10
Property, Plant, and Equipment
and Intangible Assets: Acquisition
and Disposition
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
McGraw-Hill/Irwin
Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.
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 - 2
Costs to be Capitalized
Equipment
• Net purchase price
• Taxes
• Transportation costs
• Installation costs
• Modification to building
necessary to install
equipment
• Testing and trial runs
10 - 3
Land (not depreciable)
• Purchase price
• Real estate commissions
• Attorney’s fees
• Title search
• Title transfer fees
• Title insurance premiums
• Removing old buildings
Costs to be Capitalized
Land Improvements
Separately identifiable costs of
• Driveways
• Parking lots
• Fencing
• Landscaping
• Private roads
10 - 4
Buildings
• Purchase price
• Attorney’s fees
• Commissions
• Reconditioning
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 - 5
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
reclamation or restoration.
10 - 6
Intangible Assets
Lack physical
substance.
Exclusive
Rights.
Intangible
Assets
Future benefits less certain
than tangible assets.
10 - 7
Intangible Assets ─ Patents
• An exclusive right recognized by law and granted by
the US 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 - 8
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.
10 - 9
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.
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.
Only purchased
goodwill is an
intangible asset.
The amount by which the
consideration exchanged exceeds
the fair value of net assets acquired.
10 - 10
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 - 11
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 - 12
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.
10 - 13
70,000
130,000
200,000
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 - 14
Deferred Payments
Note payable
10 - 15
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.
Deferred Payments
On January 2, 2011, Midwestern Corporation purchased
equipment by signing a noninterest-bearing note requiring
$50,000 to be paid on December 31, 2012. The prevailing
market rate of interest on notes of this nature is 10%.
Prepare the required journal entries for Midwestern on
January 2, 2011; December 31, 2011 (year-end), and
December 31, 2012 (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)
10 - 16
$ 50,000
0.82645
$ 41,323
Deferred Payments
January 2, 2011:
Equipment ...........................................................
Discount on note payable ….….…….……………
Note payable …………………………....
41,323
8,677
50,000
To record equipment acquisition.
December 31, 2011:
Interest expense (10% of $41,323)......................
Discount on note payable ………………
4,132
4,132
To record interest expense.
December 31, 2012:
Interest expense (10% of ($41,323+$4,132)) ......
Discount on note payable ……..……..…
4,545
4,545
To record interest expense.
December 31, 2012
Note payable ........................................................
Cash ……..……………………………..…
To record payment of note.
10 - 17
50,000
50,000
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 - 18
Dispositions
 Update depreciation to date of disposal.
 Remove original cost of asset and accumulated
depreciation 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, 2011, MeLo, Inc. sold equipment for $6,350
cash. The equipment was purchased on January 1, 2006 at
a cost of $15,000. The equipment was depreciated using the
straight-line method over an estimated ten-year life with zero
salvage value. MeLo last recorded depreciation on the
equipment on December 31, 2010, its year-end.
Prepare the journal entries necessary to
record the disposition of this equipment.
10 - 19
Dispositions
 Update depreciation to date of sale.
June 30, 2011:
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, 2011:
Accumulated depreciation ............................................
Cash ………………………….……………......................
Loss on sale …………………………………………….…
Equipment …………………………...............…
To record sale of equipment.
($15,000 ÷ 10 years) × 5½) = $8,250
10 - 20
8,250
6,350
400
15,000
Exchanges
General Valuation Principle (GVP): 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 is recognized.
10 - 21
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
10 - 22
$
$
600,000
400,000
200,000
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.
10 - 23
300,000
400,000
600,000
100,000
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, and
 that expected change is significant relative to the fair
value of the assets exchanged.
10 - 24
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
300,000 $ 200,000 $ 205,000
Gain = Fair Value – Book Value
Gain = $205,000 – $200,000 = $5,000
10 - 25
Fair
Value
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.
10 - 26
210,000
300,000
500,000
10,000
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.
10 - 27
Interest that could have
been avoided if the asset
were not constructed and
the money used to retire
debt.
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 - 28
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.
10 - 29
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.
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
10 - 30
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
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 - 31
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 - 32
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.
10 - 33
Other
debt
AAE
Specific
new
borrowing
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 - 34
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
10 - 35
Costs
Capitalized
Technological
Feasibility
Operating
Costs
Date of
Product
Release
Sale of
Product
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 - 36
U.S. GAAP vs. IFRS
Research and Development Costs
• 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.
10 - 37
• 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.
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.
10 - 38
• The same approach is
allowed, but not required.