Chapter 10: Acquisition and Disposition of Property, Plant, and Equipment

Question 1

Conditional Contribution

Answer 1

Has TERMS

1) specifies a “barrier” or “hurdle” that the recipient must overcome to be entitled to the resources (measurable performance requirements)
2) releases donor from obligation to transfer resources if condition is not met, or even demand their return

journalized when conditions are met and contribution received as “contribution revenue”

Question 2

Contribution of assets

Answer 2

Grants, donations, gifts or forgiveness of debt

Question 3

Contributions

Answer 3

Usually recorded as an asset at fair value and contribution revenue

Conditional: income recognition deferred
unconditional: income recognized immediately

Question 4

Fully depreciated assets still in service

Answer 4

Kept on books @ historical cost less depreciation (residual value)

disclose in notes)

Question 5

Scrapping or abandoning an asset

Answer 5

Without any asset recovery:
- recognize loss = book value

If scrap value exists:
- gain or loss is the change in scrap value + book value

Question 6

Involuntary conversion

Answer 6

Loss of asset via fire, flood, theft, condemnation etc…

report difference between value recovered (insurance recovery) if any and book value as gain or loss

reported in “other revenues and gains” or “other expenses and losses”

Question 7

Plant asset disposal

Answer 7

Disposal by: sale, exchange, or retirement (aka scrapped, discarded)

Depreciation recorded to date of disposal (or until book value = salvage value)
- if not up to date it must be brought up to date before disposal journalized

Debit Accumulated Depreciation
Credit Asset account

+ recognize any value received or loss (loss of salvage value)

Question 8

Gain or loss on disposal of plant assets

Answer 8

Really a correction of net income for the years the assets used

in income statement with customary business activities UNLESS it is sold/ abandoned/disposed of as part of a strategic shift - then reported with discontinued operations

Question 9

Journaling major repairs

Answer 9

If repairs will benefit several periods then handle as an addition, improvement or replacement

accrual of planned repairs in advance is not permitted

Question 10

Extraordinary repairs

Answer 10

AKA “major repairs”

Repair work that generates a capital expenditure because it extends the assets life past the normal expected life

Debited to an asset account
- useful life of asset increased
or quality of units produced from asset increased
or quality of units produced for the assets enhanced

Question 11

Rearrangement and re-installation of existing asset

Answer 11

Done to benefit future periods

• if original installation cost can be ascertained or estimated record as “replacement”
• otherwise material amounts are capitalized as an asset to be amortized
• if amount is not material or future benefit is questionable then record as expense

Question 12

Substitution approach

Answer 12

if the carrying amount of the old asset is available then remove the cost of the old and replace with the new - journalize as an exchange

Debit Plant Assets (new)
Debit Accumulated Depreciation (old- remove from books)
Debit loss or Credit Gain
Credit Plant Assets (old - remove from books)
Credit cash paid

Question 13

Improvements and replacements of existing plant assets

Answer 13

Improvement - substitution of better asset
Replacement - substitution of similar asset

If it is increasing future service potential:

• substitution approach
• capitalize new cost, keeping old carrying amount on the books (common practice)
• charge to accumulated depreciation (extended life without improved quality)

Question 14

Additions to existing plant assets

Answer 14

Generally capitalized as a new asset created

capitalize expenditure
amortize expense over future periods to match revenue from addition

sometimes dependent on intent

Question 15

Major types of expenditures on existing assets

Answer 15

Additions: increase or extension

Improvements & replacements

Rearrangement & reinstallation

repairs: maintains assets in operating condition

Question 16

Capital expenditures

Answer 16

Debit asset account (increase)

Credit cash or A/R

Question 17

Gains or losses on PP&E on financial statements

Answer 17

Shown in “other revenue and gains” or “other expenses and losses” not considered an operating expense

Question 18

Result of incorrect capitalization on financial statements

Answer 18

Capitalization delays expense recognition to future periods - boosts current period profits

Question 19

Journaling exchange of equipment / plant assets

Answer 19

Debit Equipment (new)
Debit Accumulated Depreciation (old - remove from books)
Debit loss or Credit gain on disposal
Credit Equipment (old - remove from books)
Credit Cash paid out

Question 20

Imputed interest rate on deferred payment contract

Answer 20

Considers credit rating, maturity date, prevailing interest rate

then cash exchange price is used as basis for recording the asset and measuring interest

Question 21

Valuation of assets purchased on long-term credit

Answer 21

Recorded at the present value of the consideration exchanged between the contracting parties at the date of the transaction

Question 22

Basic asset valuation

Answer 22

Fair value of what is given up or fair value of asset received, whichever is more clearly evident

Question 23

Interest Revenue and Capitalization

Answer 23

Should not net/ offset revenues against costs

Question 24

Capitalizing interest on land expenditures

Answer 24

Land purchased for a structure means that interest costs during construction are capitalized to plant, not to land

if land is the product then interest can be capitalized to land

interest not capitalized to land held for speculation

Question 25

Interest Capitalization

Answer 25

Basically because assuming debt being used to finance payments made in construction so applying interest from borrowing that money as a construction costs

interest to payments as if that money was earning interest after it is spent

Question 26

Interest capitalization

Answer 26

If amount is material must disclose amounts of capitalized interest relative to total interests costs

Question 27

Weighted-average interest rate

Answer 27

Total interest / total principal = weighted rate

Question 28

Weighted average accumulated expenditures

Answer 28

Multiply the interest rates by this to determine potential amount of interests to capitalize for qualifying assets

Weighs construction expenditures by amount of time (fraction of year or accounting periods) that it CAN incur interest

$ is less then or equal to the amount borrowed then use the rates on borrowed money

$ is greater then debt incurred use the weighted average of interest rates incurred on all other outstanding debt during period

Question 29

Amount of interest to capitalize during construction

Answer 29

Limited to lower of interest costs actually incurred or avoidable interest

• only if interest effect is material
• never cost of capital charge to SE

Uses weighted average accumulated expenditures

Question 30

Avoidable interest

Answer 30

for capitalizing interest

Amount of interest cost during a period that a company could have theoretically avoided if it had not made expenditures on the asset

Question 31

Assets that qualify for interest capitalization

Answer 31

Must require a period of time to get them ready for their initial use:

• starts capitalizing interest costs with the 1st expenditure related to the asset
• continues until asset is substantially ready for use

Assets: for company’s own use, for sale or lease or otherwise intended as discrete projects

Question 32

Capitalizing Interest During Construction per GAAP

Answer 32

Capitalize only the actual interest costs incurred during construction (lower of actual or avoidable)

• only interest incurred through debt financing
• all costs - including interest - incurred to bring the asset to the condition and location necessary for its intended use
• after construction interest is expensed

Must consider:

• qualifying assets
• capitalization period
• amount to capitalize

Question 33

Capitalization Period

Answer 33

Period of time during which a company must capitalize interest

Requires following conditions and continues as long as they are present:

• expenditures for the asset have been made
• activities that are necessary to get the asset ready for its intended use are in progress
• interest cost is being incurred

Question 34

Valuing self-constructed assets

Answer 34

Materials & direct labor

2 options for overhead:

• not assign any (presuming overhead all fixed)
  - would still assign some variable overhead
• full costing approach
  - assign a portion of overhead
  - pro rata portion of fixed overhead
  - this offers better cost recognition

If costs > costs of independent producer
excess = period loss to capitalize near fair value

Question 35

Cost / valuation of land

Answer 35

Land is not depreciated

All expenditures made to acquire land and make it ready for use

• purchase price
• closing costs
• preparation for use (including assessments / removal of old buildings)
• liens/ mortgages
• land improvements with INDEFINITE life
• LESS any proceeds (like sale of cleared timber)

improvements with limited lives are recorded as separate assets
- land can be an investment or inventory

Question 36

Valuation of PP&E

Answer 36

at historical cost
- cash or cash equivalent price of obtaining the asset and bringing it to the location and condition necessary for its intended use

asset retirement obligations

Question 37

Depreciation

Answer 37

A process of cost allocation (not asset valuation)
- allocates expenses to period that benefits from the use of the asset (matching principle)

does not apply to land

shows how revenue producing ability declines over an assets natural life

depreciation stops when book value = salvage value

long lived assets not depreciated if held for sale

Question 38

PP&E Write downs

Answer 38

if fair value is less than carrying balue

Happens when:

• asset is impaired
• asset is being held for sale

Question 39

(to) Capitalize

Answer 39

Recording the acquisition of land, building or other assets by debiting (increasing) an asset account

For PP&E post acquisition costs ONLY if provide future service potential

Question 40

Types of expenditures on plant assets

Answer 40

Ordinary expenditures / revenue expenditures:
- maintaining operating efficiency, shows in income statement for that period

Capital expenditures (addition and improvements)

• increases the operating efficiency, capacity or useful life
• bit the plant asset effected and then depreciated over useful life

Question 41

Plant assets

Answer 41

includes land improvements

Attributes:

• possesses physical substance
• used in operations
• not for resale to customers
• long-term
• usually depreciated expense

aka: property, plant & equipment (PP&E), plant & equipment or fixed assets

Question 42

Classes of plant assets

Answer 42

• Land (for use in ops not investment property)
• Land improvements (driveways, parking lots, etc…tend to have limited useful lives)
• Buildings (use in ops, not investments)
• Equipment

Question 43

Costs of plant assets

Answer 43

Not including maintenance and upkeep

• always at historical cost (cost principle)
• the asset is shown at that cost for its entire useful life. the contra asset account shows accumulated depreciation
• cost includes all necessary expenditures to acquire asset and make it ready for use (inc bringing it to location)
  
  • including: fees and commissions, closing costs, costs to make ready (improvements, removals), taxes, freight, discounts, trial runs, and interest costs (interest costs only during construction and only if it’s for a significant period of time)

Question 44

Impairment

Answer 44

A permanent decline in asset value down to less than the book value

intangible assets tested for impairment annually and if it occurs company records a loss in the period the decline is identified

Question 45

Land improvements

Answer 45

A depreciable improvement to land such as fencing, sprinklers, paving, signs or lighting

NOT included as cost of land (which does not depreciate) but as individual depreciable assets

Question 46

Exchange of non-monetary assets

Answer 46

Recorded on the basis of the fair value of the asset given up or the fair value of the asset received - whichever is more clearly evident

gains or losses are recognized immediately - As long as exchange has commercial substance

if no commercial substance then generally recognize a loss but defer any gains

Question 47

Commercial substance

Answer 47

Exchanges have commercial substance if future cash flows change as a result of the exchange

Question 48

Nonmonetary assets

Answer 48

Items whose price in terms of the monetary unit may change over time

Question 49

Capital Expenditure vs Revenue Expenditures

Answer 49

Capital expenditure

• balance sheet expenditure
• increases capacity or efficiency or extends useful life
• debited to an asset account

Revenue expenditure

• income statement expenditure
• does not increase capacity, efficiency, or life - just basic maintenance
• debited to an expense account

Question 50

Acquisition of PP&E with stock

Answer 50

If stocks actively traded: market price of stock issued used as value

if market value of stocks not available: use value of property as the basis of valuation

use whichever is more easily identifiable

Question 51

Cost approach to valuation

Answer 51

Based on the amount that would current be required to replace the service capacity of an asset

current replacement cost

Question 52

Income approach to valuation

Answer 52

Uses valuation technique to convert future amounts to a single present value amount (discounted)

Question 53

Market valuation approach

Answer 53

To determine fair value using observable prices / other information generated by market transactions involving comparable assets

Question 54

Relative Market Value Method (lump sum PP&E purchases)

Answer 54

Aka Relative Fair Value

A method of allocating the total cost of multiple assets purchased at one time (lump sum or basket). Total cost is divided among the assets according to their relative value.

Market value as a percent of total market value, use that percentage to calculate relative market value

Question 55

Prudent Cost

Answer 55

If a company overpaid for an asset through ignorance it is preferable to charge a loss immediately (but savings do not result in recognition of a gain)

Question 56

Recognizing gains and losses on exchanges of non-monetary assets

Answer 56

1) computer the total gain or loss
- gain or loss = fair value of asset given up less book value
a) ) if loss, recognize entire loss

Question 57

Recognizing gains and losses on exchanges of non-monetary assets

Answer 57

1) computer the total gain or loss
- gain or loss = fair value of asset given up less book value
a) if loss, recognize entire loss
b) if gain:
2) if exchange has commercial substance: recognize entire gain
3) if exchange lacks commercial substance:
a) no cash involved = no gain recognized
b) some cash given: no gain recognized
c) some cash received: recognize partial gain
cash received/ (cash received + fair value of other assets received) x total gain

Question 58

Non-monetary exchanges on financial statements

Answer 58

must disclose

• nature of the transaction
• method of accounting for exchange
• gain or loss recognized

Question 59

Journaling asset exchanged, cash received, no commercial substance

Answer 59

Debit Cash Received
Debit Asset Received
Debit Accumulated Depreciation (old)
             Credit gain on disposal (but ONLY PARTIAL - deferred amount in basis of new machine)
               Credit Equipment (old)

Question 60

Recognized gain in asset exchange which lacks commercial substance but cash is received

Answer 60

Cash Received (aka Boot) / (cash received + fair value of other assets received) x total gain

Question 61

Journaling: valuation on new asset exchanged, no commercial substance

Answer 61

Fair Value of item
less gain deferred

or

IF cash paid
Book value of used item
plus cash paid

or

IF cash received
Book value of used item
less portion of book value ????? (cash received / fair value used item x book value)

Question 62

Asset exchange, no cash received, no commercial substance

Answer 62

Recognizes only losses, defers gains via lower depreciation or eventual sales price

CHECK THIS ONE!

Equipment Received (plug value)
Accumulated depreciation (account balance)
Equipment Given Up (historical cost)
Cash paid

Value of new equipment = book value + cash paid or fair value less gain deferred

Question 63

Valuation of exchanged assets

Answer 63

Fair value of item given up + cash paid (could be list price or list price less trade in allowance)
= cost / value of new asset

Question 64

Exchange of Equipment (non-monetary assets)

Answer 64

WITH commercial substance

Equipment Received
Accumulated depreciation for old equipment
Debit loss or credit gain on disposal
       Equipment given up
       Cash given up

Question 65

Loss or gain on disposal of exchanged equipment

Answer 65

Fair value of equipment
less book value
= gain or loss on disposal

Question 66

Asset exchange

Answer 66

• Exchange has commercial substance: recognize gains and losses immediately
• Exchange lacks commercial substance, no cash received: defer gains, recognize losses immediately
• Exchange lacks commercial substance - cash received: recognize partial gain, recognize all losses immediately (unless gain is > 25% of fair value then recognize entire gain)