example 2: Continued
Tristar Production Company began operations on September 1, 2011.
Listed below are a number of transactions that occurred during its first
four months of operations. Prepare journal entries to record each
transaction.
5. On October 10, Tristar purchased machinery for cash. The purchase
price was $15,000 and $500 in freight charges also were paid.
6. On December 2, Tristar acquired various items of office equipment.
The company was short of cash and could not pay the $5,500
normal cash price. The supplier agreed to accept 200 shares of the
company’s nopar common stock in exchange for the equipment.
The fair value of the stock is not readily determinable.
Example 2: Continued
Tristar Production Company began operations on September 1, 2011.
Listed below are a number of transactions that occurred during its first
four months of operations. Prepare journal entries to record each
transaction.
7. On December 10, the company acquired a tract of land at a cost of
$20,000. It paid $2,000 down and signed a 10% note with both
principal and interest due in one year. Ten percent is an appropriate
rate of interest for this note.
Self-Constructed Assets
When self-constructing an asset, two accounting issues
must be addressed:
• overhead allocation to the self-constructed asset.
– incremental overhead only
– full-cost approach
• proper treatment of interest incurred during construction
Under certain conditions, interest incurred on qualifying
assets is capitalized.
• Asset constructed is for a company’s own use and is a
discrete project for sale or lease.
• Capitalize interest that could have been avoided if the
asset were not constructed and the money used to retire
debt.
Interest Costs During Construction
Three approaches have been suggested to account for the
interest incurred in financing the construction.
$0
Capitalize no
interest during
construction
Increase to Cost of Asset
Capitalize actual
costs incurred during
construction
GAAP
$?
Capitalize
all costs of
funds
Interest Costs During Construction
GAAP requires — capitalizing actual interest (with
modification).
Consistent with historical cost.
Capitalization considers three items:
1. Qualifying assets.
2. Capitalization period.
3. Amount to capitalize.
Qualifying Assets
Require a substantial period of time to get them ready
for their intended use.
Two types of assets:
Assets under construction for a company’s own
use.
Assets intended for sale or lease that are
constructed or produced as discrete projects.
Capitalization Period
Capitalization Period
Begins when:
1. Expenditures for the asset have been made.
2. Activities for readying the asset are in progress .
3. Interest costs are being incurred.
Ends when:
The asset is substantially complete and ready for use.
Amount to Capitalize
Capitalize the lesser of:
1. Actual interest costs
2. Avoidable interest - the amount of interest that
could have been avoided if expenditures for the
asset had not been made.
Discussion Questions
Q10–10 What interest rates should be used in determining the amount of
interest to be capitalized? How should interest revenue from temporarily
invested excess funds borrowed to finance the construction of assets be
accounted for?
Calculating the Actual and Avoidable Interest
Selecting Appropriate Interest Rate:
1.
For the portion of weighted-average accumulated expenditures that
is less than or equal to any amounts borrowed specifically to
finance construction of the assets, use the interest rate incurred on
the specific borrowings.
2.
For the portion of weighted-average accumulated expenditures that
is greater than any debt incurred specifically to finance construction
of the assets, use a weighted average of interest rates incurred on
all other outstanding debt during the period.
Calculating the Actual and Avoidable Interest
Actual Interest
Specific Debt
$
Debt
200,000
$
500,000
300,000
1,000,000
General Debt
Avoidable Interest
Interest
Rate
12%
Actual
Interest
$
24,000
14%
10%
$
70,000
30,000
124,000
Accumulated
Expenditures
$ 200,000
50,000
$ 250,000
Weighted-average
interest rate on
general debt
$100,000
$800,000
Interest
Rate
12%
12.5%
= 12.5%
Avoidable
Interest
$
24,000
6,250
$
30,250
Calculating the Actual and Avoidable Interest
Capitalize the lesser of Avoidable interest or Actual interest.
Avoidable interest
Actual interest
Journal entry to Capitalize Interest:
$
30,250
124,000
Example 3
On January 1, 2011, the Marlee Company began
construction of an office building to be used as its corporate
headquarters. The building was completed early in 2012.
Construction expenditures for 2011, which were incurred
evenly throughout the year, totaled $6,000,000. Marlee had
the following debt obligations which were outstanding
during all of 2011:
Construction loan, 10%
$1,500,000
Long-term note, 9%
2,000,000
Long-term note, 6%
4,000,000
Calculate the amount of interest capitalized in 2011 for the
building using the specific interest method.
Example 3
Average accumulated expenditures:
Weighted-average rate of all other debt:
Interest capitalized:
Example 4
On January 1, 2011, the Mason Manufacturing Company began construction of
a building to be used as its office headquarters. The building was completed on
September 30, 2012. Expenditures on the project were as follows:
January 1, 2011
$1,000,000
January 31, 2012
$270,000
March 1, 2011
600,000
April 30, 2012
585,000
June 30, 2011
800,000
August 31, 2012
900,000
October 1, 2011
600,000
On January 1, 2011, the company obtained a $3 million construction loan with a
10% interest rate. The loan was outstanding all of 2011 and 2012. The
company’s other interest-bearing debt included two long-term notes of
$4,000,000 and $6,000,000 with interest rates of 6% and 8%, respectively. Both
notes were outstanding during all of 2011 and 2012. Interest is paid annually on
all debt. The company’s fiscal year-end is December 31.
1. Calculate the amount of interest that Mason should capitalize in 2011 and
2012 using the specific interest method.
2. What is the total cost of the building?
3. Calculate the amount of interest expense that will appear in the 2011 and
2012 income statements.
Example 4: Continued
Expenditures for 2011:
January 1, 2011
$1,000,000
March 1, 2011
600,000
June 30, 2011
800,000
October 1, 2011
600,000
Accumulated expenditures
(before interest) $3,000,000
Average accumulated expenditures -
x 12/12 = $1,000,000
x 10/12 =
500,000
x 6/12 =
400,000
x 3/12 =
150,000
$2,050,000
Interest capitalized:
$2,050,000 x 10% = $205,000 = Interest capitalized in 2011
Example 4: Continued
Expenditures for 2012:
January 1, 2012
$3,205,000 x 9/9 = $3,205,000
January 31, 2012
270,000 x 8/9 =
240,000
April 30, 2012
585,000 x 5/9 =
325,000
August 31, 2012
900,000 x 1/9 =
100,000
Accumulated expenditures
(before interest) $4,960,000
Average accumulated expenditures $3,870,000
Weighted-average rate of all other debt:
$ 4,000,000 x 6% = $240,000
$ 720,000
6,000,000 x 8% = 480,000
$10,000,000
= 7.2%
$10,000,000
$720,000
Interest capitalized:
$3,000,000 x 10.0% x 9/12 = $225,000
870,000 x 7.2% x 9/12 = 46,980
$271,980 = Interest capitalized in 2012
Example 4: Continued
Cost of Building:
Expenditures in 2011
Interest capitalized in 2011
Expenditures in 2012
Interest capitalized in 2012
Total cost of building
Interest Expense for 2011:
$3,000,000 x 10% =
4,000,000 x 6% =
6,000,000 x 8% =
Total interest incurred
Less: Capitalized
2011 expense
Interest Expense for 2012:
Total interest incurred
Less: Capitalized
2012 expense
$3,000,000
205,000
1,755,000
271,980
$5,231,980
$ 300,000
240,000
480,000
1,020,000
(205,000)
$ 815,000
$1,020,000
(271,980)
$ 748,020
Example 4b: Continued
On January 1, 2011, the Mason Manufacturing Company began construction of
a building to be used as its office headquarters. The building was completed on
September 30, 2012. Expenditures on the project were as follows:
January 1, 2011
$1,000,000
January 31, 2012
$270,000
March 1, 2011
600,000
April 30, 2012
585,000
June 30, 2011
800,000
August 31, 2012
900,000
October 1, 2011
600,000
On January 1, 2011, the company obtained a $3 million construction loan with a
10% interest rate. The loan was outstanding all of 2011 and 2012. The
company’s other interest- bearing debt included two long- term notes of
$4,000,000 and $6,000,000 with interest rates of 6% and 8%, respectively. Both
notes were outstanding during all of 2011 and 2012. Interest is paid annually on
all debt. The company’s fiscal year-end is December 31.
1. Calculate the amount of interest that Mason should capitalize in 2011 and
2012 using the weighted-average method.
2. What is the total cost of the building?
3. Calculate the amount of interest expense that will appear in the 2011 and
2012 income statements.
Example 4b: Continued
Weighted-average rate of all debt:
$ 3,000,000 x 10% = $ 300,000
4,000,000 x 6% =
240,000
6,000,000 x 8% =
480,000
$13,000,000
$1,020,000
$ 1,020,000
$13,000,000
Expenditures for 2011:
Accumulated expenditures (before interest) Average accumulated expenditures -
= 7.85%
$3,000,000
$2,050,000
Interest capitalized:
$2,050,000 x 7.85% = $160,925 = Interest capitalized in 2011
Example 4b: Continued
Expenditures for 2012:
January 1, 2012
$3,160,925 x 9/9 = $3,160,925
January 31, 2012
270,000 x 8/9 =
240,000
April 30, 2012
585,000 x 5/9 =
325,000
August 31, 2012
900,000 x 1/9 =
100,000
Accumulated expenditures
(before interest) $4,915,925
Average accumulated expenditures $3,825,925
Interest capitalized:
$3,825,925 x 7.85% x 9/12 = $225,251 = Interest capitalized in 2012
Example 4b: Continued
Cost of Building:
Expenditures in 2011
Interest capitalized in 2011
Expenditures in 2012
Interest capitalized in 2012
Total cost of building
$3,000,000
160,925
1,755,000
225,251
$5,141,176
Interest Expense for 2011:
Total interest incurred
Less: Capitalized
2011 expense
$1,020,000
(160,925)
$ 859,075
Interest Expense for 2012:
Total interest incurred
Less: Capitalized
2012 expense
$1,020,000
(225,251)
$ 794,749
Noncash Acquisitions
The asset acquired is recorded at the fair value of the
consideration given or the fair value of the asset acquired,
whichever is more clearly evident.
• Issuance of equity securities
• Deferred payments
• Donated Assets
• Exchanges
Noncash Acquisitions
Issuance of Equity Securities
• Asset acquired is recorded at the fair value of the asset or the
market value of the securities, whichever is more clearly
evident.
• If the securities are actively traded, market value can be
easily determined.
• If the securities given are not actively traded, the fair value of
the asset received, as determined by appraisal, may be more
clearly evident than the fair value of the securities.
Donated Assets
• On occasion, companies acquire assets through donation.
• The receiving company is required to record
– The donated asset at fair value.
– Revenue equal to the fair value of the donated asset.
Example 5
On January 1, 2011, Byner Company purchased a used
tractor. Byner paid $5,000 down and signed a noninterestbearing note requiring $25,000 to be paid on December 31,
2013. The fair value of the tractor is not determinable. An
interest rate of 10% properly reflects the time value of
money for this type of loan agreement. The company’s
fiscal year-end is December 31.
• Prepare the journal entry to record the acquisition of the
tractor.
• How much interest expense will the company include in
its 2011 and 2012 income statements for this note?
• What is the amount of the liability the company will report
in its 2011 and 2012 balance sheets for this note?
Example 5: Continued
Prepare the journal entry.
PV(FV=25,000, pmt=0, n=3, i=10%) = 18,783
How much interest expense will the company include in its 2011 and 2012
income statements for this note?
What is the amount of the liability the company will report in its 2011 and
2012 balance sheets for this note?
Dispositions
Steps:
1. Update depreciation to date of disposal.
2. Remove original cost of asset and accumulated
depreciation from the books.
3. Record what you received.
4. The difference between book value of the asset and the
amount received is recorded as a gain or loss.
Exchanges
Generally cost of asset acquired is:
– fair value of asset given up plus cash paid or minus
cash received or
– fair value of asset acquired, if it is more clearly
evident
• In the exchange of operational assets, fair value is used
except in rare situations in which the fair value cannot be
determined or the exchange lacks commercial
substance.
• When fair value cannot be determined or the exchange
lacks commercial substance, the asset(s) acquired are
valued at the book value of the asset(s) given up, plus
(or minus) any cash exchanged. No gain is recognized.
Example 6
Southern Company owns a building that it leases. The building’s fair
value is $1,400,000 and its book value is $800,000 (original cost of
$2,000,000 less accumulated depreciation of $1,200,000). Southern
exchanges this for another building owned by the Eastern
Company. The building’s book value on Eastern’s books is
$950,000 (original cost of $1,600,000 less accumulated depreciation
of $650,000). Eastern also gives Southern $140,000 to complete
the exchange. The exchange has commercial substance for both
companies. Prepare the journal entries to record the exchange on
the books of Southern.
Example 6: Continued
Southern Company owns a building that it leases. The building’s fair
value is $1,400,000 and its book value is $800,000 (original cost of
$2,000,000 less accumulated depreciation of $1,200,000). Southern
exchanges this for another building owned by the Eastern
Company. The building’s book value on Eastern’s books is
$950,000 (original cost of $1,600,000 less accumulated depreciation
of $650,000). Eastern also gives Southern $140,000 to complete
the exchange. The exchange has commercial substance for both
companies. Prepare the journal entries to record the exchange on
the books of Eastern.
Discussion Questions
Q10–16 Stan Ott is evaluating two recent transactions involving
exchanges of equipment. In one case, the exchange has
commercial substance. In the second situation, the exchange
lacks commercial substance. Explain to Stan the differences in
accounting for each situation?
Discussion Questions
Q10–16 Stan Ott is evaluating two recent transactions involving
exchanges of equipment. In one case, the exchange has
commercial substance. In the second situation, the exchange lacks
commercial substance. Explain to Stan the differences in
accounting for each situation?
Exchange Lacks Commercial Substance
• When exchanges are recorded at fair value, any gain or loss
is recognized for the difference between the fair value and
book value of the asset(s) given-up. To preclude the
possibility of companies engaging in exchanges of
appreciated assets solely to be able to recognize gains, fair
value can only be used in legitimate exchanges that have
commercial substance.
A nonmonetary exchange is considered to have commercial
substance if the company:
1. expects a change in future cash flows as a result of the
exchange, and
2. that expected change is significant relative to the fair value of
the assets exchanged.
Example 7
The Tinsley Company exchanged land that it had been
holding for future plant expansion for a more suitable parcel
located farther from residential areas. Tinsley carried the
land at its original cost of $30,000. According to an
independent appraisal, the land currently is worth $72,000.
Tinsley gave $14,000 in cash to complete the transaction.
What is the fair value of the new parcel of land received by
Tinsley?
Example 7: Continued
The Tinsley Company exchanged land that it had been
holding for future plant expansion for a more suitable parcel
located farther from residential areas. Tinsley carried the
land at its original cost of $30,000. According to an
independent appraisal, the land currently is worth $72,000.
Tinsley gave $14,000 in cash to complete the transaction.
Prepare the journal entry to record the exchange assuming
the exchange has commercial substance.
Example 7: Continued
The Tinsley Company exchanged land that it had been
holding for future plant expansion for a more suitable parcel
located farther from residential areas. Tinsley carried the
land at its original cost of $30,000. According to an
independent appraisal, the land currently is worth $72,000.
Tinsley gave $14,000 in cash to complete the transaction.
Prepare the journal entry to record the exchange assuming
the exchange lacks commercial substance.
Accounting for Contributions
When a company contributes a non-monetary asset, it should
record the amount of the donation as an expense at the fair
value of the donated asset.
Example: Kline Industries donates land to the city of Los
Angeles for a city park. The land cost $80,000 and has a fair
value of $110,000. Kline Industries records this donation as
follows.
Contribution Expense
Land
Gain on Disposal of Land
110,000
80,000
30,000
LO 5
Discussion Questions
Q10–19 What accounting treatment is normally given to the
following items in accounting for plant assets? (a)
additions, (b) major repairs, (c) improvements and
replacements.
Discussion Questions
Q10–19
Disposition of PP&E
A company may retire plant assets voluntarily or dispose of
them by
Sale.
Involuntary conversion.
Depreciation must be taken up to the date of disposition.
Example 8
Sale of Plant Assets
Example: Ottawa Corporation owns machinery that cost $20,000
when purchased on July 1, 2009. Depreciation has been recorded
at a rate of $2,400 per year, resulting in a balance in accumulated
depreciation of $8,400 at December 31, 2012. The machinery is
sold on September 1, 2013, for $10,500.
Prepare journal entries to
a) update depreciation for 2013 and
b) record the sale.
Example 8: Continued
a) Depreciation for 2013
b) Record the sale
Disposition of PP&E
Involuntary Conversion
Sometimes an asset’s service is terminated through some type
of involuntary conversion such as fire, flood, theft, or
condemnation.
Companies report the difference between the amount
recovered (e.g., from a condemnation award or insurance
recovery), if any, and the asset’s book value as a gain or loss.
They treat these gains or losses like any other type of
disposition.