1 CHAPTER Acquisition of Property, Plant, and

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CHAPTER
11
Acquisition of Property, Plant,
and Equipment
To be considered
for each asset account
• What's included? - Recognition, classification
• What value?
- Measurement
• How reported?
- Presentation, disclosure
• Mechanics
– Accounting entries, control systems
• Meaning
– Analysis
Property, Plant, and Equipment
• Also known as:
– tangible capital assets
– plant assets
– fixed assets
• Major characteristics include:
1. Acquired for use in operations and not for
resale
2. Long-term in nature and usually subject to
amortization
3. Possess physical substance
Acquisition Cost
• Historical cost is the basis for determining cost
• Historical cost includes:
– the asset’s cash or cash equivalent price, and
– the cost of readying the asset for its intended
use
• Costs incurred after acquisition are:
– added to asset’s cost, if they provide future
service potential, or
– expensed, if they do not add to service
potential
1
Cost of Building
Cost of Land
• Land costs include:
1. Purchase price
2. Closing costs (land, legal, and recording fees)
3. Costs of getting land ready for use (removal of
old building(s), clearing, grading, etc.)
4. Assumption of liens or encumbrances
5. Additional improvements with an indefinite life
• Building costs include:
– Costs of materials and labor, and overhead
– Professional fees and building permits
• Sale of salvaged materials reduce cost of land
• Special assessments for local improvements
(e.g. pavement) part of land cost
Cost of Equipment
• All necessary and reasonable costs incurred
to get asset ready for its intended use
• Includes :
–
–
–
–
Purchase price
Freight and handling charges
Insurance while in transit
Costs of special foundation, assembly and
installation
– Trial runs
Self-Constructed Assets
• These are assets constructed by the business
for use in operations
• The cost of self-constructed assets includes:
•
•
•
•
Direct materials,
Direct labour,
Variable manufacturing overhead
Proration of fixed manufacturing overhead
2
Interest Capitalization
• CICA Handbook Section 3850.03
Where interest is capitalized the amount should
be disclosed
• GAAP = choice
• Following FASB Statement 34 three questions
must be answered:
• What are the qualifying assets?
• What is the capitalization period?
• What is the amount of interest to be capitalized?
Amount to Capitalize
• Interest amount must be directly related to
asset
• Lower of actual interest or avoidable interest
– Interest does not include cost of capital for
shareholders’ equity
• Weighted-average accumulated expenditures
(WAAE) method used to find capitalizable
interest
Capitalization Period
• Capitalization period begins when three
conditions are present:
1. Expenditures for the asset have been made
2. Activities for readying the asset are in
progress
3. Interest cost is being incurred
• Capitalization continues for as long as these
three conditions exist
• Capitalization ends when asset is substantially
complete and ready for use
Shalla Corporation – Example
Given:
• November 1, 2001 contracts with Pfeifer
Construction Co. Ltd. To construct a $1.4 million
building (on land costing $100,000)
• First payment made by Shalla to Pfeifer includes
the payment for the land
• Payments made in 2002:
– January 1
– March 1
– May 1
$ 210,000
$ 300,000
$ 540,000
December 31 $ 450,000
Total
$1,500,000
• Building completed December 31, 2002
3
Shalla Corporation – Example
• Debt outstanding at December 31, 2002
– Specific Construction Debt: $750,000
15%, three year note
– Other Debt:
10%, five year note
$550,000
12%, ten year bonds
$600,000
Shalla Corporation – Example
Weighted-Average Accumulated Expenditures:
Jan. 1
Mar. 1
May. 1
Dec. 31
WAAE
$ 210,000
300,000
540,000
450,000
12/12
10/12
8/12
0/12
=
=
=
=
$210,000
250,000
360,000
0
$820,000
Note: Land payment is included in WAAE
Next step: Avoidable interest and appropriate
interest rate calculation
Shalla Corporation – Example
5-year note
10-year note
Total Interest
Principal
$550,000
$600,000
Interest
$ 55,000
72,000
$127,000
Weighted-Average Interest Rate =
Total Interest ÷ Total Principal
(Do not include Construction Specific Debt)
$127,000 ÷ (550,000 + 600,000) = 11.04%
Shalla Corporation – Example
The rates of interest for avoidable interest
calculation are:
Construction Note:
15%
All Other Amounts:
11.04%
Avoidable Interest:
(WAAE up to Construction Specific Debt x Rate)
+
(Any residual amount of WAAE x Rate)
4
Shalla Corporation – Example
Avoidable Interest:
$750,000 x
15%
70,000 x
11.04%
$820,000
=
=
$112,500
7,728
$120,228
This amount compared to actual interest paid
Other Cost Issues
• Cash Discounts
• Deferred Payment Contracts
– Assets purchased through long term credit
(such as notes payable) recorded at
present value of consideration exchanged
• Lump Sum Purchase
Shalla Corporation – Example
Actual Interest:
$750,000 x
15%
550,000 x
10%
600,000 x
12%
Total Actual Interest Paid
=
=
=
$112,500
55,000
72,000
$239,500
Avoidable Interest = $120,228
Actual Interest
= $239,500
The lesser of these two amounts is capitalized
Entry:
Dr. Building
120,228
Cr.
Interest Expense
120,228
Other Cost Issues
• Issuance of Shares
– Market value of publicly traded shares serve
as the cost of the acquired asset
– When shares have no determinable market
value use the fair value of the acquired asset
• Nonmonetary Exchange of Assets
– Cost of assets acquired at a single lump
sum price allocated to assets on basis of
relative fair market values
5
Exchange of Nonmonetary
Assets
• The basic standard is that the exchange is
valued at:
Other Cost Issues
• Contribution of Assets
• Investment Tax Credit (ITC)
– the fair value of the asset given up, or
– the fair value of the asset received whichever
is clearly more evident, and
• The rules for gain / loss recognition depend
upon whether the assets exchanged are:
– dissimilar assets or
– similar assets
One Approach to Case Analysis
Costs Subsequent to Acquisition
• If costs incurred increase future benefits,
capitalize costs (Capital Expenditure)
• If costs maintain a given level of services,
expense costs (Revenue Expenditure)
• Costs incurred after acquisition can be:
– Additions: Increase or extension of existing
assets
– Improvements and replacements: Substitution of
an existing asset for an improved one
– Rearrangement and reinstallation: Moving asset
from one location to another
– Repairs: Costs that maintain assets in operating
condition
Major Sections of Case Write-Up
1. Context
2. Role
3. Stakeholders
4. For Each Financial Reporting Issue
A) State Issue
B) Relevant GAAP
C) Recommendation
D) More Information
5.
Ethical Issue
6
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