Chapter 10
Property, Plant, and
Equipment and
Intangible Assets:
Acquisition and
Disposition
Copyright © 2015 McGraw-Hill Education. All rights reserved.
Types of Assets
Long-lived, revenue-producing assets
Property, plant, and
equipment:
Land, Buildings, Equipment,
Machinery, Furniture,
Autos, and Trucks
Natural resources:
Oil and Gas Deposits,
Timber Tracts, and Mineral
Deposits
Intangible assets:
• Patents
• Copyrights
• Trademarks
• Franchises
• Goodwill
Illustration: Property, Plant, and Equipment—
Semtech Corporation
Illustration: Intangible Assets—Layne
Christensen Company
Illustration: Property, Plant, and Equipment and
Their Acquisition Costs
Illustration: Intangible Assets and Their
Acquisition Costs
LO10-1
Costs to Be Capitalized
Property, plant, and equipment and intangible assets
Can be acquired by:
Purchase
Donation
Self-construction
Business
combination
Exchange
Lease
Initial cost = Purchase price + all expenditures
necessary to bring the asset
to its desired condition and
location for use
LO10-1
Cost of Equipment
Includes:
• Purchase price
• Any sales tax
• Transportation costs
• Expenditures for installation and testing
• Legal fees to establish title
• Any other costs to bring the asset to its condition
and location for use
LO10-1
Illustration Initial Cost of Equipment
Central Machine Tools purchased an industrial lathe to be used in its
manufacturing process. The purchase price was $62,000. Central paid a
freight company $1,000 to transport the machine to its plant location
plus $300 shipping insurance. In addition, the machine had to be installed
and mounted on a special platform built specifically for the machine at a
cost of $1,200. After installation, several trial runs were made to ensure
proper operation. The cost of these trials including wasted materials was
$600.
Purchase price
Freight and handling
Insurance during shipping
Special foundation
Trial runs
$62,000
1,000
v300
1,200
600
$65,100
Capitalized
Concept Check √
The following expenditures relate to equipment purchased by Symington
Corporation:
Purchase price
Transportation costs
Installation and special wiring
Testing
$48,000
2,400
1,500
6,000
What is the initial cost of the equipment purchased by Symington?
a.
$51,900.
b.
$57,900.
c.
$50,800.
d.
$48,000.
$48,000 (purchase price) + $2,400 (transportation
costs) + $1,500 (installation and wiring) + $6,000
(testing) = $57,900
LO10-1
Cost of Land
Costs may include:
• Purchase price
• Attorney fees
• Real estate agent commissions
• Costs related to title and title search
• Recording fees
• Any back taxes, liens, mortgages, or other
obligations
• Expenditures such as clearing, filling, draining,
and even removing old buildings
Proceeds from the sale of salvaged materials after
purchase reduce the cost of land
LO10-1
Illustration: Initial Cost of Land
The Byers Structural Metal Company purchased a six-acre tract of
land and an existing building for $500,000. The company plans to
raze the old building and construct a new office building on the
site. In addition to the purchase price, the company made the
following expenditures at closing of the purchase:
Title insurance
$ 3,000
Commissions
16,000
Property taxes
6,000
Shortly after closing, the company paid a contractor $10,000 to
tear down the old building and remove it from the site. An
additional $5,000 was paid to grade the land. The $6,000 in
property taxes included $4,000 of delinquent taxes paid by Byers
on behalf of the seller and $2,000 attributable to the portion of the
current fiscal year after the purchase date.
LO10-1
Illustration: Initial Cost of Land (continued)
Capitalized cost of land
Purchase price of land
Title insurance
Commissions
Delinquent property taxes
Cost of removing old building
Cost of grading
$550,000
3,000
16,000
4,000
10,000
5,000
$538,000
Property taxes = $6,000 − $2,000
Related to the
current period
LO10-1
Land Improvements
• Usually have useful lives that are estimable
• Costs:
o Separately identified and capitalized
o Depreciated over periods benefited by their use
• Examples:
o Cost of parking lots, driveways, and private
roads, costs of fences and lawn and garden
sprinkler systems
LO10-1
Cost of Buildings
• Cost of acquiring a building usually includes:
Purchase price
Realtor
commissions and legal fees
Reconditioning costs
LO10-1
Cost of Natural Resources
Natural Resources
• Includes timber tracts, mineral deposits, and oil and gas
deposits
• Benefits are derived from their physical consumption
Costs of Natural Resources
•
•
If purchased
Purchase price
Any other costs
necessary to bring the
asset to condition and
location for use
•
•
•
•
If developed
Acquisition costs
Exploration costs
Development costs
Restoration costs
LO10-1
Asset Retirement Obligations
An existing legal obligation associated with the
disposition/retirement of a tangible, long-lived asset
Recognized as a liability and measured at fair value
If value can be reasonably estimated
•
•
Some companies recognized the AROs gradually over
the life of the asset
While others did not recognize the obligations until
the asset was retired or sold
Example: Oil and gas exploration company might be required to
restore land to its original condition after extraction is completed
LO10-1
Asset Retirement Obligations (continued)
Provisions of Standards to address AROs
• Scope
• Recognition
• Measurement
• Present value calculations
LO10-1
Illustration: Asset Retirement Obligations
The Jackson Mining Company paid $1,000,000 for the right to explore
for a coal deposit on 500 acres of land in Pennsylvania. Costs of
exploring for the coal deposit totaled $800,000 and intangible
development costs incurred in digging and erecting the mine shaft were
$500,000. In addition, Jackson purchased new excavation equipment for
the project at a cost of $600,000. After the coal is removed from the
site, the equipment will be sold.
Jackson is required by its contract to restore the land to a condition
suitable for recreational use after it extracts the coal. The company has
provided the following three cash flow possibilities (A, B, and C) for the
restoration costs to be paid in three years, after extraction is completed:
Cash Outflow
Probability
A
$500,000
30%
B
600,000
50%
C
700,000
20%
The company’s credit-adjusted risk free interest rate is 8%.
LO10-1
Illustration: Asset Retirement Obligations
Total capitalized cost of the coal deposit:
Purchase of rights to explore
Exploration costs
Development costs
Restoration costs
Total cost of coal deposit
$1,000,000
800,000
500,000
468,360
$2,768,360
Present value of expected cash outflow for restoration costs
(asset retirement obligation):
$500,000 × 30% =
600,000 × 50% =
700,000 × 20% =
$150,000
300,000
140,000
$590,000 × .79383 = $468,360
(.79383 is the present value of $1, n = 3, i = 8%)
LO10-1
Illustration: Asset Retirement Obligations
Total capitalized cost for the coal deposit:
Purchase of rights to explore
Exploration costs
Development costs
Restoration costs
Total cost of coal deposit
Journal Entry
Coal mine
Cash
Asset retirement liability
Excavation equipment
Cash
$1,000,000
800,000
500,000
468,360
$2,768,360
Debit
Credit
2,768,360
2,300,000
468,360
600,000
600,000
LO10-1
Illustration: Asset Retirement Obligations
Year
1
2
3
Accretion
Expense
8% (468,360) = 37,469
8% (505,829) = 40,466
8% (546,295) = 43,705
Journal Entry
Asset retirement liability
Loss
Cash
Increase in
Balance
Asset Retirement
Obligation
468,360
505,829
546,295
590,000
37,469
40,466
43,705
Debit
Credit
590,000
35,000
Loss = $625,000 — $590,000= $35,000
625,000
LO10-1
Illustration: Asset Retirement Obligations
Year
1
2
3
Accretion
Expense
8% (468,360) = 37,469
8% (505,829) = 40,466
8% (546,295) = 43,705
Journal Entry
Accretion expense
Asset retirement liability
Increase in
Balance
Asset Retirement
Obligation
468,360
505,829
546,295
590,000
37,469
40,466
43,705
Debit
Credit
37,469
37,469
Concept Check √
The Winderl Mining Co. paid $50 million for the right to explore and extract
copper from land owned by the state of Wyoming. To obtain the rights, Winderl
agreed to restore the land to a suitable condition for other uses after its
exploration and extraction activities. Winderl incurred exploration and
development costs of $15 million on the project.
The company’s credit-adjusted risk free interest rate is 6%. It estimates the
possible cash flows for restoring the land, three years after its extraction
activities begin, as follows:
Cash outflow
Probability
$ 5 million
40%
$10 million
60%
What is the initial cost of the copper mine?
a.
$65,000,000.
Restoration costs: Expected value = $8 million ($5
b.
$73,000,000.
million x 40% + $10 million x 60%). $8 million x
c.
$71,716,960. .83962 (PV factor, i = 6, n = 3) = $6,716,960
d.
$95,000,000. Cost of mine: $50,000,000 + 15,000,000 +
6,716,960 = $71,716,960
LO10-1
Intangible Assets
• Represent exclusive rights that provide benefits to the
owner
• Lack physical substance
• Difficult to anticipate the timing and the existence of
future benefits attributable to many intangible assets
Companies
can either:
Amortized
Purchase intangible assets from other entities
Ex: Existing patent, copyright, trademark
Develop intangible assets internally
Ex: Develop a new product that is then patented
Finite useful lives
Indefinite useful lives
Not
Amortized
LO10-1
Intangible Assets (continued)
all other costs necessary to
Cost = Purchase price + bring the asset to its desired
condition and location for use
Intangible Assets (continued)
LO10-1
Specifically identifiable
Patents
Copyrights
Trademarks
Right to
Right of protection Right to display a
manufacture a given to a creator of word, a slogan, a
product or to use a a published work.
symbol, or an
process
Ex: Song/film/book
emblem
Franchises
Exclusive right by
franchisor to
franchisee to use the
franchisor’s
trademark/product
Granted by the Granted for the life Registered with U.S.
Franchisor
U.S. Patent Office of the creator plus Patent Office for a
grants it for a
for a period of 20
70 years
period of 10 years
specified
years
period of time to
the franchisee
Cost includes
Costs includes
Cost includes
Initial payment plus
purchase price, purchase price, legal purchase price, legal periodic payments
legal fees, filing fees, filing fees, not fees, filing fees, not over the life of the
fees, not including including internal including internal
franchise
internal research
research &
research &
agreement
& development
development
development
LO10-1
Goodwill
• Represents the unique value of a company as a whole
over and above its identifiable tangible and intangible
assets
Goodwill can emerge from a company’s:
Clientele and reputation
Trained employees and
management team
Favorable business
location
LO10-1
Goodwill (continued)
• Because goodwill can’t be separated from a company,
it’s not possible for a buyer to acquire it without also
acquiring the whole company or a portion of it
Capitalized Cost of Goodwill:
Fair value of the
consideration exchanged
(acquisition price) for the
company
−
Fair value of the net
assets acquired
The fair value of all identifiable tangible and intangible assets
(less)
The fair value of any liabilities of the selling company assumed
LO10-1
Illustration: Goodwill
The Smithson Corporation acquired all of the outstanding common
stock of the Rider Corporation in exchange for $18 million cash.
Smithson assumed all of Rider’s long-term debts which have a fair
value of $12 million at the date of acquisition. The fair values of all
identifiable assets of Rider amounted to $25 million (which
includes receivables of $5 million, inventory of $7 million, property,
plant, and equipment of $9 million, and patent of $4 million).
The cost of the goodwill resulting from the acquisition
Fair value of consideration exchanged
Less: Fair value of net assets acquired
Assets
$25
Less: Fair value of liabilities assumed (12)
Goodwill
$18
(13)
$ 5
LO10-1
Illustration Goodwill (continued)
The Smithson Corporation acquired all of the outstanding common
stock of the Rider Corporation in exchange for $18 million cash.
Smithson assumed all of Rider’s long-term debts which have a fair
value of $12 million at the date of acquisition. The fair values of all
identifiable assets of Rider amounted to $25 million (which
includes receivables of $5 million, inventory of $7 million, property,
plant, and equipment of $9 million, and patent of $4 million).
Difference
Journal Entry
Receivables
Inventory
Property, plant, and equipment
Patent
Goodwill
Liabilities
Cash
Debit
5
7
9
4
5
Credit
12
18
Concept Check √
The Deardon Golf Ball Company acquired all of the outstanding common
stock of Sanderson Golf for $1,750,000. The book values and fair values of
Sanderson's assets and liabilities on the date of purchase were as follows:
Current assets
Property, plant, and equipment
Liabilities
Book Value
$ 430,000
1,1500,000
300,000
Fair Value
$ 415,000
1,470,000
300,000
Deardon should record goodwill of:
a.
$165,000.
b.
$470,000.
c.
$170,000.
d.
$0.
$1,750,000 – ($415,000 + 1,470,000 - 300,000) =
$165,000
LO10-2
Lump-Sum Purchases
• Refers to the acquisition of group of assets for a single
sum
Valuation of these assets differs when:
• Each asset is indistinguishable
Example:
1. 10 identical delivery trucks purchased for a lumpsum price of $150,000.
• Assets have different characteristics and different useful
lives : Allocate the lump-sum acquisition price among the
separate items
Example:
1. Acquisition of a factory that includes assets that
are significantly different such as land, building,
and equipment.
LO10-2
Illustration Lump-Sum Purchase
The Smyrna Hand & Edge Tools Company purchased an existing
factory for a single sum of $2,000,000. The price included title to the
land, the factory building, and the manufacturing equipment in the
building, a patent on a process the equipment uses, and inventories
of raw materials. An independent appraisal estimated the fair values
of the assets (if purchased separately) at $330,000 for the land,
$550,000 for the building, $660,000 for the equipment, $440,000 for
the patent, and $220,000 for the inventories.
Fair Values
Land
Building
Equipment
Patent
Inventories
Total
$$330,000
330,000
$550,000
550,000
660,000
440,000
220,000
$2,200,000
15%
25
30
20
10
100%
LO10-2
Illustration Lump-Sum Purchase (continued)
The Smyrna Hand & Edge Tools Company purchased an existing
factory for a single sum of $2,000,000. The price included title to the
land, the factory building, and the manufacturing equipment in the
building, a patent on a process the equipment uses, and inventories
of raw materials. An independent appraisal estimated the fair values
of the assets (if purchased separately) at $330,000 for the land,
$550,000 for the building, $660,000 for the equipment, $440,000 for
the patent, and $220,000 for the inventories.
Initial Valuation of
Each Asset
Consideration
Price
Land
Building
Equipment
Patent
Inventories
Total
$2,000,000
×
15%
25
30
20
10
100%
=
=
=
=
=
$ 300,000
500,000
600,000
400,000
200,000
$2,000,000
LO10-2
Illustration: Lump-Sum Purchase (continued)
Initial Valuation of
Each Asset
Consideration
Price
Land
Building
Equipment
Patent
Inventories
Total
$2,000,000
×
Journal Entry
Land
Building
Equipment
Patent
Inventories
Cash
15%
25
30
20
10
100%
=
=
=
=
=
$ 300,000
500,000
600,000
400,000
200,000
$2,000,000
Debit
Credit
300,000
500,000
600,000
400,000
200,000
2,000,000
Concept Check √
Cirrus Corporation acquired a manufacturing facility on five acres of land for
a lump-sum price of $32,000,000. The land included land improvements
such as landscaping, a sprinkler system, and a parking lot. According to
independent appraisals, the fair values were $18,000,000, $12,000,000, and
$10,000,000 for the building, land, and land improvements, respectively.
The initial values of the building, land, and land improvements would be:
Building
a.
b.
c.
d.
Land
Land improvements
$18,000,000 $12,000,000
$10,000,000
$18,000,000 $12,000,000
$ 2,000,000
$14,400,000 $ 9,600,000
$ 8,000,000
All of these answer choices are incorrect.
Total fair value = $40,000,000. Building: $18,000,000 ÷
$40,000,000 = 45% x $32,000,000 = $14,400,000.
Land: $12,000,000 ÷ $40,000,000 = 30% x
$32,000,000 = $9,600,000. Land improvements:
$10,000,000 ÷ $40,000,000 = 25% x $32,000,000 =
$8,000,000.
LO10-3
Noncash Acquisitions
• Companies can also acquire assets by:
• issuing debt or equity securities
• receiving donated assets
• exchanging other assets
• Assets acquired in noncash transactions are valued
at the fair value of the assets given or the fair value
of the assets received, whichever is more clearly
evident
LO10-3
Deferred Payments
• An obligation to make payment in the future
Example: A machine is acquired for $15,000 and the
buyer signs a note requiring the payment of $15,000
sometime in the future plus interest at a realistic
interest rate.
Journal Entry
Machine
Note payable
Debit Credit
15,000
15,000
LO10-3
Illustration: Asset Acquired with Debt—Present
Value of Note Indicative of Fair Value
On January 2, 2016, the Midwestern Steam Gas Corporation
purchased an industrial furnace. In payment, Midwestern signed a
noninterest-bearing note requiring $50,000 to be paid on
December 31, 2017. If Midwestern had borrowed cash to buy the
furnace, the bank would have required an interest rate of 10%.
Journal Entry
Furnace
Discount on note payable
Note payable
Debit
Credit
41,323
8,677
50,000
PV = $50,000 × .82645 = $41,323 (Fair value of Note)
Present value of $1: n = 2, i = 10%
Discount on note payable = $50,000 – $41,323 = $8,677
Illustration: Asset Acquired with Debt—Present
Value of Note Indicative of Fair Value (continued)
LO10-3
Adjusting entries for Midwestern’s fiscal year-ends:
Journal Entry
Debit
December 31, 2016
Interest expense ($41,323 × 10%)
Discount on note payable
4,132
4,132
December 31, 2017
Interest expense ($41,323 + $4,132) × 10%
Discount on note payable
Note payable
Cash
Note payable
Jan. 1, 2016 50,000
50,000 Dec. 31, 2017
Bal. 12/31/17 0
Credit
4,545
4,545
50,000
50,000
Discount on note payable
8,677 Jan. 1, 2016
Dec. 31, 2016 4,132
Dec. 31, 2017 4,545
0 Bal. 12/31/17
Illustration: Noninterest-Bearing Note - Fair
Value of Asset Is Known
LO10-3
On January 2, 2016, Dennison, Inc., purchased a machine and
signed a noninterest-bearing note in payment. The note requires
the company to pay $100,000 on December 31, 2018. Dennison is
not sure what interest rate appropriately reflects the time value of
money. However, price lists indicate the machine could have been
purchased for cash at a price of $79,383.
Journal Entry
Machine (Cash price)
Discount on note payable
Note payable (Face amount)
Credit
Debit
79,383
20,617
100,000
PV = Face amount × PV Factor
Implicit rate of interest
PV Factor = $79,383 ÷ $100,000 = .79383
Present value of $1: n = 2, i = ? (from Table PV table, i=8%)
Discount on note payable = $100,000 – $79,383 = $20,617
LO10-4
Issuance of Equity Securities
• Occurs when small companies incorporate and the
owner or owners contribute assets to the new
corporation in exchange for ownership securities
• Transaction’s exchange value either:
o The fair value of the assets received by the
corporation or
o The market value of the shares of corporations
whose stock is actively traded
LO10-4
Illustration: Asset Acquired by Issuing Equity
Securities
On March 31, 2016, the Elcorn Company issued 10,000
shares of its nopar common stock in exchange for land. On
the date of the transaction, the fair value of the common
stock, evidenced by its market price, was $20 per share.
Journal Entry
Land
Common stock
Debit
200,000
10,000 Shares @ $20 per share = $200,000
Credit
200,000
LO10-4
Donated Assets
• The donation usually is an enticement to do
something that benefits the donor
• Recorded at their fair values based on either an
available market price or an appraisal value
• Revenue is credited
LO10-4
Illustration: Asset Donation
Elcorn Enterprises decided to relocate its office headquarters
to the city of Westmont. The city agreed to pay 20% of the
$20 million cost of building the headquarters in order to
entice Elcorn to relocate. The building was completed on
May 3, 2016. Elcorn paid its portion of the cost of the
building in cash.
Journal Entry
Land
Cash
Revenue—donation of asset
Credit
Debit
20,000,000
16,000,000
4,000,000
Donation = $20,000,000 × 20% = $4,000,000
LO10-9
International Financial Reporting Standards
U.S. GAAP
IFRS
Government Grants
Both U.S. GAAP and IFRS require that donated assets be valued at their
fair values
Deduct the amount of the grant in
Recorded as revenue in the
determining the initial cost of the
period received
asset, or
Record the grant as a liability,
deferred income, in the balance
sheet and recognize it in the income
statement systematically over the
asset’s useful life
Concept Check √
The County of Santa Clara gave a parcel of land to the 49ers Company as
part of an agreement requiring the 49ers to construct its football stadium
on the donated land. The land cost the county $12,800,000 when
purchased several years ago and had an appraised value of $20,000,000 on
the date it was given to the 49ers. As a result of the donation, the 49ers
should record:
a.
A credit to retained earnings of $20,000,000.
b.
A debit to land of $12,800,000.
c.
A credit to revenue of $20,000,000.
d.
All of these answer choices are incorrect.
GAAP requires that if a company receives a donated
asset it must record revenue at an amount equal to the
fair value of that asset.
LO10-5
Decision Makers’ Perspective
Capital budgeting:
• Includes decisions pertaining to acquisitions of
property, plant, and equipment and intangible assets
• Requires management to forecast all future net cash
flows generated by the asset(s)
Net present value model
Present value of
future net cash flows
>
Initial
acquisition cost
LO10-5
Decision Makers’ Perspective
Fixed Asset Turnover Ratio:
• Indicates the level of sales generated by the
company’s investment in fixed assets
Book value, sometimes called
carrying value or carrying amount
(cost less accumulated depreciation and depletion)
LO10-5
Decision Makers’ Perspective
Fixed Asset Turnover Ratio
($ in millions)
GAP
Ross Stores
2014 2013 2014 2013
Property, plant, and equipment (net) $2,758 $2,619 $1,875 $1,493
Net sales—2014
$16,148
$10,230
GAP
Fixed-asset turnover ratio (2014) = $16,148
$2,688.5
($2,758 + $2,619) ÷ 2
= $6.01
Ross Stores
$10,230
$1,684
$6.07
LO10-6
Dispositions
•
•
Sale
Monetary consideration
(cash or a receivable)
The seller recognizes a
gain or loss for the
difference between the
consideration received
and the book value of
the asset sold
•
•
Retirement
No monetary
consideration
A loss is recorded for the
remaining book value of
the asset
LO10-6
Illustration: Sale of Property, Plant, and
Equipment
The Robosport Company sold for $6,000 equipment that
originally cost $20,000. Depreciation of $12,000 had been
recorded up to the date of sale.
Journal Entry
Cash
Accumulated depreciation
Loss on disposal of equipment
Equipment
Book value = ($20,000 – $12,000) = $8,000
Loss = $8,000 – $6,000 = $2,000
Debit
6,000
12,000
2,000
Credit
20,000
LO10-6
Exchanges
• Refers to the acquisition of an asset in exchange for
an asset other than cash
Old asset
(Fair value)
Traded-in
New asset acquired
(Fair value)
Difference
Paid in cash or other asset
• Gain or loss is recognized in these transactions for the
difference between the fair value and book value of
the asset given
LO10-6
Illustration: Nonmonetary Asset Exchange (Gain)
The Elcorn Company traded its laser equipment for the newer air-cooled
ion lasers manufactured by American Laser Corporation. The old
equipment had a book value of $100,000 (cost of $500,000 less
accumulated depreciation of $400,000) and a fair value of $150,000. To
equalize the fair values of the assets exchanged, in addition to the old
equipment, Elcorn paid American Laser $430,000 in cash.
Journal Entry
Laser equipment—new
Accumulated depreciation
Laser equipment—old
Cash
Gain
Debit Credit
580,000
400,000
500,000
430,000
50,000
Fair value of new equipment = $580,000 ($150,000 + $430,000)
Gain = Fair value ($150,000) − Book value ($100,000) = $50,000
LO10-6
Illustration: Nonmonetary Asset Exchange (Loss)
The Elcorn Company traded its laser equipment for the newer air-cooled
ion lasers manufactured by American Laser Corporation. The old
equipment had a book value of $100,000 (cost of $500,000 less
accumulated depreciation of $400,000) and a fair value of $75,000. To
equalize the fair values of the assets exchanged, in addition to the old
equipment, Elcorn paid American Laser $430,000 in cash.
Journal Entry
Laser equipment—new
Accumulated depreciation
Loss
Laser equipment—old
Cash
Debit Credit
505,000
400,000
25,000
500,000
430,000
Fair value of new equipment = $505,000 ($75,000 + $430,000)
Loss = Fair value ($75,000) − Book value ($100,000) = ($25,000)
Nonmonetary Asset Exchange
LO10-6
(Fair Value Not Determinable)
The Elcorn Company traded its laser equipment for the newer aircooled ion lasers manufactured by American Laser Corporation.
The old equipment had a book value of $100,000 (cost of
$500,000 less accumulated depreciation of $400,000). The fair
value of both the new and old equipment is not determinable.
Elcorn paid American Laser $430,000 in cash.
Journal Entry
Equipment—new
Accumulated depreciation
Equipment—old
Cash
Debit Credit
530,000
400,000
500,000
430,000
LO10-6
Exchange Lacks Commercial Substance
Commercial Substance:
• Present when future cash flows change as a result of the
exchange
• Example: Newer models of equipment can increase
production or improve manufacturing efficiency causing
an increase in revenue or a decrease in operating costs
with a corresponding increase in future cash flows
Exchange Lacks Commercial Substance
•
Gain Situation
Book value of the old
asset is used to record
the exchange
•
Loss Situation
Fair value of old asset is
used to record the
exchange (unlikely
situation)
LO10-6
Illustration: Nonmonetary Asset Exchange—
Exchange Lacks Commercial Substance
The Elcorn Company traded a tract of land to Sanchez
Development for a similar tract of land. The old land had a
book value of $2,500,000 and a fair value of $4,500,000. To
equalize the fair values of the assets exchanged, in addition
to the land, Elcorn paid Sanchez $500,000 in cash. This
means that the fair value of the land acquired is
$5,000,000.
Journal Entry
Land—new
Land—old
Cash
Credit
Debit
3,000,000
2,500,000
500,000
Fair value of new land = $3,000,000 ($2,500,000 + $500,000)
No gain is recognized.
Concept Check √
Arizona Pharmaceuticals exchanged laser equipment with a book value of
$70,000 and a fair value of $75,000 for the newer model of laser
equipment. In addition to the old equipment, $90,000 in cash was given.
Arizona should recognize:
a.
A loss of $5,000.
b.
A gain or 15,000.
c.
A gain or $5,000.
d.
No gain or loss.
A gain is recognized for the difference between the fair
value of the old equipment and the equipment’s book
value: $75,000 – 70,000 = $5,000
Concept Check √
Arizona Pharmaceuticals exchanged laser equipment with a book value of
$70,000 and a fair value of $75,000 for the newer model of laser
equipment. In addition to the old equipment, $90,000 in cash was given.
Arizona should record the new laser equipment at:
a.
$ 95,000.
b.
$165,000.
c.
$160,000.
d.
All of these answer choices are incorrect.
The new laser equipment is recorded at an amount
equal to the fair value of the old equipment plus the
cash given: $75,000 + 90,000 = $165,000
LO10-7
Self-Constructed Assets
• A company might decide to construct an asset for its
own use rather than buy an existing one
• Identifying the cost is difficult because there is no
external transaction to establish an exchange price
Two Critical Issues
Determining the amount
of indirect manufacturing
costs (overhead) to be
allocated to the
construction
Deciding on the proper
treatment of interest
(actual or implicit)
incurred during
construction
LO10-7
Self-Constructed Assets (continued)
Overhead Allocation
The treatment of manufacturing overhead cost and
its allocation:
1. Inclusion of only the incremental overhead costs
2. Full-cost approach
Interest Capitalization
1. Capitalized and then allocated as depreciation
LO10-7
Interest Capitalization
Qualifying Assets
• Assets that are constructed for a company’s own use as
well as assets constructed as discrete projects for sale or
lease
• Only interest incurred during the construction period is
eligible for capitalization
Period of Capitalization
• Begins when construction begins and the first
expenditure is made as long as interest costs are actually
being incurred
Average Accumulated Expenditures
• Approximates the average debt necessary for
construction
LO10-7
Illustration: Interest Capitalization
On January 1, 2016, the Mills Conveying Equipment Company began
construction of a building to be used as its office headquarters. The building
was completed on June 30, 2017. Expenditures on the project, mainly
payments to subcontractors, were as follows:
January 1, 2016
March 31, 2016
September 30, 2016
Accumulated expenditures at December 31, 2016
(before interest capitalization)
January 31, 2017
April 30, 2017
$
500,000
400,000
600,000
$ 1,500,000
600,000
300,000
On January 1, 2016, the company obtained a $1 million construction loan with
an 8% interest rate. The loan was outstanding during the entire construction
period. The company’s other interest-bearing debt included two long-term
notes of $2,000,000 and $4,000,000 with interest rates of 6% and 12%,
respectively. Both notes were outstanding during the entire construction
period.
Illustration: Interest Capitalization (continued)
LO10-7
STEP 1: Determine the average accumulated expenditures.
If expenditures incurred are fairly even throughout the period, the
average expenditures would be:
Total accumulated expenditures incurred evenly
throughout the period
Average accumulated expenditures
$1,500,000
÷2
$ 750,000
If expenditures are not incurred evenly throughout the period,
weighted average is determined:
Actual
Expenditures
January 1, 2016
$500,000 × 12/12 =
March 31, 2016
400,000 × 9/12 =
September 30, 2016
600,000 × 3/12 =
Average accumulated expenditures for 2016 =
Time-Weighted
Expenditures
$500,000
300,000
150,000
$950,000
Illustration: Interest Capitalization (continued)
LO10-7
STEP 2:
Calculate the amount of interest to be capitalized.
Interest capitalized for 2016 = $950,000 × 8% = $76,000
Accumulated expenditures at December 31, 2016
Cost of the building
$1,500,000
Interest capitalized for 2016
76,000
Accumulated expenditures at December 31, 2016 $1,576,000
STEP 3:
Compare the calculated interest with actual interest incurred.
Annual
Loans
Rate
$1,000,000 ×
8%
2,000,000 ×
6%
2,000,000 × 12%
Actual
Interest
= $ 80,000
=
120,000
=
480,000
$680,000
Calculated
Interest
Use lower amount
>
$76,000
Illustration: Interest Capitalization (continued)
LO10-7
• The same procedure is carried out for 2017.
• The method of determining the amount of interest to
capitalize by using rates from specific loans to the
extent of specific borrowings before using the average
rate of other debt is called the specific interest
method
• The alternative is the weighted-average method
Concept Check √
In January of 2016, the Mateo Company began construction of its own
storage facility. During 2016, $13,000,000 in construction costs were
incurred as follows: January 1, $2,000,000; March 31, $4,000,000; June 30,
$4,000,000; October 31, $3,000,000. Mateo took out a $4,000,000, 10%
construction loan at the beginning of the year. The company had
$20,000,000 in other interest-bearing debt with a weighted-average
interest rate of 8%. The facility was completed early in 2017. What amount
of interest should Mateo capitalize in 2016 using the specific interest
method?
a.
$600,000.
b.
$750,000.
c.
$680,000.
d.
$660,000.Average accumulated expenditures = $7,500,000
($2,000,000 x 12/12 + $4,000,000 x 9/12 + $4,000,000
x 6/12 + $3,000,000 x 2/12). Capitalized interest:
$4,0000,000 x 10% + $3,500,000 x 8% = $680,000
LO10-7
Illustration: Capitalized Interest Disclosure—
Wal-Mart Stores, Inc.
LO10-8
Research and Development (R&D)
Research
• Planned search or
critical investigation to
discover new knowledge
that helps developing a
new product or service
or a new process or
technique or improving
an existing product or
processes
Development
• Translation of research
findings into a plan or
design for a new
product or process or
improving existing
product or processes,
whether intended for
sale or use
LO10-8
Determining R&D Costs
Includes costs relevant to R&D projects, such as:
• Salaries, wages, and other labor costs of R&D personnel
• Costs of materials consumed, equipment, facilities, and
intangibles used in R&D projects
• Costs of services performed by others
• A reasonable allocation of indirect costs related to the
R&D activities
Asset purchased for
single R&D project
• Cost is considered
R&D and expensed
immediately in the
current year
•
Asset purchased for more than
a single R&D project
Depreciation or amortization of
the asset included as R&D
expense in the current and
future periods
LO10-8
Illustration: Research and Development
Expenditures
Costs incurred
are R&D costs
Costs incurred
are Non-R&D costs
LO10-8
Illustration: Research and Development Costs
The Askew Company made the following cash expenditures during 2016
related to the development of a new industrial plastic:
R&D salaries and wages
$10,000,000
R&D supplies consumed during 2016
3,000,000
Purchase of R&D equipment
5,000,000
Patent filing and legal costs
100,000
Payments to others for services performed in connection
with R&D activities
1,200,000
Total
$19,300,000
The project resulted in a new product to be manufactured in 2017. A patent
was filed with the U.S. Patent Office. The equipment purchased will be
employed in other projects. Depreciation on the equipment for 2016 was
$500,000.
Journal Entry
R&D expense
Cash
Debit
Credit
14,200,000
14,200,000
LO10-8
Illustration: Research and Development Costs
(continued)
The Askew Company made the following cash expenditures during 2016
related to the development of a new industrial plastic:
R&D salaries and wages
$10,000,000
R&D supplies consumed during 2016
3,000,000
Purchase of R&D equipment
5,000,000
Patent filing and legal costs
100,000
Payments to others for services performed in connection
with R&D activities
1,200,000
Total
$19,300,000
The project resulted in a new product to be manufactured in 2017. A patent
was filed with the U.S. Patent Office. The equipment purchased will be
employed in other projects. Depreciation on the equipment for 2016 was
$500,000.
Journal Entry
Equipment
Cash
Debit
Credit
5,000,000
5,000,000
LO10-8
Illustration: Research and Development Costs
(continued)
The Askew Company made the following cash expenditures during 2016
related to the development of a new industrial plastic:
R&D salaries and wages
$10,000,000
R&D supplies consumed during 2016
3,000,000
Purchase of R&D equipment
5,000,000
Patent filing and legal costs
100,000
Payments to others for services performed in connection
with R&D activities
1,200,000
Total
$19,300,000
The project resulted in a new product to be manufactured in 2017. A patent
was filed with the U.S. Patent Office. The equipment purchased will be
employed in other projects. Depreciation on the equipment for 2016 was
$500,000.
Journal Entry
Debit
R&D expense
Accumulated depreciation—equipment
500,000
Credit
500,000
LO10-8
Illustration: Research and Development Costs
(continued)
The Askew Company made the following cash expenditures during 2016
related to the development of a new industrial plastic:
R&D salaries and wages
$10,000,000
R&D supplies consumed during 2016
3,000,000
Purchase of R&D equipment
5,000,000
Patent filing and legal costs
100,000
Payments to others for services performed in connection
with R&D activities
1,200,000
Total
$19,300,000
The project resulted in a new product to be manufactured in 2017. A patent
was filed with the U.S. Patent Office. The equipment purchased will be
employed in other projects. Depreciation on the equipment for 2016 was
$500,000.
Journal Entry
Patent
Cash
Debit
Credit
100,000
100,000
LO10-8
Illustration: Research and Development Costs
(continued)
The Askew Company made the following cash expenditures during 2016
related to the development of a new industrial plastic:
R&D salaries and wages
$10,000,000
R&D supplies consumed during 2016
3,000,000
Purchase of R&D equipment
5,000,000
Patent filing and legal costs
100,000
Payments to others for services performed in connection
with R&D activities
1,200,000
Total
$19,300,000
The project resulted in a new product to be manufactured in 2017. A patent
was filed with the U.S. Patent Office. The equipment purchased will be
employed in other projects. Depreciation on the equipment for 2016 was
$500,000.
Expenditures reconciliation:
Recorded as R&D
Capitalized as equipment
Capitalized as patent
Total
$14,200,000
5,000,000
100,000
$19,300,000
LO10-8
R&D Performed for Others and Start-Up costs
R&D Performed for Others
• R&D costs are capitalized as inventory and carried
forward into future years until the project is
completed
Start-Up Costs
• Refers to one-time preopening costs
• Includes Organization costs
• Expensed in the period incurred
LO10-8
Illustration: Software Development Costs
“when the enterprise has completed all planning, designing,
coding, and testing activities that are necessary to establish that
the product can be produced to meet its design specifications
including functions, features, and technical performance
requirements.”
LO10-8
Software Development Costs
• Amortization of capitalized software development
costs begins when the product is available for general
release to customers
• The periodic amortization percentage:
Percentage-ofrevenue method
Percentage-ofrevenue method
>
Straight-line
method
<
Straight-line
method
LO10-8
Illustration: Software Development Costs
The Astro Corporation develops computer software graphics
programs for sale. A new development project begun in 2015
reached technological feasibility at the end of June 2016, and the
product was available for release to customers early in 2017.
Development costs incurred in 2016 prior to June 30 were
$1,200,000 and costs incurred from June 30 to the product
availability date were $800,000. 2017 revenues from the sale of
the new product were $3,000,000 and the company anticipates
an additional $7,000,000 in revenues. The economic life of the
software is estimated at four years.
Astro Corporation would expense the $1,200,000 in costs
incurred prior to the establishment of technological feasibility and
capitalize the $800,000 in costs incurred between technological
feasibility and the product availability date.
LO10-8
Illustration: Software Development Costs
(continued)
1. Percentage-of-revenue method
=
=
=
=
2. Straight-line method
=
=
=
$3,000,000
$3,000,000 + $7,000,000
30%
30% × $800,000
$240,000
1/4 or 25%
1/4 or 25% × $800,000
$200,000
Concept Check √
During 2016, the Ellison Software Company incurred development costs of
$8,000,000 related to a new software project. Of this amount, $1,600,000
was incurred after technological feasibility was achieved. The project was
completed in the middle of the year and the product was available for
release to customers on July 1. Year 2016 revenues from the sale of the
new software were $2,000,000 and the company anticipated future
additional revenues of $18,000,000. The economic life of the software is
estimated at four years. Year 2016 amortization of the software
development costs should be:
a.
$800,000.
b.
$200,000.
c.
$400,000.
d.
$160,000.
Percentage-of-revenue: 10% x $1,600,000 = $160,000
Straight-line: ½ x ($1,600,000 ÷ 4) = $200,000
Amortization is the larger of the two, $200,000
LO10-8
Purchased Research and Development
In case of purchased Research and Development
Developed technology
•
Capitalize its fair value as •
a finite-life intangible
asset and amortize that
amount over its useful
life
In-process research and
development
Capitalize the fair value of
in-process R&D as an
indefinite-life intangible
asset
R&D costs incurred after the acquisition
are expensed as incurred
LO10-9
International Financial Reporting Standards
U.S. GAAP
IFRS
Research and Development Expenditures
All research and development
Research expenditures are expensed
expenditures are expensed in the in the period incurred and
period incurred, except for
development expenditures that meet
software development costs
specified criteria are capitalized as an
incurred after technological
intangible asset
feasibility has been established
APPENDIX 10
Oil and Gas Accounting
Methods of accounting
Successful Efforts Method
• Exploration costs known •
not to have resulted in
the discovery of oil or
gas to be treated as
expenses in the period
the expenditures are
made
Full-Cost Method
Exploration costs to be
capitalized as assets and
expensed in future as oil
and gas from the successful
wells are removed from
that area
APPENDIX 10
Illustration: Oil and Gas Accounting
The Shannon Oil Company incurred $2,000,000 in
exploration costs for each of 10 oil wells drilled in 2016 in
west Texas. Eight of the 10 wells were dry holes.
8 dry holes × $2,000,000 = $16,000,000
Journal Entry
Successful Efforts Method
Oil deposit
Exploration expense
Cash
Full Cost Method
Oil deposit
Cash
Debit
Credit
4,000,000
16,000,000
20,000,000
20,000,000
20,000,000
End of Chapter 10