10

Property, Plant, and Equipment

and Intangible Assets: Acquisition
and Disposition

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA

McGraw-Hill/Irwin

Copyright 2011 by the McGraw-Hill Companies, Inc. All rights reserved.

Types of Assets
Long-lived,
Long-lived,Revenue-producing
Revenue-producingAssets
Assets
Expected
Expected to
to Benefit
Benefit Future
FuturePeriods
Periods

General Rule for Cost Capitalization

The initial cost of an asset includes the purchase price and
all expenditures necessary to bring the asset to its desired
condition and location for use.
10 - 2

Costs to be Capitalized
Equipment
Net purchase price
Taxes
Transportation costs
Installation costs
Modification to building
necessary to install
equipment
Testing and trial runs

10 - 3

Land (not depreciable)

Purchase price
Real estate commissions
Attorneys fees
Title search
Title transfer fees
Title insurance premiums
Removing old buildings

Costs to be Capitalized
Land Improvements
Separately identifiable costs of
Driveways
Parking lots
Fencing
Landscaping
Private roads

10 - 4

Buildings
Purchase price
Attorneys fees
Commissions
Reconditioning

Costs to be Capitalized
Natural Resources
Acquisition costs
Exploration costs
Development costs
Restoration costs

Intangible Assets
Patents
Copyrights
Trademarks
Franchises
Goodwill

The initial cost of an intangible

asset includes the purchase
price and all other costs
necessary to bring it to
condition and location for use,
such as legal and filing fees.
10 - 5

Asset Retirement Obligations

Often
Often encountered
encountered with
with natural
natural resource
resource
extraction
extraction when
when the
the land
land must
must be
be
restored
restored to
to aa useable
useable condition.
condition.
Recognize
Recognize the
the restoration
restoration costs
costs
as
as aa liability
liability and
and aa corresponding
corresponding
increase
increase in
in the
the related
related asset.
asset.
Record
Record at
at fair
fair value,
value, usually
usually the
the
present
present value
value of
of future
future cash
cash
outflows
outflows associated
associated with
with the
the
reclamation
reclamation or
or restoration.
restoration.
10 - 6

Intangible Assets
Lack physical
substance.

Exclusive
Rights.

Intangible
Intangible
Assets
Assets
Future benefits less certain
than tangible assets.
10 - 7

Intangible Assets Patents

An exclusive right recognized by law and granted by
the US Patent Office for 20 years.
Holder has the right to use, manufacture, or sell the
patented product or process without interference or
infringement by others.
R & D costs that lead to an internally developed patent
are expensed in the period incurred.
Torch, Inc. has developed a new device. Research and
development costs totaled $30,000. Patent registration
costs consisted of $2,000 in attorney fees and $1,000 in
federal registration fees. What is Torchs patent cost?
Torchs cost for the new patent is $3,000. The
$30,000 R & D cost is expensed as incurred.
10 - 8

Intangible Assets

10 - 9

Copyrights

Trademarks

A form of protection given

by law to authors of
literary, musical, artistic,
and similar works.
Copyright owners have
exclusive rights to print,
reprint, copy, sell or
distribute, perform and
record the work.
Generally, the legal life of
a copyright is the life of
the author plus 70 years.

A symbol,

design, or logo
associated with a business.

If

internally developed,
trademarks have no
recorded asset cost.

If

purchased, a trademark is
recorded at cost.

Registered

with U.S. Patent

Office and renewable
indefinitely in 10-year
periods.

Intangible Assets
Franchise

AA contractual
contractual arrangement
arrangement where
where the
the franchisor
franchisor
grants
grants the
the franchisee
franchisee exclusive
exclusive rights
rights to
to use
use
the
the franchisors
franchisors trademark
trademark within
within aa certain
certain
area
area for
for aa specified
specified period
period of
of time.
time.

Goodwill
Occurs when one
company buys
another company.

Only purchased
goodwill is an
intangible asset.

The amount by which the

consideration exchanged exceeds
the fair value of net assets acquired.
10 - 10

Goodwill
Eddy
Eddy Company
Company paid
paid $1,000,000
$1,000,000 to
to purchase
purchase all
all of
of
James
James Companys
Companys assets
assets and
and assumed
assumed James
James
Companys
Companys liabilities
liabilities of
of $200,000.
$200,000. James
James Companys
Companys
assets
assets were
were appraised
appraised at
at aa fair
fair value
value of
of $900,000.
$900,000. What
What
amount
amount of
of goodwill
goodwill should
should Eddy
Eddy company
company record
record as
as aa
result
result of
of the
the purchase?
purchase?

10 - 11

Lump-Sum Purchases
Several
Several assets
assets are
are acquired
acquired for
for aa single
single price
price that
that may
may
be
be lower
lower than
than the
the sum
sum of
of the
the individual
individual asset
asset fair
fair values.
values.
Allocation
Allocation of
of the
the lump-sum
lump-sum price
price is
is based
based
on
on relative
relative fair
fair values
values of
of the
the individual
individual assets.
assets.

Asset 1

Asset 2

Asset 3

On May 13, we purchase land and building for $200,000 cash.

The appraised value of the building is $162,500, and the land
is appraised at $87,500. How much of the $200,000 purchase
price will be allocated to the building account?
10 - 12

Lump-Sum Purchases
Asset
Land
Building
Total

Appraised
Value
(a)
$ 87,500
162,500
$ 250,000

% of
Value
(b)*
35%
65%

Purchase
Price
(c)
$ 200,000
200,000

Assigned
Cost
(b c)
$ 70,000
130,000
$ 200,000

* $87,500$250,000 = 35%

May 13:
Land ..........................................................
Building ..
Cash.....
To record lump-sum purchase of land and building.
10 - 13

70,000
130,000
200,000

Noncash Acquisitions

Issuance
Issuance of
of equity
equity securities
securities
Deferred
Deferred payments
payments
Donated
Donated Assets
Assets
Exchanges
Exchanges

The
The asset
asset acquired
acquired is
is recorded
recorded at
at
the
the fair
fair value
value of
of the
the consideration
consideration given
given
or
or
the
the fair
fair value
value of
of the
the asset
asset acquired,
acquired,
whichever
whichever is
is more
more clearly
clearly evident.
evident.
10 - 14

Deferred Payments
Note
Note payable
payable

10 - 15

Market
Market interest
interest
rate
rate

Less
Less than
than market
market rate
rate
or
or noninterest
noninterest bearing
bearing

Record
Record asset
asset at
at
face
face value
value of
of note
note

Record
Record asset
asset at
at present
present
value
value of
of future
future cash
cash flows.
flows.

Deferred Payments
On January 2, 2011, Midwestern Corporation purchased
equipment by signing a noninterest-bearing note requiring
$50,000 to be paid on December 31, 2012. The prevailing
market rate of interest on notes of this nature is 10%.
Prepare the required journal entries for Midwestern on
January 2, 2011; December 31, 2011 (year-end), and
December 31, 2012 (year-end).
We do not know the cash equivalent price, so we must
use the present value of the future cash payment.

10 - 16

Deferred Payments
January 2, 2011:
Equipment ...........................................................
Discount on note payable ...
Note payable ....

41,323
8,677
50,000

To record equipment acquisition.

December 31, 2011:

Interest expense (10% of $41,323)......................
Discount on note payable

4,132
4,132

To record interest expense.

December 31, 2012:

Interest expense (10% of ($41,323+$4,132)) ......
Discount on note payable ....

4,545
4,545

To record interest expense.

December 31, 2012

Note payable ........................................................
Cash ....
To record payment of note.
10 - 17

50,000
50,000

Issuance of Equity Securities

Asset acquired is recorded at the fair value of the asset
or the market value of the securities, whichever is more
clearly evident.
If the securities are actively traded, market value can be
easily determined.
If the securities given are not actively traded, the fair
value of the asset received, as determined by appraisal,
may be more clearly evident than the fair value of the
securities.

Donated Assets
On occasion, companies acquire assets through
donation.
The receiving company is required to record
The donated asset at fair value.
Revenue equal to the fair value of the donated asset.
10 - 18

Dispositions
Update depreciation to date of disposal.
Remove original cost of asset and accumulated

depreciation from the books.

The difference between book value of the asset and the
amount received is recorded as a gain or loss.
On June 30, 2011, MeLo, Inc. sold equipment for $6,350
cash. The equipment was purchased on January 1, 2006 at
a cost of $15,000. The equipment was depreciated using the
straight-line method over an estimated ten-year life with zero
salvage value. MeLo last recorded depreciation on the
equipment on December 31, 2010, its year-end.
Prepare the journal entries necessary to
record the disposition of this equipment.
10 - 19

Dispositions

Update depreciation to date of sale.

June 30, 2011:

Depreciation expense ($15,000 10 years) ) .......
Accumulated depreciation ........

750
750

To update depreciation to date of sale.

Remove original asset cost and accumulated depreciation.

Record the gain or loss.
June 30, 2011:
Accumulated depreciation ............................................
Cash .......................
Loss on sale .
Equipment ...............
To record sale of equipment.

($15,000 10 years) 5) = $8,250

10 - 20

8,250
6,350
400
15,000

Exchanges
General Valuation Principle (GVP): Cost of asset acquired is:
fair value of asset given up plus cash paid or minus cash
received or
fair value of asset acquired, if it is more clearly evident

In the exchange of assets fair value is used except in rare

situations in which the fair value cannot be determined or
the exchange lacks commercial substance.
When fair value cannot be determined or the exchange
lacks commercial substance, the asset(s) acquired are
valued at the book value of the asset(s) given up, plus (or
minus) any cash exchanged. No gain is recognized.
10 - 21

Fair Value Not Determinable

Matrix, Inc. exchanged used equipment for newer
equipment. Due to the nature of the assets exchanged,
Matrix could not determine the fair value of the asset given
up or received. The asset given up originally cost
$600,000, and had an accumulated depreciation balance of
$400,000 at the time of the exchange. Matrix exchanged
the asset and paid $100,000 cash.
Lets record this unusual transaction.

10 - 22

Fair Value Not Determinable

Matrix,
Matrix, Inc.
Inc.
The
The journal
journal entry
entry below
below shows
shows the
the proper
proper
recording
recording of
of the
the exchange.
exchange.

Equipment ($200,000 + $100,000) .................

Accumulated depreciation .........
Equipment .
Cash .............
To record equipment acquired in exchange.

10 - 23

300,000
400,000
600,000
100,000

Exchange Lacks Commercial Substance

When exchanges are recorded at fair value, any gain or
loss is recognized for the difference between the fair value
and book value of the asset(s) given-up. To preclude the
possibility of companies engaging in exchanges of
appreciated assets solely to be able to recognize gains, fair
value can only be used in legitimate exchanges that have
commercial substance.
A
A nonmonetary
nonmonetary exchange
exchange is
is considered
considered to
to have
have
commercial
commercial substance
substance ifif the
the company:
company:

expects
expects aa change
change in
in future
future cash
cash flows
flows as
as aa result
result of
of the
the
exchange,
exchange, and
and

that
that expected
expected change
change is
is significant
significant relative
relative to
to the
the fair
fair
value
value of
of the
the assets
assets exchanged.
exchanged.
10 - 24

Exchanges
Matrix, Inc. exchanged new equipment and $10,000 cash
for equipment owned by Float, Inc.
Below is information about the asset exchanged by Matrix.
Record the transaction assuming the exchange has
commercial substance.

Gain = Fair Value Book Value

Gain = $205,000 $200,000 = $5,000
10 - 25

Exchanges
$205,000 fair value + $10,000 cash
Equipment ...............................................
Accumulated depreciation.............
Equipment
Cash .
Gain on exchange ..

215,000
300,000
500,000
10,000
5,000

To record the exchange of equipment.

Record the same transaction assuming the

exchange lacks commercial substance.
$200,000 book value + $10,000 cash
Equipment ...............................................
Accumulated depreciation.............
Equipment
Cash ..
To record the exchange of equipment.
10 - 26

210,000
300,000
500,000
10,000

Self-Constructed Assets
When self-constructing an asset, two accounting issues must
be addressed:
overhead allocation to the self-constructed asset.
incremental overhead only
full-cost approach
proper treatment of interest incurred during construction

Under certain conditions, interest incurred on

qualifying assets is capitalized.
Asset constructed:
For a companys own use.
As a discrete project for sale
or lease.
10 - 27

Interest that could have

been avoided if the asset
were not constructed and
the money used to retire
debt.

Interest Capitalization
Capitalization begins when:
construction begins
interest is incurred, and
qualifying expenses are incurred.
Capitalization ends when:
the asset is substantially complete and
ready for its intended use, or
when interest costs no longer are being
incurred.

10 - 28

Interest Capitalization
Interest is capitalized based on Average
Accumulated Expenditures (AAE).
Qualifying expenditures (construction labor, material, and
overhead) weighted for the number of months outstanding
during the current accounting period.

10 - 29

If the qualifying asset is

financed through a
specific new borrowing

If there is no specific new

borrowing, and the
company has other debt

. . . use the specific rate

of the new borrowing as
the capitalization rate.

. . . use the weighted

average cost of other debt
as the capitalization rate.

Interest Capitalization
Welling, Inc. is constructing a building for its own use.
Construction activities started on May 1 and have continued
through Dec. 31. Welling made the following qualifying
expenditures: May 1, $125,000; July 31, $160,000, Oct. 1,
$200,000; and Dec. 1, $300,000. Welling borrowed $1,000,000
on May 1, from Bubs Bank for 10 years at 10 percent to
finance the construction. The loan is related to the
construction project and the company uses the specific interest
method to compute the amount of interest to capitalize.
Average Accumulated Expenditures

10 - 30

Interest Capitalization
Since the $1,000,000 of specific borrowing is sufficient to
cover the $337,500 of average accumulated expenditures
for the year, use the specific borrowing rate of 10 percent to
determine the amount of interest to capitalize.
Interest = AAE Specific Borrowing Rate Time
Interest = $337,500 10% 8/12 = $22,500

The loan, initiated on May 1, is

outstanding for 8 months of the year.
10 - 31

Interest Capitalization
IfIf Welling
Welling had
had not
not borrowed
borrowed specifically
specifically for
for this
this construction
construction
project,
project, itit would
would have
have used
used the
the weighted-average
weighted-average interest
interest
method.
method. The
The weighted
weighted average
average interest
interest rate
rate on
on other
other debt
debt
would
would have
have been
been used
used to
to compute
compute the
the amount
amount of
of interest
interest to
to
capitalize.
capitalize. For
For example,
example, ifif the
the weighted-average
weighted-average interest
interest
rate
rate on
on other
other debt
debt is
is 12
12 percent,
percent, the
the amount
amount of
of interest
interest
capitalized
capitalized would
would be:
be:
Interest
Interest == AAE
AAE Weighted-average
Weighted-average Rate
Rate Time
Time
Interest
Interest == $337,500
$337,500 12%
12% 8/12
8/12 == $27,000
$27,000

10 - 32

Interest Capitalization
IfIf specific
specific new
new borrowing
borrowing had
had been
been insufficient
insufficient to
to
cover
cover the
the average
average accumulated
accumulated expenditures
expenditures .. .. ..
. . . Capitalize this
portion using the 12
percent weightedaverage cost of debt.
. . . Capitalize this
portion using the 10
percent specific
borrowing rate.
10 - 33

Other
debt
AAE

Specific
new
borrowing

Research and Development (R&D)

Research
Research
Planned
Planned search
search or
or critical
critical investigation
investigation aimed
aimed at
at
discovery
discovery of
of new
new knowledge
knowledge .. .. ..
Development
Development
The
The translation
translation of
of research
research findings
findings or
or other
other knowledge
knowledge
into
into aa plan
plan or
or design
design .. .. ..
Most
Most R&D
R&D costs
costs are
are expensed
expensed as
as incurred.
incurred. (Must
(Must be
be
disclosed
disclosed ifif material.)
material.)

R&D
R&Dcosts
costsincurred
incurredunder
undercontract
contract for
for other
othercompanies
companiesare
are

capitalized
capitalizedas
asinventory
inventoryand
andcarried
carriedforward
forwardinto
intofuture
future
years.
years.

Costs
Costsof
ofassets
assetspurchased
purchasedfor
for R&D
R&Dpurposes
purposesare
areexpensed
expensed
in
inthe
theperiod
periodunless
unlessthey
theyhave
have alternative
alternativefuture
futureuses.
uses.
10 - 34

Software Development Costs

All
All costs
costs incurred
incurred to
to establish
establish the
the technological
technological feasibility
feasibility

of
of aa computer
computer software
software product
product are
are treated
treated as
as R&D
R&D and
and
expensed
expensed as
as incurred.
incurred.

Costs
Costs incurred
incurred after
after technological
technological feasibility
feasibility is
is established
established
and
and before
before the
the software
software is
is available
available for
for release
release to
to
customers
customers are
are capitalized
capitalized as
as an
an intangible
intangible asset.
asset.
Costs
Expensed
as R&D

Start of
R&D
Activity
10 - 35

Costs
Capitalized

Technological
Feasibility

Operating
Costs

Date of
Product
Release

Sale of
Product

Software Development Costs

Amortization
Amortization of
of capitalized
capitalized computer
computer software
software costs
costs
starts
starts when
when the
the product
product begins
begins to
to be
be marketed.
marketed.
Two
Two methods,
methods, the
the percentage
percentage of
of revenue
revenue method
method and
and
the
the straight-line
straight-line method,
method, are
are compared
compared and
and the
the method
method
producing
producing the
the largest
largest amount
amount of
of amortization
amortization is
is used.
used.

10 - 36

U.S. GAAP vs. IFRS

Research and Development Costs

10 - 37

Except for software

development costs incurred
after technological feasibility,
all research and development
expenditures are expensed in
the period incurred.
Direct costs to secure a patent
are capitalized.

Research expenditures are

expensed in the period
incurred. Development
expenditures that meet
specified criteria are
capitalized as an intangible
asset.
Direct costs to secure a patent
are capitalized.

U.S. GAAP vs. IFRS

Software Development Costs

10 - 38

The percentage used to

amortize software
development costs 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.

The same approach is

allowed, but not required.