1
Investments in
Noncurrent
Operating
Assets-Acquisitions
Learning Objectives
 Identify those costs to be included in the
acquisition cost of different types of
noncurrent operating assets.
 Properly account for noncurrent
operating asset acquisitions using
various special arrangements, including
deferred payment, self-construction, and
acquisition of an entire company.
2
Learning Objectives
 Separate costs into those that should be
expensed immediately and those that
should be capitalized, and understand
the accounting standards for research
and development and oil and gas
exploration costs.
 Discuss the pros and cons of recording
noncurrent operating assets at their
current value.
3
Learning Objectives
 Use the fixed asset turnover ratio as a
general measure of how efficiently a
company is using its property, plant, and
equipment.
EXPANDED MATERIAL
 Evaluate the different ways to compute
capitalized interest and properly
incorporate midyear loans into the
capitalized interest calculations.
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5
Time Line of Business and
Accounting Issues Involved With
Long-Term Operating Assets
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EVALUATE
possible
acquisition of
long-term
operating items
7
ACQUIRE
long-term
operating assets
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DISTINGUISH
between those
items to be
expensed and those
to be capitalized
9
RECORD
long-term
operating assets
at appropriate
amount
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ESTIMATE and
RECOGNIZE
periodic
depreciation
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MONITOR
asset value for
possible
decline
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DISPOSE
of asset
Valuation at Acquisition
• Initially record asset at cost; cost is
actual cash price.
• Cost includes all expenditures required
to obtain asset and place it in use.
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Acquisition Costs of Tangible
Noncurrent Operating Assets
• Purchase price, commissions, legal fees, and
escrow fees.
• Clearing and grading costs.
• Cost of removing unwanted structures.
• Assessments for water lines, sewers, and
roads.
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Acquisition Costs of Tangible
Noncurrent Operating Assets
• Landscaping.
• Parking lots.
• Interior sidewalks.
• Light structures (for parking and sidewalks).
• Fencing.
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Acquisition Costs of Tangible
Noncurrent Operating Assets
• Purchase price.
• Taxes, freight, and insurance during shipping
and installation.
• Special foundations or reinforcing of floors.
• Installation and testing.
Note: Any expenditure incurred in preparing the asset
for its intended use is charged to Equipment.
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Acquisition Costs of Tangible
Noncurrent Operating Assets
If a building is selfconstructed, the cost of
If ready for use: materials, labor, and
overhead establishes the
• Purchase price.
cost
of
the
asset.
• Commissions, legal fees, escrow fees,
survey fees.
If newly constructed by outsider:
• Contract price.
• Legal fees
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Acquisition Costs of Intangible
Noncurrent Operating Assets
• Patent: Purchase price, filing and registry fees, cost
of subsequent litigation to protect right. Does not
include internal research and development costs.
• Copyright: Same as Patent.
• Trademark and Trade Name: Same as Patent.
• Franchise: Expenditures made to purchase the
franchise. Legal fees and other costs incurred in
obtaining the franchise.
• Organization Costs: Expenditures to organize the
corporation--cost of stock certificates, underwriting
costs, state incorporation fees, legal fees. continued
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Acquisition Costs of Intangible
Noncurrent Operating Assets
• Software Development Costs: Expenditures made
after software is determined to be technologically
feasible but before it is ready for commercial
production.
• Goodwill: Portion of purchase price that exceeds the
sum of the current market value for all identifiable net
assets.
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Acquisition Other Than
Simple Cash Transactions
 Basket purchase
 Deferred payment
 Leasing
 Exchange of nonmonetary assets
 Issuance of securities
 Self-construction
 Donation or discovery
 Acquisition of an entire company
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Methods of Acquisition
Basket purchase: Allocate cash price to
individual assets based on percentage of
appraised or fair market value.
Land, buildings, and
equipment are acquired for
$160,000. The appraisal
values at the acquisition
date are: land, $28,000;
buildings, $60,000;
equipment, $12,000.
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Methods of Acquisition
Basket purchase: Allocate cash price to
individual assets based on percentage of
appraised or fair market value.
Land
$ 28,000 $28/$100 x $160,000 = $ 44,800
Buildings
60,000 $60/$100 x $160,000 = 96,000
Equipment 12,000 $12/$100 x $160,000 = 19,200
$160,000
$100,000
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Methods of Acquisition
Deferred payment
Record asset at face value of note, plus any
cash paid.
Land
is
acquired
on
January
2,
2002
for
Record note at fair market value of
$100,0000;
$35,000
is
paid
at
the
time
acquired asset if note’s value is not
of
purchase,
and
the
balance
is
to
be
determinable or is unreasonable.
paid in semiannual installments of
$5,000 plus interest on the unpaid
principal at an annual rate of 10%.
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Methods of Acquisition
June 30, 2002
Interest Expense
Notes Payable
Cash
3,250
5,000
8,250
$65,000 x 0.05%
Deferred Payment Illustration
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Methods of Acquisition
• Leasing: A capital lease is economically
the same as a purchase. The acquiring
company records the asset and liability at
the present value of future lease payments.
• Exchange of nonmonetary assets: The
new asset is valued at its fair market value
or at the fair market value of the asset given
up, whichever is more clearly determinable.
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Methods of Acquisition
• Issuance of securities: Record the asset at
the fair market value of the securities
issued.
• Self-construction: Recorded at cost,
including all expenditures incurred to build
the asset and make it ready for its intended
use.
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Interest Capitalization
Interest should not be
capitalized for inventories
Capitalization of interest is required
manufactured or produced
for assets that are being selfon a repetitive basis.
constructed for an enterprise’s own
use and assets that are intended to
be leased or sold to others that can
be identified as discrete projects.
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Interest Capitalization-Qualification
When assets are acquired by self-construction,
interest incurred on funds borrowed to finance
construction can be capitalized if the following
conditions are met:
 Projects are discrete.
 Costs are separately accumulated.
 Construction covers an extended
period of time.
 Construction costs are substantial.
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Interest Capitalization-Requirements
 Maximum capitalization equals actual interest
incurred during the period.
 Interest capitalization is calculated on average
amount of accumulated expenditures.
 Interest rate used is (1) actual rate on debt
incurred specifically for the project, then (2)
weighted average interest rate on all borrowings
not specifically for the project.
 If the construction period covers more than one
fiscal period, accumulated expenditures include
prior years’ capitalized interest.
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Interest Capitalization-Example: Scenario
Bee Wood, Inc., a construction
company, decides to build a new
warehouse. The following information
is applicable to the project:
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Interest Capitalization-Example: Scenario
• Construction will begin January 1, 2001,
and is expected to end December 31,
2002.
• Construction costs are estimated at
$640,000.
• A 12%, 2-year loan of $200,000 has been
obtained and will become effective on
January 1, 2001.
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Interest Capitalization-Example: Scenario
• Bee Wood, Inc.’s other debts are:
– 5-year, 10% notes payable $ 75,000
– 9% mortgage
120,000
• 2001 Expenditures were:
– January 1:
$ 100,000
– July 1:
100,000
– October 1:
100,000
• In 2002, expenditures of $340,000 occurred
evenly throughout the year.
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Interest Capitalization-Example: Solution
Maximum Interest Capitalization
Debt
Amount
Rate
Loan
$ 200,000
12%
Note
75,000
10%
Mortgage
120,000
9%
Maximum interest capitalization
Interest
$24,000
7,500
10,800
$42,300
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Interest Capitalization-Example: Solution
Weighted Average Rate:
Debt
Amount
Note
$ 75,000
Mortgage
120,000
$195,000
Rate
10%
9%
Interest
$ 7,500
10,800
$18,300
Weighted Average Rate = 9.4%
($ 18,300 ÷ $195,000 = 0.0938)
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Interest Capitalization-Example: Solution
Weighted
Average
Expenditures--2001:
Interest Capitalization--2001:
Weighted
$ 175,000 x 12% (loan) = $ 21,000
Date
Amount Ratio
Average
1/1/01
7/1/01
10/1/01
.
$100,000
100,000
100,000
$300,000
12/12
6/12
3/12
$100,000
50,000
25,000
$175,000
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Interest Capitalization-Example: Solution
Weighted Average Expenditures--2002
Acc. exp. 12/31/01
$300,000
2001 interest capitalized
21,000
Adjusted acc. exp. 12/31/01
$321,000
2002 expenditures
340,000
Acc. exp. 12/31/02
$661,000
Weighted average expenditures, 2002 $491,000
($321,000 + [$340,000 ÷ 2])
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Interest Capitalization-Example: Solution
Interest Capitalization--2002:
$200,000 x 12% =
$24,000
$291,000 x 9.4% =
27,400
Total interest
$51,400
Maximum interest
$42,300
Interest Capitalized,
$42,300
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Acquisition of an Entire Company 38
--Business Combination
There are two ways to account
for a business combination-The
purchase
method
raises
a
pooling of interest and
problem
in how to allocate the
purchase.
Compared
of interest,
purchase
pricetotopooling
the various
theassets
purchase
method records
acquired.
assets at their fair market value,
which Despite
results inopposition
lower earnings
in
from the
subsequent
due to higher
businessyears
community,
the FASB
depreciation
has
taken stepscharges.
to eliminate the
pooling of interest method.
Goodwill
• Defined: “The excess amount paid for a
company in a business combination over
the fair market value of the company’s
identifiable assets.”
• Recording Goodwill
1. Write identifiable assets up to FMV.
2. Record excess purchase price over net assets
at FMV as goodwill.
3. Amortize goodwill over its economic useful
life -- not to exceed 40 years.
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Expense/Asset Continuum
Expense
Asset
Research and
Repairs Development
Software
Land and
Supplies
Development
Buildings
Used
Oil and Gas
Exploration
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Postacquisition Expenditures
Expenditures to keep plant
and equipment in good
operating condition are
referred to as maintenance.
Expense as
incurred
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Postacquisition Expenditures
What about expenditures
that do not extend the
useful life or increase
future cash flows?
Expense as
incurred
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Postacquisition Expenditures
If the cost of the old
Next, record cost of the
component is known, remove
new component and
its cost and accumulated
recognize a gain or loss.
depreciation.
43
Postacquisition Expenditures
What if the cost of
the old component
is not known?
44
Postacquisition Expenditures
Then the cost of the new
component is deducted
from accumulated
depreciation.
45
Research and Development
Research and development costs
include those costs of materials,
equipment, facilities, personnel,
purchased intangibles, contract
services, and a reasonable
allocation of indirect costs that are
specifically related to R & D
activities and that have no
alternative future use.
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Research and Development
Examples
 Research aimed at discovery of new knowledge.
 Search for applications of research findings.
 Search for possible product or process
alternatives.
 Design, construction, and testing of preproduction
prototypes.
 Design, construction, and operation of a pilot
plant.
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Development of
Successful Software
R & D Costs
(Expense)
Software
project
initiated
Deferred Costs
(Intangible
Assets)
Technological
feasibility
established
48
Inventory
Costs
Software
available for
commercial
production
Software
sold
Fixed Asset Turnover
Lamberson Company’s sales for 2001 totaled
$46,381,530. Its beginning and ending
Property, Plant, and Equipment balances were
$9,678,233 and $10,088,997, respectively.
Average fixed assets = ($9,678,233 + $10,088,997)
2
Average fixed assets = $9,883,615
Fixed asset turnover =
$46,381,530
Sales
= 4.69
$9,883,615
Average
Fixed Assets
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The End