18th
Edition
Chapter 10
Investments in
Noncurrent
Operating Assets—
Acquisitions
Intermediate
Accounting
James D. Stice
Earl K. Stice
PowerPoint presented by Douglas Cloud
Professor Emeritus of Accounting, Pepperdine University
© 2012 Cengage Learning
10-1
What Costs Are Included in
Acquisition Cost?
•
•
•
Noncurrent operating assets are recorded
initially at cost—the original bargained or
cash sales price.
The cost of property includes not only the
original purchase price or equivalent value
but also any other expenditures required in
obtaining and preparing the asset for its
intended use.
Any taxes, freight, installation, and other
expenditures related to the acquisition should
be included in the asset’s cost.
10-2
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.
(continued)
10-3
Buildings
•
•
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
(continued)
10-4
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
(continued)
10-5
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.
(continued)
10-6
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.
10-7
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.
10-8
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 that
the product be completed and shipped.
(continued)
10-9
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.
Goodwill is a residual number, the value of
all of the synergies of a functioning
business that cannot be specifically
identified with any other intangible factor.
10-10
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.
(continued)
10-11
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.
10-12
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, 2013, 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%.
(continued)
10-13
Deferred Payment
Jan. 2, 2013—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
Cash
Notes Payable
100,000
35,000
65,000
June 30, 2013—Made first payment.
Interest Expense
Notes Payable
Cash
3,250
5,000
8,250
$65,000  0.05
(continued)
10-14
Deferred Payment
On January 2, 2013, 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, or a
total cost of $65,323. The present value of
the seven payments at the implicit effective
interest rate of 10 percent is $35,000.
(continued)
10-15
Deferred Payment
On January 2, 2013, purchased equipment with
a cash price of $50,000 for $15,000 down plus
seven annual payments of $7,189 each.
Equipment
Discount on Notes Payable
Notes Payable
Cash
50,000
15,323
50,323
15,000
(continued)
10-16
Deferred Payment
Made first payment of $7,189 on December 31,
2013. Calculations for amortization of debt
discount are as follows:
$50,323 – $15,323 = $35,000; $35,000  10% = $3,500
Notes Payable
Cash
7,189
Interest Expense
Discount on Notes Payable
3,500
7,189
3,500
(continued)
10-17
Deferred Payment
Made the second payment of $7,189 and
amortized debt discount on December 31, 2014.
Notes Payable
Cash
Interest Expense*
Discount on Notes Payable
7,189
7,189
3,131
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
$31,311  0.10 = $3,131
10-18
Leasing
•
•
•
A lease is a contract whereby one party (the
lessee) is granted a right to use property owned
by another party (the lessor) for a specified
period of time for a specified periodic cost.
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.
10-19
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 (cash, accounts
receivable).
• Nonmonetary assets include all the other
assets (inventories, land).
10-20
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.
(continued)
10-21
Acquisition by Issuing
Securities
A company issues 1,000 shares of $1 par
common stock in acquiring land; the
stock has a current market price of $45
per share. The entry should be recorded
as follows:
Land
Common Stock
Paid-in Capital in Excess
of Par
45,000
1,000
44,000
10-22
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.
10-23
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, but a
savings.
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).
10-24
Interest During Period
of Construction
• Capitalization of interest is required for
assets, such as buildings and equipment, 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.
(continued)
10-25
Interest During Period
of Construction
The following basic guidelines govern the
computation of capitalized interest:
1. Interest charges begin when the first
expenditures are made on the project and
continue as long as work continues and until
the asset is completed and actually ready for
use.
2. The amount of interest to be capitalized is
computed using the accumulated expenditure
for the project, weighted based on when the
expenditures were made during the year.
(continued)
10-26
Interest During Period
of Construction
3. The interest rate to be used in calculating the
amount of interest to capitalize are, in the
following order:
a) Interest rate incurred for any debt
specifically incurred for funds used on the
project.
b) Weighted-average interest rate from all
other enterprise borrowings regardless of
the use of funds.
(continued)
10-27
Interest During Period
of Construction
4. If the construction period covers more than
one fiscal period, accumulated expenditures
include prior years’ capitalized interest.
The results provided by the four steps is the
maximum interest that can be capitalized for the year.
10-28
IASB on Interest Capitalization
•
In 2007 the IASB revised IAS 23 to require,
starting on January 1, 2009, that all
companies capitalize “borrowing costs”
incurred in the construction of a long-term
asset.
•
The international standard requires that
companies capitalize the net amount of
interest incurred rather than the gross
amount.
10-29
Acquisition by Donation
or Discovery
•
When property is received through
donation, there is no cost that can be used
as a basis for its valuation.
•
Property acquired through donation should
be appraised and recorded at its fair value.
•
A donation is recognized as a gain in the
period in which it is received.
(continued)
10-30
Acquisition by Donation
or Discovery
Netty’s Ice Cream Parlor is given a
donation of land and a building by an
eccentric ice cream lover. The entry, using
appraised values, is as follows:
Land
Buildings
Revenue or Gain
400,000
1,500,000
1,900,000
(continued)
10-31
Acquisition by Donation
or Discovery
• FASB ASC paragraph 845-10-S99-1
requires that when a corporation receives
nonmonetary assets as an investment by a
shareholder, the assets are recorded by the
company at the shareholder’s historical cost.
• Depreciation of an asset acquired by gift
should be recoded in the usual manner, the
value assigned to the asset providing the
basis for the depreciation charge.
(continued)
10-32
Acquisition by Donation
or Discovery
•
If a gift is contingent upon some act to be
performed by the recipient, no asset should
be reported until the conditions of the gift
have been met.
•
A discovery that greatly increases the
value of the property is commonly ignored
in the accounting in the U.S. This also
applies to accretion values, such as
growing timber or aging wine.
10-33
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.
(continued)
10-34
Asset with Significant Restoration
Costs at Retirement
The journal entries to record the purchase
and the asset retirement obligation follow:
Oil Platform
Cash
750,000
750,000
Oil Platform
Asset Retirement
Obligation
(continued)
46,319
46,319
10-35
Asset with Significant Restoration
Costs at Retirement
•
Homer Company constructs and
commences operation of a nuclear power
plant. Total construction cost is $400,000.
•
The cost of cleaning up the routine
contamination is estimated to be $500,000;
this cost will be incurred in 30 years when
the plant is decommissioned. Additional
annual contamination cleanup cost
$40,000. Assume an interest rate of 9%.
(continued)
10-36
Asset with Significant Restoration
Costs at Retirement
Initial Acquisition
Nuclear Plant
Cash
Nuclear Plant
Asset Retirement
Obligation
FV = $500,000; I = 9%;
N = 30 years  $37,686
400,000
400,000
37,686
37,686
After One Year
Nuclear Plant
Asset Retirement
Obligation
3, 286
3,286
FV = $40,000; I = 9%;
N = 29 years $3,286
10-37
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
(i.e., a building’s heating and cooling
system).
Expenditures to maintain plant assets in
good operating condition are referred to
as maintenance.
(continued)
10-38
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.
(continued)
10-39
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. If a part is
removed and replaced with a different part,
the cost and accumulated depreciation
related to the replaced part should be
treated like any removed plant asset.
(continued)
10-40
Renewals and Replacements
Mendon Fireworks Company replaces
the roof of its manufacturing plant for
$40,000. The original cost of the building
was $1,600,000, and it is three-fourths
depreciated. The original roof cost
$20,000 and the new roof is recorded as
a separate component.
(continued)
10-41
Renewals and Replacements
Roof
Accumulated Depreciation—
Buildings (old roof)
Depreciation Expense
Buildings (old roof)
Cash
40,000
15,000
5,000
20,000
40,000
$20,000  3/4
$20,000  $15,000
10-42
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.
10-43
Research and Development
•
•
The FASB defined research activities as
those undertaken to discover new
knowledge that will be useful in developing
new products, services, or process or that
will result in significant improvements of
existing products or processes.
Development activities involve the
application of research findings to develop
a plan or design for new or improved
products or processes.
(continued)
10-44
Research and Development
Research and development costs include
those costs of:
Unless Research
•
•
•
•
•
•
•
materials
and development
expenditures have
equipment
alternative future
facilities
uses, they are
personnel
expensed in the
purchased intangibles
period they occur.
contract services
a reasonable allocation of indirect cost specifically
related to research and development
10-45
Computer Software
Development Expenditures
•
•
All costs in developing computer software
incurred up to the point where
technological feasibility is established
are expensed as research and
development (planning, design, and testing
activities).
Testing done after the establishment of
technological feasibility and the cost to
produce masters can be capitalized.
10-46
International Accounting
for R&D: IAS 38
• IAS 38 requires research costs to be
•
•
expensed and development costs to be
capitalized.
Preliminary indications are that the
general approach to R&D accounting in
IAS 38 will be adopted by the FASB.
Currently, U.S. GAAP requires that all R&D
costs be expensed except for postfeasibility computer software development.
10-47
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.
 Negative reaction: Small independent oil firms argued
that expensing costs that they have been capitalizing
would result in lower profits, depressed stock prices,
and difficulty in getting loans.
(continued)
10-48
Five General Categories of
Intangible Assets
1. Marketing-related intangible assets such
as trademarks, brand names, and Internet
domain names.
2. Customer-related intangible assets such
as customer lists, order backlogs, and
customer relationships.
3. Artistic-related intangible assets such as
items protected by copyright.
4. Contract-based intangible assets such as
licenses, franchises, and broadcast rights.
(continued)
10-49
Five General Categories of
Intangible Assets
5. Technology-based intangibles such as
both patented and unpatented technologies
as well as trade secrets.
10-50
Estimating the Fair
Value of Intangibles
•
The most difficult part of recording an
amount for an intangible is estimating its
fair value.
•
As described in Concepts Statement No.
7, the present value of future cash flows
can be used to estimate fair value in one
of two ways, the traditional approach and
the expected cash flow approach.
(continued)
10-51
Estimating the Fair
Value of Intangibles
Traditional Approach
Intangible Asset A is the right to receive royalty
payments in the future of $1,000 payments at
the end of each of the next five years. The riskadjusted interest rate is 12%. The fair value of
the patent is calculated as follows:
Table Value (n = 5; I = 12)  $1,000 = PV(annuity)
3.605  $1,000 = $3,605
(continued)
10-52
Estimating the Fair
Value of Intangibles
Expected Cash Flow Approach
Intangible Asset B is a secret formula to
produce a healthy fast-food cheeseburger that
is expected to have the following associated
probabilities of happening:
Outcome 1 = 10% probability of cash flows of $5,000 at
the end of each year for 10 years
Outcome 2 = 30% probability of cash flows of $1,000 at
the end of each year for 4 years
(continued)
10-53
Estimating the Fair
Value of Intangibles
Outcome 3 = 60% probability of cash flows of $100 at the
end of each year for 3 years
10-54
Acquired In-Process
Research and Development
The FASB ruled that in-process R&D is to
be recognized as an intangible asset if it is
acquired as part of a business combination
but is to be expensed if acquired as part of
a basket purchase outside of a business
combination.
The FASB realizes that this is
an inconsistency and they
intend to revisit it in the future.
10-55
Intangibles Acquired in the
Acquisition of a Business
•
•
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.
10-56
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 in Slide 10-65.
(continued)
10-57
Bargain Purchase
Note that a gain is recognized
10-58
International Accounting for
Intangibles: IAS 38 and IFRS 3
•
The IASB’s standard for the accounting of
intangible assets is IAS 38.
•
This IASB standard is very much
compatible with U.S. GAAP.
•
The most significant differences between
U.S. GAAP and IASB standards in the
accounting for intangible assets are in
testing these assets for impairment.
10-59
Valuation of Assets
at Fair Values
•
In IAS 16, the IASB permits the inclusion of
upward revaluations of noncurrent operating
assets in the financial statements as an
allowable alternative to reporting the historical
cost of those assets.
 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.
(continued)
10-60
Valuation of Assets at
Fair Values
 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.
 This practice means that upward revaluations
cannot be used to boost reported income.
 When the asset that has revalued upward is
subsequently sold, any associated balance in
the special revaluation equity is credited
directly to Retained Earnings.
10-61
Fixed Asset Turnover Ratio
General Electric’s manufacturing segments had
sales for 2008 totaled $182,515. Its beginning
and ending property, plant, and equipment
balances were $77,888 and $78,530,
respectively.
($77,888 + $78,530)
Average fixed assets =
2
= $78,209
Sales
$182,515
Fixed asset turnover ratio =
= 2.33
Average
fixed assets
$78,209
(continued)
10-62
Fixed Asset Turnover Ratio
General Electric’s manufacturing segments had
sales for 2009 totaled $156,783. Its beginning
and ending property, plant, and equipment
balances were $78,530 and $69,212,
respectively.
($78,530 + $69,212)
Average fixed assets =
2
= $73,871
Fixed asset turnover ratio =
Sales
$156,783
= 2.12
Average
fixed assets
$73,871
10-63
Dangers in Using the Fixed
Asset Turnover Ratio
•
Fixed asset turnover ratios values for two
companies in different industries cannot be
meaningfully compared.
•
The reported amount for property, plant,
and equipment can be a poor indicator of
the actual fair value of fixed assets being
used by a company.
10-64
Chapter 10
₵
The End
$
10-65
10-66