10-1 intermediate accounting james d. stice earl k. stice © 2014 cengage learning powerpoint...
TRANSCRIPT
10-1
Intermediate Accounting
James D. Stice Earl K. Stice
© 2014 Cengage Learning
PowerPoint presented by Douglas Cloud Professor Emeritus of Accounting, Pepperdine University
Investments in Noncurrent Operating Assets—Acquisitions
Chapter 10Chapter 10
19th Edition
10-2
What Costs Are Included in Acquisition Cost?
• Noncurrent operating assets are recorded initially at cost—the original bargained or cash sales price.
• The cost of property includes not only the original purchase price or equivalent value but also any other expenditures required in obtaining and preparing the asset for its intended use.
• Any taxes, freight, installation, and other expenditures related to the acquisition should be included in the asset’s cost.
10-3
Land
• Costs assigned to land should be those costs that directly relate to the land’s unlimited life.
• Purchase price, commissions, legal fees, escrow fees, surveying fees, and government assessments for water lines, sewers, and roads are charged to Land.
• Clearing and grading costs, including the removal of unwanted structures, are also part of the cost of land.
(continued)
10-4
Buildings
• If the structure is purchased ready to use, charge Buildings for: Purchase price Commissions, legal fees, escrow fees, and
reconditioning costs
• If newly constructed by an outsider: Contract price Legal fees
(continued)
10-5
Equipment
• The purchase price
• Taxes, freight, and insurance during shipping and installation
• Special foundations or reinforcing of floors
• Reconditioning and testing costs
Equipment costs include:
(continued)
10-6
Intangible Assets
• Intangible assets are those assets (not including financial assets) that lack physical substance.
• The most important distinction in intangible assets for accounting purposes is between those that are internally generated and those that are externally purchased.
(continued)
10-7
Trademark
• A trademark is a distinctive name, symbol, or slogan that distinguishes a product or service from similar products or services.
• The cost of a trademark includes the purchase price, filing and registry fees, and the cost of subsequent litigation to protect rights. It does not include internal research and development costs.
10-8
Franchises
• A franchise is the right received (usually purchased) by a business or individual to perform certain functions or sell certain products or services.
• The cost of a franchise includes expenditures made to purchase the franchise, legal fees, and other costs incurred in obtaining the franchise.
10-9
Order Backlog
• The order backlog is the amount of orders the company has received for equipment that has not yet been produced or delivered.
• These orders do not constitute sales because they do not satisfy the revenue recognition requirement that the product be completed and shipped.
(continued)
10-10
Goodwill
• Goodwill represents the business contracts, reputation, functioning systems, staff camaraderie, and industry experience that makes the company more than just a collection of assets.
• Goodwill is a residual number, the value of all of the synergies of a functioning business that cannot be specifically identified with any other intangible factor.
10-11
Basket Purchase
• A number of assets may be acquired in a basket purchase for one lump sum.
• When part of a purchase can be clearly identified with specific assets, such a cost assignment should be made and the balance allocated among the remaining assets.
(continued)
10-12
• When no part of the purchase price can be related to specific assets, the entire amount must be allocated among the different assets acquired.
Basket Purchase
10-13
Deferred Payment
• The acquisition of real estate or other property frequently involves deferred payment of all or part of the purchase price.
• Land is acquired on January 2, 2013, for $100,000; $35,000 is paid at the time of purchase, and the balance is to be paid in semiannual installments of $5,000 plus interest on the unpaid principal at an annual rate of 10%.
(continued)
10-14
June 30, 2013—Made first payment.
Interest Expense 3,250Notes Payable 5,000
Cash 8,250
Jan. 2, 2013—Purchased land for $100,000, paying $35,000 down, the balance to be paid in semiannual payments of $5,000 plus interest at 10%.
Land 100,000Cash 35,000Notes Payable 65,000
$65,000$65,000 0.050.05
Deferred Payment
(continued)
10-15
On January 2, 2013, equipment with a cash price of $50,000 is acquired under a deferred payment contract. The contract specifies a down payment of $15,000 plus seven annual payments of $7,189 each, or a total cost of $65,323. The present value of the seven payments at the implicit effective interest rate of 10 percent is $35,000.
Deferred Payment
(continued)
10-16
On January 2, 2013, purchased equipment with a cash price of $50,000 for $15,000 down plus seven annual payments of $7,189 each.
Equipment 50,000Discount on Notes Payable 15,323
Notes Payable 50,323Cash 15,000
Deferred Payment
(continued)
10-17
Made first payment of $7,189 on December 31, 2013. Calculations for amortization of debt discount are as follows:
$50,323 – $15,323 = $35,000; $35,000 10% = $3,500
Notes Payable 7,189Cash 7,189
Interest Expense 3,500Discount on Notes Payable 3,500
Deferred Payment
(continued)
10-18
Made the second payment of $7,189 and amortized debt discount on December 31, 2014.
Notes Payable 7,189Cash 7,189
Interest Expense* 3,131Discount on Notes Payable 3,131
*$50,323 $7,189 = $43,134 Notes payable$15,323 $3,500 = 11,823 Discount on notes payable $31,311 Present value of notes payable
at the end of first year
$31,311 0.10 = $3,131
Deferred Payment
10-19
Leasing
• A lease is a contract whereby one party (the lessee) is granted a right to use property owned by another party (the lessor) for a specified period of time for a specified periodic cost.
• Rental leases are operating leases and arrangements that are equivalent to a sale of leased assets are capital leases.
• Capital leases are recorded on the acquiring company’s records as assets, with a related liability at the present value of the future lease payments.
10-20
Exchange of Nonmonetary Assets
• In some cases, an enterprise acquires a new asset by exchanging or trading existing nonmonetary assets.
• Monetary assets are those assets whose amounts are fixed in terms of currency, by contract, or otherwise (cash, accounts receivable).
• Nonmonetary assets include all the other assets (inventories, land).
10-21
Acquisition by Issuing Securities
• When a fair value for the securities can be determined, that value is assigned to the asset acquired.
• In the absence of a fair value for the securities, the fair value of the asset acquired is used.
(continued)
10-22
A company issues 1,000 shares of $1 par common stock in acquiring land; the stock has a current market price of $45 per share. The entry should be recorded as follows:Land 45,000
Common Stock 1,000Paid-in Capital in Excess of Par 44,000
Acquisition by Issuing Securities
10-23
Self-Construction
• Like purchased assets, self-constructed assets are recorded at cost, including all expenditures incurred to build the asset and make it ready for its intended use.
• There is a difference of opinion regarding the amount of overhead properly assignable to construction activity.
10-24
Savings or Loss onSelf-Construction
• When the cost of self-construction of an asset is less than the cost to acquire it through purchase or construction from outsiders, the difference is not a profit, but a savings.
• When the cost is greater than the cost to acquire it through purchase or construction from outsiders, the asset should be recorded at cost (with some exceptions).
10-25
Interest During Period of Construction
• Capitalization of interest is required for assets, such as buildings and equipment, that are being self-constructed for an enterprise’s own use and for assets that are intended to be leased or sold to others that can be identified as discrete projects.
• Interest should not be capitalized for inventories manufactured or produced on a repetitive basis.
(continued)
10-26
1. Interest charges begin when the first expenditures are made on the project and continue as long as work continues and until the asset is completed and actually ready for use.
2. The amount of interest to be capitalized is computed using the accumulated expenditure for the project, weighted based on when the expenditures were made during the year.
Interest During Period of Construction
The following basic guidelines govern the computation of capitalized interest:
(continued)
10-27
3. The interest rate to be used in calculating the amount of interest to capitalize are, in the following order:
a) Interest rate incurred for any debt specifically incurred for funds used on the project.
b) Weighted-average interest rate from all other enterprise borrowings regardless of the use of funds.
Interest During Period of Construction
(continued)
10-28
Interest During Period of Construction
4. If the construction period covers more than one fiscal period, accumulated expenditures include prior years’ capitalized interest.
The results provided by the four steps is the The results provided by the four steps is the maximum interest that can be capitalized for the year. maximum interest that can be capitalized for the year.
10-29
IASB on Interest Capitalization
• In 2007 the IASB revised IAS 23 to require, starting on January 1, 2009, that all companies capitalize “borrowing costs” incurred in the construction of a long-term asset.
• The international standard requires that companies capitalize the net amount of interest incurred rather than the gross amount.
10-30
Acquisition by Donationor Discovery
• When property is received through donation, there is no cost that can be used as a basis for its valuation.
• Property acquired through donation should be appraised and recorded at its fair value.
• A donation is recognized as a gain in the period in which it is received.
(continued)
10-31
Netty’s Ice Cream Parlor is given a donation of land and a building by an eccentric ice cream lover. The entry, using appraised values, is as follows:
Land 400,000Buildings 1,500,000
Revenue or Gain 1,900,000
Acquisition by Donationor Discovery
(continued)
10-32
Acquisition by Donationor Discovery
• FASB ASC paragraph 845-10-S99-1 requires that when a corporation receives nonmonetary assets as an investment by a shareholder, the assets are recorded by the company at the shareholder’s historical cost.
• Depreciation of an asset acquired by gift should be recoded in the usual manner, the value assigned to the asset providing the basis for the depreciation charge.
(continued)
10-33
Acquisition by Donationor Discovery
• If a gift is contingent upon some act to be performed by the recipient, no asset should be reported until the conditions of the gift have been met.
• A discovery that greatly increases the value of the property is commonly ignored in the accounting in the U.S. This also applies to accretion values, such as growing timber or aging wine.
10-34
• To illustrate the initial recognition of an asset retirement obligation, assume that Bryan Beach Company purchases and erects an oil platform at a total cost of $750,000.
• At the end of ten years, the platform must be dismantled and removed from the site at an estimated cost of $100,000. Using an 8% interest rate, the present value of $100,000 for ten years is $46,319.
Asset with Significant Restoration Costs at Retirement
(continued)
10-35
Oil Platform 750,000 Cash 750,000
The journal entries to record the purchase and the asset retirement obligation follow:
Oil Platform 46,319 Asset Retirement Obligation 46,319
Asset with Significant Restoration Costs at Retirement
(continued)
10-36(continued)
• Homer Company constructs and commences operation of a nuclear power plant. Total construction cost is $400,000.
• The cost of cleaning up the routine contamination is estimated to be $500,000; this cost will be incurred in 30 years when the plant is decommissioned. Additional annual contamination cleanup cost $40,000. Assume an interest rate of 9%.
Asset with Significant Restoration Costs at Retirement
10-37
Nuclear Plant 400,000 Cash 400,000
Initial Acquisition
Nuclear Plant 37,686 Asset Retirement Obligation 37,686
Asset with Significant Restoration Costs at Retirement
FVFV = $500,000; = $500,000; I I = 9%; = 9%; NN = 30 years = 30 years $37,686 $37,686
After One Year
Nuclear Plant 3, 286 Asset Retirement Obligation 3,286
FVFV = $40,000; = $40,000; I I = 9%; = 9%; NN = 29 years = 29 years $3,286 $3,286
10-38
Postacquisition Expenditures
• A component is a portion of a property, plant, or equipment item that is separately identifiable and for which a separate useful life can be estimated (i.e., a building’s heating and cooling system).
• Expenditures to maintain plant assets in good operating condition are referred to as maintenance.
(continued)
10-39
• Expenditures to restore assets to good operating condition upon their breakdown or to restore and replace broken parts are referred to as repairs.
• Maintenance and repairs are charged to expense accounts immediately.
Postacquisition Expenditures
(continued)
10-40
• Expenditures for overhauling plant assets are frequently referred to as renewals. They should be expensed immediately.
• Substitution of parts or entire units are referred to as replacements. If a part is removed and replaced with a different part, the cost and accumulated depreciation related to the replaced part should be treated like any removed plant asset.
(continued)
Renewals and Replacements
10-41
Mendon Fireworks Company replaces the roof of its manufacturing plant for $40,000. The original cost of the building was $1,600,000, and it is three-fourths depreciated. The original roof cost $20,000 and the new roof is recorded as a separate component.
(continued)
Renewals and Replacements
10-42
Roof 40,000Accumulated Depreciation— Buildings (old roof) 15,000Depreciation Expense 5,000
Buildings (old roof) 20,000Cash 40,000
$20,000 $20,000 3/4 3/4
$20,000 $20,000 $15,000 $15,000
Renewals and Replacements
10-43
Additions and Betterments
• Enlargements and extensions of existing facilities are referred to as additions.
• Changes in asset design to provide increased or improved services are referred to as betterments.
• Capitalize the cost of additions and betterments.
10-44
Research and Development
• The FASB defined research activities as those undertaken to discover new knowledge that will be useful in developing new products, services, or process or that will result in significant improvements of existing products or processes.
• Development activities involve the application of research findings to develop a plan or design for new or improved products or processes.
(continued)
10-45
Research and Development
Research and development costs include those costs of:• materials
• equipment
• facilities
• personnel
• purchased intangibles
• contract services
• a reasonable allocation of indirect cost specifically related to research and development
Unless Research Unless Research and development and development expenditures have expenditures have alternative future alternative future uses, they are uses, they are expensed in the expensed in the period they occur.period they occur.
10-46
Computer Software Development Expenditures
• All costs in developing computer software incurred up to the point where technological feasibility is established are expensed as research and development (planning, design, and testing activities).
• Testing done after the establishment of technological feasibility and the cost to produce masters can be capitalized.
10-47
International Accounting for R&D: IAS 38
• IAS 38 requires research costs to be expensed and development costs to be capitalized.
• Preliminary indications are that the general approach to R&D accounting in IAS 38 will be adopted by the FASB.
• Currently, U.S. GAAP requires that all R&D costs be expensed except for post-feasibility computer software development.
10-48
Oil and Gas Exploration Costs
• Full cost method—all exploratory costs are capitalized. Reasoning: The cost of drilling dry wells is part of the
cost of locating productive wells.
• Successful efforts method—exploratory costs for dry wells are expensed, and only exploratory costs for successful wells are capitalized. Negative reaction: Small independent oil firms argued
that expensing costs that they have been capitalizing would result in lower profits, depressed stock prices, and difficulty in getting loans.
(continued)
10-49
Five General Categories of Intangible Assets
1. Marketing-related intangible assets such as trademarks, brand names, and Internet domain names.
2. Customer-related intangible assets such as customer lists, order backlogs, and customer relationships.
3. Artistic-related intangible assets such as items protected by copyright.
4. Contract-based intangible assets such as licenses, franchises, and broadcast rights.
(continued)
10-50
Five General Categories of Intangible Assets
5. Technology-based intangibles such as both patented and unpatented technologies as well as trade secrets.
10-51
Estimating the Fair Value of Intangibles
• The most difficult part of recording an amount for an intangible is estimating its fair value.
• As described in Concepts Statement No. 7, the present value of future cash flows can be used to estimate fair value in one of two ways, the traditional approach and the expected cash flow approach.
(continued)
10-52
Estimating the Fair Value of Intangibles
Intangible Asset A is the right to receive royalty payments in the future of $1,000 payments at the end of each of the next five years. The risk-adjusted interest rate is 12%. The fair value of the patent is calculated as follows:
Table Value (n = 5; I = 12) $1,000 = PV(annuity)
3.605 $1,000 = $3,605
Traditional ApproachTraditional ApproachTraditional ApproachTraditional Approach
(continued)
10-53
Estimating the Fair Value of Intangibles
Expected Cash Flow ApproachExpected Cash Flow ApproachExpected Cash Flow ApproachExpected Cash Flow Approach
Intangible Asset B is a secret formula to produce a healthy fast-food cheeseburger that is expected to have the following associated probabilities of happening:Outcome 1 = 10% probability of cash flows of
$5,000 at the end of each year for 10 years
Outcome 2 = 30% probability of cash flows of $1,000 at the end of each year for 4 years
(continued)
10-54
Outcome 3 = 60% probability of cash flows of $100 at the end of each year for 3 years
Estimating the Fair Value of Intangibles
10-55
Acquired In-Process Research and Development
The FASB ruled that in-process R&D is to be recognized as an intangible asset if it is acquired as part of a business combination but is to be expensed if acquired as part of a basket purchase outside of a business combination.
The FASB realizes that this is The FASB realizes that this is an inconsistency and they an inconsistency and they intend to revisit it in the future.intend to revisit it in the future.
10-56
Intangibles Acquired in the Acquisition of a Business
• Goodwill is a residual amount, the amount of the purchase price of a business that is left over after all other tangible and intangible assets have been identified.
• In a basket purchase, each identifiable asset is recorded at an amount equal to its estimated fair market value; any residual is reported as goodwill.
10-57
Bargain Purchase
• When the amount paid for another company is less than the fair value of the net identifiable assets, this is a bargain purchase.
• Assume that the Speedy Freight acquisition was for $1,000,000 instead of $1,500,000. The acquisition would be recorded as shown in Slide 10-65.
(continued)
10-58
Note that a gain is recognizedNote that a gain is recognized
Bargain Purchase
10-59
International Accounting for Intangibles: IAS 38 and IFRS 3
• The IASB’s standard for the accounting of intangible assets is IAS 38.
• This IASB standard is very much compatible with U.S. GAAP.
• The most significant differences between U.S. GAAP and IASB standards in the accounting for intangible assets are in testing these assets for impairment.
10-60
Valuation of Assets at Fair Values
• In IAS 16, the IASB permits the inclusion of upward revaluations of noncurrent operating assets in the financial statements as an allowable alternative to reporting the historical cost of those assets. If a company revalues its noncurrent
operating assets to fair value, it must do so on a regular basis and must revalue entire classes of assets rather than just picking and choosing certain assets.
(continued)
10-61
Downward revaluations are recorded as a loss.
Upward revaluations are recorded as a debit to the asset and a credit to a special “revaluation” equity account.
This practice means that upward revaluations cannot be used to boost reported income.
When the asset that has revalued upward is subsequently sold, any associated balance in the special revaluation equity is credited directly to Retained Earnings.
Valuation of Assets at Fair Values
10-62
Sales
Average fixed assets
$182,515
Fixed Asset Turnover Ratio
Fixed asset turnover ratio =
General Electric’s manufacturing segments had sales for 2008 totaled $182,515. Its beginning and ending property, plant, and equipment balances were $77,888 and $78,530, respectively.
= $78,209
$78,209
($77,888 + $78,530) 2Average fixed assets =
= 2.33
(continued)
10-63
Sales
Average fixed assets
$156,783Fixed asset turnover ratio =
General Electric’s manufacturing segments had sales for 2009 totaled $156,783. Its beginning and ending property, plant, and equipment balances were $78,530 and $69,212, respectively.
= $73,871
$73,871
($78,530 + $69,212) 2Average fixed assets =
= 2.12
Fixed Asset Turnover Ratio
10-64
Dangers in Using the Fixed Asset Turnover Ratio
• Fixed asset turnover ratios values for two companies in different industries cannot be meaningfully compared.
• The reported amount for property, plant, and equipment can be a poor indicator of the actual fair value of fixed assets being used by a company.
10-65
Chapter 10Chapter 10
The EndThe EndThe EndThe End
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10-66