CHAPTER

Property, Plant,
and Equipment:
Acquisition and
Disposal

CHAPTER OBJECTIVES

After careful study of this chapter, you will be able to:

1. Identify the characteristics of property, plant, and equipment.

2. Record the acquisition of property, plant, and equipment.

3. Determine the cost of a nonmonetary asset acquired by the exchange of another nonmonetary
asset.

4. Compute the cost of a self-constructed asset, including interest capitalization.

5. Record costs after acquisition.

6. Record the disposal of property, plant, and equipment.

7. Understand the disclosures of property, plant, and equipment.

10-1
SYNOPSIS

Characteristics of Property, Plant, and Equipment

1. Assets categorized by a company as property, plant, and equipment must (a) be held for use in the
business and not for investment, (b) have an expected life of more than one year, and (c) be tangible
in nature. Sometimes these assets are referred to as plant assets, fixed assets, or operational assets.

2. A company initially records assets included in the property, plant, and equipment category at their
acquisition cost (historical cost). The company then allocates the cost of the assets, other than land,
as an expense to the periods in which it consumes the assets and receives the benefits in order to
comply with the matching principle. This process is called depreciation. The major types of assets that
a company classifies as property, plant, and equipment are land, buildings, equipment, machinery,
furniture and fixtures, leasehold improvements, and natural resources (also called wasting assets).

Acquisition of Property, Plant, and Equipment

3. The cost of a company’s property, plant, and equipment is the cash outlay or its equivalent that is
necessary to acquire the asset and put it in operating condition. This cost includes the contract price
(less any available discounts), freight, assembly, installation, and testing costs. A company capitalizes
the costs incurred to obtain the benefits of the asset when it records them as an asset.

4. The recorded value of land includes (a) the contract price, (b) the costs of closing the transaction and
obtaining title (such as commissions, options, legal fees, title search, insurance, and past due taxes),
(c) the costs of surveys, and (d) the costs of preparing the land for its particular use (such as the cost
of removing an old building) if such improvements have an indefinite life. The costs of land
improvements that have a limited life (such as sidewalks) are separately capitalized and depreciated if
the company is responsible for maintaining them. If the local government has the responsibility for
maintaining such improvements, then the company adds the costs to the cost of the land. Because
land has an unlimited economic life and its residual value is unlikely to be less than its acquisition
cost, a company generally does not depreciate it.

5. Land acquired for future use or as an investment should not be classified as property, plant, and
equipment. A company may capitalize interest related to the purchase of such land only if the land is
undergoing activities to ready it for future use. Property taxes and insurance on land that is not being
developed for sale or lease to others, however, may be capitalized or expensed regardless of whether
the land is acquired for future use or as an investment. Once the land is used in operations, both
interest and property taxes must be expensed.

6. The recorded cost of buildings includes (a) the contract price, (b) the costs of remodeling and
reconditioning, (c) the costs of excavation for the specific building, (d) architectural costs and the
costs of building permits, (e) certain capitalized interest costs, and (f) unanticipated costs resulting
from the condition of the land. A company should expense unanticipated construction costs (such as
a strike or fire). The cost to raze an old building that is already owned is an element of the gain or
loss on retirement of the old building and is not capitalized. A company may expense or capitalize any
costs of property taxes and insurance during construction.

7. Improvements made by a lessee to leased property normally revert to the lessor at the end of the
lease. In this case, the lessee capitalizes the costs of leasehold improvements and amortizes them
over their economic life or the life of the lease, whichever is shorter.

10-2 Chapter 10: Property, Plant, and Equipment: Acquisition and Disposal
8. When a company acquires several dissimilar assets categorized as property, plant, and equipment for
a lump-sum purchase price, it allocates the price paid to the individual assets purchased. The
allocation basis is the relative fair values of the individual assets and the company records as
acquisition cost the allocated value.

9. When a company acquires property, plant, and equipment on a deferred payment basis (e.g.,
issuance of bonds or notes or assumption of a mortgage), it records the asset at its fair value or the
fair value of the liability on the transaction date, whichever is more reliable. If neither is determinable,
the asset is recorded at the present value of the deferred payments using the stated rate. If the
stated rate is materially different from the market rate, the market rate is used.

10. A company may also acquire assets categorized as property, plant, and equipment by issuing
securities such as common stock. In this case, the recorded cost is either the fair value of the assets
obtained, or the fair value of the securities issued, whichever is more reliable.

11. When a company acquires an asset through a nonreciprocal transfer (donation), it records the asset
at its fair value rather than its cost, which would be zero. In this case, cost provides an inadequate
method of accounting for the asset and for subsequent relevant income measurement. A donation by
a governmental unit is credited to a donated capital account; a donation by a nongovernmental unit
is credited as a gain and reported in the other items section of the income statement.

12. Under AICPA Statement of Position No. 98-5, a company is required to expense the costs of start-up
activities as incurred. A company may incur one-time start-up costs associated with opening a new
facility, introducing a new product or service, conducting business in a new territory, conducting
business with a new class of customers, initiating a new process in an existing facility, or beginning a
new operation. Organization costs are considered start-up costs.

13. In contrast to U.S. standards, international accounting standards allow a company to write up the
value of its property, plant, and equipment to fair value if the fair value is reliably measured. The
increase is credited to stockholders' equity as a “revaluation" surplus.

Nonmonetary Asset Exchanges

14. Under APB Opinion No. 29, a nonmonetary exchange is a transfer between a company and another
entity that results in the acquisition of nonmonetary assets or services or the satisfaction of liabilities
by surrendering other nonmonetary assets or services or incurring other obligations. Nonmonetary
exchanges may be accompanied by the payment and/or receipt of small amounts of cash. The
general principle is that the cost of a nonmonetary asset acquired in exchange for another
nonmonetary asset is the fair value of the asset surrendered. A gain or loss is recognized on the
exchange as the difference between the fair value of the asset surrendered and its book value.

15. ASB Statement No. 153 made significant changes so the treatment of nonmonetary asset exchanges
to make U.S. GAAP more similar to international GAAP. In doing so it made three exceptions to the
general rule to use fair value as the cost of the asset acquired:
a) Neither the fair value of the asset received or given up is unable to be reasonably determined.
b) The transaction is an exchange of inventory to facilitate sales to a third party.
c) The transaction lacks “commercial substance.” A nonmonetary exchange lacks commercial
substance if a company’s future cash flows are not expected to change significantly.

Chapter 10: Property, Plant, and Equipment: Acquisition and Disposal 10-3
Self-Construction

16. FASB Statement No. 34 specifies the treatment of interest incurred during the self-construction of
assets. If a company constructs an asset for either its own use or as a discrete project for sale or
lease to others, interest must be capitalized.

17. A company must not capitalize interest on (a) routinely manufactured inventories, (b) assets in use
or ready for use, or (c) assets not used in the earnings activities of the company.

18. A company determines the amount of interest to be capitalized for a qualifying asset by multiplying
either the interest rate incurred on the specific borrowing or a weighted average interest rate on all
other borrowings multiplied by the average cumulative expenditures for the qualifying asset during
the capitalization period. The total interest cost capitalized each period may not exceed the interest
cost incurred during the period.

19. The capitalization period begins when (a) expenditures for the asset have been made, (b) activities
that are necessary to get the asset ready for its intended use are in progress, and (c) interest cost is
being incurred. The capitalization period ends when the asset is (a) substantially complete and (b)
ready for its intended use.

20. The cost of self-constructed assets (items of property, plant, and equipment constructed by a
company for use in its own production process) should include all direct costs of materials, labor,
engineering, and variable manufacturing overhead. The cost of the self-constructed asset should also
include: (a) interest costs incurred during the period of self-construction on the average cumulative
invested costs during the period; (b) fixed manufacturing overhead costs: either an allocated portion
of total fixed overhead, particularly appropriate when the company is operating at full capacity; the
incremental fixed overhead actually incurred, particularly appropriate when the company is operating
with excess capacity; or no amount of fixed overhead, if the overhead does not change; and (c)
recognition of a loss and a write-down of the asset to the fair value if construction cost materially
exceeds the fair value of the asset. However, if the asset is constructed at a cost below the asset's
normal purchase price, the company should not recognize any profit.

Costs after Acquisition

21. A cost that increases the future economic benefits of the asset above those originally expected is a
capital expenditure and should be capitalized (and then depreciated as time passes) to an asset
account. A cost that is incurred to maintain existing benefits and does not increase the economic
benefits is an operating expenditure and should be expensed in the period incurred.

22. Additions to already existing assets (e.g., a new wing to a building) represent new assets and are
capitalized. Improvements (or betterments) and replacements (or renewals) involve the substitution
of new or better assets for old ones. Because the economic benefits to be derived from the asset are
increased, a company should capitalize the costs by one of the following methods depending on the
circumstances: (a) The Substitution Method (when the book value of the old asset is known): the
book value of the old asset is removed from the accounts and the new asset is recorded; (b) Reduce
Accumulated Depreciation (when the service life of the asset has been extended): the specific
Accumulated Depreciation account is debited with the costs of improvements or replacements on the
grounds that service potential that has been written off has been restored; or (c) Increase the Asset
Account (when benefits are increased above those originally expected): the specific asset account is
debited directly with the new costs on the grounds that an addition has been made to the service
potential of the asset.

23. The costs of rearranging or relocating are capitalized and expensed over the periods expected to
benefit, or expensed immediately if the difference is immaterial.

10-4 Chapter 10: Property, Plant, and Equipment: Acquisition and Disposal
24. A company expenses, in the period incurred, routine repair and maintenance costs that are incurred
to maintain the operating condition of an asset. However, in order to prevent distortion of interim
financial statements, a company may estimate annual repair and maintenance expense and then
record an equal amount as an expense each quarter. The company records the difference between
the actual expense and the prorated portion in an Allowance for Repairs account (an addition to or
offset from property, plant, and equipment) that would have a zero balance at the end of the year.

Disposal of Property, Plant, and Equipment

25. A company may dispose of property, plant, and equipment by sale, involuntary conversion,
abandonment, or exchange. When recording the disposal, depreciation expense up to the date of the
disposal must be recorded first. Then the asset account is credited and the accumulated depreciation
account is debited to remove these accounts from the records. Any gain or loss on the disposal is
recognized and is usually included as an element of ordinary income in the income statement, but it
could be an extraordinary item or disposal of a component of a business if it meets the requirements
discussed in Chapter 5.

26. A company may acquire an asset (e.g., power plant, mine) that creates an obligation related to the
retirement of the asset because of the significant costs related to closure. GAAP requires a company
to record a liability for the obligation at its fair value when the obligation is incurred, usually when the
asset is acquired. This fair value is usually measured using the present value of the future cash flows.
The discount rate that a company uses is its credit-adjusted, risk-free rate. The company records
(credits) the fair value of the liability at acquisition and increases (debits) the asset. Then the
company increases the liability (and recognizes interest, or accretion, expense) each year it uses the
asset. Upon retirement, the company eliminates the estimated liability when it pays the actual
retirement costs, and records a gain/loss if necessary.

Disclosure of Property, Plant and Equipment

27. APB Opinion No. 12 requires a company to disclose the balances of its major classes of depreciable
assets by nature or by function.

SELF-EVALUATION EXERCISES

True-False Questions

Determine whether each of the following statements is true or false.

1. A company records an expense, called Answer: False

depreciation, the cost of all assets A company will allocate the cost of an asset
classified as property, plant, and to each period in which it consumes the asset
equipment in the period in which the asset and receives benefits. The correct answer is
is either acquired or the benefits received. false because it implies that there is an
option to expense an asset in the period in
which it is acquired. Further, the cost of land
is not allocated to depreciation expense.

Chapter 10: Property, Plant, and Equipment: Acquisition and Disposal 10-5
 2. Conceptually, in determining the costs of an Answer: True
asset that are to be capitalized, cash discounts Discounts available, not actually taken, is more
available rather than cash discounts taken conceptually correct because the benefits received
should be deducted from the asset's contract from the asset are not increased when the
price. discount is not taken.
3. When purchasing land, a company immediately Answer: False
expenses rather than capitalizes the closing Closing costs and costs of obtaining the title to
costs and costs of obtaining title because they land are not expensed; they are capitalized. Land
do not extend the useful life of the asset. is considered to not have a limited life and
therefore the useful life can be neither extended
nor reduced.
4. A company may capitalize interest related to Answer: True
the purchase of land held as an investment if FASB Statement No. 34 allows a company to
the land is being readied for some future use. capitalize interest expense on land while it is being
readied for future use.
5. A company should capitalize unanticipated Answer: False
costs of constructing a building, such as labor A company should expense, not capitalize,
strikes or storm damage, as part of the total unanticipated costs such as labor strikes or storm
cost of the building. damage during the construction of a building. This
treatment is justified because the avoidable costs
of the unanticipated events were not necessary to
obtain economic benefits of the building.
6. A company had to pay to have an old building Answer: False
razed on land that it purchased to build a new The cost of razing an old building on new land
factory. The cost of the razing should be purchased is considered to be a cost of preparing
capitalized in the cost of the new building. the new land for its intended function (new
factory) and as such should be recorded as a part
of the land. If the company was able to salvage
and sell any portion of the old building or
materials, this should be netted against the razing
costs and recorded with the land.
7. Improvements with a 10-year life made to a Answer: False
building leased under a 5-year nonrenewable Improvements made by a lessee to leased
lease are capitalized and amortized over 10 property normally revert to the lessor at the end
years by the lessee. of the lease. The lessee capitalizes the costs of
leasehold improvements and amortizes them over
their economic life or the life of the lease,
whichever is shorter.
8. If a company acquires two assets in a lump- Answer: False
sum purchase, it should capitalize each asset at If one or more assets are acquired for a lump
its fair value. sum, the cost to be capitalized for each asset will
be the allocated portion of the lump sum purchase
price. This allocation of the lump sum purchase
price is generally accomplished based on the
relative fair value of the assets acquired.

10-6 Chapter 10: Property, Plant, and Equipment: Acquisition and Disposal
 9. An asset acquired by a deferred payment plan Answer: True
may be recorded at the present value of the If a company acquires an asset through a deferred
deferred payments, which is determined by payment plan then the asset is usually recorded at
discounting the payments at an appropriate the asset's fair value or the fair value of the
rate of interest. liability on the date of the transaction, whichever
is more reliable. If the value of neither is
determinable, then the present value of the
deferred payments is used.
10. When a company receives a building donated Answer: False
by a governmental unit, the asset is debited at Any asset acquired through a donation will be
its fair value and the credit is recorded as a debited at the fair value of the asset; however,
gain to recognize the increased earnings to the the credit will vary depending on who donated the
company. asset. If the asset is donated by a
nongovernmental unit the company would record
a gain. If the asset is donated by a governmental
unit the credit would be to a donated capital
account (stockholders’ equity account), not a gain;
therefore the answer to this question is false.
11. If an exchange of nonmonetary assets lacks Answer: False
commercial substance, a company must If a transaction lacks commercial substance, a
recognize a loss in full on the exchange but company would not recognize any gain or loss on
gains only to the extent that cash is involved. the exchange. An exchange lacks commercial
substance if the company’s future cash flows are
not expected to significantly change.
12. If a company is operating at full capacity, it is Answer: True
logical to allocate a portion of total fixed If a company is operating at full capacity then the
overhead to self-constructed assets produced self-constructed assets are using a portion of the
during the period. fixed overhead costs that could be used
elsewhere; therefore, it is appropriate that these
costs be allocated to the cost of the self-
constructed asset.
13. A company must capitalize one-time start-up Answer: False
costs associated with beginning a new Under AICPA Statement of Position No. 98-5, a
operation. company is required to expense, not capitalize,
the costs of start-up activities as incurred.
14. Once a company purchases an asset and Answer: False
capitalizes its original costs, all subsequent A cost that increases the future economic
expenditures that are related to the asset are benefits of the asset above those that
expensed. originally were expected should be
capitalized. Future economic benefits can be
increased by extending the life of the asset,
improving the productivity, lowering costs of
producing products, or increasing the quality
of a product.

Chapter 10: Property, Plant, and Equipment: Acquisition and Disposal 10-7
 15. Under generally accepted accounting principles, Answer: True
the degree of materiality determines if If the relocation costs are material, then a
relocation costs are capitalized or expensed company would capitalize the costs and expense
immediately. them over the period expected to benefit. If the
expenses are not material than it doesn’t matter
how a company accounts for them and they may
be expensed immediately.
16. The rationale for debiting the cost of Answer: True
improvements to a specific asset's Accumulated Conceptually, an improvement has restored some
Depreciation account is that improvements to of the asset’s previously written-off service
the asset restore the asset's service potential. potential; therefore, it makes sense to reduce the
amount of accumulated depreciation by the
amount of economic benefit that was restored.

Multiple Choice Questions

Select the one best answer for each of the following questions.

1. Davpas Company acquired an asset by issuing Answer: (a) $12,000.

100 shares of its $100 par value preferred An asset should be recorded at the most readily
stock to the seller. The company last sold apparent fair value of either the asset or what was
shares of its preferred stock two years ago at a exchanged for the asset. In this case, the asset's
price of $130 a share. While no current market fair value is more readily apparent based on an
value for the asset obtained is readily available, independent appraisal.
an independent appraisal placed its value at
$12,000. Davpas should record this asset at: Choice (b) is incorrect because this is the par
(a) $12,000. value of the stock that was exchanged. In many
instances, the par value, despite the word "value"
(b) $10,000.
in its name, has absolutely nothing to do with fair
(c) $13,000. value. Choice (c) is incorrect because the fair
(d) a zero book value until such time as value of the preferred stock that was given is
transaction-based market value is more than two years old and the age of this value
available. makes the amount questionable. Choice (d) is
incorrect because the asset must be recorded at a
value. If there is no clearly discernable value then
the Board of Directors must assign an appropriate
value.

10-8 Chapter 10: Property, Plant, and Equipment: Acquisition and Disposal
 2. Panda Company exchanged a machine with a Answer: (d) neither a gain nor a loss.
fair value of $1,000 for a similar machine with Because Panda’s exchange was for a similar asset,
a fair value of $1,200. Panda Company also their cash flows should not be expected to change
paid $200 cash as part of the exchange. The significantly because of the exchange. Because
machine was purchased three years ago for the cash flows will not significantly change, the
$3,600 and $2,300 has been depreciated. In exchange lacks commercial substance and Panda
recording this transaction, Panda should would not recognize either a gain or loss on the
recognize: exchange. Panda would record the exchange as
(a) a gain of $200. follows:
(b) a loss of $100.
Machine (new) 1,500
(c) a loss of $300.
Accumulated Depreciation (old) 2,300
(d) neither a gain nor a loss.
Machine (old) 3,600
Cash 200
Choice (a) is incorrect because of the lack of
commercial substance. While Panda did receive an
asset worth $1,200 in exchange for an asset
worth $1,000, they also paid $200 in cash. Choice
(b) is incorrect. I’m not sure how to revise…The
new machine will be recorded at $1,500, which is
the book value of the machine that it gave up of
$1,300 ($3,600 − $2,300) plus the $200 cash it
paid. Choice (c) is incorrect because the $300
difference between the book value and the worth
of the old machine is not considered when the
exchange lacks commercial substance.
3. Land donated to the Canyon Corporation by Answer: (c) fair value on the date of the
Comal County should be recorded in Blarney's donation.
accounting records at: Donated assets, whether from governmental or
(a) Comal County's book value. nongovernmental entities, should be recorded on
(b) historical cost. the books of the recipient at the asset's fair value
(c) fair value on the date of the donation. on the date of the donation. Choice (a) is incorrect
(d) its tax assessment value, which is 80% of because Comal County’s book value is irrelevant to
fair value. the Canyon Corporation. Choice (b) is incorrect
because Canyon Corporation has no historical
cost. Choice (d) is incorrect because the tax
assessment value does not represent fair value
because it is only 80% of the fair value.

Chapter 10: Property, Plant, and Equipment: Acquisition and Disposal 10-9
 4. During 2011, Reamer Inc. built a new building Answer: (a) $350,000.
to house its corporate offices. The contract cost The capitalized cost of the building should include
of the building was $350,000, which included the construction costs, the excavation costs, and
excavation costs of $37,000 and architectural the architectural costs. The total of $350,000 is
costs of $42,000. The demolition costs to raze the capitalized cost of the building.
an old building on the site were $47,000.
During the construction phase, the company Choice (b) is incorrect because it includes the cost
also incurred $12,000 of unanticipated labor of demolition of an existing building on the site.
costs due to an electrical workers' strike. The The demolition costs should be accorded to the
capitalized cost of the building will be recorded cost of the land, not the building, because it is a
at: cost of preparing the land for its intended use.
(a) $350,000. Choice (c) is incorrect because it includes the
$12,000 unanticipated labor costs due to an
(b) $397,000.
electrical workers' strike. These types of costs
(c) $362,000. should be expensed in the period incurred not
(d) $409,000. capitalized. Choice (d) is incorrect because it
(e) $313,000. includes both the demolition and labor strike
costs. Choice (e) is incorrect because it removes
the $37,000 of excavation costs. Excavation costs
for the building are a cost of the building, not the
land.
5. The Repco Company incurred costs of $3 Answer: (a) $3,000,000.
million during the year drilling oil wells. Thirty In the full-cost method of accounting for oil and
percent of the drilling resulted in oil being gas, all drilling costs (successful and unsuccessful)
found. The rest of the drilling was are capitalized; therefore, the full $3,000,000 will
unsuccessful. If Repco uses the full-cost be recorded as the value on the balance sheet.
method of accounting, the Oil and Gas
Properties will be valued on the end of the year Choice (b) is incorrect because full costing
balance sheet at: capitalizes all costs whether successful or not. The
(a) $3,000,000. $2,100,000 represents the 70% of the wells that
were not successful. Choice (c) is incorrect. The
(b) $2,100,000.
$900,000 represents the cost of the successful oil
(c) $900,000. wells. If Repco used the successful-efforts
(d) $1,500,000. method, this is the amount that would be
recorded as the oil and gas well properties. Choice
(d) is incorrect because it does not represent the
total costs incurred in drilling both the successful
and unsuccessful wells.
6. In constructing a warehouse for its own use, Answer: (c) $116,200.
Rightway Company incurred material costs of The capitalized cost of the warehouse should
$25,000, direct labor costs of $60,000, and include the material costs ($25,000), the direct
interest on funds borrowed for construction of labor costs ($60,000), the interest on construction
$7,200. Rightway's fixed overhead rate is 40% loans ($7,200), and the fixed overhead rate (40%
of direct labor. Rightway was operating at full of $60,000 = $24,000), for a total cost of
capacity during the construction. An outside $116,200.
contractor had bid $120,000 to build the
warehouse. The capitalized cost of the Choice (a) is incorrect because the bid of the
warehouse should be: outside contractor does not represent the costs
(a) $120,000. that Rightway incurred in building the warehouse.
Choice (b) is incorrect because it does not include
(b) $109,000.
the $7,200 of interest costs on the construction
(c) $116,200. loans that should be included. Choice (d) is
(d) $92,200. incorrect because it does not include the $24,000
of fixed overhead that should be appropriately
charged to the warehouse.

10-10 Chapter 10: Property, Plant, and Equipment: Acquisition and Disposal
 7. On June 30, Hilltop, Inc. purchased new Answer: (b) $37,000.
equipment by making a down payment of The debit should be recorded for the fair value of
$12,000 and issuing a $25,000 five-year note the asset or the fair value of the liability on the
with a stated (and fair) part of this statement is date of the transaction. The total costs to Hilltop
hidden, it’s here but I can’t fix it to make it would be the cash paid ($12,000) plus the fair
show all the time: interest rate of 12%. The value of the liability ($25,000) on the date of the
acquisition would be recorded by a debit to acquisition; therefore the amount recorded should
Equipment for be $37,000.
(a) $25,000.
Choice (a) is incorrect because it does not include
(b) $37,000.
the $12,000 cash that was paid in addition to the
(c) $51,338. liability at the time of acquisition. Choice (c) is
(d) $39,338. incorrect because this represents the total cash
outlay over the entire period the note is
outstanding. The cash paid and fair value of the
note ($25,000) is a better indicator of the
equipment’s value. Choice (d) is incorrect because
this represents the total of all payments made on
the note and does not include the initial payment
of $12,000.
8. Fairdown Co. acquired land, buildings, and Answer: (c) $52,500.
equipment for a lump sum price of $210,000. When a group of assets is purchased for a lump
At the time of acquisition, the land was sum price, the fair value of each item is allocated
appraised at $80,000, the buildings at in proportion to the fair values of all the assets
$100,000, and the equipment at $60,000. The acquired. The fair value of the assets acquired
cost that should be assigned to the equipment was $80,000 for the land; $100,000 for the
is: building; and $60,000 for the equipment for a
(a) $70,000. total of $240,000 for the entire group. To
(b) $60,000. determine the allocation for each asset you must
(c) $52,500. divide the fair value of each asset by the total fair
(d) $87,500. value of the entire group. Therefore the allocation
percentage for the land would be 33.33%
($80,000 ÷ $240,000); the building 41.67%
($100,000 ÷ $240,000); and 25% for the
equipment ($60,000 ÷ $240,000). These
percentage allocations are applied to the actual
price paid ($210,000) to determine the cost to
record. Therefore, the cost to record the
equipment at would be 25% of the $210,000 total
acquisition price, which is $52,500.
Choice (a) is incorrect because this is the value
assigned to the land (33.33% of $210,000).
Choice (b) is incorrect because $60,000 is the
appraised fair value of the equipment and does
not reflect the price that was actually paid for the
equipment. Choice (d) is incorrect because this is
the value assigned to the building (41.67% of
$210,000).

Strategy: The key to determining the cost of an asset acquisition is to remember that
acquisition costs include all costs that are necessary to obtain the asset and put it
in operating condition. Remember that discounts available are included whether
actually taken or not.

Chapter 10: Property, Plant, and Equipment: Acquisition and Disposal 10-11
Lump Sum Purchases:

Assets are recorded at their fair market value. But what do we do if we purchase several assets and the
purchase price is not equal to their fair value? We have to allocate the purchase cost among all of the
assets we acquired. To allocate the purchase price we use the fair values of the individual assets.

The easiest way to understand this is with an illustration:

Eikner Enterprises purchases a warehouse, two trucks, and a forklift. The total purchase price was
$320,000. The fair value for the warehouse was $240,000, the two trucks had a fair value of $45,000 each,
and the forklift had a fair value of $30,000. Therefore, the total fair value of all the assets that we
purchased is $360,000. To determine the amount to record each asset at we must allocate the total
purchase price of $320,000 among each of the assets. To do this we determine what percentage each
asset's relative value is among all the assets. The problem has now become a simple ratio problem. The
warehouse makes up $240,000/$360,000 or 66.67%; each of the two trucks makes up $45,000/$360,000
or 12.50% each; and the forklift is $30,000/$360,000 or 8.33%.

Once we know the relative percentages we use these to determine how much of the purchase price to
allocate to each asset. The warehouse would be recorded at $213,344 (0.6667 × $320,000); the trucks
would each be recorded at $40,000 (0.125 × $320,000); and the forklift would be recorded at $26,656
(.0833 × $320,000).

To check your work, just add up the recorded amounts and they should equal the total purchase price:

Warehouse $213,344
Truck (1) 40,000
Truck (2) 40,000
Forklift 26,656
Total $320,000

Nonmonetary Exchanges

The general principle of nonmonetary exchanges is that the cost of a nonmonetary asset acquired in
exchange for another nonmonetary asset is the fair value of the asset surrendered.

The company acquiring the asset will recognize as a gain or a loss on the asset the difference between the
fair value of the asset surrendered and the book value of the asset surrendered. If cash is involved, then
the cost of the asset acquired is equal to the fair value of the asset surrendered plus any cash paid or minus
any cash received.

Mathematically this is expressed as:

Fair Value of
Cost of Asset Acquired = + Cash Paid or − Cash Received
Surrendered Asset

To determine the gain or loss on the exchange we use this equation:

Fair Value of Book Value of

Gain (Loss) = −
Surrendered Asset Surrendered Assets

To illustrate these concepts let’s apply them to the following example:

10-12 Chapter 10: Property, Plant, and Equipment: Acquisition and Disposal
Meixner, Inc. exchanges a computer system worth $20,000 for land to be used for future expansion. The
land has a fair value of $35,000. In addition to the computer system, Meixner pays $15,000 in cash. The
computer system had been purchased two years ago at a cost of $45,000 and had been depreciated
$21,000 at the time of the exchange. What would Meixner report as the cost of the new land and how
much gain or loss would they recognize?

Remember, the cost of the land (asset acquired) is found by this equation:

Fair Value of
Cost of Asset Acquired = + Cash Paid or − Cash Received
Surrendered Asset
$35,000 $20,000 + $15,000

Fair Value of Book Value of

Gain (Loss) = −
Surrendered Asset Surrendered Assets
($4,000) $20,000 − $24,000

Strategy: Perhaps the easiest way to approach this problem is to use a journal entry. In this journal
entry, start by entering what the company is giving up: a computer system that is listed
on the books at $45,000, and we are also giving up the accumulated depreciation for the
computer system at $21,000.
Next, record the cost of the land. Another way to look at the cost of the land is to ask
yourself what we gave up (in terms of fair value) to acquire the land. In this case, we are
giving up a computer system that is worth (fair value) of $20,000. We are also giving up
$15,000 in cash, so the total we are giving up is $35,000 ($20,000 + $15,000).
Putting this into the journal entry we have the following:

Land 35,000
Accumulated Depreciation - Computer 21,000
Computer Equipment 45,000
Cash 15,000
The debits equal $56,000 and the credits equal $60,000. We obviously need a $4,000
debit to balance this equation. Because this is a debit entry, it means that we will record a
loss of $4,000. (If we had needed a credit to balance, we would have reported a gain.)
The final journal entry will look like this:

Land 35,000
Accumulated Depreciation - Computer 21,000
Loss on Exchange 4,000
Computer Equipment 45,000
Cash 15,000

Interest Capitalization

On a self-constructed asset, FASB Statement No. 34 requires a company to complete three steps for
interest capitalization:

1. Determine whether an asset qualifies for interest capitalization.

A company is required to capitalize interest on assets that are constructed either for its own use or
as a discrete project for sale or lease to others.

Chapter 10: Property, Plant, and Equipment: Acquisition and Disposal 10-13
2. Calculate the amount of interest to capitalize.
The amount of interest capitalized is based on the actual amounts borrowed and the cost of those
borrowings. To determine the amount to capitalize, a company applies an interest rate to the average
amount of expenditures for the qualifying asset. If a company has specific borrowing for the asset, it
applies that interest rate first before applying the rate of nonproject borrowing.

3. Identify the period over which to capitalize interest.

The capitalization period begins when expenditures for the asset have been made, activities that are
necessary to get the asset ready for its intended use are in progress, and interest costs are being
incurred. The capitalization period ends when the asset is substantially complete and is ready for its
intended use.

Rutledge Construction is constructing a new headquarters for their use. The capitalization period covers
two years; January 1, 2011, to December 31, 2012 (since it is 2 years). The expenditures on the project,
which were extended evenly over the period, were $3,000,000 in 2011 and $1,400,000 in 2012. To finance
this project Rutledge borrowed $1,000,000 at 8%. In addition, Rutledge has the following debt
outstanding: $15,000,000 at 9% and $5,000,000 at 12%.

Interest capitalization problems require the mastering of several steps.

Step 1: Determine what the average cumulative costs are:

Because the expenditures were made evenly, we can take the beginning expenditure + the
current year expenditures and divide by 2.

At the beginning of 2011, we had not expended anything on the project. At the end of 2011,
we had expended $3,000,000; therefore the average annual cumulative expenditures are:

$0 + $3,000,000
$1,500,000 =
2

Step 2: We then need to apply the interest rates to the expenditures. We apply the specific borrowing
first:

$1,000,000 × 8% = $80,000 interest capitalized from the specific borrowing. However, the
specific borrowing does not cover the average cumulative expenditures of $1,500,000. The
remaining $500,000 in expenditures will have to be covered by the other outstanding debt.
But which one do we use? We will use weighted average interest rates because these debts
are not specifically allocated to our project.

To determine the weighted average interest rate, we add the debt to determine the total
amount of nonspecific debt. We then divide each individual debt by the total debt and multiply
this result by the interest rate associated with that debt. This will give us the amount of
interest that each debt contributes to the total interest rate. Hopefully the equation below will
help explain how we accomplish this:

Remember our other debt was:

$15,000,000 at 9% and $5,000,000 at 12%
Therefore, our total amount of debt is $20,000,000.

Contribution to interest rate by $15,000,000 debt:

$15,000,000
6.75% = 9% ×
$20,000,000

10-14 Chapter 10: Property, Plant, and Equipment: Acquisition and Disposal
 Contribution to interest rate by $5,000,000 debt:
$5,000,000
3.00% = 12% ×
$20,000,000

Therefore, the weighted average interest rate of these two debts is 9.75% (6.75% + 3%).

Strategy: Weighted average interest rate is NOT the same as an average interest rate. A weighted
average interest rate allows the larger debt ($15,000,000) to contribute more to the final
answer since the amount of debt is the largest contributor to the total amount of debt.

Applying this percentage to the remaining $500,000 of expenditures:

$500,000 × 9.75% = $48,750.

Adding this to the specific borrowing interest capitalized amount of $80,000, we have
determined that in 2011 we need to capitalize $128,750 ($80,000 + $48,750) worth of
interest expense.

The journal entry to record the interest capitalization would be:

Building 128,750
Interest Expense 128,750

Notice that this entry provides a credit for interest expense that is normally a debit entry. In
essence, what we have done is removed this interest expense out of the total interest expense
and moved it into the cost of the building.

For 2012 we repeat the same process:

Step 1: Average cumulative expenditures equal:

$1,628,750 * + $1,400,000
$1,514,375 =
2

* The original $1,500,000 in expenditures plus the $128,675 of interest expense that we
capitalized.

Step 2: Interest rate capitalization:

Specific borrowing: $1,000,000 × 8% = $80,000

Other debt: $514,375 × 9.75% = $50,152

Total capitalized interest for 2012 = $80,000 + $61,303 = $130,152

The journal entry to record the interest capitalization would be:

Building 130,152
Interest Expense 130,152

Chapter 10: Property, Plant, and Equipment: Acquisition and Disposal 10-15
Test Your Knowledge

10-1. Costs incurred by Jeremy Corporation that relate to its property, plant, and equipment assets
might be recorded in one of the five following classes of accounts:

a. a land account. d. an accumulated depreciation account.

b. a building account. e. an expense account.
c. an equipment account.

For each of the costs identified below, indicate the type of account in which the cost should be
recorded by placing the appropriate letter (a through e) in the space provided.

____ 1. cost of overhauling certain equipment, thereby extending its depreciable life by four years

____ 2. property taxes paid on land used in the business

____ 3. cost of raw material used in testing new equipment prior to using the equipment in production
operations

____ 4. cost to paint and recarpet an old building recently acquired by Jeremy

____ 5. labor costs to install new equipment

____ 6. addition of safety devices to existing equipment with no effect on the useful life of the
equipment

____ 7. cost of title search related to land acquisition

____ 8. cost of changing fan belts and lubricating existing equipment

____ 9. cost of an addition to the manufacturing plant that will be used to store spare equipment parts

____ 10. delinquent taxes owed by the former owner of land and paid by Jeremy in the process of
acquiring the land

____ 11. one-time costs associated with opening its new warehouse

10-16 Chapter 10: Property, Plant, and Equipment: Acquisition and Disposal
10-2. Alpha Corporation exchanged a piece of equipment with an original cost of $30,000 for a truck
owned by Beta Corporation. Beta's truck originally cost $20,000. Following you will find two
independent sets of assumptions related to this exchange. In the spaces provided, show for each
corporation the journal entries required to record the exchange given the additional information.

(a) Alpha's equipment had a book value of $14,000, and Beta's had a book value of $9,000. At
the exchange date, both assets had a fair value of $12,000. No cash was involved in the
transaction.

Alpha Corporation:

Beta Corporation:

(b) Alpha's equipment had a book value of $17,000 and a fair value of $12,000. Beta's
equipment had a book value of $7,000 and a fair value of $14,000. Alpha paid Beta $2,000
cash in addition.

Alpha Corporation:

Chapter 10: Property, Plant, and Equipment: Acquisition and Disposal 10-17
 Beta Corporation:

10-3. Butler Dental Products is building a new factory. The expenditures for 2011 were $1,250,000 and
2012 was $2,500,000 and were expended evenly through the year. To help finance this
construction, specific funds of $1,000,000 were borrowed at 9% for three years. Butler also had a
long-term note payable for $1,500,000 at 11% and 6% bonds outstanding in the amount of
$7,000,000.

(a) Determine the amount of interest to capitalize and prepare the journal entry for 2011.

(b) Determine the amount of interest to capitalize and prepare the journal entry for 2012.

10-18 Chapter 10: Property, Plant, and Equipment: Acquisition and Disposal
Answers to Test Your Knowledge

10-1. 1. d 6. c
2. e 7. a
3. c 8. e
4. b 9. b
5. c 10. a
11. e

10-2. (a) Alpha: Truck (new) 12,000

Accumulated Depreciation: Equipment 16,000
Loss on Exchange of Equipment 2,000
Equipment (old) 30,000

Beta: Equipment (new) 12,000

Accumulated Depreciation: Truck 11,000
Truck (old) 20,000
Gain on exchange 3,000

(b) Alpha: Truck (new) 14,000

Accumulated Depreciation: Equipment 13,000
Loss on Exchange of Equipment 5,000
Equipment (old) 30,000
Cash 2,000

Beta: Cash 2,000

Equipment (new) 12,000
Accumulated Depreciation: Truck 13,000
Gain on Exchange of Equipment 7,000
Truck (old) 20,000

10-3. (a) 2011:

Average cumulative expenditures:

$625,000= ($0 + $1,250,000) / 2

Interest capitalized:

$625,000 × 9% = $56,250

Journal entry:

Building 56,250
Interest Expense 56,250

(b) 2012:
Average cumulative expenditures:
$1,306,250 + $2,500,000
$1,903,125 =
2

Chapter 10: Property, Plant, and Equipment: Acquisition and Disposal 10-19
 Weighted average interest rate:
Contribution to interest rate by $1,500,000 debt:
$1,500,000
1.94% = 11% ×
$8,500,000

Contribution to interest rate by $7,000,000 debt:

$7,000,000
4.94% = 6% ×
$8,500,000

Therefore, the weighted average interest rate of these two debts is 6.88% (1.94% +
4.94%).

Interest capitalized:

$1,500,000 × 9% = $135,000
$403,125 × 6.88% = $27,735

Total interested capitalized = $162,735

Journal entry:

Building 162,735
Interest Expense 162,735

10-20 Chapter 10: Property, Plant, and Equipment: Acquisition and Disposal