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10-1 Actively Used in Operations Tangible Property, Plant, Equipment & Natural Resources Tangible Property, Plant, Equipment & Natural Resources Intangible.

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Presentation on theme: "10-1 Actively Used in Operations Tangible Property, Plant, Equipment & Natural Resources Tangible Property, Plant, Equipment & Natural Resources Intangible."— Presentation transcript:

1 10-1 Actively Used in Operations Tangible Property, Plant, Equipment & Natural Resources Tangible Property, Plant, Equipment & Natural Resources Intangible No Physical Substance Intangible No Physical Substance Types of Operational Assets Expected to Benefit Future Periods

2 10-2 Costs to be Capitalized General Rule The initial cost of an operational asset includes the purchase price and all expenditures necessary to bring the asset to its desired condition and location for use.

3 10-3 Net purchase price Taxes Transportation costs Installation costs Modification to building necessary to install equipment Testing and trial runs Net purchase price Taxes Transportation costs Installation costs Modification to building necessary to install equipment Testing and trial runs Costs to be Capitalized Equipment Recurring & maintenance costs may not be capitalized

4 10-4 Brief Exercise 10-1 Beaverton Lumber purchased a milling machine for $35,000. In addition to the purchase price, Beaverton made the following expenditures: freight, $1,500; installation, $3,000; testing, $2,000; Annual personal property tax (not sales or use related) on the machine for the first year, $500. What is the initial cost of the machine?

5 10-5 Brief Exercise 10-1 Capitalized cost of the machine: Purchase price $35,000 Freight1,500 Installation3,000 Testing 2,000 Total cost $41,500 Note: Personal property taxes on the machine for the period after acquisition are not part of acquisition cost. They are expensed in the period incurred.

6 10-6 Land is not depreciable. Purchase price Real estate commissions Attorneys fees Title search Title transfer fees Title insurance premiums Removing old buildings Purchase price Real estate commissions Attorneys fees Title search Title transfer fees Title insurance premiums Removing old buildings Costs to be Capitalized Land

7 10-7 Separately identifiable costs of Driveways Parking lots Fencing Landscaping Private roads Separately identifiable costs of Driveways Parking lots Fencing Landscaping Private roads Costs to be Capitalized Land Improvements These will be depreciated

8 10-8 Purchase price Attorneys fees Commissions Reconditioning Purchase price Attorneys fees Commissions Reconditioning Costs to be Capitalized Buildings Long term leasehold improvements are also capitalized.

9 10-9 Brief Exercise 10-2 Fullerton Waste Management purchased land and a warehouse for $600,000. In addition to the purchase price, Fullerton made the following expenditures related to the acquisition: brokers commission, $30,000; title insurance, $3,000 miscellaneous closing costs, $6,000. The warehouse was immediately demolished at a cost of $18,000 in anticipation of the building of a new warehouse. Determine the amounts Fullerton should capitalize as the cost of the land and the building.

10 10-10 Brief Exercise 10-2 Capitalized cost of land: Purchase price $600,000 Brokers commission 30,000 Title insurance 3,000 Misc. closing costs 6,000 Demolition of old building 18,000 Total cost$657,000 All of the expenditures, including the costs to demolish the old building, are included in the initial cost of the land.

11 10-11 Several assets are acquired for a single, lump-sum price that may be lower than the sum of the individual asset prices. Lump-Sum Purchases Asset 2 Asset 1Asset 3 Allocation of the lump-sum price is based on relative values of the individual assets.

12 10-12 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 charged to the building account? 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 charged to the building account? Lump-Sum Purchases

13 10-13 The building will be apportioned $130,000 of the total purchase price of $200,000. The building will be apportioned $130,000 of the total purchase price of $200,000. Lump-Sum Purchases Prepare the journal entry to record the purchase.

14 10-14 Lump-Sum Purchases

15 10-15 Brief Exercise 10-3 Refer to the situation described in BE 10-2. Assume that Fullerton decides to use the warehouse rather than demolishing it. An independent appraisal estimates the market values of the land and warehouse at $420,000 and $280,000, respectively. Determine the amounts Fullerton should capitalize as the cost of the land and the building.

16 10-16 Brief Exercise 10-3 Cost of land and building: Purchase price $600,000 Brokers commission 30,000 Title insurance 3,000 Miscellaneous closing costs 6,000 Total cost $639,000 The total must be allocated to the land and building based on their relative market values:

17 10-17 Brief Exercise 10-3

18 10-18 Purchase price, exploration and development costs of: Timber Mineral deposits Oil and gas reserves Purchase price, exploration and development costs of: Timber Mineral deposits Oil and gas reserves Costs to be Capitalized Natural Resources

19 10-19 Asset Retirement Obligations Recognize as a liability and a corresponding increase in the related asset. Record at fair value, usually the present value of future cash outflows associated with the reclamation or restoration. Often encountered with natural resource extraction when the land must be restored to a useable condition.

20 10-20 BE 10-4 Smithson Mining operates a silver mine in Nevada. Acquisition, exploration, and development costs totaled $5.6 million. After the silver is extracted in approximately five years, Smithson is obligated to restore the land to its original condition, including constructing a wildlife preserve. The companys controller has provided the following three cash flow possibilities for the restoration costs: (1) $500,000, 20% probability; (2) $550,000, 45% probability; and (3) $650,000, 35% probability. The companys credit-adjusted, risk-free rate of interest is 6%. What is the initial cost of the silver mine?

21 10-21 Solution

22 10-22 BE 10-5 Refer to the situation described in BE 10-4. What is the carrying value of the asset retirement liability at the end of one year? Assuming that the actual restoration costs incurred after extraction is completed are $596,000, what amount of gain or loss will Smithson recognize on retirement of the liability?

23 10-23 Solution BE10-5 Or 429,675 x 1.06

24 10-24 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 at the fair value of the consideration given or the fair value of the asset acquired, whichever is more clearly evident. The 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.

25 10-25 Intangible Assets Lack physical substance. Future benefits less certain than tangible assets. Exclusive Rights. Usually acquired for operational use. Intangible Assets

26 10-26 Patents Copyrights Trademarks Franchises Goodwill Patents Copyrights Trademarks Franchises Goodwill Record at current cash equivalent cost, including purchase price, legal fees, and filing fees. Costs to be Capitalized Intangible Assets

27 10-27 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. 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. Patents

28 10-28 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 Torchs patent cost? 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 Torchs patent cost? Torchs cost for the new patent is $3,000. The $30,000 R & D cost is expensed as incurred. Patents

29 10-29 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. 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. Copyrights

30 10-30 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. 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. Trademarks

31 10-31 Right to sell products or provide services purchased by franchisee from franchisor. Franchises

32 10-32 Occurs when one company buys another company. The amount by which the purchase price exceeds the fair market value of net assets acquired. Only purchased goodwill is an intangible asset. Goodwill Generally, this represents the present value of future earnings

33 10-33 Eddy Company paid $1,000,000 to purchase all of James Companys assets and assumed James Companys liabilities of $200,000. James Companys assets were appraised at a fair value of $900,000. Goodwill

34 10-34 What amount of goodwill should be recorded on Eddy Company books? a.$100,000 b.$200,000 c.$300,000 d.$400,000 What amount of goodwill should be recorded on Eddy Company books? a.$100,000 b.$200,000 c.$300,000 d.$400,000 Goodwill

35 10-35 What amount of goodwill should be recorded on Eddy Company books? a.$100,000 b.$200,000 c.$300,000 d.$400,000 What amount of goodwill should be recorded on Eddy Company books? a.$100,000 b.$200,000 c.$300,000 d.$400,000 Goodwill

36 10-36 Goodwill - Brief Exercise 10-6 Pro-tech Software acquired all of the outstanding stock of Reliable Software for $14 million. The book value of Reliables net assets (assets minus liabilities) was $8.3 million. The fair values of Reliables assets and liabilities equaled their book values with the exception of certain intangible assets whose fair values exceeded book values by $2.5 million*. Calculate the amount paid for goodwill. Fair value of separately identified intangibles are excluded from goodwill.

37 10-37 Goodwill - Brief Exercise 10-6

38 10-38 Deferred Payments Lets consider an example where we must compute the present value of a noninterest-bearing note. Note payable Market interest rate Record asset at face value of note Less than market rate or noninterest bearing Record asset at present value of future cash flows.

39 10-39 Deferred Payments On January 2, 2012, Midwestern Corporation purchased equipment by signing a noninterest-bearing requiring $50,000 to be paid on December 31, 2013. The prevailing market rate of interest on notes of this nature is 10%. Prepare the required journal entries for Midwestern on January 2, 2012; December 31, 2012 (year-end), and December 31, 2013 (year-end). On January 2, 2012, Midwestern Corporation purchased equipment by signing a noninterest-bearing requiring $50,000 to be paid on December 31, 2013. The prevailing market rate of interest on notes of this nature is 10%. Prepare the required journal entries for Midwestern on January 2, 2012; December 31, 2012 (year-end), and December 31, 2013 (year-end).

40 10-40 Deferred Payments Since we do not know the cash equivalent price in this example, we must use the present value of the future cash payment.

41 10-41 Deferred Payments

42 10-42 Brief Exercise 10-7 On June 30, Kimberly Farms purchased custom- made harvesting machinery from a local producer. In payment, Kimberly signed a noninterest-bearing note requiring the payment of $60,000 in two years. The fair value of the machinery is not known, but an 8% interest rate properly reflects the time value of money for this type of loan agreement. At what amount will Kimberly initially value the machinery? How much interest expense will Kimberly recognize in its income statement for this note for the year ended December 31?

43 10-43 Brief Exercise 10-7 The initial value of machinery and note will be the present value of the note payment: PV = $60,000 (.85734) 1 = $51,440 1 Present value of $1: n = 2, i = 8% (from Table 2) Interest expense for 2009: $51,440 x 8% x 6/12 = $2,058

44 10-44 Fixed-Asset Turnover Ratio This ratio measures how effectively a company or its unit managers uses its fixed assets to generate revenue. Net sales Average fixed assets Fixed asset turnover ratio =

45 10-45 Dell vs. Apple comparison Compute the fixed asset turnover ratio for both companies Receivables Management (All dollar amounts in millions)

46 10-46 Receivables Management Dell $41,444 ($1,517 + $913)/2 = 34.1 Apple $8,279 ($707 + $669)/2 = 12.0 Net sales Average fixed assets Fixed asset turnover ratio = Dell generated nearly three times the sales dollars for each dollar invested in fixed assets.

47 10-47 Dispositions Update depreciation or amortization to date of disposal. Remove original cost of asset and accumulated depreciation or amortization 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, 2013, MeLo Inc. sold equipment for $6,350 cash. The equipment was purchased on January 1, 2008, at a cost of $15,000. The equipment was depreciated using the straight-line method over an estimated 10-year life with zero residual value. MeLo last recorded depreciation on the equipment on December 31, 2012, its year-end. Prepare the journal entries necessary to record the disposition of this equipment.

48 10-48 Update depreciation to date of sale. Dispositions June 30, 2013: Depreciation expense ($15,000 ÷ 10 years) × ½).......750 Accumulated depreciation ………………........750 To update depreciation to date of sale. Remove original asset cost and accumulated depreciation. Record the gain or loss. June 30, 2013: Accumulated depreciation............................................ 8,250 Cash ………………………….……………...................... 6,350 Loss on sale …………………………………………….… 400 Equipment …………………………...............… 15,000 To record sale of equipment. ($15,000 ÷ 10 years) × 5½) = $8,250

49 10-49 Exchanges 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.

50 10-50 Fair Value Not Determinable Matrix 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. Lets record this unusual transaction.

51 10-51 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 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

52 10-52 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. 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

53 10-53 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 Bubs 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. 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 Bubs 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. Interest Capitalization

54 10-54 Average Accumulated Expenditures Interest Capitalization

55 10-55 Since the $1,000,000 of specific borrowing is sufficient to cover the $225,000 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 Interest = $225,000 × 10% = $22,500 Since the $1,000,000 of specific borrowing is sufficient to cover the $225,000 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 Interest = $225,000 × 10% = $22,500 Interest Capitalization

56 10-56 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.) Research and Development (R&D)

57 10-57 R&D costs incurred under contract for other companies are expensed against revenue from the contract. Operational assets used in R&D should be capitalized if they have alternative future uses. R&D costs incurred under contract for other companies are expensed against revenue from the contract. Operational assets used in R&D should be capitalized if they have alternative future uses. Research and Development (R&D)

58 10-58 Start of R&D Activity Technological Feasibility Date of Product Release Sale of Product Costs Expensed as R&D Costs Capitalized 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

59 10-59 Software Development Costs Balance Sheet The unamortized portion of capitalized computer software cost is an asset. Income Statement Amortization expense associated with computer software cost. R&D expense associated with computer software development cost. Balance Sheet The unamortized portion of capitalized computer software cost is an asset. Income Statement Amortization expense associated with computer software cost. R&D expense associated with computer software development cost. Disclosure 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.

60 10-60 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 Expenditures 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.

61 10-61 Brief Exercise 10-16 Maxtor Technology incurred the following costs during the year related to the creation of a new type of personal computer monitor: What amount should Maxtor report as research and development expense in its income statement?

62 10-62 Brief Exercise 10-16 Research and development: Salaries$220,000 Depreciation R&D 125,000 Utilities and other direct costs 66,000 Payment to another company 120,000 Total R & D expense$531,000 Note: The patent filing and related legal costs and the costs of adapting the product to a particular customers needs are not included as research and development expense.


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