ACCT373
Intermediate Accounting II
Otto H. Chang
Professor of Accounting
Acquisition of Property, Plant, &
Equipment
• PPE defined: L-T fixed assets used in
normal business operation (c.f. investment
or other assets)
• Recorded at historical cost when acquired:
measured by cash or cash equivalent price
of obtaining the asset and bringing to the
location and condition necessary for its
intended use.
Specific Examples
• Cost of Land: includes costs for removal of
old building and special assessment for
local improvement such as pavement, lights
• Cost of land improvement: improvements
with limited lives should be separated from
land.
• Cost of land held for investment: includes
capitalized annual taxes and insurance costs
Self-Constructed Assets
• Should fixed overhead be allocated? If so,
on what basis? On the basis of resource
usage or the cost of lost production? What
happened if costs exceeds FMV?
• How to treat interest expenses incurred?
– As financing expense (no capitalization)
– Capitalize interest incurred during construction
– Capitalize all costs of funds, including imputed
SFAS #34 Capitalization of
Interest Cost
• Interest cost should be capitalized for
qualifying assets during the capitalization
period at an amount equal to the lesser of
actual interest incurred or avoidable interest
• Qualifying assets: assets requiring a period
of time to complete (if for sale, they must
produced as discrete projects, e.g., ships or
real estate developments)
Capitalization Period
• A period when the following three
conditions are present:
– Expenditures for the asset have been incurred
– Construction activities are in process
– Interest cost is being incurred
• Interest capitalization continues as log as
the three conditions are present
Amount to Capitalize
• Limited to the lower of actual interest
incurred in the period or avoidable interest
• Actual interest incurred during the period:
includes interest cost from all debts
(maximum amount to capitalize)
• Avoidable interest: interest costs that could
have been avoided if the project was not
taken
Avoidable Interest
• Avoidable interest = Weighted-Average
Accumulated Expenditures x interest rates
• Interest rates to be used:
– When WAAE is less than or equal to the
construction loan, use construction loan rate
– For excess WAAE, use weighted-average
interest rate from all other debts
Weighted-Average Accumulated
Expenditures
• Excludes expenditures require no interest
payments such as accounts payable
• includes capitalized interest cost