acfn 2082 ch01-Part I.pptx

10-1
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

10-2
 Major characteristics:
 “Used in operations” and not for resale/investment.
 Include standby assets (in non-continuous use)
 Exclude idle assets (land or building)-investment
 Revenue producing assets-productive purpose
 Long-term/long-lived in nature and usually depreciated.
 Long-term prepayments
 Bundle of future services
 Possess physical substance.
 Tangible in nature-fixed in nature
 Conversion (indirect) cost to a product
 Not directly incorporated/become part of a product
Property, plant, and equipment are assets of a durable nature.
Other terms commonly used are plant assets, fixed assets, and
capital assets.
1. NATURE OF PROPERTY, PLANT, AND EQUIPMENT
Includes:
Land,
Building
structures
(offices,
factories,
warehouses),
and
Equipment
(machinery,
furniture,
tools).

10-3
Assets
Current Assets Non-Current Assets
Investments
Operating Assets
Intangible Assets
Tangible Assets
PPE Natural Resources
Depreciable Non-Depreciable
1. NATURE OF PROPERTY, PLANT, AND EQUIPMENT

10-4
Guideline for Initial Valuation
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.
2. ACQUISITION COST OF PP&E [INITIAL VALUATION]
Companies value property, plant, and equipment in
subsequent periods using either the
 cost method or
 fair value (revaluation) method.

10-5
All expenditures made to acquire land and ready it for use.
Costs typically include:
 Cost of Land
(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)
Cost Components/Elements [Subject to Mode of Acquisition]

10-6
 Improvements with limited lives, such as private
driveways, walks, fences, and parking lots, are recorded
as Land Improvements and depreciated.
 Land acquired and held for speculation is classified as an
investment.
 Land held by a real estate concern for resale should be
classified as inventory.
 Cost of Land

10-7
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.

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

10-9
Structural additions made to land. Cost includes all
expenditures necessary to make the improvements ready for
their intended use.
 Cost of Land Improvements
 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.

10-10
Includes all costs related directly to purchase or construction.
COST OF BUILDINGS
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.
 Insurance & interest costs incurred during construction
 Walkways to and around the building

10-11
a. Money borrowed to pay building contractor
(signed a note)
b. Payment for construction from note proceeds
c. Cost of land fill and clearing
d. Delinquent real estate taxes on property
assumed by purchaser
e. Premium on 6-month insurance policy during
construction
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:
a. Notes Payable
b. Buildings
c. Land
d. Land
e. Buildings

10-12
f. Refund of 1-month insurance premium
because construction completed early
g. Architect’s fee on building
h. Cost of real estate purchased as a plant site
(land Br.200,000 and building Br.50,000)
i. Commission fee paid to real estate agency
j. Cost of razing and removing building
k. Installation of fences around property
Illustration: Determine how the following should be classified:
f. (Buildings)
g. Buildings
h. Land
i. Land
j. Land
k. Land
Improvements

10-13
l. Proceeds from residual value of demolished
building
m. Interest paid during construction on money
borrowed for construction
n. Cost of parking lots and driveways
o. Cost of trees and shrubbery planted
(permanent in nature)
p. Excavation costs for new building
Illustration: Determine how the following should be classified:
l. (Land)
m. Buildings
n. Land
Improvements
o. Land
p. Buildings

10-14
 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

10-15
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
Sales taxes
Painting and lettering 500
1,320
Br.22,000
Br.23,820
Cost of Delivery Truck

10-16
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

10-17
Vandalism (deliberate destruction of property)
Mistakes in installation
Uninsured theft
Damage during unpacking and installing
Fines for not obtaining proper permits from
government agencies
 Cost of Acquiring Fixed Assets Excludes:

10-18
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

10-19
Valuation of 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.

10-20
Three approaches have been suggested to account for the
interest incurred in financing the construction.
Interest Costs During Construction
Capitalize no
interest during
construction
Capitalize
all costs of
funds
IFRS
$ 0 $ ?
Increase to Cost of Asset
ILLUSTRATION 10-1
Capitalization of Interest
Costs
Capitalize actual
costs incurred during
construction

10-21
 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.

10-22
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.
Qualifying Assets

10-23
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

10-24
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)

10-25
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.

10-26
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:
January 1 $ 100,000
April 30 150,000
November 1 300,000
December 31 100,000
Total expenditures $ 650,000
Other general debt existing on
Jan. 1, 2015:
$500,000, 14%, 10-year
bonds payable
$300,000, 10%, 5-year
note payable

10-27
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.

10-28
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.
Step 3 - Compute weighted-average accumulated expenditures
(WAAE).

10-29
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.
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.
Step 4 - Compute the Actual and Avoidable Interest.

10-30
Accumulated Interest Avoidable
Expenditures Rate Interest
200,000
$ 12% 24,000
$
50,000 12.5% 6,250
250,000
$ 30,250
$
Step 4 - Compute the Actual and Avoidable Interest.
Avoidable Interest
Interest Actual
Debt Rate Interest
Specific Debt 200,000
$ 12% 24,000
$
General Debt 500,000 14% 70,000
300,000 10% 30,000
1,000,000
$ 124,000
$
Weighted-average
interest rate on
general debt
Actual Interest
$100,000
$800,000
= 12.5%

10-31
Avoidable interest 30,250
$
Actual interest 124,000
Journal entry to Capitalize Interest:
Equipment 30,250
Interest Expense 30,250
Step 5 – Capitalize the lesser of Avoidable interest or Actual
interest.

10-32
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.

10-33
ABC Construction completed the building, ready for occupancy, on
December 31, 2015. ABC had the following debt outstanding at
December 31, 2015.
Compute weighted-average accumulated expenditures for 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
Other Debt
2. 10%, 5-year note payable, dated December 31, 2011, with
3. 12%, 10-year bonds issued December 31, 2010, with
$750,000
$550,000
$600,000

10-34
Compute weighted-average accumulated expenditures for 2015.

10-35
Compute the avoidable interest.

10-36
Compute the actual interest cost, which represents the maximum
amount of interest that it may capitalize during 2015.
The interest cost that Shalla capitalizes is the
lesser of $120,228 (avoidable interest) and
$239,500 (actual interest), or $120,228.

10-37
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
Cash 239,500

10-38
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.

10-39
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
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:
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
October 30, 20X2 200,000
Moreover, the company made the following expenditures (payments) on the
construction of the building:

10-40
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
A. Capitalized Interest For 20X1
Step 1: Compute actual interest expense 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
Step 2: Compute Weighted Average Accumulated Expenditures
(WAAE) for 20X1.

10-41
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

10-42
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
Step 4: Capitalize the Lesser (Lower) of Actual Interest and IPC for
20X1.
Building under construction 120,228
OR
Interest Expense (239,500-120,228) 119,272
Cash (or Interest Payable) 239,500
B. Capitalized Interest For 20X2
Step 1: Compute actual interest expense for 20X2.

10-43
Expenditure Capitalization
period
WAAE
Date Amount
January 1 $1,620,228 11/11 $1,620,228
August 1 400,000 4/11 145,455
October 30 200,000 1/11 18,182
Total $2,220,228 $1,783,865
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

10-44
Step 4: Capitalize the lesser of Actual Interest and IPC
OR
Interest Expense (219,542-207,752) 11,790
Cash (or Interest Payable) 219,542

10-45
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.

10-46
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.

10-47
Material $200,000
Labor 500,000
Incremental overhead 100,000
Capitalized interest 100,000
Total $900,000
Illustration: Kaplan Limited completed the construction of equipment on
November 10, 20X1. The following itemizes total construction costs:
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
Valuation of PPE- Savings or Loss on Self-Construction

10-48
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
Valuation of PPE- Cash Discounts

10-49
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.
Valuation of PPE: Lump-sum (Basket) Purchases
Assets
Appraisal
Value
Relative
Fair Value
Total
Cost
Allocated
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

10-50
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
Valuation of PPE: Issuance of Shares

10-51
Deferred-Payment Contracts — Assets purchased on long-term credit
contracts are valued at the present value of the consideration exchanged.
Valuation of PPE- Deferred-Payment Contracts
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

10-52
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.
Exchanges of Non-Monetary Assets
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).
Valuation of PPE: Exchanges
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.

10-53
• 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).

10-54
Accounting for Exchanges
* If cash is 25% or more of the fair value of the exchange,
recognize entire gain because earnings process is complete.

10-55
Summary of Gain and Loss Recognition on Exchanges of
Nonmonetary Assets Lacks Commercial Substance

10-56
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.
Exchanges - Loss Situation

10-57
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.

10-58
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.

10-59
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
Loss on exchange 5,500
Equipment 28,000
Cash 3,000

10-60
Lacks Commercial Substance
ABC:
Equipment (12,500 – 5,242) 7,258
Cash 3,000
Equipment 28,000
Gain on exchange 1,258
Cash Received
Cash Received + FMV of Assets Received
x Total
Gain
= Recognized
Gain
$3,000
$3,000 + $12,500
x $6,500 = $1,258
Deferred gain = $6,500 – 1,258 = $5,242

10-61
Lacks Commercial Substance
XYZ (no change):
Equipment 15,500
Loss on exchange 5,500
Equipment 28,000
Cash 3,000
Companies recognize a loss immediately whether the
exchange has commercial substance or not.

10-62
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
Valuation of PPE: Contributions

10-63
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
Valuation of PPE: Contributions/Grants

10-64
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.

10-65
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.

10-66
Example 1: Grant for Lab Equipment. If AG chooses to record
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 10-17
Government Grant
Recorded as Deferred
Revenue

10-67
Example 1: Grant for Lab Equipment. If AG chooses to reduce
the cost of the lab equipment, AG reports the equipment at
€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 10-18
Government Grant Adjusted to Asset

10-68
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.

10-69
• 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
Post Acquisition Costs

10-70
Capitalize costs, if
They increase future service potential
Improvements Replacements
or
Substitution of
a better asset
for present
asset
Substitution of
a similar asset
for present
asset
Post acquisition Costs
Improvements and Replacements

10-71
 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)

10-72
 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.

10-73
 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.

10-74
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

10-75
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.

10-76
Gain or loss will be reported in the income statement
as Other Income or Other Loss.
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.
Disposition of PPE: Sale

10-77
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
(b) record the sale
Cash10,500
Machinery 20,000
Gain on sale 1,500
Disposition of PPE: Sale

10-78
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
Disposition of PPE: Discarding/ Abandonment

10-79
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.
Disposition of PPE: Involuntary Conversion

10-80
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

10-81
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

10-82
 Physically extracted in operations.
 Replaceable only by an act of nature.
Natural resources consist of standing timber and underground
deposits of oil, gas, and minerals.
Distinguishing characteristics:
Cost is the price needed to acquire the resource and prepare it
for its intended use.
Supplementary: Natural Resources & Intangible Assets

10-83
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.
 Depletion generally is a function of the units extracted.

10-84
Illustration: Lane Coal Company invests $5 million in a mine
estimated to have 1 million tons of coal and no salvage value.
Depletion

10-85
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
Depletion Expense/Inventory (coal)1,250,000
Accumulated Depletion 1,250,000
Journal entry:
Depletion

10-86
Intangible assets are rights, privileges, and competitive
advantages that result from ownership of long-lived assets
that do not possess physical substance.
 Patents
 Copyrights
 Goodwill
 Trademarks and Trade Names
 Franchises
Limited life or indefinite life.
Common types of intangibles:
Intangible Assets

10-87
Limited-Life Intangibles:
 Amortize to expense.
 Credit asset account.
Indefinite-Life Intangibles:
 No foreseeable limit on time the asset is expected to
provide cash flows.
 No amortization.
Accounting for Intangible Assets
Helpful Hint
Amortization is to
intangibles what
depreciation is to plant
assets and depletion is to
natural resources.

10-88
Patents
 Exclusive right to manufacture, sell, or otherwise control
an invention for a period of 20 years from the date of the
grant.
 Capitalize costs of purchasing a patent and amortize over
its 20-year life or its useful life, whichever is shorter.
 Expense any R&D costs in developing a patent.
 Legal fees incurred successfully defending a patent are
capitalized to the Patent account.

10-89
Illustration: National Labs purchases a patent at a cost of
$60,000. National estimates the useful life of the patent to be
eight years. Prepare the journal entry to record the annual
amortization expense.
Amortization Expense 7,500
Patents 7,500
Cost $60,000
Useful life ÷ 8
Annual expense $ 7,500

10-90
Copyrights
 Give the owner the exclusive right to reproduce and sell
an artistic or published work.
 Extend for the life of the creator plus 70 years.
 Cost of the copyright is the cost of acquiring and
defending it.
 Amortized to expense over useful life.

10-91
Trademarks and Trade Names
 Word, phrase, jingle, or symbol that identifies a
particular enterprise or product.
► Wheaties, Monopoly, Kleenex, Coca-Cola, Big Mac,
and Jeep.
 Legal protection for indefinite number of 20 year
renewal periods.
 Capitalize acquisition costs.
 No amortization.

10-92
Franchises
 Contractual arrangement between a franchisor and a
franchisee.
► Shell, Subway, and Hilton are franchises.
 Franchise (or license) with a limited life should be
amortized to expense over its useful life.
 If the life is indefinite, the cost is not amortized.

10-93
Goodwill
 Includes exceptional management, desirable location,
good customer relations, skilled employees, high-
quality products, etc.
 Only recorded when an entire business is purchased.
 Goodwill is recorded as the excess of purchase price
over the fair value of the net assets acquired.
 Not amortized.

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