Intermediate accounting 19th by stice stice chapter 10

19th Edition Chapter 10 Investments in Noncurrent Operating Assets— Acquisitions Intermediate Accounting James D Stice Earl K Stice PowerPoint presented by Douglas Cloud Professor Emeritus of Accounting, Pepperdine University © 2014 Cengage Learning 10-1 What Costs Are Included in Acquisition Cost? • Noncurrent operating assets are recorded • • initially at cost—the original bargained or cash sales price The cost of property includes not only the original purchase price or equivalent value but also any other expenditures required in obtaining and preparing the asset for its intended use Any taxes, freight, installation, and other expenditures related to the acquisition should be included in the asset’s cost 10-2 Land • • • Costs assigned to land should be those costs that directly relate to the land’s unlimited life Purchase price, commissions, legal fees, escrow fees, surveying fees, and government assessments for water lines, sewers, and roads are charged to Land Clearing and grading costs, including the removal of unwanted structures, are also part of the cost of land (continued) 10-3 Buildings • • If the structure is purchased ready to use, charge Buildings for:  Purchase price  Commissions, legal fees, escrow fees, and reconditioning costs If newly constructed by an outsider:  Contract price  Legal fees (continued) 10-4 Equipment Equipment costs include: • • • • The purchase price Taxes, freight, and insurance during shipping and installation Special foundations or reinforcing of floors Reconditioning and testing costs (continued) 10-5 Intangible Assets • • Intangible assets are those assets (not including financial assets) that lack physical substance The most important distinction in intangible assets for accounting purposes is between those that are internally generated and those that are externally purchased (continued) 10-6 Trademark • A trademark is a distinctive name, symbol, or slogan that distinguishes a product or service from similar products or services • The cost of a trademark includes the purchase price, filing and registry fees, and the cost of subsequent litigation to protect rights It does not include internal research and development costs 10-7 Franchises • • A franchise is the right received (usually purchased) by a business or individual to perform certain functions or sell certain products or services The cost of a franchise includes expenditures made to purchase the franchise, legal fees, and other costs incurred in obtaining the franchise 10-8 Order Backlog • • The order backlog is the amount of orders the company has received for equipment that has not yet been produced or delivered These orders not constitute sales because they not satisfy the revenue recognition requirement that the product be completed and shipped (continued) 10-9 Goodwill • • Goodwill represents the business contracts, reputation, functioning systems, staff camaraderie, and industry experience that makes the company more than just a collection of assets Goodwill is a residual number, the value of all of the synergies of a functioning business that cannot be specifically identified with any other intangible factor 10-10 Estimating the Fair Value of Intangibles Traditional TraditionalApproach Approach Intangible Asset A is the right to receive royalty payments in the future of $1,000 payments at the end of each of the next five years The riskadjusted interest rate is 12% The fair value of the patent is calculated as follows: Table Value (n = 5; I = 12) × $1,000 = PV(annuity) 3.605 × $1,000 = $3,605 (continued) 10-52 Estimating the Fair Value of Intangibles Expected Expected Cash Cash Flow Flow Approach Approach Intangible Asset B is a secret formula to produce a healthy fast-food cheeseburger that is expected to have the following associated probabilities of happening: Outcome = 10% probability of cash flows of $5,000 at the end of each year for 10 years Outcome = 30% probability of cash flows of $1,000 at the end of each year for years (continued) 10-53 Estimating the Fair Value of Intangibles Outcome = 60% probability of cash flows of $100 at the end of each year for years 10-54 Acquired In-Process Research and Development The FASB ruled that in-process R&D is to be recognized as an intangible asset if it is acquired as part of a business combination but is to be expensed if acquired as part of a basket purchase outside of a business combination The FASB realizes that this is an inconsistency and they intend to revisit it in the future 10-55 Intangibles Acquired in the Acquisition of a Business • • Goodwill is a residual amount, the amount of the purchase price of a business that is left over after all other tangible and intangible assets have been identified In a basket purchase, each identifiable asset is recorded at an amount equal to its estimated fair market value; any residual is reported as goodwill 10-56 Bargain Purchase • When the amount paid for another company is less than the fair value of the net identifiable assets, this is a bargain purchase • Assume that the Speedy Freight acquisition was for $1,000,000 instead of $1,500,000 The acquisition would be recorded as shown in Slide 10-65 (continued) 10-57 Bargain Purchase Note that a gain is recognized 10-58 International Accounting for Intangibles: IAS 38 and IFRS • The IASB’s standard for the accounting of intangible assets is IAS 38 • This IASB standard is very much compatible with U.S GAAP • The most significant differences between U.S GAAP and IASB standards in the accounting for intangible assets are in testing these assets for impairment 10-59 Valuation of Assets at Fair Values • In IAS 16, the IASB permits the inclusion of upward revaluations of noncurrent operating assets in the financial statements as an allowable alternative to reporting the historical cost of those assets  If a company revalues its noncurrent operating assets to fair value, it must so on a regular basis and must revalue entire classes of assets rather than just picking and choosing certain assets (continued) 10-60 Valuation of Assets at Fair Values  Downward revaluations are recorded as a loss  Upward revaluations are recorded as a debit to the asset and a credit to a special “revaluation” equity account  This practice means that upward revaluations cannot be used to boost reported income  When the asset that has revalued upward is subsequently sold, any associated balance in the special revaluation equity is credited directly to Retained Earnings 10-61 Fixed Asset Turnover Ratio General Electric’s manufacturing segments had sales for 2008 totaled $182,515 Its beginning and ending property, plant, and equipment balances were $77,888 and $78,530, respectively ($77,888 + $78,530) Average fixed assets = = $78,209 Fixed asset turnover ratio = Sales $182,515 $78,209 Average fixed assets (continued) = 2.33 10-62 Fixed Asset Turnover Ratio General Electric’s manufacturing segments had sales for 2009 totaled $156,783 Its beginning and ending property, plant, and equipment balances were $78,530 and $69,212, respectively ($78,530 + $69,212) Average fixed assets = = $73,871 Fixed asset turnover ratio = Sales $156,783 $73,871 Average fixed assets = 2.12 10-63 Dangers in Using the Fixed Asset Turnover Ratio • Fixed asset turnover ratios values for two companies in different industries cannot be meaningfully compared • The reported amount for property, plant, and equipment can be a poor indicator of the actual fair value of fixed assets being used by a company 10-64 Chapter 10 ₵ The The End End $ 10-65 10-66 ... (continued) 10- 13 Deferred Payment Jan 2, 2013—Purchased land for $100 ,000, paying $35,000 down, the balance to be paid in semiannual payments of $5,000 plus interest at 10% Land Cash Notes Payable 100 ,000... the end of first year $31,311 × 0 .10 = $3,131 10- 18 Leasing • • • A lease is a contract whereby one party (the lessee) is granted a right to use property owned by another party (the lessor) for... fixed in terms of currency, by contract, or otherwise (cash, accounts receivable) • Nonmonetary assets include all the other assets (inventories, land) 10- 20 Acquisition by Issuing Securities • When