chapter 10-1. chapter 10-2 c h a p t e r 10 acquisition and disposition of property, plant, and...

Chapter 10-1

Chapter 10-2

C H A P T E R C H A P T E R 1010

ACQUISITION AND DISPOSITION OF ACQUISITION AND DISPOSITION OF

PROPERTY, PLANT, AND EQUIPMENTPROPERTY, PLANT, AND EQUIPMENT

Intermediate Accounting13th Edition

Kieso, Weygandt, and Warfield

Chapter 10-3

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

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

3.3. Describe the accounting problems associated with self-constructed Describe the accounting problems associated with self-constructed assets.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 property, Describe the accounting treatment for the disposal of property, plant, and equipment.plant, and equipment.

Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives

Chapter 10-4

AcquisitionAcquisition

Acquisition costs: Acquisition costs: Land, buildings, Land, buildings, equipmentequipment

Self-constructed Self-constructed assetsassets

Interest costsInterest costs

ObservationsObservations

ValuationValuation Cost Subsequent Cost Subsequent to Acquisitionto Acquisition DispositionsDispositions

Cash discountsCash discounts

Deferred Deferred contractscontracts

Lump-sum Lump-sum purchasespurchases

Stock issuanceStock issuance

Nonmonetary Nonmonetary exchangesexchanges

ContributionsContributions

Other valuation Other valuation methodsmethods

SaleSale

Involuntary Involuntary conversionconversion

Miscellaneous Miscellaneous problemsproblems

AdditionsAdditions

Improvements Improvements and and replacementsreplacements

Rearrangement Rearrangement and reinstallationand reinstallation

RepairsRepairs

SummarySummary

Acquisition and Disposition of Acquisition and Disposition of Property, Plant, and EquipmentProperty, Plant, and Equipment

Acquisition and Disposition of Acquisition and Disposition of Property, Plant, and EquipmentProperty, Plant, and Equipment

Chapter 10-5

“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 EquipmentProperty, Plant, and EquipmentProperty, Plant, and Equipment

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

Chapter 10-6

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&EAcquisition of PP&EAcquisition of PP&E

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

APB Opinion No. 6 states, “property, plant, and equipment should not be

written up to reflect appraisal, market, or current values which are

above cost.”

APB Opinion No. 6 states, “property, plant, and equipment should not be

written up to reflect appraisal, market, or current values which are

above cost.”

Chapter 10-7

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.

Chapter 10-8

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.


Chapter 10-9

Include all costs incurred in acquiring the equipment and preparing it for use.


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.


Chapter 10-10

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:


(a) Money borrowed to pay building contractor

(b) Payment for construction from note proceeds

(c) Cost of land fill and clearing

(d) Delinquent real estate taxes on property assumed

(e) Premium on 6-month insurance policy during construction

(f) Refund of 1-month insurance premium because construction completed early

ClassificationClassification

Notes Notes PayablePayableBuildingBuilding

LandLand

LandLand

BuildingBuilding

(Building)(Building)


Chapter 10-11

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

(l) Proceeds from salvage of demolished building

(m) Cost of parking lots and driveways

(n) Cost of trees and shrubbery (permanent)

Costs of:Costs of:

BuildingBuilding


LandLand

LandLand

Land Land ImprovementsImprovements

LandLand

(Land)(Land)

Land Land ImprovementsImprovementsLandLand

Chapter 10-12

Self-Constructed Assets



(1) Materials and direct labor

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

Chapter 10-13

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 LO 4 Describe the accounting problems associated with interest capitalization.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 all costs of fundsof funds

GAAPGAAP

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

Chapter 10-14

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



Chapter 10-15

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



Chapter 10-16

Capitalization Period



Begins when:

1. Expenditures for the asset have been made.

2. Activities for readying the asset are in progress .

3. Interest costs are being incurred.

Ends when:

The asset is substantially complete and ready for use.

Chapter 10-17

Amount to Capitalize



Capitalize the lesser of:

1. Actual interest costs

2. Avoidable interest - the amount of interest

that could have been avoided if expenditures

for the asset had not been made.

Chapter 10-18

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:

J anuary 1, 2011 $100,000

April 30, 2011 150,000

November 1, 2011 300,000

December 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

Chapter 10-19

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.

Chapter 10-20



WeightedAverage

Actual Capitalization Accumulated Date Expenditures Period Expenditures

J an. 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.

Chapter 10-21



Step 4 - Compute the Actual and Avoidable Interest. Selecting Appropriate Interest Rate:

1. 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.

2. 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.

Chapter 10-22



Accumulated I nterest Avoidable

Expenditures Rate I nterest

200,000$ 12% 24,000$

50,000 12.5% 6,250

250,000$ 30,250$

Step 4 - Compute the Actual and Avoidable Interest.

Avoidable Avoidable InterestInterest

I nterest Actual

Debt Rate I nterest

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%

Chapter 10-23

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 expense30,250

Chapter 10-24



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.

Chapter 10-25



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.

Chapter 10-26



Compute the weighted-average accumulated expenditures during 2010.

Illustration 10-4Illustration 10-4

Solution on notes page

Chapter 10-27



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

Solution on notes page

Chapter 10-28



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.

Chapter 10-29



Shalla records the following journal entries during 2010:January 1 Land 100,000

Building (or CIP) 110,000Cash 210,000

March 1 Building 300,000Cash 300,000

May 1 Building 540,000Cash 540,000

December 31Building 450,000Cash 450,000

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

Cash 239,500

Chapter 10-30



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.



Chapter 10-31

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&EValuation of PP&EValuation of PP&E

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

Chapter 10-32

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.



Chapter 10-33



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.

Chapter 10-34



Accounting for Exchanges

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

Illustration 10-Illustration 10-1010

Chapter 10-35



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

Chapter 10-36



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.


Chapter 10-37

Equipment 13,000

Accumulated Depreciation—Equipment 4,000

Loss on Disposal of Equipment 2,000

Equipment

12,000

Cash

7,000



Illustration: Information Processing records this transaction as follows:

Illustration 10-Illustration 10-1212Loss on

Disposal

Chapter 10-38



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.

Chapter 10-39



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. Illustration 10-Illustration 10-

1313

Chapter 10-40

Semi-truck 60,000

Accumulated Depreciation—Trucks 22,000

Trucks 64,000

Gain on disposal 7,000

Cash 11,000



Illustration: Interstate records the exchange transaction as follows:


Gain on Disposa

l

Chapter 10-41




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.

Chapter 10-42

Semi-truck 53,000

Accumulated Depreciation—Trucks 22,000

Trucks 64,000

Cash 11,000



Illustration: Interstate records the exchange transaction as follows:


Chapter 10-43




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: Illustration 10-Illustration 10-1616

Chapter 10-44



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.


Chapter 10-45



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

Chapter 10-46



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

1919

Cash 10,000

Machine 54,000

Accumulated Depreciation—Machine 50,000

Machine 110,000

Gain on disposal of machine4,000

Chapter 10-47

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.


Chapter 10-48

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.


Chapter 10-49

Has Commercial Substance


Arruza:Equipment 12,500Cash

3,000Accumulated depreciation 19,000

Equipment28,000

Gain on exchange6,500

LoBianco:Equipment 15,500Accumulated depreciation 10,000

Equipment28,000

Cash3,000

Loss on exchange 5,500


Chapter 10-50

Lacks Commercial Substance


Arruza:Equipment (12,500 – 5,242) 7,258Cash

3,000Accumulated depreciation 19,000

Equipment28,000

Gain on exchange1,258

Cash ReceivedCash Received

Cash Received + FMV of Assets Cash Received + FMV of Assets ReceivedReceived

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


Chapter 10-51

Lacks Commercial Substance


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

Equipment28,000

Cash3,000

Loss on exchange 5,500Companies recognize a loss immediately whether the exchange has commercial substance or not.


Chapter 10-52

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




Chapter 10-53



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

Chapter 10-54

Costs Subsequent to AcquisitionCosts Subsequent to AcquisitionCosts Subsequent to AcquisitionCosts Subsequent to Acquisition

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

Chapter 10-55



Additions

Improvements and Replacements

Rearrangement and Reinstallation

Repairs

Major Types of Expenditures

Chapter 10-56




Summary

Chapter 10-57

Disposition of PP&EDisposition of PP&EDisposition 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.

Chapter 10-58

Disposition of PP&EDisposition of PP&EDisposition of PP&EDisposition of PP&E


Sale of Plant Assets

BE10-14: 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.

Chapter 10-59

a) Depreciation for 2011

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

Accumulated depreciation1,600


b) Record the sale

Cash 10,500

Accumulated depreciation 10,000

Machinery20,000

Gain on sale500

Disposition of Plant AssetsDisposition of Plant AssetsDisposition of Plant AssetsDisposition of Plant Assets

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

**

Chapter 10-60

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



Chapter 10-61

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



Chapter 10-62

Copyright © 2009 John Wiley & Sons, Inc. All rights

reserved. Reproduction or translation of this work beyond

that permitted in Section 117 of the 1976 United States

Copyright Act without the express written permission of

the copyright owner is unlawful. Request for further

information should be addressed to the Permissions

Department, John Wiley & Sons, Inc. The purchaser may

make back-up copies for his/her own use only and not for

distribution or resale. The Publisher assumes no

responsibility for errors, omissions, or damages, caused by

the use of these programs or from the use of the

information contained herein.

CopyrightCopyrightCopyrightCopyright

chapter 10-1. chapter 10-2 c h a p t e r 10 acquisition and disposition of property, plant, and...

Documents