OPERATIONAL ASSETS: ACQUISITION AND DISPOSITION Chapter 10 © 2009 The McGraw-Hill Companies, Inc.

McGraw-Hill /Irwin Slide 2 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 General Rule for Cost Capitalization 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.

McGraw-Hill /Irwin Slide 3 Equipment Net purchase price Taxes Transportation costs Installation costs Modification to building necessary to install equipment 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 Removing old buildings

McGraw-Hill /Irwin Slide 4 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

McGraw-Hill /Irwin Slide 5 Costs to be Capitalized 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

McGraw-Hill /Irwin Slide 6 Asset Retirement Obligations Recognize the restoration costs 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.

McGraw-Hill /Irwin Slide 7 Intangible Assets Lack physical substance. Future benefits less certain than tangible assets. Exclusive Rights. Intangible Assets

McGraw-Hill /Irwin Slide 8 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.

McGraw-Hill /Irwin Slide 9 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 no objective and reliable value can be determined, board of directors assigns a “reasonable value.” Donated Assets On occasion, companies acquire operational assets through donation. SFAS No. 116 requires the receiving company to Record the donated asset at fair value. Record revenue equal to the fair value of the donated asset.

McGraw-Hill /Irwin Slide 10Exchanges General 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 operational 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.

McGraw-Hill /Irwin Slide 11 Exchange Lacks Commercial Substance 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, 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.

McGraw-Hill /Irwin Slide 12 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.

McGraw-Hill /Irwin Slide 13 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. Interest Capitalization 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.

McGraw-Hill /Irwin Slide 14 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 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.

McGraw-Hill /Irwin Slide 15 Software Development Costs SFAS No. 86 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. Start of R&D Activity Technological Feasibility Date of Product Release Sale of Product Costs Expensed as R&D Costs Capitalized Operating Costs

McGraw-Hill /Irwin Slide 16 Software Development Costs SFAS No. 86 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.

McGraw-Hill /Irwin End of Chapter 10 © 2008 The McGraw-Hill Companies, Inc.