Ch. 10 Acquisition and Disposition of PP&E

Question 1

1. Describe PP&E

3 Statements:

1. Resale or Operations?
2. Long-term or short-term
3. soft or hard assets?

Answer 1

1. The major characteristics of property, plant, and equipment are as follows. (1) They are acquired for use in operations and not for resale. (2) They are long-term in nature and usually subject to depreciation. (3) They possess physical substance.

Question 2

2. Identify the costs to include in initial valuation of property, plant, and equipment.

3 Statements:

1. Land
2. Building
3. Equipment

Answer 2

The costs included in initial valuation of property, plant, and equipment are as follows.
Cost of land: Includes all expenditures made to acquire land and to ready it for use. Land costs typically include (1) the purchase price; (2) closing costs, such as title to the land, attorney’s fees, and recording fees; (3) costs incurred in getting the land in condi- tion for its intended use, such as grading, filling, draining, and clearing; (4) assumption of any liens, mortgages, or encumbrances on the property; and (5) any additional land improvements that have an indefinite life.
Cost of buildings: Includes all expenditures related directly to their acquisition or construction. These costs include (1) materials, labor, and overhead costs incurred during construction, and (2) professional fees and building permits.
Cost of equipment: Includes the purchase price, freight and handling charges incurred, insurance on the equipment while in transit, cost of special foundations if required, assembling and installation costs, and costs of conducting trial runs.

Question 3

3. Describe the accounting problems associated with self-constructed assets.

Answer 3

3. Indirect costs of manufacturing create special problems because companies cannot easily trace these costs directly to work and material orders related to the con- structed assets. Companies might handle these costs in one of two ways. (1) Assign no fixed overhead to the cost of the constructed asset, or (2) assign a portion of all overhead to the construction process. Companies use the second method extensively.

Question 4

4. Describe the accounting problems associated with interest capital- ization.

Answer 4

Only actual interest (with modifications) should be capitalized. The ratio- nale for this approach is that during construction, the asset is not generating revenue and therefore companies should defer (capitalize) interest cost. Once construction is completed, the asset is ready for its intended use and revenues can be recognized. Any interest cost incurred in purchasing an asset that is ready for its intended use should be expensed.

Question 5

5. Understand accounting issues related to acquiring and valuing plant assets

Answer 5

The following issues relate to acquiring and valuing plant assets. (1) Cash discounts: Whether taken or not, they are generally considered a reduction in the cost of the asset; the real cost of the asset is the cash or cash equivalent price of the asset. (2) Deferred-payment contracts: Companies account for assets purchased on long-term credit contracts at the present value of the consideration exchanged between the con- tracting parties. (3) Lump-sum purchase: Allocate the total cost among the various assets on the basis of their relative fair values. (4) Issuance of stock: If the stock is actively traded, the market price of the stock issued is a fair indication of the cost of the property acquired. If the market price of the common stock exchanged is not determinable, estab- lish the fair value of the property and use it as the basis for recording the asset and issu- ance of the common stock. (5) Exchanges of nonmonetary assets: The accounting for ex- changes of nonmonetary assets depends on whether the exchange has commercial substance. See Illustrations 10-10 (page 551) and 10-20 (page 554) for summaries of how to account for exchanges. (6) Contributions: Record at the fair value of the asset received, and credit revenue for the same amount

Question 6

6. Describe the accounting treatment for costs subsequent to acquisition

Answer 6

Additions
Capitalize cost of addition to asset account.

Improvements and replacements

(a) Carrying value known: Remove cost of and accumulated depreciation on old asset, recognizing any gain or loss. Capitalize cost of improvement/ replacement.
(b) Carrying value unknown:
1. If the asset’s useful life is extended, debit accumulated depreciation
for cost of improvement/replacement.
2. If the quantity or quality of the asset’s productivity is increased, capitalize
cost of improvement/replacement to asset account.

Rearrangement and reinstallation

(a) If original installation cost is known, account for cost of rearrangement/ reinstallation as a replacement (carrying value known).
(b) If original installation cost is unknown and rearrangement/reinstallation cost is material in amount and benefits future periods, capitalize as an asset.
(c) If original installation cost is unknown and rearrangement/reinstallation cost is not material or future benefit is questionable, expense the cost when incurred.

Repairs

(a) Ordinary: Expense cost of repairs when incurred.
(b) Major: As appropriate, treat as an addition, improvement, or replacement.

Question 7

7. Describe the accounting treatment for the disposal of property, plant, and equipment

Answer 7

Regardless of the time of disposal, companies take depreciation up to the date of disposition and then remove all accounts related to the retired asset. Gains or losses on the retirement of plant assets are shown in the income statement along with other items that arise from customary business activities. Gains or losses on involuntary conversions, if unusual and infrequent, may be reported as extraordinary items.