Intermediate Accounting,Eighth Canadian Edition

TENTH CANADIAN EDITIONINTERMEDIATE ACCOUNTINGPrepared by:Dragan Stojanovic, CARotman School of Management, University of TorontoCHAPTER 10Acquisition of Property, Plant and Equipment Kieso Weygandt Warfield Young Wiecek McConomy110: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.Copyright John Wiley & Sons Canada, Ltd.2Acquisition of Property, Plant, and EquipmentCHAPTER 10: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.Copyright John Wiley & Sons Canada, Ltd.3Acquisition of Property, Plant, and EquipmentCHAPTER Acquisition of Property, Plant, and EquipmentCopyright John Wiley & Sons Canada, Ltd.4Definition and Cost ElementsProperty, plant, and equipment assetsRecognition principleCost elementsMeasurement of CostDetermining asset costCosts associated with specific assetsMeasurement After AcquisitionCost modelRevaluation modelFair value modelCosts incurred after acquisition IFRS / ASPE ComparisonComparison of IFRS and ASPE Looking aheadProperty, Plant, and EquipmentAlso known as tangible capital assets, plant assets, and fixed assetsExamples: land, building, equipment, and natural resource propertiesMajor characteristics include:1. Acquired and held for use in operations and not for resale2. Long-term in nature and usually subject to depreciation3. Possess physical substance (tangible)Copyright John Wiley & Sons Canada, Ltd.5Asset ComponentsBoth IFRS and ASPE require componentization, although IFRS guidance is more detailedComponents of a single asset (e.g. roof of a building) should be recognized separately if they make up a relatively significant portion of the assets total costSignificant professional judgment is required in applying componentization, and other factors to consider include differing useful lives and differing patterns of economic benefits Copyright John Wiley & Sons Canada, Ltd.6Cost ElementsCapitalized 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 assets eventual disposal (e.g. site restoration)IFRS and ASPE share the above approach, but sometimes differ in specific applicationCopyright John Wiley & Sons Canada, Ltd.7Self-Constructed AssetsThese are assets constructed by the business for use in operationsThe cost of self-constructed assets includes:Direct materials,Direct labour,Directly attributable overhead (e.g. variable manufacturing overhead)Copyright John Wiley & Sons Canada, Ltd.8Borrowing CostsUnder IFRS, borrowing costs that are incurred during acquisition, construction or production of qualifying assets must be capitalized as part of the assets cost ASPE allows a choice of capitalizing or expensing such interest costsMost common approach is explained in Appendix 10ACopyright John Wiley & Sons Canada, Ltd.9Dismantling and Restoration CostsCompanies are often responsible for costs associated with dismantling the asset, removing it, and restoring the site at the end of its useful lifeThese costs are often referred to as asset retirement costs and meet the recognition criteria for capitalization as part of PP&E asset costsIFRS and ASPE share the above approach, but sometimes differ in specific applicationCopyright John Wiley & Sons Canada, Ltd.10Cash DiscountsWhen cash discounts are offered on the purchase of plant assets, the Net-of-Discount Method is the preferred methodThe asset cost is reduced by the discount amount even if discount is not takenCopyright John Wiley & Sons Canada, Ltd.11Deferred Payment Terms Deferred Payment ContractsAssets, purchased through long-term credit, are recorded at the present value of the consideration exchangedWhen no interest rate is stated, the cash price of the purchased asset is used to determine imputed interest rateInterest expense is recognized over the term of the deferred payment contractCopyright John Wiley & Sons Canada, Ltd.12Deferred Payment ContractsExample:Sutter Corporation, given:Five-year, $100,000 non-interest bearing note issued in exchange for new equipmentMarket interest rate = 10%Payable over 5 years$20,000 per yearRecord acquisition of equipmentCopyright John Wiley & Sons Canada, Ltd.13Deferred Payment ContractsCopyright John Wiley & Sons Canada, Ltd.14Calculate Present Value (PV) of Note:Annuity Payment = $20,000, n=5, i=10%PVA (Present Value of an annuity) = $75,816Entry at date of purchase:Equipment75,816Notes Payable75,816Entry to record interest expense at end of year:Interest Expense (75,816 x 10%) 7,582Notes Payable 7,582Lump-Sum PurchasesCopyright John Wiley & Sons Canada, Ltd.15Lump Sum PurchaseCost of assets, acquired at a single lump sum price, is allocated to assets on the basis of their relative fair market valuesExample: Inventory, land, and building purchased for lump sum of $80,000

Fair market values for these assets are:Lump Sum PurchaseCopyright John Wiley & Sons Canada, Ltd.16100%50%25%25%Proportion$80,00040,00020,00020,000Cost Allocation$100,000Total 50,000Building 25,000Land$ 25,000InventoryFair Market ValueAsseti.e. $80,000 x .25Non-Monetary ExchangesShare-Based PaymentsWhen property is acquired by issuing shares, the fair value of the asset received or the fair value of the shares given up is used for the cost of the asset ASPE and IFRS have slightly different application of this general approachIf the fair value of the asset received cannot be readily determined, and the shares given up are actively traded, the market value of publicly traded shares is used Copyright John Wiley & Sons Canada, Ltd.17Non-Monetary ExchangesAsset ExchangeMonetary exchange of assets occurs when:Non-monetary assets (e.g., PP&E) are acquired for cash or other monetary assets (e.g., accounts and notes receivable), orNon-monetary assets are disposed of in exchange for monetary assetsNon-monetary transaction or exchange of assets occurs when:Non-monetary asset is exchanged for another non-monetary assetCopyright John Wiley & Sons Canada, Ltd.18Exchange of Non-monetary AssetsThe basic ASPE standard is that the non-monetary exchange is valued at:the fair value of the asset given up, orthe fair value of the asset received whichever is more reliably measurable, andgain or loss on the exchange is recognized in incomeMonetary transactions are accounted for on the same basis Copyright John Wiley & Sons Canada, Ltd.19Exchange of Non-monetary AssetsException to standard:If one or more of the following conditions exist: transaction lacks commercial substance, fair values are not determinable, Then:new asset cost equals book value of assets given up, andno gain is recognized (but losses are recognized) Copyright John Wiley & Sons Canada, Ltd.20Exchange of Assets with Commercial SubstanceCopyright John Wiley & Sons Canada, Ltd.21Example: Information Processing Inc. (IPI) exchanges a used machine for a new modelFair value of used machine:$ 6,000Book value of used machine:$ 8,000(Cost=$12,000; Accum. Depreciation=$ 4,000) Cash paid to seller:$ 7,000Record the purchase in IPIs books:Equipment (new)13,000Accumulated Depreciation (old) 4,000Loss on Disposal 2,000 Equipment (old) 12,000 Cash 7,000Non-monetary Exchange with Commercial SubstanceCopyright John Wiley & Sons Canada, Ltd.22Cathay Corp. exchanges a number of trucks for land:Fair value of trucks:$ 49,000Book value of trucks:$ 42,000(Cost=$64,000; Accum. Depreciation=$ 22,000) Cash paid to seller:$ 4,000Record purchase in Cathays books:Land 53,000Accumulated Depreciation Trucks22,000 Trucks 64,000 Cash 4,000 Gain on Disposal of Trucks 7,000Non-monetary Exchange No Commercial SubstanceCopyright John Wiley & Sons Canada, Ltd.23Westco 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 $615,000Book 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=$145,000)Cash paid to seller:$ 30,000Record transaction on Westco books:Building (new) 450,000Accumulated Depreciation (old) 100,000 Building (old) 520,000 Cash 30,000 Contribution of AssetsReferred to as non-reciprocal transfers: transfer of assets where nothing is given up in exchange (e.g., donations, gift, government grants)Assets fair market value used as cost of assetTwo approaches:Capital Approach: credit Donated Capital; used for shareholder contributions only; otherwise not GAAPIncome 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)Copyright John Wiley & Sons Canada, Ltd.24Specific Assets: LandLand costs include:Purchase priceClosing costs (title, legal, and recording fees)Costs of getting land ready for use (such as removal of old building, clearing, grading, filling and draining)Assumption of liens or encumbrancesAdditional improvements with an indefinite lifeSale of salvaged materials reduces cost of landSpecial assessments for local improvements (e.g., pavement) are part of land costCopyright John Wiley & Sons Canada, Ltd.25Land ImprovementsPermanent improvements to the land such as landscaping are added to the Land accountImprovements with limited lives (such as driveways, walkways, fences, and parking lots) are recorded in a separate Land Improvements accountThese costs are separated from Land as they are depreciated over their estimated useful livesCopyright John Wiley & Sons Canada, Ltd.26Specific Assets: BuildingsBuilding costs include all costs directly related to buying or constructing the buildingThe removal of an old building previously owned and used increases loss on the disposal of the old buildingIf land is purchased with an old building on it, any demolition costs less salvage value is charged to LandCopyright John Wiley & Sons Canada, Ltd.27Specific Assets: Leasehold ImprovementsIn long-term lease contracts, the lessee may pay for improvements on the leased propertyExamples: construction of building on leased land, improvements to leased buildingThese costs are recorded in a separate account called Leasehold ImprovementsLeasehold improvements are depreciated over the lesser of the remaining lease life and the useful lifeCopyright John Wiley & Sons Canada, Ltd.28Specific Assets: EquipmentIncludes delivery equipment, office equipment, factory equipment, machinery, and furnitureCost of equipment includes all necessary and reasonable costs incurred to get asset ready for its intended useIncludes:Purchase priceFreight and handling chargesInsurance while in transitCosts of special foundation, assembly and installationCost of trial runsCopyright John Wiley & Sons Canada, Ltd.29Specific Assets: Investment PropertyProperty 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 servicesIFRS allows for special accounting subsequent to acquisitionCopyright John Wiley & Sons Canada, Ltd.30Specific Assets: Natural Resource PropertiesAlso known as wasting assetsExamples: oil and gas resources, and mineral depositsMain characteristics:Asset is completely removed or consumedAsset does not retain original characteristicsCosts to be capitalized relate to four activities:Acquisition of propertiesExplorationDevelopmentRestorationCapitalized costs make up the depletion base, and are depreciated through depletion charge into inventoryCopyright John Wiley & Sons Canada, Ltd.31Specific Assets: Biological AssetsExamples: fruit trees, grapevines, livestockSpecial standard under IFRSMeasure at fair value less costs to sell, with changes in values going through income statementCopyright John Wiley & Sons Canada, Ltd.32Measurement after AcquisitionThere are three main measurement methods to account for property, plant, and equipment subsequent to acquisition: Cost Model (CM)Revaluation Model (RM)Fair Value Model (FVM)Under ASPE, CM must be usedUnder IFRS, companies have the following choices: For investment property assets: CM or FVMFor other PP&E assets: CM or RMCopyright John Wiley & Sons Canada, Ltd.3333Revaluation ModelPP&E assets carried at fair value at the date of revaluation, lessany subsequent accumulated depreciation and impairment lossesAvailable only for PP&E assets whose fair value can be measured reliablyRevaluation must be frequent enough so that carrying value is not materially different from assets fair value (not necessarily every year)Copyright John Wiley & Sons Canada, Ltd.34Revaluation ModelWhen carrying value of asset increases (debit)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)When carrying value of asset decreases (credit)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 lifeRevaluation Surplus is transferred directly to Retained Earnings (either each period, or only at time of disposal)Copyright John Wiley & Sons Canada, Ltd.35Revaluation Model: Example Convo CorpConvo Corp (CC) purchased $100,000 building on January 2013 (fiscal year end December 31)Revaluation: every 3 yearsDepreciation: straight-lineUseful life: estimated 25 years at purchase (no residual)Fair value at December 31, 2015: $90,000Fair value at December 31, 2018: $75,000

Required: Prepare all journal entries needed at revaluation dates noted above.Copyright John Wiley & Sons Canada, Ltd.36Revaluation Model: Example Convo CorpCopyright John Wiley & Sons Canada, Ltd.37Revaluation entries at December 31, 2015

BeforeAfterRevaluationAdjustmentRevaluationBuilding100,000(12,000)90,0002,000Accumulated depreciation(12,000)12,000nilCarrying amount88,0002,00090,000

Accumulated Depreciation 12,000Building12,000

Building (90,000 88,000)2,000Revaluation Surplus (OCI) 2,000Depreciation for 2013-2015(100,0000)/25yrs = 4,000/yrX 3 years = 12,00037Copyright John Wiley & Sons Canada, Ltd.38Revaluation entries at December 31, 2018

BeforeAfterRevaluationAdjustmentRevaluationBuilding90,000(12,273)75,000(2,727)Accumulated depreciation(12,273)12,273nilCarrying amount77,727(2,727)75,000

Depreciation for 2016-2018(90,000 0) / 22yrs = 4,091/yrX 3 years = 12,273Accumulated Depreciation 12,273Building12,273

Revaluation Surplus (OCI)2,000Revaluation Loss (to income) 727Building 2,727Revaluation Model: Example Convo CorpFair Value ModelAvailable as measurement option for investment properties (under IFRS only)Investment property measured at fair value subsequent to acquisitionChanges in value reported in net income during period of changeNo depreciation is recognized over assets lifeNote that fair value must be disclosed in financial statements, even if cost model is chosen instead of fair value modelCopyright John Wiley & Sons Canada, Ltd.39Fair Value Model: ExampleErican Corp (EC) purchases shopping mall on February 2, 2011

Purchase price: 1,000,000Property transfer fee: 40,000Legal fees: 3,000Empty store painting (before rent): 2,000Mortgage financing assumed (rest in cash):730,000Tenant damage deposits acquired: 37,000

Fair values: December 31, 2014: 1,040,000December 31, 2015: 1,028,000December 31, 2016: 1,100,000

REQUIRED: Prepare all necessary journal entries to December 31, 2016Copyright John Wiley & Sons Canada, Ltd.40Fair Value Model: ExampleCopyright John Wiley & Sons Canada, Ltd.41February 2, 2014 (acquisition)

Investment Property Mall1,043,000Maintenance Expense 2,000Mortgage Payable730,000Tenant Deposits Liability 37,000Cash278,000

Fair Value Model: ExampleCopyright John Wiley & Sons Canada, Ltd.42December 31, 2014Loss in Value of Inv. Property3,000Investment Property Mall3,000(1,043,000 1,040,000)December 31, 2015Loss in Value of Inv. Property12,000Investment Property Mall12,000(1,040,000 1,028,000)December 31, 2016Investment Property Mall 72,000Gain in Value of Inv. Property72,000(1,100,000 1,028,000)Costs Subsequent to AcquisitionIf 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 assetsReplacements, major overhauls, and inspections: Substitution of a new part/component for an existing asset, and overhauls/inspections whether or not physical parts are replacedRearrangement and reinstallation: Moving an asset from one location to anotherRepairs: Costs that maintain assets in good operating conditionCopyright John Wiley & Sons Canada, Ltd.43Replacements, Major Overhauls, and InspectionsGenerally meet definition for capitalization, and costs added to carrying amountHowever, replaced assets or previous overhauls and/or inspections already have a depreciated carrying value on booksTherefore, original assets carrying value should be removedIf original cost and accumulated depreciation are not known, they must be estimatedASPE is less strict than IFRS and allows for new cost to be debited to Accumulated Depreciation or simply added to assets carrying valueCopyright John Wiley & Sons Canada, Ltd.44Rearrangement and ReinstallationAccounting treatment for rearrangement and reinstallation costs:If the original installation cost is known, record as a replacementIf the original installation cost is not known, cost is expensedIf the original installation cost is not known and amount is material, capitalize cost (ASPE)Copyright John Wiley & Sons Canada, Ltd.45RepairsOrdinary repairs are costs that keep asset in good operating conditionOrdinary repairs are treated as an expenseExamples: replacement of minor parts, repainting, lubricating equipmentCopyright John Wiley & Sons Canada, Ltd.46Looking AheadThere are two significant projects under way by IASBDevelopment of new and comprehensive accounting standards for extractive industries (e.g. mining, oil, gas)Updating standards relating to government grants and assistanceCopyright John Wiley & Sons Canada, Ltd.47COPYRIGHTCopyright 2013 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information contained herein.