PREVIEW OF CHAPTER 1

Topics/Learning Objectives (L.O.)

1. Nature of plant assets
2. Cost of plant assets/Valuation
3. Costs after acquisition
4. Depreciation & depletion of plant assets
5. Disposition of plant assets
6. Nature, cost, & amortization of intangible assets

10-1
 1. NATURE OF PROPERTY, PLANT, AND EQUIPMENT

Property, plant, and equipment are assets of a durable nature.

Other terms commonly used are plant assets, fixed assets,
assets and
capital assets.
assets

Includes:

Major characteristics:

“Used operations and not for resale/investment.
Used in operations”
Land,

Include standby assets (in non-continuous use)
Building

structures

Exclude idle assets (land or building)-investment
(offices,

Revenue producing assets-productive purpose factories,

Long-term/long-lived in nature and usually depreciated. warehouses),

Long-term prepayments and

Bundle of future services
Equipment
(machinery,

Possess physical substance.
substance
furniture,

Tangible in nature-fixed in nature tools).

Conversion (indirect) cost to a product
10-2

Not directly incorporated/become part of a product
 1. NATURE OF PROPERTY, PLANT, AND EQUIPMENT
Assets

Current Assets Non-Current Assets

Operating Assets Investments

Tangible Assets Intangible Assets

PPE Natural Resources

Depreciable Non-Depreciable

10-3
 2. ACQUISITION COST OF PP&E [INITIAL VALUATION]

Guideline for Initial Valuation

Guideline

Historical cost [Cost principle] measures the cash or cash

equivalent price of obtaining the asset and bringing it to the
location and condition necessary for its intended use.

Cost consists of all expenditures necessary & reasonable to

acquire an asset and make it ready for its intended use.

Companies value property, plant, and equipment in

subsequent periods using either the
 cost method or
 fair value (revaluation) method.

10-4
 2. ACQUISITION COST OF PP&E [INITIAL VALUATION]

Cost Components/Elements [Subject to Mode of Acquisition]

 Cost of Land
All expenditures made to acquire land and ready it for use.
Costs typically include:
(1) purchase price;
(2) closing costs, such as title (fees) to the land, attorney’s fees,
recording fees, sales taxes, broker’s commission
(3) costs of surveying, grading, filling, leveling, draining, and clearing;
(4) Razing or removing unwanted buildings, less the salvage
(5) assumption of any liens (delinquent real estate taxes),
mortgages, or encumbrances on the property; and
(6) additional land improvements that have an indefinite life (Paving a
public street bordering the land)
10-5
 2. ACQUISITION COST OF PP&E [INITIAL VALUATION]

 Cost of Land
 lives such as private
Improvements with limited lives,
driveways, walks, fences, and parking lots, are recorded
as Land Improvements and depreciated.

 Land acquired and held for speculation is classified as an

investment.
investment

 Land held by a real estate concern for resale should be

classified as inventory.
inventory

10-6
 2. ACQUISITION COST OF PP&E [INITIAL VALUATION]

Illustration: Sunrise Company acquires real estate at a cash

cost of Br.100,000. The property contains an old warehouse
that is razed at a net cost of Br.6,000 (Br.7,500 in costs less
Br.1,500 proceeds from salvaged materials). Additional
expenditures are the attorney’s fee, Br.1,000, and the real
estate broker’s commission, Br.8,000.

Required: Determine the amount to be reported as the cost of

the land.

10-7
 2. ACQUISITION COST OF PP&E [INITIAL VALUATION]

Required: Determine amount to be reported as the cost of the

land.
Land
Cash price of property (Br.100,000) Br.100,000
Net removal cost of warehouse (Br.7,500-Br.1,500) 6,000
Attorney's fees (Br.1,000) 1,000
Real estate broker’s commission (Br.8,000) 8,000
Cost of Land Br.115,000
Illustration 10-
10-2
Computation of cost of land

10-8
 2. ACQUISITION COST OF PP&E [INITIAL VALUATION]

 Cost of Land Improvements

Structural additions made to land. Cost includes all
expenditures necessary to make the improvements ready for
their intended use.
use

 Examples: driveways, parking lots, fences, landscaping,

and underground sprinklers, trees and shrubs, outdoor
lighting, concrete sewers and drainage.
 Limited useful lives.

 Expense (depreciate) the cost of land improvements over

their useful lives.

10-9
 2. ACQUISITION COST OF PP&E [INITIAL VALUATION]

COST OF BUILDINGS
Includes all costs related directly to purchase or construction.
Purchase costs:
 Purchase price, closing costs (attorney’s fees, title insurance, etc.)
and real estate broker’s commission.
 Remodeling, and replacing or repairing the roof, floors, electrical
wiring, and plumbing. Reconditioning (purchase of an existing
building)
Construction costs:
 materials, labor, and overhead costs incurred during construction
and professional fees and building permits.
 Contract price plus payments for architects’ fees, Engineers’ fees,
building permits, and excavation costs.
 Companies consider all costs incurred, from excavation to
completion as part of the building costs.
completion,
 Insurance & interest costs incurred during construction
 Walkways to and around the building
10-10
 2. ACQUISITION COST OF PP&E [INITIAL VALUATION]

Illustration: The expenditures and receipts below are related to land,

land improvements, and buildings acquired for use in a business
enterprise. Determine how the following should be classified
classified:

a. Money borrowed to pay building contractor a. Notes Payable

(signed a note)
b. Payment for construction from note proceeds b. Buildings
c. Cost of land fill and clearing c. Land
d. Delinquent real estate taxes on property d. Land
assumed by purchaser
e. Premium on 6-month insurance policy during e. Buildings
construction

10-11
 2. ACQUISITION COST OF PP&E [INITIAL VALUATION]

Illustration: Determine how the following should be classified:

classified

f. Refund of 1-month insurance premium f. (Buildings)

because construction completed early
g. Architect’s fee on building g. Buildings
h. Cost of real estate purchased as a plant site h. Land
(land Br.200,000 and building Br.50,000)
i. Commission fee paid to real estate agency i. Land
j. Cost of razing and removing building j. Land
k. Installation of fences around property k. Land
Improvements

10-12
 2. ACQUISITION COST OF PP&E [INITIAL VALUATION]

Illustration: Determine how the following should be classified:

classified

l. Proceeds from residual value of demolished l. (Land)

building
m. Interest paid during construction on money m. Buildings
borrowed for construction
n. Land
n. Cost of parking lots and driveways
Improvements
o. Cost of trees and shrubbery planted o. Land
(permanent in nature)
p. Excavation costs for new building p. Buildings

10-13
 2. ACQUISITION COST OF PP&E [INITIAL VALUATION]

 Cost of Equipment
Include all expenditures incurred in acquiring the equipment
and preparing it for use. Costs include:
 Cash purchase price,
 freight and handling charges,
 insurance on the equipment while in transit,
 cost of special foundations if required,
 assembling and installation costs, and
 costs of conducting trial runs.
 Sales taxes
 Repairs (purchase of used equipment)
 Reconditioning (purchase of used equipment)
 Modifying for use

10-14
 2. ACQUISITION COST OF PP&E [INITIAL VALUATION]

Illustration: Lenard Company purchases a delivery truck at a cash

price of Br.22,000. Related expenditures are sales taxes Br.1,320,
painting and lettering Br.500, motor vehicle license $80, and a
three-year accident insurance policy Br.1,600. Compute the cost of
the delivery truck.
Truck
Cash price Br.22,000
Sales taxes 1,320
Painting and lettering 500

Cost of Delivery Truck Br.23,820

Illustration 10-4
Computation of cost of
delivery truck

10-15
 2. ACQUISITION COST OF PP&E [INITIAL VALUATION]

Illustration: Lenard Company purchases a delivery truck at a

cash price of Br.22,000. Related expenditures are sales taxes
Br.1,320, painting and lettering Br.500, motor vehicle license
Br.80, and a three-year accident insurance policy Br.1,600.
Prepare the journal entry to record these costs.

Equipment 23,820
License Expense 80
Prepaid Insurance 1,600
Cash 25,500

10-16
 2. ACQUISITION COST OF PP&E [INITIAL VALUATION]

 Cost of Acquiring Fixed Assets Excludes:

Vandalism (deliberate destruction of property)

Mistakes in installation

Uninsured theft

Damage during unpacking and installing

Fines for not obtaining proper permits from
government agencies

10-17
2. Special Issues
a) Self-Construction
∗Factory Overhead [FOH]
∗Interest cost [Debt Financing]
b) Savings or loss on self-construction
c) Cash discounts
c) Deferred payment contracts
d) Issuance of shares
e) Group/Basket/Lump sum purchases (vs.
individual/separate)
f) Donations/Grants/Gifts
g) Exchanges of non-monetary assets
10-18
 Valuation of PPE-
PPE-Interest Capitalization
Self-Constructed assets: These are assets constructed by the
business for use in operations.
Costs include:
 Materials and direct labor
 Direct/Variable manufacturing overhead
 Interest during construction [b/c of HC & Matching principles]
 Pro rata portion of indirect manufacturing overhead, i.e. Full
costing approach.
 Full costing is the most commonly used and is the generally
accepted method used to allocate the indirect MOH between
the normal operation (inventories) and self-construction. That
is all overhead costs are allocated both to production and to
self-constructed assets based on the relative amount of a
chosen cost driver (for example, labor hours) incurred.

10-19
 Valuation of PPE-
PPE-Interest Capitalization

Interest Costs During Construction

Three approaches have been suggested to account for the
interest incurred in financing the construction.

Increase to Cost of Asset

$0 $?

Capitalize no Capitalize
interest during Capitalize actual all costs of
construction costs incurred during funds
construction

ILLUSTRATION 10- 10-1

Capitalization of Interest
Costs IFRS

10-20
 Valuation of PPE-
PPE-Interest Capitalization

 IFRS requires — capitalizing actual interest (with

modification).

 Interest should be capitalized on all “pre-

earning” assets
 Consistent with historical cost.

 Capitalization considers three items:

1. Qualifying assets.

2. Capitalization period.

3. Amount to capitalize.

10-21
 Valuation of PPE-
PPE-Interest Capitalization

Qualifying Assets
Require a substantial period of time to get them ready for their
intended use or sale.
Two types of assets:

Assets under construction for a company’s own use.

Assets intended for sale or lease that are constructed or
produced as discrete projects.
Non-qualifying assets include:

Inventories that are routinely manufactured.

Assets that are in use or ready for their intended use.

Assets that are not being used in the earning activities of the
company and are not undergoing the activities necessary to
get them ready for use.
10-22
 Valuation of PPE-
PPE-Interest Capitalization
Capitalization Period
Begins when:
1. Expenditures for the assets are being incurred.
2. Activities for readying the asset for use or sale are in progress .
3. Interest costs are being incurred.
 Capitalization continues for as long as these three conditions exist or
ceases when any one of the three conditions is not met or when the
asset is substantially completed.
 If the first condition is not met, the conceptual basis for interest
capitalization is absent.
 If the second condition is not met, construction activities are not the
cause of the opportunity cost.
 If the third condition is not met, there is no interest to capitalize.
Ends when:
The asset is substantially complete and ready for use

10-23
 Valuation of PPE-
PPE-Interest Capitalization
Interrupted when:
 Brief & inherent in normal construction work (e.g. labor disputes)-
Capitalization continues
 Intentional delays (e.g. customer choice of fixtures)-Capitalization
discontinued.

 Capitalization period: time between the expenditure date and the

date interest capitalization stops or year-end (whichever comes first)

 If the construction period covers more than one fiscal period,

accumulated expenditures include prior years’ capitalized
interest. (See comprehensive illus #2)

10-24
 Valuation of PPE-
PPE-Interest Capitalization

Amount to Capitalize
Capitalize the lesser of:
1. Actual interest cost incurred [both on the specific & general
or other loans].
2. Avoidable interest (Interest Potentially Capitalizable =IPC):
the amount of interest cost during the period that a
company could theoretically avoid if it had not made
expenditures for the asset. Or Avoidable interest is the
amount that could have been avoided, if expenditures for
the asset had not been made. It is a function of AAE.
 Average Accumulated Expenditures [AAE]-is a measure of
the debt that could have been retired and is the average
cash investment during the construction period.
10-25
 Valuation of PPE-
PPE-Interest Capitalization

Illustration:
Illustration: Assume a company borrowed $200,000 at 12% interest
from State Bank on Jan. 1, 2015, for specific purposes of constructing
special-purpose equipment to be used in its operations. Construction on
the equipment began on Jan. 1, 2015, and the following expenditures
were made prior to the project’s completion on Dec. 31, 2015:

Actual Expenditures during 2015: Other general debt existing on

January 1 $ 100,000 Jan. 1, 2015:

$500,000, 14%,
14% 10-year
April 30 150,000
November 1 300,000 bonds payable
December 31 100,000
Total expenditures $ 650,000 $300,000, 10%,
10% 5-year
note payable

10-26
 Valuation of PPE-
PPE-Interest Capitalization

Step 1 - Determine which assets qualify for capitalization of

interest.
Special purpose equipment qualifies because it requires a period of
time to get ready and it will be used in the company’s operations.

Step 2 - Determine the capitalization period.

The capitalization period is from Jan. 1, 2015 through Dec. 31, 2015,
because expenditures are being made and interest costs are being
incurred during this period while construction is taking place.

10-27
 Valuation of PPE-
PPE-Interest Capitalization

Step 3 - Compute weighted-

weighted-average accumulated expenditures
(WAAE).
Weighted
Average
Actual Capitalization Accumulated
Date Expenditures Period Expenditures
Jan. 1 $ 100,000 12/12 $ 100,000
Apr. 30 150,000 8/12 100,000
Nov. 1 300,000 2/12 50,000
Dec. 31 100,000 0/12 -
$ 650,000 $ 250,000

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.
10-28
 Valuation of PPE-
PPE-Interest Capitalization

Step 4 - Compute the Actual and Avoidable Interest.

Selecting Appropriate Interest Rate:

1. For the portion of weighted-average accumulated expenditures
that is less than or equal to any amounts borrowed specifically to
finance construction of the assets, use the interest rate incurred
on the specific borrowings.
borrowings

2. For the portion of weighted-average accumulated expenditures

that is greater than any debt incurred specifically to finance
construction of the assets, use a weighted average of interest
rates incurred on all other outstanding debt during the period.
period

10-29
 Valuation of PPE-
PPE-Interest Capitalization

Step 4 - Compute the Actual and Avoidable Interest.

Actual Interest
Interest Actual
Debt Rate Interest Weighted-average
Specific Debt $ 200,000 12% $ 24,000 interest rate on
general debt
$100,000
= 12.5%
General Debt 500,000 14% 70,000
300,000 10% 30,000 $800,000
$ 1,000,000 $ 124,000

Accumulated Interest Avoidable

Avoidable Interest Expenditures Rate Interest
$ 200,000 12% $ 24,000
50,000 12.5% 6,250
$ 250,000 $ 30,250
10-30
 Valuation of PPE-
PPE-Interest Capitalization

Step 5 – Capitalize the lesser of Avoidable interest or Actual

interest.

Avoidable interest $ 30,250

Actual interest 124,000

Journal entry to Capitalize Interest:

Equipment 30,250
Interest Expense 30,250

10-31
 Valuation of PPE-
PPE-Interest Capitalization

Comprehensive Illustration 1: On November 1, 2014, ABC

Company contracted Pfeifer Construction Co. to construct a building
for $1,400,000 on land costing $100,000 (purchased from the
contractor and included in the first payment). ABC made the
following payments to the construction company during 2015.

10-32
 Valuation of PPE-
PPE-Interest Capitalization

ABC Construction completed the building, ready for occupancy, on

December 31, 2015. ABC had the following debt outstanding at
December 31, 2015.
Specific Construction Debt
1. 15%, 3-year note to finance purchase of land and
construction of the building, dated December 31, 2014, with
interest payable annually on December 31 $750,000
Other Debt
2. 10%, 5-year note payable, dated December 31, 2011, with
interest payable annually on December 31 $550,000
3. 12%, 10-year bonds issued December 31, 2010, with
interest payable annually on December 31 $600,000

Compute weighted-average accumulated expenditures for 2015.

10-33
 Valuation of PPE-
PPE-Interest Capitalization

Compute weighted-average accumulated expenditures for 2015.

ILLUSTRATION 10-
10-4
Computation of Weighted-Average
Accumulated Expenditures

10-34
 Valuation of PPE-
PPE-Interest Capitalization

ILLUSTRATION 10-10-5
Compute the avoidable interest. Computation of
Avoidable Interest

10-35
 Valuation of PPE-
PPE-Interest Capitalization

Compute the actual interest cost, which represents the maximum

amount of interest that it may capitalize during 2015.

ILLUSTRATION 10-10-6
Computation of Actual
Interest Cost
The interest cost that Shalla capitalizes is the
lesser of $120,228 (avoidable interest) and
$239,500 (actual interest), or $120,228.

10-36
 Valuation of PPE-
PPE-Interest Capitalization

ABC records the following journal entries during 2015:

January 1 Land 100,000

Buildings (or CIP) 110,000
Cash 210,000
March 1 Buildings 300,000
Cash 300,000
May 1 Buildings 540,000
Cash 540,000
December 31 Buildings 450,000
Cash 450,000
Buildings (Capitalized Interest) 120,228
Interest Expense. 119,272
Cash
239,500
10-37
 Valuation of PPE-
PPE-Interest Capitalization

At December 31, 2015, ABC discloses the amount of interest

capitalized either as part of the income statement or in the notes
accompanying the financial statements.

ILLUSTRATION 10- 10-7

Capitalized Interest
Reported in the Income
Statement

ILLUSTRATION 10- 10-8

Capitalized Interest
Disclosed in a Note

10-38
 Valuation of PPE-
PPE-Interest Capitalization
Comprehensive Illustration 2: On January 2, 20X1, A Company
commenced construction of a new building for its own use at an
estimated cost of Br. 2,200,000. The construction is expected to
be completed one month before the end of Year 20X2 (November
30). The following debts were held by the company throughout
the term of construction of the building:
Construction (specific) loan Br. 750,000, 15%, 3 years Notes Payable
General (nonspecific) loans 550,000, 10%, 5 years Notes Payable
600,000, 12%, 10 years, Bonds Payable
Moreover, the company made the following expenditures (payments) on the
construction of the building:
January 1, 20X1 $210,000
March 1, 20X1 300,000
May 1, 20X1 540,000
December 31, 20X1 450,000
August 1, 20X2 400,000
10-39
October 30, 20X2 200,000
 Valuation of PPE-
PPE-Interest Capitalization

A. Capitalized Interest For 20X1

Step 1: Compute actual interest expense for 20X1.
Construction loan (750,000*0.15*12/12) $112,500
Long-term note (550,000*0.10*12/12) 55,000
Long-term bonds (600,000*0.12*12/12) 72,000
Total Actual Interest $239,500

Step 2: Compute Weighted Average Accumulated Expenditures

(WAAE) for 20X1.
Expenditure Capitalization Period WAAE
Date Amount
January 1 $210,000 12/12 $210,000
March 1 300,000 10/12 250,000
May 1 540,000 8/12 360,000
December 31 450,000 0/12 0
Total $1,500,000 $820,000
10-40
 Valuation of PPE-
PPE-Interest Capitalization

Step 3: Compute the Interest Potentially Capitalizable (IPC) for 20X1.

•Case 1 WAAE > Construction (Specific) Loan
IPC = Interest on + Interest on Excess of WAAE
Construction Loan over Construction Loan

Interest on Excess of WAAE

Over Construction Loan = (WAAE- Construction Loan)*WAIR
WAIR = Total Actual Interest on Nonspecific Loans
Total Nonspecific Interest-Bearing Loans
•Case 2 WAAE < Construction (Specific) Loan
IPC = WAAE * Interest Rate on Specific Loan
Thus, IPC for 20X1:
= (750,000*0.15) + (820,000-750,000)*0.1104 = $120,228

10-41
 Valuation of PPE-
PPE-Interest Capitalization

Step 4: Capitalize the Lesser (Lower) of Actual Interest and IPC for
20X1.
Building under construction 120,228
Interest Expense 120,228
OR
Interest Expense (239,500-120,228) 119,272
Building under construction 120,228
Cash (or Interest Payable) 239,500
B. Capitalized Interest For 20X2
Step 1: Compute actual interest expense for 20X2.
Construction loan (750,000*0.15*11/12) $103,125
Long-term note (550,000*0.10*11/12) 50,417
Long-term bonds (600,000*0.12*11/12) 66,000
Total Actual Interest $219,542
10-42
 Valuation of PPE-
PPE-Interest Capitalization

Step 2: Compute Weighted Average Accumulated Expenditures

(WAAE) for 20X2.
1,620,228 = 1,500,000 (Construction Costs for 20X1) +120,228 (capitalized
interest for 20X1)
Step 3: Compute the Interest Potentially Capitalizable (IPC) for 20X2.
= (750,000*0.15*11/12) + (1,783,865-750,000)*0.1104*11/12= $207,752
Expenditure Capitalization WAAE
Date Amount period
January 1 $1,620,228 11/11 $1,620,228
August 1 400,000 4/11 145,455
October 1 200,000 1/11 18,182
Total $2,220,228 $1,783,865

10-43
 Valuation of PPE-
PPE-Interest Capitalization
Step 4: Capitalize the lesser of Actual Interest and IPC
Building under construction 207,752
Interest Expense 207,752
OR
Interest Expense (219,542-207,752) 11,790
Building under construction 207,752
Cash (or Interest Payable) 219,542

10-44
 Valuation of PPE-
PPE-Interest Capitalization

Comprehensive illus #3: Cut Industries, Inc. has decided to

construct a new computerized assembly plant.
 Construction will take about 18 months.
 Construction costs are estimated at $6.4 million (excluding
capitalized interest).
 A 12%, $2 million loan is obtained and will become
effective on January 1, 2013, at the beginning of
construction.
 Cut Industries, Inc.’s other debts are:
5-year notes payable, 11% interest $3,000,000
Mortgage on other plant, 9% interest 4,800,000

10-45
 Valuation of PPE-
PPE-Interest Capitalization
The weighted-average interest rate on the general nonconstruction
debt is computed as follows:

The following expenditures were incurred on the project during

2013.
January 1, 2013 $1,200,000
October 1, 2013 1,800,000
In the previous slide we noted that the weighted-average rate
was 9.8% (rounded).
10-46
 Valuation of PPE-
PPE-Interest Capitalization
Computation of the amount of interest to be capitalized
for 2013 follows:

In previous, the weighted- The firm borrowed

average rate was determined $1,800,000 on October 1
to be 9.8%

10-47
 Valuation of PPE-
PPE-Interest Capitalization
The amount of interest capitalized cannot exceed total interest
incurred during the year. Total interest during 2013 was as follows:

The actual interest was $1,002,000 and the calculated interest

was $192,500. Thus, the entry is as follows:
Construction in Progress 192,500
Interest Expense 809,500
Cash 1,002,000
$1,002,000 − $192,500
10-48
 Valuation of PPE-
PPE-Interest Capitalization

Assume that additional construction expenditures of $3,200,000

were made on February 1, 2014, and the project was completed
on May 31, 2014. The amount of interest to be capitalized for
2014 follows.

10-49
 Valuation of PPE-
PPE-Interest Capitalization

• Avoidable interest in 2014 includes interest on all loans that

could have been repaid with the construction expenditures
made in 2013.
• These expenditures total $3,193,500 ($1,200,000 + $1,800,000
+ $192,500) and include interest capitalized in 2013.
• Interest is capitalized until construction is completed on May
31 and the building is ready for use.
• Because $253,227 is less than the actual annual interest of
$1,002,000, the entire $253,227 is capitalized in 2014.
• The total building cost is $6,645,727, which includes $192,500
of interest capitalized in 2013 and $253,227 in 2014.

10-50
 Valuation of PPE-
PPE-Interest Capitalization

Special Issues Related to Interest Capitalization

1. Expenditures for Land
 If land is purchased as a site for a structure, interest
costs capitalized during the period of construction are
part of the cost of the plant, not the land.

 Conversely, if the company develops land for lot sales,

it includes any capitalized interest cost as part of the
acquisition cost of the developed land.

2. Interest Revenue
 In general, companies should not offset interest revenue
against interest cost unless earned on specific borrowings.
10-51
 Valuation of PPE- Savings or Loss on Self-Construction

 When the cost of self-construction of an asset is less

than the cost to acquire it through purchase or
construction from outsiders, the difference is not a
profit, but a savings.
• When the cost is greater than the cost to acquire it
through purchase or construction from outsiders, the
asset should be recorded at cost.

10-52
 Valuation of PPE- Savings or Loss on Self-Construction
Illustration: Kaplan Limited completed the construction of equipment on
November 10, 20X1. The following itemizes total construction costs:
Material $200,000
Labor 500,000
Incremental overhead 100,000
Capitalized interest 100,000
Total $900,000
Kaplan recorded all construction costs in equipment under construction.
1. If the asset’s market value at completion equals or exceeds
$900,000, the following entry would be made on November 10,
20X1:
Equipment…………………………..900,000
Equipment under construction…………….900, 000
2. If the asset’s market value is only $880,000, the following entry
would be made on November 10, 20X1:
Equipment……………………………….880, 000
Loss on Construction of Equipment…….20,000
Equipment under construction…………….900, 000
10-53
 Valuation of PPE- Cash Discounts
Cash Discounts — whether taken or not — generally considered a
reduction in the cost of the asset. The Net-of-Discount Method is
the preferred method
Example: ABC Co purchased equipment for Br 60,000 on account
under the term 2/10, n/30. Record the purchase:
Equipment ………………………………… 58,800
Accounts Payable…………………………………… 58,800

10-54
 Valuation of PPE: Lump-sum (Basket) Purchases
Lump-Sum Purchases — Allocate the total cost among the various
assets on the basis of their relative fair market values.
Example: A company pays $120,000 for equipment and a building.
The land and building are appraised at $50,000 and $75,000,
respectively.
Appraisal Relative Total Allocated
Assets Value Fair Value Cost Cost
Equipment 50,000 50,000/125,000 120,000 48,000
Building 75,000 75,000/125,000 120,000 72,000
Total 125,000 120,000

Equipment 48,000
Building 72,000
Cash 120,000
10-55
 Valuation of PPE: Issuance of Shares

Issuance of Shares — The market price of the shares issued is a

fair indication of the cost of the property acquired.
Example: North Co. decides to purchase building located adjacent to
it for expansion of its operation. The building is owned by Sky Co. In
lieu of paying cash for the building, North issues to Sky Co. 5,000
shares of common stock (par value $10) that have a fair value of $12
per share. Make the journal entry

Building (5,000 x $12)…………………….. 60,000

Common Stock………………………………………………….. 50,000
Paid-In Capital in Excess of Par—Common Stock.. 10,000

10-56
 Valuation of PPE- Deferred-Payment Contracts
Deferred-Payment Contracts — Assets purchased on long-term credit
contracts are valued at the present value of the consideration exchanged.
Example 1: On January 2, 2013, purchased equipment with a cash price of
$50,000 for $15,000 down plus seven annual payments of $7,189 each.

Equipment 50,000
Discount on Notes Payable 15,323
Notes Payable 50,323
Cash 15,000
Example 2: Greathouse Company purchases equipment today in exchange
for a $10,000 zero-interest-bearing note payable four years from now. The
market interest rate is 9%. Record the purchase
Equipment …………………………… 7,084.30
Discount on Notes Payable………… 2,915.70
Notes Payable ………………..…………………. 10,000
10-57
 Valuation of PPE: Exchanges
Exchanges of Non-
Non-Monetary Assets
Ordinarily accounted for on the basis of:
 the fair value of the asset given up or
 the fair value of the asset received,
whichever is clearly more evident.
Companies should recognize immediately any gains or losses on
the exchange when the transaction has commercial substance
(future cash flows change as a result of the transaction).
For example, ABC Co. exchanges some of its equipment for Building
held by XYZ Co. It is likely that the timing and amount of the cash
flows arising for the building will differ significantly from the cash
flows arising from the equipment. As a result, both ABC Co. and XYZ
Co. are in different economic positions. Therefore, the exchange has
commercial substance, and the companies recognize a gain or loss on
the exchange.
10-58
 Valuation of PPE: Exchanges

• In some cases, an enterprise acquires a new asset

by exchanging or trading existing nonmonetary
assets.

• Monetary assets are those assets whose amounts

are fixed in terms of currency, by contract, or
otherwise (cash, accounts receivable).

• Nonmonetary assets include all the other assets

(inventories, land).

10-59
 Valuation of PPE: Exchanges

Accounting for Exchanges

* If cash is 25% or more of the fair value of the exchange,

recognize entire gain because earnings process is complete.

10-60
 Valuation of PPE: Exchanges

Summary of Gain and Loss Recognition on Exchanges of

Nonmonetary Assets Lacks Commercial Substance

10-61
 Valuation of PPE: Exchanges

Exchanges - Loss Situation

Companies recognize a loss immediately whether the exchange

has commercial substance or not.
Rationale: Companies should not value assets at more than their
cash equivalent price; if the loss were deferred, assets would be
overstated.

10-62
 Valuation of PPE: Exchanges

Exchange – Gain Situation Illustration: ABC Company exchanged

equipment used in its manufacturing operations for similar equipment used
in the operations of XYZ Company plus $3,000 in cash . The following
information pertains to the exchange.

ABC XYZ
Equipment (cost) $28,000 $28,000
Accumulated Depreciation 19,000 10,000

Fair value of equipment 15,500 12,500

Cash given up 3,000

Instructions: Prepare the journal entries to record the exchange on the books
of both companies.

10-63
 Valuation of PPE: Exchanges

Calculation of Gain or Loss

ABC XYZ
Fair value of equipment received $12,500 $15,500
Cash received / paid 3,000 (3,000)
Less: Bookvalue of equipment
($28,000-19,000) (9,000)
($28,000-10,000) (18,000)
Gain or (Loss) on Exchange $6,500 ($5,500)

When a company receives cash (sometimes referred to as “boot”)

in an exchange that lacks commercial substance, it may
immediately recognize a portion of the gain.

10-64
 Valuation of PPE: Exchanges

Has Commercial Substance

ABC:
Equipment 12,500
Cash 3,000
Accumulated depreciation 19,000
Equipment 28,000
Gain on exchange 6,500

XYZ:
Equipment 15,500
Accumulated depreciation 10,000
Loss on exchange 5,500
Equipment 28,000
Cash 3,000

10-65
 Valuation of PPE: Exchanges

Lacks Commercial Substance

ABC:
Equipment (12,500 – 5,242) 7,258
Cash 3,000
Accumulated depreciation 19,000
Equipment 28,000
Gain on exchange 1,258

Cash Received Total Recognized

x =
Cash Received + FMV of Assets Received Gain Gain

$3,000
x $6,500 = $1,258
$3,000 + $12,500
Deferred gain = $6,500 – 1,258 = $5,242
10-66
 Valuation of PPE: Exchanges

Lacks Commercial Substance

XYZ (no change):

Equipment 15,500
Accumulated depreciation 10,000
Loss on exchange 5,500
Equipment 28,000
Cash 3,000

Companies recognize a loss immediately whether the

exchange has commercial substance or not.

10-67
 Valuation of PPE: Contributions
Contributions: Nonreciprocal transfers: transfer of assets
where nothing is given up in exchange (e.g. donations, gift, grants)
Companies should use:

the fair value of the asset to establish its value on the books and

should recognize contributions received as revenues in the period
received.

When a company contributes a non-monetary asset, it should
record the amount of the donation as an expense at the fair value
of the donated asset.

Two approaches to valuing and recording such transfer:
1. Capital Approach: credit contributed surplus account (donated
capital)
2. Income Approach: credit represents income and the gain is
deferred over the life of the asset (exception being land)
a) Cost Reduction Method: credit the respective asset account
b) Deferral Method: credit Deferred Revenue
10-68
 Valuation of PPE: Contributions/Grants

Illustration: Kline Industries donates land to the city of Los Angeles

for a city park. The land cost $80,000 and has a fair value of $110,000.
Kline Industries records this donation as follows.

Donor’s Book:

Contribution Expense 110,000

Land 80,000
Gain on Disposal of Land 30,000
Donee’s Book:
Land 110,000
Contribution Revenue 110,000

10-69
 Valuation of PPE: Contributions/Grants

Government Grants are assistance received from a government

in the form of transfers of resources to a company in return for
past or future compliance with certain conditions relating to the
operating activities of the company.

IFRS requires grants to be recognized in income (income

approach) on a systematic basis that matches them with the
related costs that they are intended to compensate.

10-70
 Valuation of PPE: Contributions/Grants

Example 1: Grant for Lab Equipment. AG Company received a

€500,000 subsidy from the government to purchase lab
equipment on January 2, 2015. The lab equipment cost is
€2,000,000, has a useful life of five years, and is depreciated on
the straight-line basis.

IFRS allows AG to record this grant in one of two ways:

1. Credit Deferred Grant Revenue for the subsidy and amortize

the deferred grant revenue over the five-year period.

2. Credit the lab equipment for the subsidy and depreciate this
amount over the five-year period.

10-71
 Valuation of PPE: Contributions/Grants

Equipment If AG chooses to record

Example 1: Grant for Lab Equipment.
deferred revenue of €500,000, it amortizes this amount over the
five-year period to income (€100,000 per year). The effects on the
financial statements at December 31, 2015, are:

ILLUSTRATION 10-
10-17
Government Grant
Recorded as Deferred
Revenue

10-72
 Valuation of PPE: Contributions/Grants

Example 1: Grant for Lab Equipment. If AG chooses to reduce

equipment AG reports the equipment at
the cost of the lab equipment,
€1,500,000 (€2,000,000 - €500,000) and depreciates this amount
over the five-year period. The effects on the financial statements
at December 31, 2015, are: ILLUSTRATION 10-
10-18
Government Grant Adjusted to Asset

10-73
 Post Acquisition Costs
• In general:
1. If costs incurred increase future benefits, capitalize
costs (Capital Expenditure)
2. If costs maintain a given level of services, expense
costs (Revenue Expenditure)
• Evidence of future economic benefit would include
increases in
1. useful life,
2. quantity of product produced, and
3. quality of product produced.

10-74
 Post Acquisition Costs

• Costs incurred after acquisition can be:

1. Additions: increase or extension of existing assets &
capitalize the cost of addition to asset account.
2. Improvements and replacements: substitution of an
existing asset for an improved or equivalent one
3. Rearrangement and reinstallation[ Relocation/
Reorganization]: moving asset from one location to
another
4. Repairs: costs that maintain assets in operating
condition

10-75
 Post acquisition Costs

Improvements and Replacements

Capitalize costs, if

They increase future service potential

Improvements or Replacements

Substitution of Substitution of
a better asset a similar asset
for present for present
asset asset
10-76
 Post acquisition Costs
 Capitalization Approaches
a. Carrying value of asset is known
Substitution approach: Remove cost of and accumulated
depreciation on old asset, recognizing any gain or loss. Capitalize
cost of improvement/ replacement.
b. Carrying value of the asset is unknown
 Capitalize the new asset (without removing the old asset from
the pool), [If the quantity or quality of the asset’s productivity is
increased capitalize cost of improvement/replacement to asset
account] OR
 Debit accumulated depreciation (when expenditures extend
useful life of asset)

10-77
 Post acquisition Costs

 Rearrangement and reinstallation

a) If original installation cost is known, account for cost of

rearrangement/ reinstallation as a replacement (carrying value
known).
b) If original installation cost is unknown and rearrangement/
reinstallation cost is material in amount and benefits future
periods, capitalize as an asset.
c) If original installation cost is unknown and rearrangement/
reinstallation cost is not material or future benefit is
questionable, expense the cost when incurred.

10-78
Post acquisition Costs
 Repairs
a. Ordinary: Expense cost of repairs when incurred.
b. Major/Extraordinary: As appropriate, treat as an
addition, improvement, or replacement.
Example: Improvements
Instinct Enterprises decides to replace the pipes in its
plumbing system. A plumber suggests that the company
use plastic tubing in place of the cast iron pipes and
copper tubing. The old pipe and tubing have a book value
of $15,000 (cost of $150,000 less accumulated
depreciation of $135,000), and a scrap value of $1,000.
The plastic tubing costs $125,000.
10-79
Post acquisition Costs

If Instinct pays $124,000 for the new tubing after

exchanging the old tubing, it makes the following entry:
Plant Assets (plumbing system)….. 125,000
Acc. Dep.—Plant Assets……………… 135,000
Loss on Disposal of Plant Assets…… 14,000
Plant Assets………………………….………… 150,000
Cash ($125,000 - $1,000)………………… 124,000

10-80
 Disposition of PPE

A company may retire plant assets voluntarily or dispose of

them by
 Sale,

 Exchange,

 Involuntary conversion, or

 Abandonment.

Depreciation must be taken up to the date of disposition.

10-81
 Disposition of PPE: Sale
When fixed assets are sold, the owner may break
even, sustain a loss, or realize a gain.

1. If the sale price is equal to book value, there will

be no gain or loss.
2. If the sale price is less than book value, there will
be a loss equal to the difference.
3. If the sale price is more than book value, there will
be a gain equal to the difference.

Gain or loss will be reported in the income statement

as Other Income or Other Loss.

10-82
 Disposition of PPE: Sale
Illustration: City Company 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.
(a) update depreciation for 2007
Depreciation expense ($3,000 x 8/12) 2,000
Accumulated depreciation 2,000
(b) record the sale
Cash 10,500
Accumulated depreciation 11,000
Machinery 20,000
Gain on sale 1,500
10-83
 Disposition of PPE: Discarding/ Abandonment
Illustration 1: A piece of equipment acquired at a cost of $25,000 is
fully depreciated. On February 14, the equipment is discarded.
Accumulated Depr.—Equipment 25,000
Equipment 25,000
Illustration 2: costing $6,000 is depreciated at an annual straight-line
rate of 10%. After the adjusting entry, Accumulated Depreciation—
Equipment had a $4,750 balance. The equipment was discarded on
March 24.
a. Update the Depreciation
Depreciation Expense.—Equipment 150
Accum. Depreciation—Equipment[=600 × 3/12] 150
b. Write-off Equipment Discarded
Accumulated Depr.—Equipment 4900
Loss on Disposal of Fixed Asset 1100
Equipment 6000
10-84
 Disposition of PPE: Involuntary Conversion

Involuntary Conversion: Sometimes an asset’s service is

terminated through some type of involuntary conversion such as
fire, flood, theft, or condemnation.

Companies report the difference between the amount recovered

(e.g., from a condemnation award or insurance recovery), if any,
and the asset’s book value as a gain or loss.

They treat these gains or losses like any other type of disposition
or often reported as extraordinary items.

10-85
 Disposition of PPE: Involuntary Conversion

Illustration 1: Camel Transport Corp. had to sell a plant located on

company property that stood directly in the path of an interstate
highway. Camel received $500,000, which substantially exceeded
the book value of the land of $150,000 and the book value of the
building of $100,000 (cost of $300,000 less accumulated depreciation
of $200,000). Camel made the following entry.

Cash 500,000
Accumulated Depreciation—Buildings 200,000
Buildings 300,000
Land 150,000
Gain on Disposal of Plant Assets 250,000

10-86
 Disposition of PPE: Involuntary Conversion

Illustration 2: A company’s building with cost Br900,000 and

accumulated depreciation of br580,000, is condemned by the
government for the construction of a highway. The government sets a
price of br200,000 as the condemnation award.

Cash 200,000
Accumulated Depreciation—Buildings 580,000
Loss on condemnation of property 120,000
Buildings 900,000

10-87
 Supplementary: Natural Resources & Intangible Assets

Natural resources consist of standing timber and underground

deposits of oil, gas, and minerals.

Distinguishing characteristics:
characteristics

 Physically extracted in operations.

 Replaceable only by an act of nature.

Cost is the price needed to acquire the resource and prepare it

for its intended use.

10-88
 Depletion

The allocation of the cost to expense in a rational and

systematic manner over the resource’s useful life.
 Companies generally use units-of-activity method.
units-of-
 Depletion generally is a function of the units extracted.
extracted

10-89
 Depletion

Illustration: Lane Coal Company invests $5 million in a mine

estimated to have 1 million tons of coal and no salvage value.

10-90
 Depletion

Illustration: Lane Coal Company invests $5 million in a mine

estimated to have 1 million tons of coal and no salvage value. In
the first year, Lane extracts and sells 250,000 tons of coal. Lane
computes the depletion expense as follows:

$5,000,000 ÷ 1,000,000 = $5.00 depletion cost per ton

$5.00 x 250,000 = $1,250,000 annual depletion expense

Journal entry:
Depletion Expense/Inventory (coal)1,250,000
Accumulated Depletion 1,250,000

10-91
 Summary

10-92
 Summary

10-93
 Summary

10-94