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Property, Plant, and Equipment: Acquisition
and Disposal
Chapter10
COPYRIGHT © 2010 South-Western/Cengage Learning
Intermediate AccountingIntermediate Accounting 11th edition 11th edition
Nikolai Bazley JonesNikolai Bazley Jones
An electronic presentationAn electronic presentationBy Norman SundermanBy Norman Sundermanand Kenneth Buchananand Kenneth BuchananAngelo State University
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Characteristics of Property, Plant, and Equipment
1. The asset must be held for use and not for investment.
2. The asset must have an expected life of more than one year.
3. The asset must be tangible in nature.
To be included in the property, plant, and equipment category, an asset must have three characteristics:
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Acquisition of Property, Plant, and Equipment
Determination of CostDetermination of Cost
Devon Company purchases a machine with a contract price of $100,000 on terms of 2/10, n/30. The company does not take the cash
discount and incurs transportation costs of $2,500, as well as installation and testing costs of $3,000. Sales tax is $7,000 on the purchase.
During installation, uninsured damages of $500 are incurred.
Devon Company purchases a machine with a contract price of $100,000 on terms of 2/10, n/30. The company does not take the cash
discount and incurs transportation costs of $2,500, as well as installation and testing costs of $3,000. Sales tax is $7,000 on the purchase.
During installation, uninsured damages of $500 are incurred.
What is the cost of the machine?What is the cost of the machine?What is the cost of the machine?What is the cost of the machine?
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Determination of CostDetermination of Cost
Contract price $100,000 Discount not taken (2,000)Transportation cost 2,500 Installation and testing 3,000 Sales tax 7,000 Cost of machine $110,500
Contract price $100,000 Discount not taken (2,000)Transportation cost 2,500 Installation and testing 3,000 Sales tax 7,000 Cost of machine $110,500
Acquisition of Property, Plant, and Equipment
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Machine 110,500Repair Expense 500Discounts Lost 2,000 Cash
113,000
The company does not include the $500 of
damages because it was not a necessary cost.
The company does not include the $500 of
damages because it was not a necessary cost.
Acquisition of Property, Plant, and Equipment
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Contract price Costs of closing the
transaction, obtaining title, including commissions options, legal fees, title search, insurance, and past due taxes
Contract price Costs of closing the
transaction, obtaining title, including commissions options, legal fees, title search, insurance, and past due taxes
Acquisition of Property, Plant, and Equipment
Cost of LandCost of Land
Costs of surveys Cost of preparing
the land for its particular use, such as clearing, grading, and razing old buildings when such improvements have an indefinite life
Costs of surveys Cost of preparing
the land for its particular use, such as clearing, grading, and razing old buildings when such improvements have an indefinite life
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Landscaping Streets Sidewalks Sewers
Cost of Land ImprovementsCost of Land Improvements
Acquisition of Property, Plant, and Equipment
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The contract price The costs of remodeling and reconditioning The costs of excavation for the specific
building Architectural costs and the costs of building
permits Capitalized interest costs Unanticipated costs resulting from the
condition of the land
The contract price The costs of remodeling and reconditioning The costs of excavation for the specific
building Architectural costs and the costs of building
permits Capitalized interest costs Unanticipated costs resulting from the
condition of the land
Cost of BuildingsCost of Buildings
Acquisition of Property, Plant, and Equipment
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Leasehold ImprovementsLeasehold Improvements
Revert to the lessor unless exempted in lease agreement
A lessee capitalizes the cost of a leasehold improvement, such as the interior design of a retail store
Amortizes the cost over its economic life or the life of the lease, whichever is shorter
Acquisition of Property, Plant, and Equipment
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Lump-Sum PurchaseLump-Sum Purchase
Under the lump-sum purchase method, the value of each asset is based on the proportion of its market value to the total market value of the
group of assets being purchased.
Acquisition of Property, Plant, and Equipment
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A company pays $120,000 for land and a building. The land and building are appraised at
$50,000 and $75,000, respectively.
A company pays $120,000 for land and a building. The land and building are appraised at
$50,000 and $75,000, respectively.
Appraisal Relative Fair Total Allocated Value Value × Cost = Cost
Land $ 50,000 $50,000/$125,000 × $120,000 = $ 48,000Building 75,000 $75,000/$125,000 × $120,000 = 72,000Total $125,000 $120,000
Acquisition of Property, Plant, and Equipment
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A company pays $120,000 for land and a building. The land and building are appraised at
$50,000 and $75,000, respectively.
A company pays $120,000 for land and a building. The land and building are appraised at
$50,000 and $75,000, respectively.
Acquisition of Property, Plant, and Equipment
Land 48,000Building 72,000 Cash 120,000
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Deferred PaymentsDeferred Payments
Antush Company purchases equipment by issuing a $10,000 non-interest-bearing five-year note. A $2,000 payment will be made at the end of each year. The market rate for obligations of
this type is 12%.
Antush Company purchases equipment by issuing a $10,000 non-interest-bearing five-year note. A $2,000 payment will be made at the end of each year. The market rate for obligations of
this type is 12%.
Equipment 7,210Discount on Notes Payable 2,790 Notes Payable
10,000
($2,000 × 3.604776)
Acquisition of Property, Plant, and Equipment
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Assets Acquired by DonationAssets Acquired by Donation
The city of Julesberg (a governmental unit) donates land worth $20,000 to the Klemme
Company.
The city of Julesberg (a governmental unit) donates land worth $20,000 to the Klemme
Company.
Land 20,000 Donated Capital 20,000
Acquisition of Property, Plant, and Equipment
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The CEO of Hrouda Company donates a building worth $50,000 to the company.
The CEO of Hrouda Company donates a building worth $50,000 to the company.
Building 50,000 Gain from Receipt of Donated Building 50,000
Acquisition of Property, Plant, and Equipment
The gain is reported in the other items section of the income statement.
Assets Acquired by DonationAssets Acquired by Donation
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Start-up CostsGAAP requires that a company
expense the costs of start-up activities as incurred. Start-up costs are costs
related to one-time activities for opening a new facility, introducing a
new product, etc.
GAAP requires that a company expense the costs of start-up activities as incurred. Start-up costs are costs
related to one-time activities for opening a new facility, introducing a
new product, etc.
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The general principle is that the cost of a nonmonetary asset acquired in
exchange for another nonmonetary asset is the fair value of the asset
surrendered.
The general principle is that the cost of a nonmonetary asset acquired in
exchange for another nonmonetary asset is the fair value of the asset
surrendered.
Nonmonetary Asset Exchanges
No Cash Included in ExchangeNo Cash Included in Exchange
Arnold Company Carbon Company
Cost $100,000Accum. depr. 54,000Fair value 40,000
Cost $60,000Accum. depr. 32,000Fair value 40,000
Assets Acquired by Exchange of Other Assets
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Arnold Company
Cost $100,000Accum. depr. 54,000Fair value 40,000
Equipment 40,000Accum. depr. 54,000Loss 6,000 Building 100,000
Book value $46,000Fair value 40,000Loss $ 6,000
Assets Acquired by Exchange of Other Assets
No Cash Included in ExchangeNo Cash Included in Exchange
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Arnold Company
Equipment 40,000Accum. depr. 54,000Loss 6,000 Building 100,000
Cost $40,000 Book value $46,000Fair value 40,000Loss $ 6,000
Assets Acquired by Exchange of Other Assets
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No Cash Included in ExchangeNo Cash Included in Exchange
Cost $60,000Accum. Depr. 32,000Fair value 40,000
Building 40,000Accum. Depr. 32,000 Equipment 60,000 Gain 12,000
Book value $28,000Fair value 40,000Gain $12,000
Carbon Company
Assets Acquired by Exchange of Other Assets
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No Cash Included in ExchangeNo Cash Included in Exchange
Cost $40,000Book value $28,000Fair value 40,000Gain $12,000
Building 40,000Accum. Depr. 32,000 Equipment 60,000 Gain 12,000
Carbon Company
Assets Acquired by Exchange of Other Assets
No Cash Included in ExchangeNo Cash Included in Exchange
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Cash Included in ExchangeCash Included in Exchange
Arnold Company
Cost $100,000Accum. depr. 54,000Fair value 40,000Cash received 5,000
Cost $60,000Accum. depr. 32,000Fair value 35,000Cash paid (5,000)
Assets Acquired by Exchange of Other Assets
Carbon Company
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Arnold Company
Cost $100,000Accum. depr. 54,000Fair value 40,000Cash received 5,000
Equipment 35,000Accum. depr. 54,000Cash 5,000Loss 6,000 Building 100,000
Assets Acquired by Exchange of Other Assets
Book value $46,000Fair value 40,000Loss $ 6,000
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Cash Included in ExchangeCash Included in Exchange
Arnold Company Equipment 35,000Accum. depr. 54,000Cash 5,000Loss 6,000 Building 100,000
Cost $35,000
Assets Acquired by Exchange of Other Assets
Cash Included in ExchangeCash Included in Exchange
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Cost $60,000Accum. Depr. 32,000Fair value 35,000Cash paid 5,000
Building 40,000Accum. Depr. 32,000 Equipment 60,000 Cash 5,000 Gain 7,000
Assets Acquired by Exchange of Other Assets
Book value $28,000Fair value 35,000Gain $ 7,000
Carbon Company
Cash Included in ExchangeCash Included in Exchange
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Exceptions to the General Rule
1. Neither the fair value of the asset received or given up is reasonably determinable.
2. The transaction is an exchange of inventory to facilitate sales to a third party; for example, when a company exchanges its inventory with another company in order to sell the newly acquired inventory to a third company.
A company would not recognize a gain or loss when:
ContinuedContinuedContinuedContinued
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Exceptions to the General Rule
3. The transaction lacks “commercial substance.” A nonmonetary exchange does not have commercial substance if the company’s future cash flows are not expected to change significantly.
Messenger Company exchanged a used truck and $2,000 cash for another used truck.
Truck 32,000Accumulated Depreciation 20,000 Truck 50,000 Cash 2,000
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The cost of materials, labor, and overhead used in the self-construction of
property, plant, and equipment intended for a firm’s production process
are added to the cost of the asset.
The cost of materials, labor, and overhead used in the self-construction of
property, plant, and equipment intended for a firm’s production process
are added to the cost of the asset.
Self-Construction
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Capitalization of Interest
A company is required to capitalize interest on assets that
are either constructed for its own use or constructed as discrete products for sale or lease to
others.
A company is required to capitalize interest on assets that
are either constructed for its own use or constructed as discrete products for sale or lease to
others.
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Capitalization of Interest—Qualifying Assets
Must be built for the company’s own use, or be constructed as discrete projects for sale or lease to others.
Qualifying expenditures were made. The amount to be capitalized is the actual
interest incurred, not imputed. Activities that are necessary to get the asset
ready for its intended use are in progress.
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Interest cannot be capitalized for the following types of assets:1. Inventories that are routinely manufactured.
2. Assets that are in use or ready for their intended use.
3. Assets that are not being used in the earning activities of the company and are not undergoing the activities necessary to get them ready for use.
Capitalization of Interest
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There are three alternatives for a company to include fixed overhead costs in the cost of a self-constructed asset.
There are three alternatives for a company to include fixed overhead costs in the cost of a self-constructed asset.
1. Allocate a portion of total fixed overhead to the self-constructed asset.
2. Include only incremental fixed overhead in the cost of the self-constructed asset.
3. Include no fixed overhead in the cost of the self-constructed asset.
Fixed Overhead Costs
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Costs Subsequent to Acquisition
Extending the life of the asset Improving productivity Producing the same product at
lower cost Increasing the quality of the
product
Extending the life of the asset Improving productivity Producing the same product at
lower cost Increasing the quality of the
product
The future economic benefits of a productive asset or product can be increased by:
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The cost of an addition represents a new asset and
therefore is capitalized.
The cost of an addition represents a new asset and
therefore is capitalized.
Additions
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Rearrangement and Moving
The costs of rearranging the facilities within a building or moving them to a new location are capitalized and expensed over the period expected to benefit.
Many companies expense such costs immediately, which is an acceptable procedure if the difference is immaterial.
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Repairs and Maintenance
Routine repair and maintenance costs should be expensed in the period incurred.
If incurred unevenly during the year, the amount of repair costs in each interim period may be averaged by using an allowance account.
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Asset Retirement Obligations
The acquisition of some assets automatically creates a legal obligation related to the retirement of the asset.– Power plants
– Mines
– Industrial manufacturing sites
The usual method of measuring the fair value is the present value of the future cash flows that will be paid by the company.
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IFRS vs. U.S. GAAP
IFRS allow a company to write the value of its property, plant, and equipment up to fair value if fair value can reliably be measured. Increases are credited to stockholders’ equity as a revaluation surplus.
IFRS require that the cost of relocating or reorganizing property, plant, and equipment be expensed.
Under U.S. GAAP, companies can elect to either capitalize or expense these expenditures.
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Disclosure of Property, Plant, and Equipment
GAAP requires a company to disclose the balances of its major classes of depreciable assets by nature or function.
GAAP requires a company to disclose the balances of its major classes of depreciable assets by nature or function.
Land Building and
leasehold improvements
Machinery and equipment
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Successful-efforts
approach?
Successful-efforts
approach?Full-cost method?
Full-cost method?
Appendix: Oil and Gas Properties
42
Expense dry wells
immediately?
Expense dry wells
immediately?
Capitalize all drilling efforts?
Capitalize all drilling efforts?
Appendix: Oil and Gas Properties
43
Chapter 10
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