Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition Question 10-1 The difference between tangible and intangible long-lived, revenue-producing assets is that intangible assets lack physical substance and they primarily refer to the ownership of rights. Question 10-2 The cost of property, plant, and equipment and intangible assets includes the purchase price (less any discounts received from the seller), transportation costs paid by the buyer to transport the asset to the location in which it will be used, expenditures for installation, testing, legal fees to establish title, and any other costs of bringing the asset to its condition and location for use. Question 10-3 The cost of a developed natural resource includes the acquisition costs for the use of land, the exploration and development costs incurred before production begins, and the restoration costs incurred during or at the end of extraction. Question 10-4 Purchased intangibles are valued at their original cost to include the purchase price and all other necessary costs to bring the asset to condition and location for use. Research and development costs incurred to internally develop an intangible asset are expensed in the period incurred. Filing and legal costs for both purchased and developed intangibles are capitalized. Question 10-5 Goodwill represents the unique value of the company as a whole over and above all identifiable tangible and intangible assets. 10-1 Chapter 10 Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition QUESTIONS FOR REVIEW OF KEY TOPICS
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Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Question 10-1 The difference between tangible and intangible long-lived, revenue-producing assets is that
intangible assets lack physical substance and they primarily refer to the ownership of rights.
Question 10-2 The cost of property, plant, and equipment and intangible assets includes the purchase price
(less any discounts received from the seller), transportation costs paid by the buyer to transport the asset to the location in which it will be used, expenditures for installation, testing, legal fees to establish title, and any other costs of bringing the asset to its condition and location for use.
Question 10-3 The cost of a developed natural resource includes the acquisition costs for the use of land, the
exploration and development costs incurred before production begins, and the restoration costs incurred during or at the end of extraction.
Question 10-4 Purchased intangibles are valued at their original cost to include the purchase price and all
other necessary costs to bring the asset to condition and location for use. Research and development costs incurred to internally develop an intangible asset are expensed in the period incurred. Filing and legal costs for both purchased and developed intangibles are capitalized.
Question 10-5 Goodwill represents the unique value of the company as a whole over and above all
identifiable tangible and intangible assets. This value results from a company’s clientele and reputation, its trained employees and management team, its unique business location, and any other unique features of the company that can’t be associated with a specific asset.
Because goodwill can’t be separated from a company, it is not possible for a buyer to acquire it without also acquiring the whole company or a substantial portion of it. Goodwill will appear as an asset in a balance sheet only when it was paid for in connection with the acquisition of another company. The capitalized cost of goodwill equals the purchase price of the acquired company less the fair value of the net assets acquired. The fair value of the net assets equals the fair value of all identifiable tangible and intangible assets less the fair value of any liabilities of the selling company assumed by the buyer.
10-1
Chapter 10 Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
QUESTIONS FOR REVIEW OF KEY TOPICS
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Answers to Questions (continued)
Question 10-6 A lump-sum purchase price generally is allocated based on the relative fair values of the
individual assets. The relative fair value percentages are multiplied by the lump-sum purchase price to arrive at the initial valuation of each of the separate assets.
Question 10-7 Assets acquired in exchange for deferred payment contracts are valued at their fair value or the
present value of payments using a realistic interest rate. Theoretically, both alternatives should lead to the same valuation.
Question 10-8 Assets acquired through the issuance of equity securities are valued at the fair value of the
securities if known; if not known, the fair value of the assets received is used.
Question 10-9 Donated assets are valued at their fair values.
Question 10-10 When an item of property, plant, and equipment is sold, a gain or loss is recognized for the
difference between the consideration received and the asset’s book value. Retirements and abandonments are handled in a similar fashion. The only difference is that there will be no monetary consideration received. A loss is recorded for the remaining book value of the asset.
Question 10-11 The basic principle used to value assets acquired in a nonmonetary exchange is to use the fair
value of asset(s) given up plus (minus) monetary consideration - cash - paid (received).
Question 10-12 The two exceptions are (1) when fair value is not determinable and (2) when the exchange
lacks commercial substance.
Question 10-13 GAAP require the capitalization of interest incurred during the construction of assets for a
company’s own use as well as for assets constructed for sale or lease. Assets qualifying for capitalization exclude inventories that are routinely manufactured in large quantities on a repetitive basis and assets that are in use or ready for their intended purpose. Only assets that are constructed as discrete projects qualify for interest capitalization.
10-2
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Answers to Questions (continued)
Question 10-14 Average accumulated expenditures for a period is an approximation of the average amount of
debt the company would have had outstanding if it borrowed all of the funds necessary for construction. If construction expenditures are incurred equally throughout the period, the average accumulated expenditures for the period can be estimated by adding the accumulated expenditures at the beginning of the period to the accumulated expenditures at the end of the period and dividing by two. If expenditures on the project are unequal throughout the period, individual expenditures, perhaps expenditures grouped by month, should be weighted by the amount of time outstanding until the end of the construction period or the end of the company’s fiscal year, whichever comes first.
Question 10-15 Applying the specific interest method, the interest rate on any construction related debt is used
up to the amount of the construction debt and any excess average accumulated expenditures is multiplied by a weighted-average interest rate of all other debt. The weighted-average method multiplies average accumulated expenditures by the weighted-average interest rate of all debt, including any construction-related debt.
Question 10-16 GAAP defines research and development as follows:Research is planned search or critical investigation aimed at discovery of new knowledge with
the hope that such knowledge will be useful in developing a new product or service or a new process or technique or in bringing about a significant improvement to an existing product or process.
Development is the translation of research findings or other knowledge into a plan or design for a new product or process or for a significant improvement to an existing product or process whether intended for sale or use.
Question 10-17 GAAP specifically excludes from current R&D expense the cost of property, plant, and
equipment and intangible assets that have “alternative future uses” beyond the current R&D project. However, the depreciation or amortization of these assets will be included as R&D expenses in the future periods the assets are used for R&D activities. If the asset has no alternative future use, its cost is expensed as R&D immediately.
Question 10-18 GAAP requires the capitalization of software development costs incurred after technological
feasibility is established. Technological feasibility is established “when the enterprise has completed all planning, designing, coding, and testing activities that are necessary to establish that the product can be produced to meet its design specifications including functions, features, and technical performance requirements.” Costs incurred after technological feasibility but before the product is available for general release to customers are capitalized as an intangible asset. These costs include coding and testing costs and the production of product masters. Costs incurred after commercial production begins usually are not R&D expenditures.
10-3
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Answers to Questions (concluded)
Question 10-19 The cost of developed technology is capitalized and expensed over its expected useful life.
Developed technology relates to those projects that have reached technological feasibility. Before 2009, the cost of in-process R&D was expensed in the period of the acquisition. Now, the cost of in-process R&D is capitalized and treated as an indefinite life intangible asset and not amortized. If the R&D project is completed successfully, we switch to the way we account for developed technology and amortize the capitalized amount over the estimated period the product or process developed will provide benefits. If the project instead is abandoned, we expense the entire balance immediately. Research and development costs incurred after the acquisition to complete the project are expensed as incurred, consistent with the treatment of any other R&D not acquired in an acquisition.
Question 10-20 Other than software development costs incurred after technological feasibility has been
established, U.S. GAAP requires all research and development expenditures to be expensed in the period incurred. IAS No. 38 draws a distinction between research activities and development activities. Research expenditures are expensed in the period incurred. However, development expenditures that meet specified criteria are capitalized as an intangible asset.
Question 10-21 The periodic amortization percentage for capitalized computer software development costs
under U.S. GAAP is the greater of (1) the ratio of current revenues to current and anticipated revenues or (2) the straight-line percentage over the useful life of the software. This approach is allowed under IFRS, but not required.
Question 10-22 The successful efforts method allows companies to capitalize only exploration costs resulting
in successful wells. The full-cost method allows companies to capitalize all exploration costs incurred within a geographical area.
10-4
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Note: Personal property taxes on the machine for the period after acquisition are not part of acquisition cost. They are expensed in the period incurred.
Capitalized cost of land:
Purchase price $600,000Broker’s commission 30,000Title insurance 3,000Miscellaneous closing costs 6,000Demolition of old building 18,000
Total cost $657,000
All of the expenditures, including the costs to demolish the old building, are included in the initial cost of the land.
The total must be allocated to the land and building based on their relative fair values:
10-5
Brief Exercise 10-1
Brief Exercise 10-2
Brief Exercise 10-3
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Asset Fair Value
Percent of Total Fair Value
InitialValuation(Percent x $639,000)
Land $420,000 60% $383,400Building 280,000 40 255,600
$700,000 100% $639,000
Cost of silver mine:Acquisition, exploration, and development $5,600,000Restoration costs 429,675 †
$6,029,675
† $500,000 x 20% = $100,000 550,000 x 45% = 247,500 650,000 x 35% = 227,500
$575,000 x .74726* = $429,675*Present value of $1, n = 5, i = 6% (from Table 2)
After one year, the liability will increase to $455,456.($429,675† + ($429,675 x 6%) = $455,456)
† $500,000 x 20% = $100,000 550,000 x 45% = 247,500 650,000 x 35% = 227,500
$575,000 x .74726* = $429,675*Present value of $1, n = 5, i = 6% (from Table 2)
Actual restoration costs $596,000Less: Asset retirement liability (575,000) Loss on retirement $ (21,000)
10-6
Brief Exercise 10-4
Brief Exercise 10-5
Brief Exercise 10-6
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Calculation of goodwill:
Consideration exchanged $14,000,000Less fair value of net assets:
Book value of assets $8,300,000Plus: Excess of fair value over book value of intangible assets 2,500,000 (10,800,000)
Goodwill $ 3,200,000
The initial value of machinery and note will be the present value of the note payment:
PV = $60,000 (.85734) = $51,440 Present value of $1: n = 2, i = 8% (from Table 2)
10-7
Brief Exercise 10-7
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Interest expense for July 1 to December 31, 2011:
$51,440 x 8% x 6/12 = $2,058
The cost of the patent equals the fair value of the stock given in exchange:
50,000 x $22 = $1,100,000
Average PP&E for 2011 = ($740,000 + 940,000) ÷ 2 = $840,000
Net sales ÷ Average PP&E = Fixed-asset turnover ratio ? ÷ $840,000 = 3.25Average PP&E x Fixed-asset turnover ratio = Net sales $840,000 x 3.25 = $2,730,000
$3,000,000 x 8% = $240,000 5,000,000 x 6% = 300,000$8,000,000 $540,000
$540,000 = 6.75% weighted average$8,000,000
10-10
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Average accumulated expenditures:
January 1, 2011 $500,000 x 12/12 = $ 500,000March 31, 2011 600,000 x 9/12 = 450,000June 30, 2011 400,000 x 6/12 = 200,000October 30, 2011 600,000 x 2/12 = 100,000
$1,250,000
Interest capitalized:
$1,250,000 x 6.77%* = $84,625
* Weighted-average rate of all other debt:
$ 700,000 x 7% = $ 49,0003,000,000 x 8% = 240,000
5,000,000 x 6% = 300,000$8,700,000 $589,000
$589,000 = 6.77% weighted average$8,700,000
Research and development:Salaries $220,000Depreciation on R & D facilities and equipment 125,000Utilities and other direct costs 66,000Payment to another company 120,000 Total R & D expense $531,000
Note: The patent filing and related legal costs and the costs of adapting the product to a particular customer’s needs are not included as research and development expense.
10-11
Brief Exercise 10-15
Brief Exercise 10-16
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Capitalized cost of land:
Purchase price $60,000Demolition of old building $4,000Less: Sale of materials (2,000) 2,000Legal fees for title investigation 2,000
Total cost of land $64,000
Capitalized cost of building:
Construction costs $500,000Architect's fees 12,000Interest on construction loan 5,000
Total cost of building $517,000
Note: Property taxes on the land for the period after acquisition are not part of acquisition cost. They are expensed in the period incurred.
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Exercise 10-3
Requirement 1
Cost of land and building:
Purchase price $4,000,000Title search and insurance 16,000Legal fees 5,000State transfer fees 4,000
Total cost $4,025,000
Note: The pro-rated property taxes for the period after acquisition are not included in the initial valuation of the land and building. They are recorded instead as prepaid taxes and expensed over the related period.
The total is allocated to the land and building based on their relative fair values:
Asset Fair Value
Percent of Total Fair Value
InitialValuation(Percent x $4,025,000)
Land $3,300,000 75% $3,018,750Building 1,100,000 25 1,006,250
$4,400,000 100% $4,025,000
Assets: Land $3,018,750 Building 1,006,250 Land improvements: Parking lot 82,000 Landscaping 40,000
10-13
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Exercise 10-3 (concluded)
Requirement 2
Cost of land:Purchase price $4,000,000Title search and insurance 16,000Legal fees 5,000State transfer fees 4,000Demolition of old building $250,000
Less: Sale of materials (6,000) 244,000Clearing and grading costs 86,000
Total cost of land $4,355,000
Land improvements: Parking lot 82,000 Landscaping 40,000
Requirement 1
Cost of copper mine:Mining site $1,000,000Development costs 600,000Restoration costs 303,939 †
$1,903,939
† $300,000 x 25% = $ 75,000 400,000 x 40% = 160,000 600,000 x 35% = 210,000
$445,000 x .68301* = $303,939*Present value of $1, n = 4, i = 10% (from Table 2)
Consideration exchanged $11,000,000Less fair value of net assets:
Book value of net assets $7,800,000Plus: Fair value in excess of book value: Property, plant, and equipment 1,400,000 Intangible assets 1,000,000Less: Book value in excess of fair value:
Machinery:Purchase price $860,000Freight charges 32,000Special platforms and wire installation 12,000Cost of trial runs 7,000
Total cost of machinery $911,000
Land improvements:Landscaping $45,000Sprinkler system 5,000
Fork lifts:
PV = $16,000 + 70,000 (.93458) = $81,421Present value of $1: n = 1, i = 7% (from Table 2)
Prepaid insurance: $24,000To record the acquisition of land in exchange for common stock.
February 1, 2011Land ............................................................................. 90,000
Common stock (5,000 shares x $18).............................. 90,000
To record the acquisition of a building through purchase and donation.
November 2, 2011Building ........................................................................ 600,000
Cash ......................................................................... 400,000Revenue - donation of asset (difference)...................... 200,000
10-17
Exercise 10-11
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Requirement 1($ in millions)Average PP&E for 2009 = ($4,043 + 4,151) ÷ 2 = $4,097
Net sales ÷ Average PP&E = Fixed-asset turnover ratio$36,117 ÷ $4,097 = 8.82
Requirement 2The fixed-asset turnover ratio indicates the level of sales generated by the
company’s investment in fixed assets. Cisco is able to generate $8.82 in sales for every $1 invested in property, plant, and equipment.
Requirement 1
Cash.............................................................................. 3,000Accumulated depreciation - tractor (account balance)....... 26,000Loss on sale of tractor (difference)................................... 1,000
The Codification topic number for nonmonetary transactions is FASB ASC 845: “Nonmonetary Transactions.”
Requirement 2The specific citations that describe the required disclosures for nonmonetary
transactions are FASB ASC 845–10–50–1 to 2: “Nonmonetary Transactions–Overall–Disclosure.”
Requirement 3
10-21
Exercise 10-20
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
An entity that engages in one or more nonmonetary transactions during a period shall disclose in financial statements for the period all of the following:
10-22
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
a. The nature of the transactions
b. The basis of accounting for the assets transferred
c. Gains or losses recognized on transfers.
In accordance with paragraph 845-10-50-1, entities shall disclose, in each period's financial statements, the amount of gross operating revenue recognized as a result of nonmonetary transactions.
The FASB Accounting Standards Codification represents the single source of authoritative U.S. generally accepted accounting principles. The specific citation for each of the following items is:
1. The disclosure requirements in the notes to the financial statements for depreciation on property, plant, and equipment:
FASB ASC 360–10–50–1: “Property, Plant, and Equipment–Overall–Disclosure.”
10-23
Exercise 10-21
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Because of the significant effects on financial position and results of operations of the depreciation method or methods used, all of the following disclosures shall be made in the financial statements or in notes thereto:
a. Depreciation expense for the period
b. Balances of major classes of depreciable assets, by nature or function, at the balance sheet date
c. Accumulated depreciation, either by major classes of depreciable assets or in total, at the balance sheet date
d. A general description of the method or methods used in computing depreciation with respect to major classes of depreciable assets.
10-24
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Exercise 10-21 (continued)
2. The criteria for determining commercial substance in a nonmonetary exchange:
FASB ASC 845–10–30–4: “Nonmonetary Transactions–Overall–Initial Measurement.”A nonmonetary exchange has commercial substance if the entity's future cash flows are expected to significantly change as a result of the exchange. The entity's future cash flows are expected to significantly change if either of the following criteria is met:
a. The configuration (risk, timing, and amount) of the future cash flows of the asset(s) received differs significantly from the configuration of the future cash flows of the asset(s) transferred. The configuration of future cash flows is composed of the risk, timing, and amount of the cash flows. A change in any one of those elements would be a change in configuration.
b. The entity-specific value of the asset(s) received differs from the entity-specific value of the asset(s) transferred, and the difference is significant in relation to the fair values of the assets exchanged. An entity-specific value (referred to as an entity-specific measurement in FASB Concepts Statement No. 7, Using Cash Flow Information and Present Value in Accounting Measurements) is different from a fair value measurement. As described in paragraph 24(b) of Concepts Statement No. 7, an entity-specific value attempts to capture the value of an asset or liability in the context of a particular entity. For example, an entity computing an entity-specific value of an asset would use its expectations about its use of that asset rather than the use assumed by marketplace participants. If it is determined that the transaction has commercial substance, the exchange would be measured at fair value, rather than at the entity-specific value.
A qualitative assessment will, in some cases, be conclusive in determining that the estimated cash flows of the entity are expected to significantly change as a result of the exchange.
10-25
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Exercise 10-21 (continued)
3. The disclosure requirements for interest capitalization:
FASB ASC 835–20–50–1: “Interest Capitalization–Overall–Disclosure.”An entity shall disclose the following information with respect to interest cost in the financial statements or related notes:
a. For an accounting period in which no interest cost is capitalized, the amount of interest cost incurred and charged to expense during the period
b. For an accounting period in which some interest cost is capitalized, the total amount of interest cost incurred during the period and the amount thereof that has been capitalized.
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Exercise 10-21 (concluded)
4. The elements of costs to be included as R&D activities:
FASB ASC 730–10–25–2: “Research & Development–Overall–Recognition.”Elements of costs shall be identified with research and development activities as follows: a. Materials, equipment, and facilities. The costs of materials (whether from the entity's normal inventory or acquired specially for research and development activities) and equipment or facilities that are acquired or constructed for research and development activities and that have alternative future uses (in research and development projects or otherwise) shall be capitalized as tangible assets when acquired or constructed. The cost of such materials consumed in research and development activities and the depreciation of such equipment or facilities used in those activities are research and development costs. However, the costs of materials, equipment, or facilities that are acquired or constructed for a particular research and development project and that have no alternative future uses (in other research and development projects or otherwise) and therefore no separate economic values are research and development costs at the time the costs are incurred.
b. Personnel. Salaries, wages, and other related costs of personnel engaged in research and development activities shall be included in research and development costs.
c. Intangible assets purchased from others. The costs of intangible assets that are purchased from others for use in research and development activities and that have alternative future uses (in research and development projects or otherwise) shall be accounted for in accordance with Topic 350. The amortization of those intangible assets used in research and development activities is a research and development cost. However, the costs of intangibles that are purchased from others for a particular research and development project and that have no alternative future uses (in other research and development projects or otherwise) and therefore no separate economic values are research and development costs at the time the costs are incurred.
d. Contract services. The costs of services performed by others in connection with the research and development activities of an entity, including research and development conducted by others in behalf of the entity, shall be included in research and development costs.
e. Indirect costs. Research and development costs shall include a reasonable allocation of indirect costs. However, general and administrative costs that are not clearly related to research and development activities shall not be included as research and development costs.
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Average accumulated expenditures:
$6,000,000 = $3,000,000 2
Interest capitalized:
$3,000,000- 1,500,000 x 10% = $150,000 1,500,000 x 7%* = 105,000
$255,000 = interest capitalized
* Weighted-average rate of all other debt:
$2,000,000 x 9% = $180,000 4,000,000 x 6% = 240,000$6,000,000 $420,000
$420,000 = 7% $6,000,000
Average accumulated expenditures for 2011:
January 1, 2011 $500,000 x 12/12 = $ 500,000March 1, 2011 600,000 x 10/12 = 500,000July 31, 2011 480,000 x 5/12 = 200,000September 30, 2011 600,000 x 3/12 = 150,000December 31, 2011 300,000 x 0/12 = - 0 -
$1,350,000
Interest capitalized:
$1,350,000 x 8% = $108,000
10-28
Exercise 10-22
Exercise 10-23
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Average accumulated expenditures for 2011:
January 1, 2011 $ 600,000 x 12/12 = $ 600,000March 31, 2011 1,200,000 x 9/12 = 900,000June 30, 2011 800,000 x 6/12 = 400,000September 30, 2011 600,000 x 3/12 = 150,000December 31, 2011 400,000 x 0/12 = - 0 -
$2,050,000
Interest capitalized:
$2,050,000- 1,500,000 x 8.0% = $120,000 550,000 x 10.5%* = 57,750
$177,750 = interest capitalized
* Weighted-average rate of all other debt:
$5,000,000 x 12% = $600,000 3,000,000 x 8% = 240,000$8,000,000 $840,000
$840,000 = 10.5%
$8,000,000
To expense R&D costs incorrectly capitalized.
Research and development expense (below)...................3,180,000Patent........................................................................ 3,180,000
Research and development expenditures:
Basic research to develop the technology $2,000,000Engineering design work 680,000
10-29
Exercise 10-24
Exercise 10-25
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Development of a prototype 300,000Testing and modification of the prototype 200,000 Total $3,180,000
To capitalize cost of equipment incorrectly capitalized as patent.
To record depreciation on equipment used in R&D projects.
Research and development expense.............................. 10,000Accumulated depreciation - equipment...................... 10,000
Research and development expense:
Salaries and wages for lab research $ 400,000Materials used in R&D projects 200,000Fees paid to outsiders for R&D projects 320,000Depreciation on R&D equipment 120,000 Total $1,040,000
The patent filing and legal costs are capitalized as the cost of the patent. The salaries, wages, and supplies for R&D performed for another company are included as inventory and expensed as cost of goods sold using either the completed contract or percentage-of-completion method.
Requirement 1
According to U.S. GAAP, the following costs would be expensed as R&D:
Research for new formulas $2,425,000Development of a new formula 1,600,000 Total $4,025,000
The legal and filing fees are capitalized as an intangible asset.
10-30
Exercise 10-26
Exercise 10-27
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Requirement 2According to IFRS, only the $2,425,000 in research costs would be expensed as
R&D. Both the development costs incurred after feasibility is established and the legal and filing fees are capitalized as intangible assets.
.
List A List B
f 1. Depreciation a. Exclusive right to display a word, a symbol,or an emblem.
d 2. Depletion b. Exclusive right to benefit from a creativework.
i 3. Amortization c. Assets that represent rights. g 4. Average accumulated d. The allocation of cost for natural resources.
expenditures h 5. Revenue - donation of asset e. Purchase price less fair value of net
identifiable assets. j 6. Nonmonetary exchange f. The allocation of cost for plant and
equipment. k 7. Natural resources g. Approximation of average amount of debt if
all construction funds were borrowed. c 8. Intangible assets h. Account credited when assets are donated to a
corporation. b 9. Copyright i. The allocation of cost for intangible assets. a 10. Trademark j. Basic principle is to value assets acquired
using fair value of assets given. e 11. Goodwill k. Wasting assets.
Requirement 1
($ in millions)Research and development expense.............................. 4Software development costs.......................................... 2
1. d. Simons Company should value the land at $170,500. All expenditures incurred to purchase land should be part of the capitalized asset. $150,000 + ($150,000 x .07) + $5,000 + $5,000
2. c. Costs attributable to land: $60,000 + $2,000 + $5,000 - $3,000 = $64,000Costs attributable to building: $8,000 + $350,000 = $358,000
3. d. There are eight payments due, the first one due immediately, and the remaining seven due each year on December 31. Therefore, the correct factor to use is the present value of an annuity in advance (annuity due) for 8 periods, or 5.712 x $20,000 = $114,240, the present value at the inception of the note and therefore the initial value of the machine. Another way to calculate the answer is to view the annuity as a 7 period ordinary annuity, with a down payment today of $20,000. This would yield a calculation of $20,000 + ($20,000 x 4.712) or $114,240.
4. b. The recorded cost of the new asset is equal to the fair value of the asset given up, $20,000. In this case, there are two new assets acquired, new truck, $15,000, and cash, $5,000. The gain on the trade is $8,000 (FV old truck $20,000 - $12,000 book value).
10-33
Exercise 10-30
CPA / CMA REVIEW QUESTIONS
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
5. c. Dahl Corporation should capitalize the materials, engineering fees, and labor and electricity for construction and testing: ($20,000 + $5,000 + $3,000 + $1,000 + $1,000 + $1,000). The labor and electricity to run the machine should not be capitalized. These should be expensed because they are not part of the construction costs and were not incurred prior to activating the asset.
10-34
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
CPA Exam Questions (concluded)
6. b. The interest cost capitalized is the lesser of the formula amount based on average accumulated expenditures or the actual interest cost incurred. In this case the formula amount ($40,000) is the smaller amount and should be the amount capitalized as part of the cost of the building.
7. a. Amortization of capitalized software is the greater of the amount calculated using the percentage-of-revenue method and the straight-line method. In this case, the straight-line percentage is 20% (1/5) and the percentage-of-revenue method is 30%. Therefore, we amortize 30% of the cost yielding book value of 70%.
8. d. All of the expenditures are considered research and development.
CMA Exam Questions
1. a. The costs of fixed assets (plant and equipment) are all costs necessary to acquire these assets and to bring them to the condition and location required for their intended use. These costs include shipping, installation, pre-use testing, sales taxes, interest, capitalization, etc. The original cost of the machinery to be recorded in the books is the sum of the purchase price, installation, and delivery charges.
2. d. GAAP states that the basic principle to be followed in these exchanges is to value the asset received at fair value and to recognize gain or loss (the difference between the fair value and the book value of the asset given up). Harper’s used machine has a book value of $64,000 ($162,500 cost - $98,500 accumulated depreciation). The fair value of the used machine is $80,000 resulting in a gain of $16,000 ($80,000 – 64,000). The only exceptions to using fair value are (1) when fair value is not determinable and (2) when the exchange lacks commercial substance.
3. c. The answer is the same as question 2.
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Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
PROBLEMS1. To record the acquisition of land and building.
Land (determined below)..................................................................... 62,500Building (determined below)............................................. 37,500
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Title insurance 18,000Cost of razing existing building 75,000Balance, September 30, 2012 $735,000
Requirement 2Blackstone Corporation
CAPITALIZED COST OF OFFICE BUILDINGAs of September 30, 2012
Contract cost $3,000,000Plans, specifications, and blueprints 12,000Architects’ fees for design and supervision 95,000Capitalized interest for 2011: $900,000 x 14% x 10/12 105,000Capitalized interest for 2012: $2,300,000 x 14% x 9/12 241,500Total capitalized cost, September 30, 2012 $3,453,500
Requirement 1
Pell CorporationANALYSIS OF CHANGES IN PLANT ASSETS
Consideration exchanged $500,000Less: Fair value of net assets (380,000)Goodwill $120,000
1. To expense R&D costs.
Research and development expense.............................. 12,000Cash.......................................................................... 12,000
2. To expense legal fees for unsuccessful defense of patent.
*Fair value of old machine (Fair value of new machine - Cash given):$10,000 - 8,000 = $2,000
Southern Company:
Cash.............................................................................. 140,000Building - new ($1,400,000 - 140,000)............................... 1,260,000Accumulated depreciation - building (account balance). . . . 1,200,000
Building - old (account balance).................................... 2,000,000Gain ($1,400,000 – 800,000).......................................... 600,000
Eastern Company:
The fair value of Eastern’s building is $1,260,000 ($1,400,000 fair value of Southern’s building less $140,000 cash given).
Building - new ($1,260,000 + 140,000).............................. 1,400,000Accumulated depreciation - building (account balance). . . . 650,000
Cash.......................................................................... 140,000Building - old (account balance).................................... 1,600,000Gain on exchange of buildings ($1,260,000 – 950,000). . 310,000
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Problem 10-6
Problem 10-7
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Problem 10-8 (continued)
Case B.
Requirement 1Fair value less book value = gain on exchange $700,000 - 500,000 = $200,000 gain
Fair value of old land + cash given = Initial value of new land $700,000 + 50,000 = $750,000
Journal entry (not required):
New land ($700,000 + 50,000).......................................... 750,000Cash ......................................................................... 50,000Old land (account balance)............................................ 500,000Gain ($700,000 – 200,000) ........................................... 200,000
Requirement 2Book value less fair value = loss on exchange $500,000 - 400,000 = $100,000 loss
Fair value of old land + cash given = Initial value of new land $400,000 + 50,000 = $450,000
Journal entry (not required):
New land ($400,000 + 50,000).......................................... 450,000Loss ($500,000 – 400,000) ................................................ 100,000
Cash ......................................................................... 50,000Old land (account balance)............................................ 500,000
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Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Problem 10-8 (concluded)
Requirement 3If the exchange lacked commercial substance, no gain is recognized.
Book value of old land + cash given = Initial value of new land $500,000 + 50,000 = $550,000
Journal entry (not required):
New land ($500,000 + 50,000).......................................... 550,000Cash ......................................................................... 50,000Old land (account balance)............................................ 500,000
Requirement 1
2011:Expenditures for 2011:January 1, 2011 $1,000,000 x 12/12 = $1,000,000March 1, 2011 600,000 x 10/12 = 500,000June 30, 2011 800,000 x 6/12 = 400,000October 1, 2011 600,000 x 3/12 = 150,000
$3,870,000- 3,000,000 x 10.0% x 9/12 = $225,000 870,000 x 7.2%* x 9/12 = 46,980
$271,980 = Interest capitalized in 2012
* Weighted-average rate of all other debt:
$ 4,000,000 x 6% = $240,000 $720,000 6,000,000 x 8% = 480,000 = 7.2%$10,000,000 $720,000 $10,000,000
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Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Problem 10-9 (concluded)
Requirement 2Accumulated expenditures 9/30/12 before interest capitalization (above) $4,960,0002012 interest capitalized (above) 271,980 Total cost of building $5,231,980
Requirement 32011
$3,000,000 x 10% = $ 300,0004,000,000 x 6% = 240,0006,000,000 x 8% = 480,000Total interest incurred 1,020,000Less: Interest capitalized (205,000) 2011 interest expense $ 815,000
Interest capitalized:$3,825,925 x 7.85% x 9/12 =$225,251 = Interest capitalized in 2012
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Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Problem 10-10 (concluded)
Requirement 2Accumulated expenditures 9/30/12, before interest capitalization (above) $4,915,9252012 interest capitalized (above) 225,251 Total cost of building $5,141,176
Requirement 32011:
$3,000,000 x 10% = $ 300,0004,000,000 x 6% = 240,0006,000,000 x 8% = 480,000Total interest incurred 1,020,000Less: Interest capitalized (160,925)2011 interest expense $ 859,075
To capitalize the cost of equipment to be used on future projects incorrectly charged to R&D expense.
Equipment..................................................................... 400,000Research and development expense........................... 400,000
To record depreciation on equipment used in R&D projects. $400,000 ÷ 5 years = $80,000
Research and development expense.............................. 80,000Accumulated depreciation - equipment...................... 80,000
To capitalize filing and legal fees for patent incorrectly charged to R&D expense.
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Problem 10-11
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Patent............................................................................ 40,000Research and development expense........................... 40,000
To reclassify the expenditures made for quality control during commercial production.
Inventory*..................................................................... 20,000Research and development expense........................... 20,000
*Quality control costs would either be treated as manufacturing overhead and included in the cost of inventory (as in this journal entry), or expensed in the period incurred.
Requirement 1
LandPurchase price (determined below) $714,404Closing costs 20,000Removal of old building 70,000Clearing and grading 50,000
$854,404
Purchase price of land: Cash paid $200,000 Value of note† 514,404
$714,404
† Present value of note payment:
PV = $600,000 (.85734) = $514,404Present value of $1: n = 2, i = 8% (from Table 2)
Land improvementsParking lot and landscaping $285,000
BuildingConstruction expenditures:
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Problem 10-12
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
May 30 $1,200,000July 30 1,500,000September 1 900,000October 1 1,800,000 Total expenditures 5,400,000
Interest capitalized (determined below) 94,000 Total cost of building $5,494,000
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Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Problem 10-12 (concluded)
Average accumulated expenditures:May 31, 2011 $1,200,000 x 5/6 = $ 1,000,000 July 30, 2011 1,500,000 x 3/6 = 750,000September 1, 2011 900,000 x 2/6 = 300,000 October 1, 2011 1,800,000 x 1/6 = 300,000
$2,350,000
Interest capitalized:$2,350,000 x 8% x 6/12 = $94,000
Equipment and furniture and fixtures
InitialPercent of Total Valuation
Fair Value Fair Value % x $600,000Equipment $455,000 65% $390,000Furniture & fixtures 245,000 35 % 210,000
Interest expense:Note issued to purchase land and building, $514,404 x 8% x 9/12 = $ 30,864Construction loan, $3,000,000 x 8% x 8/12 160,000Long-term note, $2,000,000 x 9% 180,000Long-term bonds, $4,000,000 x 6% 240,000 Total 610,864Less: Interest capitalized (determined above) (94,000)
Interest expense $516,864
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Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Requirement 1
All costs necessary to bring the land to its condition for use should be capitalized as the cost of the land. This should include the following costs :
Purchase price. Title insurance. Escrow fees. Delinquent property taxes. Cost of removing old building. Cost of grading and other land preparation costs.
Requirement 2Assets acquired in exchange for deferred payment contracts are valued at their
fair value or the present value of payments using a realistic interest rate.
Requirement 3In general, property, plant, and equipment and intangible assets received in
exchange for other nonmonetary assets should be valued at the fair value of the nonmonetary assets given up plus (minus) monetary consideration given (received). There are certain exceptions when the assets received are valued at the book value of the nonmonetary assets given up plus (minus) monetary consideration given (received).
The new machine acquired by exchanging an older, similar machine generally would be valued at the fair value of the old machine plus (minus) any cash given (received). However, if fair value cannot be determined or if the exchange lacks commercial substance, then the new machine would be valued at the book value of the old machine plus (minus) any cash given (received).
Requirement 1
The appropriate accounting treatment for asset retirement obligations is specified in FASB ASC 410-20 “Asset Retirement Obligations.” Section 410-20-25 requires that an existing legal obligation associated with the retirement of a tangible, long-lived asset be recognized as a liability and measured at fair value. Section 410-20-25-5 requires that upon initial recognition of the liability, the entity records the related asset at the same amount.
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CASES
Judgment Case 10-1
Research Case 10-2
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Usually, the fair value is estimated by calculating the present value of estimated future cash outflows. Section 410-20-30-1 describes the approach to be used in calculating present value. Traditionally, the way uncertainty has been considered in present value calculations has been by discounting the “best estimate” of future cash flows applying a discount rate that has been adjusted to reflect the uncertainty or risk of those cash flows. That's not the approach taken here. Instead, we follow the approach described in the FASB’s Concept Statement No. 7, which is to adjust the cash flows, not the discount rate, for the uncertainty or risk of those cash flows. This expected cash flow approach incorporates specific probabilities of cash flows into the analysis. We use a discount rate equal to the credit-adjusted risk free rate. The higher a company’s credit risk, the higher will be the discount rate.
Requirement 2The cost of the coal mine is $24,513,419 determined as follows:
Mining site $15,000,000Development costs 6,000,000Restoration costs 3,513,419 †
$24,513,419† $3 million x 20% = $ 600,000
4 million x 30% = 1,200,000 5 million x 25% = 1,250,000 6 million x 25% = 1,500,000
$4,550,000 x .77218* = $3,513,419*Present value of $1, n = 3, i = 9%
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Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Requirement 4$3,513,419 x 9% = $316,208 x 6/12 = $158,104The measurement of accretion expense is described in FASB ASC 410-20-35-5.
The classification of accretion expense in the income statement is addressed in FASB ASC 410-20-45-1.
Requirement 5
If the actual restoration costs are more (less) than the recorded liability at the retirement date, a loss (gain) on retirement of the obligation is recognized for the difference.
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Case 10-2 (concluded)
Requirement 6An entity shall disclose the following information about its asset retirement
obligations:
a. A general description of the asset retirement obligations and the associated long-lived assets.
b. The fair value of assets that are legally restricted for purposes of settling asset retirement obligations.
c. A reconciliation of the beginning and ending aggregate carrying amount (book value) of asset retirement obligations showing separately the changes attributable to (1) liabilities incurred in the current period, (2) liabilities settled in the current period, (3) accretion expense (interest expense), and (4) revisions in estimated cash flows, whenever there is a significant change in one or more of those four components during the reporting period.
If the fair value of an asset retirement obligation cannot be reasonably estimated, that fact and the reasons therefore shall be disclosed.
These disclosure requirements can be found at FASB ASC 410-20-50-1.
Requirement 1
The cost of a self-constructed asset includes identifiable materials and labor and a portion of the company's manufacturing overhead costs.
Requirement 2The treatment of manufacturing overhead cost and its allocation between
construction projects and normal production is a difficult issue. One alternative is to include only the incremental overhead costs in the total cost of construction. That is, only those additional costs that are incurred because of the decision to construct the asset should be added to the cost of the asset. This would exclude such indirect costs as depreciation and the salaries of supervisors that would be incurred whether or not the construction project is undertaken. If, however, a new construction supervisor were hired specifically to work on the project, then that salary would be included in asset cost.
A second alternative is to assign overhead on the same basis that is used for the regular manufacturing process. For example, all overhead costs might be allocated both to production and to self-constructed assets based on the relative amount of labor hours incurred. This is known as the full-cost approach and is the generally accepted method used to determine the cost of a self-constructed asset.
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Judgment Case 10-3
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Requirement 3Generally accepted accounting principles provide specific guidelines for the
treatment of interest costs incurred during construction. These guidelines pertain to the construction of assets for a company’s own use as well as for assets constructed for sale or lease. Assets qualifying for capitalization exclude inventories that are routinely manufactured in large quantities on a repetitive basis and assets that are in use or ready for their intended purpose. Only assets that are constructed as discrete projects qualify for interest capitalization.
The construction of equipment by the Chilton Company appears to qualify for interest capitalization. The cost of the equipment would include interest if, during the construction period, interest costs were actually being incurred.
Requirement 1
Only assets that are constructed as discrete projects qualify for interest capitalization. Assets qualifying for capitalization exclude inventories that are routinely manufactured in large quantities on a repetitive basis and assets that are in use or ready for their intended purpose.
Requirement 2The capitalization period for a self-constructed asset starts when (1) expenditures
(materials, labor and overhead) have been made and (2) interest cost is being incurred. The interest cost incurred does not have to pertain to specific borrowings related to the construction project. The capitalization period ends either when the asset is substantially complete and ready for use or when interest costs are no longer incurred.
Requirement 3Average accumulated expenditures is an approximation of the average amount of
debt that the company would have had outstanding during the period if every dollar spent on the project was borrowed. If construction expenditures are incurred equally throughout the period, the average accumulated expenditures for the period can be estimated by adding the accumulated expenditures at the beginning of the period to the accumulated expenditures at the end of the period and dividing by two. If expenditures on the project are unequal throughout the period, individual expenditures, perhaps expenditures grouped by month, should be weighted by the amount of time outstanding until the end of the construction period or the end of the company’s fiscal year, whichever comes first.
Requirement 4One method that could be used to determine the appropriate interest rate(s) to be
used in capitalizing interest is the specific interest method. If debt financing has been obtained specifically for the construction project, its interest rate is applied to the average accumulated expenditures up to the amount of the specific borrowing. Any
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Judgment Case 10-4
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
remaining average accumulated expenditures in excess of specific borrowings is multiplied by the weighted-average rate on all other outstanding interest-bearing debt.
Sometimes it is difficult to associate specific borrowings with projects. In these situations, it is easier to just use the weighted-average rate on all interest-bearing debt, including all construction loans. This is the weighted-average method.
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Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Case 10-4 (concluded)
Requirement 5The three steps used to determine the amount of interest capitalized during a
period are:1. Determine the average accumulated expenditures for the period.2. Multiply average accumulated expenditures by the appropriate interest rate(s).3. Compare interest capitalized with total interest cost incurred. Interest capitalized
can’t exceed interest cost incurred.(Note: This case requires the student to reference a journal article.]
Requirement 2The FASB has tentatively decided that purchased goodwill does meet the criteria
in Concepts Statement 5 for initial recognition as an asset. Goodwill does represent “future economic benefits” that are in the “control” of the enterprise and that have arisen from a “past transaction or event.”
Requirement 3Some believe that goodwill is not an asset because of concerns about 1) equating
costs and assets, 2) exchangeability of goodwill, and 3) controllability.
($ in millions)
Increase in property and equipment, net ($25,756 – 24,095) $1,661Add: Depreciation for the year 1,814Less: Additions to property and equipment (3,547)
Book value of property and equipment sold * (72)Proceeds from sale of equipment 39Loss on sale of property and equipment $(33)
*OR,Book value of property and equipment, beginning of the year $24,095Add: additions 3,547Less: depreciation (1,814)Less: book value of property and equipment, end of the year (25,756)
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Research Case 10-5
Real World Case 10-6
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Book value of property and equipment sold $ 72
Requirement 1
Goodwill represents the unique value of a company as a whole over and above all identifiable tangible and intangible assets. This value results from a company’s clientele and reputation, its trained employees and management team, its unique business location, and any other unique features of the company that can’t be associated with a specific asset.
Requirement 2The controller would be correct in her valuation of goodwill only if the total fair
value of all of the identifiable net assets (assets less liabilities) of Georgia, Inc. equals the total book value of Georgia’s net assets ($2,800,000). Goodwill, by definition, is the excess of the consideration exchanged (purchase price) over the fair value of net assets, not the book value of net assets.
Requirement 1
A company undertakes an R&D project because it believes the project will eventually provide benefits that exceed the current expenditures. Unfortunately, though, it’s difficult to predict which individual research and development projects will ultimately provide benefits. In fact, only one in ten actually reach commercial production. Moreover, even for those projects that pan out, a direct relationship between research and development costs and specific future revenue is difficult to establish. In other words, even if R&D costs do lead to future benefits, it’s difficult to objectively determine the size of the benefits and in which periods the costs should be expensed if they are capitalized. These are the issues that prompted the FASB to require immediate expensing.
Requirement 2Possible reasons include:
1. The larger a firm is, the more likely it is to prefer income-reducing accounting methods (e.g., expense R&D). This is particularly true in politically sensitive industries where excessive profits could trigger intervention into a firm's activities by government, unions, and other special interest groups.
2. Large firms may tend to have more R&D activities occurring simultaneously, creating a portfolio effect. That is, the number of successful R&D projects relative to total projects may be fairly stable from year to year in large firms. There may be much more variability in smaller firms creating larger variability in income if R&D is expensed.
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Judgment Case 10-7
Judgment Case 10-8
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
3. Earnings-based management compensation schemes may be more prevalent in smaller R&D companies, thus creating a preference for accounting methods that can be more easily manipulated (e.g., capitalize R&D).
4. Smaller companies may be more dependent on debt financing. Debt covenants (contractual limitations on debt) could create a preference for accounting methods that can be more easily manipulated (e.g., capitalize R&D).
Requirement 1
The costs of research equipment used exclusively for Trouver would be reported as research and development expenses in the period incurred.
The costs of research equipment used on both Trouver and future research projects would be capitalized and shown as equipment (less accumulated depreciation) in the balance sheet. An appropriate method of depreciation should be used. Depreciation on capitalized research equipment should be reported as a research and development expense.
Requirement 2a. Matching refers to the process of expense recognition by associating costs
with revenues on a cause and effect basis.b. Research and development costs usually are expensed in the period incurred
and may not be matched with revenues. This accounting treatment is justified by the high degree of uncertainty regarding the amount and timing of future benefits. A direct relationship between research and development costs and future revenues generally cannot be demonstrated.
Requirement 3Corporate headquarters’ costs allocated to research and development would be
classified as general and administrative expenses in the period incurred, because they are not clearly related to research and development activities.
Requirement 4The legal expenses incurred in defending the patent should be capitalized as part
of the cost of the intangible asset, patent.Both views, expense and capitalize, can
and often are convincingly defended. The process of developing and synthesizing the
arguments will likely be more beneficial than just acceptance of the standard. Each student should benefit from participating in the process, interacting first with his or her partner, and then witnessing or participating in a debate on the issue. It is important that each student actively participate in the process of arriving at a consensus argument. Domination by one individual should be discouraged.
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Judgment Case 10-9
Communication Case 10-10
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Arguments supporting the expense view should include the reasons cited by the FASB in FASB ASC 730-10-05. Arguments supporting the capitalize view should include reference to violations to the matching principle for successful R&D projects.
Suggested Grading Concepts and Grading Scheme:
Content (70%)_______ 20 Defines research and development according to FASB ASC 730.
_______ 30 Explains the conceptual reasons for the conclusion reached by the FASB on accounting for R&D.______ High degree of uncertainty regarding the amount and timing of future benefits.______ Lack of direct relationship between R&D costs and future
revenues.
_______ 20 Describes the treatment of equipment costs.______ $200,000 should be expensed as R&D.______ $300,000 should be capitalized and depreciated.
_____________ 70 points
Writing (30%)_______ 6 Terminology and tone appropriate to the audience of a
company president.
_______ 12 Organization permits ease of understanding.______ Introduction that states purpose.______ Paragraphs that separate main points.
_______ 12 English______ Sentences grammatically clear and well organized,
concise.______ Word selection.______ Spelling.______ Grammar and punctuation.
_____________ 30 points
Requirement 1
If the equipment is to be used only in the single R&D project (as is likely) the correct treatment is to expense the entire $30 million. If capitalized, only $6 million
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Communication Case 10-11
Ethics Case 10-12
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
would be expensed ($30 million divided by 5 years). Therefore, Alice's treatment will increase before tax earnings by $24 million ($30 million - 6 million).
Requirement 2Discussion should include these elements.
Ethical Dilemma:Is Alice's responsibility to follow GAAP by expensing the equipment purchase
greater than her responsibility to assist the company in seeking new financing?
Who is affected?
AlicePresident and other managersOther employeesShareholdersPotential shareholdersCreditorsCompany auditors
Requirement 2
The company expenses all research expenditures in the financial year in which it is incurred. Development expenditures are assessed and capitalized if they meet all of the following criteria:
- an asset is created than can be identified;- it is probable that the asset created will generate future economic benefits; and- the development cost of the asset can be measured reliably.
U.S. GAAP requires that both research and development expenditures be expensed in the period incurred. The only exception is the capitalization of certain computer software development costs.
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IFRS Case 10-13
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Requirement 1
The fixed-asset turnover ratio is computed by dividing net sales by average fixed assets. A ratio of 2.87 for National indicates that they are able to generate $2.87 in net sales for each dollar invested in fixed assets (property, plant, and equipment).
Requirement 2($ in millions)Book value of PP&E, beginning of 2009 $557 Add: purchases during 2009 84 Deduct: book value of PP&E sold during 2009 (4) Deduct: depreciation for 2009 (175)Book value of PP&E, end of 2009 $462
Average PP&E for 2009 = ($557 + 462) ÷ 2 = $509.5
Turnover ratio = Net sales ÷ Average PP&E
2.87 = Net sales ÷ $509.5
Net sales = $1,462
Requirement 1
Elegant was not correct in its treatment of the software development costs. Generally accepted accounting principles require companies to expense costs incurred to develop computer software to be sold, leased or otherwise marketed as R&D costs until technological feasibility of the product or process has been established. Only those costs incurred after technological feasibility has been attained and before the product is available for general release to customers can be capitalized.
Requirement 2The amortization of capitalized computer software development costs begins with
the start of commercial production. The periodic amortization percentage is the greater of (1) the ratio of current revenues to current and anticipated revenues (percentage of revenue method), or (2) the straight-line percentage over the useful life of the asset.
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Analysis Case 10-14
Judgment Case 10-15
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
Requirement 3
The following is based on Home Depot's 2009 (year ended February 1, 2009) financial statements. Answers will vary depending on the financial statement dates chosen.
a. The company lists land, buildings, furniture, fixtures and equipment, leasehold improvements, construction in progress, and capital leases under Property and equipment. Goodwill (cost in excess of fair value of net assets acquired) is listed as a separate noncurrent asset.
b. $1,847 million.c. Note 6 indicates that $20 million of interest was capitalized during the year
ended February 1, 2009.d. Fixed-asset turnover ratio = Net sales ÷ Average PP&E
($ in millions)= $71,288 = 2.65 $26,855*
* Average PP&E for 2009 = ($26,234 + 27,476) ÷ 2 = $
Requirement 1
In its balance sheet, Dell lists Property, plant and equipment, Goodwill, and Purchased intangible assets as its long-lived, revenue-producing assets. In its disclosure notes, Dell lists Computer equipment, Land and buildings, Machinery and other equipment under property, plant and equipment.
Requirement 2The statement of cash flows reports that $440 million was spent in the year ended
January 30, 2009 on capital expenditures. This compares to $831 million in the previous year.
Requirement 3The fixed-asset turnover ratio is computed by dividing net sales (revenues) by
average fixed assets. Using 2009 data, the ratio for Dell is
($ in millions) $61,101 = 24.7
$2,472.5*
*Average plant and equipment for 2009 = ($2,277 + 2,668) ÷ 2 = $2,472.5
Dell’s ratio is significantly higher than HP’s ratio of 9.84.
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Real World Case 10-16
Analysis Case 10-17
Chapter 10 - Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition
The ratio is intended to measure a company's effectiveness in managing property, plant, and equipment. It indicates the level of sales generated by the company's investment in these assets. Like any ratio, it is but one piece of a larger puzzle and should not be interpreted in isolation.
Requirement 1
In Per note 2, BA amortizes computer software development costs using the straight-line method. The percentage used to amortize computer software development costs under U.S. GAAP is the greater of (1) the ratio of current revenues to current and anticipated revenues or (2) the straight-line percentage over the useful life of the software. This approach is allowed under IFRS, but not required.
Requirement 2Except for software development costs incurred after technological feasibility has
been established, U.S. GAAP requires all research and development expenditures to be expensed in the period incurred. IFRS draws a distinction between research activities and development activities. Research expenditures are expensed in the period incurred. However, development expenditures that meet specified criteria are capitalized as an intangible asset.