CHAPTER 10Property, Plant, and Equipmentand Intangible Assets: Acquisition and Disposition

Learning ObjectivesLO10-1 Identify the various costs included in the initial cost of property, plant, and equipment, natural resources, and intangible assets. (Exclude: Asset Retirement Obligations)LO10-2 Determine the initial cost of individual property, plant, and equipment and intangible assets acquired as a group for a lump-sum purchase price.LO10-3 Determine the initial cost of property, plant, and equipment and intangible assets acquired in exchange for a deferred payment contract.LO10-4 Determine the initial cost of property, plant, and equipment and intangible assets acquired in exchange for equity securities, or through donation.LO10-5 Calculate the fixed-asset turnover ratio used by analysts to measure how effectively managers use property, plant, and equipment. (SELF-STUDY)LO10-6 Explain how to account for dispositions and exchanges for other nonmonetary assets (Not Covered)LO10-7 Identify the items included in the cost of a self-constructed asset and determine the amount of capitalized interest.LO10-8 Explain the difference in the accounting treatment of costs incurred to purchase intangible assets versus the costs incurred to internally develop intangible assets (R&D).LO10-9 Discuss the primary differences between U.S. GAAP and IFRS with respect to the acquisition and disposition of property, plant, and equipment and intangible assets (SELF-STUDY)

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

Types of Assets

Expected to Benefit Future PeriodsExpected to Benefit Future PeriodsExpected 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 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 Back Taxes Removing old buildings

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Costs to be CapitalizedLand ImprovementsSeparately identifiable

costs of Driveways Parking lots Fencing Landscaping Private roads

Buildings Purchase price Attorney’s fees Commissions Reconditioning

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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.

Costs to be CapitalizedIntangible Assets Patents Copyrights Trademarks Franchises Goodwill

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An exclusive right recognized by law and granted by the U.S. 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. Torch’s cost for the new patent is $3,000. The $30,000 R & D cost is expensed as The $30,000 R & D cost is expensed as

incurred. 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 (SELF-STUDY)

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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.

FranchiseSelf-study

Intangible Assets

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Occurs when onecompany buys

another company.

The amount by which theconsideration exchanged exceeds

the fair value of net identifiable assets acquired.

Only purchased goodwill is an

intangible asset.

Goodwill

Intangible Assets -Goodwill

Goodwill is Goodwill is not not

amortized.amortized.

A unique intangible asset in that its cost cannot be directly associated with any specifically identifiable right or asset of an entity and is not separable from the company as a whole.Represents the unique value of the company as a whole over and above all identifiable tangible and intangible assets.

Assets acquired as a group for a lump-sum purchase price

The purchase price is allocated in proportion to the relative fair values of the assets acquired.  The Smyrna Hand & Edge Tools Company purchased an existing factory for a single sum of $2,000,000. The price included title to the land, the factory building, and the manufacturing equipment in the building, a patent on a process the equipment uses, and inventories of raw materials.

An independent appraisal estimated the fair values of the assets \(if purchased separately) at $330,000 for the land, $550,000 for the building, $660,000 for the equipment, $440,000 for the patent and $220,000 for the inventories.  

The lump-sum purchase price of $2,000,000 is allocated to the separate assets as follows:

Fair valuesLand $ 330,000 15% <= 330,000 / 2,200,000Building 550,000 25Equipment 660,000 30Patent 440,000 20Inventories 220,000 10 Total $2,200,000 100%

Journal Entry:Land (15% x $2,000,000) 300,000Building (25% x $2,000,000) 500,000Equipment (30% x $2,000,000) 600,000Patent (20% x $2,000,000) 400,000Inventories (10% x $2,000,000) 200,000 Cash 2,000,000

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Noncash Acquisitions Issuance of equity securities (Ex 11) Deferred payments (Not Covered) Donated assets Exchanges (Not Covered)

Issuance of equity securities (Ex 11) Deferred payments (Not Covered) Donated assets Exchanges (Not Covered)

The asset acquired is recorded atthe fair value of the consideration

givenor

the fair value of the asset acquired,whichever is more clearly evident.

The asset acquired is recorded atthe fair value of the consideration

givenor

the fair value of the asset acquired,whichever is more clearly evident.

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Issuance of Equity Securities (Exercise 11) 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 Assets (Exercise 11) On 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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Exchanges (NOT COVERED)General Valuation Principle: 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 or loss is recognized.

10-16Exchange Lacks Commercial

Substance(NOT COVERED)

When 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.

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.

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Self-Constructed Assets (Covered) When self-constructing an asset, two accounting issues must be

addressed: Overhead allocation to the self-constructed asset.

Incremental overhead only (Hiring of New Construction Supervisor);

Full-cost approach (All overhead costs are allocated based on the relative amount of a chosen COST DRIVER (example: Labor Hours))

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 (Covered)

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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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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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INTEREST CAPITALIZATION ILLUSTRATION

On January 1, 2013, the Mills Conveying Equipment Company began construction of a building to be used as its office headquarters. The building was completed on June 30, 2014. Expenditures on the project, mainly payments to subcontractors, were as follows:

  January 3, 2013 $ 500,000

March 31, 2013 400,000

September 30, 2013 600,000

Accumulated expenditures at Dec. 31, $1,500,0002013 (before interest capitalization)  

January 31, 2014 600,000

April 30, 2014 300,000

On January 2, 2013, the company obtained a $1 million construction loan with an 8% interest rate. The loan was outstanding during the entire construction period.

The company’s other interest-bearing debt included two long-term notes of $2,000,000 and $4,000,000 with interest rates of 6% and 12%, respectively. Both notes were outstanding during the entire construction period.

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INTEREST CAPITALIZATION ILLUSTRATION2013: Step 1: Determine the average accumulated expenditures.  January 3, 2013 $500,000 x 12/12 = $500,000 March 31, 2013 400,000 x 9/12 = 300,000 Sept. 30, 2013 600,000 x 3/12 = 150,000

Average accumulated expenditures for 2013 $950,000 

Step 2: Calculate the amount of interest to be capitalized. Use the construction loan rate because average accumulated expenditures is less than the specific construction loan rate. This is known as the specific interest method.  Interest capitalized for 2013 = $950,000 x 8% = $76,000Step 3: Compare calculated interest with actual interest incurred.

Actual CalculatedLoans Rate Interest Interest

$1,000,000 x 8% = $ 80,000 2,000,000 x 6% = 120,000 4,000,000 x 12% = 480,000

$680,000 $76,000 USE THIS RATE

 

10-23INTEREST CAPITALIZATION ILLUSTRATION

2013:The interest of $76,000 is added to the cost of the building, bringing accumulated expenditures at December 31, 2013 to $1,576,000 = ($1,500,000 + $76,000).

The remaining interest cost incurred but not capitalized is expensed.

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2014:

Step 1: Determine the average accumulated expenditures:

  January 1, 2014 $1,576,000 x 6/6 = $1,576,000 January 31, 2014 600,000 x 5/6 = 500,000 April 30, 2014300,000 x 2/6 = 100,000 Average accumulated expenditures for 2014 $2,176,000

Step 2: Calculate the amount of interest to be capitalized. The weighted-average interest rate on all other debt is applied to the excess of average accumulated expenditures over specific construction borrowings. Loans Rate Interest $2,000,000 x 6% = $120,000 4,000,000 x 12% = 480,000 $6,000,000 $600,000  Weighted-average rate: = 10% <= 600,000 / 6,000,000

Interest capitalized for 2014:

Average Accumulated Annual Fraction = Interest CostExpenditures Rate of Year

AAE 2014 $2,176,000 Specific Borrowing 1,000,000 8% 6/12 = $40,000 Excess 1,176,000 10% 6/12 = 58,800 Capitalized Interest $98,800

10-26 INTEREST CAPITALIZATION ILLUSTRATION

Step 3: Compare calculated interest with actual interest incurred.

Actual Calculated

Loans Rate Interest Interest

$1,000,000 x 8% x 6/12 =$ 40,000

2,000,000 x 6% x 6/12 = 60,000

4,000,000 x 12% x 6/12 = 240,000

$340,000 $98,800

Use lower amount

For the first six months of 2014, $98,800 interest would be capitalized, bringing the total capitalized cost of the building to $2,574,800 = ($2,476,000 + 98,800), and $241,200 =($340,000 - 98,800) in interest would be expensed

Exercise 25

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Research and Development (R&D) -Covered

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 . . .

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

2. In general, costs incurred before the start of commercial production are all expensed as 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 . . .

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

2. In general, costs incurred before the start of commercial production are all expensed as R&D.

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.

10-28Research and Development (R&D)

| | | | | |

Start of Start of Sale ofR&D Commercial ProductActivity Production or Process

Examples of R&D Costs: | Examples of Non-R&D Costs:|

•Laboratory research aimed at | • Engineering follow-through discovery of new knowledge | in an early phase of commercial

| production|

Searching for applications of | • Quality control during commercialnew research findings or | production including routine other knowledge | testing of products

|•Design, construction, and | • Routine ongoing efforts to testing of preproduction | refine, enrich, or otherwiseprototypes and models | improve on the qualities of an

| existing product|

•Modification of the formulation | • Adaptation of an existing or design of a product or process | capability to a particular

| requirement or customer’s need as| part of a continuing commercial| activity

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Research and Development (R&D)

Exercise 26Exercise 27

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Start ofR&D

Activity

TechnologicalFeasibility

Date ofProductRelease

Sale of Product

CostsExpensedas R&D

CostsCapitalized

Operating 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 (Covered)

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Software Development Costs (Covered)

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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End of Chapter 10