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© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Chapter 10
Operational Assets: Acquisition and Disposition
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-2
Actively Used in OperationsActively Used in Operations
Tangible
Property, Plant, Equipment &
Natural Resources
Tangible
Property, Plant, Equipment &
Natural Resources
Intangible
No PhysicalSubstance
Intangible
No PhysicalSubstance
Types of Operational Assets
Expected to Benefit Future PeriodsExpected to Benefit Future Periods
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-3
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.
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.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-4
Net purchase priceTaxesTransportation costs Installation costsModification to building
necessary to install equipment
Testing and trial runs
Net purchase priceTaxesTransportation costs Installation costsModification to building
necessary to install equipment
Testing and trial runs
Costs to be Capitalized ---- Equipment
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-5
Land is not depreciable.Land is not depreciable.
Purchase price Real estate commissions Attorney’s fees Title search Title transfer fees Title insurance premiums Removing old buildings
Purchase price Real estate commissions Attorney’s fees Title search Title transfer fees Title insurance premiums Removing old buildings
Costs to be Capitalized ---- Land
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-6
Separately identifiable costs of Driveways Parking lots Fencing Landscaping Private roads
Separately identifiable costs of Driveways Parking lots Fencing Landscaping Private roads
Costs to be Capitalized ---- Land Improvements
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-7
Purchase priceArchitectural feesCost of permitsExcavation costsConstruction costs
Purchase priceArchitectural feesCost of permitsExcavation costsConstruction costs
Costs to be Capitalized ---- Buildings
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-8
Purchase price, exploration and development costs of: TimberMineral depositsOil and gas reserves
Purchase price, exploration and development costs of: TimberMineral depositsOil and gas reserves
Costs to be Capitalized ---- Natural Resources
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-9
Asset Retirement Obligations
Recognize as a liabilityand a corresponding
increase in the related asset.
Recognize as a liabilityand a corresponding
increase in the related asset.
Record at fair value, usually thepresent value of future cash outflows associated with thereclamation or restoration.
Record at fair value, usually thepresent value of future cash outflows associated with thereclamation or restoration.
Often encountered with natural resource extraction when the land must be
restored to a useable condition.
Often encountered with natural resource extraction when the land must be
restored to a useable condition.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-10
Intangible Assets
Lack physicalsubstance.
Lack physicalsubstance.
Economic benefitslast beyond thecurrent period.
Economic benefitslast beyond thecurrent period.
Useful life isoften difficultto determine.
Useful life isoften difficultto determine.
Usually acquired for operational
use.
Usually acquired for operational
use.
IntangibleAssets
IntangibleAssets
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-11
PatentsCopyrightsTrademarksFranchisesOrganization
costsGoodwill
PatentsCopyrightsTrademarksFranchisesOrganization
costsGoodwill
Record at current cash equivalent cost, including purchase price, legal fees, and
filing fees.
Costs to be Capitalized ---- Intangible Assets
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-12
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 expensedin the period incurred.
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 expensedin the period incurred.
Patents
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-13
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, 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.
Torch’s cost for the new patent is $3,000. The $30,000 R & D cost is expensed as
incurred.
Patents
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-14
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 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.
Copyrights
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-15
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.
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.
Trademarks
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-16
Right to sell products or provide services purchased by franchisee from franchisor.
Right to sell products or provide services purchased by franchisee from franchisor.
Franchises
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-17
Occurs when onecompany buys
another company.
The amount by which thepurchase price exceeds the fair
market value of net assets acquired.
Only purchased goodwill is an
intangible asset.
Goodwill
Goodwill
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-18
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.
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.
Goodwill
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-19
What amount of goodwill should be recorded on Eddy Company books?
a. $100,000
b. $200,000
c. $300,000
d. $400,000
What amount of goodwill should be recorded on Eddy Company books?
a. $100,000
b. $200,000
c. $300,000
d. $400,000
What amount of goodwill should be recorded on Eddy Company books?
a. $100,000
b. $200,000
c. $300,000
d. $400,000
What amount of goodwill should be recorded on Eddy Company books?
a. $100,000
b. $200,000
c. $300,000
d. $400,000
Goodwill
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-20
Several assets are acquired for a single, lump-sum price that may be lower than the
sum of the individual asset prices.
Several assets are acquired for a single, lump-sum price that may be lower than the
sum of the individual asset prices.
Lump-Sum Purchases
Asset 2Asset 1 Asset 3
Portions of the lump-sum price attributable to particular assets are
assigned to those assets.
Allocation of theremaining lump-sum
price is based onrelative values of
the individual assets.
Allocation of theremaining lump-sum
price is based onrelative values of
the individual assets.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-21
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?
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 $200,000 purchase price will be charged to the building account?
Lump-Sum Purchases
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-22
Appraised % of Purchase AssignedAsset Value Value Price Cost
(a) (b)* (c) (b × c)Land 87,500$ 35% 200,000$ 70,000$ Building 162,500 65% 200,000 130,000 Total 250,000$ 200,000$
* $87,500÷$250,000 = 35%
The building will be apportioned $130,000of the total purchase price of $200,000.
The building will be apportioned $130,000of the total purchase price of $200,000.
Lump-Sum Purchases
Prepare the journal entry to record the purchase.Prepare the journal entry to record the purchase.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-23
Lump-Sum Purchases
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-24
Noncash Acquisitions
Deferred paymentsIssuance of equity securitiesDonated AssetsExchanges
Deferred paymentsIssuance of equity securitiesDonated AssetsExchanges
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-25
Deferred Payments
The asset acquired is recorded at the
Cash equivalent price (market value)
orPresent value of future cash payments using
the prevailing market interest rate
Whichever is more objective and reliable.
The asset acquired is recorded at the
Cash equivalent price (market value)
orPresent value of future cash payments using
the prevailing market interest rate
Whichever is more objective and reliable.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-26
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 noninterest-
bearing. 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).
On May 1, 2003, Fesler, Inc. purchased equipment paying $3,000 down and issuing a note payable. The note requires four annual
payments of $2,500 with the first payment due on May 1, 2004. The note is noninterest-
bearing. The prevailing market rate of interest on notes of this nature is 12%.
Prepare the required journal entries on May 1, 2003, and December 31, 2003 (year-end).
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-27
Annuity payment 2,500$ x PVA $1, n=4, i=12% 3.03735 = PV of note (rounded) 7,593$ + Down payment 3,000 = Cost of equipment 10,593$
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$
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.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-28
GENERAL JOURNAL Page ##
Date Description PR Debit Credit
5/1 Equipment 10,593 Discount on Note Payable 2,407 Cash 3,000 Note Payable 10,000
Discount = $10,000 - $7,593
GENERAL JOURNAL Page ##
Date Description PR Debit Credit
May 1 Equipment 10,593 Discount on Note Payable 2,407 Cash 3,000 Note Payable 10,000
Discount = $10,000 - $7,593
Dec. 31 Interest Expense 607 Discount on Note Payable 607 $7,593 × 12% × 8/12 = $607
Deferred PaymentsExample
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-29
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 canbe determined, board of directorsassigns a “reasonable value.”
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 canbe determined, board of directorsassigns a “reasonable value.”
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-30
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.
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.
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.McGraw-Hill/Irwin
Slide10-31
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 gainor loss. Accountin
g
Steps
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-32
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 torecord the disposition of this equipment.
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 torecord the disposition of this equipment.
Dispositions
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-33
Page 9
Date Description PR Debit Credit
June 30 Depreciation Expense 750
Accumulated Depreciation 750
($15,000 ÷ 10 years) × ½ = $750
GENERAL JOURNAL
Update depreciation to date of sale.
Dispositions
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-34
Page 9
Date Description PR Debit Credit
June 30 Accumulated Depreciation 8,250
Cash 6,350
Loss on Sale 400
Equipment 15,000
($15,000 ÷ 10 years) × 5½ years = $8,250
GENERAL JOURNAL
Remove original cost of asset and accumulated depreciation from the books.
Record the gain or loss.
Dispositions
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-35
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.
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.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-36
Exchanges
Assets are Dissimilar Assets are SimilarValue acquired asset according to GVP.
Recognize loss in full.
Gain Indicated
Loss Indicated
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.
Value acquired asset according to GVP.
Recognize gain in full.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-37
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 booksof SAM and Mette.
Exchanges of Dissimilar Assets
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-38
The assets exchanged are dissimilar in nature, so the implied gain should be
recognized in full.
The assets exchanged are dissimilar in nature, so the implied gain should be
recognized in full.
Exchanges of Dissimilar Assets
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-39
SAM, Co.
Asset acquired should be valued at the fair value of asset given up.
SAM, Co.
Asset acquired should be valued at the fair value of asset given up.
Exchanges of Dissimilar Assets
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-40
The assets exchanged are dissimilar in nature, so the implied gain should be recognized in full.
The assets exchanged are dissimilar in nature, so the implied gain should be recognized in full.
Exchanges of Dissimilar Assets
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-41
Mette, Inc.
Asset acquired should be valued at the fair value of asset transferred.
Mette, Inc.
Asset acquired should be valued at the fair value of asset transferred.
Exchanges of Dissimilar Assets
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-42
Now let’s see anexample with
similar assets.
Exchanges of Similar Assets
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-43
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.
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.
Exchanges of Similar Assets
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-44
The assets exchanged are similar in nature,and cash is not received, so the implied
gain should not be recognized.
The assets exchanged are similar in nature,and cash is not received, so the implied
gain should not be recognized.
Exchanges of Similar Assets
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-45
AmgenEquipment received should be valued at the BV of
equipment transferred plus cash paid.
AmgenEquipment received should be valued at the BV of
equipment transferred plus cash paid.
Page 9
Date Description PR Debit Credit
Equipment 210,000
Accumulated Depreciation 300,000
Equipment 500,000
Cash 10,000
$200,000 + $10,000
GENERAL JOURNAL
Exchanges of Similar Assets
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-46
The assets exchanged are similar in nature.Since cash is received, a partial gain
should be recognized.
The assets exchanged are similar in nature.Since cash is received, a partial gain
should be recognized.
Exchanges of Similar Assets
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-47
Exchanges of Similar Assets
The assets exchanged are similar in nature.Since cash is received, a partial gain
should be recognized.
The assets exchanged are similar in nature.Since cash is received, a partial gain
should be recognized.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-48
VersaEquipment received valued at fair value
less portion of gain not recognized.
VersaEquipment received valued at fair value
less portion of gain not recognized.
Page 9
Date Description PR Debit Credit
Equipment 166,860
Accumulated Depreciation 100,000
Cash 10,000
Equipment 275,000
Gain on Exchange 1,860
GENERAL JOURNAL
Exchanges of Similar Assets
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-49
Let’s change the subject.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-50
Self-Constructed Assets
When self-constructing an asset, two accounting issues must be addressed:Overhead allocation to the self-
constructed asset.Incremental overhead onlyFull-cost approach
Proper treatment of interest incurred during construction
When self-constructing an asset, two accounting issues must be addressed:Overhead allocation to the self-
constructed asset.Incremental overhead onlyFull-cost approach
Proper treatment of interest incurred during construction
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-51
Under certain conditions, avoidable interest incurred on qualifying assets is
capitalized.
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.
Interest that could have been avoided if the asset
were not constructed and the money used to
retire debt.
An asset constructed:
For a company’s own use.
As a discrete project for sale or lease.
An asset constructed:
For a company’s own use.
As a discrete project for sale or lease.
Interest Capitalization
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-52
Interest is capitalized based on Average Accumulated Expenditures (AAE).
Interest is capitalized based on Average Accumulated Expenditures (AAE).
Examples include:•Cash payments for construction•Transfer of other assets•Incurrence of interest-bearing liabilities
Examples include:•Cash payments for construction•Transfer of other assets•Incurrence of interest-bearing liabilities
Qualifying expenditures
weighted for the number of months outstanding during
the current accounting period.
Qualifying expenditures
weighted for the number of months outstanding during
the current accounting period.
Interest Capitalization
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-53
If the qualifying asset is financed
through a specific new borrowing . . .
If the qualifying asset is financed
through a specific new borrowing . . .
. . . use the specific rate of the new
borrowing as the capitalization rate.
. . . use the specific rate of the new
borrowing as the capitalization rate.
If the qualifying asset is internally
financed . . .
If the qualifying asset is internally
financed . . .
. . . use the weighted average cost of debt as the capitalization rate.
. . . use the weighted average cost of debt as the capitalization rate.
Interest Capitalization
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-54
If the AAE < the amount of the specific new
borrowing . . .
If the AAE < the amount of the specific new
borrowing . . .
Specificnew
borrowingAAE
. . . Capitalize this portion using specific
borrowing rate.
Interest Capitalization
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-55
If the AAE is > the amount of the specific new borrowing . . .
If the AAE is > the amount of the specific new borrowing . . .
Specificnew
borrowing
AAE. . . Capitalize this portion using specific
borrowing rate.
Internal financing
. . . Capitalize this portion using weighted average cost of debt.
Interest Capitalization
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-56
Capitalization begins when construction beginsinterest is incurred, andqualifying 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.
Capitalization begins when construction beginsinterest is incurred, andqualifying 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.
Interest Capitalization
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-57
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.
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.
Interest Capitalization
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-58
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%.
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%.
Interest Capitalization
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-59
Actual interest expense is $175,000. Compute AAE:
Fraction ofDate Expenditure Year AAE5/1 125,000$ 8/12 83,333$
7/31 160,000 5/12 66,667 10/1 200,000 3/12 50,000 12/1 300,000 1/12 25,000
785,000$ 225,000$
Fraction ofDate Expenditure Year AAE5/1 125,000$ 8/12 83,333$
7/31 160,000 5/12 66,667 10/1 200,000 3/12 50,000 12/1 300,000 1/12 25,000
785,000$ 225,000$
Interest Capitalization
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-60
Compute the IPC: Since AAE < Specific Borrowing, use
the specific borrowing interest rate of 12%.
IPC = AAE × Capitalization rateIPC = $225,000 × 12% = $27,000
Compute the IPC: Since AAE < Specific Borrowing, use
the specific borrowing interest rate of 12%.
IPC = AAE × Capitalization rateIPC = $225,000 × 12% = $27,000
Interest Capitalization
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-61
Capitalize the smaller of actual interest or IPC.Actual interest ($175,000) > IPC ($27,000)
Capitalize $27,000!
Capitalize the smaller of actual interest or IPC.Actual interest ($175,000) > IPC ($27,000)
Capitalize $27,000!
Interest Capitalization
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-62
ResearchPlanned search or critical investigation aimed at
discovery of new knowledge . . .
DevelopmentThe 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.)
ResearchPlanned search or critical investigation aimed at
discovery of new knowledge . . .
DevelopmentThe 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.)
Research and Development (R&D)
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
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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.
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.
Research and Development (R&D)
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide10-64
Software Development Costs SFAS No. 86
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.
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.
“Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed”
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
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Software Development Costs SFAS No. 86
Start ofR&D
Activity
TechnologicalFeasibility
Start ofCommercialProduction
Sale of Product
or Process
Costs areExpensed
as R&DCosts are
CapitalizedCosts arenot R&D
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
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Amortization of capitalized computer software costs starts when the product begins to be marketed.
Two methods are allowed:Revenue methodStraight-line method
Amortization of capitalized computer software costs starts when the product begins to be marketed.
Two methods are allowed:Revenue methodStraight-line method
Software Development Costs SFAS No. 86
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
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Balance SheetUnamortized computer software product
master cost is an asset.
Income StatementAmortization expense associated with
computer software cost.R&D expense associated with computer
software development cost.
Balance SheetUnamortized computer software product
master cost is an asset.
Income StatementAmortization expense associated with
computer software cost.R&D expense associated with computer
software development cost.
Software Development Costs SFAS No. 86
Disclosure
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
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End of Chapter 10
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