Acquisition and Disposition of Property, Plant, and Equipment

Chapter

10

Chapter 10-1

Property, Plant, and Equipment

Property, plant, and equipment includes land, buildings, and equipment (machinery, furniture, tools). Major characteristics include:
Used in operations and not for resale. Long-term in nature and usually depreciated.

Possess physical substance.

Chapter 10-2

Acquisition and Valuation of PP&E

Valued at Historical Cost - measures the cash or cash equivalent price of obtaining the asset and bringing it to the location and condition necessary for its intended use.

reasons include:
At acquisition, cost reflects fair value. Historical cost is reliable.

Companies should not anticipate gains and losses but should recognize gains and losses only when the asset is sold.
Chapter 10-3

Acquisition and Valuation of PP&E

Cost of Land
Includes all costs to acquire land and ready it for use.
Costs typically include: (1) the purchase price;

(2) closing costs, such as title to the land, attorneys fees, and recording fees;
(3) costs of grading, filling, draining, and clearing; (4) assumption of any liens, mortgages, or encumbrances on the property; and (5) Additional land improvements that have an indefinite life.
Chapter 10-4

Acquisition and Valuation of PP&E

Cost of Buildings
Includes all costs related directly to acquisition or construction.
Costs typically include:

(1) materials, labor, and overhead costs incurred during construction and
(2) professional fees and building permits. (3) Generally companies consider all costs from excavation to completion when buildings are constructed
Chapter 10-5

Acquisition and Valuation of PP&E

Cost of Equipment
Include all costs incurred in acquiring the equipment and preparing it for use.
Costs typically include:

(1) purchase price,

(2) freight and handling charges (3) insurance on the equipment while in transit, (4) cost of special foundations if required, (5) assembling and installation costs, and (6) costs of conducting trial runs.
Chapter 10-6

Acquisition and Valuation of PP&E

E10-1 (Acquisition Costs of Realty) The following expenditures
and receipts are related to land, land improvements, and buildings acquired for use in a business enterprise. Determine how they should be classified:

Chapter 10-7

Acquisition and Valuation of PP&E

Self-Constructed Assets
Costs typically include:
(1) Materials and direct labor
(2) Overhead can be handled in two ways: 1. Assign no fixed overhead 2. Assign a portion of all overhead to the construction process. Companies use the second method extensively. (3) Interest costs?
Chapter 10-8

Acquisition and Valuation of PP&E

Interest Costs During Construction
Three approaches have been suggested to account for the interest incurred in financing the construction.
$ 0

Increase to Cost of Asset

$ ?

Capitalize no interest during construction

Illustration 10-1

Capitalize actual interest costs incurred during construction (with modification)

Capitalize all costs of funds

GAAP
Chapter 10-9

Acquisition and Valuation of PP&E

Step 1 - Determine which assets qualify for
capitalization of interest.
must require a period of time to get them ready for their intended use

Step 2 - Determine the capitalization period.

The capitalization period begins when expenditures are being made and if interest costs are being incurred during the period while construction is taking place.
Chapter 10-10

Acquisition and Valuation of PP&E

Step 3 - Compute weighted-average accumulated
expenditures. (BE 10-2)
A company weights the construction expenditures by the amount of time (fraction of a year or accounting period) that it can incur interest cost on the expenditure.

Doing so allows for a single interest rate to be applied to the weighted amount of costs that are tied up in the construction.

Chapter 10-11

Acquisition and Valuation of PP&E

Step 4 - Compute the Avoidable Interest.
Selecting Appropriate Interest Rate to apply to the weighted average accumulated expenditure: (BE 10-3 & 4)
1. First use the interest rate incurred on the specific borrowings (up to specific debt amount outstanding). 2. For the portion of weighted-average accumulated expenditures that is greater than any specific debt incurred, use a weighted average of interest rates incurred on all other outstanding debt during the period.

Chapter 10-12

Acquisition and Valuation of PP&E

Step 5 Capitalize the lesser of Avoidable
interest or Actual interest incurred on all debt of the company.

Journal entry to Capitalize Interest:

Equipment
Interest expense

XXXX
XXXX

Chapter 10-13

Acquisition and Valuation of PP&E

Interest capitalization Exercises, Problems

Ex 10-7, Ex 10-8, P 10-7

See handout for comprehensive problem (in additional materials section of Blackboard)

Chapter 10-14

Valuation
Generally
Companies should record property, plant, and equipment:
at the fair value of what they give up or

at the fair value of the asset received,

whichever is more clearly evident.

Chapter 10-15

Valuation- Other Issues

Deferred-Payment Contracts Assets, purchased
through long term credit, are recorded at the present value of the consideration exchanged.

Lump-Sum Purchases Allocate the total cost among

(See BE 10-6)

the various assets on the basis of their fair market values.

Issuance of Stock The market value of the stock

issued is a fair indication of the cost of the property acquired.

Chapter 10-16

Valuation- Other Issues

Exchanges of Nonmonetary Assets
If commercial substance is met (means that future cash flows change as a result of the transaction)
- exchanges of non-monetary assets has similar treatment & recognition of gains & losses as a regular sale of PP&E for cash. If no commercial substance, then any gains must be deferred -partial recognition of gain if some cash received with the exchange
Chapter 10-17

Valuation- Other Issues

Summary of Gain and Loss Recognition on Exchanges of Nonmonetary Assets Lacks Commercial Substance

Chapter 10-18

Valuation- Other Issues

EX 10-19, P 10-9

Chapter 10-19

Costs Subsequent to Acquisition

Recognize costs subsequent to acquisition as an asset when the costs can be

measured reliably and it is probable that the company will obtain future economic benefits. Future economic benefit would include increases in
1. 2. 3.

useful life, quantity of product produced, and quality of product produced.

Chapter 10-20

Costs Subsequent to Acquisition

Major Types of Expenditures
Additions Improvements and Replacements

Rearrangement and Reinstallation

Repairs

Chapter 10-21

Costs Subsequent to Acquisition

Summary
Illustration 10-21

Chapter 10-22

Costs Subsequent to Acquisition

EX 10-22 & 24

Chapter 10-23

Disposition of Plant Assets

Sale of Plant Assets
Example Sim City Corporation owns machinery that cost $20,000 when purchased on January 1, 2004. Depreciation has been recorded at a rate of $3,000 per year, resulting in a balance in accumulated depreciation of $9,000 at December 31, 2006. The machinery is sold on September 1, 2007, for $10,500. Prepare journal entries to (a) update depreciation for 2007 and (b) record the sale.

Chapter 10-24

Disposition of Plant Assets

(a) update depreciation for 2007

(b) record the sale

Chapter 10-25

Disposition of Plant Assets

Ex 10-24

Chapter 10-26

IFRS Revaluation of PP&E

Chapter 10-27