ACC 319 Chapter 9

Maloy, Creighton University

where is PP+E reported on the balance sheet?

in the third sub-classification under Assets titled “Property, Plant & Equipment”

what types of assets are includes in PP+E?

assets that are…

• tangible in nature

• long-lived

• used in operations

does the order of PP+E accounts on the balance sheet matter?

no, BUT contra-asset accounts (eg. A/D) must directly follow their related asset

why is land held for resale not reported as PP+E?

it is not used in operations → reported instead under “Long-term Investments”

how are PP+E assets measured?

land → cost

all others → amortized (historical) cost

what is the general rule for capitalizing costs into PP+E?

any cost is capitalized if it is both…

• necessary to get the asset ready for its intended use

• normal, reasonable, and/or expected

a tangible asset that has permanently declined in value (impaired) must be…

written down to its impaired value

what are other terms for PP+E?

• plant assets

• fixed assets

how are cash discounts treated when acquiring assets?

asset is recorded at the amount actually paid (net if discount is taken, gross if not)

what is a lump-sum acquisition?

multiple assets are purchased at a single acquisition price

how is the total cost of a lump-sum acquisition allocated to each asset?

by using the “proportional method” or the “incremental method”

what is the proportional method for allocating the cost of lump-sum acquisitions?

the cost is allocated based on each asset’s fair value / the total purchase fair value

[cost x (fair value of 1 asset / fair value of all assets)]

when is the incremental method used when allocating for lump-sum purchases?

when the fair value of only one asset is unknown

→ the known assets are allocated first, the remaining cost goes to the unknown asset

if land is purchased that includes a building that will be razed, how is the purchase recorded?

the entire cost is allocated to “Land”; noting goes to the “Building” account

how are costs related to razing treated?

• company pays a contractor to raze a building → increase “Land”

• company receives salvage proceeds or contractor pays company to raze a building → decrease “Land”

special assessments

improvements that increase the value of the land but will be maintained by the local legislative body

how are the costs related to special assessments treated?

capitalized into “Land”

what are land improvements vs. land?

permanent improvements (landscaping) → “Land”

limited-life improvements → “Land Improvements” ; depreciated

how are costs related to improvements of a permanent nature treated?

capitalized into “Land”

how are costs related to improvements with a limited life treated?

capitalized into “Land Improvements” and depreciated over their estimated useful lives

what does historical cost consist of?

• acquisition price + sales tax

• freight/shipping costs

• installation and testing costs

what costs are capitalized into equipment?

all costs necessary to ready equipment for its intended use, includes:

• purchase price + sales tax

• freight/shipping costs

• insurance paid by purchaser during transit

• assembling, installation, and testing costs

what costs are expensed for equipment?

all recurring costs → does not benefit future periods

self-constructed assets

assets constructed by the company itself and assets constructed by someone else, specifically for the company

what costs are capitalized into self-constructed assets?

• direct materials

• direct labor

• allocated overhead (when asset is constructed by company itself)

• interest on borrowed funds

what are the types of interest related to self-constructed assets?

• interest on borrowed funds

• interest on equity funds

how is interest on borrowed funds for a self-constructed asset treated?

interest can and must be capitalized into the cost of a self-constructed asset

how is interest on equity funds or a self-constructed asset treated?

interest may not be capitalized into the cost of a self-constructed asset

*companies in the utility business may, with the justification of “Industry Practices”

interest on equity funds

“make-believe” interest that would be paid by the company to itself because of the use of company funds to finance construction

why is a self-constructed asset’s fair value greater than its cost?

the asset would have cost more had it been acquired in the open market

“profit on self-construction”

the difference between what a self-constructed asset cost and what it would have cost had it been acquired rather than self-constructed

can companies report or disclose “profit on self-construction”?

no → the self-constructed asset must be reported at cost

self-constructed assets are reported at _____

cost

how are assets acquired with a normal notes payable reported?

at either fair value of the asset received or the present value of the note given up, whichever is more evident

what are the 3 steps related to an asset and note payable transaction?

1. make a PV computation and make an entry from it

2. prepare an effective-interest-rate amortization schedule

3. make entries from the schedule

what value are asset exchange transactions recorded at?

the fair value of what is given up or received, whichever is more clearly evident

how are gains/losses treated if the fair value of both the asset received and given up are unknown?

no gain/loss is recognized

what must be done before recording an asset exchange?

the old asset must be depreciated to the date of exchange

transactions with commercial substance

those that are driven by legitimate business purposes and can significantly affect a company’s financial position, performance, or cash flows

how are gains/losses treated if commercial substance exists?

all gains/losses are recorded immediately

transactions that lack commercial substance

those that do not result in any meaningful change in a company’s financial position or cash flows; may be ones carried out for tax or financial reporting purposes

how are losses treated when a transaction lacks commercial substance?

the apparent loss is always recognized immediately

how are gains treated when a transaction lacks commercial substance?

• no boot involved or boot is paid → defer gain into the new asset

• boot is received → recognize a portion of the apparent gain [gain x (boot received / total received)]

• boot is ≥ 25% of transaction’s fair value → treated as one with commercial substance

boot

any cash, property, or debt received that’s added to an exchange to equalize value

formula for partial gain recognition

recognized gain = apparent gain x (boot received / total received)

what value is the new asset in an asset exchange transaction recorded at?

its apparent value less any unrecognized apparent gain

what is the theoretical basis for recording an exchange that lacks commercial substance?

conservatism

how are assets acquired with stock recorded?

if stock is actively traded → fair value of stock issued is used

entry to record acquisition of an asset for significantly more than its fair value

Db. Asset [for its fair value]

Db. Loss from Overpayment of Purchase Price [plug]

Cr. Cash

entry to record acquisition of an asset for significantly less than its fair value (bargain purchase)

Db. Asset [for amt. paid]

Cr. Cash

how is a bargain purchase recorded?

asset is recorded at the amount paid; no gain is recognized

what costs aree capitalized after asset acquisition?

• additions

• betterments

• extraordinary repairs

• costs that either…

  • improve the quality of asset’s output

  • improve the quantity of asset’s output

extraordinary repair

a repair or improvement that extends the normal life of an asset

what costs are expensed after asset acquisition?

• ordinary repairs

• preventative maintenance

how are rearrangement costs after asset acquisition treated?

• provide a future benefit → capitalized

• do not provide a future benefit → expensed

rearrangement costs

expenses incurred when moving machinery or equipment to improve production efficiency

what are the three capitalization approaches?

1. debit the asset account

2. debit the A/D account

3. replacement method

when is the “debit asset account” approach taken? (post-asset-acqusition costs)

cost is an addition or betterment

when is the “debit A/D” approach taken? (post-asset-acqusition costs)

cost is an extraordinary repair

when is the “replacement method” approach taken? (post-asset-acqusition costs)

cost improves the quality or quantity of asset’s output

“replacement method” methodology

1. Db. the new portion of the asset for its cost

2. Cr. the old portion of the asset for its cost

3. balance the entry with a Db. to A/D related to the old asset

what must always be done before disposing of an asset?

depreciate it to the date of disposition

entry to record a discarded asset

Db. A/D [for depreciation to date]

Cr. Asset [for historical cost]

Cr. Cash [amount paid for dispostion]

→ balance with “Loss on Disposal of Asset”

where is “Loss on Disposal of Asset” reported?

in the “Other Expense” section of I/S

entry to record the sale of an asset

Db. Cash [for amount received]

Db. A/D [for depreciation to date]

Cr. Asset [for historical cost]

→ balance with “Gain on Sale of Asset” or “Loss on Sale of Asset”

where are “Gain on Sale of Asset” or “Loss on Sale of Asset” reported?

in the “Other Income-Other Expense” section of I/S

involuntary conversion

the loss of an asset due to fire, flood, condemnation, etc.

discarded asset

an asset that is given away or is disposed of by paying someone else to

how are involuntary conversions accounted for?

handled the same as a normal disposal → recognize any gains/losses

how are fully depreciated assets still in use reported?

the asset’s cost and depreciation are left of on the books’; disclosure in footnotes