Lecture Intermediate accounting (IFRS/e) - Chapter 10: Property, plant and equipment, investment property, and intangible assets: acquisition and disposition

After studying this chapter, you should be able to: Identify the various costs included in the initial cost of property, plant, and equipment, natural resources, and intangible assets; determine the initial cost of individual property, plant, and equipment and intangible assets acquired as a group for a lump-sum purchase price; determine the initial cost of property, plant, and equipment and intangible assets acquired in exchange for a deferred payment contract;....

PROPERTY, PLANT AND

EQUIPMENT,

INVESTMENT PROPERTY, AND INTANGIBLE

ASSETS: ACQUISITION

AND DISPOSITION

Chapter 10

Long-lived, Revenue-producing Assets

Types of Assets

Expected to Benefit Future Periods

General Rule for Cost CapitalizationThe initial cost of an asset includes the purchase price and all expenditures necessary to bring the asset to its desired

condition and location for use

• Title transfer fees

• Title insurance premiums

• Removing old buildings

Investment Property

• Land costs

• Building costs

Same as costs for

property, plant and

equipment

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

Asset Retirement Obligations

Recognize the restoration costs

as a liability and a corresponding increase in the related asset.

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.

Record at fair value, usually the

present value of future cash

reclamation or restoration.

Often encountered with natural resource

extraction when the land must be restored to a useable condition.

Often encountered with natural resource

extraction when the land must be restored to a useable condition.

Intangible Assets

Lack physical substance.

Exclusive Rights.

Intangible Assets

Intangible Assets

Future benefits less certain

than tangible assets.

• An exclusive right recognized by law and granted by a sovereign state for a limited period (usually 20 years.)

• Holder has the right to use, manufacture, or sell the patented product or process without interference or infringement by others

• Some R & D costs that lead to an internally developed patent are expensed in the period incurred, while

others are capitalized

Intangible Assets ─ Patents

• 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 50-100 years (or a finite period for anonymous or corporate creations).

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 relevant national authority and renewable indefinitely in (usually) 10-year periods.

Intangible Assets

Occurs when one

company buys another company.

The amount by which the consideration exchanged exceeds the fair value of net assets acquired.

Only purchased goodwill is an intangible asset.

A contractual arrangement where the franchisor grants the franchisee exclusive rights to use the franchisor’s trademark within a certain

area for a specified period of time

A contractual arrangement where the franchisor grants the franchisee exclusive rights to use the franchisor’s trademark within a certain

area for a specified period of time

Goodwill Franchise

Intangible Assets

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 What amount of goodwill should Eddy company record as a

result of the purchase?

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 What amount of goodwill should Eddy company record as a

result of the purchase?

Goodwill

Several assets are acquired for a single price that may

be lower than the sum of the individual asset fair values.

Several assets are acquired for a single price that may

be lower than the sum of the individual asset fair values.

Lump-Sum Purchases

Asset 2

Allocation of the lump-sum price is based

on relative fair values of the individual assets

Allocation of the lump-sum price is based

on relative fair values of the individual assets

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 allocated to the building account?

Appraised % of Purchase Assigned

Land $ 87,500 35% $ 200,000 $ 70,000 Building 162,500 65% 200,000 130,000

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.

face value of note

Less than market rate

On January 2, 2013, Midwestern Corporation purchased equipment by signing a noninterest-bearing note requiring

$50,000 to be paid on December 31, 2014 The prevailing market rate of interest on notes of this nature is 10%

January 2, 2013; December 31, 2013 (year-end), and

Discount on note payable ……… 4,132

To record interest expense.

December 31, 2014:

Interest expense (10% of ($41,323+$4,132)) 4,545

Discount on note payable …… …… … 4,545

To record interest expense.

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 records

• The donated asset at fair value

• Revenue equal to the fair value of the donated asset

Donated Assets: Government Grants

• IAS No 20 requires government grants to be

categorized as either asset related or income related

Donated Assets : Government Grants

Impact on statement of comprehensive income is the

same for either accounting method Additional

disclosures may be required.

Fixed-Asset Turnover Ratio

This ratio measures how effectively a company manages its fixed assets to generate revenue.

Net sales

Average fixed assets

Fixed asset turnover ratio

=

Gymboree generates $0.44 more in sales dollars

for each dollar invested in fixed assets

Gymboree generates $0.44 more in sales dollars

for each dollar invested in fixed assets

= 5.13

$14,526($2,933 + $3,267)/2 = 4.69

$1,001($204 + $186)/2

2009 2008 2009 2008 Property, plant, and

equipment (net) $ 2,933 $ 3,267 $ 204 $ 186 Net sales 14,526 1,001

GAP Gymboree

 Update depreciation to date of disposal

 Remove original cost of asset and accumulated

depreciation from the books

 The difference between book value of the asset and the amount received is recorded as a gain or loss

On June 30, 2013, MeLo, Inc sold equipment for $6,350 cash The equipment was purchased on January 1, 2008 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, 2012, its year-end.

record the disposition of this equipment.

 Update depreciation to date of sale.Dispositions

June 30, 2013:

Depreciation expense ($15,000 ÷ 10 years) × ½) 750

Accumulated depreciation ……… 750

To update depreciation to date of sale.

 Remove original asset cost and accumulated depreciation.

 Record the gain or loss

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 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 net book value of the asset(s) given up, plus (or minus) any cash exchanged No gain is recognized

Fair Value Not Determinable

Matrix, Inc exchanged used equipment for newer equipment Due to the nature of the assets exchanged, Matrix could not determine the fair value of the asset given

up or received The asset given up originally cost

$600,000, and had an accumulated depreciation balance of $400,000 at the time of the exchange Matrix exchanged

the asset and paid $100,000 cash

Let’s record this unusual transaction

Matrix, Inc.

The journal entry below shows the proper

recording of the exchange.

Matrix, Inc.

The journal entry below shows the proper

recording of the exchange.

Fair Value Not Determinable

Equipment ($200,000 + $100,000) 300,000

Accumulated depreciation ….……… 400,000

Equipment ……… 600,000 Cash ……… 100,000

To record equipment acquired in exchange.

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

Matrix, Inc exchanged new equipment and $10,000 cash

for equipment owned by Float, Inc

Below is information about the asset exchanged by Matrix

Record the transaction assuming the exchange has

commercial substance

Gain = Fair Value – Book ValueGain = $205,000 – $200,000 = $5,000

To record the exchange of equipment.

$205,000 fair value + $10,000 cash

Equipment 210,000

Accumulated depreciation……… 300,000

Equipment ……… 500,000 Cash ……… 10,000

To record the exchange of equipment.

$200,000 book value + $10,000 cash

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 and other costs that are incurred

in connection with the borrowing of funds that are directly attributable to the acquisition, construction or production of

Asset that necessarily

takes a substantial period

of time to get ready for its

intended use.

Under certain conditions, borrowing costs

incurred on qualifying assets is capitalized.

Capitalization begins when:

• construction begins

• Borrowing cost is incurred, and

• qualifying expenses are incurred.

Capitalization ends when:

• the asset is substantially complete and ready for its intended use, or

• when borrowing costs no longer are being incurred.

Borrowing Cost Capitalization

Borrowing Cost 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

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

Interest Capitalization

Welling, Inc is constructing a building for its own use

Construction activities started on May 1 and have continued through Dec 31 Welling made the following qualifying expenditures: May 1, $125,000; July 31, $160,000, Oct 1,

$200,000; and Dec 1, $300,000 Welling borrowed $1,000,000

on May 1, from Bub’s Bank for 10 years at 10 percent to

finance the construction The loan is related to the construction project and the company uses the specific interest

Average Accumulated Expenditures

Fraction of Construction

Since the $1,000,000 of specific borrowing is sufficient to cover the $337,500 of average accumulated expenditures for the year, use the specific borrowing rate of 10 percent to

determine the amount of interest to capitalize

Interest = AAE × Specific Borrowing Rate × TimeInterest = $337,500 × 10% × 8/12 = $22,500

The loan, initiated on May 1, is outstanding for 8 months of the year

Interest Capitalization

If Welling had not borrowed specifically for this constructionproject, it would have used the weighted-average interestmethod The weighted average interest rate on other debtwould have been used to compute the amount of interest tocapitalize For example, if the weighted-average interestrate on other debt is 12 percent, the amount of interest

capitalized would be:

Interest = AAE × Weighted-average Rate × Time Interest = $337,500 × 12% × 8/12 = $27,000

If Welling had not borrowed specifically for this constructionproject, it would have used the weighted-average interestmethod The weighted average interest rate on other debtwould have been used to compute the amount of interest tocapitalize For example, if the weighted-average interest

capitalized would be:

Interest = AAE × Weighted-average Rate × Time Interest = $337,500 × 12% × 8/12 = $27,000

Interest Capitalization

If specific new borrowing had been insufficient to cover the average accumulated expenditures

If specific new borrowing had been insufficient to cover the average accumulated expenditures

Specific new borrowing

Research and Development (R&D)

• Development is the application of research findings or other

knowledge into a plan or design for the production of new or substantially improved materials, devices, products, process, systems or services before the start of commercial production or use

Most R&D costs are expensed as incurred (Must be disclosed if material.)

• Development is the application of research findings or other

knowledge into a plan or design for the production of new or substantially improved materials, devices, products, process, systems or services before the start of commercial production or use

Most R&D costs are expensed as incurred (Must be disclosed if material.)

 R&D costs incurred under contract for other companies are capitalized

as inventory and carried forward into future years.

 Costs of assets purchased for R&D purposes are expensed in the

period unless they have alternative future uses.

 R&D costs incurred under contract for other companies are capitalized

as inventory and carried forward into future years.

 Costs of assets purchased for R&D purposes are expensed in the

period unless they have alternative future uses.