FAR SEC 8 Flashcards
What is the definition of Property, Plant, & Equipment (PPE)? (5 elements)
1) These assets are called property, plant, and equipment; fixed assets; or plant assets. They provide benefits from their use in the production of goods and services, not from their consumption.
2) PPE are tangible. They have physical existence.
3) PPE may be either personal property (something movable, e.g., equipment) or real property (such as land or a building).
4) PPE are used in the ordinary operations of an entity and are not held primarily for investment, resale, or inclusion in another product. But they are often sold.
5) PPE are noncurrent. They are not expected to be used up within 1 year or the normal operating cycle of the business, whichever is longer.
How is the carrying amount of PPE calculated?
The carrying amount of an item of PPE is the amount at which it is presented in the financial statements. This amount is equal to the historical cost minus accumulated depreciation and impairment losses.
[Historical or Initial Cost] -[Accumulated Depreciation] - [Impairment Losses] = PPE Asset’s Carrying Amount
What are the seven types of PPE?
1) Land
2) Buildings
3) Land improvements, such as landscaping, drainage, streets, street lighting, sewers, sidewalks, parking lots, driveways, and fences
4) Machinery and equipment, such as furniture, fixtures (personal property permanently attached to real property, such as a central heating system), and vehicles
5) Leasehold improvements, such as buildings constructed on, and other modifications made to, the leased property by a lessee
6) Internally constructed assets
7) Miscellaneous items, such as tools, patterns and dies, and returnable containers
What are the four relevant accounting principles for PPE?
1) PPE are initially measured at historical cost, which consists of
i) The amount paid to acquire the asset and
ii) The costs needed to bring the asset to the condition and location necessary for its intended use.
-The initial measurement embraces all other costs to acquire PPE, transport them to the sites of their intended use, and prepare them for operations.
-Freight-in (transportation-in), installation costs, renovation or reconditioning costs, expenses of tests or trial runs, and insurance and taxes during the preoperations period are capitalized to the initial cost of the asset.
2) Historical cost is adjusted for changes in utility over the life of the asset, e.g., depreciation and impairment.
i) In general, expenses should be recognized at the time related revenues are earned.
ii) However, no direct relationship ordinarily exists between the consumption of service potential and specific revenues. Thus, the depreciation expense must be systematically and rationally allocated to periods expected to be benefited.
3) Depreciation does not start until PPE are placed in operation and begin to contribute economic benefits.
4) Under GAAP, PPE are not revalued upward to reflect appraisal, market, current, or fair values that are above historical cost (or carrying amount) of PPE.
How is PPE initially recognized? (3 elements)
1) PPE are initially measured at historical cost, which consists of
2) The amount paid to acquire the asset and
3) The costs needed to bring the asset to the condition and location necessary for its intended use.
i) The initial measurement embraces all other costs to acquire PPE, transport them to the sites of their intended use, and prepare them for operations.
ii) Freight-in (transportation-in), installation costs, renovation or reconditioning costs, expenses of tests or trial runs, and insurance and taxes during the preoperations period are capitalized to the initial cost of the asset.
How is historical cost adjusted for changes in utility over the life of the asset? (2 elements)
Historical cost is adjusted for changes in utility over the life of the asset, e.g., depreciation and impairment.
1) In general, expenses should be recognized at the time related revenues are earned.
2) However, no direct relationship ordinarily exists between the consumption of service potential and specific revenues. Thus, the depreciation expense must be systematically and rationally allocated to periods expected to be benefited.
What are the six attributes of the initial cost of land for PPE?
1) The costs of acquiring and preparing land for its expected use are capitalized.
2) The price should include not only the cash price but also any encumbrances assumed (such as mortgages or tax liens).
3) The cost of land also includes transaction costs, e.g., surveying costs, legal fees, brokers’ commissions, title insurance, and escrow fees.
4) Site preparation costs [clearing, draining, filling, leveling the property, and razing existing buildings, minus any proceeds (such as timber sales)] are costs of the land, not of the building to be constructed on the land.
5) Certain permanent improvements of the land made by the entity that have indefinite lives are debited to the land account.
6) Land has an indefinite useful life and therefore is not depreciated.
For PPE, how is the initial cost of land improvements treated?
Land improvements with finite useful lives that are maintained and replaced by the reporting entity are capitalized separately from land and depreciated.
For PPE, how are the initial costs of buildings treated? (6 elements)
1) The costs that are necessary to the purchase or construction of a building and that will result in future economic benefits should be capitalized. These include
2) The purchase price, including any liens assumed by the purchaser, etc.
3) Costs of renovating and preparing the structure for its expected use.
4) The expenses of excavating the site to build the foundation (but not site preparation costs).
i) The costs of razing an old building are either debited to the land account or treated as an adjustment of a gain or loss on disposal. The accounting depends on whether the land was purchased as a site for the new structure or the old building was previously used in the entity’s operations.
ii) The carrying amount of an existing building previously used in the entity’s operations is not included in the cost of the new structure. It will not produce future benefits.
5) The materials, labor, and overhead costs of construction
6) Interest costs incurred during construction of a building for an entity’s own use should be capitalized. (The outline for capitalization of interest is in Subunit 8.2.)
For PPE, what are the two attributes of the treatment of excavating the site (building initial cost)?
The expenses of excavating the site to build the foundation (but not site preparation costs).
1) The costs of razing an old building are either debited to the land account or treated as an adjustment of a gain or loss on disposal. The accounting depends on whether the land was purchased as a site for the new structure or the old building was previously used in the entity’s operations.
2) The carrying amount of an existing building previously used in the entity’s operations is not included in the cost of the new structure. It will not produce future benefits.
For PPE, how is the initial cost of machinery and equipment treated? (3 elements)
Costs include
1) Purchase price (including sales taxes)
2) Freight-in, handling, insurance, and storage until use begins
3) Preparation, installation, and start-up costs, such as testing and trial runs
For PPE, how are the initial costs of leasehold improvements treated? (2 elements)
1) Leasehold improvements, such as buildings constructed on leased land, are accounted for by the lessee in the same way as property to which title is held. However, the term of the lease may limit the depreciation period.
2) If the useful life of the asset extends beyond the lease term and lease renewal is reasonably certain, the amortization period may include all or part of the renewal period. If renewal is uncertain, the useful life is the remaining term of the lease.
For PPE, what are the Other Factors affecting initial measurement? (2 elements)
1) Acquisition in exchange for a noncurrent obligation. If an item of PPE is acquired in exchange for a noncurrent note, its cost is the present value of the consideration paid (the note). But the note’s interest rate may be unstated or unreasonable, or the face amount may differ materially from the cash price of the PPE or the market value of the note. In these cases, the cost of the PPE should be the more clearly determinable of the cash price of the PPE or the market value of the note.
2) Donated assets. In general, contributions received should be recognized as (1) revenues or gains in the period of receipt and (2) assets, or decreases in liabilities or expenses. They are measured at fair value.
PPE $XXX
Contribution revenue $XXX
For PPE, how is the acquisition of a group of assets via a lump-sum purchase treated?
When two or more assets are acquired for a single price, the cost must be allocated to the individual assets in the group.
-Allocation is based on the relative fair values of the assets acquired.
For internally constructed assets, how is the capitalization of interest treated?
The costs necessary to bring an asset to the condition and location of its intended use are part of the historical cost. Interest incurred during construction is such a cost and must be capitalized as part of an asset’s initial cost. An imputed cost of equity capital is not recognized.
For internally constructed assets, is an imputed cost of equity capital recognized?
No, an imputed cost of equity capital is not recognized.
What are the three categories of qualifying internally constructed assets for capitalization of interest?
Qualifying assets are assets for which interest must be capitalized. The following are qualifying assets:
1) Assets that are constructed or produced by the entity for its own use
2) Assets that are constructed or produced for the entity by others for which deposits or progress payments have been made
3) Assets that are constructed or produced for sale or lease as separate projects, such as real estate developments or ships
What are three nonqualifying categories of internally constructed assets that are not qualified for interest capitalization?
The following are assets for which interest must not be capitalized (nonqualifying assets):
1) Inventories routinely produced in large quantities on a repetitive basis
2) Assets in use or ready for their intended use in earning activities
3) Assets not being used in earning activities that are not undergoing the activities necessary to ready them for use
For interest capitalization of internally constructed assets, what is the capitalization period for interest costs? (3 elements)
1) This period is the time required to carry out the activities necessary to bring a qualifying asset to the condition and location necessary for its intended use.
2) The period begins and continues as long as
i) Expenditures for a qualifying asset are being made,
ii) Activities necessary to make the asset ready for its intended use (i.e., construction) are in progress, and
iii) Interest cost is being incurred.
3) Capitalization ends when the asset is substantially complete and ready for its intended use. Also, interest capitalization must cease if substantially all asset-related activities are suspended.
For interest capitalization of internally constructed assets, what are the three conditions for the capitalization period to begin and continue?
The period begins and continues as long as
1) Expenditures for a qualifying asset are being made,
2) Activities necessary to make the asset ready for its intended use (i.e., construction) are in progress, and
3) Interest cost is being incurred.
For capitalization of interest for internally constructed assets, what is the limitation? (4 elements)
1) Interest cost includes interest (1) on obligations with explicit interest rates (including amortization of issue costs and discount or premium), (2) imputed on certain payables, and (3) on a finance lease.
2) Capitalizable interest is limited to the amount theoretically avoidable if expenditures for ICAs had not been made. For example, if the entity had not incurred costs for ICAs, it might have used the funds to repay debt or to avoid issuing new debts.
3) Interest capitalized may not exceed the actual total interest cost incurred during the period.
4) Interest earned on borrowed funds is ordinarily not offset against interest cost to determine either capitalization rates or limitations on interest costs to be capitalized.
For capitalized interest on internally constructed assets, what are the three interest costs?
1)Interest cost includes interest
(1) on obligations with explicit interest rates (including amortization of issue costs and discount or premium),
(2) imputed on certain payables, and
(3) on a finance lease.
For interest capitalization of internally constructed assets, how is the amount of interest to be capitalized determined? (3 elements)
1) Capitalized interest equals the weighted average accumulated expenditures (AAE) for the qualifying asset during the capitalization period times the interest rate(s). The weighting is based on the time expenditures incurred interest.
2) If a specific new borrowing outstanding during the period can be identified with the asset, the rate on that obligation may be applied to the extent that the AAE do not exceed the amount borrowed.
3) To the extent that AAE exceed the amount of specific new borrowings, a weighted-average rate must be applied that is based on other (not the specific) borrowings outstanding during the period.
For interest capitalization of internally constructed assets, what disclosures are requried?
If no interest cost is capitalized, the amount incurred and expensed during the period should be reported. If some interest cost is capitalized, the total incurred and the amount capitalized should be disclosed.
What are the three accounting issues for subsequent expenditures for PPE?
1) The issues are to determine whether subsequent expenditures should be capitalized or expensed and to determine the accounting methods to be used.
2) Capital expenditures are capitalized. They provide additional benefits by improving the quality of services rendered by the asset, extending its useful life, or increasing its output.
3) Revenue expenditures (expenses) maintain an asset’s normal service capacity.
i) These costs are recurring, are not expected to benefit future periods, and are expensed when incurred.
ii) An entity usually specifies a materiality threshold below which all costs are expensed, thereby avoiding the burden of depreciating immaterial amounts.
For subsequent expenditures on PPE, how are extensions or expansions treated? (3 elements)
1) Substantial expenditures for extensions or expansions of existing assets are capitalized. An example is an additional floor for a building.
2) If the addition is essentially a separate asset, it is recorded in a separate account and depreciated over its own useful life. Otherwise, the addition should be debited to the original asset account and depreciated over the life of that asset.
3) The basic entry is
Asset (new or old) $XXX
Cash, etc. $XXX
For subsequent expenditures on PPE, how are replacements and improvements (betterments) treated? (3 elements)
Replacements and Improvements (Betterments)
1) A replacement substitutes a new component of an asset for a similar one, for example, a tile roof for a tile roof. But an improvement substitutes a better component, such as a more efficient heating system.
2) Substitution method. If the old component was recorded separately, e.g., recording a central air conditioning system separately from the building, the procedure is to remove it from the ledger, along with accumulated depreciation, and to substitute the cost of the new component. A loss may be recognized.
i) The new component will be depreciated over the shorter of its useful life or that of the entire asset.
ii) The basic entry is
New asset $XXX
Accumulated depreciation of old asset $XXX
Loss $XXX
Old asset $XXX
Cash, etc. $XXX
3) If (1) the component replaced or improved has not been separately accounted for or (2) the old component has been modified, the substitution method is not used.
i) If the replacement or improvement increases the asset’s service potential but does not extend its estimated useful life, the asset is debited. The carrying amount of the old component is not removed.
ii) If the replacement or improvement primarily extends the useful life without enhancing service potential, the entry is to debit accumulated depreciation. The expenditure is a recovery of depreciation, not an increase in the quality of service.
Accumulated depreciation $XXX
Cash, etc. $XXX
For subsequent expenditures for PPE in the treatment of replacements and improvements, what is the substitution method? (3 elements)
1) Substitution method. If the old component was recorded separately, e.g., recording a central air conditioning system separately from the building, the procedure is to remove it from the ledger, along with accumulated depreciation, and to substitute the cost of the new component. A loss may be recognized.
2) The new component will be depreciated over the shorter of its useful life or that of the entire asset.
3) The basic entry is
New asset $XXX
Accumulated depreciation of old asset $XXX
Loss $XXX
Old asset $XXX
Cash, etc. $XXX
For subsequent expenditures for PPE in the treatment of replacements and improvements, when should the substitution method not be used, and what is the alternative? (3 elements)
1) If (1) the component replaced or improved has not been separately accounted for or (2) the old component has been modified, the substitution method is not used.
2) If the replacement or improvement increases the asset’s service potential but does not extend its estimated useful life, the asset is debited. The carrying amount of the old component is not removed.
3) If the replacement or improvement primarily extends the useful life without enhancing service potential, the entry is to debit accumulated depreciation. The expenditure is a recovery of depreciation, not an increase in the quality of service.
Accumulated depreciation $XXX
Cash, etc. $XXX
For subsequent expenditures on PPE, what are the four attributes of rearrangements, reinstallations, and relocations?
1) Rearranging the configuration of plant assets, reinstalling such assets, or relocating operations may require material outlays that are separable from recurring expenses and provide probable future benefits.
2) The substitution method of accounting for these costs may be used if the original installation costs and accumulated depreciation are known.
3) Otherwise, if these costs are material, they should be debited to a new account and amortized over the period benefited.
4) Relocation (moving) costs often are expensed as incurred.
For subsequent expenditures on PPE, what are the two attributes of repairs and maintenance?
1) Routine, minor expenditures made to maintain the operating efficiency of PPE are ordinarily expensed as incurred. However, as the amounts involved become more significant and the benefits to future periods increase, treatment of a major repair as an addition, etc., may be more appropriate.
2) Although a repair or maintenance cost ordinarily should be allocated to a single annual period only, its full recognition at the interim date when incurred may distort the interim statements.
-Accordingly, an anticipated repair or maintenance cost may be allocated to the interim periods that will benefit.
For subsequent expenditures on PPE, what is the summary table?
What is the definition of depreciation?
Depreciation is the process of systematically and rationally allocating the depreciable base of a tangible capital asset over its expected useful life.
-It is not a process of valuation.
How is depreciation expense recognized?
The periodic depreciation expense is recognized in the income statement. Accumulated depreciation is a contra-asset account. The journal entry is
Depreciation expense $XXX
Accumulated depreciation $XXX
What is the depreciable base? (3 elements)
1) An asset’s depreciable base is the total amount that is to be systematically and rationally allocated.
Depreciable base = Historical cost – Salvage value – Recognized impairment loss
2) The estimated useful life is an estimated period over which services (economic benefits) are expected to be obtained from the use of the asset.
3) Salvage value is the amount that an entity expects to obtain from disposal of the asset at the end of the asset’s useful life.
How should a depreciation method be selected for a particular asset?
The depreciation method chosen should reflect the pattern in which economic benefits (services) from the assets are expected to be received. The chosen method allocates the cost of the asset as equitably as possible to the periods during which services (economic benefits) are obtained from the use of the asset.
What is the straight-line depreciation method? (3 elements)
1) Straight-line depreciation is the simplest method because an equal amount of depreciation is charged to each period of the asset’s useful life.
2) The easiest way to calculate straight-line depreciation is to divide the depreciable base by the estimated useful life.
Periodic expense = Depreciable base ÷ Estimated useful life
3) The straight-line percentage is 100% divided by the number of years in the asset’s estimated useful life.
What is the formula for periodic expense?
Periodic expense = Depreciable base ÷ Estimated useful life
What is the formula for depreciable base?
Depreciable base = Historical cost – Salvage value – Recognized impairment loss
What is the declining balance depreciation method?
Accelerated methods were popularized when they became allowable on tax returns. But the same method need not be used for tax and financial statement purposes.
Accelerated methods are time-based. They result in decreasing depreciation charges over the life of the asset. The two major time-based methods are declining balance and sum-of-the-years’-digits.
Declining balance determines depreciation expense by multiplying the carrying amount (not the depreciable base equal to cost minus salvage value) at the beginning of each period by some percentage (e.g., 200% or 150%) of the straight-line rate of depreciation.
Periodic expense = Carrying amount × Declining-balance percentage
The carrying amount decreases by the depreciation recognized. The result is the use of a constant rate against a declining balance.
Salvage value is ignored in determining the carrying amount, but the asset is not depreciated below salvage value.
Is it necessary to use the same depreciation method on both the tax return and the financial statements?
No. Accelerated methods were popularized when they became allowable on tax returns. But the same method need not be used for tax and financial statement purposes.
What is the declining balance depreciation method? (5 elements)
1) Accelerated methods were popularized when they became allowable on tax returns. But the same method need not be used for tax and financial statement purposes.
2) Accelerated methods are time-based. They result in decreasing depreciation charges over the life of the asset. The two major time-based methods are declining balance and sum-of-the-years’-digits.
3) Declining balance determines depreciation expense by multiplying the carrying amount (not the depreciable base equal to cost minus salvage value) at the beginning of each period by some percentage (e.g., 200% or 150%) of the straight-line rate of depreciation.
Periodic expense = Carrying amount × Declining-balance percentage
4) The carrying amount decreases by the depreciation recognized. The result is the use of a constant rate against a declining balance.
5) Salvage value is ignored in determining the carrying amount, but the asset is not depreciated below salvage value.
For any depreciation method, what is the estimated useful life?
The estimated useful life is an estimated period over which services (economic benefits) are expected to be obtained from the use of the asset.
For any depreciation method, what is salvage value?
Salvage value is the amount that an entity expects to obtain from disposal of the asset at the end of the asset’s useful life.
For the declining balance method, what is the formula for periodic expense?
Declining balance determines depreciation expense by multiplying the carrying amount (not the depreciable base equal to cost minus salvage value) at the beginning of each period by some percentage (e.g., 200% or 150%) of the straight-line rate of depreciation.
Periodic expense = Carrying amount × Declining-balance percentage
What is the sum-of-years’-digits deprecation method?
Sum-of-the-years’-digits (SYD) multiplies not the carrying amount but the constant depreciable base (cost minus salvage value) by a declining fraction. It is a declining-rate, declining-charge method.
Periodic expense = Depreciable base ×(Remaining years in useful life)/(Sum of all years in useful life)
What is the usage-centered depreciation method? (2 elements)
1) Usage-centered activity methods calculate depreciation as a function of an asset’s use rather than the time it has been held.
2) The units-of-output method allocates cost based on production. As production varies, so will the depreciation expense.
Periodic depreciation expense = Depreciable base ×
(Units produced during current period)/(Estimated total lifetime units)
For the usage-centered depreciation method, what is the formula for periodic depreciation expense?
Periodic depreciation expense = Depreciable base ×
(Units produced during current period)/(Estimated total lifetime units)
For the sum of years’ digits depreciation method, what is the formula for periodic depreciation expense?
Periodic expense = Depreciable base ×(Remaining years in useful life)/(Sum of all years in useful life)
For the declining balance method, what is the formula for periodic depreciation expense?
Periodic expense = Carrying amount × Declining-balance percentage
What is group and composite deprecation?
1) These methods apply straight-line accounting to a collection of assets depreciated as if they were a single asset. The composite method applies to groups of dissimilar assets with varying useful lives, and the group method applies to similar assets. They provide an efficient way to account for large numbers of depreciable assets. They also result in the offsetting of under- and overstated depreciation estimates.
2) Each method calculates (1) the total depreciable cost (Total acquisition cost – Salvage value) for all the assets debited to a control account, (2) the weighted-average estimated useful life (Total depreciable cost ÷ Total annual straight-line depreciation), and (3) the weighted-average depreciation rate based on cost (Total annual straight-line depreciation ÷ Total acquisition cost). One accumulated depreciation account also is maintained.
3) Early and late retirements are expected to offset each other. Thus, gains and losses on retirements of single assets are not recognized but are treated as adjustments of accumulated depreciation. The entry is
Cash (proceeds) $XXX
Asset (cost) $XXX
Accumulated depreciation (dr. or cr.) $XXX
4) Periodic depreciation equals the weighted-average rate times the beginning balance of the asset account for the period. Thus, depreciation is calculated based on the cost of assets in use during the period. Prior-period retirements are reflected in this balance.
What is depreciation for a fractional period? (4 elements)
1) An asset is most likely to be acquired or disposed of at a time other than the beginning or end of a fiscal year. Thus, depreciation may need to be calculated for a fraction of a period. Time-based methods most often compute depreciation to the nearest month of a partial year, but other conventions also are permitted.
Each entity might have different policies for depreciation of a fractional period. For example,
1) A full year’s depreciation may be recognized in the year of acquisition and none in the year of disposal or vice versa.
2) Depreciation may be recognized to the nearest full year or the nearest half-year.
3) A half-year’s depreciation may be recognized in both the year of acquisition and the year of disposal.
What disclosures are required for depreciation? (5 elements)
1) Full disclosure should be made of depreciation methods and practices, including
2) Depreciation expense for the period
3) Balances of major classes of depreciable assets by nature or function
4) Accumulated depreciation either by major class or in total
5) Description of depreciation methods for each major class of assets
How do depreciation methods effect net income?
Because the accelerated methods charge higher amounts to depreciation expense in the earlier years of an asset’s economic life, those methods result in lower net income than the straight-line method in those years.
For depreciation methods, what are the effects of accounting changes?
A change in the estimates for depreciation is accounted for prospectively (from the beginning of the period in which the change in estimate was made). The new estimates are used in the year of the change, and no “catch-up” amounts are recorded.
How are PPE exchanges measured at fair value? (4 elements)
1) Accounting for exchanges of monetary assets (receivables, financial instruments, etc.) is straightforward because they are stated in terms of units of money.
i) Monetary exchanges are measured at the fair value of the assets involved, with gain or loss recognized immediately.
ii) The fair value of the assets given up generally is used to measure the cost of the assets acquired unless the fair value of the assets received is more clearly evident.
2) Nonmonetary exchange of assets is treated as a monetary exchange when the fair value of both assets is determinable.
i) The asset received is measured at the fair value of the asset given up, and any gain or loss is recognized immediately.
ii) This gain or loss is the difference between the fair value of the asset given up and its carrying amount.
-If the fair value of the asset given up is greater (lower) than its carrying amount, a gain (loss) for the difference is recognized.
3) One of the parties to a nonmonetary exchange also may transfer cash (boot). The party paying boot includes this amount in the total fair value of assets given up in the exchange.
i) The party receiving the boot measures the asset received at the fair value of the asset given up minus the boot (i.e., the net fair value of the asset given up).
4) The fair value of the asset received may be more clearly evident. For example, the fair value of the asset given up is not known, but the fair value of the asset received can be determined. Accordingly, the asset received is measured at its fair value.
-The gain or loss on the exchange is the difference between the fair value of all the assets received (Fair value of assets received + Any cash received) and the carrying amount of all the assets given up (Carrying amount of assets given up + Any cash paid).
What is monetary exchange of PPE assets measured at fair value? (3 elements)
1) Accounting for exchanges of monetary assets (receivables, financial instruments, etc.) is straightforward because they are stated in terms of units of money.
2) Monetary exchanges are measured at the fair value of the assets involved, with gain or loss recognized immediately.
3) The fair value of the assets given up generally is used to measure the cost of the assets acquired unless the fair value of the assets received is more clearly evident.
What is nonmonetary exchange of PPE assets measured at fair value? (3 elements)
1) Nonmonetary exchange of assets is treated as a monetary exchange when the fair value of both assets is determinable.
2) The asset received is measured at the fair value of the asset given up, and any gain or loss is recognized immediately.
3) This gain or loss is the difference between the fair value of the asset given up and its carrying amount.
-If the fair value of the asset given up is greater (lower) than its carrying amount, a gain (loss) for the difference is recognized.
How does boot pertain to nonmonetary exchanges? (2 elements)
1) One of the parties to a nonmonetary exchange also may transfer cash (boot). The party paying boot includes this amount in the total fair value of assets given up in the exchange.
2) The party receiving the boot measures the asset received at the fair value of the asset given up minus the boot (i.e., the net fair value of the asset given up).
When the fair value of the asset received is more clearly evident but the fair value of the asset given up is not known, how is the exchange accounted for? (2 elements)
The fair value of the asset received may be more clearly evident. For example, the fair value of the asset given up is not known, but the fair value of the asset received can be determined. Accordingly, the asset received is measured at its fair value.
The gain or loss on the exchange is the difference between the fair value of all the assets received (Fair value of assets received + Any cash received) and the carrying amount of all the assets given up (Carrying amount of assets given up + Any cash paid).
For exchanges measured at carrying amount, what is the basis? (2 elements)
1) When certain exceptions apply, the accounting for a nonmonetary exchange is based on the carrying amount of the assets given up. Unless boot is received, no gain is recognized. The following are the exceptions:
i) Neither the fair value of the assets given up nor the fair value of the assets received is reasonably determinable,
ii) The exchange involves inventory sold in the same line of business that facilitates sales to customers not parties to the exchange, or
iii) The exchange lacks commercial substance because it is not expected to change the entity’s cash flows significantly.
2) If (1) an exchange is based on the carrying amount of the assets given up and (2) the fair value of the asset to be exchanged is lower than its carrying amount, the total loss must be recognized for the difference.
i) First, the asset to be exchanged is written down to its fair value and an impairment loss is recognized.
ii) Second, the exchange is measured at the new carrying amount of the asset given up (fair value of the asset on the exchange date).
For nonmonetary exchanges measured at carrying amount, how is the boot treated? (4 elements)
1) If boot is given as part of an exchange measured at carrying amount, the recipient of the boot must recognize a proportionate amount of any potential gain. The amount of gain is calculated in the following steps:
2) Calculate the total potential gain on the exchange.
Fair value of other assets received +
Boot received = Carrying amount of assets given up
Carrying amount of assets given up - Total potential gain
FORMULA WRONG? NEEDS TO RESEARCH CORRECT FORMULA
3) Calculate the proportion of assets received represented by boot.
Proportion of Assets Received Represented by Boot = (Boot received)/(Fair value of other assets received + Boot received)
4) Determine the amount of gain to be recognized.
Total potential gain × Proportion represented by boot
How are exchanges measured at carrying value treated if the boot is more than 25% of the fair value of the exchange?
If boot constitutes 25% or more of the fair value of the exchange, the exchange is treated as a monetary exchange. Both parties record the transaction at fair value and recognize any gain or loss in full.
What is shown on the Measure of Exchange Summary Table?
What are the procedures for disposals other than by exchange? (4 elements)
1) Depreciation is recorded up to the time of disposal so that periodic depreciation expense is not understated and the carrying amount of the asset is not overstated.
2) The asset’s carrying amount is removed from the accounts by eliminating the asset, its accumulated depreciation, and any other valuation account.
3) Any consideration (proceeds) received is debited appropriately.
4) Gain or loss is recognized for the difference between the proceeds received and the carrying amount of an asset.
How is the sale treated for disposals other than by exchange?
Accounting for a cash sale of PPE (including a scrap sale) is straightforward.
-Depreciation, if any, is recognized to the date of sale, the carrying amount is removed from the books, the proceeds are recorded, and any gain or loss is recognized.
How is abandonment treated for disposals other than by exchange? (3 elements)
1) An asset to be abandoned is disposed of when it is no longer used.
2) If the asset to be abandoned is still in use, it is normally not immediately written down to zero. Continued use indicates that the asset has service potential. However, depreciation estimates should be revised to account for the reduced service period.
3) A noncurrent asset that is temporarily idled is not treated as abandoned.
For disposals other than by exchange, how is involuntary conversion treated? (5 elements)
1) An item of PPE is involuntarily converted when it is (1) lost through a casualty (flood, earthquake, fire, etc.), (2) expropriated (seized by a foreign government), or (3) condemned (through the governmental power of eminent domain).
2) The accounting is the same as for other nonexchange dispositions.
3) The gain or loss on an involuntary conversion is reported in income from continuing operations.
4) A nonmonetary asset may be involuntarily converted to monetary assets (e.g., insurance proceeds).
5) Gain or loss recognition is required even though the entity reinvests or is required to reinvest the proceeds in replacement nonmonetary assets.
-Hence, the replacement property should be recorded at its cost. The involuntary conversion and replacement are not equivalent to a single exchange transaction between entities.
What is the two-step impairment test for long-lived assets? (4 elements)
1) Testing for impairment occurs when events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable, for example, when
i) The market price has decreased significantly, or
ii) The use or physical condition of the asset has changed significantly and adversely.
2) The test for impairment has two steps.
i) Recoverability test. The carrying amount of a long-lived asset to be held and used is not recoverable if it exceeds the sum of the undiscounted future cash flows expected from the use and disposition of the asset.
ii) If the carrying amount is not recoverable, an impairment loss may be recognized. It equals the excess of the carrying amount of the asset over its fair value.
-An impairment loss is recognized in income from continuing operations.
3) The entry for an impairment of a depreciable asset is
Impairment loss $XXX
Accumulated depreciation $XXX
Determination of an Impairment Loss
i. Events or changes in circumstances indicate a possible loss
.
ii. Carrying amount > Sum of undiscounted cash flows
iii. Loss = Carrying amount – Fair value
4) The carrying amount of a long-lived asset adjusted for an impairment loss is its new cost basis. A previously recognized impairment loss must not be reversed.
What is shown on the table for determination of impairment loss? (3 elements)
What are the six conditions for classifying an asset as held-for-sale?
An asset (disposal group) is classified as held for sale when six conditions are met:
1) Management has committed to a plan to sell.
2) The asset is available for immediate sale in its current condition on usual and customary terms.
3) Actions (such as actively seeking a buyer) have begun to complete the plan.
4) Completion of sale within 1 year is probable.
5) The asset is actively marketed at a price reasonably related to current fair value.
6) The likelihood is low of significant change in, or withdrawal of, the plan.
For held-for-sale classification criteria, what is the disposal group?
The disposal group consists of assets to be disposed of together in one transaction and directly associated liabilities to be transferred in the same transaction (for example, warranties associated with an acquired customer base).
For assets classified as held for sale, what happens whenever the conditions to classify as held-for-sale are not met?
Whenever the conditions are not met, the asset or disposal group must be reclassified as held and used.
For assets classified as held for sale, what happens if the disposition is to be other than by sale?
If disposition is to be other than by sale, for example, by abandonment or exchange, the asset is classified as held and used until disposal. It will continue to be depreciated or amortized.
What two circumstances result in assets being classified as held and used?
1) Whenever the conditions are not met, the asset or disposal group must be reclassified as held and used.
2) If disposition is to be other than by sale, for example, by abandonment or exchange, the asset is classified as held and used until disposal. It will continue to be depreciated or amortized.
How are assets held for sale measured? (5 elements)
1) Assets held for sale are measured at the lower of carrying amount or fair value minus cost to sell.
2) An asset classified as held for sale is not depreciated or amortized, but expenses related to the liabilities of a disposal group are accrued.
3) Costs to sell are the incremental direct costs. Examples are brokers’ commissions, legal and title transfer fees, and closing costs (but not future operating losses expected to be incurred).
4) A loss is recognized for a write-down to fair value minus cost to sell. A gain is recognized for any subsequent increase but only to the extent of previously recognized losses for write-downs.
5) A gain or loss from the sale is recognized at the date of sale.
For assets held for sale, what happens if plans change and the sale does not occur? (2 elements)
1) A plan of sale may change because of circumstances (previously unlikely) that result in a decision not to sell. The asset (disposal group) then must be reclassified as held and used.
2) A reclassified long-lived asset is measured individually at the lower of
i) Carrying amount before the asset (disposal group) was classified as held for sale, minus any depreciation (amortization) that would have been recognized if it had always been classified as held and used, or
ii) Fair value at the date of the decision not to sell.
What are the rules for reporting assets held for sale? (2 elements)
1) If a long-lived asset is held for sale, it is reported separately.
-If a disposal group is held for sale, its assets and liabilities are reported separately in the balance sheet and are not presented as one amount.
2) When a component of an entity is reclassified as held and used, its results of operations previously reported in discontinued operations are reclassified and included in income from continuing operations for all periods presented.
What are natural resources?
Natural resources (wasting assets) are held for direct resale or consumption in other products. Examples are petroleum, gold, silver, timber, iron ore, gravel, and coal.
In what three ways do natural resources differ from depreciable assets?
Natural resources differ from depreciable assets because they
1) Lose their separate character during extraction and consumption
2) Are produced only by natural processes
3) Are recorded as inventory after extraction
i) The entry to record the inventory and the depletion of the natural resource is
Inventory $XXX
Accumulated depletion (a contra account) $XXX
ii) But some entities credit the natural resource account directly.
What is depletion?
Depletion is similar to depreciation. It is an accounting process of allocating the historical cost of a tangible asset to the periods benefited by its uses.
What are the four components of the depletion base?
1) Acquisition costs of land (but not the costs of extractive machinery, which are depreciated and recognized as separate items of PPE)
2) Development costs to prepare the site for extraction (added)
3) Restoration costs required by law to return the land to its original condition (added)
4) The residual value of the property (subtracted)
How is periodic depletion calculated?
1) Depletion is similar to usage-centered depreciation because it is most often determined by applying the units-of-output (production) method.
2) The per-unit depletion rate is determined by dividing the depletion base by the total number of units estimated to be economically recoverable during the property’s useful life.
Per-unit depletion rate = (Depletion base)/(Total estimated recoverable units)
3) Units extracted times the depletion rate equals periodic depletion.
(Units Extracted) * (Per Unit Depletion Rate) = Periodic Depletion
i) To the extent that extracted units are sold, cost of goods sold is debited.
ii) Unsold units remain in inventory.
How is periodic depletion calculated?
(Units Extracted) * (Per Unit Depletion Rate) = Periodic Depletion
