INTERMEDIATE
ACCOUNTING
Sixth Canadian Edition
KIESO, WEYGANDT, WARFIELD, IRVINE, SILVESTER, YOUNG, WIECEK
Prepared by:
Gabriela H. Schneider, CMA; Grant MacEwan College
CHAPTER
11
Acquisition and Disposition of
Tangible Capital Assets
Learning Objectives
1. Describe the major characteristics of tangible
capital assets.
2. Identify the costs included in the initial
valuation of land, buildings, and equipment.
3. Describe the accounting problems associated
with self-constructed assets.
4. Describe the accounting problems associated
with interest capitalization.
Learning Objectives
5. Understand accounting issues related to
acquiring and valuing plant assets.
6. Describe the accounting treatment for costs
subsequent to acquisition.
7. Describe the accounting treatment for the
disposal of property, plant, and equipment.
Acquisition and Disposition of
Tangible Capital Assets
Acquisition
Other “Cost”
Issues
Acquisition costs: Cash discounts
land buildings,
Deferred contracts
equipment
Lump sum
Self-constructed
Share issuance
assets
Nonmonetary
Interest during
exchanges
construction
Contributions
Investment tax
credit
Other valuation
methods
Costs
Disposition
Subsequent to
Acquisition
Sale
Additions
Improvements and
replacements
Rearrangement and
reinstallation
Repairs
Involuntary
conversion
Donations
Miscellaneous
problems
Tangible Capital Assets
• Examples:
property, plant, and equipment
plant assets
fixed assets
• Major characteristics are:
1. acquired for use in operations and not for
resale
2. long-term in nature and usually subject to
amortization
3. possess physical substance
Acquisition Cost
• Historical cost is the basis for determining
cost
• Historical cost includes:
• the asset’s cash or cash equivalent price
• the cost of readying the asset for it’s intended use
• Costs incurred after acquisition are:
• added to asset’s cost, if they provide future
service potential
• expensed, if they do not add to service potential
Cost of Land
• Land costs include:
• purchase price
• closing costs, land title fees, legal fees, and
recording fees
• costs of getting land ready for use (removing of
old buildings, clearing, grading, etc.)
• special assessments for local improvements
• assumption of liens or encumbrances
• additional improvements with an indefinite life
• Sale of salvaged materials reduce cost of land
Land Improvements, Building, and Plant
• Improvements with limited lives are recorded as
Land Improvements (and not as Land)
• Building cost includes:
• costs of materials and labour and overhead
• professional fees and building permits
• Cost of equipment includes:
• purchase price
• freight and handling charges
• insurance while in transit
• costs of special foundation, assembly and installation
• trial runs
Self-Constructed Assets
• These are assets constructed by the business
for use in operations
• The cost of self-constructed assets includes:
• cost of direct materials
• cost of direct labour
• variable manufacturing overhead
• a pro rata portion of the fixed overhead
• actual interest costs incurred during construction
(with modification)
Interest Capitalization
• Interest costs incurred during construction
of capital assets
• Accepted approach to interest
capitalization:
Capitalize only the actual interest costs incurred
during construction
- follows historical cost concept, with only
actual costs recorded
- disclosure of capitalized interest must be
disclosed
Interest Capitalization
• CICA Handbook, par. 1000.60(b)
professional judgement is appropriate in
determining interest to be capitalized.
• Following FASB Statement 34, three questions
must be answered:
• What are the qualifying assets?
• What is the capitalization period?
• What is the amount of interest to be capitalized?
Qualifying Assets
• List includes:
– assets under construction for company’s
own use
– assets intended for sale or lease produced
as discrete projects
• Non-qualifying assets include:
– assets in use or ready for intended use
– assets not be used in company’s earnings
activities
Capitalization Period
•
Capitalization period begins when
three conditions are present:
1. Expenditures for the asset have been made
2. Activities for readying the asset are in progress
3. Interest cost is being incurred
•
Capitalization continues for as long as these
three conditions exist
•
Capitalization ends when asset is
substantially complete and ready for use
Amount to Capitalize
• Amount of interest to be capitalized is the
lesser of:
• the actual interest cost incurred on debt
• the avoidable interest for construction of asset
• Avoidable interest is the amount that could
have been avoided, if expenditures for the
asset had not been made
• Weighted-average accumulated expenditures
calculation required
Computing Avoidable Interest:
Steps
1
2
Determine
weighted-average
accumulated
expenditures
Multiply
by
Avoidable interest
Capitalize, if less
than actual interest
Appropriate
interest rate
(see page 501)
Interest Capitalization: Example
Given:
Bridge construction project – time line 17 months
Payments made to Contractor:
March 1
$ 240,000
July 1
$ 480,000
November 1
$ 360,000
Total
$1,080,000
Year-end: December 31st
Compute the Weighted-Average Accumulated
Expenditure at December 31st .
Weighted-Average Accumulated
Expenditure (WAAE)
Date
Amount
Capitalization
Period
WAAE
March 1
$240,000
10/12 months
$200,000
July 1
$480,000
6/12 months
$240,000
Nov. 1
$360,000
2/12 months
$ 60,000
December 31st – WAAE
= $500,000
Capitalization period: time between the expenditure date and the date
interest capitalization stops or year-end (whichever comes first)
Interest Capitalization – Special
Issues: Land Expenditures
Amount of Capitalized Interest based on
the intent of the land purchased
Intent
Capitalized Interest Cost Attached to:
Specific Purpose
Land
Structure Site
Structure
Lot Sales
Developed land
Investment
Interest costs should not
be capitalized
Interest Capitalization – Special
Issues: Interest Revenue
• When funds borrowed for asset
acquisition are not immediately used
• May be temporarily invested
• Should the interest earned be netted
out against the capitalized interest cost?
• Current treatment is to treat the
interest earned as a revenue item
Interest Capitalization – Special Issues:
Interest Capitalization Significance
•
•
•
Capitalized interest increases net
income for the period
Impact on EPS can be significant
Two main arguments on the treatment
of interest and capitalization
1. Interest should be capitalized on all “preearning” assets
2. No interest should be capitalized; interest
is an expense of the period
Other Cost Issues
• Cash Discounts
– The Net-of-Discount Method is the preferred method
• Deferred Payment Contracts
– Assets, purchased through long-term credit, are
recorded at the present value of the consideration
exchanged
• Lump Sum Purchase
– Cost of assets, acquired at a single lump sum price, is
allocated to assets on the basis of their relative fair
market values
Other Cost Issues
• Issuance of Shares
– Market value of publicly-traded shares serve as
the cost of the acquired asset
– When shares have no determinable market value,
use the market value of the acquired asset
• Nonmonetary Exchange of Assets
– Transaction is nonmonetary where cash is 10% or
less of the total fair value given up or received
• Dissimilar Assets
• Similar Assets
Exchange of Nonmonetary
Assets
• The basic rule is that the exchange must be
based on:
– the fair value of the asset given up, or
– the fair value of the asset received
whichever is clearly more evident.
• The rules for gain / loss recognition depend
upon whether the assets exchanged are:
– dissimilar assets or
– similar assets
Accounting for Exchanges
Types of
Exchange
Accounting
Guidance
Rationale
Dissimilar
Assets
Recognize gain
and losses
Earnings process
is complete
Similar Assets
(Cash
Received )
Recognize loss;
Gain up to boot
(partial gain)
Earnings process
is partially
complete
Similar Assets
(No Cash
received)
Recognize loss;
Defer gain
Earnings process
is not complete
Recognize gain
and losses
Earnings process
is complete
NonMonetary
(Similar or Dissimilar Assets exchanged)
Dissimilar Assets
• Amber Company exchanges a number of trucks for land
from Becktel company.
• Fair value of trucks:
$ 49,000
• Book value of trucks:
$ 42,000
(Cost, $64,000; Accum. Amor., $ 22,000)
• Cash paid to Becktel (boot):
$ 17,000
• Record the purchase in Amber’s books.
Land
Accumulated Amortization
Trucks
Cash
Gain on disposal
66,000
22,000
64,000
17,000
7,000
Similar Assets (Loss)
• Amber Company exchanges a used machine for a
similar machine from Becktel company.
• Fair value of used machine:
$ 6,000
• Book value of used machine: $ 8,000
(Cost, $12,000; Accu. Amor., $ 4,000)
• Cash paid to Becktel:
$ 7,000
• Record the purchase in Amber’s books.
New Machine
Accumulated Amortization
Loss on disposal
Machine (old)
Cash
13,000
4,000
2,000
12,000
7,000
Other Cost Issues
•
Contribution of Assets
–
–
–
Nonreciprocal transfers: transfer of assets where
nothing is given up in exchange (e.g. donations, gift,
grants)
Asset’s fair market value used as cost of the asset
Two approaches to valuing and recording such
transfer:
1. Capital Approach: credit contributed surplus account
(donated capital)
2. Income Approach: credit represents income and the gain is
deferred over the life of the asset (exception being land)
a) Cost Reduction Method: credit the respective asset account
b) Deferral Method: credit Deferred Revenue
Other Cost Issues
• Investment Tax Credit (ITC)
– Governed by tax legislation
– Income is reduced in the year of acquisition by a
prescribed percentage of the cost of eligible
capital assets
– ITCs are accounted for following Accounting
Standards Board policy: taken into income using
either:
• Cost Reduction Method, or
• Deferral Method
Costs Subsequent to Acquisition
• If costs incurred increase future benefits,
capitalize costs (Capital Expenditure)
• If costs maintain a given level of services,
expense costs (Revenue Expenditure)
• Costs incurred after acquisition can be:
Additions: increase or extension of existing assets
Improvements and replacements: substitution of an
existing asset for an improved one
Rearrangement and reinstallation: moving asset from one
location to another
Repairs: costs that maintain assets in operating condition
Improvements and Replacements
Capitalize costs, if
They increase future service potential
Improvements
Substitution of
a better asset
for present
asset
or
Replacements
Substitution of
a similar asset
for present
asset
Capitalization Approaches
• Carrying value of
asset is known
• Substitution approach
• Carrying value of the • Capitalize the new asset
(without removing the
asset is unknown
old asset from the
pool), or
• Debit accumulated
amortization (when
expenditures extend
useful life of asset)
Dispositions of PP&E
• Plant assets may be:
– retired voluntarily, or
– disposed of by sale, exchange, involuntary conversion
• Amortization is recorded up to the date of
disposal before determining gain or loss
• Gains or losses from involuntary conversion are
often reported as extraordinary items
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