Operational Assets: Acquisition

1. Operational Assets: Acquisition Operational Assets: Actively used in operations Expected to produce future benefits Tangible or intangible AIM3331-Interm. Acctg. Acqusition and Disposition of PP&E

2. Acquisition Costs(costs capitalized to the asset account rather than to an expense of the period) General Rule“The historical cost of acquiring an asset includes the costs necessarily incurred to bring it to the condition and location necessary for its intended use.” AIM3331-Interm. Acctg. Acqusition and Disposition of PP&E

3. Types of costs capitalized to Equipment • Net purchase price • Installation costs • Modification to buildingnecessary to install equipment • Transportation costs • Taxes AIM3331-Interm. Acctg. Acqusition and Disposition of PP&E

4. Types of costs capitalized to Land • Purchase price • Real estate commissions • Back taxes • Title transfer fees • Title insurance premiums • Costs of clearing, filling, draining and removing old buildings (net of any salvage) *Land is not depreciable. AIM3331-Interm. Acctg. Acqusition and Disposition of PP&E

5. Types of costs capitalized to Land Improvements • Separately identifiable costs of : • Driveways • Parking lots • Fencing • Landscaping AIM3331-Interm. Acctg. Acqusition and Disposition of PP&E

6. Types of costs capitalized to Buildings • Architectural fees • Cost of permits • Legal fees • Reconditioning costs • Purchase price • Construction costs AIM3331-Interm. Acctg. Acqusition and Disposition of PP&E

7. Costs to capitalize? Which of the following costs incurred in connection with equipment purchased for use in a company’s manufacturing operations would be capitalized? a.Insurance on equipment while in transit b. Testing and preparation of equipment for use c. Both insurance while in transit and testing and preparation d. Neither insurance while in transit or testing and preparation AIM3331-Interm. Acctg. Acqusition and Disposition of PP&E

8. Correct Classification of Capitalized Costs It is important to assign capitalized costs to the correct fixed asset account because different depreciation rates and useful lives are applied to these accounts and affect net income and the amounts reported on the balance sheet AIM3331-Interm. Acctg. Acqusition and Disposition of PP&E

9. EXAMPLE AIM3331-Interm. Acctg. Acqusition and Disposition of PP&E

10. Self-Constructed Assets • Capitalize all costs directly associated with the construction including materials, labor and overhead. • Under certain conditions, avoidable interest incurred on qualifying assetsis capitalized. • Avoidable interest -- interest that could have been avoided if the asset were not constructed and the money used to retire debt. AIM3331-Interm. Acctg. Acqusition and Disposition of PP&E

11. Interest Capitalization • Interest is capitalized on Average Accumulated Expenditures (AAE) • Qualifying expenditures weighted for the number of months outstanding during the current accounting period. • Qualifying Expenditures • Cash payments for construction • Incurrence of interest-bearing liabilities AIM3331-Interm. Acctg. Acqusition and Disposition of PP&E

12. Interest Capitalization • Capitalization begins when . . . • Qualifying expenditures have been made, and • Construction activities are underway, and • Interest cost has been incurred. • Capitalization ends when . . . • The asset is substantially complete and ready for its intended use. • Interest Potentially Capitalizable (IPC) • Multiply the AAE by the “capitalization rate or rates.” AIM3331-Interm. Acctg. Acqusition and Disposition of PP&E

13. Interest Capitalization • Capitalization Rate – Specific Interest Method » If the qualifying asset is financed through a specific new borrowing, the interest rate on the new borrowing is used for the computation of IPC (interest potentially capitalizable). » If the qualifying asset is financed by general borrowings, the capitalization rate will be the weighted-average cost of debt. » Use both rates, if partially financed with a specific borrowing. Use the specific rate first and then apply the weighted average debt rate. AIM3331-Interm. Acctg. Acqusition and Disposition of PP&E

14. Interest Capitalization Steps in the capitalization process • Compute actual interest expense. • Compute AAE (average accumulated expenditures). • Compute IPC (interest potentially capitalizable). • Capitalize the smaller of actual interest or IPC. AIM3331-Interm. Acctg. Acqusition and Disposition of PP&E

15. Interest Capitalization Example: AIM3331-Interm. Acctg. Acqusition and Disposition of PP&E

16. Purchase on Credit (Deferred Payment Contracts) The asset acquired is recorded at the Cash equivalent price (market value) or Present value of future cash payments using the prevailing market interest rate Whichever is more objective and reliable. (APB Opinion No. 21) AIM3331-Interm. Acctg. Acqusition and Disposition of PP&E

17. Deferred Payment Contract EXAMPLE Marshall company purchased machinery on January 1, 2001 and signed a two-year, 6 percent, $2,000 note that pays interest each December 31. The market interest is 12 percent on notes of similar risk. Provide the journal entry to record this asset acquisition. AIM3331-Interm. Acctg. Acqusition and Disposition of PP&E

18. Lump-Sum Purchase Several assets are acquired for a single, lump-sum price that may be lower than the sum of the individual asset prices. • Allocate the lump-sum price to the separate items in proportion to the individual asset’s relative market value AIM3331-Interm. Acctg. Acqusition and Disposition of PP&E

19. Lump-Sum PurchaseExample On May 13, we purchase land and building for $200,000 cash. The appraised value of the building is $162,500, and the land is appraised at $87,500. Provide the journal entry to record the acquisition of these assets. AIM3331-Interm. Acctg. Acqusition and Disposition of PP&E

20. Disposal of Plant AssetsExample On June 30, 2003, Hilo Inc. sold equipment for $6,350 cash. The equipment was purchased on January 1, 1998 at a cost of $15,000. On the date of the disposal, the equipment had accumulated depreciation of $8,250. Prepare the journal entry necessary to record the disposal of this equipment. AIM3331-Interm. Acctg. Acqusition and Disposition of PP&E

21. Non-monetary Exchanges with Commercial Substance If the transaction has “commercial substance”, then: • The exchange of non-monetary assets should be based on the fair value of the asset given up or the fair value of the asset received, whichever is more reliable. • All gains and losses on exchange are recognized. AIM3331-Interm. Acctg. Acqusition and Disposition of PP&E

22. Non-monetary Exchanges without Commercial Substance If transaction has no “commercial substance”, then: • the exchange is based on book value of the asset given up • and no gain is recognized through the exchange. Note: According to Paragraph 22 of APB 29, which was not modified by SFAS No. 153, losses are recorded on all exchanges, even those that lack commercial substance. AIM3331-Interm. Acctg. Acqusition and Disposition of PP&E

23. Commercial Substance • An exchange has “Commercial Substance” if the expected future cash flows change as a result of the exchange • Exchange of dissimilar assets (example-machinery exchanged for land) typically has commercial substance because the assets have different uses and therefore different cash flows • For the exchange of similar assets (example- truck exchanged for a truck), the exchange has commercial substance if cash flows are expected to be significantly different. AIM3331-Interm. Acctg. Acqusition and Disposition of PP&E

24. Cash Paid in Non-monetary Exchanges When the monetary consideration is significant (25% or more of the fair value of the exchange), the transaction is considered a monetary exchange by both parties and all gains and losses are fully recognized. AIM3331-Interm. Acctg. Acqusition and Disposition of PP&E

25. Nonmonetary ExchangeExample Carlton Co. exchanged old equipment, with an original cost of $145,000, for new equipment and paid $15,000 cash in the exchange. At the time of the exchange, their equipment had accumulated depreciation of $45,000. Carlton determined that the fair value of the equipment received was $140,000. Question: Assume that the transaction has commercial substance, provide Carlton’s journal entries to record this exchange. AIM3331-Interm. Acctg. Acqusition and Disposition of PP&E

26. Nonmonetary ExchangeExample Palomar Co. exchanged old equipment for new equipment and received $16,200 cash in the exchange. At the time of the exchange, the book value of their equipment was $100,000 and the fair value of their equipment was determined to be $96,000. Question: Assume that the transaction has commercial substance, provide Palomar’s journal entries to record this exchange. AIM3331-Interm. Acctg. Acqusition and Disposition of PP&E