Chapter 10
OPERATIONAL ASSETS:
ACQUISITION AND
DISPOSITION
McGraw-Hill /Irwin
© 2009 The McGraw-Hill Companies, Inc.
Slide 2
Types of Operational Assets
Actively Used in Operations
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 operational asset includes the
purchase price and all expenditures necessary to bring the
asset to its desired condition and location for use.
10-2
Slide 3
Costs to be Capitalized
Equipment
• Net purchase price
• Taxes
• Transportation costs
• Installation costs
• Modification to building
necessary to install
equipment
• 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
10-3
Slide 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
10-4
Slide 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.
10-5
Slide 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
reclamation or restoration.
10-6
Slide 7
Intangible Assets
Lack physical
substance.
Exclusive
Rights.
Intangible
Assets
Future benefits less certain
than tangible assets.
10-7
Slide 8
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
Slide 9
Intangible Assets
Copyrights
Trademarks
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.

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.

10-9
Slide 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.
Only purchased
goodwill is an
intangible asset.
The amount by which the
consideration given price exceeds
the fair value of net assets acquired.
10-10
Slide 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 be
recorded in Eddy Company books?
a. $100,000
b. $200,000
c. $300,000
d. $400,000
10-11
Slide 12
Lump-Sum Purchases
Several assets are acquired for a single price that may
be lower than the sum of the individual asset prices.
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 charged to the building account?
10-12
Slide 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 apportioned $130,000
of the total purchase price of $200,000.
GENERAL JOURNAL
Date
Description
May 13 Land
Building
Page 14
PR
Debit
Credit
70,000
130,000
Cash
200,000
10-13
Slide 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.
10-14
Slide 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.
Let’s consider an example where we must compute
the present value of a noninterest-bearing note.
10-15
Slide 16
Deferred Payments
On January 2, 2009, Midwestern Corporation purchased
equipment by signing a noninterest-bearing note requiring
$50,000 to be paid on December 31, 2009. The prevailing
market rate of interest on notes of this nature is 10%.
Prepare the required journal entries for Midwestern on
January 2, 2009; December 31, 2009 (year-end), and
December 31, 2010 (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
10-16
Slide 17
Deferred Payments
GENERAL JOURNAL
Date
Description
Page 73
PR
Jan. 2 Equipment
2009 Discount on Note Payable
Note Payable
Debit
Credit
41,323
8,677
50,000
Discount = $50,000 - $41,323
GENERAL JOURNAL
Date
Description
Page 74
PR
Debit
Dec. 31 Interest Expense
2009
Discount on Note Payable
Interest = 10% of $41,323
4,132
Dec. 31 Interest Expense
2010
Discount on Note Payable
Interest = 10% of ($41,323 + $4,132)
4,545
Dec. 31 Note Payable
2010
Cash
Credit
4,132
4,545
50,000
50,000
10-17
Slide 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 no objective and reliable value can be determined,
board of directors assigns a “reasonable value.”
Donated Assets
 On occasion, companies acquire operational assets
through donation.
 SFAS No. 116 requires the receiving company to
• Record the donated asset at fair value.
• Record revenue equal to the fair value of the donated
asset.
10-18
Slide 19
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
Dell
2007
Property, plant, and
equipment (net)
Net sales
$
2,409
57,420
$57,420
= 26
($2,409 + $1,993)/2
Apple
2006
$
1,993
2007
$
1,832
24,006
2006
$
1,281
$24,006
= 15.4
($1,832 + $1,281)/2
Dell generates nearly two times more sales dollars for
each dollar invested in fixed assets than Apple does.
10-19
Slide 20
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, 2009, MeLo, Inc. sold equipment for $6,350
cash. The equipment was purchased on January 1, 2004 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, 2008, its year-end.
Prepare the journal entries necessary to
record the disposition of this equipment.
10-20
Slide 21
Dispositions
 Update depreciation to date of sale.
GENERAL JOURNAL
Date
Description
Page 9
PR
June 30 Depreciation Expense
Debit
Credit
750
Accumulated Depreciation
750
($15,000 ÷ 10 years) × ½ = $750
 Remove original asset cost and accumulated depreciation.
 Record the gain or loss.
GENERAL JOURNAL
Date
Description
June 30 Accumulated Depreciation
Cash
Loss on Sale
Equipment
Page 9
PR
Debit
Credit
8,250
6,350
400
15,000
($15,000 ÷ 10 years) × 5½ years = $8,250
10-21
Slide 22
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 operational 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.
10-22
Slide 23
Fair Value Not Determinable
Matrix, Inc. exchanged one unique operational asset for
another operational asset. 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
10-23
Slide 24
Fair Value Not Determinable
Matrix, Inc.
The journal entry below shows the proper
recording of the exchange.
GENERAL JOURNAL
Date
Description
Debit
Equipment ($200,000 + $100,000)
Accumulated depreciation
Equipment
Cash
300,000
400,000
Credit
600,000
100,000
10-24
Slide 25
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.
10-25
Slide 26
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
10-26
Slide 27
Exchanges
$205,000 fair value + $10,000 cash
GENERAL JOURNAL
Date
Description
Debit
Equipment
Accumulated Depreciation
Equipment
Cash
Gain on exchange
215,000
300,000
Credit
500,000
10,000
5,000
Record the same transaction assuming the
exchange lacks commercial substance.
$200,000 book value + $10,000 cash
GENERAL JOURNAL
Date
Description
Equipment
Accumulated Depreciation
Equipment
Cash
Debit
Credit
210,000
300,000
500,000
10,000
10-27
Slide 28
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.
10-28
Slide 29
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.
10-29
Slide 30
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.
10-30
Slide 31
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
10-31
Slide 32
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.
10-32
Slide 33
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
10-33
Slide 34
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
10-34
Slide 35
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 expensed against revenue from the contract.
Operational assets used in R&D should be capitalized if
they have alternative future uses.
10-35
Slide 36
Software Development Costs
SFAS No. 86
 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
10-36
Slide 37
Software Development Costs
SFAS No. 86
• 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.
10-37
Slide 38
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.
10-38
Slide 39
Oil and Gas Accounting
The Shannon Oil Company incurred $2,000,000 in exploration
costs for each of 10 oil wells in 2009. Eight of the 10 wells
were dry holes. Prepare the journal entries to record the
exploration costs under both of the acceptable methods.
GENERAL JOURNAL
Successful Date
Efforts
Description
Oil deposit
Exploration expense
Cash
Debit
Credit
4,000,000
16,000,000
20,000,000
GENERAL JOURNAL
Full
Cost
Date
Description
Oil deposit
Cash
Debit
Credit
20,000,000
20,000,000
10-39
End of Chapter 10
McGraw-Hill /Irwin
© 2009 The McGraw-Hill Companies, Inc.