ch10

CHAPTER 10

Acquisition and Dispositionof Property, Plant, and Equipment

ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)

Topics QuestionsBrief

Exercises Exercises Problems Concepts for Analysis

1. Valuation and classification of land, buildings, and equipment.

1, 2, 3, 4, 6, 7, 12, 13, 21

1 1, 2, 3, 4, 5, 13

1, 2, 3, 5 1, 6, 7

2. Self-constructed assets, capitalization of overhead.

5, 8, 20, 21 4, 6, 12, 16 2

3. Capitalization of interest. 8, 9, 10, 11, 13, 21

2, 3, 4 4, 5, 7, 8, 9, 10, 16

1, 5, 6, 7 3, 4

4. Exchanges of assets 12, 16, 17 8, 9, 10, 11, 12

3, 11, 16, 17, 18, 19, 20

4, 8, 9, 10, 11

5

5. Lump-sum purchases, issuance of stock, deferred-payment contracts.

12, 14, 15 5, 6, 7 3, 6, 11, 12, 13, 14, 15, 16

2, 11

6. Costs subsequent to acquisition.

18, 19 13 21, 22, 23 1

7. Alternative valuations. 22 3

8. Disposition of assets. 23 14, 15 24, 25 4 1

Copyright © 2010 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 13/e Instructor’s Manual (For Instructor Use Only) 10-1

ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)

Learning Objectives Brief Exercises Exercises Problems

1. Describe property, plant, and equipment.

2. Identify the costs to include in initial valuation of property, plant, and equipment.

1 1, 2, 3, 4, 5, 11, 12, 13

1, 2, 3, 4, 5, 6, 11

3. Describe the accounting problems associated with self-constructed assets.

4, 5, 6, 11, 12

3

4. Describe the accounting problems associated with interest capitalization.

2, 3, 4 5, 6, 7, 8, 9, 10

5, 6, 7, 8, 9, 10, 11

5. Understand accounting issues related to acquiring and valuing plant assets.

5, 6, 7, 8, 9, 10, 11, 12

11, 12, 13, 14, 15, 16, 17, 18, 19, 20

3, 4

6. Describe the accounting treatment for costs subsequent to acquisition.

13 21, 22, 23

7. Describe the accounting treatment for the disposal of property, plant, and equipment.

14, 15 24, 25 2, 4, 11

10-2 Copyright © 2010 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 13/e Instructor’s Manual (For Instructor Use Only)

ASSIGNMENT CHARACTERISTICS TABLE

Item DescriptionLevel of Difficulty

Time (minutes)

E10-1 Acquisition costs of realty. Moderate 15–20

E10-2 Acquisition costs of realty. Simple 10–15 E10-3 Acquisition costs of trucks. Simple 10–15 E10-4 Purchase and self-constructed cost of assets. Moderate 20–25 E10-5 Treatment of various costs. Moderate 30–40 E10-6 Correction of improper cost entries. Moderate 15–20 E10-7 Capitalization of interest. Moderate 20–25 E10-8 Capitalization of interest. Moderate 20–25 E10-9 Capitalization of interest. Moderate 20–25 E10-10 Capitalization of interest. Moderate 20–25 E10-11 Entries for equipment acquisitions. Simple 10–15 E10-12 Entries for asset acquisition, including self-construction. Simple 15–20 E10-13 Entries for acquisition of assets. Simple 20–25 E10-14 Purchase of equipment with zero-interest-bearing debt. Moderate 15–20 E10-15 Purchase of computer with zero-interest-bearing debt. Moderate 15–20 E10-16 Asset acquisition. Moderate 25–35 E10-17 Nonmonetary exchange. Simple 10–15 E10-18 Nonmonetary exchange. Moderate 20–25 E10-19 Nonmonetary exchange. Moderate 15–20 E10-20 Nonmonetary exchange. Moderate 15–20 E10-21 Analysis of subsequent expenditures. Moderate 20–25 E10-22 Analysis of subsequent expenditures. Simple 15–20 E10-23 Analysis of subsequent expenditures. Simple 10–15 E10-24 Entries for disposition of assets. Moderate 20–25 E10-25 Disposition of assets. Simple 15–20

P10-1 Classification of acquisition and other asset costs. Moderate 35–40 P10-2 Classification of acquisition costs. Moderate 40–55 P10-3 Classification of land and building costs. Moderate 35–45 P10-4 Dispositions, including condemnation, demolition,

and trade-in.Moderate 35–40

P10-5 Classification of costs and interest capitalization. Moderate 20–30 P10-6 Interest during construction. Moderate 25–35 P10-7 Capitalization of interest. Moderate 20–30 P10-8 Nonmonetary exchanges. Moderate 35–45 P10-9 Nonmonetary exchanges. Moderate 30–40 P10-10 Nonmonetary exchanges. Moderate 30–40 P10-11 Purchases by deferred payment, lump-sum, and

nonmonetary exchanges.Moderate 35–45


ASSIGNMENT CHARACTERISTICS TABLE (Continued)

Item DescriptionLevel of Difficulty

Time (minutes)

CA10-1 Acquisition, improvements, and sale of realty. Moderate 20–25CA10-2 Accounting for self-constructed assets. Moderate 20–25

CA10-3 Capitalization of interest. Simple 20–25

CA10-4 Capitalization of interest. Moderate 30–40CA10-5 Nonmonetary exchanges. Moderate 30–40CA10-6 Costs of acquisition. Simple 20–25CA10-7 Cost of land vs. building—ethics. Moderate 20–25


LEARNING OBJECTIVES

1. Describe property, plant and equipment.2. Identify the costs to include in initial valuation of property, plant, and equipment.3. Describe the accounting problems associated with self-constructed assets.4. Describe the accounting problems associated with interest capitalization.5. Understand accounting issues related to acquiring and valuing plant assets.6. Describe the accounting treatment for costs subsequent to acquisition.7. Describe the accounting treatment for the disposal of property, plant, and equipment.


CHAPTER REVIEW

1. Chapter 10 presents a discussion of the basic accounting problems associated with the incurrence of costs related to property, plant, and equipment; and the accounting methods used to retire or dispose of these costs. These assets, also referred to as fixed assets, are of a durable nature and include land, building structures, and equipment. Fixed assets are an important part of the operations of most business organizations. They provide the major means of support for the production and/or distribution of a company’s product or service.

2. (S.O. 1) Property, plant, and equipment possess certain characteristics that distinguish them from other assets owned by a business enterprise. These characteristics may be expressed as follows: (a) acquired for use in operations and not for resale, (b) long-term in nature and usually depreciated, and (c) possess physical substance. An asset must be used in the normal business operations to be classified as a fixed asset. These assets last for a number of years and their costs must be allocated to the periods which benefit from their use.

Acquisition of Property, Plant, and Equipment

3. (S.O. 2) Property, plant and equipment are valued in the accounts at their historical cost. Historical cost is measured by the cash or cash equivalent price of obtaining the asset and bringing it to the location and condition necessary for its intended use. Thus, charges associated with freight costs and installation are considered a part of the asset’s cost. The process of allocating the historical cost of property, plant, and equipment to the periods benefited by those assets is known as depreciation. The topic of depreciation is presented in Chapter 11.

4. With minor exceptions, use of a method other than historical cost in valuing property, plant, and equipment represents a departure from generally accepted accounting principles. This position is justified on the grounds that: (a) cost reflects fair value on the date of acquisition, (b) historical cost involves actual, not hypothetical transactions, and (c) gains and losses should not be anticipated but should be recognized when the asset is sold.

5. The assets normally classified on the balance sheet as property, plant, and equipment include land, buildings, and various kinds of machinery and equipment. The cost of each item includes the acquisition price plus those expenditures incurred in getting the asset ready for its intended use. In the case of land, cost typically includes (a) purchase price; (b) closing costs such as title, attorney, and recording fees; (c) cost of grading, filling, draining, and clearing the property; (d) assumption of any liens, mortgages, or encumbrances on the property; and (e) any additional land improvements that have an indefinite life. The cost of removing an old building from land purchased for the purpose of constructing a new building is properly charged to the land account. Also, when improvements that have a limited life (fences, driveways, etc.) are made to the land they should be set up in a separate Land Improvements account so they can be depreciated over their estimated useful life.

6. Building costs include materials, labor, and overhead costs incurred during construction. Also, any fees such as those incurred for building permits or the services of an attorney are included in acquisition cost. In general, all costs incurred from excavation of the site to completion of the building are considered part of the building costs.


7. With respect to equipment, cost includes purchase price plus all expenditures related to the purchase that occur subsequent to acquisition but prior to actual use. These related costs would include such items as freight charges, insurance charges on the asset while in transit, assembly and installation, special preparation of facilities, and asset testing costs.

Self-Constructed Assets

8. (S.O. 3) When machinery and equipment to be used by an entity are constructed rather than purchased, a problem exists concerning the allocation of overhead costs. These costs may be handled in one of two ways: (a) assign no fixed overhead to the cost of the constructed asset, or (b) assign a portion of all overhead to the construction process. The second method called a full-costing approach appears preferable because of its consistency with the historical cost principle. It should be noted that the cost recorded for a constructed asset can never exceed the price charged by an outside producer.

Interest Costs

9. (S.O. 4) Capitalization of interest cost incurred in connection with financing the construction or acquisition of property, plant, and equipment generally follows the rule of capitalizing only the actual interest costs incurred during construction. While some modification to this general rule occurs, its adoption is consistent with the concept that the historical cost of acquiring an asset includes all costs incurred to bring the asset to the condition and location necessary for its intended use.

10. To qualify for interest capitalization, assets must require a period of time to get them ready for their intended use. Assets that qualify for interest cost capitalization include assets under construction for an enterprise’s own use (such as buildings, plants, and machinery) and assets intended for sale or lease that are constructed or otherwise produced as discrete projects (like ships or real estate developments). The period during which interest must be capitalized begins when three conditions are present: (a) expenditures for the asset have been made; (b) activities that are necessary to get the asset ready for its intended use are in progress; and (c) interest cost is being incurred.

11. The amount of interest to capitalize is limited to the lower of (a) actual interest cost incurred during the period or (b) the amount of interest cost incurred during the period that theoretically could have been avoided if the expenditure for the asset had not been made (avoidable interest). The potential amount of interest that may be capitalized during an accounting period is determined by multiplying interest rate(s) by the weighted-average amount of accumulated expenditures for qualifying assets during the period.

12. Examples which demonstrate computation of the weighted-average accumulated expenditures and selecting the appropriate interest rate are included in the chapter. Also, a comprehensive illustration of interest capitalization is shown in the text. This illustration includes both the computations and the related journal entries that should be made in a situation when an asset is constructed and capitalizable interest is a part of the transaction.


13. Two special issues relate to interest capitalization. If a company purchases land as a site for a structure, interest costs capitalized during the period of construction are part of the cost of the plant, not the land. In addition, companies should generally not net or offset interest revenue against interest cost.

Acquisition and Valuation

14. (S.O. 5) A number of accounting problems are involved in the acquisition and valuation of fixed assets. In general, an asset should be recorded at the fair market value of what is given up to acquire it or its own fair market value, whichever is more clearly evident. This appears to be a rather straight forward approach that can be easily followed. However, determining fair market value is not always as easy as it might appear. Some of the problems one encounters in determining proper valuation are discussed in the paragraphs that follow.

15. The purchase of a plant asset is often accompanied by a cash discount for prompt payment. If the discount is taken, it results in a reduction in the purchase price of the asset. However, when the discount is allowed to lapse, should a loss be recorded or should the asset be recorded at a higher purchase price? Currently, while the “loss approach” is preferred, both methods are employed in practice.

16. Plant assets purchased on long-term credit contracts should be accounted for at the present value of the consideration exchanged on the date of purchase. When the obligation stipulates no interest rate, or the rate is unreasonable, an imputed rate of interest must be determined for use in calculating the present value. Factors to be considered in imputing an interest rate are the borrower’s credit rating, the amount and maturity date of the note, and prevailing interest rates. If determinable, the cash exchange price of the asset acquired should be used as the basis for recording the asset and measuring the interest element.

17. In some instances a company may purchase a group of plant assets at a single lump sum price. The best way to allocate the purchase price of the assets to the individual items is the relative fair values of the assets acquired. To determine fair value, an appraisal for insurance purposes, the assessed valuation for property taxes, or simply an independent appraisal by a qualified appraiser might be used. When assets are acquired for an entity’s stock, the best measure of cost is the fair value of the stock issued.

Exchanges of Property, Plant, and Equipment

18. Nonmonetary assets such as inventory or property, plant, and equipment are items whose price may change over time. Controversy exists in regard to the accounting for these assets when one nonmonetary asset is exchanged for another nonmonetary asset.


19. As stated previously, ordinarily companies account for the exchange of nonmonetary assets on the basis of the fair value of the asset given up or the fair value of the asset received, whichever is clearly more evident. Thus, companies should recognize immediately any gains or losses on the exchange. The rationale for immediate recognition is that most transactions have commercial substance and therefore should be recognized. An exchange has commercial substance if the future cash flows change as a result of the transaction. An exchange of trucks with different useful lives might have commercial substance while an exchange of trucks with no significant difference in useful lives would probably not.

20. Companies immediately recognize losses they incur on all exchanges. The accounting for gains depends on whether the exchange has commercial substance. If the exchange has commercial substance, the company recognizes the gain immediately. However, the rule for immediate recognition of a gain when an exchange lacks commercial substance is treated differently. If the company receives no cash (boot) in such an exchange, it defers recognition of a gain. If the company receives cash in such an exchange, it recognizes part of the gain immediately. The portion to be recognized is equal to the ratio of the cash received to the total consideration received times the total gain indicated.

21. To summarize these concepts, when a transaction involves an exchange of nonmonetary assets, losses are always recognized. Gains are recognized if the exchange has commercial substance. However, gains are deferred (not immediately recognized) if the exchange has no commercial substance, unless cash or some other form of monetary consideration is received, in which case a partial gain is recognized. Also, a gain or loss on the exchange on nonmonetary assets is computed by comparing the book value of the asset given up with the fair value of that same asset. The examples shown below are designed to demonstrate the various situations where exchanges of nonmonetary assets are included.

Exchange with Commercial Substance

Al Company exchanged a used machine with a book value of $26,000 (cost $54,000 less $28,000 accumulated depreciation) and cash of $8,000 for a delivery truck. The machine is estimated to have a fair market value of $36,000.

Cost of truck:Fair value of machine exchanged................... $36,000Cash paid........................................................ 8,000Cost of truck.................................................... $44,000

Journal entry:Truck............................................................... $44,000Accumulated Depreciation—Machine............. 28,000

Machine.................................................. 54,000Gain on Machine Disposal...................... 10,000Cash....................................................... 8,000


Exchange with No Commercial Substance

Al Company trades drill press A for drill press B from another company. Drill Press A has a book value of $11,000 (cost $32,000 less $21,000 accumulated depreciation) and a fair market value of $8,000. Drill press B has a list price of $38,000, and the seller has allowed a trade-in allowance of $15,000 on the press.

Cost of new machine:List price of drill press B.................................. $38,000Less trade-in allowance.................................. 15,000Cash payment due.......................................... 23,000Fair value of drill press A................................. 8,000Cost of drill press B......................................... $31,000

Journal entry:Equipment....................................................... 31,000Accumulated depreciation............................... 21,000Loss on disposal of equipment........................ 3,000

Equipment............................................... 32,000Cash........................................................ 23,000

Loss verification:Book value of drill press A............................... $11,000Fair value of drill press A................................. 8,000Loss on disposal of drill press A...................... $ 3,000

Exchange with No Commercial Substance

Al Company contracts with Peg Company to exchange delivery vans. Al Company will trade four Dodge Caravans for four Ford Freestars owned by Peg Company. The fair value of the Caravans is $51,000 with a book value of $38,000 (cost $65,000 less $27,000 accumulated depreciation). The Freestars have a fair value of $66,000 and Al Company gives $15,000 in cash in addition to the Caravans.

Computation of Gain:Fair value of Caravans.................................... $51,000Book value, of Caravans................................. 38,000Total gain (unrecognized)................................ $13,000

Basis of new vans to Al Company:Fair value of Freestars..................................... $66,000Less gain deferred........................................... 13,000Basis of Freestar vans..................................... $53,000


OR

Book value of Caravans.............................. $38,000Cash paid.................................................... 15,000Basis of Freestar vans................................. $53,000

Al Company journal entry:Freestar vans............................................... 53,000Accumulated depreciation........................... 27,000

Caravan vans...................................... 65,000Cash.................................................... 15,000

Exchange with No Commercial Substance-Gain Situation(Some Cash Received)

From the previous example, assume the book value of the Freestar Vans exchanged by Peg Company was $52,000 (cost $75,000 less $23,000 of accumulated depreciation). Thus, the total gain on the exchange to Peg Company is as follows:

Fair value of vans exchanged................................. $66,000Book value of vans exchanged............................... 52,000Total gain................................................................ $14,000

Recognized gain due to cash received:$15,000/($15,000 + $51,000) X $14,000 = $3,182

Deferred gain:$14,000 – $3,182 = $10,818

Basis of new vans to Peg Company:Fair value of Caravans........................... $51,000Less gain deferred................................. (10,818)Basis of Caravans.................................. $40,182

Peg Company journal entry:Cash...................................................... 15,000Caravan vans......................................... 40,182Accumulated depreciation..................... 23,000

Freestar vans................................. 75,000Gain on disposal of vans............... 3,182

22. Many companies receive assets through donations from other organizations, individuals, or the federal government. These transactions are known as nonreciprocal transfers. When an asset is received through donation, the appraisal or fair market value of the asset should be used to establish its value on the books. In theory, the credit for this transaction could be made to (1) a Donated Capital account that would appear in stockholders’ equity, or (2) revenue. A FASB standard states that, in general, contributions received should be recorded as revenue.


Other Asset Valuation Methods

23. Valuation of property, plant, and equipment on a basis other than historical cost has been widely discussed by those concerned with the financial reporting process. However, historical cost continues to be recognized as the accepted method for valuing these assets in the financial statements. One valuation approach that is sometimes allowed and not considered a violation of historical cost is a method referred to as prudent cost. This concept holds that if for some reason you were ignorant about a certain price and paid too much for an asset originally, it is theoretically preferable to charge a loss immediately.

Costs Subsequent to Acquisition

24. (S.O. 6) Costs related to plant assets that are incurred after the asset is placed in use are either added to the asset account (capitalized) or charged against operations (expensed) when incurred. In general, costs incurred to achieve greater future benefits from the asset should be capitalized, whereas expenditures that simply maintain a given level of service should be expensed. For the costs to be capitalized, one of three conditions must be present: (a) the useful life of the asset must be increased, (b) the quantity of service produced from the asset must be increased, or (c) the quality of the units produced must be enhanced. In many instances, a considerable amount of judgment is required in deciding whether to capitalize or expense an item. However, consistent application of a capital/expense policy is normally more important than attempting to provide theoretical guidelines.

25. Generally, expenditures related to plant assets being used in a productive capacity may be classified as: (a) additions, (b) improvements and replacements, (c) reinstallation and rearrangement, and (d) repairs. Because additions result in the creation of new assets, they should be capitalized.

26. Improvements and replacements are substitutions of one asset for another. Improvements substitute a better asset for the one currently used, whereas a replacement substitutes a similar asset. The major problem in accounting for improvements and replacements concerns differentiating these expenditures from normal repairs. If an improvement or replacement increases the future service potential of the asset, it should be capitalized. Capitalization may be accomplished by: (a) substituting the cost of the new asset for the cost of the asset replaced, (b) capitalizing the new cost without eliminating the cost of the asset replaced, or (c) debiting the expenditure to accumulated depreciation. The specific facts related to the situation will aid in determining the most appropriate method to use.

27. Rearrangement and reinstallation costs are generally carried forward as a separate asset and amortized against future income. Ordinary repairs are expenditures made to maintain plant assets in operating condition. They are charged to an expense account in the period in which they are incurred.

Dispositions of Plant Assets

28. (S.O. 7) When a plant asset is disposed of, the accounting records should be relieved of the cost and accumulated depreciation associated with the asset. Depreciation should be recorded on the asset up to the date of disposal, and any resulting gains or losses should be reported. Plant assets may be retired voluntarily or disposed of by sale, exchange, involuntary conversion, or abandonment.


LECTURE OUTLINE

Chapter 10 presents issues related to the acquisition and disposition of plant assets. The chapter, which can generally be covered in three class sessions, deals with three major topics:

1. General principles involved in accounting for the acquisition and disposition of plant assets: Students should be familiar with these from elementary accounting courses.

2. Capitalization of interest cost during construction: Students generally have difficulty with the computational procedures required.

3. Nonmonetary exchanges: This is a difficult topic for some students. Students should be encouraged to understand the meaning of commercial substance.

The following lecture outline is appropriate for this chapter.

A. (L.O. 1) Characteristics of Property, Plant, and Equipment.

1. Acquired for use and not resale.

2. Long-term in nature and subject to depreciation, except for land.

3. Possess physical substance.

B. (L.O. 2) Acquisition and Valuation of Property, Plant, and Equipment.

1. Historical cost is the usual basis for valuation. This is the cash or cash equivalent price of obtaining the asset and getting it ready for its intended use.

2. Components of cost.

a. Cost of Land: All expenditures made to acquire the land and prepare it for use are included in the cost of the land. Special assessments for relatively permanent improvements such as pavements and drainage systems are included in the land account. Improvements with limited lives are recorded separately as Land Improvements and depreciated over their estimated lives.

b. Cost of Buildings: All expenditures related directly to acquisition or construction are capitalized. This includes attorneys’ and architects’ fees, building permits, and all costs incurred beginning with excavation and ending with completion of the building.

c. Cost of Equipment: All expenditures incurred in acquiring the equipment and preparing it for use are included. This includes freight charges, insurance while in transit, assembly costs, and the cost of conducting trial runs.

d. (L.O. 3) Self-Constructed Assets: Such assets may cause valuation problems because of the assignment of overhead. The options are to assign a portion of all overhead, or assign no fixed overhead. The first option is preferred.


C. (L.O. 4) Interest Costs During Construction.

1. Basic principle: Interest cost incurred during construction of plant assets is part of the cost of acquiring the assets and preparing them for their intended use. Like other acquisition costs, interest cost should be capitalized and depreciated over the expected useful life of the assets involved.

2. Describe the computational steps involved in determining the amount of interest to be capitalized.

Illustration 10-1 provides a step-by-step description of interest capitalization.

a. Determine which assets qualify for capitalization of interest.

b. Determine the capitalization period.

c. Compute the expenditures made during the capitalization period.

d. Compute the weighted-average accumulated expenditures.

e. Compute avoidable interest. Typically, this computation is difficult for students. They must pay attention to the dates of construction expenditures and to the date of specific construction loans and other outstanding general debt.

f. Compute the actual interest cost incurred.

g. Determine the interest cost to be capitalized.

Illustration 10-2 provides a numerical example of interest capitalization for self-constructed special-purpose equipment.

Illustration 10-3 provides a flowchart diagram of the requirements of FASB Statement No. 34.

3. Special issues related to interest capitalization.

a. Interest costs incurred in the purchase of land to be used for a building site are part of the building’s cost, not the land.

b. Interest costs incurred on land being developed for lot sales, are part of the land’s cost.

c. Interest revenue earned on funds borrowed to finance construction of assets is not netted against the interest expense incurred.


D. (L.O. 5) Means of Acquisition and Valuation.

1. Cash Discounts: The asset should be recorded at the current cash equivalent price at the date of acquisition. It is preferable to exclude the cash discount from the recorded cost of the asset, whether the discount is taken or not. Any discount not taken should be recorded as an expense.

2. Deferred-Payment Contracts: Assets purchased on long-term credit contracts should be accounted for at the present value of the consideration exchanged. When no interest rate is stated, or if the specified rate is unreasonable, an appropriate rate should be imputed. (At this point, it would be useful to review the procedure for computing the present value of a note.)

3. Lump Sum Purchases: Total cost should be allocated on the basis of relative fair values. Insurance appraisals, property tax assessments, or independent appraisals may be used as indicators of relative fair values.

4. Issuance of Stock: Market value of stock issued is used as an indication of the cost of the property acquired. If the stock’s market value is not determinable, use the fair value of the property acquired.

5. Exchanges of property, plant, and equipment (nonmonetary assets). In presenting this topic, it is important to emphasize both the basic accounting procedures and the basic accounting principles involved.

a. Commercial substance is the basis for immediate recognition of any gain or loss on the exchange.

b. Basic accounting procedures.

Illustration 10-4 provides a description of the accounting procedures employed for the exchange of nonmonetary assets. Illustration 10-5 puts these accounting procedures into a flowchart.

(1) Compute the net book value of the old asset.

(2) Compute the realized gain or loss.

(3) Determine the amount of gain or loss to be recognized.

(4) Prepare the journal entry to record the exchange. Remind students to ensure that their entry balances; this is frequently overlooked.

Illustration 10-6 provides a numerical example of an exchange that lacks commercial substance with cash paid and received.


6. Acquisition and disposition of contributions (nonreciprocal transfers).

a. Acquisition: The fair value of the asset should be used to record the asset on the company’s books. A strict application of the cost principle would not result in a reasonable valuation of the asset. The corresponding credit which the company will record is revenue in the amount of the asset’s fair value.

b. Disposition: When a plant asset is contributed, two types of income statement accounts may be affected.

(1) Contribution expense should be recorded at the fair value of the asset.

(2) A gain or loss should be recorded for the difference between the fair value and the book value of the asset.

7. Other Asset Valuation Method. The prudent cost concept states that it is theoretically preferable to charge a loss immediately if a company ignorantly paid too much for an asset originally.

E. (L.O. 6) Costs Subsequent to Acquisition. Students have some difficulty in distinguishing the different natures of costs subsequent to acquisition such as additions, improvements and replacements, reinstallation and rearrangement, and ordinary and major repairs.

1. In order to capitalize costs, one of three conditions must be present:

a. The useful life of the asset must be increased.

b. The quantity of units produced from the asset must be increased.

c. The quality of the units produced must be enhanced.

Illustration 10-7 provides a comparative summary of costs subsequent to the acquisition of property, plant, and equipment.

2. Additions. Any additions should be capitalized.

3. Improvements and Replacements. The proper accounting treatment depends on whether the carrying value of the old component is known or unknown.

4. Reinstallation and Rearrangement. The proper accounting treatment depends on whether the carrying value of the original installation is known or unknown.


5. Repairs.

a. Ordinary repairs should be expensed in the period incurred.

b. Major repairs should be treated as an addition, improvement, or replacement.

F. (L.O. 7) Dispositions of Plant Assets. Depreciation up to the date of disposition must be recorded. The cost and accumulated depreciation of the asset must be removed from the books, any cash received must be recorded, and a gain or loss is recognized.

1. Sale of Plant Assets.

2. Involuntary Conversion. Gains or losses are the same in any other type of disposition regardless of whether any resulting cash proceeds are going to be reinvested in re-placement assets.

3. Abandonment.

Key difference between iGAAP and GAAP relating to property, plant, and equipment is:

I. Under iGAAP, capitalization of interest on borrowing costs incurred during construction of assets can be either expensed or capitalized.


ILLUSTRATION 10-1CAPITALIZATION OF INTEREST COST


ILLUSTRATION 10-1 (continued)


ILLUSTRATION 10-2CAPITALIZATION OF INTEREST EXAMPLE




ILLUSTRATION 10-3FLOWCHART FOR DETERMINING CAPITALIZATION OF INTEREST COST


ILLUSTRATION 10-4ACCOUNTING FOR NONMONETARY EXCHANGES


ILLUSTRATION 10-5NONMONETARY EXCHANGE FLOWCHART


ILLUSTRATION 10-6EXCHANGE OF NONMONETARY ASSETS(WITH AND WITHOUT BOOT)




ILLUSTRATION 10-7SUMMARY OF COSTS SUBSEQUENT TO ACQUISITION OF PROPERTY, PLANT, AND EQUIPMENT


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acquisition of assets

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acquisition costs of

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asset costs

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