Operational Assets: Acquisition, Disposal and

Exchange

OPERATIONAL ASSETS

Basic characteristics – Actively used in primary operations– Expected to benefit future periods (long-term)– Generally not held for resale

Grouping of operational assets– Tangible = have physical substance– Intangible = value not tied to physical substance

OPERATIONAL ASSETS

Classification– Property, plant, and equipment• Buildings• Machinery, furniture and fixtures• Land• Land improvements

– Natural resources– Intangibles

ASSET ACQUISITION

With cash On credit In exchange for equity securities of the acquiring company Through donation from another entity Through construction In exchange for nonmonetary assets

ACQUISITION COSTGeneral Rule

“The historical cost of acquiring an assetincludes the costs necessarily incurred to bring it

to the condition and location necessary for itsintended use.”

SFAS No. 34

ACQUISITION COST BUILDINGS

Architectural fees Cost of permits Excavation costs Construction costs Purchase price

ACQUISITION COSTMACHINERY, FURNITURE & FIXTURES

Net purchase price Transportation costs Installation Costs Modification to building

necessary to install equipment

Purchase price Real estate commissions Title search Title transfer fees Title insurance premiums

Land is not depreciable.Land is not depreciable.

ACQUISITION COST LAND

ACQUISITION COSTLAND IMPROVEMENTS

Driveways

Parking lots

Fencing

Landscaping

PURCHASE ON CREDITThe asset acquired is recorded at the

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

Present value of future cash payments Present value of future cash payments using the prevailing market interest rateusing the prevailing market interest rate

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

Purchased With Equity Securities

Asset acquired is recorded at the fair market value of the asset or the fair market value of the securities, whichever is more objective and reliable.

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

If no objective and reliable value can be determined, board of directors assigns a “reasonable value.”

DONATED ASSETS Municipalities may donate land and/or

buildings to induce a company to locate in the area.

SFAS No. 116 defines a contribution as“an unconditional transfer of cash or other assets

to an entity or a settlement or cancellation of its liabilities in a voluntary nonreciprocal transfernonreciprocal transfer. .”

LUMP-SUM PURCHASE

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

Portions of the lump-sum directly attributable to particular assets are assigned to those assets.

The remainder is allocated on the basis of relative value of the assets.

SELF-CONSTRUCTED ASSETS

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

In certain cases a company can capitalize– General overhead– Interest expense

SELF-CONSTRUCTED ASSETS

The asset’s recorded cost must never exceednever exceed its fair market value.

If costs actually incurred exceed fair market value, a loss must be recognized.

INTEREST CAPITALIZATION

In some cases a company may capitalize “avoidable interest” incurred on “qualifying assets.”– Avoidable interest -- interest that could have

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

Key questions to be answered– What are “qualifying assets?”– What is the capitalization period?– What amount should be capitalized?

PP&E - val - 17

INTEREST CAPITALIZATION

Qualifying assets– Self-constructed and required a period of time to

“get them ready for use” Capitalization period

– Begins when all following conditions exist• Expenditures have been made• Asset is being prepared for use• Interest cost is being incurred

– Ends when asset is ready for intended use Amount capitalized

– Lower of “actual interest incurred” or “avoidable interest”

PP&E - val - 18

AVOIDABLE INTEREST

Computation of amount– Interest rate x Weighted-average accumulated expenditures (WAAE)

Appropriate interest rates– For WAEE < or = to amount actually borrowed for

construction --- Use actual rate on specific borrowings for construction

– For portion of WAEE > than amount actually borrowed for construction --- use weighted average rate for all other outstanding debt during the capitalization period

DISPOSAL OF PLANT ASSETS Update depreciation to date of disposal.

Original cost of asset and accumulated depreciation are removed from the accounts.

The difference between book value of the asset and the amount received in the disposal process is recorded as a gain or lossgain or loss.

NONMONETARY EXCHANGESGeneral Principle

Accounting for the exchange of nonmonetary assets should be based on:

• Market value of assets transferred

oror• Market value of assets acquired

Whichever is more readily determinable

PP&E - val - 21

NONMONETARY EXCHANGES

Exchange situation Accounting Fair values determinable

& Assumes commercial substance

Record new asset using FMV & recognize gain or loss

FMV of either asset received or given up is not determinable

OR Lacks commercial substance

OR Exchange to facilitate sales

Record new asset using BV & no gain or loss recognized

PP&E - val - 22

NONMONETARY EXCHANGESCommercial Substance

Exchange has “commercial substance” if the entity’s future cash flows are expected to change significantly as a result of the transaction

– Configuration of future cash flows changes

– Value of assets received differs from value of assets transferred

POST-ACQUISITION EXPENDITURES

Maintenance and ordinary repairs. Improvements (betterments),

replacements, and extraordinary repairs.

Additions. Rearrangements and other

adjustments.

Normally we debit an expense expense account for amounts spent on:

Maintenance and Ordinary RepairsMaintenance and Ordinary Repairs

Concept: keep assets in proper working order.

POST-ACQUISITION EXPENDITURES

Normally we debit the asset asset account for amounts spent on:

Improvements, Replacements,Improvements, Replacements,and Extraordinary Repairsand Extraordinary Repairs

Concept: increase useful life or productivity of the original asset.

POST-ACQUISITION EXPENDITURES

Normally we debit the asset asset account for amounts spent on:

AdditionsAdditions

Concept: expansion of an existing asset.

POST-ACQUISITION EXPENDITURES

Normally we debit an other asset other asset account for amounts spent on:

Rearrangements and Other AdjustmentsRearrangements and Other Adjustments

Concept: increase efficiency of operations.

POST-ACQUISITION EXPENDITURES

INFORMATION GLUT!INFORMATION GLUT!