Financial 3 PP&E : Cost Basis

Question 1

Capitalization Rules

Answer 1

• Any cost incurred to acquire and make ready a plant asset is capitalized. In other words, the cost capitalized will include all costs that are reasonable and necessary to get the asset in the condition or location for its intended use
• Capitalized Interest = the smaller of the total interest incurred or the avoidable interest. Avoidable interest = the weighted average amount of accumulated expenditures on the job during the period

Question 2

Component Method Use

Answer 2

• If the carrying value of the damaged portion of the building is known and uninsured, the component method is used
• With the above info, a loss in the amount of the carrying value of the damaged portion of the building must be recognized. The refurbishing costs create a new asset (the reconstructed building) and must be capitalized

Question 3

Incurring Interest

Answer 3

• General Rule: Interest costs incurred during the construction period of machinery to be used by a firm as a fixed asset, should be capitalized as part of the historic cost of acquiring the fixed asset. Interest costs on the fixed asset subsequent to the construction period as well as all interest costs on the routine manufacture of machinery for sales to customers (inventory) should be expensed in the income statement for the period incurred.

Interest incurred DURING construction is CAPITALIZED
Interest incurred before or after construction in expensed in the appropriate period

Question 4

Leasehold Improvement Capitalization Rules

Answer 4

• Leasehold Improvements are capitalized and then amortized over the lesser of the life of the improvements or the remaining term of the lease. This rule makes sense because the party making the leasehold improvements will benefit from the improvements for either the life of the improvements or the term of the lease if the term of the lease is shorter than the life of the improvements.

Question 5

Criteria for Recording Land Cost

Answer 5

• Includes all costs to acquire the land and get it ready for use

Examples: Cash paid for land, title search fees (acquisition cost), county assessment, removal of building

Building excavation costs are costs incurred to construct the building. That will be included in total building cost

Question 6

Criteria for Capitalizing Cost of Equipment

Answer 6

Necessary Amounts: Amount to purchase equipment, bring the equipment to the location and condition of intended use.

Examples: Cash paid for down payment, present value of the note payable, shipping charges and installation charges

**Notes payable are required to be reported at the present value of the payments to be made, computed using market rate of interest.

Annual payments * PV of ordinary annuity factor = PV of the note payable