Acct 3311 - Class 19 Chapter 10 acquisition and disposition of property, plant and equipment Sommers – Intermediate I Chapter 1: Environment and Theoretical Structure of Financial Accounting.

Types of Operational Assets Long-lived, Revenue-producing Assets Expected to Benefit Future Periods Tangible Property, Plant, Equipment & Natural Resources Part I. Operational assets are assets that are used actively in the operations of the business, and that are expected to benefit the operations into the future. There are two major categories of operational assets. Tangible operational assets have physical substance. Included in this category are land, buildings, equipment, machinery, vehicles, and natural resources such as oil, gas, and mineral deposits. Intangible assets are operational assets without physical substance. Included in this category are patents, copyrights, trademarks, franchises, and goodwill. Part II. Operational assets may be acquired in a number of ways. Regardless of the method of acquisition, the assets are recorded at their original cost. The recorded cost includes the purchase price and all expenditures necessary to bring the asset to its desired condition and location for use. 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.

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 Equipment Net purchase price Taxes Transportation costs Installation costs Modification to building necessary to install equipment Testing and trial runs Part I. The costs to be capitalized for equipment include: the net purchase price, less discounts, taxes, transportation costs, installation costs, modification to a building necessary to install the equipment, testing and trial runs. Part II. The cost of land includes: the purchase price, real estate commissions, attorney’s fees, title search, title transfer fees, title insurance premiums, the cost of making the land ready for its intended use, including the cost of removing old buildings. Unlike other operational assets in the property, plant and equipment category, land is not depreciated.

Costs to be Capitalized Land Improvements – Separately identifiable costs Driveways Parking lots Fencing Landscaping Private roads Buildings Purchase price Attorney’s fees Commissions Reconditioning Natural Resources Acquisition costs Exploration costs Development costs Restoration costs Self Constructed Assets Materials Direct Labor Overhead Part I. Land improvements are enhancements to property such as driveways, parking lots, fencing, landscaping, and private roads. These are separately identifiable costs that are recorded in the land improvement asset account rather than in the land account. Unlike land, land improvements are depreciated. Part II. The cost of buildings includes: the purchase price, real estate commissions, attorney’s fees, reconditioning costs to get the building ready for use.

Discussion Questions Q10–4 Indicate where the following items would be shown on a balance sheet. (a) A lien that was attached to the land when purchased. (b) Landscaping costs. (c) Attorney’s fees and recording fees related to purchasing land (d) Variable overhead related to construction of machinery.

Discussion Questions Q10–4 (e) A parking lot servicing employees in the building. (f) Cost of temporary building for workers during construction of building (g) Interest expense on bonds payable incurred during construction of a building. (h) Assessments for sidewalks that are maintained by the city. (i) The cost of demolishing an old building that was on the land when purchased.

Example 1: Continued Semtech Manufacturing purchased land and building for $4 million. In addition to the purchase price, Semtech made the following expenditures in connection with the purchase of the land and building: Title insurance $ 16,000 Legal fees for drawing the contract 5,000 Pro-rated property taxes for period after acquisition 36,000 State transfer fees 4,000 An independent appraisal estimated the fair values of the land and building, if purchased separately, at $3.3 and $1.1 million, respectively. Shortly after acquisition, Semtech spent $82,000 to construct a parking lot and $40,000 for landscaping. Determine the initial valuation of each asset Semtech acquired in these transactions.

Example 1: Continued Purchase price $4,000,000 Title search and insurance 16,000 Legal fees 5,000 State transfer fees 4,000 Total cost $4,025,000 Fair Value % of Total Valuation Land $3,300,000 75% $3,018,750 Building 1,100,000 25% 1,006,250 $4,400,000 100% $4,025,000 Land $3,018,750 Building 1,006,250 Land improvements: Parking lot 82,000 Landscaping 40,000

Example 1: Continued Semtech Manufacturing purchased land and building for $4 million. In addition to the purchase price, Semtech made the following expenditures in connection with the purchase of the land and building: Title insurance $16,000 Legal fees for drawing the contract 5,000 Pro-rated property taxes for period after acquisition 36,000 State transfer fees 4,000 An independent appraisal estimated the fair values of the land and building, if purchased separately, at $3.3 and $1.1 million, respectively. Shortly after acquisition, Semtech spent $82,000 to construct a parking lot and $40,000 for landscaping. Now assume that immediately after acquisition, Semtech demolished the building. Demolition costs were $250,000 and the salvaged materials were sold for $6,000. In addition, Semtech spent $86,000 clearing and grading the land in preparation for the construction of a new building.

Example 1: Continued Cost of land: Purchase price $4,000,000 Title search and insurance 16,000 Legal fees 5,000 State transfer fees 4,000 Demolition of old building $250,000 Less: Sale of materials (6,000) 244,000 Clearing and grading costs 86,000 Total cost of land $4,355,000 Land improvements: Parking lot $ 82,000 Landscaping $ 40,000

Percent of Total Fair Value Example 2 Tristar Production Company began operations on September 1, 2011. Listed below are a number of transactions that occurred during its first four months of operations. Prepare journal entries to record each transaction. On September 1, the company acquired five acres of land with a building that will be used as a warehouse. Tristar paid $100,000 in cash for the property. According to appraisals, the land had a fair value of $75,000 and the building had a fair value of $45,000.   Asset    Fair Value  Percent of Total Fair Value Initial Valuation Land Building

Example 2: Continued Tristar Production Company began operations on September 1, 2011. Listed below are a number of transactions that occurred during its first four months of operations. Prepare journal entries to record each transaction. On September 1, Tristar signed a $40,000 noninterest-bearing note to purchase equipment. The $40,000 payment is due on September 1, 2012. Assume that 8% is a reasonable interest rate.

Example 2: Continued Tristar Production Company began operations on September 1, 2011. Listed below are a number of transactions that occurred during its first four months of operations. Prepare journal entries to record each transaction. On September 15, a truck was donated to the corporation. Similar trucks were selling for $2,500. On September 18, the company paid its lawyer $3,000 for organizing the corporation.

Example 2: Continued Tristar Production Company began operations on September 1, 2011. Listed below are a number of transactions that occurred during its first four months of operations. Prepare journal entries to record each transaction. On October 10, Tristar purchased machinery for cash. The purchase price was $15,000 and $500 in freight charges also were paid. On December 2, Tristar acquired various items of office equipment. The company was short of cash and could not pay the $5,500 normal cash price. The supplier agreed to accept 200 shares of the company’s nopar common stock in exchange for the equipment. The fair value of the stock is not readily determinable.

Example 2: Continued Tristar Production Company began operations on September 1, 2011. Listed below are a number of transactions that occurred during its first four months of operations. Prepare journal entries to record each transaction. On December 10, the company acquired a tract of land at a cost of $20,000. It paid $2,000 down and signed a 10% note with both principal and interest due in one year. Ten percent is an appropriate rate of interest for this note.

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 Under certain conditions, interest incurred on qualifying assets is capitalized. Asset constructed is for a company’s own use and is a discrete project for sale or lease. Capitalize interest that could have been avoided if the asset were not constructed and the money used to retire debt. Part I. There are two difficult accounting issues that must be addressed when a company is constructing assets for its own use: determining the amount the company’s manufacturing overhead to be included in the asset’s cost.  deciding on the proper treatment of interest incurred during the construction period. One approach to assigning overhead to self-constructed assets is the incremental approach, where actual incremental overhead costs are recorded in the asset account. However, the most commonly used method is to assign overhead using a predetermined overhead rate, based on an overhead cost driver activity, that is used to assign the company’s overhead to regular production. This approach is called the full cost approach. Unlike purchased assets, self-constructed assets may take a long period of time to be made ready for their intended use. The construction activities during this period require construction financing. Following our general rule for the cost of an asset, all costs necessary to make the asset ready for its intended use, including interest during the construction period, should be included in the asset’s cost. Part II. Interest is capitalized (included in the asset’s cost) for qualifying assets. Qualifying assets are: assets built for a company’s own use. assets constructed as discrete projects for sale or lease. Assets in this category are large construction projects such as a real estate development built for sale or lease. Only the portion of interest cost incurred during the construction period that could have been avoided if the construction had not been undertaken may be capitalized.

Interest Costs During Construction Three approaches have been suggested to account for the interest incurred in financing the construction. Increase to Cost of Asset $ 0 $ ? Capitalize no interest during construction Capitalize all costs of funds Capitalize actual costs incurred during construction GAAP

Interest Costs During Construction GAAP requires — capitalizing actual interest (with modification). Consistent with historical cost. Capitalization considers three items: Qualifying assets. Capitalization period. Amount to capitalize.

Qualifying Assets Require a substantial period of time to get them ready for their intended use. Two types of assets: Assets under construction for a company’s own use. Assets intended for sale or lease that are constructed or produced as discrete projects.

Capitalization Period Begins when: Expenditures for the asset have been made. Activities for readying the asset are in progress . Interest costs are being incurred. Ends when: The asset is substantially complete and ready for use.

Amount to Capitalize Capitalize the lesser of: Actual interest costs Avoidable interest - the amount of interest that could have been avoided if expenditures for the asset had not been made.

Discussion Questions Q10–10 What interest rates should be used in determining the amount of interest to be capitalized? How should interest revenue from temporarily invested excess funds borrowed to finance the construction of assets be accounted for?

Calculating the Actual and Avoidable Interest Selecting Appropriate Interest Rate: For the portion of weighted-average accumulated expenditures that is less than or equal to any amounts borrowed specifically to finance construction of the assets, use the interest rate incurred on the specific borrowings. For the portion of weighted-average accumulated expenditures that is greater than any debt incurred specifically to finance construction of the assets, use a weighted average of interest rates incurred on all other outstanding debt during the period.

Calculating the Actual and Avoidable Interest Actual Interest Weighted-average interest rate on general debt $100,000 $800,000 = 12.5% Avoidable Interest

Calculating the Actual and Avoidable Interest Capitalize the lesser of Avoidable interest or Actual interest. Journal entry to Capitalize Interest:

Example 3 On January 1, 2011, the Marlee Company began construction of an office building to be used as its corporate headquarters. The building was completed early in 2012. Construction expenditures for 2011, which were incurred evenly throughout the year, totaled $6,000,000. Marlee had the following debt obligations which were outstanding during all of 2011: Construction loan, 10% $1,500,000 Long-term note, 9% 2,000,000 Long-term note, 6% 4,000,000 Calculate the amount of interest capitalized in 2011 for the building using the specific interest method.

Example 3 Average accumulated expenditures: Weighted-average rate of all other debt: Interest capitalized:

Example 4 On January 1, 2011, the Mason Manufacturing Company began construction of a building to be used as its office headquarters. The building was completed on September 30, 2012. Expenditures on the project were as follows: January 1, 2011 $1,000,000 January 31, 2012 $270,000 March 1, 2011 600,000 April 30, 2012 585,000 June 30, 2011 800,000 August 31, 2012 900,000 October 1, 2011 600,000 On January 1, 2011, the company obtained a $3 million construction loan with a 10% interest rate. The loan was outstanding all of 2011 and 2012. The company’s other interest-bearing debt included two long-term notes of $4,000,000 and $6,000,000 with interest rates of 6% and 8%, respectively. Both notes were outstanding during all of 2011 and 2012. Interest is paid annually on all debt. The company’s fiscal year-end is December 31. Calculate the amount of interest that Mason should capitalize in 2011 and 2012 using the specific interest method. What is the total cost of the building? Calculate the amount of interest expense that will appear in the 2011 and 2012 income statements.

Example 4: Continued Expenditures for 2011: January 1, 2011 $1,000,000 x 12/12 = $1,000,000 March 1, 2011 600,000 x 10/12 = 500,000 June 30, 2011 800,000 x 6/12 = 400,000 October 1, 2011 600,000 x 3/12 = 150,000 Accumulated expenditures (before interest) - $3,000,000 Average accumulated expenditures - $2,050,000 Interest capitalized: $2,050,000 x 10% = $205,000 = Interest capitalized in 2011

Example 4: Continued Expenditures for 2012: January 1, 2012 $3,205,000 x 9/9 = $3,205,000 January 31, 2012 270,000 x 8/9 = 240,000 April 30, 2012 585,000 x 5/9 = 325,000 August 31, 2012 900,000 x 1/9 = 100,000 Accumulated expenditures (before interest) - $4,960,000 Average accumulated expenditures - $3,870,000 Weighted-average rate of all other debt: $ 4,000,000 x 6% = $240,000 $ 720,000 6,000,000 x 8% = 480,000 $10,000,000 = 7.2% $10,000,000 $720,000 Interest capitalized: $3,000,000 x 10.0% x 9/12 = $225,000 870,000 x 7.2% x 9/12 = 46,980 $271,980 = Interest capitalized in 2012

Example 4: Continued Cost of Building: Expenditures in 2011 $3,000,000 Interest capitalized in 2011 205,000 Expenditures in 2012 1,755,000 Interest capitalized in 2012 271,980 Total cost of building $5,231,980 Interest Expense for 2011: $3,000,000 x 10% = $ 300,000 4,000,000 x 6% = 240,000 6,000,000 x 8% = 480,000 Total interest incurred 1,020,000 Less: Capitalized (205,000) 2011 expense $ 815,000 Interest Expense for 2012: Total interest incurred $1,020,000 Less: Capitalized (271,980) 2012 expense $ 748,020

Example 4b: Continued On January 1, 2011, the Mason Manufacturing Company began construction of a building to be used as its office headquarters. The building was completed on September 30, 2012. Expenditures on the project were as follows: January 1, 2011 $1,000,000 January 31, 2012 $270,000 March 1, 2011 600,000 April 30, 2012 585,000 June 30, 2011 800,000 August 31, 2012 900,000 October 1, 2011 600,000 On January 1, 2011, the company obtained a $3 million construction loan with a 10% interest rate. The loan was outstanding all of 2011 and 2012. The company’s other interest- bearing debt included two long- term notes of $4,000,000 and $6,000,000 with interest rates of 6% and 8%, respectively. Both notes were outstanding during all of 2011 and 2012. Interest is paid annually on all debt. The company’s fiscal year-end is December 31. Calculate the amount of interest that Mason should capitalize in 2011 and 2012 using the weighted-average method. What is the total cost of the building? Calculate the amount of interest expense that will appear in the 2011 and 2012 income statements.

Example 4b: Continued Weighted-average rate of all debt: $ 3,000,000 x 10% = $ 300,000 4,000,000 x 6% = 240,000 $ 1,020,000 6,000,000 x 8% = 480,000 $13,000,000 = 7.85% $13,000,000 $1,020,000 Expenditures for 2011: Accumulated expenditures (before interest) - $3,000,000 Average accumulated expenditures - $2,050,000 Interest capitalized: $2,050,000 x 7.85% = $160,925 = Interest capitalized in 2011

Example 4b: Continued Expenditures for 2012: January 1, 2012 $3,160,925 x 9/9 = $3,160,925 January 31, 2012 270,000 x 8/9 = 240,000 April 30, 2012 585,000 x 5/9 = 325,000 August 31, 2012 900,000 x 1/9 = 100,000 Accumulated expenditures (before interest) - $4,915,925 Average accumulated expenditures - $3,825,925 Interest capitalized: $3,825,925 x 7.85% x 9/12 = $225,251 = Interest capitalized in 2012

Example 4b: Continued Cost of Building: Expenditures in 2011 $3,000,000 Interest capitalized in 2011 160,925 Expenditures in 2012 1,755,000 Interest capitalized in 2012 225,251 Total cost of building $5,141,176 Interest Expense for 2011: Total interest incurred $1,020,000 Less: Capitalized (160,925) 2011 expense $ 859,075 Interest Expense for 2012: Less: Capitalized (225,251) 2012 expense $ 794,749

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 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?

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.

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.

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?

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?

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?

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.

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.

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.

Discussion Questions Q10–19

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

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.