After studying this chapter, you should be able to: Identify the various costs included in the initial cost of property, plant, and equipment, natural resources, and intangible assets; determine the initial cost of individual property, plant, and equipment and intangible assets acquired as a group for a lump-sum purchase price; determine the initial cost of property, plant, and equipment and intangible assets acquired in exchange for a deferred payment contract;....
Chapter 10 PROPERTY, PLANT AND EQUIPMENT, INVESTMENT PROPERTY, AND INTANGIBLE ASSETS: ACQUISITION AND DISPOSITION © 2013 The McGraw-Hill Companies, Inc 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 - 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 - Land (not depreciable) • Purchase price • Real estate commissions • Attorney’s 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 - Buildings • Purchase price • Attorney’s fees • Commissions • Reconditioning Costs to be Capitalized Investment Property • Land costs • Building costs Same as costs for property, plant and equipment 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 - 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 - Intangible Assets Lack physical substance Exclusive Rights Intangible Intangible Assets Assets Future benefits less certain than tangible assets 10 - Intangible Assets ─ Patents • An exclusive right recognized by law and granted by a sovereign state for a limited period (usually 20 years.) • Holder has the right to use, manufacture, or sell the patented product or process without interference or infringement by others • Some R & D costs that lead to an internally developed patent are expensed in the period incurred, while others are capitalized 10 - Intangible Assets Copyrights Trademarks • 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 relevant national authority and renewable indefinitely in (usually) 10-year periods • • 10 - 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 50-100 years (or a finite period for anonymous or corporate creations) 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 franchisor’s franchisor’s 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 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, borrowing costs incurred on qualifying assets is capitalized Asset that necessarily takes a substantial period of time to get ready for its intended use 10 - 30 Interest and other costs that are incurred in connection with the borrowing of funds that are directly attributable to the acquisition, construction or production of the qualifying asset Borrowing Cost Capitalization Capitalization begins when: • construction begins • Borrowing cost is incurred, and • qualifying expenses are incurred Capitalization ends when: • the asset is substantially complete and ready for its intended use, or • when borrowing costs no longer are being incurred 10 - 31 Interest Capitalization Borrowing Cost 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 - 32 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 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 Bub’s 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 Date 5/1 7/31 10/1 12/1 10 - 33 Expenditure $ 125,000 160,000 200,000 300,000 $ 785,000 Fraction of Construction Period 8/8 5/8 3/8 1/8 $ $ AAE 125,000 100,000 75,000 37,500 337,500 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 months of the year 10 - 34 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 Interest Interest 10 - 35 == == AAE AAE ×× Weighted-average Weighted-average Rate Rate ×× Time Time $337,500 $337,500 ×× 12% 12% ×× 8/12 8/12 == $27,000 $27,000 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 - 36 Other debt AAE Specific new borrowing Research and Development (R&D) Research Research •• Research Researchisisoriginal originaland andplanned plannedinvestigation investigationundertaken undertakenwith withthe the prospect prospectof ofgaining gainingnew newscientific scientificor or technical technicalknowledge knowledgeand and understanding understanding Development Development •• Development Developmentisisthe theapplication applicationof ofresearch researchfindings findings or orother other knowledge knowledgeinto intoaaplan planor ordesign designfor forthe theproduction productionof ofnew newor or substantially substantiallyimproved improvedmaterials, materials,devices, devices,products, products,process, process, systems systemsor orservices servicesbefore beforethe thestart startof ofcommercial commercialproduction productionor or use use Most MostR&D R&Dcosts costsare areexpensed expensedas asincurred incurred.(Must (Mustbe bedisclosed disclosedififmaterial.) material.) R&D R&Dcosts costsincurred incurredunder undercontract contractfor forother othercompanies companiesare arecapitalized capitalized as asinventory inventoryand andcarried carriedforward forwardinto intofuture futureyears years Costs Costsof ofassets assetspurchased purchasedfor forR&D R&Dpurposes purposesare areexpensed expensedininthe the period periodunless unlessthey theyhave havealternative alternativefuture futureuses uses 10 - 37 R&D Costs All All expenditure expenditure in in the the research research phase phase are are to to be be expensed expensed when when incurred incurred Expenditure Expenditure incurred incurred in in the the development development phase, phase, but but before before the the R&D R&D is is successfully successfully completed, completed, are are to to be be capitalized capitalized Costs Expensed as R&D Start of R&D Activity 10 - 38 Costs Capitalized Operating Costs and Amortization Capitalization R&D Completed Criterion Successfully (Enter Development Phase) Sale of Product Start-up Costs and Software Development Costs •• Start-up Start-up costs, costs, including including pre-operating pre-operating costs costs and and establishment establishment costs, costs, are are expensed expensed in in the the period period incurred incurred •• IFRS IFRS applies applies the the same same accounting accounting treatment treatment for for R&D R&D expenditure expenditure to to software software development development costs costs Disclosure Balance BalanceSheet Sheet •• The Theunamortized unamortizedportion portionof ofcapitalized capitalized computer computersoftware softwarecost costisis an anasset asset Income IncomeStatement Statement •• Amortization Amortizationexpense expenseassociated associatedwith withcomputer computer software softwarecost cost •• R&D R&D expense expense associated associatedwith withcomputer computersoftware software development development cost cost 10 - 39 U.S GAAP vs IFRS Research and Development Costs • • 10 - 40 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 - 41 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 Appendix 10 ─ Oil and Gas Accounting Two Two acceptable acceptable accounting accounting alternatives alternatives Successful Successful efforts efforts method method Full-cost Full-cost method method Exploration Exploration costs costs resulting resulting in in unsuccessful unsuccessful wells wells (dry (dry holes) holes) are are expensed expensed Exploration Exploration costs costs resulting resulting in in unsuccessful unsuccessful wells wells may may be be capitalized capitalized Political Political pressure pressure prevented prevented the the FASB FASB from from requiring requiring all all companies companies to to use use the the successful successful efforts efforts method method 10 - 42 Oil and Gas Accounting The The Shannon Shannon Oil Oil Company Company incurred incurred $2,000,000 $2,000,000 in in exploration exploration costs costs for for each each of of 10 10 oil oil wells wells in in 2013 2013 Eight Eight of of the the 10 10 wells wells were were dry dry holes holes Prepare Prepare the the journal journal entries entries to to record record the the exploration exploration costs costs under under both both of of the the acceptable acceptable methods methods 10 - 43 Successful Efforts: Oil deposit Exploration expense ……………… Cash ……………………… 4,000,000 16,000,000 Full Cost: Oil deposit Cash ……………………… 20,000,000 20,000,000 20,000,000 End of Chapter 10 ... Commissions • Reconditioning Costs to be Capitalized Investment Property • Land costs • Building costs Same as costs for property, plant and equipment Intangible Assets • Patents • Copyrights • Trademarks... restoration restoration 10 - Intangible Assets Lack physical substance Exclusive Rights Intangible Intangible Assets Assets Future benefits less certain than tangible assets 10 - Intangible Assets ─... $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 •• •• •• ••