Chapter 10: Acquisition and Disposition of Property, Plant, and Equipment Flashcards
Conditional Contribution
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”
Contribution of assets
Grants, donations, gifts or forgiveness of debt
Contributions
Usually recorded as an asset at fair value and contribution revenue
Conditional: income recognition deferred
unconditional: income recognized immediately
Fully depreciated assets still in service
Kept on books @ historical cost less depreciation (residual value)
disclose in notes)
Scrapping or abandoning an asset
Without any asset recovery:
- recognize loss = book value
If scrap value exists:
- gain or loss is the change in scrap value + book value
Involuntary conversion
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”
Plant asset disposal
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)
Gain or loss on disposal of plant assets
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
Journaling major repairs
If repairs will benefit several periods then handle as an addition, improvement or replacement
accrual of planned repairs in advance is not permitted
Extraordinary repairs
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
Rearrangement and re-installation of existing asset
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
Substitution approach
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
Improvements and replacements of existing plant assets
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)
Additions to existing plant assets
Generally capitalized as a new asset created
capitalize expenditure
amortize expense over future periods to match revenue from addition
sometimes dependent on intent
Major types of expenditures on existing assets
Additions: increase or extension
Improvements & replacements
Rearrangement & reinstallation
repairs: maintains assets in operating condition
Capital expenditures
Debit asset account (increase)
Credit cash or A/R
Gains or losses on PP&E on financial statements
Shown in “other revenue and gains” or “other expenses and losses” not considered an operating expense
Result of incorrect capitalization on financial statements
Capitalization delays expense recognition to future periods - boosts current period profits
Journaling exchange of equipment / plant assets
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
Imputed interest rate on deferred payment contract
Considers credit rating, maturity date, prevailing interest rate
then cash exchange price is used as basis for recording the asset and measuring interest
Valuation of assets purchased on long-term credit
Recorded at the present value of the consideration exchanged between the contracting parties at the date of the transaction
Basic asset valuation
Fair value of what is given up or fair value of asset received, whichever is more clearly evident
Interest Revenue and Capitalization
Should not net/ offset revenues against costs
Capitalizing interest on land expenditures
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
Interest Capitalization
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
Interest capitalization
If amount is material must disclose amounts of capitalized interest relative to total interests costs
Weighted-average interest rate
Total interest / total principal = weighted rate
Weighted average accumulated expenditures
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
Amount of interest to capitalize during construction
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
Avoidable interest
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
Assets that qualify for interest capitalization
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
Capitalizing Interest During Construction per GAAP
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
Capitalization Period
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
Valuing self-constructed assets
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
Cost / valuation of land
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
Valuation of PP&E
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
Depreciation
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
PP&E Write downs
if fair value is less than carrying balue
Happens when:
- asset is impaired
- asset is being held for sale
(to) Capitalize
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
Types of expenditures on plant assets
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
Plant assets
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
Classes of plant assets
- 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
Costs of plant assets
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)
Impairment
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
Land improvements
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
Exchange of non-monetary assets
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
Commercial substance
Exchanges have commercial substance if future cash flows change as a result of the exchange
Nonmonetary assets
Items whose price in terms of the monetary unit may change over time
Capital Expenditure vs Revenue Expenditures
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
Acquisition of PP&E with stock
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
Cost approach to valuation
Based on the amount that would current be required to replace the service capacity of an asset
current replacement cost
Income approach to valuation
Uses valuation technique to convert future amounts to a single present value amount (discounted)
Market valuation approach
To determine fair value using observable prices / other information generated by market transactions involving comparable assets
Relative Market Value Method (lump sum PP&E purchases)
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
Prudent Cost
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)
Recognizing gains and losses on exchanges of non-monetary assets
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
Recognizing gains and losses on exchanges of non-monetary assets
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
Non-monetary exchanges on financial statements
must disclose
- nature of the transaction
- method of accounting for exchange
- gain or loss recognized
Journaling asset exchanged, cash received, no commercial substance
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)Recognized gain in asset exchange which lacks commercial substance but cash is received
Cash Received (aka Boot) / (cash received + fair value of other assets received) x total gain
Journaling: valuation on new asset exchanged, no commercial substance
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)
Asset exchange, no cash received, no commercial substance
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
Valuation of exchanged assets
Fair value of item given up + cash paid (could be list price or list price less trade in allowance)
= cost / value of new asset
Exchange of Equipment (non-monetary assets)
WITH commercial substance
Equipment Received
Accumulated depreciation for old equipment
Debit loss or credit gain on disposal
Equipment given up
Cash given up
Loss or gain on disposal of exchanged equipment
Fair value of equipment
less book value
= gain or loss on disposal
Asset exchange
- 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)
