© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Chapter 10 Operational Assets: Acquisition...

© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin

Chapter 10

Operational Assets: Acquisition and Disposition


Slide10-2

Actively Used in OperationsActively Used in Operations

Tangible

Property, Plant, Equipment &

Natural Resources

Tangible

Property, Plant, Equipment &

Natural Resources

Intangible

No PhysicalSubstance

Intangible

No PhysicalSubstance

Types of Operational Assets

Expected to Benefit Future PeriodsExpected to Benefit Future Periods


Slide10-3

Costs to be Capitalized

General Rule

The initial cost of an operational asset includes the purchase price and all

expenditures necessary to bring the asset to its desired condition and location for use.

General Rule

The initial cost of an operational asset includes the purchase price and all

expenditures necessary to bring the asset to its desired condition and location for use.


Slide10-4

Net purchase priceTaxesTransportation costs Installation costsModification to building

necessary to install equipment

Testing and trial runs

Net purchase priceTaxesTransportation costs Installation costsModification to building

necessary to install equipment

Testing and trial runs

Costs to be Capitalized ---- Equipment


Slide10-5

Land is not depreciable.Land is not depreciable.

Purchase price Real estate commissions Attorney’s fees Title search Title transfer fees Title insurance premiums Removing old buildings

Purchase price Real estate commissions Attorney’s fees Title search Title transfer fees Title insurance premiums Removing old buildings

Costs to be Capitalized ---- Land


Slide10-6

Separately identifiable costs of Driveways Parking lots Fencing Landscaping Private roads

Separately identifiable costs of Driveways Parking lots Fencing Landscaping Private roads

Costs to be Capitalized ---- Land Improvements


Slide10-7

Purchase priceArchitectural feesCost of permitsExcavation costsConstruction costs

Purchase priceArchitectural feesCost of permitsExcavation costsConstruction costs

Costs to be Capitalized ---- Buildings


Slide10-8

Purchase price, exploration and development costs of: TimberMineral depositsOil and gas reserves

Purchase price, exploration and development costs of: TimberMineral depositsOil and gas reserves

Costs to be Capitalized ---- Natural Resources


Slide10-9

Asset Retirement Obligations

Recognize as a liabilityand a corresponding

increase in the related asset.

Recognize as a liabilityand a corresponding

increase in the related asset.

Record at fair value, usually thepresent value of future cash outflows associated with thereclamation or restoration.

Record at fair value, usually thepresent value of future cash outflows associated with thereclamation or restoration.

Often encountered with natural resource extraction when the land must be

restored to a useable condition.

Often encountered with natural resource extraction when the land must be

restored to a useable condition.


Slide10-10

Intangible Assets

Lack physicalsubstance.

Lack physicalsubstance.

Economic benefitslast beyond thecurrent period.

Economic benefitslast beyond thecurrent period.

Useful life isoften difficultto determine.

Useful life isoften difficultto determine.

Usually acquired for operational

use.

Usually acquired for operational

use.

IntangibleAssets

IntangibleAssets


Slide10-11

PatentsCopyrightsTrademarksFranchisesOrganization

costsGoodwill

PatentsCopyrightsTrademarksFranchisesOrganization

costsGoodwill

Record at current cash equivalent cost, including purchase price, legal fees, and

filing fees.

Costs to be Capitalized ---- Intangible Assets


Slide10-12

An exclusive right recognized by law and granted by the US Patent Office for 20 years.

Holder has the right to use, manufacture, or sell the patented product or process without interference or infringement by others.

Internally developed costs (R&D)that result in patents are expensedin the period incurred.

An exclusive right recognized by law and granted by the US Patent Office for 20 years.

Holder has the right to use, manufacture, or sell the patented product or process without interference or infringement by others.

Internally developed costs (R&D)that result in patents are expensedin the period incurred.

Patents


Slide10-13

Torch, Inc. has developed a new device. Research and development costs totaled

$30,000. Patent registration costs consisted of $2,000 in attorney fees and $1,000 in

federal registration fees.

What is Torch’s patent cost?

Torch, Inc. has developed a new device. Research and development costs totaled

$30,000. Patent registration costs consisted of $2,000 in attorney fees and $1,000 in

federal registration fees.

What is Torch’s patent cost?

Torch’s cost for the new patent is $3,000. The $30,000 R & D cost is expensed as

incurred.

Torch’s cost for the new patent is $3,000. The $30,000 R & D cost is expensed as

incurred.

Patents


Slide10-14

A form of protection given by law to authors of literary, musical, artistic, and similar works.

Copyright owners have exclusive rights to print, reprint, copy, sell or distribute, perform and record the work.

Generally, the legal life of a copyright is the life of the author plus 70 years.

A form of protection given by law to authors of literary, musical, artistic, and similar works.

Copyright owners have exclusive rights to print, reprint, copy, sell or distribute, perform and record the work.

Generally, the legal life of a copyright is the life of the author plus 70 years.

Copyrights


Slide10-15

A symbol, design, or logo associated with a business.

If internally developed, trademarks have no recorded asset cost.

If purchased, a trademark is recorded at cost.

Registered with U.S. Patent Office and renewable indefinitely in 10-year periods.

A symbol, design, or logo associated with a business.

If internally developed, trademarks have no recorded asset cost.

If purchased, a trademark is recorded at cost.

Registered with U.S. Patent Office and renewable indefinitely in 10-year periods.

Trademarks


Slide10-16

Right to sell products or provide services purchased by franchisee from franchisor.

Right to sell products or provide services purchased by franchisee from franchisor.

Franchises


Slide10-17

Occurs when onecompany buys

another company.

The amount by which thepurchase price exceeds the fair

market value of net assets acquired.

Only purchased goodwill is an

intangible asset.

Goodwill

Goodwill


Slide10-18

Eddy Company paid $1,000,000 to purchase all of James Company’s assets and assumed James

Company’s liabilities of $200,000. James Company’s assets were appraised at a fair

value of $900,000.

Eddy Company paid $1,000,000 to purchase all of James Company’s assets and assumed James

Company’s liabilities of $200,000. James Company’s assets were appraised at a fair

value of $900,000.

Goodwill


Slide10-19

What amount of goodwill should be recorded on Eddy Company books?

a. $100,000

b. $200,000

c. $300,000

d. $400,000


a. $100,000

b. $200,000

c. $300,000

d. $400,000


a. $100,000

b. $200,000

c. $300,000

d. $400,000


a. $100,000

b. $200,000

c. $300,000

d. $400,000

Goodwill


Slide10-20

Several assets are acquired for a single, lump-sum price that may be lower than the

sum of the individual asset prices.

Several assets are acquired for a single, lump-sum price that may be lower than the

sum of the individual asset prices.

Lump-Sum Purchases

Asset 2Asset 1 Asset 3

Portions of the lump-sum price attributable to particular assets are

assigned to those assets.

Allocation of theremaining lump-sum

price is based onrelative values of

the individual assets.

Allocation of theremaining lump-sum

price is based onrelative values of

the individual assets.


Slide10-21

On May 13, we purchase land and building for $200,000 cash. The appraised value of

the building is $162,500, and the land is appraised at $87,500.

How much of the $200,000 purchase price will be charged to the building account?

On May 13, we purchase land and building for $200,000 cash. The appraised value of

the building is $162,500, and the land is appraised at $87,500.

How much of the $200,000 purchase price will be charged to the building account?

Lump-Sum Purchases


Slide10-22

Appraised % of Purchase AssignedAsset Value Value Price Cost

(a) (b)* (c) (b × c)Land 87,500$ 35% 200,000$ 70,000$ Building 162,500 65% 200,000 130,000 Total 250,000$ 200,000$

* $87,500÷$250,000 = 35%

The building will be apportioned $130,000of the total purchase price of $200,000.

The building will be apportioned $130,000of the total purchase price of $200,000.

Lump-Sum Purchases

Prepare the journal entry to record the purchase.Prepare the journal entry to record the purchase.


Slide10-23

Lump-Sum Purchases


Slide10-24

Noncash Acquisitions

Deferred paymentsIssuance of equity securitiesDonated AssetsExchanges

Deferred paymentsIssuance of equity securitiesDonated AssetsExchanges


Slide10-25

Deferred Payments

The asset acquired is recorded at the

Cash equivalent price (market value)

orPresent value of future cash payments using

the prevailing market interest rate

Whichever is more objective and reliable.

The asset acquired is recorded at the

Cash equivalent price (market value)

orPresent value of future cash payments using

the prevailing market interest rate

Whichever is more objective and reliable.


Slide10-26

Deferred Payments

On May 1, 2003, Fesler, Inc. purchased equipment paying $3,000 down and issuing a note payable. The note requires four annual

payments of $2,500 with the first payment due on May 1, 2004. The note is noninterest-

bearing. The prevailing market rate of interest on notes of this nature is 12%.

Prepare the required journal entries on May 1, 2003, and December 31, 2003 (year-end).

On May 1, 2003, Fesler, Inc. purchased equipment paying $3,000 down and issuing a note payable. The note requires four annual

payments of $2,500 with the first payment due on May 1, 2004. The note is noninterest-

bearing. The prevailing market rate of interest on notes of this nature is 12%.

Prepare the required journal entries on May 1, 2003, and December 31, 2003 (year-end).


Slide10-27

Annuity payment 2,500$ x PVA $1, n=4, i=12% 3.03735 = PV of note (rounded) 7,593$ + Down payment 3,000 = Cost of equipment 10,593$

Annuity payment 2,500$ x PVA $1, n=4, i=12% 3.03735 = PV of note (rounded) 7,593$ + Down payment 3,000 = Cost of equipment 10,593$

Deferred Payments

Since we do not know the cash equivalent price in this example, we must use the

present value of the future cash payments.


Slide10-28

GENERAL JOURNAL Page ##

Date Description PR Debit Credit

5/1 Equipment 10,593 Discount on Note Payable 2,407 Cash 3,000 Note Payable 10,000

Discount = $10,000 - $7,593

GENERAL JOURNAL Page ##


May 1 Equipment 10,593 Discount on Note Payable 2,407 Cash 3,000 Note Payable 10,000

Discount = $10,000 - $7,593

Dec. 31 Interest Expense 607 Discount on Note Payable 607 $7,593 × 12% × 8/12 = $607

Deferred PaymentsExample


Slide10-29

Issuance of Equity Securities

Asset acquired is recorded at the market value of the asset or the market value of the securities, whichever is more objective and reliable.

If the securities are actively traded, market value can be easily determined.

If no objective and reliable value canbe determined, board of directorsassigns a “reasonable value.”

Asset acquired is recorded at the market value of the asset or the market value of the securities, whichever is more objective and reliable.

If the securities are actively traded, market value can be easily determined.

If no objective and reliable value canbe determined, board of directorsassigns a “reasonable value.”


Slide10-30

Donated Assets

On occasion, companies acquire operational assets through donation.

SFAS No. 116 requires the receiving company to record revenue equal to the

value of the donated asset.Record the donated asset on

the books at market value.

On occasion, companies acquire operational assets through donation.

SFAS No. 116 requires the receiving company to record revenue equal to the

value of the donated asset.Record the donated asset on

the books at market value.

Recently, in an effort to lure a facility for Dell Computers to

Nashville, TN, the city donated land

for the new facility.

The deal created about 3,000 jobs

locally.


Slide10-31

Dispositions

Update depreciation to date of disposal.

Remove original cost of asset and accumulated depreciation from the books.

The difference between BV of the asset and the amount received is recorded as a gainor loss. Accountin

g

Steps


Slide10-32

On June 30, 2003, MeLo, Inc. sold equipment for $6,350 cash. The equipment was purchased on January 1, 1998 at a cost of $15,000. The asset

had a useful life of 10 years and no salvage value. MeLo last recorded depreciation on the equipment on December 31, 2002, its year-end.

Prepare the journal entries necessary torecord the disposition of this equipment.

On June 30, 2003, MeLo, Inc. sold equipment for $6,350 cash. The equipment was purchased on January 1, 1998 at a cost of $15,000. The asset

had a useful life of 10 years and no salvage value. MeLo last recorded depreciation on the equipment on December 31, 2002, its year-end.

Prepare the journal entries necessary torecord the disposition of this equipment.

Dispositions


Slide10-33

Page 9


June 30 Depreciation Expense 750

Accumulated Depreciation 750

($15,000 ÷ 10 years) × ½ = $750

GENERAL JOURNAL

Update depreciation to date of sale.

Dispositions


Slide10-34

Page 9


June 30 Accumulated Depreciation 8,250

Cash 6,350

Loss on Sale 400

Equipment 15,000

($15,000 ÷ 10 years) × 5½ years = $8,250

GENERAL JOURNAL

Remove original cost of asset and accumulated depreciation from the books.

Record the gain or loss.

Dispositions


Slide10-35

Exchanges

The valuation of a nonmonetary asset exchange depends on whether cash is paid or received.

General Valuation Principle (GVP):Cost of asset acquired is . . .

Fair value of asset given up plus cash paid or minus cash received

or

Fair value of asset acquired, if it is more readily determinable.

The valuation of a nonmonetary asset exchange depends on whether cash is paid or received.

General Valuation Principle (GVP):Cost of asset acquired is . . .

Fair value of asset given up plus cash paid or minus cash received

or

Fair value of asset acquired, if it is more readily determinable.


Slide10-36

Exchanges

Assets are Dissimilar Assets are SimilarValue acquired asset according to GVP.

Recognize loss in full.

Gain Indicated

Loss Indicated

If cash is paid or not involved, value acquired

asset at BV of asset transferred plus cash paid.

No gain recognized.

If cash is received, recognize only fraction of the gain. Value acquired

asset at fair value less portion of gain not

recognized.

Value acquired asset according to GVP.

Recognize gain in full.


Slide10-37

SAM, Co. exchanged inventory for a piece of equipment owned by Mette, Inc. The inventory has a

cost basis to SAM of $125,000, and a fair value of $200,000. The equipment has a fair value of

$220,000, and a cost basis to Mette of $325,000. Mette has recorded depreciation of $150,000 on the

equipment.

Record the exchange on the booksof SAM and Mette.

Exchanges of Dissimilar Assets


Slide10-38

The assets exchanged are dissimilar in nature, so the implied gain should be

recognized in full.

The assets exchanged are dissimilar in nature, so the implied gain should be

recognized in full.



Slide10-39

SAM, Co.

Asset acquired should be valued at the fair value of asset given up.

SAM, Co.

Asset acquired should be valued at the fair value of asset given up.



Slide10-40

The assets exchanged are dissimilar in nature, so the implied gain should be recognized in full.

The assets exchanged are dissimilar in nature, so the implied gain should be recognized in full.



Slide10-41

Mette, Inc.

Asset acquired should be valued at the fair value of asset transferred.

Mette, Inc.

Asset acquired should be valued at the fair value of asset transferred.



Slide10-42

Now let’s see anexample with

similar assets.

Exchanges of Similar Assets


Slide10-43

Amgen, Co. exchanged similar equipment and $10,000 cash for equipment owned by Versa, Inc.

Using the information below, record the exchange on the books of Amgen and Versa.

Amgen, Co. exchanged similar equipment and $10,000 cash for equipment owned by Versa, Inc.

Using the information below, record the exchange on the books of Amgen and Versa.



Slide10-44

The assets exchanged are similar in nature,and cash is not received, so the implied

gain should not be recognized.

The assets exchanged are similar in nature,and cash is not received, so the implied

gain should not be recognized.



Slide10-45

AmgenEquipment received should be valued at the BV of

equipment transferred plus cash paid.

AmgenEquipment received should be valued at the BV of

equipment transferred plus cash paid.

Page 9


Equipment 210,000

Accumulated Depreciation 300,000

Equipment 500,000

Cash 10,000

$200,000 + $10,000

GENERAL JOURNAL



Slide10-46

The assets exchanged are similar in nature.Since cash is received, a partial gain

should be recognized.





Slide10-47







Slide10-48

VersaEquipment received valued at fair value

less portion of gain not recognized.

VersaEquipment received valued at fair value

less portion of gain not recognized.

Page 9


Equipment 166,860

Accumulated Depreciation 100,000

Cash 10,000

Equipment 275,000

Gain on Exchange 1,860

GENERAL JOURNAL



Slide10-49

Let’s change the subject.


Slide10-50

Self-Constructed Assets

When self-constructing an asset, two accounting issues must be addressed:Overhead allocation to the self-

constructed asset.Incremental overhead onlyFull-cost approach

Proper treatment of interest incurred during construction

When self-constructing an asset, two accounting issues must be addressed:Overhead allocation to the self-

constructed asset.Incremental overhead onlyFull-cost approach

Proper treatment of interest incurred during construction


Slide10-51

Under certain conditions, avoidable interest incurred on qualifying assets is

capitalized.

Under certain conditions, avoidable interest incurred on qualifying assets is

capitalized.

Interest that could have been avoided if the asset

were not constructed and the money used to

retire debt.

Interest that could have been avoided if the asset

were not constructed and the money used to

retire debt.

An asset constructed:

For a company’s own use.

As a discrete project for sale or lease.

An asset constructed:

For a company’s own use.

As a discrete project for sale or lease.

Interest Capitalization


Slide10-52

Interest is capitalized based on Average Accumulated Expenditures (AAE).

Interest is capitalized based on Average Accumulated Expenditures (AAE).

Examples include:•Cash payments for construction•Transfer of other assets•Incurrence of interest-bearing liabilities

Examples include:•Cash payments for construction•Transfer of other assets•Incurrence of interest-bearing liabilities

Qualifying expenditures

weighted for the number of months outstanding during

the current accounting period.

Qualifying expenditures

weighted for the number of months outstanding during

the current accounting period.



Slide10-53

If the qualifying asset is financed

through a specific new borrowing . . .

If the qualifying asset is financed

through a specific new borrowing . . .

. . . use the specific rate of the new

borrowing as the capitalization rate.

. . . use the specific rate of the new

borrowing as the capitalization rate.

If the qualifying asset is internally

financed . . .

If the qualifying asset is internally

financed . . .

. . . use the weighted average cost of debt as the capitalization rate.

. . . use the weighted average cost of debt as the capitalization rate.



Slide10-54

If the AAE < the amount of the specific new

borrowing . . .

If the AAE < the amount of the specific new

borrowing . . .

Specificnew

borrowingAAE

. . . Capitalize this portion using specific

borrowing rate.



Slide10-55

If the AAE is > the amount of the specific new borrowing . . .

If the AAE is > the amount of the specific new borrowing . . .

Specificnew

borrowing

AAE. . . Capitalize this portion using specific

borrowing rate.

Internal financing

. . . Capitalize this portion using weighted average cost of debt.



Slide10-56

Capitalization begins when construction beginsinterest is incurred, andqualifying expenses are incurred.

Capitalization ends when . . .The asset is substantially complete and ready

for its intended use,or when interest costs no longer are being

incurred.

Capitalization begins when construction beginsinterest is incurred, andqualifying expenses are incurred.

Capitalization ends when . . .The asset is substantially complete and ready

for its intended use,or when interest costs no longer are being

incurred.



Slide10-57

Steps in the capitalization process

Compute actual interest expense.Compute AAE.Determine how much interest is

potentially capitalizable (IPC).Capitalize the smaller of actual

interest or capitalizable interest.

Steps in the capitalization process

Compute actual interest expense.Compute AAE.Determine how much interest is

potentially capitalizable (IPC).Capitalize the smaller of actual

interest or capitalizable interest.



Slide10-58

Welling, Inc. is constructing a building for its own use. Construction activities started on May 1 and

have continued through Dec. 31. Welling made the following qualifying expenditures: May 1,

$125,000; July 31, $160,000, Oct. 1, $200,000; and Dec. 1, $300,000.

Welling recorded total interest expense of $175,000 during the year, including construction borrowing of $1,000,000 on May 1, from Bub’s Bank for 10

years at 12%.

Welling, Inc. is constructing a building for its own use. Construction activities started on May 1 and

have continued through Dec. 31. Welling made the following qualifying expenditures: May 1,

$125,000; July 31, $160,000, Oct. 1, $200,000; and Dec. 1, $300,000.

Welling recorded total interest expense of $175,000 during the year, including construction borrowing of $1,000,000 on May 1, from Bub’s Bank for 10

years at 12%.



Slide10-59

Actual interest expense is $175,000. Compute AAE:

Fraction ofDate Expenditure Year AAE5/1 125,000$ 8/12 83,333$

7/31 160,000 5/12 66,667 10/1 200,000 3/12 50,000 12/1 300,000 1/12 25,000

785,000$ 225,000$

Fraction ofDate Expenditure Year AAE5/1 125,000$ 8/12 83,333$

7/31 160,000 5/12 66,667 10/1 200,000 3/12 50,000 12/1 300,000 1/12 25,000

785,000$ 225,000$



Slide10-60

Compute the IPC: Since AAE < Specific Borrowing, use

the specific borrowing interest rate of 12%.

IPC = AAE × Capitalization rateIPC = $225,000 × 12% = $27,000

Compute the IPC: Since AAE < Specific Borrowing, use

the specific borrowing interest rate of 12%.

IPC = AAE × Capitalization rateIPC = $225,000 × 12% = $27,000



Slide10-61

Capitalize the smaller of actual interest or IPC.Actual interest ($175,000) > IPC ($27,000)

Capitalize $27,000!

Capitalize the smaller of actual interest or IPC.Actual interest ($175,000) > IPC ($27,000)

Capitalize $27,000!



Slide10-62

ResearchPlanned search or critical investigation aimed at

discovery of new knowledge . . .

DevelopmentThe translation of research findings or other

knowledge into a plan or design . . .

Most R&D costs are expensed as incurred. (Must be disclosed if material.)

ResearchPlanned search or critical investigation aimed at

discovery of new knowledge . . .

DevelopmentThe translation of research findings or other

knowledge into a plan or design . . .

Most R&D costs are expensed as incurred. (Must be disclosed if material.)

Research and Development (R&D)


Slide10-63

R&D costs incurred under contract for other companies are expensed against revenue from the contract.

Operational assets used in R&D should be capitalized if they have alternative future uses.

R&D costs incurred under contract for other companies are expensed against revenue from the contract.

Operational assets used in R&D should be capitalized if they have alternative future uses.

Research and Development (R&D)


Slide10-64

Software Development Costs SFAS No. 86

All costs incurred to establish the technological feasibility of a computer software product are to be treated as R&D and expensed as incurred.

Subsequent costs to obtain product masters are to be capitalized as an intangible asset.

All costs incurred to establish the technological feasibility of a computer software product are to be treated as R&D and expensed as incurred.

Subsequent costs to obtain product masters are to be capitalized as an intangible asset.

“Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed”


Slide10-65


Start ofR&D

Activity

TechnologicalFeasibility

Start ofCommercialProduction

Sale of Product

or Process

Costs areExpensed

as R&DCosts are

CapitalizedCosts arenot R&D


Slide10-66

Amortization of capitalized computer software costs starts when the product begins to be marketed.

Two methods are allowed:Revenue methodStraight-line method

Amortization of capitalized computer software costs starts when the product begins to be marketed.

Two methods are allowed:Revenue methodStraight-line method



Slide10-67

Balance SheetUnamortized computer software product

master cost is an asset.

Income StatementAmortization expense associated with

computer software cost.R&D expense associated with computer

software development cost.

Balance SheetUnamortized computer software product

master cost is an asset.

Income StatementAmortization expense associated with

computer software cost.R&D expense associated with computer

software development cost.


Disclosure


Slide10-68

End of Chapter 10

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