Presentation on theme: "CHAPTER 10 Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition."— Presentation transcript:
CHAPTER 10 Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Learning Objectives LO10-1Identify the various costs included in the initial cost of property, plant, and equipment, natural resources, and intangible assets. (Exclude: Asset Retirement Obligations) LO10-2Determine the initial cost of individual property, plant, and equipment and intangible assets acquired as a group for a lump-sum purchase price. LO10-3Determine the initial cost of property, plant, and equipment and intangible assets acquired in exchange for a deferred payment contract. LO10-4Determine the initial cost of property, plant, and equipment and intangible assets acquired in exchange for equity securities, or through donation. LO10-5Calculate the fixed-asset turnover ratio used by analysts to measure how effectively managers use property, plant, and equipment. (SELF-STUDY) LO10-6Explain how to account for dispositions and exchanges for other nonmonetary assets (Not Covered) LO10-7Identify the items included in the cost of a self-constructed asset and determine the amount of capitalized interest. LO10-8Explain the difference in the accounting treatment of costs incurred to purchase intangible assets versus the costs incurred to internally develop intangible assets (R&D). LO10-9Discuss 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)
10-3 Long-lived, Revenue-producing Assets Tangible Property, Plant, Equipment & Natural Resources Tangible Property, Plant, Equipment & Natural Resources Intangible No Physical Substance Intangible No Physical Substance Types of Assets Expected to Benefit Future Periods General Rule for Cost Capitalization The 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.
10-4 Equipment Net purchase price Taxes Transportation costs Installation costs Testing and trial runs Costs to be Capitalized Land (not depreciable) Purchase price Real estate commissions Attorney’s fees Title search Title transfer fees Title insurance premiums Back Taxes Removing old buildings
10-5 Costs to be Capitalized Land Improvements Separately identifiable costs of Driveways Parking lots Fencing Landscaping Private roads Buildings Purchase price Attorney’s fees Commissions Reconditioning
10-6 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 Capitalized Intangible Assets Patents Copyrights Trademarks Franchises Goodwill
10-7 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. The $30,000 R & D cost is expensed as incurred.
10-8 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)
10-9 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. Franchise Self-study Intangible Assets
10-10 Occurs when one company buys another company. The amount by which the consideration exchanged exceeds the fair value of net identifiable assets acquired. Only purchased goodwill is an intangible asset. Goodwill Intangible Assets - Goodwill Goodwill is not 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 $2,000,000 is allocated to the separate assets as follows: Fair values Land$ 330,00015% <= 330,000 / 2,200,000 Building 550,00025 Equipment 660,00030 Patent 440,00020 Inventories 220,00010 Total $2,200, % Journal Entry: Land (15% x $2,000,000)300,000 Building (25% x $2,000,000)500,000 Equipment(30% x $2,000,000)600,000 Patent (20% x $2,000,000)400,000 Inventories(10% x $2,000,000)200,000 Cash2,000,000
10-13 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 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.
10-14 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.
10-15 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.
10-16 Exchange 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.
10-17 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.
10-18 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)
10-19 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
10-20 If specific new borrowing had been insufficient to cover the average accumulated expenditures... Specific new borrowing AAE... Capitalize this portion using the 10 percent specific borrowing rate. Other debt... Capitalize this portion using the 12 percent weighted- average cost of debt. Interest Capitalization
10-21 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, Expenditures on the project, mainly payments to subcontractors, were as follows: January 3, 2013 $ 500,000 March 31, ,000 September 30, ,000 Accumulated expenditures at Dec. 31, $1,500, (before interest capitalization) January 31, ,000 April 30, ,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.
10-22 INTEREST CAPITALIZATION ILLUSTRATION 2013: Step 1: Determine the average accumulated expenditures. January 3, 2013$500,000 x 12/12 =$500,000 March 31, ,000 x 9/12 = 300,000 Sept. 30, ,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% = $76,000 Step 3: Compare calculated interest with actual interest incurred. ActualCalculated Loans RateInterestInterest $1,000,000 x 8% =$ 80,000 2,000,000 x 6% = 120,000 4,000,000 x 12% = 480,000 $680,000$76,000 USE THIS RATE
10-23 INTEREST 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.
10-24 INTEREST CAPITALIZATION ILLUSTRATION 2014: Step 1: Determine the average accumulated expenditures: January 1, 2014$1,576,000 x 6/6 =$1,576,000 January 31, ,000 x 5/6 = 500,000 April 30, ,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. LoansRateInterest $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 AccumulatedAnnualFraction = Interest Cost ExpendituresRateof Year AAE 2014$2,176,000 Specific Borrowing 1,000,0008%6/12= $40,000 Excess 1,176,00010%6/12= 58,800 Capitalized Interest $98,800
10-26 INTEREST CAPITALIZATION ILLUSTRATION Step 3: Compare calculated interest with actual interest incurred. ActualCalculated LoansRateInterestInterest $1,000,000 x 8% x 6/12 =$ 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, ,800), and $241,200 =($340, ,800) in interest would be expensed Exercise 25
10-27 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 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 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.
10-28 Research and Development (R&D) || | Start of Start of Sale of R&D Commercial Product Activity 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 commercial new research findings or |production including routine other knowledge|testing of products | Design, construction, and | Routine ongoing efforts to testing of preproduction | refine, enrich, or otherwise prototypes 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
10-29 Research and Development (R&D) Exercise 26 Exercise 27
10-30 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 (Covered )
10-31 Software Development Costs (Covered) 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. EXERCISE 30 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. EXERCISE 30 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.