Chapter
10-1

C H A P T E R 10
Chapter
10-2
Intermediate Accounting
13th Edition
Kieso, Weygandt, and Warfield

Learning Objectives
1.
Describe property, plant, and equipment.
2.
Identify the costs to include in initial valuation of property, plant, and equipment.
3.
Describe the accounting problems associated with self-constructed assets.
4.
Describe the accounting problems associated with interest capitalization.
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.
Chapter
10-3

Acquisition and Disposition of
Property, Plant, and Equipment
Acquisition
Acquisition costs:
Land, buildings, equipment
Self-constructed assets
Interest costs
Observations
Valuation
Cash discounts
Deferred contracts
Lump-sum purchases
Stock issuance
Nonmonetary exchanges
Contributions
Other valuation methods
Cost Subsequent to Acquisition
Additions
Improvements and replacements
Rearrangement and reinstallation
Repairs
Summary
Dispositions
Sale
Involuntary conversion
Miscellaneous problems
Chapter
10-4

Chapter
10-5
Property, Plant, and Equipment
Property, plant, and equipment includes land, buildings, and equipment (machinery, furniture, tools).
Major characteristics include:
“Used in operations” and not for resale.
Long-term in nature and usually depreciated.
Possess physical substance.
LO 1 Describe property, plant, and equipment.

Acquisition of PP&E
Historical cost is reliable.
Companies should not anticipate gains and losses but should recognize gains and losses only when the asset is sold.
APB Opinion No. 6 states, “property, plant, and equipment should not be written up to reflect appraisal, market, or current values which are above cost.”
Chapter
10-6
LO 2 Identify the costs to include in initial valuation of property, plant, and equipment.

Acquisition of PP&E
Chapter
10-7
Includes all costs to acquire land and ready it for use.
Costs typically include:
(1) the purchase price;
(2) closing costs, such as title to the land, attorney’s fees, and recording fees;
(3) costs of grading, filling, draining, and clearing;
(4) assumption of any liens, mortgages, or encumbrances on the property; and
(5) Additional land improvements that have an indefinite life.
LO 2 Identify the costs to include in initial valuation of property, plant, and equipment.

Chapter
10-8
Acquisition of PP&E
Includes all costs related directly to acquisition or construction.
Costs typically include:
(1) materials, labor, and overhead costs incurred during construction and
(2) professional fees and building permits.
LO 2 Identify the costs to include in initial valuation of property, plant, and equipment.

Acquisition of PP&E
Chapter
10-9
Include all costs incurred in acquiring the equipment and preparing it for use.
Costs typically include:
(1) purchase price,
(2) freight and handling charges
(3) insurance on the equipment while in transit,
(4) cost of special foundations if required,
(5) assembling and installation costs, and
(6) costs of conducting trial runs.
LO 2 Identify the costs to include in initial valuation of property, plant, and equipment.

Acquisition of PP&E
E10-1 (variation): The following expenditures and receipts are related to land, land improvements, and buildings acquired for use in a business enterprise. Determine how the following should be classified:
Classification
(a) Money borrowed to pay building contractor
(b) Payment for construction from note proceeds
(c) Cost of land fill and clearing
(d) Delinquent real estate taxes on property assumed
(e) Premium on 6-month insurance policy during construction
(f) Refund of 1-month insurance premium because construction completed early
Notes Payable
Building
Land
Land
Building
(Building)
Chapter
10-10
LO 2 Identify the costs to include in initial valuation of property, plant, and equipment.

Acquisition of PP&E
E10-1 (variation): The following expenditures and receipts are related to land, land improvements, and buildings acquired for use in a business enterprise. Determine how the following should be classified:
Costs of:
(g) Architect’s fee on building
(h) Cost of real estate purchased as a plant site
(land $200,000 and building $50,000)
(i) Commission fee paid to real estate agency
(j) Installation of fences around property
Building
Land
Land
Land Improvements
(k) Cost of razing and removing building
(l) Proceeds from salvage of demolished building
Land
(Land)
(m) Cost of parking lots and driveways Land Improvements
(n) Cost of trees and shrubbery (permanent)
Chapter
10-11
Land
LO 2 Identify the costs to include in initial valuation of property, plant, and equipment.

Acquisition of PP&E
Costs typically include:
(1) Materials and direct labor
(2) Overhead can be handled in two ways:
1.
Assign no fixed overhead
2.
Assign a portion of all overhead to the construction process.
Companies use the second method extensively.
Chapter
10-12
LO 3 Describe the accounting problems associated with self-constructed assets.

Acquisition of PP&E
Three approaches have been suggested to account for the interest incurred in financing the construction.
Illustration 10-1
$ 0
Increase to Cost of Asset
$ ?
Capitalize no interest during construction
Capitalize actual costs incurred during construction
(with modification)
Capitalize all costs of funds
GAAP
Chapter
10-13
LO 4 Describe the accounting problems associated with interest capitalization.

Acquisition of PP&E
GAAP requires — capitalizing actual interest (with modification).
Consistent with historical cost — all costs incurred to bring the asset to the condition for its intended use.
Capitalization considers three items:
1.
Qualifying assets.
2.
Capitalization period.
3.
Amount to capitalize.
Chapter
10-14
LO 4 Describe the accounting problems associated with interest capitalization.

Acquisition of PP&E
Require a 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.
Chapter
10-15
LO 4 Describe the accounting problems associated with interest capitalization.

Acquisition of PP&E
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.
Chapter
10-16
LO 4 Describe the accounting problems associated with interest capitalization.

Acquisition of PP&E
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.
Chapter
10-17
LO 4 Describe the accounting problems associated with interest capitalization.

Acquisition of PP&E
Interest Capitalization Illustration: KC Corporation borrowed
$200,000 at 12% interest from State Bank on Jan. 1, 2011, for specific purposes of constructing special-purpose equipment to be used in its operations. Construction on the equipment began on
Jan. 1, 2011, and the following expenditures were made prior to the project’s completion on Dec. 31, 2011:
Actual Expenditures:
January 1, 2011
April 30, 2011
November 1, 2011
December 31, 2011
Total expenditures
$100,000
150,000
300,000
100,000
$650,000
Other general debt existing on Jan. 1, 2011:
$500,000, 14%, 10-year bonds payable
$300,000, 10%, 5-year note payable
Chapter
10-18
LO 4 Describe the accounting problems associated with interest capitalization.

Acquisition of PP&E
Determine which assets qualify for capitalization of interest.
Special purpose equipment qualifies because it requires a period of time to get ready and it will be used in the company’s operations.
Determine the capitalization period.
The capitalization period is from Jan. 1, 2011 through Dec. 31, 2011, because expenditures are being made and interest costs are being incurred during this period while construction is taking place.
Chapter
10-19
LO 4 Describe the accounting problems associated with interest capitalization.

Acquisition of PP&E
Compute weighted-average accumulated expenditures.
Weighted
Actual
Date Expenditures
Jan. 1
Apr. 30
$ 100,000
150,000
Average
Capitalization Accumulated
Period
12/12
8/12
Expenditures
$ 100,000
100,000
Nov. 1
Dec. 31
300,000
100,000
$ 650,000
2/12
0/12
50,000
-
$ 250,000
A company weights the construction expenditures by the amount of time
(fraction of a year or accounting period) that it can incur interest cost on the expenditure.
Chapter
10-20
LO 4 Describe the accounting problems associated with interest capitalization.

Acquisition of PP&E
Compute 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 .
Chapter
10-21
LO 4 Describe the accounting problems associated with interest capitalization.

Acquisition of PP&E
Compute the Actual and Avoidable Interest.
Actual Interest
Debt
Specific Debt
General Debt 500,000
300,000
Interest
Rate
12%
14%
10%
Actual
Interest
70,000
30,000
Weighted-average interest rate on general debt
$100,000
$800,000
= 12.5%
Avoidable Interest
Accumulated Interest
Expenditures Rate
50,000
12%
12.5%
Avoidable
Interest
6,250
Chapter
10-22
LO 4 Describe the accounting problems associated with interest capitalization.

Acquisition of PP&E
Capitalize the lesser of Avoidable interest or Actual interest.
Avoidable interest
Actual interest 124,000
Journal entry to Capitalize Interest:
Equipment
Interest expense
30,250
30,250
Chapter
10-23
LO 4 Describe the accounting problems associated with interest capitalization.

Acquisition of PP&E
Comprehensive Illustration: On November 1, 2009,
Shalla Company contracted Pfeifer Construction Co. to construct a building for $1,400,000 on land costing
$100,000 (purchased from the contractor and included in the first payment). Shalla made the following payments to the construction company during 2010.
Chapter
10-24
LO 4 Describe the accounting problems associated with interest capitalization.

Acquisition of PP&E
Pfeifer Construction completed the building, ready for occupancy, on December 31, 2010. Shalla had the following debt outstanding at December 31, 2010.
Compute the weighted-average accumulated expenditures during 2010.
Chapter
10-25
LO 4 Describe the accounting problems associated with interest capitalization.

Acquisition of PP&E
Compute the weighted-average accumulated expenditures during 2010.
Illustration 10-4
Solution on notes page
Chapter
10-26
LO 4 Describe the accounting problems associated with interest capitalization.

Acquisition of PP&E
Compute the avoidable interest.
Illustration 10-5
Chapter
10-27
Solution on notes page
LO 4 Describe the accounting problems associated with interest capitalization.

Acquisition of PP&E
Compute the actual interest cost, which represents the maximum amount of interest that it may capitalize during
2010,
Illustration 10-6
The interest cost that Shalla capitalizes is the lesser of
$120,228 (avoidable interest) and $239,500 (actual interest), or $120,228.
Chapter
10-28
LO 4 Describe the accounting problems associated with interest capitalization.

Acquisition of PP&E
Shalla records the following journal entries during 2010:
January 1
March 1
May 1
Land
Building (or CIP)
Cash
Building
Cash
Building
Cash
December 31 Building
Cash
Building (Capitalized Interest)
Interest Expense
Cash
100,000
110,000
300,000
540,000
450,000
120,228
119,272
210,000
300,000
540,000
450,000
239,500
Chapter
10-29
LO 4 Describe the accounting problems associated with interest capitalization.

Acquisition of PP&E
At December 31, 2010, Shalla discloses the amount of interest capitalized either as part of the nonoperating section of the income statement or in the notes accompanying the financial statements.
Illustration 10-7
Illustration 10-8
Chapter
10-30
LO 4 Describe the accounting problems associated with interest capitalization.

Valuation of PP&E
Companies should record property, plant, and equipment: at the fair value of what they give up or at the fair value of the asset received, whichever is more clearly evident.
Chapter
10-31
LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Valuation of PP&E
— whether taken or not — generally considered a reduction in the cost of the asset.
— Assets, purchased through long term credit, are recorded at the present value of the consideration exchanged.
— Allocate the total cost among the various assets on the basis of their fair market values.
— The market value of the stock issued is a fair indication of the cost of the property acquired.
Chapter
10-32
LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Valuation of PP&E
Ordinarily accounted for on the basis of: the fair value of the asset given up or the fair value of the asset received, whichever is clearly more evident.
Companies should recognize immediately any gains or losses on the exchange when the transaction has commercial substance .
Chapter
10-33
LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Valuation of PP&E
Illustration 10-10
* If cash is 25% or more of the fair value of the exchange, recognize entire gain because earnings process is complete.
Chapter
10-34
LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Valuation of PP&E
Companies recognize a loss immediately whether the exchange has commercial substance or not.
Rationale: Companies should not value assets at more than their cash equivalent price; if the loss were deferred, assets would be overstated.
Chapter
10-35
LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Valuation of PP&E
Illustration: Information Processing, Inc. trades its used machine for a new model at Jerrod Business Solutions Inc. The exchange has commercial substance. The used machine has a book value of
$8,000 (original cost $12,000 less $4,000 accumulated depreciation) and a fair value of $6,000. The new model lists for
$16,000. Jerrod gives Information Processing a trade-in allowance of $9,000 for the used machine. Information Processing computes the cost of the new asset as follows.
Illustration 10-11
Chapter
10-36
LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Valuation of PP&E
Illustration: Information Processing records this transaction as follows:
Equipment 13,000
Accumulated Depreciation—Equipment 4,000
Loss on Disposal of Equipment 2,000
Equipment
Cash
12,000
7,000
Illustration 10-12
Loss on
Disposal
Chapter
10-37
LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Valuation of PP&E
Has Commercial Substance . Company usually records the cost of a nonmonetary asset acquired in exchange for another nonmonetary asset at the fair value of the
asset given up, and immediately recognizes a gain.
Chapter
10-38
LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Valuation of PP&E
Illustration: Interstate Transportation Company exchanged a number of used trucks plus cash for a semi-truck. The used trucks have a combined book value of $42,000 (cost $64,000 less
$22,000 accumulated depreciation). Interstate’s purchasing agent, experienced in the second-hand market, indicates that the used trucks have a fair market value of $49,000. In addition to the trucks, Interstate must pay $11,000 cash for the semi-truck.
Interstate computes the cost of the semi-truck as follows.
Illustration 10-13
Chapter
10-39
LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Valuation of PP&E
Illustration: Interstate records the exchange transaction as follows:
Semi-truck
Accumulated Depreciation—Trucks
Trucks
Gain on disposal
Cash
60,000
22,000
64,000
7,000
11,000
Illustration 10-14
Gain on
Disposal
Chapter
10-40
LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Valuation of PP&E
Lacks Commercial Substance—No Cash Received.
Now assume that Interstate Transportation Company exchange lacks commercial substance. That is, the economic position of Interstate did not change significantly as a result of this exchange. In this case,
Interstate defers the gain of $7,000 and reduces the basis of the semi-truck.
Chapter
10-41
LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Valuation of PP&E
Illustration: Interstate records the exchange transaction as follows:
Semi-truck 53,000
Accumulated Depreciation—Trucks 22,000
Trucks
Cash
64,000
11,000
Illustration 10-15
Chapter
10-42
LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Valuation of PP&E
Lacks Commercial Substance—Some Cash Received.
When a company receives cash (sometimes referred to as “boot”) in an exchange that lacks commercial substance, it may immediately recognize a portion of the gain. The general formula for gain recognition when an exchange includes some cash is as follows:
Illustration 10-16
Chapter
10-43
LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Valuation of PP&E
Illustration: Queenan Corporation traded in used machinery with a book value of $60,000 (cost $110,000 less accumulated depreciation $50,000) and a fair value of
$100,000. It receives in exchange a machine with a fair value of $90,000 plus cash of $10,000.
Illustration 10-17
Chapter
10-44
LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Valuation of PP&E
The portion of the gain a company recognizes is the ratio of monetary assets (cash in this case) to the total consideration received.
Illustration 10-18
Solution on notes page
Chapter
10-45
LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Valuation of PP&E
Queenan would record the following entry.
Illustration 10-19
Cash
Machine
Accumulated Depreciation—Machine
Machine
Gain on disposal of machine
10,000
54,000
50,000
110,000
4,000
Chapter
10-46
LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Valuation of PP&E
E10-19 variation: Carlos Arruza Company exchanged equipment used in its manufacturing operations plus $3,000 in cash for similar equipment used in the operations of Tony LoBianco
Company. The following information pertains to the exchange.
Equipment (cost)
Accumulated Depreciation
Fair value of equipment
Cash given up
Arruza
$28,000 $28,000
19,000
15,500
LoBianco
10,000
12,500
3,000
Instructions: Prepare the journal entries to record the exchange on the books of both companies.
Chapter
10-47
LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Valuation of PP&E
Calculation of Gain or Loss
Fair value of equipment received
Cash received / paid
Less: Bookvalue of equipment
($28,000-19,000)
($28,000-10,000)
Gain or (Loss) on Exchange
Arruza
$12,500
LoBianco
$15,500
3,000 (3,000)
(9,000)
(18,000)
$6,500 ($5,500)
When a company receives cash (sometimes referred to as “boot”) in an exchange that lacks commercial substance, it may immediately recognize a portion of the gain.
Chapter
10-48
LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Valuation of PP&E
Has Commercial Substance
Arruza:
Equipment
Cash
Accumulated depreciation
Equipment
Gain on exchange
LoBianco:
Equipment
Accumulated depreciation
Equipment
Cash
Loss on exchange
12,500
3,000
19,000
15,500
10,000
28,000
6,500
28,000
3,000
5,500
Chapter
10-49
LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Valuation of PP&E
Lacks Commercial Substance
Arruza:
Equipment (12,500 – 5,242)
Cash
Accumulated depreciation
Equipment
Gain on exchange
7,258
3,000
19,000
28,000
1,258
Cash Received
Cash Received + FMV of Assets Received
$3,000
$3,000 + $12,500 x $6,500 = $1,258
Deferred gain = $6,500 – 1,258 = $5,242
Chapter
10-50
LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Valuation of PP&E
Lacks Commercial Substance
LoBianco (no change):
Equipment
Accumulated depreciation
Equipment
Cash
Loss on exchange
15,500
10,000
5,500
28,000
3,000
Companies recognize a loss immediately whether the exchange has commercial substance or not.
Chapter
10-51
LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Valuation of PP&E
Summary of Gain and Loss Recognition on Exchanges of Nonmonetary Assets Lacks Commercial Substance
Illustration 10-20
Chapter
10-52
LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Valuation of PP&E
Companies should use: the fair value of the asset to establish its value on the books and should recognize contributions received as revenues in the period received.
Chapter
10-53
LO 5 Understand accounting issues related to acquiring and valuing plant assets.

Costs Subsequent to Acquisition
In general, costs incurred to achieve greater future benefits should be capitalized, whereas expenditures that simply maintain a given level of services should be expensed.
To capitalize costs, one of three conditions must be present:
Useful life of the asset must be increased.
Quantity of units produced from asset must be increased.
Quality of units produced must be enhanced.
Chapter
10-54
LO 6 Describe the accounting treatment for costs subsequent to acquisition.

Costs Subsequent to Acquisition
Additions
Improvements and Replacements
Rearrangement and Reinstallation
Repairs
Chapter
10-55
LO 6 Describe the accounting treatment for costs subsequent to acquisition.

Costs Subsequent to Acquisition
Summary
Illustration 10-21
Chapter
10-56
LO 6 Describe the accounting treatment for costs subsequent to acquisition.

Chapter
10-57
Disposition of PP&E
A company may retire plant assets voluntarily or dispose of them by
 sale,
 exchange,
 involuntary conversion, or
 abandonment.
Depreciation must be taken up to the date of disposition.
LO 7 Describe the accounting treatment for the disposal of property, plant, and equipment.

Disposition of PP&E
BE10-14: Ottawa Corporation owns machinery that cost
$20,000 when purchased on July 1, 2007. 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, 2010. The machinery is sold on September 1, 2011, for
$10,500.
Prepare journal entries to a) update depreciation for 2011 and b) record the sale.
Chapter
10-58
LO 7 Describe the accounting treatment for the disposal of property, plant, and equipment.

Disposition of Plant Assets a) Depreciation for 2011
Depreciation expense ($2,400 x 8/12) 1,600
Accumulated depreciation b) Record the sale
Cash
Accumulated depreciation
Machinery
Gain on sale
10,500
10,000 *
1,600
20,000
500
Chapter
10-59
* $8,400 + $1,600 = $10,000
LO 7 Describe the accounting treatment for the disposal of property, plant, and equipment.

Disposition of Plant Assets
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.
Chapter
10-60
LO 7 Describe the accounting treatment for the disposal of property, plant, and equipment.

Disposition of Plant Assets
If a company scraps or abandons an asset without any cash recovery, it recognizes a loss equal to the asset’s book value.
If scrap value exists, the gain or loss that occurs is the difference between the asset’s scrap value and its book value.
If an asset still can be used even though it is fully depreciated, it may be kept on the books at historical cost less depreciation.
Chapter
10-61
LO 7 Describe the accounting treatment for the disposal of property, plant, and equipment.

Copyright
Chapter
10-62
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