chapter 10
TRANSCRIPT
Kun Yu, Intermediate Accounting I 8-1
AF310- Intermediate Accounting I
Chapter 10 Acquisition and Disposition
of PPE
Kun Yu, Intermediate Accounting I 8-2
Property, Plant, and Equipment
PPE “Used in operations” and not for resale. Long-term in nature and usually depreciated. Possess physical substance.
Use historical cost to measure PPE Cost related to the acquisition of PPE Cost related to getting PPE ready for use
Kun Yu, Intermediate Accounting I 8-3
Cost of Land Purchase price Closing costs, such as title to the land,
attorney’s fees, and recording fees Costs of grading, filling, draining, and
clearing Assumption of any liens, mortgages, or
encumbrances on the property Additional land improvements that have
an indefinite life.
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Cost of Buildings Materials, labor, and overhead
costs incurred during construction Professional fees and building
permits
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Cost of Equipment purchase price freight and handling charges insurance on the equipment while
in transit cost of special foundations if
required assembling and installation costs costs of conducting trial runs
Kun Yu, Intermediate Accounting I 8-6
Self-Constructed Assets Materials and direct labor Overhead can be handled in two
ways: Assign no fixed overhead Assign a portion of all overhead to the
construction process.
Kun Yu, Intermediate Accounting I 8-7
Interest Capitalization Interest costs during construction need to be
capitalized Interest costs after construction need to be
expensed Computation of the amount to be capitalized
Compute weighted average accumulated expenditures Expenditures are weighted by the amount of time that interest
cost is incurred. Compute avoidable interest cost and actual interest cost
Avoidable interest cost: the amount of interest that could have been avoided if expenditures for the asset had not been made
Apply the interest rate on the specific borrowings for the portion below the amount of specific borrowings
Apply weighted average interest rate on other borrowings for the portion above the amount of specific borrowings
Capitalize the lesser of avoidable interest cost or actual interest cost
Kun Yu, Intermediate Accounting I 8-8
Interest Capitalization Illustration: KC Corporation borrowed $200,000 at 12% interest from State Bank on Jan. 1, 2011, for specific purposes of constructing special-purpose equipment to be used in its operations. Construction on the equipment began on Jan. 1, 2011, and the following expenditures were made prior to the project’s completion on Dec. 31, 2011:Actual Expenditures:
J anuary 1, 2011 $100,000
April 30, 2011 150,000
November 1, 2011 300,000
December 31, 2011 100,000
Total expenditures $650,000
Other general debt existing on Jan. 1, 2011:
$500,000, 14%, 10-year bonds payable
$300,000, 10%, 5-year note payable
Interest Capitalization
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WeightedAverage
Actual Capitalization Accumulated Date Expenditures Period Expenditures
J an. 1 100,000$ 12/ 12 100,000$ Apr. 30 150,000 8/ 12 100,000 Nov. 1 300,000 2/ 12 50,000 Dec. 31 100,000 0/ 12 -
650,000$ 250,000$
A company weights the construction expenditures by the amount of time (fraction of a year or accounting period) that it can incur interest cost on the expenditure.
Compute Weighted Average Accumulated Expenditures
Kun Yu, Intermediate Accounting I 8-10
Accumulated I nterest Avoidable
Expenditures Rate I nterest
200,000$ 12% 24,000$
50,000 12.5% 6,250
250,000$ 30,250$
Avoidable Avoidable InterestInterest
I nterest Actual
Debt Rate I nterest
Specific Debt 200,000$ 12% 24,000$
General Debt 500,000 14% 70,000
300,000 10% 30,000
1,000,000$ 124,000$
Weighted-average interest rate on general
debt
Actual InterestActual Interest
$100,000 $800,000
= 12.5%
Compute the Actual and Avoidable Interest
Kun Yu, Intermediate Accounting I 8-11
Avoidable interest 30,250$
Actual interest 124,000
Journal entry to Capitalize Interest:
Equipment 30,250
Interest expense30,250
Capitalize the Lesser of Avoidable Interest or Actual Interest
Kun Yu, Intermediate Accounting I 8-12
Valuation of PPE Valuation of PPE
the fair value of the asset given up the fair value of the asset received
Cash Discounts — whether taken or not — generally considered a reduction in the cost of the asset.
Lump-Sum Purchases — Allocate the total cost among the various assets on the basis of their fair market values.
Issuance of Stock — The market value of the stock issued is a fair indication of the cost of the property acquired.
Kun Yu, Intermediate Accounting I 8-13
Examples UMB Purchased a equipment with list price
$10,000 and cash discount 5/10, n/30. UMB paid cash within the discount period.
Dr. Equipment 9,500 Cr. Cash 9,500
UMB issued 1000 shares of common stock to purchase land. The market value of the common stock is $10 per share, and par value is $1 per share.
Dr. Land 10,000 Cr. Common stock 1,000 APIC 9,000
Kun Yu, Intermediate Accounting I 8-14
Accounting for Exchanges of nonmonetary Assets
Commercial substance Effect of the transaction on future cash flows
Exchanges have commercial substance Recognize gains and losses immediately
Exchanges have no commercial substance No cash received
Defer gains, but recognize losses immediately Cash received
Recognize partial gains, but recognize losses immediately
Kun Yu, Intermediate Accounting I 8-15
Illustration: Information Processing, Inc. trades its used machine for a new model at Jerrod Business Solutions Inc. The exchange has commercial substance. The used machine has a book value of $8,000 (original cost $12,000 less $4,000 accumulateddepreciation) and a fair value of $6,000. The new model lists for $16,000. Jerrod gives Information Processing a trade-in allowance of $9,000 for the used machine. Information Processing computes the cost of the new asset as follows.
Exchanges: Loss Situation
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Equipment 13,000
Accumulated Depreciation—Equipment 4,000
Loss on Disposal of Equipment 2,000
Equipment
12,000
Cash
7,000
Exchanges: Loss Situation
Kun Yu, Intermediate Accounting I 8-17
Illustration: Interstate Transportation Company exchanged a number of used trucks plus cash for a semi-truck. The used trucks have a combined book value of $42,000 (cost $64,000 less $22,000 accumulated depreciation). Interstate’s purchasing agent, experienced in the second-hand market, indicates that the used trucks have a fair market value of $49,000. In addition to the trucks, Interstate must pay $11,000 cash for the semi-truck. Interstate computes the cost of the semi-truck as follows.
Gains With Commercial Substance
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Semi-truck 60,000
Accumulated Depreciation—Trucks 22,000
Trucks 64,000
Gain on disposal 7,000
Cash 11,000
Gains with Commercial Substance
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Now assume that Interstate Transportation Company
exchange lacks commercial substance. That is, the
economic position of Interstate did not change
significantly as a result of this exchange. In this case,
Interstate defers the gain of $7,000 and reduces the
basis of the semi-truck.
Gains without Commercial Substance: No cash Received
Kun Yu, Intermediate Accounting I 8-20
Semi-truck 53,000
Accumulated Depreciation—Trucks 22,000
Trucks 64,000
Cash 11,000
Gains without Commercial Substance: No cash Received
Kun Yu, Intermediate Accounting I 8-21
When a company receives cash (sometimes referred
to as “boot”) in an exchange that lacks commercial
substance, it may immediately recognize a portion of
the gain. The general formula for gain recognition
when an exchange includes some cash is as follows:
Gains without Commercial Substance: Some cash Received
Kun Yu, Intermediate Accounting I 8-22
Illustration: Queenan Corporation traded in used
machinery with a book value of $60,000 (cost $110,000
less accumulated depreciation $50,000) and a fair value
of $100,000. It receives in exchange a machine with a
fair value of $90,000 plus cash of $10,000.
Gains without Commercial Substance: Some cash Received
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Exchanges without Commercial Substance—Some Cash Received
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Gains without Commercial Substance: Some cash Received
Cash 10,000
Machine 54,000
Accumulated Depreciation—Machine 50,000
Machine 110,000
Gain on disposal of machine4,000
Kun Yu, Intermediate Accounting I 8-25
Summary of Gain and Loss Recognition on Exchanges
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Cost Subsequent to Acquisition
Capitalizing vs. expensing Costs incurred to achieve greater future benefits
should be capitalized (e.g., Additions, improvements or replacements)
Useful life of the asset must be increased. Quantity of units produced from asset must be increased. Quality of units produced must be enhanced
Expenditures that simply maintain a given level of services should be expensed (e.g. ordinary repairs)
WorldCom: Capitalize a significant amount of expenditures to report positive net income
Kun Yu, Intermediate Accounting I 8-27
Disposal of PPE Gain (loss) = Selling price of PPE – Net book value
of PPE
Eliminate all the accounts related to the sold PPE PPE Accumulated Depreciation
E.g. Federal Express sold a small delivery truck that had been used in the business for the last three years. The company’s records shows the following:
Delivery truck cost $28K Accumulated depreciation $23K
Kun Yu, Intermediate Accounting I 8-28
Disposal of PPE Give the journal entry assuming the truck was sold for:
1. $5.2k
1. $4.6K
Dr. Cr.Cash (+A) 5.2Accumulated depreciation (-XA, +A) 23
Delivery truck Inventory (-A) 28 Gain (+SE) 0.2
Dr. Cr.Cash (+A) 4.6
Accumulated depreciation (-XA, +A) 23Loss (-SE) 0.4
Delivery truck Inventory (-A) 28