Chapter 10
Operational Assets: Acquisition
and Disposition
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-2
Types of Operational Assets
Actively Used in Operations
Expected to Benefit Future Periods
Tangible
Property, Plant,
Equipment &
Natural
Resources
McGraw-Hill/Irwin
Intangible
No Physical
Substance
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-3
Costs to be Capitalized
General Rule
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.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-4
Costs to be Capitalized ---Equipment
Net purchase price
 Taxes
 Transportation costs
 Installation costs
 Modification to building
necessary to install
equipment
 Testing and trial runs

McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-5
Costs to be Capitalized ---- Land







Purchase price
Real estate commissions
Attorney’s fees
Title search
Title transfer fees
Title insurance premiums
Removing old buildings
McGraw-Hill/Irwin
Land is not
depreciable.
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-6
Costs to be Capitalized ---- Land
Improvements
Separately identifiable costs of





Driveways
Parking lots
Fencing
Landscaping
Private roads
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-7
Costs to be Capitalized ---Buildings

Purchase price
 Architectural fees
 Cost of permits
 Excavation costs
 Construction costs
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-8
Costs to be Capitalized ---Natural Resources
Purchase price,
exploration and
development costs of:
 Timber
 Mineral deposits
 Oil and gas reserves
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-9
Asset Retirement Obligations
Often encountered with natural resource
extraction when the land must be
restored to a useable condition.
Recognize 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.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-10
Intangible Assets
Useful life is
often difficult
to determine.
Lack physical
substance.
Intangible
Assets
Economic benefits
last beyond the
current period.
McGraw-Hill/Irwin
Usually acquired
for operational
use.
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-11
Costs to be Capitalized ---Intangible Assets
Record at current
cash equivalent
cost, including
purchase price,
legal fees, and
filing fees.
McGraw-Hill/Irwin

Patents
 Copyrights
 Trademarks
 Franchises
 Organization
costs
 Goodwill
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-12
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.
 Internally developed costs (R&D)
that result in patents are expensed
in the period incurred.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-13
Patents
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.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-14
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.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-15
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.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-16
Franchises
Right to sell products or provide services
purchased by franchisee from franchisor.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-17
Goodwill
Goodwill
Occurs when one
company buys
another company.
Only purchased
goodwill is an
intangible asset.
The amount by which the
purchase price exceeds the fair
market value of net assets acquired.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-18
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.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-19
Goodwill
What amount of goodwill should be
recorded on Eddy Company books?
a.
b.
c.
d.
McGraw-Hill/Irwin
$100,000
$200,000
$300,000
$400,000
FMV of Assets
Debt Assumed
$ 900,000
200,000
FMV of Net Assets
Purchase Price
Goodwill
$ 700,000
1,000,000
$ 300,000
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-20
Lump-Sum Purchases
Several assets are acquired for a single,
lump-sum price that may be lower than the
sum of the individual asset prices.
Portions of the lump-sum
price attributable to
particular assets are
assigned to those assets.
Asset 1
McGraw-Hill/Irwin
Asset 2
Allocation of the
remaining lump-sum
price is based on
relative values of
the individual assets.
Asset 3
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-21
Lump-Sum Purchases
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?
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-22
Lump-Sum Purchases
Appraised
Value
(a)
$ 87,500
162,500
$ 250,000
Asset
Land
Building
Total
% 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.
Prepare the journal entry to record the purchase.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-23
Lump-Sum Purchases
GENERAL JOURNAL
Date
Description
May 13 Land
Building
PR
Debit
Credit
70,000
130,000
Cash
McGraw-Hill/Irwin
Page 14
200,000
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-24
Noncash Acquisitions

Deferred payments
 Issuance of equity securities
 Donated Assets
 Exchanges
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-25
Deferred Payments
The asset acquired is recorded at the
Cash equivalent price (market value)
or
Present value of future cash payments using
the prevailing market interest rate
Whichever is more objective and reliable.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-26
Deferred Payments
On May 1, 2003, Fesler, Inc. purchased
equipment paying $3,000 down and issuing a
note payable. The note requires four annual
payments of $2,500 with the first payment due
on May 1, 2004. The note is noninterestbearing. The prevailing market rate of interest
on notes of this nature is 12%.
Prepare the required journal entries on May 1,
2003, and December 31, 2003 (year-end).
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-27
Deferred Payments
Since we do not know the cash equivalent
price in this example, we must use the
present value of the future cash payments.
Annuity payment
$ 2,500
x PVA $1, n=4, i=12%
3.03735
= PV of note (rounded) $ 7,593
+ Down payment
3,000
= Cost of equipment
$ 10,593
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-28
Deferred Payments
Example
GENERAL JOURNAL
Date
Description
5/1 1 Equipment
May
Discount on Note Payable
Cash
Note Payable
Page ##
PR
Debit
Credit
10,593
2,407
3,000
10,000
Discount = $10,000 - $7,593
Dec. 31 Interest Expense
Discount on Note Payable
$7,593 × 12% × 8/12 = $607
McGraw-Hill/Irwin
607
607
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-29
Issuance of Equity Securities



Asset acquired is recorded at the market value
of the asset or the market value of the securities,
whichever is more objective and reliable.
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.”
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-30
Donated Assets

On occasion, companies
acquire operational assets
through donation.
 SFAS No. 116 requires the
receiving company to

record revenue equal to the
value of the donated asset.
 Record the donated asset on the
books at market value.
McGraw-Hill/Irwin
Recently, in an
effort to lure a
facility for Dell
Computers to
Nashville, TN, the
city donated land
for the new
facility.
The deal created
about 3,000 jobs
locally.
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-31
Dispositions
 Update depreciation to date of
disposal.
 Remove original cost of asset
and accumulated depreciation
from the books.
 The difference between BV of
the asset and the amount
received is recorded as a gain
or loss.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-32
Dispositions
On June 30, 2003, MeLo, Inc. sold equipment for
$6,350 cash. The equipment was purchased on
January 1, 1998 at a cost of $15,000. The asset
had a useful life of 10 years and no salvage
value. MeLo last recorded depreciation on the
equipment on December 31, 2002, its year-end.
Prepare the journal entries necessary to
record the disposition of this equipment.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-33
Dispositions
Update depreciation to date of sale.
GENERAL JOURNAL
Date
Description
June 30 Depreciation Expense
Accumulated Depreciation
Page 9
PR
Debit
Credit
750
750
($15,000 ÷ 10 years) × ½ = $750
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-34
Dispositions
Remove original cost of asset and
accumulated depreciation from the books.
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
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-35
Exchanges

The valuation of a nonmonetary asset exchange
depends on whether cash is paid or received.
 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
readily determinable.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-36
Exchanges
Loss
Indicated
Gain
Indicated
McGraw-Hill/Irwin
Assets are Dissimilar
Assets are Similar
Value acquired asset according to GVP.
Recognize loss in full.
Value acquired asset
according to GVP.
Recognize gain in full.
If cash is paid or not
involved, value acquired
asset at BV of asset
transferred plus cash paid.
No gain recognized.
If cash is received,
recognize only fraction of
the gain. Value acquired
asset at fair value less
portion of gain not
recognized.
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-37
Exchanges of Dissimilar Assets
SAM, Co. exchanged inventory for a piece of
equipment owned by Mette, Inc. The inventory has a
cost basis to SAM of $125,000, and a fair value of
$200,000. The equipment has a fair value of $220,000,
and a cost basis to Mette of $325,000. Mette has
recorded depreciation of $150,000 on the equipment.
Record the exchange on the books
of SAM and Mette.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-38
Exchanges of Dissimilar Assets
SAM, Co.
Fair value of inventory
Cost of inventory
Gain indicated
$ 200,000
125,000
$ 75,000
The assets exchanged are dissimilar in
nature, so the implied gain should be
recognized in full.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-39
Exchanges of Dissimilar Assets
SAM, Co.
Asset acquired should be valued at the fair
value of asset given up.
GENERAL JOURNAL
Date
Description
Equipment
Inventory
Gain on Exchange
McGraw-Hill/Irwin
Page 9
PR
Debit
Credit
200,000
125,000
75,000
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-40
Exchanges of Dissimilar Assets
Mette, Inc.
Fair value of equipment $ 220,000
BV of equipment
(Cost - Accum. Depr.)
($325,000 - $150,000)
175,000
Gain indicated
$ 45,000
The assets exchanged are dissimilar in nature, so
the implied gain should be recognized in full.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-41
Exchanges of Dissimilar Assets
Mette, Inc.
Asset acquired should be valued at the fair
value of asset transferred.
GENERAL JOURNAL
Date
Description
Inventory
Accumulated Depreciation
Equipment
Gain on Exchange
McGraw-Hill/Irwin
Page 9
PR
Debit
Credit
220,000
150,000
325,000
45,000
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-42
Exchanges of Similar Assets
Now let’s see an
example with
similar assets.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-43
Exchanges of Similar Assets
Amgen, Co. exchanged similar equipment and $10,000
cash for equipment owned by Versa, Inc.
Using the information below, record the exchange on the
books of Amgen and Versa.
Cost
Accumulated
Depreciation
Amgen's
Equipment $ 500,000 $
Versa's
Equipment $ 275,000 $
McGraw-Hill/Irwin
300,000
Book
Value
Fair
Value
$ 200,000
$ 205,000
100,000 $ 175,000 $ 215,000
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-44
Exchanges of Similar Assets
Amgen
Fair value of equipment $ 205,000
BV of equipment
(Cost - Accum. Depr.)
($500,000 - $300,000)
200,000
Gain indicated
$
5,000
The assets exchanged are similar in nature,
and cash is not received, so the implied
gain should not be recognized.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-45
Exchanges of Similar Assets
Amgen
Equipment received should be valued at the BV of
equipment transferred plus cash paid.
GENERAL JOURNAL
Date
Description
Equipment
Accumulated Depreciation
Equipment
Cash
$200,000 + $10,000
McGraw-Hill/Irwin
Page 9
PR
Debit
Credit
210,000
300,000
500,000
10,000
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-46
Exchanges of Similar Assets
Versa
Fair value of equipment $ 215,000
BV of equipment
(Cost - Accum. Depr.)
($275,000 - $100,000)
175,000
Gain indicated
$ 40,000
The assets exchanged are similar in nature.
Since cash is received, a partial gain
should be recognized.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-47
Exchanges of Similar Assets
Fractional
Gain
Cash Received
Cash
FV of Asset
+
Received
Acquired
x
Indicated
Gain
10,000
10,000
+
205,000
x
40,000
Fractional
=
Gain
=
$
1,860 rounded
The assets exchanged are similar in nature.
Since cash is received, a partial gain
should be recognized.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-48
Exchanges of Similar Assets
Versa
Equipment received valued at fair value
less portion of gain not recognized.
GENERAL JOURNAL
Date
Description
Equipment
Accumulated Depreciation
Cash
Equipment
Gain on Exchange
McGraw-Hill/Irwin
Page 9
PR
Debit
Credit
166,860
100,000
10,000
275,000
1,860
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-49
Let’s change the subject.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-50
Self-Constructed Assets
When self-constructing an asset,
two accounting issues must be
addressed:
Overhead allocation to the selfconstructed asset.
 Incremental
overhead only
 Full-cost approach
Proper treatment of interest
incurred during construction
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-51
Interest Capitalization
Under certain conditions, avoidable
interest incurred on qualifying assets is
capitalized.
Interest that could have
been avoided if the asset
were not constructed
and the money used to
retire debt.
McGraw-Hill/Irwin
An asset constructed:
 For a company’s own
use.
As a discrete project
for sale or lease.
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-52
Interest Capitalization
Interest is capitalized based on Average
Accumulated Expenditures (AAE).
Qualifying
expenditures
weighted for the
number of months
outstanding during
the current
accounting period.
McGraw-Hill/Irwin
Examples include:
•Cash payments for
construction
•Transfer of other
assets
•Incurrence of interestbearing liabilities
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-53
Interest Capitalization
If the qualifying
asset is financed
through a specific
new borrowing . . .
If the qualifying
asset is internally
financed . . .
. . . use the specific
rate of the new
borrowing as the
capitalization rate.
. . . use the
weighted average
cost of debt as the
capitalization rate.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-54
Interest Capitalization
If the AAE < the
amount of the
specific new
borrowing . . .
. . . Capitalize this
portion using specific
borrowing rate.
McGraw-Hill/Irwin
AAE
Specific
new
borrowing
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-55
Interest Capitalization
If the AAE is > the amount of the
specific new borrowing . . .
. . . Capitalize this
portion using weighted
average cost of debt.
. . . Capitalize this
portion using specific
borrowing rate.
McGraw-Hill/Irwin
Internal
financing
AAE
Specific
new
borrowing
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-56
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.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-57
Interest Capitalization
Steps in the capitalization
process
Compute actual interest expense.
Compute AAE.
Determine how much interest is
potentially capitalizable (IPC).
Capitalize the smaller of actual
interest or capitalizable interest.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-58
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 recorded total interest expense of $175,000
during the year, including construction borrowing
of $1,000,000 on May 1, from Bub’s Bank for 10
years at 12%.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-59
Interest Capitalization
 Actual interest expense is $175,000.
 Compute AAE:
Date
5/1
7/31
10/1
12/1
McGraw-Hill/Irwin
Expenditure
$ 125,000
160,000
200,000
300,000
$ 785,000
Fraction of
Year
8/12
5/12
3/12
1/12
$
$
AAE
83,333
66,667
50,000
25,000
225,000
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-60
Interest Capitalization
 Compute the IPC:
Since AAE < Specific Borrowing, use
the specific borrowing interest rate of
12%.
IPC = AAE × Capitalization rate
IPC = $225,000 × 12% = $27,000
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-61
Interest Capitalization
Capitalize the smaller of actual
interest or IPC.
Actual interest ($175,000) > IPC ($27,000)
Capitalize $27,000!
GENERAL JOURNAL
Date
Description
Dec. 31 Construction-In-Progress
Interest Expense
McGraw-Hill/Irwin
Page 14
PR
Debit
Credit
27,000
27,000
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-62
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.)
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-63
Research and Development (R&D)

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.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-64
Software Development Costs
SFAS No. 86
“Accounting for the Costs of Computer Software
to be Sold, Leased, or Otherwise Marketed”

All costs incurred to establish the
technological feasibility of a
computer software product are to
be treated as R&D and expensed as
incurred.
 Subsequent costs to obtain product
masters are to be capitalized as an
intangible asset.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-65
Software Development Costs
SFAS No. 86
Costs are
Expensed
as R&D
Start of
R&D
Activity
McGraw-Hill/Irwin
Costs are
Capitalized
Technological
Feasibility
Costs are
not R&D
Start of
Commercial
Production
Sale of
Product
or Process
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-66
Software Development Costs
SFAS No. 86

Amortization of capitalized computer
software costs starts when the
product begins to be marketed.
 Two methods are allowed:
 Revenue
method
 Straight-line method
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-67
Software Development Costs
SFAS No. 86
Disclosure
Balance Sheet
 Unamortized
computer software product
master cost is an asset.
Income Statement
 Amortization
expense associated with
computer software cost.
 R&D expense associated with computer
software development cost.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
10-68
End of Chapter 10
I need
help!
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.