10-1
Types of Operational Assets
Actively Used in Operations
Expected to Benefit Future Periods
Tangible
Property, Plant,
Equipment &
Natural
Resources
Intangible
No Physical
Substance
10-2
Costs to be Capitalized
General Rule
The initial cost of an operational asset
includes the purchase price and all
expenditures necessary to bring the asset
to its desired condition and location for use.
Costs to be Capitalized
Equipment





Net purchase price
Taxes
Transportation costs
Installation costs
Modification to building necessary
to install equipment
 Testing and trial runs
Recurring & maintenance costs may not be
capitalized
10-3
10-4
Brief Exercise 10-1

Beaverton Lumber purchased a milling machine
for $35,000. In addition to the purchase price,
Beaverton made the following expenditures:
freight, $1,500;
installation, $3,000;
testing, $2,000;
Annual personal property tax (not sales or use related)
on the machine for the first year, $500.

What is the initial cost of the machine?
10-5
Brief Exercise 10-1
Capitalized cost of the machine:

Purchase price
$35,000

Freight
1,500

Installation
3,000

Testing
2,000

Total cost $41,500
 Note: Personal property taxes on the machine
for the period after acquisition are not part of
acquisition cost. They are expensed in the
period incurred.

10-6
Costs to be Capitalized
Land







Purchase price
Real estate commissions
Attorney’s fees
Title search
Title transfer fees
Title insurance premiums
Removing old buildings
Land is not
depreciable.
Costs to be Capitalized
Land Improvements
Separately identifiable costs of
Driveways
Parking lots
Fencing
Landscaping
Private roads
These will be depreciated
10-7
Costs to be Capitalized
Buildings
Purchase price
 Attorney’s fees
 Commissions
 Reconditioning

Long term leasehold
improvements are
also capitalized.
10-8
10-9
Brief Exercise 10-2

Fullerton Waste Management purchased land
and a warehouse for $600,000. In addition to the
purchase price, Fullerton made the following
expenditures related to the acquisition:





broker’s commission, $30,000;
title insurance, $3,000
miscellaneous closing costs, $6,000.
The warehouse was immediately demolished at a cost of
$18,000 in anticipation of the building of a new warehouse.
Determine the amounts Fullerton should
capitalize as the cost of the land and the
building.
10-10
Brief Exercise 10-2

Capitalized cost of land:





Purchase price
Broker’s commission
Title insurance
Misc. closing costs
Demolition of old building
$600,000
30,000
3,000
6,000
18,000
Total cost
$657,000
 All of the expenditures, including the costs to
demolish the old building, are included in the
initial cost of the land.

10-11
Lump-Sum Purchases
Several assets are acquired for a single,
lump-sum price that may be lower than the
sum of the individual asset prices.
Allocation of the lump-sum
price is based on relative
values of the individual assets.
Asset 1
Asset 2
Asset 3
10-12
Lump-Sum Purchases
On May 13, we purchase land and building for
$200,000 cash. The appraised value of the
building is $162,500, and the land is appraised
at $87,500.
How much of the $200,000 purchase price will
be charged to the building account?
10-13
Lump-Sum Purchases
Asset
Land
Building
Total
Appraised
Value
(a)
$ 87,500
162,500
$ 250,000
% of
Value
(b)*
35%
65%
Purchase
Price
(c)
$ 200,000
200,000
Assigned
Cost
(b × c)
$ 70,000
130,000
$ 200,000
* $87,500÷$250,000 = 35%
The building will be apportioned $130,000
of the total purchase price of $200,000.
Prepare the journal entry to record the purchase.
10-14
Lump-Sum Purchases
GENERAL JOURNAL
Date
Description
May 13 Land
Building
Page 14
PR
Debit
Credit
70,000
130,000
Cash
200,000
10-15
Brief Exercise 10-3
Refer to the situation described in BE 10-2.
Assume that Fullerton decides to use the
warehouse rather than demolishing it. An
independent appraisal estimates the market
values of the land and warehouse at $420,000
and $280,000, respectively.
 Determine the amounts Fullerton should
capitalize as the cost of the land and the
building.

10-16
Brief Exercise 10-3

Cost of land and building:





Purchase price
Broker’s commission
Title insurance
Miscellaneous closing costs
Total cost
$600,000
30,000
3,000
6,000
$639,000
The total must be allocated to the land and
building based on their relative market values:
10-17
Brief Exercise 10-3
Costs to be Capitalized
Natural Resources
Purchase price,
exploration and
development costs of:
 Timber
 Mineral deposits
 Oil and gas reserves
10-18
10-19
Asset Retirement Obligations
Often encountered with natural resource
extraction when the land must be
restored to a useable condition.
Recognize as a liability
and a corresponding
increase in the related asset.
Record at fair value, usually the
present value of future cash
outflows associated with the
reclamation or restoration.
10-20
BE 10-4
Smithson Mining operates a silver mine in Nevada.
Acquisition, exploration, and development costs
totaled $5.6 million. After the silver is extracted in
approximately five years, Smithson is obligated to
restore the land to its original condition, including
constructing a wildlife preserve.
The company’s controller has provided the following
three cash flow possibilities for the restoration costs:
(1) $500,000, 20% probability; (2) $550,000, 45%
probability; and (3) $650,000, 35% probability. The
company’s credit-adjusted, risk-free rate of interest
is 6%.
What is the initial cost of the silver mine?
10-21
Solution
10-22
BE 10-5
Refer to the situation described in BE 10-4. What is
the carrying value of the asset retirement liability at
the end of one year?
Assuming that the actual restoration costs incurred
after extraction is completed are $596,000, what
amount of gain or loss will Smithson recognize on
retirement of the liability?
10-23
Solution BE10-5
Or 429,675 x 1.06
10-24
Noncash Acquisitions
Issuance of equity securities
 Deferred payments
 Donated assets
 Exchanges

The asset acquired is recorded at
the fair value of the consideration given
or
the fair value of the asset acquired,
whichever is more clearly evident.
10-25
Intangible Assets
Lack physical
substance.
Exclusive
Rights.
Intangible
Assets
Future benefits
less certain than
tangible assets.
Usually acquired
for operational
use.
10-26
Costs to be Capitalized
Intangible Assets
Record at current
cash equivalent
cost, including
purchase price,
legal fees, and
filing fees.
 Patents
 Copyrights
 Trademarks
 Franchises
 Goodwill
10-27
Patents
An exclusive right recognized by law and
granted by the US Patent Office for 20 years.
 Holder has the right to use, manufacture, or
sell the patented product or process without
interference or infringement by others.
 R & D costs that lead to an
internally developed patent
are expensed in the period
incurred.

10-28
Patents
Torch, Inc. has developed a new device.
Research and development costs totaled
$30,000. Patent registration costs consisted
of $2,000 in attorney fees and $1,000 in
federal registration fees.
What is Torch’s patent cost?
Torch’s cost for the new patent is $3,000.
The $30,000 R & D cost is expensed as
incurred.
10-29
Copyrights
A form of protection given by law to
authors of literary, musical, artistic, and
similar works.
 Copyright owners have exclusive rights to
print, reprint, copy, sell or distribute,
perform and record the work.
 Generally, the legal life of a copyright is
the life of the author plus 70 years.

10-30
Trademarks

A symbol, design, or logo
associated with a business.

If internally developed, trademarks
have no recorded asset cost.

If purchased, a trademark is
recorded at cost.

Registered with U.S. Patent Office
and renewable indefinitely in 10year periods.
10-31
Franchises
Right to sell products or provide services
purchased by franchisee from franchisor.
10-32
Goodwill
Goodwill
Occurs when one
company buys
another company.
Only purchased
goodwill is an
intangible asset.
The amount by which the
purchase price exceeds the fair
market value of net assets acquired.
Generally, this represents the present value of future earnings
10-33
Goodwill
Eddy Company paid $1,000,000 to
purchase all of James Company’s
assets and assumed James Company’s
liabilities of $200,000. James
Company’s assets were appraised at a
fair value of $900,000.
10-34
Goodwill
What amount of goodwill should be recorded
on Eddy Company books?
a.
b.
c.
d.
$100,000
$200,000
$300,000
$400,000
10-35
Goodwill
What amount of goodwill should be recorded
on Eddy Company books?
a.
b.
c.
d.
$100,000
$200,000
$300,000
$400,000
10-36
Goodwill - Brief Exercise 10-6

Pro-tech Software acquired all of the outstanding
stock of Reliable Software for $14 million. The
book value of Reliable’s net assets (assets
minus liabilities) was $8.3 million. The fair values
of Reliable’s assets and liabilities equaled their
book values with the exception of certain
intangible assets whose fair values exceeded
book values by $2.5 million*. Calculate the
amount paid for goodwill.
Fair value of separately identified intangibles are excluded from goodwill.
10-37
Goodwill - Brief Exercise 10-6
10-38
Deferred Payments
Note payable
Market interest
rate
Less than market rate
or noninterest bearing
Record asset at
face value of note
Record asset at present
value of future cash flows.
Let’s consider an example where we must compute
the present value of a noninterest-bearing note.
10-39
Deferred Payments
On January 2, 2012, Midwestern Corporation
purchased equipment by signing a
noninterest-bearing requiring $50,000 to be
paid on December 31, 2013. The prevailing
market rate of interest on notes of this nature
is 10%.
Prepare the required journal entries for
Midwestern on January 2, 2012; December
31, 2012 (year-end), and December 31, 2013
(year-end).
10-40
Deferred Payments
Since we do not know the cash equivalent
price in this example, we must use the
present value of the future cash payment.
Face amount of note
$ 50,000
× PV of $1, n=2, i=10%
0.82645
= PV of note (rounded) $ 41,323
GENERAL JOURNAL
Date
Jan. 2
Description
Equipment
Discount on Note Payable
Note Payable
Discount = $50,000 - $41,323
Page 73
PR
Debit
Credit
41,323
8,677
50,000
10-41
Deferred Payments
GENERAL JOURNAL
Date
Description
Page 74
PR
Dec. 31 Interest Expense
2012
Discount on Note Payable
Debit
Credit
4,132
4,132
Interest = 10% of $41,323
Dec. 31 Interest Expense
2013
Discount on Note Payable
Interest = 10% of ($41,323 + $4,132)
Dec. 31 Note Payable
2013
Cash
4,545
4,545
50,000
50,000
10-42
Brief Exercise 10-7
On June 30, Kimberly Farms purchased custommade harvesting machinery from a local
producer. In payment, Kimberly signed a
noninterest-bearing note requiring the payment
of $60,000 in two years. The fair value of the
machinery is not known, but an 8% interest rate
properly reflects the time value of money for this
type of loan agreement.
 At what amount will Kimberly initially value the
machinery?
 How much interest expense will Kimberly
recognize in its income statement for this note
for the year ended December 31?

10-43
Brief Exercise 10-7

The initial value of machinery and note will be
the present value of the note payment:
PV = $60,000 (.85734) = $51,440
Present value of $1: n = 2, i = 8% (from Table 2)

1
1

Interest expense for 2009:
$51,440 x 8% x 6/12 = $2,058
10-44
Fixed-Asset Turnover Ratio
Fixed asset
=
turnover
ratio
Net sales
Average fixed assets
This ratio measures how effectively a
company or its unit managers uses its
fixed assets to generate revenue.
10-45
Receivables Management
Dell vs. Apple comparison
Dell
2004
Property, plant, and
equipment (net)
Net sales
$
1,517
41,444
Apple
2003
$
913
2004
$
707
8,279
(All dollar amounts in millions)
Compute the fixed asset turnover
ratio for both companies
2003
$
669
10-46
Receivables Management
Dell
2004
Property, plant, and
equipment (net)
Net sales
$
1,517
41,444
Fixed asset
=
turnover
ratio
Dell
$41,444
($1,517 + $913)/2
Apple
2003
$
913
2004
$
707
8,279
2003
$
Net sales
Average fixed assets
Apple
= 34.1
$8,279
= 12.0
($707 + $669)/2
Dell generated nearly three times the sales
dollars for each dollar invested in fixed assets.
669
10-47
Dispositions
 Update depreciation or amortization to date of disposal.
 Remove original cost of asset and accumulated
depreciation or amortization from the books.
 The difference between book value of the asset and the
amount received is recorded as a gain or loss.
On June 30, 2013, MeLo Inc. sold equipment for $6,350
cash. The equipment was purchased on January 1, 2008, at
a cost of $15,000. The equipment was depreciated using the
straight-line method over an estimated 10-year life with zero
residual value. MeLo last recorded depreciation on the
equipment on December 31, 2012, its year-end.
Prepare the journal entries necessary to
record the disposition of this equipment.
10-48
Dispositions
 Update depreciation to date of sale.
June 30, 2013:
Depreciation expense ($15,000 ÷ 10 years) × ½) .......
Accumulated depreciation ………………........
750
750
To update depreciation to date of sale.
 Remove original asset cost and accumulated depreciation.
 Record the gain or loss.
June 30, 2013:
Accumulated depreciation ............................................
Cash ………………………….……………......................
Loss on sale …………………………………………….…
Equipment …………………………...............…
To record sale of equipment.
($15,000 ÷ 10 years) × 5½) = $8,250
8,250
6,350
400
15,000
10-49
Exchanges
General Valuation Principle: Cost of asset acquired is:
 fair value of asset given up plus cash paid or minus cash
received or
 fair value of asset acquired, if it is more clearly evident
In the exchange of assets fair value is used except in rare
situations in which the fair value cannot be determined or the
exchange lacks commercial substance.
When fair value cannot be determined or the exchange lacks
commercial substance, the asset(s) acquired are valued at the
book value of the asset(s) given up, plus (or minus) any cash
exchanged. No gain or loss is recognized.
10-50
Fair Value Not Determinable
Matrix Inc. exchanged used equipment for newer equipment.
Due to the nature of the assets exchanged, Matrix could not
determine the fair value of the asset given up or received. The
asset given up originally cost $600,000, and had an accumulated
depreciation balance of $400,000 at the time of the exchange.
Matrix exchanged the asset and paid $100,000 cash.
Let’s record this unusual transaction.
Matrix Inc.
Cost of asset given up
Accumulated depreciation
Book value
$
$
600,000
400,000
200,000
10-51
Self-Constructed Assets
When self-constructing an
asset, two accounting issues
must be addressed:
Overhead allocation to the selfconstructed asset.
 Incremental overhead only
 Full-cost approach
Proper treatment of interest
incurred during construction
10-52
Interest Capitalization
Capitalization begins when
 construction begins
 interest is incurred, and
 qualifying expenses are incurred.
Capitalization ends when . . .
 The asset is substantially complete and ready
for its intended use,
 or when interest costs no longer are being
incurred.
10-53
Interest Capitalization
Welling, Inc. is constructing a building for its own
use. Construction activities started on May 1 and
have continued through Dec. 31. Welling made the
following qualifying expenditures: May 1, $125,000;
July 31, $160,000, Oct. 1, $200,000; and Dec. 1,
$300,000.
Welling borrowed $1,000,000 on May 1, from Bub’s
Bank for 10 years at 10 percent to finance the
construction. The loan is related to the construction
project and the company uses the specific interest
method to compute the amount of interest to
capitalize.
10-54
Interest Capitalization
Average Accumulated Expenditures
Date
5/1
7/31
10/1
12/1
Expenditure
$ 125,000
160,000
200,000
300,000
$ 785,000
Fraction of
Year
8/12
5/12
3/12
1/12
$
$
AAE
83,333
66,667
50,000
25,000
225,000
10-55
Interest Capitalization
Since the $1,000,000 of specific borrowing is sufficient to
cover the $225,000 of average accumulated expenditures for
the year, use the specific borrowing rate of 10 percent to
determine the amount of interest to capitalize.
Interest = AAE × Specific Borrowing Rate
Interest = $225,000 × 10% = $22,500
GENERAL JOURNAL
Date
Description
Dec. 31 Construction-In-Progress
Interest Expense
Page 14
PR
Debit
Credit
22,500
22,500
10-56
Research and Development (R&D)
Research
Planned search or critical investigation aimed at
discovery of new knowledge . . .
Development
The translation of research findings or other
knowledge into a plan or design . . .
Most R&D costs are expensed as incurred.
(Must be disclosed if material.)
10-57
Research and Development (R&D)
 R&D
costs incurred under contract for
other companies are expensed against
revenue from the contract.
 Operational assets used in R&D should
be capitalized if they have alternative
future uses.
10-58
Software Development Costs


All costs incurred to establish the technological feasibility of a
computer software product are treated as R&D and expensed
as incurred.
Costs incurred after technological feasibility is established and
before the software is available for release to customers are
capitalized as an intangible asset.
Costs
Expensed
as R&D
Start of
R&D
Activity
Costs
Capitalized
Technological
Feasibility
Operating
Costs
Date of
Product
Release
Sale of
Product
10-59
Software Development Costs


Amortization of capitalized computer software costs starts
when the product begins to be marketed.
Two methods, the percentage-of-revenue method and the
straight-line method, are compared and the method
producing the largest amount of amortization is used.
Disclosure
Balance Sheet
 The unamortized portion of capitalized computer software cost is an
asset.
Income Statement
 Amortization expense associated with computer software cost.
 R&D expense associated with computer software development cost.
10-60
U.S. GAAP vs. IFRS
Research and Development Expenditures


Except for software development
costs incurred after technological
feasibility, all research and
development expenditures are
expensed in the period incurred.
Direct costs to secure a patent
are capitalized.


Research expenditures are
expensed in the period incurred.
Development expenditures that
meet specified criteria are
capitalized as an intangible asset.
Direct costs to secure a patent
are capitalized.
10-61
Brief Exercise 10-16

Maxtor Technology incurred the following costs
during the year related to the creation of a new
type of personal computer monitor:
What amount should Maxtor report as research and
development expense in its income statement?
10-62
Brief Exercise 10-16
Research and development:
 Salaries
 Depreciation R&D
 Utilities and other direct costs
 Payment to another company
 Total R & D expense

$220,000
125,000
66,000
120,000
$531,000
Note: The patent filing and related legal costs and the costs of
adapting the product to a particular customer’s needs are not
included as research and development expense.