PowerPoint Authors:Susan Coomer Galbreath, Ph.D., CPACharles W. Caldwell, D.B.A., CMAJon A. Booker, Ph.D., CPA, CIACynthia J. Rooney, Ph.D., CPA

Property, Plant, and Equipmentand Intangible Assets: Acquisition

and Disposition

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McGraw-Hill/Irwin Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.

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Long-lived, Revenue-producing AssetsLong-lived, Revenue-producing Assets

Types of Assets

Expected to Benefit Future PeriodsExpected to Benefit Future Periods

General Rule for Cost CapitalizationThe initial cost of an asset includes the purchase price and all expenditures necessary to bring the asset to its desired

condition and location for use.

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Equipment• Net purchase price• Taxes• Transportation costs• Installation costs• Modification to building

necessary to install equipment

• Testing and trial runs

Costs to be CapitalizedLand (not depreciable)• Purchase price• Real estate commissions• Attorney’s fees• Title search• Title transfer fees• Title insurance premiums• Removing old buildings

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Land Improvements

Separately identifiable costs of• Driveways• Parking lots• Fencing• Landscaping• Private roads

Buildings• Purchase price• Attorney’s fees• Commissions• Reconditioning

Costs to be Capitalized

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Natural Resources• Acquisition costs• Exploration costs• Development costs• Restoration costs

The initial cost of an intangible asset includes the purchase

price and all other costs necessary to bring it to

condition and location for use, such as legal and filing fees.

Intangible Assets• Patents• Copyrights• Trademarks• Franchises• Goodwill

Costs to be Capitalized

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Asset Retirement Obligations

Recognize the restoration costsas a liability and a corresponding

increase in the related asset.

Recognize the restoration costsas a liability and a corresponding

increase in the related asset.

Record at fair value, usually thepresent value of future cash outflows associated with the

reclamation or restoration.

Record at fair value, usually thepresent value of future cash outflows associated with the

reclamation or restoration.

Often encountered with natural resource extraction when the land must berestored to a useable condition.

Often encountered with natural resource extraction when the land must berestored to a useable condition.

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Intangible Assets

Lack physicalsubstance.

Exclusive Rights.

IntangibleIntangibleAssetsAssets

IntangibleIntangibleAssetsAssets

Future benefits less certainthan tangible assets.

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• An exclusive right recognized by law and granted by the US Patent Office for 20 years.

• Holder has the right to use, manufacture, or sell the patented product or process without interference or infringement by others.

• R & D costs that lead to an internally developed patent are expensed in the period incurred.

Intangible Assets ─ Patents

Torch, Inc. has developed a new device. Research and development costs totaled $30,000. Patent registration costs consisted of $2,000 in attorney fees and $1,000 in federal registration fees. What is Torch’s patent cost?

Torch’s cost for the new patent is $3,000. The Torch’s cost for the new patent is $3,000. The $30,000 R & D cost is expensed as incurred. $30,000 R & D cost is expensed as incurred.

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Copyrights• A form of protection given

by law to authors of literary, musical, artistic, and similar works.

• Copyright owners have exclusive rights to print, reprint, copy, sell or distribute, perform and record the work.

• Generally, the legal life of a copyright is the life of the author plus 70 years.

Trademarks A symbol, design, or logo

associated with a business.

If internally developed, trademarks have no recorded asset cost.

If purchased, a trademark is recorded at cost.

Registered with U.S. Patent Office and renewable indefinitely in 10-year periods.

Intangible Assets

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Occurs when onecompany buys

another company.

The amount by which theconsideration exchanged exceeds

the fair value of net assets acquired.

Only purchased goodwill is an

intangible asset.

A contractual arrangement where the franchisor grants the franchisee exclusive rights to use the franchisor’s trademark within a certain

area for a specified period of time.

A contractual arrangement where the franchisor grants the franchisee exclusive rights to use the franchisor’s trademark within a certain

area for a specified period of time.

Goodwill

Franchise

Intangible Assets

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Eddy Company paid $1,000,000 to purchase all of Eddy Company paid $1,000,000 to purchase all of James Company’s assets and assumed James James Company’s assets and assumed James

Company’s liabilities of $200,000. James Company’s Company’s liabilities of $200,000. James Company’s assets were appraised at a fair value of $900,000. What assets were appraised at a fair value of $900,000. What amount of goodwill should Eddy company record as a amount of goodwill should Eddy company record as a

result of the purchase? result of the purchase?

Eddy Company paid $1,000,000 to purchase all of Eddy Company paid $1,000,000 to purchase all of James Company’s assets and assumed James James Company’s assets and assumed James

Company’s liabilities of $200,000. James Company’s Company’s liabilities of $200,000. James Company’s assets were appraised at a fair value of $900,000. What assets were appraised at a fair value of $900,000. What amount of goodwill should Eddy company record as a amount of goodwill should Eddy company record as a

result of the purchase? result of the purchase?

Goodwill

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Several assets are acquired for a single price that maySeveral assets are acquired for a single price that maybe lower than the sum of the individual asset fair values.be lower than the sum of the individual asset fair values.Several assets are acquired for a single price that maySeveral assets are acquired for a single price that may

be lower than the sum of the individual asset fair values.be lower than the sum of the individual asset fair values.

Lump-Sum Purchases

Asset 2Asset 2Asset 1 Asset 3

Allocation of the lump-sum price is basedon relative fair values of the individual assets.

Allocation of the lump-sum price is basedon relative fair values of the individual assets.

On May 13, we purchase land and building for $200,000 cash. The appraised value of the building is $162,500, and the land is appraised at $87,500. How much of the $200,000 purchase

price will be allocated to the building account?

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Appraised % of Purchase AssignedAsset Value Value Price Cost

(a) (b)* (c) (b × c)Land 87,500$ 35% 200,000$ 70,000$ Building 162,500 65% 200,000 130,000 Total 250,000$ 200,000$

* $87,500÷$250,000 = 35%

Lump-Sum Purchases

May 13:Land .......................................................... 70,000Building ………………….…….…………… 130,000

Cash……………………………..... 200,000To record lump-sum purchase of land and building.

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Noncash Acquisitions

• Issuance of equity securities• Deferred payments• Donated Assets• Exchanges

• Issuance of equity securities• Deferred payments• Donated Assets• Exchanges

The asset acquired is recorded atThe asset acquired is recorded at

the fair value of the consideration given

or

the fair value of the asset acquired,

whichever is more clearly evident.whichever is more clearly evident.

The asset acquired is recorded atThe asset acquired is recorded at

the fair value of the consideration given

or

the fair value of the asset acquired,

whichever is more clearly evident.whichever is more clearly evident.

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Deferred Payments

Note payableNote payable

Market interestrate

Market interestrate

Record asset atface value of noteRecord asset at

face value of note

Less than market rateor noninterest bearingLess than market rateor noninterest bearing

Record asset at presentvalue of future cash flows.Record asset at present

value of future cash flows.

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On January 2, 2011, Midwestern Corporation purchased equipment by signing a noninterest-bearing note requiring $50,000 to be paid on December 31, 2012. The prevailing

market rate of interest on notes of this nature is 10%. Prepare the required journal entries for Midwestern on January 2, 2011; December 31, 2011 (year-end), and

December 31, 2012 (year-end).

Face amount of note 50,000$ × PV of $1, n=2, i=10% 0.82645 = PV of note (rounded) 41,323$

Face amount of note 50,000$ × PV of $1, n=2, i=10% 0.82645 = PV of note (rounded) 41,323$

We do not know the cash equivalent price, so we must use the present value of the future cash payment.

Deferred Payments

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Deferred PaymentsJanuary 2, 2011:Equipment ........................................................... 41,323Discount on note payable ….….…….…………… 8,677

Note payable ………………………….... 50,000To record equipment acquisition.

December 31, 2011:Interest expense (10% of $41,323)...................... 4,132

Discount on note payable ……………… 4,132To record interest expense.

December 31, 2012:Interest expense (10% of ($41,323+$4,132)) ...... 4,545

Discount on note payable ……..……..… 4,545To record interest expense.

December 31, 2012Note payable ........................................................ 50,000

Cash ……..……………………………..… 50,000 To record payment of note.

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Issuance of Equity Securities• Asset acquired is recorded at the fair value of the asset

or the market value of the securities, whichever is more clearly evident.

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

• If the securities given are not actively traded, the fair value of the asset received, as determined by appraisal, may be more clearly evident than the fair value of the securities.

Donated AssetsOn occasion, companies acquire assets through

donation.The receiving company is required to record

• The donated asset at fair value.• Revenue equal to the fair value of the donated asset.

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Fixed-Asset Turnover RatioThis ratio measures how effectively a company manages its fixed assets to generate revenue.

Net sales Average fixed assets

Fixed assetturnoverratio

=

Gymboree generates $0.44 more in sales dollarsGymboree generates $0.44 more in sales dollarsfor each dollar invested in fixed assets.for each dollar invested in fixed assets.

Gymboree generates $0.44 more in sales dollarsGymboree generates $0.44 more in sales dollarsfor each dollar invested in fixed assets.for each dollar invested in fixed assets.

= 5.13$14,526($2,933 + $3,267)/2

= 4.69 $1,001

($204 + $186)/2

2009 2008 2009 2008Property, plant, and equipment (net) 2,933$ 3,267$ 204$ 186$ Net sales 14,526 1,001

GAP Gymboree2009 2008 2009 2008

Property, plant, and equipment (net) 2,933$ 3,267$ 204$ 186$ Net sales 14,526 1,001

GAP Gymboree

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Dispositions Update depreciation to date of disposal. Remove original cost of asset and accumulated

depreciation from the books. The difference between book value of the asset and the

amount received is recorded as a gain or loss.

On June 30, 2011, MeLo, Inc. sold equipment for $6,350 cash. The equipment was purchased on January 1, 2006 at a cost of $15,000. The equipment was depreciated using the straight-line method over an estimated ten-year life with zero

salvage value. MeLo last recorded depreciation on the equipment on December 31, 2010, its year-end.

Prepare the journal entries necessary torecord the disposition of this equipment.

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Update depreciation to date of sale.Dispositions

June 30, 2011:Depreciation expense ($15,000 ÷ 10 years) × ½) ....... 750

Accumulated depreciation ………………........ 750To update depreciation to date of sale.

Remove original asset cost and accumulated depreciation.

Record the gain or loss.

June 30, 2011:Accumulated depreciation ............................................ 8,250Cash ………………………….……………...................... 6,350Loss on sale …………………………………………….… 400

Equipment …………………………...............… 15,000To record sale of equipment.

($15,000 ÷ 10 years) × 5½) = $8,250

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ExchangesGeneral Valuation Principle (GVP): Cost of asset acquired is:

• fair value of asset given up plus cash paid or minus cash received or

• fair value of asset acquired, if it is more clearly evident

In the exchange of assets fair value is used except in rare situations in which the fair value cannot be determined or

the exchange lacks commercial substance.

When fair value cannot be determined or the exchange lacks commercial substance, the asset(s) acquired are

valued at the book value of the asset(s) given up, plus (or minus) any cash exchanged. No gain is recognized.

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Fair Value Not DeterminableMatrix, Inc. exchanged used equipment for newer

equipment. Due to the nature of the assets exchanged, Matrix could not determine the fair value of the asset given

up or received. The asset given up originally cost $600,000, and had an accumulated depreciation balance of $400,000 at the time of the exchange. Matrix exchanged

the asset and paid $100,000 cash.Let’s record this unusual transaction.

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Matrix, Inc.

The journal entry below shows the proper recording of the exchange.

Matrix, Inc.

The journal entry below shows the proper recording of the exchange.

Fair Value Not Determinable

Equipment ($200,000 + $100,000) ................. 300,000Accumulated depreciation ….……………........ 400,000

Equipment ……………………………. 600,000Cash …………………………............. 100,000

To record equipment acquired in exchange.

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Exchange Lacks Commercial SubstanceWhen exchanges are recorded at fair value, any gain or

loss is recognized for the difference between the fair value and book value of the asset(s) given-up. To preclude the

possibility of companies engaging in exchanges of appreciated assets solely to be able to recognize gains, fair value can only be used in legitimate exchanges that have

commercial substance.

A nonmonetary exchange is considered to have commercial substance if the company:

expects a change in future cash flows as a result of the exchange, and

that expected change is significant relative to the fair value of the assets exchanged.

A nonmonetary exchange is considered to have commercial substance if the company:

expects a change in future cash flows as a result of the exchange, and

that expected change is significant relative to the fair value of the assets exchanged.

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ExchangesMatrix, Inc. exchanged new equipment and $10,000 cash

for equipment owned by Float, Inc.

Below is information about the asset exchanged by Matrix. Record the transaction assuming the exchange has

commercial substance.

Gain = Fair Value – Book ValueGain = $205,000 – $200,000 = $5,000

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Exchanges

Record the same transaction assuming the exchange lacks commercial substance.

Equipment ............................................... 215,000Accumulated depreciation………............. 300,000

Equipment ……………………… 500,000Cash ……………………………. 10,000Gain on exchange …………….. 5,000

To record the exchange of equipment.

$205,000 fair value + $10,000 cash

Equipment ............................................... 210,000Accumulated depreciation………............. 300,000

Equipment ……………………… 500,000Cash …………………………….. 10,000

To record the exchange of equipment.

$200,000 book value + $10,000 cash

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Self-Constructed Assets When self-constructing an asset, two accounting issues must

be addressed: overhead allocation to the self-constructed asset.

• incremental overhead only

• full-cost approach proper treatment of interest incurred during construction

Interest that could have been avoided if the asset were not constructed and the money used to retire

debt.

Asset constructed: For a company’s own use.

As a discrete project for sale or lease.

Under certain conditions, interest incurred on qualifying assets is capitalized.

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Capitalization begins when: • construction begins• interest is incurred, and• qualifying expenses are incurred.

Capitalization ends when:• the asset is substantially complete and

ready for its intended use, or• when interest costs no longer are being

incurred.

Interest Capitalization

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Interest is capitalized based on Average Accumulated Expenditures (AAE).

Qualifying expenditures (construction labor, material, and overhead) weighted for the number of months outstanding

during the current accounting period.

If the qualifying asset is financed through a

specific new borrowing

. . . use the specific rate of the new borrowing as the capitalization rate.

If there is no specific new borrowing, and the

company has other debt

. . . use the weighted average cost of other debt as the capitalization rate.

Interest Capitalization

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Welling, Inc. is constructing a building for its own use. Construction activities started on May 1 and have continued

through Dec. 31. Welling made the following qualifying expenditures: May 1, $125,000; July 31, $160,000, Oct. 1,

$200,000; and Dec. 1, $300,000. Welling borrowed $1,000,000 on May 1, from Bub’s Bank for 10 years at 10 percent to

finance the construction. The loan is related to the construction project and the company uses the specific interest

method to compute the amount of interest to capitalize.

Average Accumulated ExpendituresFraction of

ConstructionDate Expenditure Period AAE5/1 125,000$ 8/8 125,000$

7/31 160,000 5/8 100,000 10/1 200,000 3/8 75,000 12/1 300,000 1/8 37,500

785,000$ 337,500$

Fraction ofConstruction

Date Expenditure Period AAE5/1 125,000$ 8/8 125,000$

7/31 160,000 5/8 100,000 10/1 200,000 3/8 75,000 12/1 300,000 1/8 37,500

785,000$ 337,500$

Interest Capitalization

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Since the $1,000,000 of specific borrowing is sufficient to cover the $337,500 of average accumulated expenditures

for the year, use the specific borrowing rate of 10 percent to determine the amount of interest to capitalize.

Interest = AAE × Specific Borrowing Rate × TimeInterest = $337,500 × 10% × 8/12 = $22,500

The loan, initiated on May 1, is outstanding for 8 months of the year.

Interest Capitalization

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If Welling had not borrowed specifically for this constructionproject, it would have used the weighted-average interestmethod. The weighted average interest rate on other debtwould have been used to compute the amount of interest to

capitalize. For example, if the weighted-average interestrate on other debt is 12 percent, the amount of interest

capitalized would be:

Interest = AAE × Weighted-average Rate × Time Interest = $337,500 × 12% × 8/12 = $27,000

If Welling had not borrowed specifically for this constructionproject, it would have used the weighted-average interestmethod. The weighted average interest rate on other debtwould have been used to compute the amount of interest to

capitalize. For example, if the weighted-average interestrate on other debt is 12 percent, the amount of interest

capitalized would be:

Interest = AAE × Weighted-average Rate × Time Interest = $337,500 × 12% × 8/12 = $27,000

Interest Capitalization

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If specific new borrowing had been insufficient to cover the average accumulated expenditures . . .

If specific new borrowing had been insufficient to cover the average accumulated expenditures . . .

Specificnew

borrowing

AAE. . . Capitalize this portion using the 10 percent specific borrowing rate.

Otherdebt

. . . Capitalize this portion using the 12 percent weighted- average cost of debt.

Interest Capitalization

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Research and Development (R&D)Research

• Planned search or critical investigation aimed at discovery of new knowledge . . .

Development• The translation of research findings or other knowledge

into a plan or design . . .

Most R&D costs are expensed as incurred. (Must be disclosed if material.)

Research• Planned search or critical investigation aimed at

discovery of new knowledge . . .

Development• The translation of research findings or other knowledge

into a plan or design . . .

Most R&D costs are expensed as incurred. (Must be disclosed if material.)

R&D costs incurred under contract for other companies are capitalized as inventory and carried forward into future years.

Costs of assets purchased for R&D purposes are expensed in the period unless they have alternative future uses.

R&D costs incurred under contract for other companies are capitalized as inventory and carried forward into future years.

Costs of assets purchased for R&D purposes are expensed in the period unless they have alternative future uses.

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Start ofR&D

Activity

TechnologicalFeasibility

Date ofProductRelease

Sale of Product

CostsExpensed

as R&DCosts

CapitalizedOperating

Costs

All costs incurred to establish the technological feasibility of a computer software product are treated as R&D and expensed as incurred.

Costs incurred after technological feasibility is established and before the software is available for release to customers are capitalized as an intangible asset.

All costs incurred to establish the technological feasibility of a computer software product are treated as R&D and expensed as incurred.

Costs incurred after technological feasibility is established and before the software is available for release to customers are capitalized as an intangible asset.

Software Development Costs

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Software Development Costs

• Amortization of capitalized computer software costs starts when the product begins to be marketed.

• Two methods, the percentage of revenue method and the straight-line method, are compared and the method producing the largest amount of amortization is used.

• Amortization of capitalized computer software costs starts when the product begins to be marketed.

• Two methods, the percentage of revenue method and the straight-line method, are compared and the method producing the largest amount of amortization is used.

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U.S. GAAP vs. IFRS

• Except for software development costs incurred after technological feasibility, all research and development expenditures are expensed in the period incurred.

• Direct costs to secure a patent are capitalized.

Research and Development Costs

• Research expenditures are expensed in the period incurred. Development expenditures that meet specified criteria are capitalized as an intangible asset.

• Direct costs to secure a patent are capitalized.

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U.S. GAAP vs. IFRS

• The percentage used to amortize software development costs is the greater of (1) the ratio of current revenues to current and anticipated revenues or (2) the straight-line percentage over the useful life of the software.

Software Development Costs

• The same approach is allowed, but not required.

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Appendix 10 ─ Oil and Gas Accounting

Two acceptable accounting alternativesTwo acceptable accounting alternatives

Successful effortsmethod

Successful effortsmethod

Full-costmethod

Full-costmethod

Exploration costs resultingin unsuccessful wells

(dry holes) are expensed.

Exploration costs resultingin unsuccessful wells

(dry holes) are expensed.

Exploration costs resultingin unsuccessful wellsmay be capitalized.

Exploration costs resultingin unsuccessful wellsmay be capitalized.

Political pressure prevented the FASB from requiringPolitical pressure prevented the FASB from requiringall companies to use the successful efforts method.all companies to use the successful efforts method.

Political pressure prevented the FASB from requiringPolitical pressure prevented the FASB from requiringall companies to use the successful efforts method.all companies to use the successful efforts method.

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The Shannon Oil Company incurred $2,000,000 in exploration costs for each of 10 oil wells in 2011. Eight of the 10 wells were dry holes. Prepare the journal entries to record the exploration costs under both of the acceptable methods.

The Shannon Oil Company incurred $2,000,000 in exploration costs for each of 10 oil wells in 2011. Eight of the 10 wells were dry holes. Prepare the journal entries to record the exploration costs under both of the acceptable methods.

Oil and Gas Accounting

Successful Efforts:Oil deposit ..................................... 4,000,000Exploration expense ……………… 16,000,000

Cash ………………………. 20,000,000

Full Cost:Oil deposit ..................................... 20,000,000

Cash ………………………. 20,000,000

End of Chapter 10