Acfn 2082 Ch01-Part I

PREVIEW OF CHAPTER 1
Topics/Learning Objectives (L.O.)

1. Nature of plant assets
2. Cost of plant assets/Valuation
3. Costs after acquisition
4. Depreciation & depletion of plant assets
5. Disposition of plant assets
6. Nature, cost, & amortization of intangible assets
10-1
1. NATURE OF PROPERTY, PLANT, AND EQUIPMENT
Property, plant, and equipment are assets of a durable nature.

Other terms commonly used are plant assets, fixed assets, and
capital
Major assets.
characteristics:
 Includes:
 “Used in operations” and not for resale/investment.
Land,
 Include standby assets (in non-continuous use)
Building
 Exclude idle assets (land or building)-investment
structures
 Revenue producing assets-productive purpose (offices,
 Long-term/long-lived in nature and usually depreciated. factories,
warehouses),
 Long-term prepayments
and
 Bundle of future services
Equipment
 Possess physical substance. (machinery,
 Tangible in nature-fixed in nature furniture,
tools).
 Conversion (indirect) cost to a product
 Not directly incorporated/become part of a product
10-2
1. NATURE OF PROPERTY, PLANT, AND EQUIPMENT
Assets
Current Assets Non-Current Assets
Operating Assets Investments
Tangible Assets Intangible Assets
PPE Natural Resources
Depreciable Non-Depreciable
10-3
2. ACQUISITION COST OF PP&E [INITIAL VALUATION]
Guideline for Initial Valuation
 Historical cost [Cost principle] measures the cash or cash

equivalent price of obtaining the asset and bringing it to the
location and condition necessary for its intended use.
 Cost consists of all expenditures necessary & reasonable

to acquire an asset and make it ready for its intended use.
 Companies value property, plant, and equipment in

subsequent periods using either the
 cost method or
 fair value (revaluation) method.
10-4
 Cost Components/Elements [Subject to Mode of Acquisition]

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

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

the land.
10-7
Required: Determine amount to be reported as the cost of the

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

Structural additions made to land. Cost includes all
expenditures necessary to make the improvements ready
for their intended use.
 Examples: driveways, parking lots, fences, landscaping,

and underground sprinklers, trees and shrubs, outdoor
lighting, concrete sewers and drainage.
 Limited useful lives.
 Expense (depreciate) the cost of land improvements over
their useful lives.
10-9
COST OF BUILDINGS
Includes all costs related directly to purchase or construction.
Purchase costs:
 Purchase price, closing costs (attorney’s fees, title insurance, etc.)
and real estate broker’s commission.
 Remodeling, and replacing or repairing the roof, floors, electrical
wiring, and plumbing. Reconditioning (purchase of an existing
building)
Construction costs:
 materials, labor, and overhead costs incurred during construction
and professional fees and building permits.

 Contract price plus payments for architects’ fees, Engineers’ fees,
building permits, and excavation costs.
 Companies consider all costs incurred, from excavation to
completion, as part of the building costs.
 Insurance & interest costs incurred during construction
 Walkways to and around the building
10-10
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. Money borrowed to pay building contractor a. Notes Payable

(signed a note)
b. Payment for construction from note proceeds b. Buildings
c. Cost of land fill and clearing c. Land
d. Delinquent real estate taxes on property d. Land
assumed by purchaser
e. Premium on 6-month insurance policy during e. Buildings
construction
10-11
Illustration: Determine how the following should be classified:
f. Refund of 1-month insurance premium f. (Buildings)

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

building
m. Interest paid during construction on money m. Buildings
borrowed for construction
n. Land
n. Cost of parking lots and driveways
Improvements
o. Cost of trees and shrubbery planted o. Land
(permanent in nature)
p. Excavation costs for new building p. Buildings
10-13
 Cost of Equipment
Include all expenditures incurred in acquiring the equipment
and preparing it for use. Costs include:
 Cash purchase price,
 freight and handling charges,
 insurance on the equipment while in transit,
 cost of special foundations if required,
 assembling and installation costs, and
 costs of conducting trial runs.
 Sales taxes
 Repairs (purchase of used equipment)
 Reconditioning (purchase of used equipment)
 Modifying for use
10-14
Illustration: Lenard Company purchases a delivery truck at a

cash price of Br.22,000. Related expenditures are sales taxes
Br.1,320, painting and lettering Br.500, motor vehicle license $80,
and a three-year accident insurance policy Br.1,600. Compute the
cost of the delivery truck.
Truck
Cash price Br.22,000
Sales taxes 1,320
Painting and lettering 500
Cost of Delivery Truck Br.23,820
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
Br.80, and a three-year accident insurance policy Br.1,600.
Prepare the journal entry to record these costs.
Equipment 23,820
License Expense 80
Prepaid Insurance 1,600
Cash 25,500
10-16
 Cost of Acquiring Fixed Assets Excludes:
 Vandalism (deliberate destruction of property)

 Mistakes in installation
 Uninsured theft
 Damage during unpacking and installing
 Fines for not obtaining proper permits from
government agencies
10-17
2. Special Issues
a) Self-Construction
Factory Overhead [FOH]
Interest cost [Debt Financing]
b) Savings or loss on self-construction
c) Cash discounts
c) Deferred payment contracts
d) Issuance of shares
e) Group/Basket/Lump sum purchases (vs.
individual/separate)
f) Donations/Grants/Gifts
g) Exchanges of non-monetary assets
10-18
Valuation of PPE-Interest Capitalization
Self-Constructed assets: These are assets constructed by the
business for use in operations.
Costs include:
 Materials and direct labor
 Direct/Variable manufacturing overhead
 Interest during construction [b/c of HC & Matching principles]
 Pro rata portion of indirect manufacturing overhead, i.e. Full
costing approach.
 Full costing is the most commonly used and is the generally
accepted method used to allocate the indirect MOH between
the normal operation (inventories) and self-construction. That
is all overhead costs are allocated both to production and to
self-constructed assets based on the relative amount of a
chosen cost driver (for example, labor hours) incurred.
10-19
Interest Costs During Construction

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

modification).
 Interest should be capitalized on all “pre-

earning” assets
 Consistent with historical cost.
 Capitalization considers three items:
1. Qualifying assets.
2. Capitalization period.
3. Amount to capitalize.
10-21
Qualifying Assets
Require a substantial period of time to get them ready for their
intended use or sale.
Two types of assets:
 Assets under construction for a company’s own use.
 Assets intended for sale or lease that are constructed or
produced as discrete projects.
Non-qualifying assets include:
 Inventories that are routinely manufactured.
 Assets that are in use or ready for their intended use.
 Assets that are not being used in the earning activities of the
company and are not undergoing the activities necessary to
get them ready for use.
10-22
Capitalization Period
Begins when:
1. Expenditures for the assets are being incurred.
2. Activities for readying the asset for use or sale are in progress .
3. Interest costs are being incurred.
 Capitalization continues for as long as these three conditions exist or
ceases when any one of the three conditions is not met or when the
asset is substantially completed.
 If the first condition is not met, the conceptual basis for interest
capitalization is absent.
 If the second condition is not met, construction activities are not the
cause of the opportunity cost.
 If the third condition is not met, there is no interest to capitalize.
Ends when:
The asset is substantially complete and ready for use
10-23
Interrupted when:
 Brief & inherent in normal construction work (e.g. labor disputes)-
Capitalization continues
 Intentional delays (e.g. customer choice of fixtures)-Capitalization
discontinued.
 Capitalization period: time between the expenditure date and the

date interest capitalization stops or year-end (whichever comes first)
 If the construction period covers more than one fiscal period,

accumulated expenditures include prior years’ capitalized
interest. (See comprehensive illus #2)
10-24
Amount to Capitalize
Capitalize the lesser of:
1. Actual interest cost incurred [both on the specific & general
or other loans].
2. Avoidable interest (Interest Potentially Capitalizable =IPC):
the amount of interest cost during the period that a
company could theoretically avoid if it had not made
expenditures for the asset. Or Avoidable interest is the
amount that could have been avoided, if expenditures for
the asset had not been made. It is a function of AAE.
 Average Accumulated Expenditures [AAE]-is a measure of
the debt that could have been retired and is the average
cash investment during the construction period.
10-25
Illustration: Assume a company borrowed $200,000 at 12% interest

from State Bank on Jan. 1, 2015, for specific purposes of constructing
special-purpose equipment to be used in its operations. Construction on
the equipment began on Jan. 1, 2015, and the following expenditures
were made prior to the project’s completion on Dec. 31, 2015:
Actual Expenditures during 2015: Other general debt existing on

January 1 $ 100,000 Jan. 1, 2015:
April 30 150,000
$500,000, 14%, 10-year
November 1 300,000 bonds payable
December 31 100,000
Total expenditures $ 650,000 $300,000, 10%, 5-year
note payable
10-26
Step 1 - Determine which assets qualify for capitalization of

interest.
Special purpose equipment qualifies because it requires a period of
time to get ready and it will be used in the company’s operations.
Step 2 - Determine the capitalization period.

The capitalization period is from Jan. 1, 2015 through Dec. 31, 2015,
because expenditures are being made and interest costs are being
incurred during this period while construction is taking place.
10-27
Step 3 - Compute weighted-average accumulated

expenditures (WAAE).
Weighted
Average
Actual Capitalization Accumulated
Date Expenditures Period Expenditures
Jan. 1 $ 100,000 12/12 $ 100,000
Apr. 30 150,000 8/12 100,000
Nov. 1 300,000 2/12 50,000
Dec. 31 100,000 0/12 -
$ 650,000 $ 250,000
A company weights the construction expenditures by the amount of time

(fraction of a year or accounting period) that it can incur interest cost on the
expenditure.
10-28
Step 4 - Compute the Actual and Avoidable Interest.
Selecting Appropriate Interest Rate:

1. For the portion of weighted-average accumulated expenditures
that is less than or equal to any amounts borrowed specifically to
finance construction of the assets, use the interest rate incurred
on the specific borrowings.
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.
10-29
Step 4 - Compute the Actual and Avoidable Interest.

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

Avoidable Interest Expenditures Rate Interest
$ 200,000 12% $ 24,000
50,000 12.5% 6,250
$ 250,000 $ 30,250
10-30
Step 5 – Capitalize the lesser of Avoidable interest or Actual

interest.
Avoidable interest $ 30,250

Actual interest 124,000
Journal entry to Capitalize Interest:
Equipment 30,250
Interest Expense 30,250
10-31
Comprehensive Illustration 1: On November 1, 2014, ABC

Company contracted Pfeifer Construction Co. to construct a building
for $1,400,000 on land costing $100,000 (purchased from the
contractor and included in the first payment). ABC made the
following payments to the construction company during 2015.
10-32
ABC Construction completed the building, ready for occupancy, on

December 31, 2015. ABC had the following debt outstanding at
December 31, 2015.
Specific Construction Debt
1. 15%, 3-year note to finance purchase of land and
construction of the building, dated December 31, 2014, with
interest payable annually on December 31 $750,000
Other Debt
2. 10%, 5-year note payable, dated December 31, 2011, with
interest payable annually on December 31 $550,000
3. 12%, 10-year bonds issued December 31, 2010, with
interest payable annually on December 31
$600,000
Compute weighted-average accumulated expenditures for 2015.
10-33
Compute weighted-average accumulated expenditures for 2015.
10-34
Compute the avoidable interest.
10-35
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.
10-36
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
10-37
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.
10-38
Comprehensive Illustration 2: On January 2, 20X1, A
Company commenced construction of a new building for its own
use at an estimated cost of Br. 2,200,000. The construction is
expected to be completed one month before the end of Year 20X2
(November 30). The following debts were held by the company
throughout the term of construction of the building:
Construction (specific) loan Br. 750,000, 15%, 3 years Notes Payable
General (nonspecific) loans 550,000, 10%, 5 years Notes Payable
600,000, 12%, 10 years, Bonds Payable
Moreover, the company made the following expenditures (payments) on the
construction of the building:
January 1, 20X1 $210,000
March 1, 20X1 300,000
May 1, 20X1 540,000
December 31, 20X1 450,000
August 1, 20X2 400,000
October 30, 20X2 200,000
10-39
A.Capitalized Interest For 20X1

Step 1: Compute actual interest expense for 20X1.
Construction loan (750,000*0.15*12/12) $112,500
Long-term note (550,000*0.10*12/12) 55,000
Long-term bonds (600,000*0.12*12/12) 72,000
Total Actual Interest $239,500
Step 2: Compute Weighted Average Accumulated Expenditures

(WAAE) for 20X1.
Expenditure Capitalization Period WAAE
Date Amount
January 1 $210,000 12/12 $210,000
March 1 300,000 10/12 250,000
May 1 540,000 8/12 360,000
December 31 450,000 0/12 0
Total $1,500,000 $820,000
10-40
Step 3: Compute the Interest Potentially Capitalizable (IPC) for 20X1.

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

Over Construction Loan = (WAAE- Construction Loan)*WAIR
WAIR = Total Actual Interest on Nonspecific Loans
Total Nonspecific Interest-Bearing Loans
•Case 2 WAAE < Construction (Specific) Loan
IPC = WAAE * Interest Rate on Specific Loan
Thus, IPC for 20X1:
= (750,000*0.15) + (820,000-750,000)*0.1104 = $120,228
10-41
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.
Construction loan (750,000*0.15*11/12) $103,125
Long-term note (550,000*0.10*11/12) 50,417
Long-term bonds (600,000*0.12*11/12) 66,000
Total Actual Interest $219,542
10-42
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)
Expenditure + (1,783,865-750,000)*0.1104*11/12=
Capitalization WAAE $207,752
Date Amount period
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
10-43
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
10-44
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.
10-45
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.
10-46
Valuation of PPE- Savings or Loss on Self-Construction
Illustration: Kaplan Limited completed the construction of equipment on
November 10, 20X1. The following itemizes total construction costs:
Material $200,000
Labor 500,000
Incremental overhead 100,000
Capitalized interest 100,000
Total $900,000
Kaplan recorded all construction costs in equipment under
construction.
1. If the asset’s market value at completion equals or exceeds
$900,000, the following entry would be made on November 10,
20X1:
Equipment…………………………..900,000
Equipment under construction…………….900, 000
2. If the asset’s market value is only $880,000, the following entry
would be made on November 10, 20X1:
Equipment……………………………….880, 000
Loss on Construction of Equipment…….20,000
Equipment under construction…………….900, 000
10-47
Valuation of PPE- Cash Discounts
Cash Discounts — whether taken or not — generally considered a
reduction in the cost of the asset. The Net-of-Discount Method is
the preferred method
Example: ABC Co purchased equipment for Br 60,000 on account
under the term 2/10, n/30. Record the purchase:
Equipment ………………………………… 58,800
Accounts Payable…………………………………… 58,800
10-48
Valuation of PPE: Lump-sum (Basket) Purchases
Lump-Sum Purchases — Allocate the total cost among the various
assets on the basis of their relative fair market values.
Example: A company pays $120,000 for equipment and a building.
The land and building are appraised at $50,000 and $75,000,
respectively.
Appraisal Relative Total Allocated
Assets Value Fair Value Cost Cost
Equipment 50,000 50,000/125,000 120,000 48,000
Building 75,000 75,000/125,000 120,000 72,000
Total 125,000 120,000
Equipment 48,000
Building 72,000
Cash 120,000
10-49
Valuation of PPE: Issuance of Shares
Issuance of Shares — The market price of the shares issued is a

fair indication of the cost of the property acquired.
Example: North Co. decides to purchase building located adjacent to
it for expansion of its operation. The building is owned by Sky Co. In
lieu of paying cash for the building, North issues to Sky Co. 5,000
shares of common stock (par value $10) that have a fair value of $12
per share. Make the journal entry
Building (5,000 x $12)…………………….. 60,000

Common Stock………………………………………………….. 50,000
Paid-In Capital in Excess of Par—Common Stock.. 10,000
10-50
Valuation of PPE- Deferred-Payment Contracts
Deferred-Payment Contracts — Assets purchased on long-term credit
contracts are valued at the present value of the consideration exchanged.
Example 1: On January 2, 2013, purchased equipment with a cash price of
$50,000 for $15,000 down plus seven annual payments of $7,189 each.
Equipment 50,000
Discount on Notes Payable 15,323
Notes Payable 50,323
Cash 15,000
Example 2: Greathouse Company purchases equipment today in exchange
for a $10,000 zero-interest-bearing note payable four years from now. The
market interest rate is 9%. Record the purchase
Equipment …………………………… 7,084.30
Discount on Notes Payable………… 2,915.70
Notes Payable ………………..…………………. 10,000
10-51
Valuation of PPE: Exchanges
Exchanges of Non-Monetary Assets

Ordinarily accounted for on the basis of:
 the fair value of the asset given up or
 the fair value of the asset received,
whichever is clearly more evident.
Companies should recognize immediately any gains or losses on
the exchange when the transaction has commercial substance
(future cash flows change as a result of the transaction).
For example, ABC Co. exchanges some of its equipment for Building
held by XYZ Co. It is likely that the timing and amount of the cash
flows arising for the building will differ significantly from the cash
flows arising from the equipment. As a result, both ABC Co. and XYZ
Co. are in different economic positions. Therefore, the exchange has
commercial substance, and the companies recognize a gain or loss on
the exchange.
10-52
• 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).
10-53
Accounting for Exchanges
* If cash is 25% or more of the fair value of the exchange,

recognize entire gain because earnings process is complete.
10-54
Summary of Gain and Loss Recognition on Exchanges of

Nonmonetary Assets Lacks Commercial Substance
10-55
Exchanges - Loss Situation
Companies recognize a loss immediately whether the exchange

has commercial substance or not.
Rationale: Companies should not value assets at more than their
cash equivalent price; if the loss were deferred, assets would be
overstated.
10-56
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.
10-57
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.
10-58
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
10-59
Lacks Commercial Substance
ABC:
Equipment (12,500 – 5,242) 7,258
Cash 3,000
Equipment 28,000
Gain on exchange 1,258
Cash Received Total Recognized

x =
Cash Received + FMV of Assets Received Gain Gain
$3,000
x $6,500 = $1,258
$3,000 + $12,500
Deferred gain = $6,500 – 1,258 = $5,242
10-60
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.
10-61
Valuation of PPE: Contributions
Contributions: Nonreciprocal transfers: transfer of assets where
nothing is given up in exchange (e.g. donations, gift, grants)
Companies should use:
 the fair value of the asset to establish its value on the books and
 should recognize contributions received as revenues in the period
received.
 When a company contributes a non-monetary asset, it should
record the amount of the donation as an expense at the fair value
of the donated asset.
 Two approaches to valuing and recording such transfer:
1. Capital Approach: credit contributed surplus account (donated
capital)
2. Income Approach: credit represents income and the gain is
deferred over the life of the asset (exception being land)
a) Cost Reduction Method: credit the respective asset account
b) Deferral Method: credit Deferred Revenue
10-62
Valuation of PPE: Contributions/Grants
Illustration: Kline Industries donates land to the city of Los Angeles

for a city park. The land cost $80,000 and has a fair value of $110,000.
Kline Industries records this donation as follows.
Donor’s Book:
Contribution Expense 110,000
Land 80,000
Gain on Disposal of Land 30,000
Donee’s Book:
Land 110,000
Contribution Revenue 110,000
10-63
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.
10-64
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.
10-65
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
10-66
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
10-67
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.
10-68
Post Acquisition Costs
• Costs incurred after acquisition can be:

1. Additions: increase or extension of existing assets &
capitalize the cost of addition to asset account.
2. Improvements and replacements: substitution of an
existing asset for an improved or equivalent one
3. Rearrangement and reinstallation[ Relocation/
Reorganization]: moving asset from one location to
another
4. Repairs: costs that maintain assets in operating
condition
10-69
Post acquisition Costs
Improvements and Replacements

Capitalize costs, if
They increase future service potential
Improvements or Replacements
Substitution of Substitution of
a better asset a similar asset
for present for present
asset asset
10-70
 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)
10-71
 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.
10-72
 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.
10-73
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
10-74
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.
10-75
Disposition of PPE: Sale
When fixed assets are sold, the owner may break
even, sustain a loss, or realize a gain.
1. If the sale price is equal to book value, there will
be no gain or loss.
2. If the sale price is less than book value, there will
be a loss equal to the difference.
3. If the sale price is more than book value, there will
be a gain equal to the difference.
Gain or loss will be reported in the income statement

as Other Income or Other Loss.
10-76
Disposition of PPE: Sale
Illustration: City Company owns machinery that cost $20,000 when
purchased on January 1, 2004. Depreciation has been recorded at a
rate of $3,000 per year, resulting in a balance in accumulated
depreciation of $9,000 at December 31, 2006. The machinery is sold
on September 1, 2007, for $10,500. Prepare journal entries to (a)
update depreciation for 2007 and (b) record the sale.
(a) update depreciation for 2007
Depreciation expense ($3,000 x 8/12) 2,000
(b) record the sale
Cash 10,500
Machinery 20,000
Gain on sale 1,500
10-77
Disposition of PPE: Discarding/ Abandonment
Illustration 1: A piece of equipment acquired at a cost of $25,000 is
fully depreciated. On February 14, the equipment is discarded.
Accumulated Depr.—Equipment 25,000
Equipment 25,000
Illustration 2: costing $6,000 is depreciated at an annual straight-line
rate of 10%. After the adjusting entry, Accumulated Depreciation—
Equipment had a $4,750 balance. The equipment was discarded on
March 24.
a. Update the Depreciation
Depreciation Expense.—Equipment 150
Accum. Depreciation—Equipment[=600 × 3/12] 150
b. Write-off Equipment Discarded
Accumulated Depr.—Equipment 4900
Loss on Disposal of Fixed Asset 1100
Equipment 6000
10-78
Disposition of PPE: Involuntary Conversion
Involuntary Conversion: Sometimes an asset’s service is

terminated through some type of involuntary conversion such as
fire, flood, theft, or condemnation.
Companies report the difference between the amount recovered

(e.g., from a condemnation award or insurance recovery), if any,
and the asset’s book value as a gain or loss.
They treat these gains or losses like any other type of disposition.
10-79
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
10-80
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
10-81
Supplementary: Natural Resources & Intangible Assets
Natural resources consist of standing timber and

underground deposits of oil, gas, and minerals.
Distinguishing characteristics:
 Physically extracted in operations.

 Replaceable only by an act of nature.
Cost is the price needed to acquire the resource and prepare it

for its intended use.
10-82
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.
10-83
Depletion
Illustration: Lane Coal Company invests $5 million in a mine

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

estimated to have 1 million tons of coal and no salvage value. In
the first year, Lane extracts and sells 250,000 tons of coal. Lane
computes the depletion expense as follows:
$5,000,000 ÷ 1,000,000 = $5.00 depletion cost per ton
$5.00 x 250,000 = $1,250,000 annual depletion expense
Journal entry:
Depletion Expense/Inventory (coal)1,250,000
Accumulated Depletion
1,250,000
10-85
Intangible Assets
Intangible assets are rights, privileges, and competitive

advantages that result from ownership of long-lived assets
that do not possess physical substance.
Limited life or indefinite life.

Common types of intangibles:
 Patents  Trademarks and Trade Names

 Copyrights  Franchises
 Goodwill
10-86
Accounting for Intangible Assets
Limited-Life Intangibles:
Helpful Hint
 Amortize to expense. Amortization is to
intangibles what
depreciation is to plant
 Credit asset account. assets and depletion is to
natural resources.
Indefinite-Life Intangibles:
 No foreseeable limit on time the asset is expected to
provide cash flows.
 No amortization.
10-87
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.
10-88
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.
Cost $60,000
Useful life ÷ 8
Annual expense $ 7,500
Amortization Expense 7,500

Patents
7,500
10-89
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.
10-90
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.
10-91
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.
10-92
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.
10-93
Summary
10-94
Summary
10-95
Summary
10-96

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PREVIEW OF CHAPTER 1

Topics/Learning Objectives (L.O.)

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

Current Assets Non-Current Assets

Operating Assets Investments

Tangible Assets Intangible Assets

PPE Natural Resources

Guideline for Initial Valuation

 Historical cost [Cost principle] measures the cash or cash

 Cost consists of all expenditures necessary & reasonable

 Companies value property, plant, and equipment in

 Cost Components/Elements [Subject to Mode of Acquisition]

Illustration: Sunrise Company acquires real estate at a cash

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

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

 Cost of Land Improvements

 Examples: driveways, parking lots, fences, landscaping,

and professional fees and building permits.

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

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

Illustration: Determine how the following should be classified:

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

Illustration: Determine how the following should be classified:

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

Illustration: Lenard Company purchases a delivery truck at a

Cost of Delivery Truck Br.23,820

Illustration: Lenard Company purchases a delivery truck at a

 Cost of Acquiring Fixed Assets Excludes:

 Vandalism (deliberate destruction of property)

Interest Costs During Construction

 IFRS requires — capitalizing actual interest (with

 Interest should be capitalized on all “pre-

 Capitalization period: time between the expenditure date and the

 If the construction period covers more than one fiscal period,

Illustration: Assume a company borrowed $200,000 at 12% interest

Actual Expenditures during 2015: Other general debt existing on

Step 1 - Determine which assets qualify for capitalization of

Step 2 - Determine the capitalization period.

Step 3 - Compute weighted-average accumulated

A company weights the construction expenditures by the amount of time

Step 4 - Compute the Actual and Avoidable Interest.

Selecting Appropriate Interest Rate:

2. For the portion of weighted-average accumulated expenditures

Step 4 - Compute the Actual and Avoidable Interest.

Accumulated Interest Avoidable

Step 5 – Capitalize the lesser of Avoidable interest or Actual

Avoidable interest $ 30,250

Journal entry to Capitalize Interest:

Comprehensive Illustration 1: On November 1, 2014, ABC

ABC Construction completed the building, ready for occupancy, on

Compute weighted-average accumulated expenditures for 2015.

Compute weighted-average accumulated expenditures for 2015.

Compute the avoidable interest.

Compute the actual interest cost, which represents the maximum

The interest cost that Shalla capitalizes is the

ABC records the following journal entries during 2015:

January 1 Land 100,000

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

A.Capitalized Interest For 20X1