Chapter
10-1
CHAPTER
10
ACQUISITION AND DISPOSITION OF
PROPERTY, PLANT, AND EQUIPMENT
Intermediate Accounting
13th Edition
Kieso, Weygandt, and Warfield
Chapter
10-2
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
Valuation
Cost Subsequent
to Acquisition
Dispositions
Acquisition costs:
Land, buildings,
equipment
Cash discounts
Additions
Sale
Deferred
contracts
Involuntary
conversion
Self-constructed
assets
Lump-sum
purchases
Improvements
and
replacements
Interest costs
Stock issuance
Observations
Nonmonetary
exchanges
Contributions
Other valuation
methods
Chapter
10-4
Rearrangement
and reinstallation
Repairs
Summary
Miscellaneous
problems
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.
Chapter
10-5
LO 1 Describe property, plant, and equipment.
Acquisition of PP&E
Valued at Historical Cost, reasons include:
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
Cost of Land
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.
Chapter
10-7
LO 2 Identify the costs to include in initial valuation
of property, plant, and equipment.
Acquisition of PP&E
Cost of Buildings
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.
Chapter
10-8
LO 2 Identify the costs to include in initial valuation
of property, plant, and equipment.
Acquisition of PP&E
Cost of Equipment
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.
Chapter
10-9
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
Notes Payable
Building
(c) Cost of land fill and clearing
Land
(d) Delinquent real estate taxes on property
assumed
Land
(e) Premium on 6-month insurance policy during
construction
(f) Refund of 1-month insurance premium because
construction completed early
Chapter
10-10
Building
(Building)
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:
Building
(g) Architect’s fee on building
(h) Cost of real estate purchased as a plant site
(land $200,000 and building $50,000)
Land
(i) Commission fee paid to real estate agency
Land
(j) Installation of fences around property
Land Improvements
(k) Cost of razing and removing building
Land
(l) Proceeds from salvage of demolished building
(Land)
(m) Cost of parking lots and driveways
(n) Cost of trees and shrubbery (permanent)
Chapter
10-11
Land Improvements
Land
LO 2 Identify the costs to include in initial valuation
of property, plant, and equipment.
Acquisition of PP&E
Self-Constructed Assets
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
Interest Costs During Construction
Three approaches have been suggested to account for the
interest incurred in financing the construction.
Illustration 10-1
$ 0
Capitalize no
interest
during
construction
Increase to Cost of Asset
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
Interest Costs During Construction
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
Qualifying Assets
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
Capitalization Period
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
Amount to Capitalize
Capitalize the lesser of:
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
150,000
November 1, 2011
300,000
December 31, 2011
100,000
Total expenditures
Chapter
10-18
$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
LO 4 Describe the accounting problems associated with interest capitalization.
Acquisition of PP&E
Step 1 - 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.
Step 2 - 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
Step 3 - Compute weighted-average accumulated
expenditures.
Date
Jan. 1
Apr. 30
Nov. 1
Dec. 31
Actual
Capitalization
Expenditures
Period
$ 100,000
12/12
150,000
8/12
300,000
2/12
100,000
0/12
$ 650,000
Weighted
Average
Accumulated
Expenditures
$ 100,000
100,000
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
Step 4 - 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
Step 4 - Compute the Actual and Avoidable Interest.
Actual Interest
Specific Debt
General Debt
$
Interest
Actual
Debt
Rate
Interest
200,000
12%
500,000
14%
70,000
300,000
10%
30,000
$1,000,000
Avoidable Interest
$
$ 124,000
$100,000
$800,000
= 12.5%
Accumulated
Interest
Avoidable
Expenditures
Rate
Interest
$ 200,000
12%
50,000
$ 250,000
Chapter
10-22
24,000
Weighted-average
interest rate on
general debt
$
12.5%
24,000
6,250
$
30,250
LO 4 Describe the accounting problems associated with interest capitalization.
Acquisition of PP&E
Step 5 – Capitalize the lesser of Avoidable
interest or Actual interest.
Avoidable interest
Actual interest
$
30,250
124,000
Journal entry to Capitalize Interest:
Equipment
Interest expense
Chapter
10-23
30,250
30,250
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
December 31
Chapter
10-29
Land
Building (or CIP)
Cash
100,000
110,000
Building
Cash
300,000
Building
Cash
540,000
Building
Cash
Building (Capitalized Interest)
Interest Expense
Cash
450,000
120,228
119,272
210,000
300,000
540,000
450,000
239,500
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
Cash Discounts — whether taken or not — generally
considered a reduction in the cost of the asset.
Deferred-Payment Contracts — Assets, purchased
through long term credit, are recorded at the present value
of the consideration exchanged.
Lump-Sum Purchases — Allocate the total cost among
the various assets on the basis of their fair market values.
Issuance of Stock — 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
Exchanges of Nonmonetary Assets
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
Accounting for Exchanges
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
Exchanges - Loss Situation
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
Accumulated Depreciation—Equipment
4,000
Loss on Disposal of Equipment
2,000
Equipment
Cash
Loss on
Disposal
Chapter
10-37
13,000
12,000
7,000
Illustration 10-12
LO 5 Understand accounting issues related to acquiring and valuing plant assets.
Valuation of PP&E
Exchanges - Gain Situation
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
60,000
Accumulated Depreciation—Trucks
22,000
Trucks
64,000
Gain on disposal
7,000
Cash
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
Exchanges - Gain Situation
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
Exchanges - Gain Situation
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
10,000
Machine
54,000
Accumulated Depreciation—Machine
50,000
Machine
Gain on disposal of machine
Chapter
10-46
110,000
4,000
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
19,000
15,500
LoBianco
$28,000
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
3,000
LoBianco
$15,500
(3,000)
(9,000)
$6,500
(18,000)
($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
12,500
3,000
19,000
28,000
6,500
LoBianco:
Equipment
Accumulated depreciation
Equipment
Cash
Loss on exchange
Chapter
10-49
15,500
10,000
5,500
28,000
3,000
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
Cash Received
Cash Received + FMV of Assets Received
$3,000
$3,000 + $12,500
x
Total
Gain
28,000
1,258
=
x $6,500 =
Recognized
Gain
$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
Accounting for Contributions
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
Major Types of Expenditures
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
Chapter
10-56
Illustration 10-21
LO 6 Describe the accounting treatment for costs subsequent to acquisition.
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.
Chapter
10-57
LO 7 Describe the accounting treatment for the
disposal of property, plant, and equipment.
Disposition of PP&E
Sale of Plant Assets
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
1,600
b) Record the sale
Cash
10,500
Accumulated depreciation
10,000 *
Machinery
Gain on sale
Chapter
10-59
* $8,400 + $1,600 = $10,000
20,000
500
LO 7 Describe the accounting treatment for the
disposal of property, plant, and equipment.
Disposition of Plant Assets
Involuntary Conversion
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
Miscellaneous Problems
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.
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Chapter
10-62