10-1
Property, Plant, and Equipment
and Intangible Assets: Acquisition
and Disposition
Chapter 10
PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
10-2
Types of Assets
Long-lived, Revenue-producing Assets
Expected to Benefit Future Periods
Tangible
Property, Plant,
Equipment & Natural
Resources
Intangible
No Physical
Substance
General Rule for Cost Capitalization
The initial cost of an asset includes the purchase price and all
expenditures necessary to bring the asset to its desired
condition and location for use.
10-3
Costs to be Capitalized
Equipment
 Net purchase price
 Taxes
 Transportation costs
 Installation costs
 Testing and trial runs
Land (not depreciable)
 Purchase price
 Real estate commissions
 Attorney’s fees
 Title search
 Title transfer fees
 Title insurance premiums
 Removing old buildings
10-4
Costs to be Capitalized
Land Improvements
Separately identifiable costs of
 Driveways
 Parking lots
 Fencing
 Landscaping
 Private roads
Buildings
 Purchase price
 Attorney’s fees
 Commissions
 Reconditioning
10-5
Costs to be Capitalized
Natural Resources
 Acquisition costs
 Exploration costs
 Development costs
 Restoration costs
Intangible Assets
 Patents
 Copyrights
 Trademarks
 Franchises
 Goodwill
The initial cost of an intangible
asset includes the purchase price
and all other costs necessary to
bring it to condition and location
for use, such as legal and filing
fees.
10-6
Asset Retirement Obligations
Often encountered with natural resource
extraction when the land must be
restored to a useable condition.
Recognize the restoration costs
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
restoration.
10-7
Intangible Assets
Lack physical
substance.
Exclusive
Rights.
Intangible
Assets
Future benefits less certain
than tangible assets.
10-8
Intangible Assets ─ Patents



An exclusive right recognized by law and granted by the U.S.
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.
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.
10-9
Intangible Assets
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.
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 10-year periods.
10-10
Intangible Assets
Franchise
A contractual arrangement where the franchisor
grants the franchisee exclusive rights to use the
franchisor’s trademark within a certain area for a
specified period of time.
Goodwill
Occurs when one
company buys
another company.
Goodwill is not
amortized.
Only purchased
goodwill is an
intangible asset.
The amount by which the
consideration exchanged exceeds
the fair value of net assets acquired.
10-11
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.
What amount of goodwill should Eddy company
record as a result of the purchase?
10-12
Lump-Sum Purchases
Several assets are acquired for a single price that may
be lower than the sum of the individual asset fair values.
Allocation of the lump-sum price is based
on relative fair values of the individual assets.
Asset 1
Asset 2
Asset 3
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
allocated 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 allocated $130,000
of the total purchase price of $200,000.
May 13:
Land ..........................................................
Building ………………….…….……………
Cash…………………………….....
To record lump-sum purchase of land and building.
70,000
130,000
200,000
10-14
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.
10-15
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.
10-16
Deferred Payments
On January 2, 2013, Midwestern Corporation purchased an
industrial furnace by signing a noninterest-bearing note
requiring $50,000 to be paid on December 31, 2014. The
appropriate interest rate on notes of this nature is 10%.
Prepare the required journal entries for Midwestern on
January 2, 2013; December 31, 2013 (year-end); and
December 31, 2014 (year-end).
We do not know the cash equivalent price, so we must use
the present value of the future cash payment.
Face amount of note
× PV of $1, n =2, i =10%
= PV of note (rounded)
$ 50,000
0.82645
$ 41,323
10-17
Deferred Payments
January 2, 2013:
Furnace ..............................................................
Discount on note payable ….….…….……………
Note payable …………………………....
41,323
8,677
50,000
To record furnace acquisition.
December 31, 2013:
Interest expense (10% of $41,323)......................
Discount on note payable ………………
4,132
4,132
To record interest expense.
December 31, 2014:
Interest expense (10% of ($41,323+$4,132)) ......
Discount on note payable ……..……..…
4,545
4,545
To record interest expense.
December 31, 2014
Note payable ........................................................
Cash ……..……………………………..…
To record payment of note.
50,000
50,000
10-18
Issuance of Equity Securities
 Asset acquired is recorded at the fair value of the asset or the
market value of the securities, whichever is more clearly
evident.
 If the securities are actively traded, market value can be easily
determined.
 If the securities given are not actively traded, the fair value of
the asset received, as determined by appraisal, may be more
clearly evident than the fair value of the securities.
Donated Assets
 On occasion, companies acquire assets through donation.
 The receiving company is required to record
 The donated asset at fair value.
 Revenue equal to the fair value of the donated asset.
10-19
U.S. GAAP vs. IFRS
Government Grants

Fair value of donated assets
granted by a governmental unit is
recorded as revenue.

Donated assets from a
governmental unit are accounted
for at fair value, but not recorded
as revenue. Two alternatives:


Deduct the fair value amount to
determine the initial cost of the
asset.
Record the grant as deferred
income and recognize it as
income over the asset’s useful
life.
10-20
Fixed-Asset Turnover Ratio
This ratio measures how effectively a company
manages its fixed assets to generate revenue.
Fixed-asset
Net sales
=
turnover
Average fixed assets
ratio
Gap
2011
Property, plant, and
equipment (net)
Net sales
$
2,563
14,664
$14,664
= 5.65
($2,563 + $2,628)/2
Ross Stores
2011
2010
2010
$
2,628
$
984
7,866
$
943
$7866
= 8.16
($984 + $943)/2
Ross Stores generates $2.51 more in sales dollars than
GAP for each dollar invested in fixed assets.
10-21
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.
10-22
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
10-23
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.
10-24
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
10-25
Fair Value Not Determinable
Matrix Inc.
The journal entry below shows the proper
recording of the exchange.
Equipment ($200,000 + $100,000) .................
Accumulated depreciation ….……………........
Equipment …………………………….
Cash ………………………….............
To record equipment acquired in exchange.
300,000
400,000
600,000
100,000
10-26
Exchange Lacks Commercial Substance
When exchanges are recorded at fair value, any gain or loss is
recognized for the difference between the fair value and book
value of the asset(s) given up. To preclude the possibility of
companies engaging in exchanges of appreciated assets solely to
be able to recognize gains, fair value can only be used in legitimate
exchanges that have commercial substance.
A nonmonetary exchange is considered to have commercial
substance if the company expects a change in future cash flows
as a result of the exchange.
10-27
Exchanges
Matrix Inc. exchanged new equipment and $10,000 cash for
equipment owned by Float Inc.
Below is information about the asset exchanged by Matrix.
Record the transaction assuming the exchange has
commercial substance.
Cost
Matrix's
Equipment $ 500,000
Accumulated
Depreciation
$
Book
Value
Fair
Value
300,000 $ 200,000 $ 205,000
Gain = Fair Value – Book Value
Gain = $205,000 – $200,000 = $5,000
10-28
Exchanges
$205,000 fair value + $10,000 cash
Equipment ...............................................
Accumulated depreciation……….............
Equipment ………………………
Cash …………………………….
Gain on exchange ……………..
215,000
300,000
500,000
10,000
5,000
To record the exchange of equipment.
Record the same transaction assuming the
exchange lacks commercial substance.
$200,000 book value + $10,000 cash
Equipment ...............................................
Accumulated depreciation……….............
Equipment ………………………
Cash ……………………………..
To record the exchange of equipment.
210,000
300,000
500,000
10,000
10-29
Self-Constructed Assets
When self-constructing an asset, two accounting issues must be
addressed:
 Overhead allocation to the self-constructed asset.
 Incremental overhead only
 Full-cost approach
 Proper treatment of interest incurred during construction
Under certain conditions, interest incurred on
qualifying assets is capitalized.
Asset constructed:
 For a company’s own use.
 As a discrete project for sale
or lease.
Interest that could have been
avoided if the asset were not
constructed and the money
used to retire debt.
10-30
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.
10-31
Interest Capitalization
Interest is capitalized based on Average
Accumulated Expenditures (AAE).
Qualifying expenditures (construction labor, material, and
overhead) weighted for the number of months outstanding
during the current accounting period.
If the qualifying asset is
financed through a specific
new borrowing
If there is no specific new
borrowing, and the company
has other debt
. . . use the specific rate of
the new borrowing as the
capitalization rate.
. . . use the weighted average
cost of other debt as the
capitalization rate.
10-32
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.
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
Construction
Period
8/8
5/8
3/8
1/8
$
$
AAE
125,000
100,000
75,000
37,500
337,500
10-33
Interest Capitalization
Since the $1,000,000 of specific borrowing is sufficient to cover
the $337,500 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 × Time
Interest = $337,500 × 10% × 8/12 = $22,500
The loan, initiated on May 1, is
outstanding for 8 months of the year.
10-34
Interest Capitalization
If Welling had not borrowed specifically for this construction
project, it would have used the weighted-average interest
method. The weighted-average interest rate on other debt
would have been used to compute the amount of interest to
capitalize. For example, if the weighted-average interest
rate on other debt is 12 percent, the amount of interest
capitalized would be:
Interest = AAE × Weighted-average Rate × Time
Interest = $337,500 × 12% × 8/12 = $27,000
10-35
Interest Capitalization
If specific new borrowing had been insufficient to cover
the average accumulated expenditures . . .
. . . Capitalize this
portion using the 12
percent weightedaverage cost of debt.
. . . Capitalize this
portion using the 10
percent specific
borrowing rate.
Other
debt
AAE
Specific
new
borrowing
10-36
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.)


R&D costs incurred under contract for other companies are
capitalized as inventory and carried forward into future years.
Costs of assets purchased for R&D purposes are expensed in
the period unless they have alternative future uses.
10-37
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
10-38
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.
10-39
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.
10-40
U.S. GAAP vs. IFRS
Software Development Costs

The percentage used to amortize
software development costs is the
greater of (1) the ratio of current
revenues to current and
anticipated revenues or (2) the
straight-line percentage over the
useful life of the software.

The same approach is allowed, but
not required.
10-41
Appendix 10 ─ Oil and Gas Accounting
Two acceptable accounting alternatives
Successful efforts
method
Full-cost
method
Exploration costs resulting
in unsuccessful wells
(dry holes) are expensed.
Exploration costs resulting
in unsuccessful wells
may be capitalized.
Political pressure prevented the FASB from requiring
all companies to use the successful efforts method.
10-42
Oil and Gas Accounting
The Shannon Oil Company incurred $2,000,000 in exploration costs
for each of 10 oil wells in 2013. Eight of the 10 wells were dry holes.
Prepare the journal entries to record the exploration costs under
both of the acceptable methods.
Successful Efforts:
Oil deposit .....................................
Exploration expense ………………
Cash ……………………….
4,000,000
16,000,000
Full Cost:
Oil deposit .....................................
Cash ……………………….
20,000,000
20,000,000
20,000,000
10-43
End of Chapter 10