INTERMEDIATE ACCOUNTING
TENTH CANADIAN EDITION
Kieso • Weygandt • Warfield • Young • Wiecek • McConomy
CHAPTER 10
Acquisition of
Property, Plant and
Equipment
Prepared by:
Dragan Stojanovic, CA
Rotman School of Management,
University of Toronto
CHAPTER 10:
Acquisition of Property, Plant, and Equipment
After studying this chapter, you should be able to:
•
Understand the importance of property, plant, and equipment from a
business perspective.
•
Identify the characteristics of property, plant, and equipment assets.
•
Identify the recognition criteria for property, plant, and equipment.
•
Identify the costs to include in the measurement of property, plant, and
equipment assets at acquisition.
•
Determine asset cost when the transaction has delayed payment
terms or is a lump-sum purchase, a non-monetary exchange, or a
contributed asset.
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2
CHAPTER 10:
Acquisition of Property, Plant, and Equipment
After studying this chapter, you should be able to:
(continued)
•
Identify the costs included in specific types of property, plant, and equipment.
•
Understand and apply the cost model.
•
Understand the revaluation model and apply it using the asset adjustment
method.
•
Understand and apply the fair value model.
•
Explain and apply the accounting treatment for costs incurred after acquisition.
•
Identify differences in accounting between ASPE and IFRS, and what changes
are expected in the near future.
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Acquisition of Property, Plant, and
Equipment
Definition and Cost
Elements
•Property, plant,
and equipment
assets
•Recognition
principle
•Cost elements
Measurement of
Cost
•Determining asset
cost
•Costs associated
with specific assets
Measurement After
Acquisition
•Cost model
•Revaluation
model
•Fair value model
•Costs incurred
after acquisition
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IFRS / ASPE
Comparison
•Comparison of
IFRS and ASPE
•Looking ahead
4
Property, Plant, and Equipment
• Also known as tangible capital assets, plant assets,
and fixed assets
• Examples: land, building, equipment, and natural
resource properties
• Major characteristics include:
1. Acquired and held for use in operations and not
for resale
2. Long-term in nature and usually subject to
depreciation
3. Possess physical substance (tangible)
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5
Asset Components
• Both IFRS and ASPE require componentization,
although IFRS guidance is more detailed
• Components of a single asset (e.g. roof of a
building) should be recognized separately if they
make up a relatively significant portion of the
asset’s total cost
• Significant professional judgment is required in
applying componentization, and other factors to
consider include differing useful lives and differing
patterns of economic benefits
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Cost Elements
• Capitalized cost of property, plant, and equipment
includes all expenditures needed to:
• acquire the asset (purchase price, net of
discounts and rebates)
• bring it to its location and to state where it is
ready for use (including delivery, site preparation,
installation, assembly, professional fees, etc)
• discharge obligations associated with asset’s
eventual disposal (e.g. site restoration)
• IFRS and ASPE share the above approach, but
sometimes differ in specific application
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Self-Constructed Assets
• These are assets constructed by the business
for use in operations
• The cost of self-constructed assets includes:
• Direct materials,
• Direct labour,
• Directly attributable overhead (e.g. variable
manufacturing overhead)
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8
Borrowing Costs
• Under IFRS, borrowing costs that are
incurred during acquisition, construction
or production of qualifying assets must be
capitalized as part of the asset’s cost
• ASPE allows a choice of capitalizing or
expensing such interest costs
• Most common approach is explained in
Appendix 10A
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Dismantling and Restoration Costs
• Companies are often responsible for costs
associated with dismantling the asset,
removing it, and restoring the site at the end
of its useful life
• These costs are often referred to as asset
retirement costs and meet the recognition
criteria for capitalization as part of PP&E
asset costs
• IFRS and ASPE share the above approach,
but sometimes differ in specific application
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10
Cash Discounts
• When cash discounts are offered on the
purchase of plant assets, the Net-ofDiscount Method is the preferred method
• The asset cost is reduced by the discount
amount even if discount is not taken
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Deferred Payment Terms
Deferred Payment Contracts
• Assets, purchased through long-term credit,
are recorded at the present value of the
consideration exchanged
• When no interest rate is stated, the cash price
of the purchased asset is used to determine
imputed interest rate
• Interest expense is recognized over the term
of the deferred payment contract
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Deferred Payment Contracts
Example:
Sutter Corporation, given:
• Five-year, $100,000 non-interest bearing
note issued in exchange for new
equipment
• Market interest rate = 10%
• Payable over 5 years—$20,000 per year
• Record acquisition of equipment
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Deferred Payment Contracts
Calculate Present Value (PV) of Note:
Annuity Payment = $20,000, n=5, i=10%
PVA (Present Value of an annuity) = $75,816
Entry at date of purchase:
Equipment
75,816
Notes Payable
75,816
Entry to record interest expense at end of year:
Interest Expense (75,816 x 10%) 7,582
Notes Payable
7,582
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Lump-Sum Purchases
• Lump Sum Purchase
– Cost of assets, acquired at a single lump
sum price, is allocated to assets on the
basis of their relative fair market values
• Example: Inventory, land, and building
purchased for lump sum of $80,000
• Fair market values for these assets are:
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Lump Sum Purchase
Asset
Inventory
Fair Market Proportion
Value
$ 25,000
25%
Cost
Allocation
20,000
Land
25,000
25%
20,000
Building
50,000
50%
40,000
$100,000
100%
$80,000
Total
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i.e. $80,000
x .25
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Non-Monetary Exchanges
Share-Based Payments
• When property is acquired by issuing shares,
the fair value of the asset received or the fair
value of the shares given up is used for the
cost of the asset
– ASPE and IFRS have slightly different application
of this general approach
• If the fair value of the asset received cannot
be readily determined, and the shares given
up are actively traded, the market value of
publicly traded shares is used
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Non-Monetary Exchanges
Asset Exchange
• Monetary exchange of assets occurs when:
– Non-monetary assets (e.g., PP&E) are acquired
for cash or other monetary assets (e.g., accounts
and notes receivable), or
– Non-monetary assets are disposed of in
exchange for monetary assets
• Non-monetary transaction or exchange of
assets occurs when:
– Non-monetary asset is exchanged for another
non-monetary asset
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Exchange of Non-monetary Assets
• The basic ASPE standard is that the nonmonetary exchange is valued at:
– the fair value of the asset given up, or
– the fair value of the asset received whichever
is more reliably measurable, and
– gain or loss on the exchange is recognized in
income
• Monetary transactions are accounted for
on the same basis
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Exchange of Non-monetary Assets
Exception to standard:
• If one or more of the following conditions
exist:
1. transaction lacks commercial substance,
2. fair values are not determinable,
• Then:
– new asset cost equals book value of assets
given up, and
– no gain is recognized (but losses are
recognized)
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Exchange of Assets with Commercial
Substance
Example: Information Processing Inc. (IPI)
exchanges a used machine for a new model
• Fair value of used machine:
$ 6,000
• Book value of used machine:
$ 8,000
(Cost=$12,000; Accum. Depreciation=$ 4,000)
• Cash paid to seller:
$ 7,000
Record the purchase in IPI’s books:
Equipment (new)
13,000
Accumulated Depreciation (old) 4,000
Loss on Disposal
2,000
Equipment (old)
Cash
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12,000
7,000
21
Non-monetary Exchange with
Commercial Substance
Cathay Corp. exchanges a number of trucks for land:
• Fair value of trucks:
• Book value of trucks:
(Cost=$64,000; Accum. Depreciation=
• Cash paid to seller:
Record purchase in Cathay’s books:
Land
53,000
Accumulated Depreciation – Trucks
22,000
Trucks
Cash
Gain on Disposal of Trucks
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$ 49,000
$ 42,000
$ 22,000)
$ 4,000
64,000
4,000
7,000
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Non-monetary Exchange – No
Commercial Substance
Westco Ltd. exchanges a commercial property in Ontario
for almost identical one in Alberta from Eastco Ltd.
(assume no commercial substance)
• Fair value of Westco property
$615,000
• Book value of Westco property:
$420,000
(Cost=$520,000; Accum. Depreciation=$ 100,000)
• Book value of Eastco property:
$395,000
(Cost=$540,000, Accum. Depreciation=$145,000)
• Cash paid to seller:
$ 30,000
Record transaction on Westco books:
Building (new)
450,000
Accumulated Depreciation (old)
100,000
Building (old)
Cash
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520,000
30,000
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Contribution of Assets
•
•
•
Referred to as non-reciprocal transfers: transfer of
assets where nothing is given up in exchange (e.g.,
donations, gift, government grants)
Asset’s fair market value used as cost of asset
Two approaches:
1. Capital Approach: credit Donated Capital; used for
shareholder contributions only; otherwise not GAAP
2. Income Approach: credit represents income; used for
non-owner contributions;
•
Cost Reduction Method: credit the respective asset
account (benefit recognized through reduced
depreciation expense)
•
Deferral Method: credit Deferred Revenue (benefit
amortized into income)
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Specific Assets: Land
• Land costs include:
1. Purchase price
2. Closing costs (title, legal, and recording fees)
3. Costs of getting land ready for use (such as removal
of old building, clearing, grading, filling and draining)
4. Assumption of liens or encumbrances
5. Additional improvements with an indefinite life
• Sale of salvaged materials reduces cost of land
• Special assessments for local improvements (e.g.,
pavement) are part of land cost
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Land Improvements
• Permanent improvements to the land such as
landscaping are added to the Land account
• Improvements with limited lives (such as
driveways, walkways, fences, and parking
lots) are recorded in a separate Land
Improvements account
• These costs are separated from Land as they
are depreciated over their estimated useful
lives
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Specific Assets: Buildings
• Building costs include all costs directly
related to buying or constructing the
building
• The removal of an old building previously
owned and used increases loss on the
disposal of the old building
• If land is purchased with an old building on
it, any demolition costs less salvage value
is charged to Land
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Specific Assets: Leasehold
Improvements
• In long-term lease contracts, the lessee may
pay for improvements on the leased property
• Examples: construction of building on leased
land, improvements to leased building
• These costs are recorded in a separate
account called Leasehold Improvements
• Leasehold improvements are depreciated
over the lesser of the remaining lease life and
the useful life
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Specific Assets: Equipment
• Includes delivery equipment, office equipment, factory
equipment, machinery, and furniture
• Cost of equipment includes all necessary and
reasonable costs incurred to get asset ready for its
intended use
• Includes:
–
–
–
–
Purchase price
Freight and handling charges
Insurance while in transit
Costs of special foundation, assembly and
installation
– Cost of trial runs
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Specific Assets: Investment Property
• Property that is held to generate rental
revenue and/or appreciate in value, rather
than
– sell as part of ordinary business or
– use in production, administration, or supplying
of goods and services
• IFRS allows for special accounting
subsequent to acquisition
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Specific Assets: Natural Resource
Properties
•
•
•
•
•
Also known as wasting assets
Examples: oil and gas resources, and mineral deposits
Main characteristics:
1. Asset is completely removed or consumed
2. Asset does not retain original characteristics
Costs to be capitalized relate to four activities:
1. Acquisition of properties
2. Exploration
3. Development
4. Restoration
Capitalized costs make up the depletion base, and are
depreciated through depletion charge into inventory
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Specific Assets: Biological Assets
•
Examples: fruit trees, grapevines, livestock
•
Special standard under IFRS
–
Measure at fair value less costs to sell, with
changes in values going through income
statement
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Measurement after Acquisition
•
There are three main measurement methods
to account for property, plant, and equipment
subsequent to acquisition:
1.
2.
3.
•
•
Cost Model (CM)
Revaluation Model (RM)
Fair Value Model (FVM)
Under ASPE, CM must be used
Under IFRS, companies have the following
choices:
– For investment property assets: CM or FVM
– For other PP&E assets: CM or RM
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Revaluation Model
•
PP&E assets carried at
–
–
•
•
fair value at the date of revaluation, less
any subsequent accumulated depreciation and
impairment losses
Available only for PP&E assets whose fair
value can be measured reliably
Revaluation must be frequent enough so
that carrying value is not materially different
from assets’ fair value (not necessarily
every year)
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Revaluation Model
•
When carrying value of asset increases (debit)
–
•
When carrying value of asset decreases (credit)
–
•
•
Credit Revaluation Surplus (equity, OCI), unless
increase reverses previous declines recognized in
income (in this case, recognize increase in income to
extent of prior declines)
Debit Revaluation Surplus (equity, OCI) to the extent the
account has credit balance for the asset. Otherwise,
debit is recognized as decrease in income.
There can be no net increase in net income from
revaluing the asset over its life
Revaluation Surplus is transferred directly to Retained
Earnings (either each period, or only at time of
disposal)
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Revaluation Model: Example – Convo
Corp
Convo Corp (CC) purchased $100,000 building on
January 2013 (fiscal year end December 31)
Revaluation: every 3 years
Depreciation: straight-line
Useful life: estimated 25 years at purchase (no
residual)
Fair value at December 31, 2015: $90,000
Fair value at December 31, 2018: $75,000
Required: Prepare all journal entries needed at
revaluation dates noted above.
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Revaluation Model: Example – Convo
Corp
Revaluation entries at December 31, 2015
Depreciation for 2013-2015
(100,000–0)/25yrs = 4,000/yr
Before
After
X 3 years = 12,000
Building
Revaluation
Adjustment
Revaluation
100,000
(12,000)
90,000
2,000
Accumulated depreciation
(12,000)
12,000
nil
Carrying amount
88,000
2,000
90,000
Accumulated Depreciation
Building
12,000
Building (90,000 – 88,000)
Revaluation Surplus (OCI)
2,000
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12,000
2,000
37
Revaluation Model: Example – Convo
Corp
Revaluation entries at December 31, 2018
Depreciation for 2016-2018
(90,000 – 0) / 22yrs = 4,091/yr Before
X 3 years = 12,273
Building
After
Revaluation
Adjustment
Revaluation
90,000
(12,273)
75,000
(2,727)
Accumulated depreciation
(12,273)
12,273
nil
Carrying amount
77,727
(2,727)
75,000
Accumulated Depreciation
Building
12,273
12,273
Revaluation Surplus (OCI)
2,000
Revaluation Loss (to income)
727
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Building
Ltd.
2,727
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Fair Value Model
•
•
•
•
•
Available as measurement option for
investment properties (under IFRS only)
Investment property measured at fair value
subsequent to acquisition
Changes in value reported in net income
during period of change
No depreciation is recognized over asset’s
life
Note that fair value must be disclosed in
financial statements, even if cost model is
chosen instead of fair value model
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Fair Value Model: Example
Erican Corp (EC) purchases shopping mall on February 2, 2011
Purchase price:
Property transfer fee:
Legal fees:
Empty store painting (before rent):
Mortgage financing assumed (rest in cash):
Tenant damage deposits acquired:
1,000,000
40,000
3,000
2,000
730,000
37,000
Fair values:
•
•
•
December 31, 2014:
December 31, 2015:
December 31, 2016:
1,040,000
1,028,000
1,100,000
REQUIRED: Prepare all necessary journal entries to December 31, 2016
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40
Fair Value Model: Example
February 2, 2014 (acquisition)
Investment Property – Mall 1,043,000
Maintenance Expense
2,000
Mortgage Payable
730,000
Tenant Deposits Liability
37,000
Cash
278,000
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41
Fair Value Model: Example
December 31, 2014
Loss in Value of Inv. Property
Investment Property – Mall
(1,043,000 – 1,040,000)
3,000
3,000
December 31, 2015
Loss in Value of Inv. Property
12,000
Investment Property – Mall
12,000
(1,040,000 – 1,028,000)
December 31, 2016
Investment Property – Mall
72,000
Gain in Value of Inv. Property
72,000
(1,100,000 – 1,028,000)
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Costs Subsequent to Acquisition
• If costs incurred achieve greater future benefits, capitalize costs
(Capital expenditure)
• If costs maintain a specific level of service, expense costs (Revenue
expenditure)
• Major types of expenditures are:
– Additions: Increase or extension of existing assets
– Replacements, major overhauls, and inspections: Substitution of
a new part/component for an existing asset, and
overhauls/inspections whether or not physical parts are replaced
– Rearrangement and reinstallation: Moving an asset from one
location to another
– Repairs: Costs that maintain assets in good operating condition
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Replacements, Major Overhauls, and
Inspections
• Generally meet definition for capitalization, and
costs added to carrying amount
• However, replaced assets or previous overhauls
and/or inspections already have a depreciated
carrying value on books
• Therefore, original asset’s carrying value should
be removed
• If original cost and accumulated depreciation are
not known, they must be estimated
• ASPE is less strict than IFRS and allows for new
cost to be debited to Accumulated Depreciation or
simply added to asset’s carrying value
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Rearrangement and Reinstallation
• Accounting treatment for rearrangement
and reinstallation costs:
1. If the original installation cost is known,
record as a replacement
2. If the original installation cost is not known,
cost is expensed
3. If the original installation cost is not known
and amount is material, capitalize cost
(ASPE)
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Repairs
• Ordinary repairs are costs that keep asset
in good operating condition
• Ordinary repairs are treated as an
expense
• Examples: replacement of minor parts,
repainting, lubricating equipment
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Looking Ahead
• There are two significant projects under
way by IASB
– Development of new and comprehensive
accounting standards for extractive industries
(e.g. mining, oil, gas)
– Updating standards relating to government
grants and assistance
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