Intermediate accounting 19th by stice stice chapter 10

• The cost of property includes not only the original purchase price or equivalent value but also any other expenditures required in obtaining and preparing the asset for its intended

Intermediate

Accounting

James D Stice Earl K Stice

Investments in Noncurrent

What Costs Are Included in

Acquisition Cost?

• Noncurrent operating assets are recorded

initially at cost—the original bargained or cash

sales price.

• The cost of property includes not only the

original purchase price or equivalent value but

also any other expenditures required in obtaining and preparing the asset for its intended use.

• Any taxes, freight, installation, and other

expenditures related to the acquisition should be included in the asset’s cost.

• Costs assigned to land should be those

costs that directly relate to the land’s

unlimited life

• Purchase price, commissions, legal fees,

escrow fees, surveying fees, and

government assessments for water lines,

sewers, and roads are charged to Land

• Clearing and grading costs, including the

removal of unwanted structures, are also

part of the cost of land

• If the structure is purchased ready to use,

charge Buildings for:

• The purchase price

• Taxes, freight, and insurance during shipping and installation

• Special foundations or reinforcing of floors

• Reconditioning and testing costs

(continued)

Intangible Assets

including financial assets) that lack

physical substance.

• The most important distinction in

intangible assets for accounting

purposes is between those that are

internally generated and those that are externally purchased.

(continued)

symbol, or slogan that distinguishes a product or service from similar

products or services.

• The cost of a trademark includes the

purchase price, filing and registry fees, and the cost of subsequent litigation to

protect rights It does not include

internal research and development

costs.

purchased) by a business or individual to perform certain functions or sell certain products or services.

• The cost of a franchise includes

expenditures made to purchase the

franchise, legal fees, and other costs

incurred in obtaining the franchise.

Order Backlog

orders the company has received for

equipment that has not yet been

produced or delivered.

• These orders do not constitute sales

because they do not satisfy the

revenue recognition requirement that

the product be completed and shipped.

(continued)

• Goodwill represents the business

contracts, reputation, functioning systems, staff camaraderie, and industry experience that makes the company more than just a collection of assets

• Goodwill is a residual number, the value of all of the synergies of a functioning

business that cannot be specifically

identified with any other intangible factor

Basket Purchase

• A number of assets may be acquired

in a basket purchase for one lump

sum.

• When part of a purchase can be

clearly identified with specific assets, such a cost assignment should be

made and the balance allocated

among the remaining assets.

(continued)

• When no part of the purchase price

can be related to specific assets, the

entire amount must be allocated

among the different assets acquired.

Basket Purchase

Deferred Payment

• The acquisition of real estate or other

property frequently involves deferred

payment of all or part of the purchase price

• Land is acquired on January 2, 2013, for

$100,000; $35,000 is paid at the time of

purchase, and the balance is to be paid in semiannual installments of $5,000 plus

interest on the unpaid principal at an annual rate of 10%

June 30, 2013—Made first payment.

Jan 2, 2013—Purchased land for $100,000, paying

$35,000 down, the balance to be paid in semiannual payments of $5,000 plus interest at 10%.

On January 2, 2013, equipment with a cash price of $50,000 is acquired under a

deferred payment contract The contract

specifies a down payment of $15,000 plus seven annual payments of $7,189 each, or a total cost of $65,323 The present value of the seven payments at the implicit effective interest rate of 10 percent is $35,000

Deferred Payment

(continued)

On January 2, 2013, purchased equipment with

a cash price of $50,000 for $15,000 down plus seven annual payments of $7,189 each.

Made first payment of $7,189 on December 31,

2013 Calculations for amortization of debt

discount are as follows:

Made the second payment of $7,189 and

amortized debt discount on December 31, 2014.

$15,323 − $3,500 = 11,823 Discount on notes payable

$31,311 Present value of notes payable

at the end of first year

$31,311 × 0.10 = $3,131

Deferred Payment

• A lease is a contract whereby one party (the

lessee) is granted a right to use property owned

by another party (the lessor) for a specified

period of time for a specified periodic cost.

• Rental leases are operating leases and

arrangements that are equivalent to a sale of

leased assets are capital leases.

• Capital leases are recorded on the acquiring

company’s records as assets, with a related

liability at the present value of the future lease payments.

Exchange of Nonmonetary Assets

• In some cases, an enterprise acquires a new asset by exchanging or trading

existing nonmonetary assets

• Monetary assets are those assets whose amounts are fixed in terms of currency, by contract, or otherwise (cash, accounts

receivable)

• Nonmonetary assets include all the other assets (inventories, land)

Acquisition by Issuing

Securities

• When a fair value for the securities can

be determined, that value is assigned to the asset acquired.

• In the absence of a fair value for the

securities, the fair value of the asset

acquired is used.

(continued)

A company issues 1,000 shares of $1 par common stock in acquiring land; the

stock has a current market price of $45

per share The entry should be recorded

• Like purchased assets, self-constructed

expenditures incurred to build the asset and make it ready for its intended use.

• There is a difference of opinion regarding the amount of overhead properly

assignable to construction activity.

Savings or Loss on Self-Construction

• When the cost of self-construction of an

asset is less than the cost to acquire it

through purchase or construction from

outsiders, the difference is not a profit, but a savings

• When the cost is greater than the cost to

acquire it through purchase or construction from outsiders, the asset should be

recorded at cost (with some exceptions)

Interest During Period

of Construction

• Capitalization of interest is required for

assets, such as buildings and equipment, that are being self-constructed for an enterprise’s

own use and for assets that are intended to be leased or sold to others that can be identified as discrete projects.

• Interest should not be capitalized for

inventories manufactured or produced on a

repetitive basis.

(continued)

1. Interest charges begin when the first

expenditures are made on the project and

continue as long as work continues and until the asset is completed and actually ready for use.

2. The amount of interest to be capitalized is

computed using the accumulated expenditure for the project, weighted based on when the

expenditures were made during the year.

Interest During Period

of Construction

The following basic guidelines govern the

computation of capitalized interest:

3 The interest rate to be used in calculating the

amount of interest to capitalize are, in the

following order:

a) Interest rate incurred for any debt

specifically incurred for funds used on the project.

b) Weighted-average interest rate from all

other enterprise borrowings regardless of the use of funds.

Interest During Period

of Construction

(continued)

Interest During Period

of Construction

4 If the construction period covers more than

one fiscal period, accumulated expenditures include prior years’ capitalized interest.

The results provided by the four steps is the maximum interest that can be capitalized for the year

IASB on Interest Capitalization

• In 2007 the IASB revised IAS 23 to require, starting on January 1, 2009, that all

companies capitalize “borrowing costs”

incurred in the construction of a long-term asset

• The international standard requires that

companies capitalize the net amount of

interest incurred rather than the gross

amount

Acquisition by Donation

or Discovery

• When property is received through

donation, there is no cost that can be used

as a basis for its valuation

• Property acquired through donation should

be appraised and recorded at its fair value

• A donation is recognized as a gain in the

period in which it is received

(continued)

Netty’s Ice Cream Parlor is given a donation of land and a

building by an eccentric ice cream lover The entry, using

appraised values, is as follows:

Acquisition by Donation

or Discovery

• FASB ASC paragraph 845-10-S99-1

requires that when a corporation receives

nonmonetary assets as an investment by a shareholder, the assets are recorded by the company at the shareholder’s historical cost.

should be recoded in the usual manner, the value assigned to the asset providing the

basis for the depreciation charge.

• A discovery that greatly increases the

value of the property is commonly ignored

in the accounting in the U.S This also

applies to accretion values, such as

growing timber or aging wine

• To illustrate the initial recognition of an asset retirement obligation, assume that Bryan

Beach Company purchases and erects an

oil platform at a total cost of $750,000

• At the end of ten years, the platform must be dismantled and removed from the site at an estimated cost of $100,000 Using an 8%

interest rate, the present value of $100,000 for ten years is $46,319.

Asset with Significant Restoration

Costs at Retirement

Oil Platform 750,000

The journal entries to record the purchase

and the asset retirement obligation follow:

• Homer Company constructs and

commences operation of a nuclear power plant Total construction cost is $400,000

• The cost of cleaning up the routine

contamination is estimated to be $500,000; this cost will be incurred in 30 years when the plant is decommissioned Additional

annual contamination cleanup cost

$40,000 Assume an interest rate of 9%

Asset with Significant Restoration

Costs at Retirement

Postacquisition Expenditures

plant, or equipment item that is separately identifiable and for which a separate

useful life can be estimated (i.e., a

building’s heating and cooling system).

• Expenditures to maintain plant assets in good operating condition are referred to

as maintenance

• Expenditures to restore assets to good operating condition upon their

breakdown or to restore and replace

broken parts are referred to as repairs

• Maintenance and repairs are charged

to expense accounts immediately.

Postacquisition Expenditures

• Expenditures for overhauling plant assets are frequently referred to as renewals

They should be expensed immediately

• Substitution of parts or entire units are

referred to as replacements If a part is

removed and replaced with a different part, the cost and accumulated depreciation

related to the replaced part should be

treated like any removed plant asset

Renewals and Replacements

Mendon Fireworks Company replaces

the roof of its manufacturing plant for

$40,000 The original cost of the building was $1,600,000, and it is three-fourths

depreciated The original roof cost

$20,000 and the new roof is recorded as

a separate component.

(continued)

Renewals and Replacements

Additions and Betterments

• Enlargements and extensions of existing facilities are referred

Research and Development

• The FASB defined research activities as

those undertaken to discover new knowledge that will be useful in developing new

products, services, or process or that will

result in significant improvements of existing products or processes.

• Development activities involve the

application of research findings to develop a plan or design for new or improved products

or processes.

Research and Development

Research and development costs include

those costs of:

Computer Software Development Expenditures

• All costs in developing computer software incurred up to the point where

technological feasibility is established

are expensed as research and

development (planning, design, and testing activities)

• Testing done after the establishment of

technological feasibility and the cost to

produce masters can be capitalized

International Accounting

for R&D: IAS 38

• IAS 38 requires research costs to be

expensed and development costs to be

capitalized

• Preliminary indications are that the

general approach to R&D accounting in

IAS 38 will be adopted by the FASB.

• Currently, U.S GAAP requires that all R&D costs be expensed except for post-

feasibility computer software development

Oil and Gas Exploration Costs

• Full cost method —all exploratory costs are

capitalized

cost of locating productive wells.

• Successful efforts method —exploratory costs

for dry wells are expensed, and only exploratory costs for successful wells are capitalized.

that expensing costs that they have been capitalizing would result in lower profits, depressed stock prices, and difficulty in getting loans

Five General Categories of

Intangible Assets

1 Marketing-related intangible assets such

as trademarks, brand names, and Internet domain names

2 Customer-related intangible assets such

as customer lists, order backlogs, and

customer relationships

items protected by copyright

4 Contract-based intangible assets such as

licenses, franchises, and broadcast rights

Five General Categories of

Intangible Assets

5 Technology-based intangibles such as

both patented and unpatented technologies

as well as trade secrets

Estimating the Fair Value of Intangibles

• The most difficult part of recording an

amount for an intangible is estimating its fair value

• As described in Concepts Statement No

7, the present value of future cash flows

can be used to estimate fair value in one

of two ways, the traditional approach and the expected cash flow approach

(continued)

Estimating the Fair Value of Intangibles

Intangible Asset A is the right to receive royalty payments in the future of $1,000 payments at

the end of each of the next five years The adjusted interest rate is 12% The fair value of the patent is calculated as follows:

Traditional Approach

Traditional Approach

(continued)

Estimating the Fair Value of Intangibles

Expected Cash Flow Approach

Expected Cash Flow Approach

Intangible Asset B is a secret formula to

produce a healthy fast-food cheeseburger that

is expected to have the following associated

probabilities of happening:

Outcome 1 = 10% probability of cash flows of $5,000 at

the end of each year for 10 years Outcome 2 = 30% probability of cash flows of $1,000 at

the end of each year for 4 years

(continued)

Outcome 3 = 60% probability of cash flows of $100 at the

end of each year for 3 years

Estimating the Fair Value of Intangibles

Acquired In-Process Research and Development

The FASB ruled that in-process R&D is to

be recognized as an intangible asset if it is acquired as part of a business combination but is to be expensed if acquired as part of

a basket purchase outside of a business

combination.

The FASB realizes that this is

an inconsistency and they intend to revisit it in the future