acquisition and disposition of property, plant, and equ

11

ACQUISITION AND DISPOSITION OF PROPERTY, ACQUISITION AND DISPOSITION OF PROPERTY, PLANT, AND EQUIPMENTPLANT, AND EQUIPMENT

22

JOIN KHALID AZIZJOIN KHALID AZIZ

FRESH CLASSESFRESH CLASSES ICap module b & dICap module b & d

FINANCIAL ACCOUNTING, FINANCIAL ACCOUNTING, ECONOMICS & COST ECONOMICS & COST ACCOUNTINGACCOUNTING

INDIVIDUAL & GROUPSINDIVIDUAL & GROUPS

33


ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.B.COM.

FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP MODULE B, B.COM, BBA, MBA & PIPFA.ICAP MODULE B, B.COM, BBA, MBA & PIPFA.

COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE D, BBA, MBA & PIPFA.MODULE D, BBA, MBA & PIPFA.

CONTACT:CONTACT: 0322-33857520322-3385752 0312-23028700312-2302870 R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA,

KARACHI, PAKISTAN.KARACHI, PAKISTAN.

44

1.1. Describe property, plant, and equipment.Describe property, plant, and equipment.

2.2. Identify the costs to include in initial valuation of property, Identify the costs to include in initial valuation of property, plant, and equipment.plant, and equipment.

3.3. Describe the accounting problems associated with self-Describe the accounting problems associated with self-constructed assets.constructed assets.

4.4. Describe the accounting problems associated with interest Describe the accounting problems associated with interest capitalization.capitalization.

5.5. Understand accounting issues related to acquiring and valuing Understand accounting issues related to acquiring and valuing plant assets.plant assets.

6.6. Describe the accounting treatment for costs subsequent to Describe the accounting treatment for costs subsequent to acquisition.acquisition.

7.7. Describe the accounting treatment for the disposal of Describe the accounting treatment for the disposal of property, plant, and equipment.property, plant, and equipment.

Learning ObjectivesLearning Objectives

55

Acquisition

Acquisition costs: Land, buildings, equipment

Self-constructed assets

Interest costs

Observations

ValuationCost Subsequent

to AcquisitionDispositions

Cash discounts

Deferred contracts

Lump-sum purchases

Stock issuance

Nonmonetary exchanges

Contributions

Other valuation methods

Sale

Involuntary conversion

Miscellaneous problems

Additions

Improvements and replacements

Rearrangement and reinstallation

Repairs

Summary

Acquisition and Disposition of Property, Plant, and Equipment

66

“Used in operations” and not for resale.

Long-term in nature and usually depreciated.

Possess physical substance.

Property, plant, and equipment includes land, buildings, and equipment (machinery, furniture, tools).

Major characteristics include:

Property, Plant, and EquipmentProperty, Plant, and Equipment

LO 1 Describe property, plant, and equipment.LO 1 Describe property, plant, and equipment.

77

Historical cost is reliable.

Companies should not anticipate gains and losses but should recognize gains and losses only when the asset is sold.

Valued at Historical Cost, reasons include:

Acquisition of PP&EAcquisition of PP&E

LO 2 Identify the costs to include in initial valuation LO 2 Identify the costs to include in initial valuation of property, plant, and equipment.of property, plant, and equipment.

APB Opinion No. 6 s t a t e s , “ p r o p e r t y , p la n t , a n d

e q u ip m e n t s h o u ld n o t b e w r i t t e n u p t o r e f le c t

a p p r a is a l , m a r k e t , o r c u r r e n t v a lu e s w h ic h a r e a b o v e

c o s t . ”

88

Includes all costs to acquire land and ready it for use. Costs typically include:

Cost of Land



(1) the purchase price;(2) closing costs, such as title to the land, attorney’s

fees, and recording fees; (3) costs of grading, filling, draining, and clearing;(4) assumption of any liens, mortgages, or encumbrances

on the property; and (5) Additional land improvements that have an indefinite

life.

99

Includes all costs related directly to acquisition or construction.Costs typically include:

Cost of Buildings


(1) materials, labor, and overhead costs incurred during construction and

(2) professional fees and building permits.


1010

Include all costs incurred in acquiring the equipment and preparing it for use.Costs typically include:

Cost of Equipment


(1) purchase price, (2) freight and handling charges(3) insurance on the equipment while in transit, (4) cost of special foundations if required, (5) assembling and installation costs, and (6) costs of conducting trial runs.


1111

E10-1 (variation): The following expenditures and receipts are related to land, land improvements, and buildings acquired for use in a business enterprise. Determine how the following should be classified:


• Money borrowed to pay building contractor • Payment for construction from note proceeds• Cost of land fill and clearing• Delinquent real estate taxes on property

assumed• Premium on 6-month insurance policy during

construction• Refund of 1-month insurance premium because

construction completed early

ClassificationClassification

Notes PayableNotes Payable

BuildingBuilding

LandLand

LandLand

BuildingBuilding

(Building)(Building)


1212

E10-1 (variation): The following expenditures and receipts are related to land, land improvements, and buildings acquired for use in a business enterprise. Determine how the following should be classified:


(g) Architect’s fee on building(h) Cost of real estate purchased as a plant site

(land $200,000 and building $50,000)(i) Commission fee paid to real estate agency(j) Installation of fences around property(k) Cost of razing and removing building• Proceeds from salvage of demolished building• Cost of parking lots and driveways• Cost of trees and shrubbery (permanent)

Costs of:Costs of:

BuildingBuilding


LandLand

LandLand

Land ImprovementsLand Improvements

LandLand(Land)(Land)

Land ImprovementsLand ImprovementsLandLand

1313

Self-Constructed Assets


Costs typically include:

(2) Materials and direct labor

(3) Overhead can be handled in two ways:

1. Assign no fixed overhead

2. Assign a portion of all overhead to the construction process.

Companies use the second method extensively.

LO 3 Describe the accounting problems associated with self-constructed assets.LO 3 Describe the accounting problems associated with self-constructed assets.

1414

Three approaches have been suggested to account for the interest incurred in financing the construction.

Interest Costs During Construction


LO 4 Describe the accounting problems associated with interest capitalization.LO 4 Describe the accounting problems associated with interest capitalization.

Capitalize no Capitalize no interest interest during during

constructionconstruction

Capitalize actual Capitalize actual costs incurred costs incurred

during construction during construction (with modification)(with modification)

Capitalize Capitalize all costs of all costs of

fundsfunds

GAAPGAAP

$ 0$ 0 $ ?$ ?Increase to Cost of AssetIncrease to Cost of AssetIllustration 10-1Illustration 10-1

1515

GAAP requires — capitalizing actual interest (with modification).

Consistent with historical cost — all costs incurred to bring the asset to the condition for its intended use.

Capitalization considers three items:

1. Qualifying assets.

2. Capitalization period.

3. Amount to capitalize.

Interest Costs During Construction



1616

Require a period of time to get them ready for their intended use.

Two types of assets:

Assets under construction for a company’s own use.

Assets intended for sale or lease that are constructed or produced as discrete projects.

Qualifying Assets



1717

Capitalization Period



Begins when:

2. Expenditures for the asset have been made.

3. Activities for readying the asset are in progress .

4. Interest costs are being incurred.

Ends when:The asset is substantially complete and ready

for use.

1818

Amount to Capitalize



Capitalize the lesser of:

2. Actual interest costs

3. Avoidable interest - the amount of

interest that could have been avoided

if expenditures for the asset had not

been made.

1919

Interest Capitalization Illustration: KC Corporation borrowed $200,000 at 12% interest from State Bank on Jan. 1, 2011, for specific purposes of constructing special-purpose equipment to be used in its operations. Construction on the equipment began on Jan. 1, 2011, and the following expenditures were made prior to the project’s completion on Dec. 31, 2011:



Actual Expenditures:January 1, 2011 $100,000 April 30, 2011 150,000November 1, 2011 300,000December 31, 2011 100,000

Total expenditures $650,000

Other general debt existing on Jan. 1, 2011:

$500,000, 14%, 10-year bonds payable

$300,000, 10%, 5-year note payable

2020

Step 1 - Determine which assets qualify for capitalization of interest.

Special purpose equipment qualifies because it requires a period of time to get ready and it will be used in the company’s operations.



Step 2 - Determine the capitalization period.

The capitalization period is from Jan. 1, 2011 through Dec. 31, 2011, because expenditures are being made and interest costs are being incurred during this period while construction is taking place.

2121



WeightedAverage

Actual Capitalization Accumulated Date Expenditures Period Expenditures

Jan. 1 100,000$ 12/12 100,000$ Apr. 30 150,000 8/12 100,000 Nov. 1 300,000 2/12 50,000 Dec. 31 100,000 0/12 -

650,000$ 250,000$

Step 3 - Compute weighted-average accumulated expenditures.

A company weights the construction expenditures by the amount of time (fraction of a year or accounting period) that it can incur interest cost on the expenditure.

2222



Step 4 - Compute the Actual and Avoidable Interest.

Selecting Appropriate Interest Rate:

❷ For the portion of weighted-average accumulated expenditures that is less than or equal to any amounts borrowed specifically to finance construction of the assets, use the interest rate incurred on the specific borrowings.

❷ For the portion of weighted-average accumulated expenditures that is greater than any debt incurred specifically to finance construction of the assets, use a weighted average of interest rates incurred on all other outstanding debt during the period.

2323



Accumulated Interest AvoidableExpenditures Rate Interest

200,000$ 12% 24,000$ 50,000 12.5% 6,250

250,000$ 30,250$

Step 4 - Compute the Actual and Avoidable Interest.

Avoidable InterestAvoidable Interest

Interest ActualDebt Rate Interest

Specific Debt 200,000$ 12% 24,000$

General Debt 500,000 14% 70,000 300,000 10% 30,000

1,000,000$ 124,000$

Weighted-average interest rate on

general debt

Actual InterestActual Interest

$100,000 $800,000

= 12.5%

2424

Step 5 – Capitalize the lesser of Avoidable interest or Actual interest.



Avoidable interest 30,250$ Actual interest 124,000

Journal entry to Capitalize Interest:

Equipment 30,250

Interest expense 30,250

2525



Comprehensive Illustration: On November 1, 2009, Shalla Company contracted Pfeifer Construction Co. to construct a building for $1,400,000 on land costing $100,000 (purchased from the contractor and included in the first payment). Shalla made the following payments to the construction company during 2010.

2626







2727



Pfeifer Construction completed the building, ready for occupancy, on December 31, 2010. Shalla had the following debt outstanding at December 31, 2010.

Compute the weighted-average accumulated expenditures during 2010.

2828



Compute the weighted-average accumulated expenditures during 2010.

Illustration 10-4Illustration 10-4

Solution on notes page

2929



Compute the avoidable interest.Illustration 10-5Illustration 10-5

Solution on notes page

3030



Compute the actual interest cost, which represents the maximum amount of interest that it may capitalize during 2010,


The interest cost that Shalla capitalizes is the lesser of $120,228 (avoidable interest) and $239,500 (actual interest), or $120,228.

3131



Shalla records the following journal entries during 2010:

January 1 Land 100,000Building (or CIP) 110,000

Cash 210,000

March 1 Building 300,000Cash 300,000

May 1 Building 540,000Cash 540,000

December 31 Building 450,000Cash 450,000

Building (Capitalized Interest) 120,228Interest Expense 119,272

Cash 239,500

3232



At December 31, 2010, Shalla discloses the amount of interest capitalized either as part of the nonoperating section of the income statement or in the notes accompanying the financial statements.



3333

Companies should record property, plant, and equipment:

at the fair value of what they give up or

at the fair value of the asset received,

whichever is more clearly evident.

Valuation of PP&EValuation of PP&E

LO 5 Understand accounting issues related to acquiring and valuing plant assets.LO 5 Understand accounting issues related to acquiring and valuing plant assets.

3434

Cash Discounts — whether taken or not — generally considered a reduction in the cost of the asset.

Deferred-Payment Contracts — Assets, purchased through long term credit, are recorded at the present value of the consideration exchanged.

Lump-Sum Purchases — Allocate the total cost among the various assets on the basis of their fair market values.

Issuance of Stock — The market value of the stock issued is a fair indication of the cost of the property acquired.



3535



Ordinarily accounted for on the basis of:

the fair value of the asset given up or

the fair value of the asset received,

whichever is clearly more evident.

Exchanges of Nonmonetary Assets

Companies should recognize immediately any gains or losses on the exchange when the transaction has commercial substance.

3636



Accounting for Exchanges

* If cash is 25% or more of the fair value of the exchange, recognize entire gain because earnings process is complete.


3737



Companies recognize a loss immediately whether the exchange has commercial substance or not.

Rationale: Companies should not value assets at more than their cash equivalent price; if the loss were deferred, assets would be overstated.

Exchanges - Loss Situation

3838



Illustration: Information Processing, Inc. trades its used machine for a new model at Jerrod Business Solutions Inc. The exchange has commercial substance. The used machine has a book value of $8,000 (original cost $12,000 less $4,000 accumulateddepreciation) and a fair value of $6,000. The new model lists for $16,000. Jerrod gives Information Processing a trade-in allowance of $9,000 for the used machine. Information Processing computes the cost of the new asset as follows.


3939

Equipment 13,000Accumulated Depreciation—Equipment 4,000Loss on Disposal of Equipment 2,000

Equipment 12,000Cash 7,000



Illustration: Information Processing records this transaction as follows:


Loss on Disposal

4040



Exchanges - Gain Situation

Has Commercial Substance. Company usually records the cost of a nonmonetary asset acquired in exchange for another nonmonetary asset at the fair value of the asset given up, and immediately recognizes a gain.

4141



Illustration: Interstate Transportation Company exchanged a number of used trucks plus cash for a semi-truck. The used trucks have a combined book value of $42,000 (cost $64,000 less $22,000 accumulated depreciation). Interstate’s purchasingagent, experienced in the second-hand market, indicates that the used trucks have a fair market value of $49,000. In addition to the trucks, Interstate must pay $11,000 cash for the semi-truck. Interstate computes the cost of the semi-truck as follows.


4242

Semi-truck 60,000Accumulated Depreciation—Trucks 22,000

Trucks 64,000Gain on disposal 7,000Cash 11,000



Illustration: Interstate records the exchange transaction as follows:


Gain on Disposal

4343




Lacks Commercial Substance—No Cash Received. Now assume that Interstate Transportation Company exchange lacks commercial substance. That is, the economic position of Interstate did not change significantly as a result of this exchange. In this case,Interstate defers the gain of $7,000 and reduces the basis of the semi-truck.

4444

Semi-truck 53,000Accumulated Depreciation—Trucks 22,000

Trucks 64,000Cash 11,000



Illustration: Interstate records the exchange transaction as follows:


4545




Lacks Commercial Substance—Some Cash Received. When a company receives cash (sometimes referred to as “boot”) in an exchange that lacks commercial substance, it may immediately recognize a portion of the gain. The general formula for gain recognition when an exchange includes some cash is as follows:


4646







4747



Illustration: Queenan Corporation traded in used machinery with a book value of $60,000 (cost $110,000 less accumulated depreciation $50,000) and a fair value of $100,000. It receives in exchange a machine with a fair value of $90,000 plus cash of $10,000.


4848



The portion of the gain a company recognizes is the ratio of monetary assets (cash in this case) to the total consideration received.


Solution on Solution on notes pagenotes page

4949



Queenan would record the following entry.Illustration 10-19Illustration 10-19

Cash 10,000Machine 54,000Accumulated Depreciation—Machine 50,000

Machine 110,000Gain on disposal of machine 4,000

5050

E10-19 variation: Carlos Arruza Company exchanged equipment used in its manufacturing operations plus $3,000 in cash for similar equipment used in the operations of Tony LoBianco Company. The following information pertains to the exchange.


Arruza LoBiancoEquipment (cost) $28,000 $28,000 Accumulated Depreciation 19,000 10,000Fair value of equipment 15,500 12,500Cash given up 3,000

Instructions: Prepare the journal entries to record the exchange on the books of both companies.


5151

Calculation of Gain or Loss


Arruza LoBiancoFair value of equipment received $12,500 $15,500 Cash received / paid 3,000 (3,000)Less: Bookvalue of equipment

($28,000-19,000) (9,000)($28,000-10,000) (18,000)

Gain or (Loss) on Exchange $6,500 ($5,500)

When a company receives cash (sometimes referred to as “boot”) in an exchange that lacks commercial substance, it may immediately recognize a portion of the gain.


5252

Has Commercial Substance


Arruza:Equipment 12,500Cash 3,000Accumulated depreciation 19,000

Equipment 28,000Gain on exchange 6,500

LoBianco:Equipment 15,500Accumulated depreciation 10,000


Loss on exchange 5,500


5353

Lacks Commercial Substance


Arruza:Equipment (12,500 – 5,242) 7,258Cash 3,000Accumulated depreciation 19,000

Equipment 28,000Gain on exchange 1,258

Cash ReceivedCash Received

Cash Received + FMV of Assets ReceivedCash Received + FMV of Assets Receivedxx Total Total

GainGain== Recognized Recognized

GainGain

$3,000$3,000

$3,000 + $12,500$3,000 + $12,500xx $6,500$6,500 == $1,258$1,258

Deferred gain = $6,500 – 1,258 = $5,242Deferred gain = $6,500 – 1,258 = $5,242


5454

Lacks Commercial Substance


LoBianco (no change):Equipment 15,500Accumulated depreciation 10,000


Loss on exchange 5,500

Companies recognize a loss immediately whether the exchange has commercial substance or not.


5555

Summary of Gain and Loss Recognition on Exchanges of Nonmonetary Assets Lacks Commercial Substance




5656



Companies should use:

the fair value of the asset to establish its value on the books and

should recognize contributions received as revenues in the period received.

Accounting for Contributions

5757

Costs Subsequent to AcquisitionCosts Subsequent to Acquisition

LO 6 Describe the accounting treatment for costs subsequent to acquisition.LO 6 Describe the accounting treatment for costs subsequent to acquisition.

In general, costs incurred to achieve greater future benefits should be capitalized, whereas expenditures that simply maintain a given level of services should be expensed.

To capitalize costs, one of three conditions must be present:

Useful life of the asset must be increased.

Quantity of units produced from asset must be increased.

Quality of units produced must be enhanced.

5858



Additions

Improvements and Replacements

Rearrangement and Reinstallation

Repairs

Major Types of Expenditures

5959



Illustration 10-21Illustration 10-21Summary

6060

Disposition of PP&EDisposition of PP&E

LO 7 Describe the accounting treatment for the LO 7 Describe the accounting treatment for the disposal of property, plant, and equipment.disposal of property, plant, and equipment.

A company may retire plant assets voluntarily or dispose of them by sale, exchange, involuntary conversion, or abandonment.

Depreciation must be taken up to the date of disposition.

6161

Disposition of PP&EDisposition of PP&E


Sale of Plant AssetsBE10-14: Ottawa Corporation owns machinery that cost $20,000 when purchased on July 1, 2007. 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, 2010. The machinery is sold on September 1, 2011, for $10,500. Prepare journal entries to

a) update depreciation for 2011 and b) record the sale.

6262

a) Depreciation for 2011

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


b) Record the sale

Cash 10,500Accumulated depreciation 10,000

Machinery 20,000Gain on sale 500

Disposition of Plant AssetsDisposition of Plant Assets

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

**

6363

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



6464

If a company scraps or abandons an asset without any cash recovery, it recognizes a loss equal to the asset’s book value.

If scrap value exists, the gain or loss that occurs is the difference between the asset’s scrap value and its book value.

If an asset still can be used even though it is fully depreciated, it may be kept on the books at historical cost less depreciation.

Miscellaneous Problems



6565







acquisition and disposition of property, plant, and equ

Business

costs subsequent

overhead costs

acquisitionacquisition

initial valuation of

disposition of property

fees costs of grading

disposal of property

purchase priceclosing