Chapter 10:
PPE part 1
What is Property, Plant, and Equipment (PPE)?
1. Acquired for use and not resale.
(They do not become part of a product held for resale.)
2. Long-lived in nature and subject to depreciation
(except for land).
3. Possess physical substance (tangible assets)
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Acquisition of PPE
Usual valuation method is historical cost. Which is
the cash or cash equivalent of obtaining asset and
getting it ready for its intended use.
Land: if purchased to construct a building, then all
net costs up to excavation for building. Special
assessments (streets, drainage) for relatively
permanent improvements are included in the land
account. Improvements (parking lots, fences) are
recorded in Land Improvements account and
depreciated over estimated lives.
Land held as an investment should be recorded in
an investment account.
Land held by a real estate company for resale
should be classified as inventory.
Buildings: all costs related to acq. and construction
are capitalized (from excavation till completion).
Equipment: all costs to prepare for intended use—
includes cost for trial runs and training.
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Self-constructed assets: Assignment of overhead—
portion of all OH versus no fixed OH—former
preferred.
Disposition of PPE
Depreciation should be updated to date of disposal.
All accounts should be relieved of the cost and A/D
related to the asset being disposed.
Gains/losses from disposal are shown in the
appropriate income account.
Assets may be retired by: sales, exchange,
involuntary conversion, or abandonment.
The basic J.E.:
Cash
$1,000
A/D
3,700
*Loss on disposal 5,300
Machinery
$10,000
* a plug figure, would have been a gain if a credit
entry.
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Fully depreciated assets that are still in service
remain on the books at historical cost minus A/D.
GAAP requires that the amount of fully
depreciated assets in service be disclosed in notes
to F/S.
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Valuation of PPE when fair value is obscured by the
form of the transaction.
Cash discounts—gross versus net method, both
are allowed, net preferred.
Deferred payment—(1) use fair value at time of
purchase or (2) record at present value of pmts.
Lump-sum purchases—allocate (prorate) cost
among “basket” of assets based on their relative
fair values.
Issuance of stock for asset—use market value of
stock not par value.
Some exceptions to historical cost valuation:
1. Fair value is used for Donated assets—gains to
other revenue.
2. Prudent cost can be used if self-constructed
assets cost exceed fair value or if you were
ignorant about price and paid too much for an
asset originally.
3. Non-monetary exchanges assets considered
non-commercial and gain indicated—asset is
recorded at amount that balances the entry.
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Costs Subsequent to Acquisition
General rule is that costs that achieve greater future
benefits are capitalized and costs that only
maintain a given level of service should be
expensed in the period incurred.
Greater future benefits are defined as one or more of
the following:
(1) Increase the useful life of an asset.
(2) Increase the quantity (throughput) of units
produced. Or decrease the cost/unit.
(3) Enhance the quality of units produced.
Firms have limits on capitalization (materiality) and
expense all small expenditures.
Repairs are expensed—e.g., oil change in trucks.
Costs for: Additions, Improvements, Replacements,
Rearrangements, Reinstallation, and Major
repairs that benefit several periods are
capitalized. Three approaches are possible to
capitalize: (1) substitute, (2) capitalize new cost,
(3) debit A/D—used when useful life is extended.
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Chapter 10 Part 2:
CONSTRUCTION PERIOD INTEREST COSTS
Interest costs during construction of assets—it is a
financing cost? In which case, it should be expensed.
Or, is it a cost needed to bring an asset to usable
condition and location? In which case, it should be
capitalized with cost of asset. GAAP generally is
consistent with capitalizing interest during the
construction period of a qualified asset.
Qualifying Assets—require a period of time to
prepare for intended use (either self use or discrete
project for sale or lease.)
Period of capitalization—begins with the first
expenditure of the project and ends when asset is
substantially complete and ready for its intended use
or when interest ends which ever is first.
Interest can be from specific (or non-specific) project
borrowings, but interest does not include a cost for
equity—there must be actual interest expense.
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Average accumulated expenditures (AAE)--Maximum interest expense (capitalizable) cannot
exceed the actual construction expenditures during a
period. You have to determine the time-weighted
average amount of construction expenditures during
the period. If expenses occurred evenly throughout
the period, a simple average (total/2) would be
adequate.
FAS34 defines expenditures as: “…capitalized expenditures (net of progress
payment collections) for the qualifying asset that have required the payment of cash,
the transfer of other assets, or the incurring of a liability on which interest is
recognized (in contrast to liabilities, such as trade payables, accruals, and retainers
on which interest is not recognized). However, reasonable approximations of net
capitalized expenditures may be used. For example, capitalized costs for an asset
may be used as a reasonable approximation of capitalized expenditures unless the
difference is material.”
Disclosure:
FAS34 requires that:
a. For an accounting period in which no interest
cost is capitalized, the amount of interest cost
incurred and charged to expense during the
period.
b. For an accounting period in which some
interest cost is capitalized, the total amount of
interest cost incurred during the period and the
amount thereof that has been capitalized.
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Interest rate—Specific Interest Method
If a specific loan was taken out for the construction
project and if it was equal to or greater than AAE,
Max. interest capitalized (MIC) = rate for specific
loan*AAE.
If AAE exceeds specific loan amount, then use the
weighted-average rate on all other borrowings times
the AAE in excess of specific construction loan to
calculate MIC. In this case:
MIC = rate for specific loan * AAE (up to amount of
loan) + weighted average rate on other borrowings *
AAE in excess of specific loan amount.
When there are no specific borrowings for specific
projects, the Weighted-Average Method is used to
calculate the appropriate interest rate to use. This is a
minor variation to the above. You would use the
weighted-average of all borrowings and apply to the
total of AAE.
IC has to be less than or equal to actual interest!
IC cannot be greater then AAE!
Any interest not capitalized must be expensed for the
period.
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In class problem::::
ACE Construction started the building of a new
corporate headquarters on Feb 1, 2000. The
building was ready for use on July 1, 2002. The
expenditures for the project were:
Feb. 1, 2000
Apr. 1, 2000
Aug. 1, 2000
Dec. 1, 2000
Jan. 1 through
Dec. 31, 2001 (evenly)
Apr. 1, 2002
July 1, 2002
$1,000,000
2,500,000
3,200,000
5,000,000
12,000,000
750,000
2,300,000
During the entire period 1/1/2000 to 12/31/2002,
ACE had debt outstanding consisting of 6%,
$10M bond issue and a 5%, $7M bond issue. On
July 1, 2000, ACE obtained a $10M, 10%
construction loan for the project. How much
interest should ACE capitalize and expense for
2000, 2001, and 2002? Assume that ACE paid
off the construction loan on Sept. 1, 2002 and all
other debt is outstanding as of 1/1/2003.
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NONMONETARY EXCHANGES
Wow, in 2004, FASB revised/amended APB
No. 29 with FASB No. 153.
We thought that the revision would greatly
simplify the complicated rules, but the only big
change was to drop the determination of
similar/dissimilar assets and add “commercial
substance”. The intent is that more exchanges
will be classified as having commercial
substance than in the past (some similar asset
exchanges can have commercial substance).
In other words, more exchanges will now
recognize fully the gains/losses on exchange.
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An asset acquired in a non-monetary exchange
generally is recorded at the cash equivalent
value of the assets exchanged:
1. Fair value of assets given up, or
2. Fair value of the assets received, whichever is
clearly more evident (easier to determine).

If we can't determine the fair value of either
asset in the exchange, the asset received is
valued at the book value of the asset given
(no gain or loss on exchange).
Gain/loss recognition depends upon whether
the exchange has commercial substance.
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Commercial Substance
* Future cash flows change as a result of the
exchange. Exchange of similar assets can
have commercial substance.
Is the risk, timing, and amount of cash flow
for the asset received different from the cash
flow associated with the asset given up?
or—Are cash flows affected by the
exchange?
Another way to ask this is:
Has our economic position changed?
Yes or no determination.
If yes, then recognize the full gain/loss on the exchange.
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Accounting for Exchanges
Type of
Exchange
Commercial
substance
Lacks
commercial
substance
Accounting for
Asset Received
Accounting for
gain/loss
Recognize at fair Recognize
value
gain/loss fully
either (a) at fair
value or it is a
(b) plug.
(a) Recognize
loss,
(b)prorate gain
based on ratio of
cash received to
FMV of all
assets received.
Remember that assets are never recognized at
greater than their cash equivalent price (fair value).
Therefore, do not value new assets at their list price
or book value of assets given up if this means that
the new assets will be recognized at an amount that
exceeds their fair value!
[If cash (boot) exchanged is 25% or more of FV of all assets received, then the
exchange is considered a monetary exchange and all gains/losses on exchange are
recognized by both parties.]
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The AL Company traded land it had been holding as an
investment in exchange for equipment. The land had a
book value of $100,000. In addition to the land, AL
gave up $10,000 cash. This exchange is considered to
have commercial substance.

The new asset is simply recorded at its fair value. The
difference between that amount and the book value of
the old asset, plus cash paid (or less cash received),
reflects a loss or gain on the exchange.
Situation 1:
The fair value of the land is $80,000.
Equipment ($80,000 + 10,000) .........................
Loss ($100,000 - 80,000) ....................................
Cash (amount paid) .....................................
Land (book value) .......................................
$90,000
20,000
10,000
100,000
Situation 2:
The fair value of the land is $140,000.
Equipment ($140,000 + 10,000) ....................... $150,000
Cash (amount paid) .....................................
10,000
Land (book value) .......................................
100,000
Gain ($140,000 - 100,000).......................................
40,000
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The AL Company traded land it had been holding as an
investment in exchange for other land. AL’s land had a
book value of $100,000. In addition to the land, AL
gave up $10,000 cash. Assume that this exchange is
considered to LACK commercial substance.

The new asset is simply recorded at the book value of
the assets given up. There is NO gain recognized on
exchange (no cash was received).
Situation 3:
The fair value of the new land is $120,000.
New Land (plug) ........................................... $110,000
Cash (amount paid) .....................................
10,000
Old Land (book value) ...............................
100,000
Situation 4:
The fair value of the new land is $50,000. Recognize the loss
immediately.
New Land (fair value) ...................................
Loss on exchange ..........................................
Cash (amount paid) .....................................
Old Land (book
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$50,000
60,000
10,000
100,000
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The AL Company traded land it had been holding as an
investment in exchange for other land. AL’s land had a
book value of $100,000. In addition to the land, AL
received $10,000 cash. Assume that this exchange is
considered to LACK commercial substance.

Now AL can recognize part of the full gain.
Make a trial entry to calculate the “full gain” ($30,000),
then prorate it by 10/130 = 0.076923
Situation 5:
The fair value of the new land is $120,000.
New Land (plug) ...........................................
Cash (amount received) ..................................
Gain on exchange .........................................
Old Land (book value) ...............................
$92,308
10,000
2,308
100,000
Situation 6:
The fair value of the new land is $50,000. Recognize the loss
immediately.
New Land (fair value) ...................................
Loss on exchange ..........................................
Cash (amount received) ..................................
Old Land (book
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$50,000
40,000
10,000
100,000
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