AIM3331-Interm. Acctg. Acqusition and Disposition of PP&E1 Operational Assets: Acquisition...

AIM3331-Interm. Acctg. Acqusition and AIM3331-Interm. Acctg. Acqusition and Disposition of PP&EDisposition of PP&E

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Operational Assets: AcquisitionOperational Assets: Acquisition

Operational Assets:Actively used in operations

Expected to produce future benefits

Tangible or intangible


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Acquisition CostsAcquisition Costs(costs capitalized to the asset account rather than to an (costs capitalized to the asset account rather than to an

expense of the period)expense of the period)

General RuleGeneral Rule

“The historical cost of acquiring an asset includes the costs necessarily incurred to bring it to the condition and location necessary for its intended use.”


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Types of costs capitalized to Types of costs capitalized to EquipmentEquipment

Net purchase price

Installation costs

Modification to buildingnecessary to install equipment

Transportation costs

Taxes


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Types of costs capitalized to Types of costs capitalized to LandLand

• Purchase price• Real estate commissions• Back taxes• Title transfer fees• Title insurance premiums• Costs of clearing, filling, draining and

removing old buildings (net of any salvage)

*Land is not depreciable.


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Types of costs capitalized to Types of costs capitalized to Land ImprovementsLand Improvements

• Separately identifiable costs of :

• Driveways

• Parking lots

• Fencing

• Landscaping


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Types of costs capitalized to Types of costs capitalized to BuildingsBuildings

• Architectural fees

• Cost of permits

• Legal fees

• Reconditioning costs

• Purchase price

• Construction costs


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Costs to capitalize?Costs to capitalize?Which of the following costs incurred in

connection with equipment purchased for use in a company’s manufacturing operations would be capitalized?

a. Insurance on equipment while in transit

b. Testing and preparation of equipment for use

c. Both insurance while in transit and testing and preparation

d. Neither insurance while in transit or testing and preparation


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Correct Classification of Correct Classification of Capitalized CostsCapitalized Costs

It is important to assign capitalized costs to the correct fixed asset account because different depreciation rates and useful lives are applied to these accounts and affect net income and the amounts reported on the balance sheet


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EXAMPLEEXAMPLEOn March 1, 2000, Beldon Corp. purchased land as a factory site for $50,000. An old building on the property was demolished, and construction began on a new building that was completed on December 15, 2000. Costs incurred during this period are listed below: Demolition of old building $4,000 Architect’s fees (for new building) 10,000 Legal fees for the investigation of land 2,000 Property taxes on land (for period beginning March 1, 2000) 3,000 Construction costs 500,000 Salvaged materials resulting from the demolition of the old building were sold for $2,000 REQUIRED: Determine the amounts that Beldon should capitalize as the cost of the land and the new building.


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Self-Constructed AssetsSelf-Constructed Assets

• Capitalize all costs directly associated with the construction including materials, labor and overhead.

• Under certain conditions, avoidable interest incurred on qualifying assets is capitalized.– Avoidable interest -- interest that could have been

avoided if the asset were not constructed and the money used to retire debt.


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Interest CapitalizationInterest Capitalization

• Interest is capitalized on Average Accumulated Expenditures (AAE)– Qualifying expenditures weighted for the

number of months outstanding during the current accounting period.

• Qualifying Expenditures– Cash payments for construction– Incurrence of interest-bearing liabilities


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• Capitalization begins when . . .– Qualifying expenditures have been made, andand

– Construction activities are underway, andand

– Interest cost has been incurred.

• Capitalization ends when . . .– The asset is substantially complete and ready

for its intended use.

• Interest Potentially Capitalizable (IPC)– Multiply the AAE by the “capitalization rate or

rates.”


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Interest CapitalizationInterest Capitalization• Capitalization Rate – Specific Interest Method

» If the qualifying asset is financed through a specific new borrowingspecific new borrowing, the interest rate on the new borrowing is used for the computation of IPC (interest potentially capitalizable).» If the qualifying asset is financed by general financed by general borrowingsborrowings, the capitalization rate will be the weighted-average cost of debt.» Use both ratesboth rates, if partially financed with a specific borrowing. Use the specific rate first and then apply the weighted average debt rate.


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Steps in the capitalization process• Compute actual interest expense.• Compute AAE (average

accumulated expenditures).

• Compute IPC (interest potentially capitalizable).

• Capitalize the smallersmaller of actual interest or IPC.


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Example:Costanza Corporation constructed an addition to its factory building. The project began on January 1, 1998 and was completed on December 31, 1998. Expenditures on the project, all of which qualify for inclusion in the calculation of average accumulated expenditures, were as follows:

January 1, 1998 $700,000 March 1, 1998 $240,000 September 1, 1998 $300,000

Costanza has concluded that this project was financed entirely by borrowed funds. Costanza obtained a one-year construction loan from its bank for $400,000 on January 1, 1998. This loan had an 11 percent annual interest rate and was entirely repaid on December 31, 1998. Costanza’s other debt, which was outstanding during the entire construction period consisted of two long-term notes. These notes had principal amounts of $5,000,000 and $20,000,000, bearing interest rates of 8 percent and 10 percent respectively. REQUIRED: Compute the average accumulated expenditures and the amount of interest to be capitalized for 1998.


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Purchase on Credit (Deferred Purchase on Credit (Deferred Payment Contracts)Payment Contracts)

The asset acquired is recorded at the

Cash equivalent price (market value)Cash equivalent price (market value)

ororPresent value of future cash payments using the Present value of future cash payments using the

prevailing market interest rateprevailing market interest rate

Whichever is more objective and reliable. (APB Opinion No. 21)


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Deferred Payment Contract Deferred Payment Contract EXAMPLEEXAMPLE

Marshall company purchased machinery on January 1, 2001 and signed a two-year, 6 percent, $2,000 note that pays interest each December 31. The market interest is 12 percent on notes of similar risk.

Provide the journal entry to record this asset acquisition.


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Lump-Sum PurchaseLump-Sum Purchase

Several assets are acquired for a single, lump-sum price that may be lower than the sum of the individual asset prices.

• Allocate the lump-sum price to the separate items in proportion to the individual asset’s relative market value


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Lump-Sum PurchaseLump-Sum PurchaseExampleExample

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.

Provide the journal entry to record the acquisition of these assets.


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Disposal of Plant AssetsDisposal of Plant AssetsExampleExample

On June 30, 2003, Hilo Inc. sold equipment for $6,350 cash. The equipment was purchased on January 1, 1998 at a cost of $15,000. On the date of the disposal, the equipment had accumulated depreciation of $8,250.

Prepare the journal entry necessary to record the disposal of this equipment.


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Non-monetary Exchanges Non-monetary Exchanges withwith Commercial SubstanceCommercial Substance

If the transaction has “commercial substance”, then:

• The exchange of non-monetary assets should be based on the fair value of the asset given up or the fair value of the asset received, whichever is more reliable.

• All gains and losses on exchange are recognized.


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Non-monetary Exchanges Non-monetary Exchanges withoutwithout Commercial SubstanceCommercial Substance

If transaction has no “commercial substance”, then:

• the exchange is based on book value of the asset given up

• and no gain is recognized through the exchange.

Note: According to Paragraph 22 of APB 29, which was not modified by SFAS No. 153, losses are recorded on all exchanges, even those that lack commercial substance.


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Commercial SubstanceCommercial Substance

• An exchange has “Commercial Substance” if the expected future cash flows change as a result of the exchange

• Exchange of dissimilar assets (example-machinery exchanged for land) typically has commercial substance because the assets have different uses and therefore different cash flows

• For the exchange of similar assets (example- truck exchanged for a truck), the exchange has commercial substance if cash flows are expected to be significantly different.


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Cash Paid in Non-monetary Cash Paid in Non-monetary ExchangesExchanges

When the monetary consideration is significant (25% or more of the fair value of the exchange), the transaction is considered a monetary exchange by both parties and all gains and losses are fully recognized.


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Nonmonetary ExchangeNonmonetary ExchangeExampleExample

Carlton Co. exchanged old equipment, with an original cost of $145,000, for new equipment and paid $15,000 cash in the exchange. At the time of the exchange, their equipment had accumulated depreciation of $45,000. Carlton determined that the fair value of the equipment received was $140,000.

Question: Assume that the transaction has commercial substance, provide Carlton’s journal entries to record this exchange.


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Nonmonetary ExchangeNonmonetary ExchangeExampleExample

Palomar Co. exchanged old equipment for new equipment and received $16,200 cash in the exchange. At the time of the exchange, the book value of their equipment was $100,000 and the fair value of their equipment was determined to be $96,000.

Question: Assume that the transaction has commercial substance, provide Palomar’s journal entries to record this exchange.

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