Acct 3311 - Class 20 From Reader’s Digest My 50-something friend Nancy and I decided to introduce her mother to the magic of the Internet. Our first move was to access the popular Ask Jeeves site, and we told her it could answer any question she had. Nancy's mother was very skeptical until Nancy said, "It's true, Mom. Think of something to ask it." As I sat with my fingers poised over the keyboard, Nancy's mother thought for a minute, then responded, "How is Aunt Helen feeling?" --Catherine Burns I am five feet three inches tall and pleasingly plump. After I had a minor accident, my mother accompanied me to the emergency room. The triage nurse asked for my height and weight, and I blurted out, "Five-foot-eight and 125 pounds.“ "Sweetheart," my mother gently chided, "this is not the Internet." --M.M. Anytime companies merge, employees worry about layoffs. When the company I work for was bought, I was no exception. My fears seemed justified when a photo of the newly merged staff appeared on the company's website with the following words underneath: "Updated daily." --Dianne Stevens
Acct 3311 - Class 20 Chapter 10 acquisition and disposition of property, plant, and equipment Sommers – ACCT 3311 Chapter 1: Environment and Theoretical Structure of Financial Accounting.
Noncash Acquisitions 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. Issuance of equity securities Deferred payments Donated Assets Exchanges Part I. Companies sometimes acquire operational assets without paying cash. Assets may be acquired by issuing debt or equity securities, by receiving donated assets, or by exchanging other assets. Part II. In any noncash acquisition, the components of the transaction should be recorded at their fair values. The first indication of fair value is the fair value of the consideration given to acquire the asset. Sometimes the fair value of the asset received is used when that fair value is more clearly evident than the fair value of the consideration given.
Noncash Acquisitions 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 Assets 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. Part I. When an asset is acquired with the issuance of equity securities, it 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. Part II. On occasion, companies acquire assets through donation. The donation usually is an enticement to get the company to do something that benefits the donor. Donated assets are recorded at fair value with a debit on the recipient company’s books and a corresponding credit to a revenue account for the fair value of the asset. The reasoning is that the company receiving the asset is performing a service for the donor in exchange for the asset donated.
Example 5 On January 1, 2011, Byner Company purchased a used tractor. Byner paid $5,000 down and signed a noninterest- bearing note requiring $25,000 to be paid on December 31, 2013. The fair value of the tractor is not determinable. An interest rate of 10% properly reflects the time value of money for this type of loan agreement. The company’s fiscal year-end is December 31. Prepare the journal entry to record the acquisition of the tractor. How much interest expense will the company include in its 2011 and 2012 income statements for this note? What is the amount of the liability the company will report in its 2011 and 2012 balance sheets for this note?
Example 5: Continued Prepare the journal entry. PV(FV=25,000, pmt=0, n=3, i=10%) = 18,783 Tractor ($5,000 cash + $18,783 note) 23,783 Discount on note payable (difference) 6,217 Cash 5,000 Note payable (face amount) 25,000 How much interest expense will the company include in its 2011 and 2012 income statements for this note? 2011: Interest expense ($18,783 x 10%) = $1,878 2012: Interest expense [($18,783 + $1,878) x 10%] = 2,066 What is the amount of the liability the company will report in its 2011 and 2012 balance sheets for this note? 2011: $25,000 – ($6,217 – $1,878) = $20,661 2012: $25,000 – ($6,217 – $1,878 – $2,066) = 22,727
Dispositions Steps: Update depreciation to date of disposal. Remove original cost of asset and accumulated depreciation from the books. Record what you received. The difference between book value of the asset and the amount received is recorded as a gain or loss. Part I. After using property, plant, and equipment and intangible assets, companies dispose of them by sale, retirement, or exchanging them for other assets. Three accounting steps are involved in dispositions: update depreciation to the date of disposal. remove the original cost of the asset and its accumulated depreciation from the books. record a gain or loss for the difference between the book value of the asset and the amount received. Consider the following example where an asset is sold for cash. Part II. 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 to record the disposition of this equipment.
Exchanges Generally 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. Part I. Operational assets are sometimes acquired in exchanges for other operational assets. Trade-ins of old assets in exchange for new assets is probably the most frequent type of exchange. Cash is involved in the transactions to equalize fair values. The general principle to be followed is that the cost of the asset acquired is: equal to the fair value of asset given up plus cash paid or minus cash received, or equal to the fair value of asset acquired, if that is more clearly evident. A gain or loss is recognized for the difference between the fair value of the asset given up and its book value. Part II. We follow the general principle based on fair value in the exchange of operational assets 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. Let’s look at an example where fair value cannot be determined.
Example 6 Southern Company owns a building that it leases. The building’s fair value is $1,400,000 and its book value is $800,000 (original cost of $2,000,000 less accumulated depreciation of $1,200,000). Southern exchanges this for another building owned by the Eastern Company. The building’s book value on Eastern’s books is $950,000 (original cost of $1,600,000 less accumulated depreciation of $650,000). Eastern also gives Southern $140,000 to complete the exchange. The exchange has commercial substance for both companies. Prepare the journal entries to record the exchange on the books of Southern. Cash 140,000 Building - new ($1,400,000 - 140,000) 1,260,000 Accum deprec - building (acct balance) 1,200,000 Building - old (acct balance) 2,000,000 Gain ($1,400,000 – 800,000) 600,000
Example 6: Continued Southern Company owns a building that it leases. The building’s fair value is $1,400,000 and its book value is $800,000 (original cost of $2,000,000 less accumulated depreciation of $1,200,000). Southern exchanges this for another building owned by the Eastern Company. The building’s book value on Eastern’s books is $950,000 (original cost of $1,600,000 less accumulated depreciation of $650,000). Eastern also gives Southern $140,000 to complete the exchange. The exchange has commercial substance for both companies. Prepare the journal entries to record the exchange on the books of Eastern. Building - new 1,400,000 Accum deprec - building (acct balance) 650,000 Cash 140,000 Building - old (acct balance) 1,600,000 Gain on exch of bldgs 310,000
Discussion Questions Q10–16 Stan Ott is evaluating two recent transactions involving exchanges of equipment. In one case, the exchange has commercial substance. In the second situation, the exchange lacks commercial substance. Explain to Stan the differences in accounting for each situation. Ordinarily accounting for the exchange of nonmonetary assets should be based on the fair value of the asset given up or the fair value of the asset received, whichever is more clearly evident. Thus any gains and losses on the exchange should be recognized immediately. If the fair value of either asset is not reasonably determinable, the book value of the asset given up is usually used as the basis for recording the nonmonetary exchange. This approach is always employed when the exchange has commercial substance.
Discussion Questions Q10–16 Stan Ott is evaluating two recent transactions involving exchanges of equipment. In one case, the exchange has commercial substance. In the second situation, the exchange lacks commercial substance. Explain to Stan the differences in accounting for each situation. The general rule is modified when exchanges lack commercial substance. In this case, the enterprise is not considered to have completed the earnings process and therefore a gain should not be recognized. However, a loss should be recognized immediately. In certain situations, gains on an exchange that lacks commercial substance may be recorded when monetary consideration is received. When monetary consideration is received, it is assumed that a portion of the earnings process is completed, and therefore, a partial gain is recognized.
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. Part I. 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. Part II. 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 the expected change in cash flows is significant relative to the fair value of the assets exchanged. If the exchange does not meet these two conditions, it lacks commercial substance and, book value is used to value the asset(s) acquired. No gain is recognized. Let’s look at an example, first with commercial substance, and then without commercial substance.
Example 7 The Tinsley Company exchanged land that it had been holding for future plant expansion for a more suitable parcel located farther from residential areas. Tinsley carried the land at its original cost of $30,000. According to an independent appraisal, the land currently is worth $72,000. Tinsley gave $14,000 in cash to complete the transaction. What is the fair value of the new parcel of land received by Tinsley? FV of old land + Cash given = FV of new land $72,000 + 14,000 = $86,000
Example 7: Continued The Tinsley Company exchanged land that it had been holding for future plant expansion for a more suitable parcel located farther from residential areas. Tinsley carried the land at its original cost of $30,000. According to an independent appraisal, the land currently is worth $72,000. Tinsley gave $14,000 in cash to complete the transaction. Prepare the journal entry to record the exchange assuming the exchange has commercial substance. Land - new ($72,000 + 14,000) 86,000 Cash 14,000 Land - old (book value) 30,000 Gain ($72,000 – 30,000) 42,000
Example 7: Continued The Tinsley Company exchanged land that it had been holding for future plant expansion for a more suitable parcel located farther from residential areas. Tinsley carried the land at its original cost of $30,000. According to an independent appraisal, the land currently is worth $72,000. Tinsley gave $14,000 in cash to complete the transaction. Prepare the journal entry to record the exchange assuming the exchange lacks commercial substance. Land - new ($30,000 + 14,000) 44,000 Cash 14,000 Land - old (book value) 30,000
Accounting for Contributions When a company contributes a non-monetary asset, it should record the amount of the donation as an expense at the fair value of the donated asset. Example: Kline Industries donates land to the city of Los Angeles for a city park. The land cost $80,000 and has a fair value of $110,000. Kline Industries records this donation as follows. Contribution Expense 110,000 Land 80,000 Gain on Disposal of Land 30,000 LO 5
Discussion Questions Q10–19 What accounting treatment is normally given to the following items in accounting for plant assets? (a) additions, (b) major repairs, (c) improvements and replacements. Additions. Additions represent entirely new units or extensions and enlargements of old units. Expenditures for additions are capitalized by charging either old or new asset accounts depending on the nature of the addition. Major Repairs. Expenditures to replace parts or otherwise to restore assets to their previously efficient operating condition are regarded as repairs. To be considered a major repair, several periods must benefit from the expenditure. The cost should be handled as an addition, improvement or replacement depending on the type of major repair made.
Discussion Questions Q10–19 Improvements. An improvement does not add to existing plant assets. Expenditures for such betterments represent increases in the quality of existing plant assets by rearrangements in plant layout or the substitution of improved components for old components so that the facilities have increased productivity, greater capacity, or longer life. The cost of improvements is accounted for by charges to the appropriate property accounts and the elimination of the cost and accumulated depreciation associated with the replaced components, if any. Replacements involve an “in kind” substitution of a new asset or part for an old asset or part. Accounting for major replacements requires entries to retire the old asset or part and to record the cost of the new asset or part. Minor replacements are treated as period costs.
Disposition of PP&E A company may retire plant assets voluntarily or dispose of them by Sale. Involuntary conversion. Depreciation must be taken up to the date of disposition.
Example 8 Sale of Plant Assets Example: Ottawa Corporation owns machinery that cost $20,000 when purchased on July 1, 2009. Depreciation has been recorded at a rate of $2,400 per year, resulting in a balance in accumulated depreciation of $8,400 at December 31, 2012. The machinery is sold on September 1, 2013, for $10,500. Prepare journal entries to update depreciation for 2013 and record the sale.
Example 8: Continued a) Depreciation for 2013 b) Record the sale Depreciation expense ($2,400 x 8/12) 1,600 Accumulated depreciation 1,600 b) Record the sale Cash 10,500 Accumulated depreciation 10,000 Machinery 20,000 Gain on sale 500 * * $8,400 + $1,600 = $10,000
Disposition of PP&E Involuntary Conversion Sometimes an asset’s service is terminated through some type of involuntary conversion such as fire, flood, theft, or condemnation. Companies report the difference between the amount recovered (e.g., from a condemnation award or insurance recovery), if any, and the asset’s book value as a gain or loss. They treat these gains or losses like any other type of disposition.
E10-25 On April 1, 2014, Gloria Estefan Company received a condemnation award of $430,000 cash as compensation for the forced sale of the company’s land and building, which stood in the path of a new state highway. The land and building cost $60,000 and $280,000, respectively, when they were acquired. At April 1, 2014, the accumulated depreciation relating to the building amounted to $160,000. On August 1, 2014, Estefan purchased a piece of replacement property for cash. The new land cost $90,000, and the new building cost $400,000. Prepare the journal entries to record the transactions on April 1 and August 1, 2014.
E10-25: Continued April 1 Cash 430,000 Accumulated Depreciation—Buildings 160,000 Land 60,000 Buildings 280,000 Gain on Disposal of Plant Assets 250,000 August 1 Land 90,000 Buildings 400,000 Cash 490,000
Example 9 On January 1, 2011, the Haskins Company adopted the dollar-value LIFO method for its one inventory pool. The pool’s value on this date was $660,000. The 2011 and 2012 ending inventory valued at year-end costs were $690,000 and $760,000, respectively. The appropriate cost indexes are 1.04 for 2011 and 1.08 for 2012. Calculate the inventory value at the end of 2011 and 2012 using the dollar-value LIFO method.
Example 9: Continued 2011 Ending Inventory at Base Year Cost $690,000 / 1.04 = $663,462 Inventory Layers at Base Year Cost Base $660,000 2011 3,462 $663,462 Inventory Layers Converted to Cost $660,000 x 1.00 = $660,000 3,462 x 1.04 = 3,600 $663,600
Example 9 On January 1, 2011, the Haskins Company adopted the dollar-value LIFO method for its one inventory pool. The pool’s value on this date was $660,000. The 2011 and 2012 ending inventory valued at year-end costs were $690,000 and $760,000, respectively. The appropriate cost indexes are 1.04 for 2011 and 1.08 for 2012. Calculate the inventory value at the end of 2011 and 2012 using the dollar-value LIFO method.
Example 9: Continued 2012 Ending Inventory at Base Year Cost $760,000 / 1.08 = $703,704 Inventory Layers at Base Year Cost Base $660,000 2011 3,462 2012 40,242 $703,704 Inventory Layers Converted to Cost $660,000 x 1.00 = $660,000 3,462 x 1.04 = 3,600 40,242 x 1.08 = 43,461 $707,061
Example 10 Mercury Company has only one inventory pool. On December 31, 2011, Mercury adopted the dollar-value LIFO inventory method. The inventory on that date using the dollar-value LIFO method was $200,000. Inventory data are as follows: Ending Inventory at Ending Inventory at Year Year-End Costs Base Year Costs 2012 $231,000 $220,000 2013 299,000 260,000 2014 300,000 250,000 Compute the inventory at December 31, 2012, 2013, and 2014, using the dollar-value LIFO method.
Example 10: Continued 2012 Calculation of Cost Index $231,000 / $220,000 = 1.05 Inventory Layers Converted to Cost $200,000 x 1.00 = $200,000 20,000 x 1.05 = 21,000 $221,000
Example 10 Mercury Company has only one inventory pool. On December 31, 2011, Mercury adopted the dollar-value LIFO inventory method. The inventory on that date using the dollar-value LIFO method was $200,000. Inventory data are as follows: Ending Inventory at Ending Inventory at Year Year-End Costs Base Year Costs 2012 $231,000 $220,000 2013 299,000 260,000 2014 300,000 250,000 Compute the inventory at December 31, 2012, 2013, and 2014, using the dollar-value LIFO method.
Example 10: Continued 2013 Calculation of Cost Index $299,000 / $260,000 = 1.15 Inventory Layers Converted to Cost $200,000 x 1.00 = $200,000 20,000 x 1.05 = 21,000 40,000 x 1.15 = 46,000 $267,000
Example 10 Mercury Company has only one inventory pool. On December 31, 2011, Mercury adopted the dollar-value LIFO inventory method. The inventory on that date using the dollar-value LIFO method was $200,000. Inventory data are as follows: Ending Inventory at Ending Inventory at Year Year-End Costs Base Year Costs 2012 $231,000 $220,000 2013 299,000 260,000 2014 300,000 250,000 Compute the inventory at December 31, 2012, 2013, and 2014, using the dollar-value LIFO method.
Example 10: Continued 2014 Calculation of Cost Index $300,000 / $250,000 = 1.20 Inventory Layers Converted to Cost $200,000 x 1.00 = $200,000 20,000 x 1.05 = 21,000 30,000 x 1.15 = 34,500 $255,500