From Reader’s Digest My 50-something friend Nancy and I decided to introduce her mother to the...

From Reader’s Digest

• My 50-something friend Nancy and I decided to introduce her mother to the magic of the Internet. Our first move was to access the popular Ask Jeeves site, and we told her it could answer any question she had. Nancy's mother was very skeptical until Nancy said, "It's true, Mom. Think of something to ask it." As I sat with my fingers poised over the keyboard, Nancy's mother thought for a minute, then responded, "How is Aunt Helen feeling?" --Catherine Burns

• I am five feet three inches tall and pleasingly plump. After I had a minor accident, my mother accompanied me to the emergency room. The triage nurse asked for my height and weight, and I blurted out, "Five-foot-eight and 125 pounds.“"Sweetheart," my mother gently chided, "this is not the Internet." --M.M.

• Anytime companies merge, employees worry about layoffs. When the company I work for was bought, I was no exception. My fears seemed justified when a photo of the newly merged staff appeared on the company's website with the following words underneath: "Updated daily." --Dianne Stevens

CHAPTER 10

ACQUISITION AND DISPOSITION OF PROPERTY, PLANT, AND

EQUIPMENT

Sommers – ACCT 3311

Noncash Acquisitions

The asset acquired is recorded at the fair value of the consideration given or the fair value of the asset acquired, whichever is more clearly evident.

• Issuance of equity securities

• Deferred payments

• Donated Assets

• Exchanges

Noncash Acquisitions

Issuance of Equity Securities• Asset acquired is recorded at the fair value of the asset or the

market value of the securities, whichever is more clearly evident.

• If the securities are actively traded, market value can be easily determined.

• If the securities given are not actively traded, the fair value of the asset received, as determined by appraisal, may be more clearly evident than the fair value of the securities.

Donated Assets• On occasion, companies acquire assets through donation.• The receiving company is required to record

– The donated asset at fair value.– Revenue equal to the fair value of the donated asset.

Example 5

On January 1, 2011, Byner Company purchased a used tractor. Byner paid $5,000 down and signed a noninterest-bearing note requiring $25,000 to be paid on December 31, 2013. The fair value of the tractor is not determinable. An interest rate of 10% properly reflects the time value of money for this type of loan agreement. The company’s fiscal year-end is December 31.

• Prepare the journal entry to record the acquisition of the tractor.

• How much interest expense will the company include in its 2011 and 2012 income statements for this note?

• What is the amount of the liability the company will report in its 2011 and 2012 balance sheets for this note?

Example 5: Continued

Prepare the journal entry. PV(FV=25,000, pmt=0, n=3, i=10%) = 18,783

Tractor ($5,000 cash + $18,783 note) 23,783Discount on note payable (difference) 6,217

Cash 5,000Note payable (face amount) 25,000

How much interest expense will the company include in its 2011 and 2012 income statements for this note?

2011: Interest expense ($18,783 x 10%) = $1,8782012: Interest expense [($18,783 + $1,878) x 10%] = 2,066

What is the amount of the liability the company will report in its 2011 and 2012 balance sheets for this note?

2011: $25,000 – ($6,217 – $1,878) = $20,6612012: $25,000 – ($6,217 – $1,878 – $2,066) = 22,727

Dispositions

Steps:

1. Update depreciation to date of disposal.

2. Remove original cost of asset and accumulated depreciation from the books.

3. Record what you received.

4. The difference between book value of the asset and the amount received is recorded as a gain or loss.

Exchanges

Generally 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 clearly

evident• In the exchange of operational assets, fair value is used

except in rare situations in which the fair value cannot be determined or the exchange lacks commercial substance.

• When fair value cannot be determined or the exchange lacks commercial substance, the asset(s) acquired are valued at the book value of the asset(s) given up, plus (or minus) any cash exchanged. No gain is recognized.

Example 6

Southern Company owns a building that it leases. The building’s fair value is $1,400,000 and its book value is $800,000 (original cost of $2,000,000 less accumulated depreciation of $1,200,000). Southern exchanges this for another building owned by the Eastern Company. The building’s book value on Eastern’s books is $950,000 (original cost of $1,600,000 less accumulated depreciation of $650,000). Eastern also gives Southern $140,000 to complete the exchange. The exchange has commercial substance for both companies. Prepare the journal entries to record the exchange on the books of Southern.

Cash 140,000

Building - new ($1,400,000 - 140,000) 1,260,000

Accum deprec - building (acct balance) 1,200,000

Building - old (acct balance) 2,000,000

Gain ($1,400,000 – 800,000) 600,000


Southern Company owns a building that it leases. The building’s fair value is $1,400,000 and its book value is $800,000 (original cost of $2,000,000 less accumulated depreciation of $1,200,000). Southern exchanges this for another building owned by the Eastern Company. The building’s book value on Eastern’s books is $950,000 (original cost of $1,600,000 less accumulated depreciation of $650,000). Eastern also gives Southern $140,000 to complete the exchange. The exchange has commercial substance for both companies. Prepare the journal entries to record the exchange on the books of Eastern.

Building - new 1,400,000

Accum deprec - building (acct balance) 650,000

Cash 140,000

Building - old (acct balance) 1,600,000

Gain on exch of bldgs 310,000

Discussion Questions

Q10–16 Stan Ott is evaluating two recent transactions involving exchanges of equipment. In one case, the exchange has commercial substance. In the second situation, the exchange lacks commercial substance. Explain to Stan the differences in accounting for each situation.

Ordinarily accounting for the exchange of nonmonetary assets should be based on the fair value of the asset given up or the fair value of the asset received, whichever is more clearly evident. Thus any gains and losses on the exchange should be recognized immediately. If the fair value of either asset is not reasonably determinable, the book value of the asset given up is usually used as the basis for recording the nonmonetary exchange. This approach is always employed when the exchange has commercial substance.


Q10–16 Stan Ott is evaluating two recent transactions involving exchanges of equipment. In one case, the exchange has commercial substance. In the second situation, the exchangelacks commercial substance. Explain to Stan the differences in accounting for each situation.

The general rule is modified when exchanges lack commercial substance. In this case, the enterprise is not considered to have completed the earnings process and therefore a gain should not be recognized. However, a loss should be recognized immediately. In certain situations, gains on an exchange that lacks commercial substance may be recorded when monetary consideration is received. When monetary consideration is received, it is assumed that a portion of the earnings process is completed, and therefore, a partial gain is recognized.

Exchange Lacks Commercial Substance

• When exchanges are recorded at fair value, any gain or loss is recognized for the difference between the fair value and book value of the asset(s) given-up. To preclude the possibility of companies engaging in exchanges of appreciated assets solely to be able to recognize gains, fair value can only be used in legitimate exchanges that have commercial substance.

A nonmonetary exchange is considered to have commercial substance if the company:

1. expects a change in future cash flows as a result of the exchange, and

2. that expected change is significant relative to the fair value of the assets exchanged.

Example 7

The Tinsley Company exchanged land that it had been holding for future plant expansion for a more suitable parcel located farther from residential areas. Tinsley carried the land at its original cost of $30,000. According to an independent appraisal, the land currently is worth $72,000. Tinsley gave $14,000 in cash to complete the transaction.

What is the fair value of the new parcel of land received by Tinsley?

FV of old land + Cash given = FV of new land

$72,000 + 14,000 = $86,000



Prepare the journal entry to record the exchange assuming the exchange has commercial substance.

Land - new ($72,000 + 14,000) 86,000

Cash 14,000

Land - old (book value) 30,000

Gain ($72,000 – 30,000) 42,000



Prepare the journal entry to record the exchange assuming the exchange lacks commercial substance.

Land - new ($30,000 + 14,000) 44,000

Cash 14,000

Land - old (book value) 30,000

LO 5

When a company contributes a non-monetary asset, it should

record the amount of the donation as an expense at the fair

value of the donated asset.

Example: Kline Industries donates land to the city of Los

Angeles for a city park. The land cost $80,000 and has a fair

value of $110,000. Kline Industries records this donation as

follows.

Contribution Expense 110,000

Land 80,000

Gain on Disposal of Land 30,000

Accounting for Contributions


Q10–19 What accounting treatment is normally given to the following items in accounting for plant assets? (a) additions, (b) major repairs, (c) improvements and replacements.Additions. Additions represent entirely new units or extensions and enlargements of old units. Expenditures for additions are capitalized by charging either old or new asset accounts depending on the nature of the addition.

Major Repairs. Expenditures to replace parts or otherwise to restore assets to their previously efficient operating condition are regarded as repairs. To be considered a major repair, several periods must benefit from the expenditure. The cost should be handled as an addition, improvement or replacement depending on the type of major repair made.


Q10–19

Improvements. An improvement does not add to existing plant assets. Expenditures for such better ments represent increases in the quality of existing plant assets by rearrangements in plant layout or the substitution of improved components for old components so that the facilities have increased productivity, greater capacity, or longer life. The cost of improvements is accounted for by charges to the appropriate property accounts and the elimination of the cost and accumulated depre ciation associated with the replaced components, if any.

Replacements involve an “in kind” substitution of a new asset or part for an old asset or part. Accounting for major replacements requires entries to retire the old asset or part and to record the cost of the new asset or part. Minor replacements are treated as period costs.

A company may retire plant assets voluntarily or dispose of

them by

Sale.

Involuntary conversion.

Depreciation must be taken up to the date of disposition.

Disposition of PP&E

Example: Ottawa Corporation owns machinery that cost $20,000

when purchased on July 1, 2009. Depreciation has been recorded

at a rate of $2,400 per year, resulting in a balance in accumulated

depreciation of $8,400 at December 31, 2012. The machinery is

sold on September 1, 2013, for $10,500.

Prepare journal entries to

a) update depreciation for 2013 and

b) record the sale.

Sale of Plant Assets

Example 8

a) Depreciation for 2013

Depreciation expense ($2,400 x 8/12) 1,600

Accumulated depreciation 1,600

b) Record the sale

Cash 10,500

Accumulated depreciation 10,000

Machinery 20,000

Gain on sale 500

* $8,400 + $1,600 = $10,000

*


Sometimes an asset’s service is terminated through some type of involuntary conversion such as fire, flood, theft, or condemnation.

Companies report the difference between the amount recovered (e.g., from a condemnation award or insurance recovery), if any, and the asset’s book value as a gain or loss.

They treat these gains or losses like any other type of disposition.

Involuntary Conversion

Disposition of PP&E

E10-25

On April 1, 2014, Gloria Estefan Company received a condemnation award of $430,000 cash as compensation for the forced sale of the company’s land and building, which stood in the path of a new state highway. The land and building cost $60,000 and $280,000, respectively, when they were acquired. At April 1, 2014, the accumulated depreciation relating to the building amounted to $160,000. On August 1, 2014, Estefan purchased a piece of replacement property for cash. The new land cost $90,000, and the new building cost $400,000. Prepare the journal entries to record the transactions on April 1 and August 1, 2014.

E10-25: Continued

April 1

Cash 430,000

Accumulated Depreciation—Buildings 160,000

Land 60,000

Buildings 280,000

Gain on Disposal of Plant Assets 250,000

August 1

Land 90,000

Buildings 400,000

Cash 490,000

Example 9

On January 1, 2011, the Haskins Company adopted the dollar-value LIFO method for its one inventory pool. The pool’s value on this date was $660,000. The 2011 and 2012 ending inventory valued at year-end costs were $690,000 and $760,000, respectively. The appropriate cost indexes are 1.04 for 2011 and 1.08 for 2012.

Calculate the inventory value at the end of 2011 and 2012 using the dollar-value LIFO method.


2011

Ending Inventory at Base Year Cost

$690,000 / 1.04 = $663,462

Inventory Layers at Base Year Cost

Base $660,000

2011 3,462

$663,462

Inventory Layers Converted to Cost

$660,000 x 1.00 = $660,000

3,462 x 1.04 = 3,600

$663,600

Example 9

On January 1, 2011, the Haskins Company adopted the dollar-value LIFO method for its one inventory pool. The pool’s value on this date was $660,000. The 2011 and 2012 ending inventory valued at year-end costs were $690,000 and $760,000, respectively. The appropriate cost indexes are 1.04 for 2011 and 1.08 for 2012.

Calculate the inventory value at the end of 2011 and 2012 using the dollar-value LIFO method.


2012

Ending Inventory at Base Year Cost

$760,000 / 1.08 = $703,704

Inventory Layers at Base Year Cost

Base $660,000

2011 3,462

2012 40,242

$703,704


$660,000 x 1.00 = $660,000

3,462 x 1.04 = 3,600

40,242 x 1.08 = 43,461

$707,061

Example 10

Mercury Company has only one inventory pool. On December 31, 2011, Mercury adopted the dollar-value LIFO inventory method. The inventory on that date using the dollar-value LIFO method was $200,000. Inventory data are as follows:

Ending Inventory at Ending Inventory at

Year Year-End Costs Base Year Costs

2012 $231,000 $220,000

2013 299,000 260,000

2014 300,000 250,000

Compute the inventory at December 31, 2012, 2013, and 2014, using the dollar-value LIFO method.


2012

Calculation of Cost Index

$231,000 / $220,000 = 1.05


$200,000 x 1.00 = $200,000

20,000 x 1.05 = 21,000

$221,000

Example 10




2012 $231,000 $220,000

2013 299,000 260,000

2014 300,000 250,000



2013


$299,000 / $260,000 = 1.15


$200,000 x 1.00 = $200,000

20,000 x 1.05 = 21,000

40,000 x 1.15 = 46,000

$267,000

Example 10




2012 $231,000 $220,000

2013 299,000 260,000

2014 300,000 250,000



2014


$300,000 / $250,000 = 1.20


$200,000 x 1.00 = $200,000

20,000 x 1.05 = 21,000

30,000 x 1.15 = 34,500

$255,500

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