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Property, Plant, and Property, Plant, and Equipment: Equipment:

Acquisition and Acquisition and DisposalDisposal

Chapter9

An electronic presentation by Douglas Cloud

Pepperdine University

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1. Identify the characteristics of property, plant, and equipment.

2. Record the acquisition of property, plant, and equipment.

3. Determine the cost of assets acquired by the exchange of other assets.

4. Compute the cost of a self-constructed asset, including interest capitalization.

Objectives

ContinuedContinued

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5. Record costs subsequent to acquisition. 6. Record the disposal of property, plant, and

equipment. 7. Understand the disclosures of property,

plant, and equipment. 8. Explain the accounting for oil and gas

properties (Appendix).

Objectives

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Characteristics of Property, Plant, and Equipment

1. The asset must be held for use and not for investment.

2. The asset must have an expected life of more than one year.

3. The asset must be tangible in nature.

To be included in the property, plant, and equipment category, an asset must have three characteristics:

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Acquisition of Property, Plant, and Equipment

Determination of Cost

Devon Company purchases a machine with a contract price of $100,000 on terms of 2/10, n/30. The company does not take the cash discount and incurs transportation costs of $2,500, as well as

installation and testing costs of $3,000. Sales taxes total $5,000 on the purchase. During installation,

uninsured damages of $500 are incurred.

What is the cost of What is the cost of the machine?the machine?

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Acquisition of Property, Plant, and Equipment

Determination of Cost

Contract price $100,000 Discount not taken (2,000 )Transportation cost 2,500 Installation and testing 3,000 Sales tax 5,000 Cost of machine $108,500

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Acquisition of Property, Plant, and Equipment

Machine 108,500Repair Expense 500Discounts Lost 2,000 Cash 111,000

The company does not include the $500 damage as part of the cost of the

machinery because it was not a necessary cost.

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• Contract price• Costs of closing the

transaction, obtaining the title, options, legal fees, title search, insurance, past due taxes

Acquisition of Property, Plant, and Equipment

Cost of Land

• Cost of surveys• Clearing and grading

property to get it ready for its intended use

• Razing old buildings (net of salvage)

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• Landscaping• Streets• Sidewalks• Sewers

Acquisition of Property, Plant, and Equipment

Cost of Land Improvements

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Contract price Remodeling and reconditioning Excavating for the specific

building Architectural and building

permit costs Capitalized interest Certain unanticipated costs

Acquisition of Property, Plant, and Equipment

Cost of Buildings

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Acquisition of Property, Plant, and Equipment

Lump-Sum Purchases

A company pays $120,000 for land and a building. The land and building are appraised

at $50,000 and $75,000, respectively.

Appraisal Relative Fair Value Value x Total Cost = Allocated Cost

Land $ 50,000 $50,000/$125,000 x $120,000 = $ 48,000Building 75,000 $75,000/$125,000 x $120,000 = 72,000Total $125,000 $120,000

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Acquisition of Property, Plant, and Equipment

Deferred Payments

A company purchases equipment by issuing a $10,000 non-interest-bearing 5-year note. A $2,000 payment will be made at the end of each year. The

market rate for obligations of this type is 12%.

Equipment 7,210Discount on Notes Payable 2,790 Notes Payable 10,000

($2,000 x 3.604776)

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Acquisition of Property, Plant, and Equipment

Assets Acquired by Donation

The City of Julesberg (a governmental unit) donates land worth $20,000 to the

Klemme Company.

Land 20,000 Donated Capital 20,000

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Assets Acquired by Exchange of Other Assets

The general exchange principle is that the cost of a nonmonetary asset

acquired in exchange for another nonmonetary asset is the fair value of

the asset surrendered.

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Assets Acquired by Exchange of Other Assets

Dissimilar

Company A Company B

Cost $100,000Accum. depr. 54,000Fair value 40,000

Cost $60,000Accum. depr. 32,000Fair value 40,000

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Assets Acquired by Exchange of Other Assets

Dissimilar

Company A

Cost $100,000Accum. depr. 54,000Fair value 40,000

Equipment 40,000Accum. depr. 54,000Loss 6,000 Building 100,000

Cost $40,000No boot involved

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Assets Acquired by Exchange of Other Assets

Dissimilar

Company B

Cost $60,000Accum. Depr. 32,000Fair value 40,000

Building 40,000Accum. Depr. 32,000 Equipment 60,000 Gain 12,000 Cost $40,000

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Assets Acquired by Exchange of Other Assets

Dissimilar with Boot

Company A Company B

Cost $100,000Accum. depr. 54,000Fair value 40,000Cash received 5,000

Cost $60,000Accum. depr. 32,000Fair value 35,000Cash paid 5,000

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Assets Acquired by Exchange of Other Assets

Dissimilar with Boot

Company A

Cost $100,000Accum. depr. 54,000Fair value 40,000Cash received 5,000

Equipment 35,000Accum. depr. 54,000Cash 5,000Loss 6,000 Building 100,000Cost $35,000

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Assets Acquired by Exchange of Other Assets

Dissimilar with Boot

Company B

Cost $60,000Accum. Depr. 32,000Fair value 35,000Cash paid 5,000

Building 40,000Accum. Depr. 32,000 Equipment 60,000 Cash 5,000 Gain 7,000 Cost $40,000

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Nonmonetary Productive Asset Exchanges

Are Similar Productive

Assets Used in the Same Line

of Business Being

Exchange?

Yes

No Account for Assets at Fair Value. Recognize

Gains and Losses

Is the Boot 25% of the Total Value of the

Exchange?

Yes

No

Next slide

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Nonmonetary Productive Asset Exchanges

Is Boot Received?

YesIs FV BV?

Yes

Cost = FV - Boot Received

Loss = FV - BV

No Cost = BV + Gain -

Boot ReceivedGain = Boot Boot + FV

(FV - BV)ContinuedContinued

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Nonmonetary Productive Asset Exchanges

Is Boot Received?

No

Is FV BV?

Is Boot Paid?

No

YesCost = FVLoss = FV - BV

No Cost = BVGain Not Recognized

Is FV BV? Cost = FV

+ Boot Paid

Loss = FV - BV

Yes

Cost = BV + Boot Paid

Gain Not Recognized

No

Yes

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Exchange of Similar Assets

Company A Company B

Cost $100,000Accum. depr. 54,000Fair value 40,000Cash received 5,000

Cost $60,000Accum. depr. 32,000Fair value 35,000Cash paid 5,000

Boot Paid by Company Incurring a Gain

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Exchange of Similar Assets

Boot Paid by Company Incurring a Gain

Company A

Cost $100,000Accum. depr. 54,000Fair value 40,000Cash received 5,000

Equipment 35,000Accum. Depr. 54,000Loss 6,000Cash 5,000 Equipment 100,000 Cost = $35,000

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Exchange of Similar Assets

Company B

Cost $60,000Accum. depr. 32,000Fair value 35,000Cash paid 5,000

Boot Paid by Company Incurring a Gain

Equipment 33,000Accum. Depr. 32,000 Equipment 60,000 Cash 5,000 $28,000 + $5,000

Cost = $33,000

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Exchange of Similar Assets

Boot Received by Company Incurring a Gain

Company A Company B

Cost $100,000Accum. depr. 80,000Fair value 30,000Cash received 3,000

Cost $60,000Accum. depr. 32,000Fair value 27,000Cash paid 3,000

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Exchange of Similar Assets

Equipment 18,000Accum. Depr. 80,000Cash 3,000 Equipment 100,000 Gain 1,000

Company A

Cost $100,000Accum. depr. 80,000Fair value 30,000Cash received 3,000

Click on button to see how gain was calculated.

Boot Received by Company Incurring a Gain

Cost = $18,000

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Boot Received by Company Incurring a Gain

Company B

Cost $60,000Accum. depr. 32,000Fair value 27,000Cash paid 3,000

Exchange of Similar Assets

Equipment 30,000Accum. Depr. 32,000Loss 1,000 Equipment 60,000 Cash 3,000 Cost = $30,000

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Summary of Productive Asset Exchanges

1. Are dissimilar productive assets exchanged?2. Does the boot equal or exceed 25% of the value

of a similar asset exchange?3. For exchanges of similar productive assets, is

there a loss?4. For exchange of similar productive assets

between two dealers or between two nondealers in which there is a gain, is cash received or paid?

Four Issues

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Self-ConstructionSelf-Construction

The cost of materials, labor, and overhead used in the self-construction of property, plant, and equipment intended for

a firm’s production process are added to the

cost of the asset.

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Capitalization of InterestCapitalization of Interest

A company is required to capitalize interest on assets that are constructed for its own use or constructed as

discrete products.

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Capitalization of InterestCapitalization of InterestInterest cannot be capitalized for the following types of assets:1. Inventories that are routinely manufactured or

otherwise produced in large quantities on a repetitive basis.

2. Assets that are in use or ready for their intended use.

3. Assets that are not being used in the earning activities of the company and are not undergoing the activities necessary to get them ready for use.

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Capitalization of Interest

Cia Company started a building project on January 1, 2004 and completed it on December 31, 2005.

($0 + $1,000,000) ÷ 2

Capitalized Interest, 2004

$500,000 x 10% = $50,000

During 2004, $1 million was spent on the project and in 2005, $2.9 million was spent.

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Capitalization of Interest

Capitalized Interest, 2005

$1,500,000 x 10% = $150,000$1,000,000 x 12.6% = $126,000

$276,000

(12% x $4,000,000/$10,000,000) + (13% x $6,000,000/$10,000,000)

During 2004, $1 million was spent on the project and in 2005, $2.9 million was spent.

Amounts borrowed and outstanding: $1.5 million at 10% was borrowed specifically for the project.

Amounts borrowed for other purposes: $4 million at 12% and $6 million at 13%

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Fixed Overhead Costs

There are three alternatives for a company to include fixed overhead costs in the cost of a self-constructed asset.

1. Allocate a portion of total fixed overhead to the self-constructed asset.

2. Include only incremental fixed overhead in the cost of the self-constructed asset.

3. Include no fixed overhead in the cost of the self-constructed asset.

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Costs Subsequent to Acquisition

• Extending the life of the asset.• Improving the productivity.• Producing the same product at

lower cost.• Increasing the quality of the

product.

The future economic benefits of a productive asset or product can be increased by--

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Additions

The cost of an addition represents a new asset and

therefore is capitalized.

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Improvements and Replacements

A company decides to replace its oil furnace with a gas furnace. The oil furnace is carried on the books

at a cost of $50,000 with an accumulated depreciation of $30,000. The scrap value of the old furnace is

$5,000, and the new furnace costs $70,000.

Furnace 70,000Accumulated Depreciation: Furnace 30,000Loss on Disposal of Furnace 15,000 Furnace 50,000 Cash 65,000

Substitution Method

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Improvements and Replacements

A capital expenditure of $50,000 is incurred in replacing a roof on a factory building.

Accumulated Depreciation 50,000 Cash 50,000

Reduce Accumulated Depreciation

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Improvements and Replacements

A capital expenditure of $50,000 is incurred to enlarge a factory.

Factory 50,000 Cash 50,000

Increase the Asset Account

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Disposal of Property, Plant,and Equipment

A company has a machine that originally cost $10,000, has accumulated depreciation of $8,000 at

the beginning of the current year, and is being depreciation at $1,000 per year. On December 30,

the company sells the machine for $600.

Depreciation 1,000 Accumulated Depreciation 1,000

To bring depreciation to point of sale.

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Disposal of Property, Plant,and Equipment

A company has a machine that originally cost $10,000, has accumulated depreciation of $8,000 at

the beginning of the current year, and is being depreciation at $1,000 per year. On December 30,

the company sells the machine for $600.

Cash 600Accumulated Depreciation 9,000Loss on Disposal 400 Machine 10,000

To record disposal of machine for $600.

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Disclosure of Property,Plant, and Equipment

APB Opinion No. 12 requires a company to

disclose the balances of its major classes of depreciable assets by nature or function.

LandBuilding and

leasehold improvements

Machinery and equipment

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Oil and Gas Properties

Successful-efforts

approach?Full-cost method?

Click here to skip Appendix material

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Oil and Gas Properties

Once a company selects a method, a company must follow specific SEC accounting rules.

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Chapter9

The EndThe End

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Click on button to return to Slide 28

Gain = ($30,000 - $20,000) = $1,000$3,000

$3,000 + $27,000

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