Ch 10 Flashcards
How relevant is Fair value to property, plant and equipment?
Not very
Consistent with going concern assumption that it’s held
For use of business not for sale like inventory
Property, plant and equipment AKA Plant Assets
AKA Fixed Assets
Land,
building structures (offices, factories, warehouses),
Equipment (machinery, furniture, tools)
3 major characteristics with property, plant and equipment?
1 acquired for use in operations, not for resale
2 Longterm in nature and usually depreciated
3 they possess physical substance
Historical cost
Measures cash price of obtaining the asset and
Bringing to location + condition necessary for use
Under IFRS, historical cost for property, plant and equipment is the…
Benchmark (preferred) treatment
However companies may revalue these assets regularly
2 reasons subsequent to acquisition, why companies should not write up property, plant, equipment to reflect fair value when it’s above cost?
1 historical cost is most reliable (includes actual transactions)
2 companies should not anticipate gains and losses
But should recognize them when asset is sold
Removal of old buildings, clearing, grading and filling is a…why?
Land cost
because activity is necessary to condition land for
intended purpose
Special assessments for local improvements 4 examples?
Pavements, street lights, sewers, drainage systems
4 examples of improvements with limited lives?
Driveways, walks, fences, parking lots
If land is held for speculation it should be classified as?
If a real estate concern holds land for resale it should be classified as?
An investment
Inventory
Self constructed asset accounting problems?
When company makes its own equipment it’s hard
To allocate indirect costs
There’s no purchase or contract price
2 ways a company can handle indirect costs when they make their own equipment?
1 assign no fixed overhead to cost of constructed asset
2 assign full portion of all overhead to construction process
Assigning no fixed overhead to cost of constructed asset assumes?
Company will have same overhead costs regardless
Company assigns variable overhead costs that would
Increase due to the construction
Full costing approach, definition? Belief?
Assign portion of all overhead to construction process
Of self made asset
Belief that all costs should attach to all products
And assets manufactured
Companies should assign to a self constructed asset a…
Pro rata portion of fixed overhead to determine its cost
3 suggested approaches to account for interest incurred in financing construction of property, plant and equipment?
1 capitalize no interest charges during construction
2 charge construction with all costs of funds employed,
Whether identifiable or not
3 capitalize only actual interest cost incurred during
construction
Interest costs Approach: Capitalize no interest charges during construction
Interest is considered a cost of financing and not
A cost of construction
Interest costs Approach: charge construction with all costs of funds employed whether identifiable or not
Cost of construction should include cost of financing
Whether by cash, debt or stock
Interest cost approach: capitalize only actual interest costs incurred during construction
Capitalizes interest costs incurred through debt financing
GAAP Aproach
3 items considered in capitalizing interest approach?
1 qualifying assets
2 capitalization period
3 amount of capitalize
The objective of capitalizing interest is to obtain a…
Measure of acquisition cost that reflects company’s total
Investment in the asset
and charge that cost to future periods Benefited
2 general kinds of Qualifying assets for interest cost capitalization? Give examples
1) Assets under construction for company’s use (buildings,
Plants, large machinery)
2) assets intended for sale or lease that are constructed
(ships, real estate developments)
2 types of assets that do not qualify for interest capitalization? Examples
1 assets in use or ready for intended use
2 assets that company does not use in its earning activities
And not undergoing activities intended to get ready for use
Ex land remaining undeveloped,
assets not used from excess capacity
Need for repair
Capitalization period
Period of time during which company must capitalize
Interest
Ends when asset is substantially complete and ready
For intended use
3 conditions of capitalization period?
1 expenditures for assets have been made
2 activities necessary to get asset ready for intended use
Are in progress
3 interest cost is being incurred
IFRS changes made for capitalizing interest as part of IASB’s convergence project?
IFRS now requires companies to capitalize borrowing costs
Related to qualifying assets
Avoidable interest
Amount of interest cost during period company Could theoretically avoid if it hadn’t made expenditures For asset
Determining the potential amount of interest under
The avoidable interest concept: equation
Potential amount of interest = Interest rate(s) X (weighted-average accumulated expenditures)
For portion of weighted avg. accumulated expenditures that is less than or equal to any amounts borrowed specifically to finance construction of assets use the…
Interest rate incurred on specific borrowings
For the portion of weighted avg. accumulated expenditures that is greater than any debt incurred specifically to finance construction use…
Weighted avg. of interest rates incurred on all outstanding
Debt during period
2 special issues related to interest capitalization?
1 expenditures for land
2 interest revenue
If a company purchases land as a site for a structure (such as a plant site) interest costs capitalized during the period of construction are…
Part of the cost of the plant, not the land
Purchase of land for speculation, how are interest costs treated?
Should not capitalize interest costs in purchasing
Land held for speculation because asset ready for intended use
IFRS requires interest revenue earned on specific borrowings should…
Offset interest costs capitalized
Should companies offset interest revenue against interest cost when determining amount of interest to capitalize as part of construction cost of assets?
Companies should not net or offset interest revenue
Against interest cost
Valuation: companies should record property, plant and equipment at…
The fair value of what they give up
Or at fair value of asset received
Companies account for assets purchased on long term credit contracts at…
Present value of consideration exchanged btw
contracting parties at date of transaction
How does the company use the cash exchange price of the asset acquired?
Cash exchange price used as,
basis for recording asset and measuring interest element
When a company purchases a group of plant assets at a single lump sum price, how does the company valuate the transaction?
Company allocates total cost among various assets on
Basis of their relative fair values
When a company acquires property by issuing securities, such as common stock, what is a fair indication of cost of the property? What is not a good indication?
Market price of stock issued is fair indication of
cost of property acquired (at current cash equivalent price)
Par or stated value of stock fails to properly measure
Property cost
How do companies account for no monetary assets?
On basis of fair value for assets given up or assets received
Companies should recognize gains and losses immediately
An exchange has commercial substance if?
Future cash flows change and economic position as
result of transaction
How is an exchange of nonmonetary assets accounted for when it lacks commercial substance?
Defer gains, recognize losses immediately
Exchange has commercial substance
Recognize gains and losses immediately
Exchange lacks commercial substance, cash received?
Recognize partial gain; recognize losses immediately
Formula for gain recognition, some cash received?
Recognized gain =
Total gain X
(Cash received (boot)
/cash received (boot) + fair value other assets Received)
Contributions
Donations or gifts
Non reciprocal transfers, examples?
Transfer of assets in one direction
Ex. Cash, land, securities, buildings, use of facilities
How are no reciprocal transfers accounted for?
Fair value of asset to establish value on books
FASB’s position on recognizing received no reciprocal transfers?
Recognize as revenues in period received
Unconditional, contribution expense
Depends only on passage of time or demand by recipient on performance
Company should record contribution expense (donation
expense) immediately
Conditional contribution expense
Company recognizes expense in period benefited
By contribution
Prudent cost concept
If company ignorantly paid too much for asset
It’s theoretically preferable to charge a loss immediately
Costs incurred to achieve greater future benefits should be…
Whereas expenditures that simply maintain a given level of service should be…
Capitalized
Expensed
3 conditions required to capitalize costs?
1 useful life of asset must be increased
2 quantity of units produced from asset must be increased
3 quality of units produced must be enhanced
4 Major types of expenditures?
1 additions
2 improvements and replacements
3 rearrangement and reinstallation
4 repairs
Expenditure: additions, define? How should they be accounted for and why?
Increase or extension of existing assets
Companies capitalize any addition to plant assets
Because new asset is created
Expenditure: improvements and replacements
Substitution of an improved asset for an existing one
Expenditure: rearrangement and reinstallation
Movement if assets from one location to another
Benefits future periods
Repairs
Expenditures that maintain assets in condition for operations
What is the difference btw an improvement and a replacement?
Substitution of a better asset for the one currently used
Replacement = substitution of similar asset
Accounting for improvements and replacements 3 ways?
1 use substitution approach
2 capitalize new cost
3 charge to accumulated depreciation
Improvements and replacements: substitution approach, requirement? Define?
Correct if carrying amount of old asset is available
Remove the cost of old asset to replace with new asset
Improvements and replacements: capitalize new cost
Capitalizes improvements
And keeps,carrying amount of old asset on books
Improvements and replacements: charge to accumulated depreciation, define? How is it debited in the journal?
When company does not improve quantity or quality
Of asset itself but extends its useful life
Company debits expenditure to Accumulated Depreciation
How are repairs accounted for?
Charges ordinary repairs to expense account in
period incurred on basis that it’s primary period benefited
Major repair, such as an overhaul. How should it be accounted for?
Cost should be handled as an addition, improvement or replacement
Improvements and replacements: carrying value known how is it accounted for?
Remove cost of and accumulated depreciation on old asset
Recognizing gain or loss
Capitalize cost of improvement or replacement
Improvements and replacements: carrying value unknown 2 conditions?
1 assets useful life is extended, debit acc. Depr.
For cost of improvement/replacement
2 if quantity or quality of asset’s useful life is increased
Capitalize cost of improvement/replacement to asset acct.
Rearrangement and reinstallation: if original installation cost is known?
Account for cost of rearrangement/reinstallation as
replacement (carrying amount known)
Rearrangement and reinstallation: if original installation cost is unknown and rearrangement/reinstallation cost is material in amount and future benefits?
Capitalize as asset
Rearrangement and reinstallation: if original installation cost is unknown and rearrangement/reinstallation cost is immaterial or future benefit is questionable?
Expense cost when incurred
Involuntary conversion, define, examples?
Asset’s service terminated involuntarily
Ex. Fire, flood, theft, condemnation
