1. Operational Assets: Acquisition and Disposition
Chapter 10
Operational Assets: Acquisition and Disposition

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

3. 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.

4. Costs to be Capitalized ---- Equipment
Net purchase price
Taxes
Transportation costs
Installation costs
Modification to building necessary to install equipment
Testing and trial runs

5. Costs to be Capitalized ---- Land
Purchase price
Real estate commissions
Attorney’s fees
Title search
Title transfer fees
Title insurance premiums
Removing old buildings
Land is not depreciable.

6. Costs to be Capitalized ---- Land Improvements
Separately identifiable costs of
Driveways
Parking lots
Fencing
Landscaping
Private roads

7. Costs to be Capitalized ---- Buildings
Purchase price
Architectural fees
Cost of permits
Excavation costs
Construction costs

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

9. Asset Retirement Obligations
Often encountered with natural resource extraction when the land must be restored to a useable condition.
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.

10. Intangible Assets Intangible Assets Lack physical substance.
Useful life is often difficult to determine.
Intangible Assets
Economic benefits last beyond the current period.
Usually acquired for operational use.

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

12. Patents
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.
Internally developed costs (R&D) that result in patents are expensed in the period incurred.

13. What is Torch’s patent cost?
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.

14. 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.

15. 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.

16. Franchises
Right to sell products or provide services purchased by franchisee from franchisor.

17. Goodwill Goodwill 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.

18. Goodwill
Eddy Company paid $1,000,000 to purchase all of James Company’s assets and assumed James Company’s liabilities of $200,000. James Company’s assets were appraised at a fair value of $900,000.

19. Goodwill
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

20. Lump-Sum Purchases
Several assets are acquired for a single, lump-sum price that may be lower than the sum of the individual asset prices.
Portions of the lump-sum price attributable to particular assets are assigned to those assets.
Allocation of the remaining lump-sum price is based on relative values of the individual assets.
Asset 1
Asset 2
Asset 3

21. Lump-Sum Purchases
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?

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

23. Lump-Sum Purchases

24. Noncash Acquisitions Deferred payments Issuance of equity securities
Donated Assets
Exchanges

25. Deferred Payments or The asset acquired is recorded at the
Cash equivalent price (market value) or
Present value of future cash payments using the prevailing market interest rate
Whichever is more objective and reliable.

26. Deferred Payments
On May 1, 2003, Fesler, Inc. purchased equipment paying $3,000 down and issuing a note payable. The note requires four annual payments of $2,500 with the first payment due on May 1, The note is noninterest-bearing. The prevailing market rate of interest on notes of this nature is 12%.
Prepare the required journal entries on May 1, 2003, and December 31, 2003 (year-end).

27. Deferred Payments
Since we do not know the cash equivalent price in this example, we must use the present value of the future cash payments.

28. Deferred Payments Example

29. Issuance of Equity Securities
Asset acquired is recorded at the market value of the asset or the market value of the securities, whichever is more objective and reliable.
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.”

30. The deal created about 3,000 jobs locally.
Donated Assets
On occasion, companies acquire operational assets through donation.
SFAS No. 116 requires the receiving company to
record revenue equal to the value of the donated asset.
Record the donated asset on the books at market value.
Recently, in an effort to lure a facility for Dell Computers to Nashville, TN, the city donated land for the new facility.
The deal created about 3,000 jobs locally.

31. Dispositions Update depreciation to date of disposal.
Remove original cost of asset and accumulated depreciation from the books.
The difference between BV of the asset and the amount received is recorded as a gain or loss.
Accounting Steps

32. Dispositions
On June 30, 2003, MeLo, Inc. sold equipment for $6,350 cash. The equipment was purchased on January 1, 1998 at a cost of $15,000. The asset had a useful life of 10 years and no salvage value. MeLo last recorded depreciation on the equipment on December 31, 2002, its year-end.
Prepare the journal entries necessary to record the disposition of this equipment.

33. Dispositions
Update depreciation to date of sale.

34. Dispositions
Remove original cost of asset and accumulated depreciation from the books.
Record the gain or loss.

35. Exchanges
The valuation of a nonmonetary asset exchange depends on whether cash is paid or received.
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 readily determinable.

36. Exchanges

37. Exchanges of Dissimilar Assets
SAM, Co. exchanged inventory for a piece of equipment owned by Mette, Inc. The inventory has a cost basis to SAM of $125,000, and a fair value of $200,000. The equipment has a fair value of $220,000, and a cost basis to Mette of $325,000. Mette has recorded depreciation of $150,000 on the equipment.
Record the exchange on the books of SAM and Mette.

38. Exchanges of Dissimilar Assets
The assets exchanged are dissimilar in nature, so the implied gain should be recognized in full.

39. Exchanges of Dissimilar Assets
SAM, Co.
Asset acquired should be valued at the fair value of asset given up.

40. Exchanges of Dissimilar Assets
The assets exchanged are dissimilar in nature, so the implied gain should be recognized in full.

41. Exchanges of Dissimilar Assets
Mette, Inc.
Asset acquired should be valued at the fair value of asset transferred.

42. Exchanges of Similar Assets
Now let’s see an example with similar assets.

43. Exchanges of Similar Assets
Amgen, Co. exchanged similar equipment and $10,000 cash for equipment owned by Versa, Inc.
Using the information below, record the exchange on the books of Amgen and Versa.

44. Exchanges of Similar Assets
The assets exchanged are similar in nature, and cash is not received, so the implied gain should not be recognized.

45. Exchanges of Similar Assets
Amgen
Equipment received should be valued at the BV of equipment transferred plus cash paid.

46. Exchanges of Similar Assets
The assets exchanged are similar in nature. Since cash is received, a partial gain should be recognized.

47. Exchanges of Similar Assets
The assets exchanged are similar in nature. Since cash is received, a partial gain should be recognized.

48. Exchanges of Similar Assets
Versa
Equipment received valued at fair value less portion of gain not recognized.

49. Let’s change the subject.

50. 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

51. Interest Capitalization
Under certain conditions, avoidable interest incurred on qualifying assets is capitalized.
Interest that could have been avoided if the asset were not constructed and the money used to retire debt.
An asset constructed:
For a company’s own use.
As a discrete project for sale or lease.

52. Interest Capitalization
Interest is capitalized based on Average Accumulated Expenditures (AAE).
Qualifying expenditures weighted for the number of months outstanding during the current accounting period.
Examples include:
Cash payments for construction
Transfer of other assets
Incurrence of interest-bearing liabilities

53. Interest Capitalization
If the qualifying asset is financed through a specific new borrowing . . .
If the qualifying asset is internally financed . . .
. . . use the specific rate of the new borrowing as the capitalization rate.
. . . use the weighted average cost of debt as the capitalization rate.

54. Interest Capitalization
If the AAE < the amount of the specific new borrowing . . .
Specific new
borrowing
. . . Capitalize this portion using specific borrowing rate.
AAE

55. Interest Capitalization
If the AAE is > the amount of the specific new borrowing . . .
. . . Capitalize this portion using weighted average cost of debt.
Internal financing
. . . Capitalize this portion using specific borrowing rate.
AAE
Specific new
borrowing

56. Interest Capitalization
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.

57. Interest Capitalization
Steps in the capitalization process
Compute actual interest expense.
Compute AAE.
Determine how much interest is potentially capitalizable (IPC).
Capitalize the smaller of actual interest or capitalizable interest.

58. Interest Capitalization
Welling, Inc. is constructing a building for its own use. Construction activities started on May 1 and have continued through Dec Welling made the following qualifying expenditures: May 1, $125,000; July 31, $160,000, Oct. 1, $200,000; and Dec. 1, $300,000.
Welling recorded total interest expense of $175,000 during the year, including construction borrowing of $1,000,000 on May 1, from Bub’s Bank for 10 years at 12%.

59. Interest Capitalization
Actual interest expense is $175,000.
Compute AAE:

60. Interest Capitalization
Compute the IPC:
Since AAE < Specific Borrowing, use the specific borrowing interest rate of 12%. IPC = AAE × Capitalization rate
IPC = $225,000 × 12% = $27,000

61. Interest Capitalization
Capitalize the smaller of actual interest or IPC.
Actual interest ($175,000) > IPC ($27,000)
Capitalize $27,000!

62. Research and Development (R&D)
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.)

63. Research and Development (R&D)
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.

64. Software Development Costs SFAS No. 86
“Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed”
All costs incurred to establish the technological feasibility of a computer software product are to be treated as R&D and expensed as incurred.
Subsequent costs to obtain product masters are to be capitalized as an intangible asset.

65. Software Development Costs SFAS No. 86
Costs are Expensed as R&D
Costs are Capitalized
Costs are not R&D
Start of R&D Activity
Technological Feasibility
Start of Commercial Production
Sale of Product or Process

66. Software Development Costs SFAS No. 86
Amortization of capitalized computer software costs starts when the product begins to be marketed.
Two methods are allowed:
Revenue method
Straight-line method

67. Software Development Costs SFAS No. 86
Disclosure
Balance Sheet
Unamortized computer software product master cost is an asset.
Income Statement
Amortization expense associated with computer software cost.
R&D expense associated with computer software development cost.

68. End of Chapter 10
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