Investments in Noncurrent Operating Assets—Acquisition Intermediate Accounting,17E Stice | Stice |...

Investments in Noncurrent Operating Assets—Acquisition

Intermediate Accounting,17E

Stice | Stice | Skousen

© 2010 Cengage Learning

PowerPoint presented by: Douglas Cloud Professor Emeritus of Accounting, Pepperdine University

10-2

What Costs Are Included in Acquisition Cost?

• Initially record noncurrent operating assets at cost.

• Cost includes all expenditures required to obtain asset and place it in use.

• Most costs associated with internally-generated intangible assets are expensed.

• The cost of externally purchased intangibles is generally recorded as an asset.

10-4

(continues)

10-5

(concluded)

10-6

Tangible Assets—Land

• Costs assigned to land should be those costs that directly relate to the land’s unlimited life.

• Purchase price, commissions, legal fees, escrow fees, surveying fees, and government assessments for water lines, sewers, and roads are charged to Land.

• Clearing and grading costs, including the removal of unwanted structures, are also part of the cost of land.

10-7

Tangible Assets—Land Improvements

• Landscaping• Paving parking lots• On-property sidewalks• Light structures (for parking and

sidewalks)• Fencing

Land improvements include:

10-8

Tangible Assets—Building

• If the structure is purchased ready to use, charge Buildings for: Purchase price Commissions, legal fees, escrow fees,

and reconditioning costs• If newly constructed by an outsider:

Contract price Legal fees

10-9

Tangible Assets—Equipment

• The purchase price• Taxes, freight, and insurance during

shipping and installation• Special foundations or reinforcing of

floors• Reconditioning and testing costs

Equipment costs include:

10-10

Intangible Assets

• Intangible assets are those assets (not including financial assets) that lack physical substance.• The most important distinction in intangible assets for accounting purposes is between those that are internally generated and those that are externally purchased.

10-11

Trademark

• A trademark is a distinctive name, symbol, or slogan that distinguishes a product or service from similar products or services.

• The cost of a trademark includes the purchase price, filing and registry fees, and the cost of subsequent litigation to protect rights. It does not include internal research and development costs.

10-12

Franchises

• A franchise is the right received (usually purchased) by a business or individual to perform certain functions or sell certain products or services.

• The cost of a franchise includes expenditures made to purchase the franchise, legal fees, and other costs incurred in obtaining the franchise.

10-13

Order Backlog

• The order backlog is the amount of orders the company has received for equipment that has not yet been produced or delivered.• These orders do not constitute sales because they do not satisfy the revenue recognition requirement.

10-14

Goodwill

• Goodwill represents the business contracts, reputation, functioning systems, staff camaraderie, and industry experience that makes the company more than just a collection of assets.

• The portion of the purchase price that exceeds the sum of the current market value for all identifiable net assets is considered goodwill.

10-15

Basket Purchase

• A number of assets may be acquired in a basket purchase for one lump sum.

• When part of a purchase can be clearly identified with specific assets, such a cost assignment should be made and the balance allocated among the remaining assets.

(continues)

10-16

• When no part of the purchase price can be related to specific assets, the entire amount must be allocated among the different assets acquired.

Basket Purchase

10-17

Deferred Payment

• The acquisition of real estate or other property frequently involves deferred payment of all or part of the purchase price.

• Land is acquired on January 2, 2011, for $100,000; $35,000 is paid at the time of purchase, and the balance is to be paid in semiannual installments of $5,000 plus interest on the unpaid principal at an annual rate of 10%.

10-18

Deferred Payment

June 30, 2011—Made first payment.

Interest Expense 3,250Notes Payable 5,000

Cash 8,250

Jan. 2, 2011—Purchased land for $100,000, paying $35,000 down, the balance to be paid in semiannual payments of $5,000 plus interest at 10%.Land 100,000

Cash 35,000Notes Payable 65,000

$65,000$65,000 0.050.05

10-19

Deferred Payment

On January 2, 2011, equipment with a cash price of $50,000 is acquired under a deferred payment contract. The contract specifies a down payment of $15,000 plus seven annual payments of $7,189 each (a total cost of $65,323). The present value of the seven payments at 10 percent is $35,000.

10-20

Deferred Payment

January 2, 2011—Purchased equipment with a cash price of $50,000 for $15,000 down plus seven annual payments of $7,189 each.

Equipment 50,000Discount on Notes Payable 15,323

Notes Payable 50,323Cash 15,000

10-21

December 31, 2011—Made first payment of $7,189.

Amortization of debt discount:

$50,323 – $15,323 = $35,000; $35,000 10% = $3,500

Journal entries:Notes Payable 7,189

Cash 7,189

Interest Expense 3,500Discount on Notes Payable 3,500

Deferred Payment

10-22

December 31, 2012—Made second payment of $7,189 and amortized debt discount.

Notes Payable 7,189Cash 7,189

Interest Expense* 3,131Discount on Notes Payable 3,131

Deferred Payment

*$50,323 $7,189 = $43,134 Notes payable$15,323 $3,500 = 11,823 Discount on notes payable $31,311 Present value of notes payable

at the end of first year

$31,311 0.10 = $3,131

10-23

Leasing

• A lease is a contract whereby one party (the lessee) is granted a right to use property owned by another party (the lessor).

• Rental leases are operating leases and arrangements that are equivalent to a sale of leased assets are capital leases.

• Capital leases are recorded on the acquiring company’s records as assets, with a related liability at the present value of the future lease payments.

10-24

Exchange of Nonmonetary Assets

•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.

10-25

Acquisition by Issuing Securities

•When a fair value for the securities can be determined, that value is assigned to the asset acquired.

• In the absence of a fair value for the securities, the fair value of the asset acquired is used. This may require the services of an independent appraiser.

10-26

Self-Construction

•Like purchased assets, self-constructed assets are recorded at cost, including all expenditures incurred to build the asset and make it ready for its intended use.

•There is a difference of opinion regarding the amount of overhead properly assignable to construction activity.

10-27

Savings or Loss onSelf-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.• When the cost is greater than the cost to acquire it through purchase or construction from outsiders, the asset should be recorded at cost (with some exceptions).

10-28

Interest Capitalization

• Capitalization of interest is required for assets that are being self-constructed for an enterprise’s own use and for assets that are intended to be leased or sold to others that can be identified as discrete projects.• Interest should not be capitalized for inventories manufactured or produced on a repetitive basis.

10-29


• When assets are acquired by self-construction, interest incurred on funds borrowed to finance construction can be capitalized if the following conditions are met: Projects are discrete Costs are separately accumulated Construction covers an extended period

of time Construction costs are substantial

10-30


• Interest charges begin when the first expenditures are made on the project and continue until the asset is completed.

• Interest capitalization is calculated on the average amount of accumulated expenditures.

(continues)

10-31


• The interest rate to use is the actual rate on the debt incurred specifically for the project.

• If the construction period covers more than one fiscal period, accumulated expenditures include prior years’ capitalized interest.

10-32

Interest Capitalization Example

• Construction will take about 18 months.• Construction costs are estimated at $6.4

million.• A 12%, $2 million loan is obtained and

will become effective on January 1, 2011.

Cutler Industries, Inc. has decided to construct a new computerized assembly plant.

(continues)

10-33

Cutler Industries, Inc.’s other debts are:

5-year notes payable, 11% interest $3,000,000

Mortgage on other plant, 9% interest 4,800,000

The weighted-average interest rate on the general nonconstruction debt is computed as follows:

(continues)


10-34

The following expenditures were incurred on the project during 2011.

January 1, 2011 $1,200,000October 1, 2011 1,800,000

In the previous slide we noted that the weighted-average rate was 9.8% (rounded).

(continues)


10-35

Computation of the amount of interest to be capitalized for 2011 follows:

In Slide 10-33, the weighted-average rate was determined to be 9.8%

The firm borrowed $1,800,000 on October 1

(continues)


10-36

The amount of interest capitalized cannot exceed total interest incurred during the year. Total interest during 2011 was as follows:

(continues)


10-37

The actual interest was $1,002,000 and the calculated interest was $192,500. Thus, the entry is as follows:Construction in Progress 192,500Interest Expense 809,500

Cash 1,002,000

$1,002,000 $1,002,000 $192,500 $192,500

(continues)


10-38

FASB Statement No. 34 requires disclosure of the total interest expense for the year and the amount capitalized. This disclosure can be made either in the body of the income statement or in a note to the statements.

(continues)


10-39

Acquisition by Donationor Discovery

Property acquired through donation should be appraised and recorded at its fair market value.

Land 400,000Buildings 1,500,000

Revenue or Gain 1,900,000

10-40

To illustrate the initial recognition of an asset retirement obligation, assume that Bryan Beach Company purchases and erects an oil platform at a total cost of $750,000. At the end of ten years, the platform must be dismantled and removed from the site at an estimated cost of $100,000. Using an 8% interest rate, the present value of $100,000 for ten years is $46,319.

(continues)

Asset with Significant Restoration Costs at

Retirement

10-41

Oil Platform 750,000 Cash 750,000

Asset with Significant Restoration Costs at

RetirementThe journal entries to record the purchase and the asset retirement obligation follow:

Oil Platform 750,000 Asset Retirement Obligation 750,000

10-42

Postacquisition Expenditures

• A component is a portion of a property, plant, or equipment item that is separately identifiable and for which a separate useful life can be estimated.

• Expenditures to keep plant and equipment in good operating condition are referred to as maintenance.

10-43

• Expenditures to restore assets to good operating condition upon their breakdown or to restore and replace broken parts are referred to as repairs.

• Maintenance and repairs are charged to expense accounts immediately.

Postacquisition Expenditures

10-45

Renewals and Replacements

• Expenditures for overhauling plant assets are frequently referred to as renewals. They should be expensed immediately.

• Substitution of parts or entire units are referred to as replacements. Treat the removed part similar to removing any plant asset.

10-46

Additions and Betterments

• Enlargements and extensions of existing facilities are referred to as additions.

• Changes in asset design to provide increased or improved services are referred to as betterments.

• Capitalize the cost of additions and betterments.

10-47

Research and DevelopmentResearch (discovering new knowledge) and development (formulation, design, and testing of products) costs include:

Costs of materials Equipment Facilities Personnel Purchased intangibles Contract services Reasonable allocation of indirect costs that are

specifically related to R&D activities and that have no alternative future use

Research and Research and development development expenditures expenditures are expensed are expensed in the period in the period they occur.they occur.

Research and Research and development development expenditures expenditures are expensed are expensed in the period in the period they occur.they occur.

10-48

International Accounting for R&D: IAS 38

• IAS 38 requires research costs to be expensed and development costs to be capitalized.

• Research costs are those R&D costs incurred before technical and commercial feasibility has been attained.

• Development costs are those incurred after technical and commercial feasibility.

10-49

Oil and Gas Exploration Costs

• Full cost method—all exploratory costs are capitalized. Reasoning: The cost of drilling dry wells

is part of the cost of locating productive wells.

• Successful efforts method— exploratory costs for dry wells are expensed, and only exploratory costs for successful wells are capitalized.

10-50

Intangibles Acquired in a Basket Purchase

A company pays $700,000 to purchase a patent along with a functioning factory and special equipment used to produce the patented product. The estimated fair values are allocated as shown next.

10-51

Intangibles Acquired in a Basket Purchase

10-52

Five General Categories of Intangible Assets

1. Marketing-related—trademarks, brand names, and Internet domain names

2. Customer-related—customer lists, order backlogs, and customer relationships

3. Artistic-related—items protected by copyright

4. Contract-based—licenses, franchises, and broadcast rights

5. Technology-based—patented and unpatented technologies as well as trade secrets

10-53

Estimating the Fair Value of Intangibles—Traditional Approach

Intangible Asset A is expected to generate $1,000 in royalty payments at the end of each of the next five years. The risk-adjusted interest rate is 12%. The fair value of the patent is calculated as follows:Table Value (n = 5; I = 10) $1,000 = PV(annuity)

3.605 $1,000 = $3,605

10-54

Estimating the Fair Value of Intangibles—Expect Cash Flow Approach

Intangible Asset B is a secret formula that is expected to have the following probabilities of happening:

• 10% probability of cash flows of $5,000 at the end of each year for 10 years

• 30% probability of cash flows of $1,000 at the end of each year for 4 years

• 60% probability of cash flows of $100 at the end of each year for 3 years

(continues)

10-55

Estimating the Fair Value of Intangibles—Expect Cash Flow Approach

10-56

Goodwill

• Goodwill is a residual amount, the amount of the purchase price of a business that is left over after all other tangible and intangible assets have been identified.

• In a basket purchase, each identifiable asset is recorded at an amount equal to its estimated fair market value; any residual is reported as goodwill.

10-57

Goodwill Illustration

Airnational Corporation purchases the net assets of Speedy Freight Airlines for $1,500,000 in cash. The book value of Speedy Freight at the time of purchase is shown below.

(continues)

10-58


Analysis between the costs and market values of the assets acquired reveal a difference of $513,300 ($1,266,500 $753,200).

(continues)

10-59


a)The difference between the purchase price of $1,500,000 and the net asset book value of $767,200 ($1,036,700 – $269,500) is $732,800.

b)The market value of the noncash assets (inventory, land, building, patents, etc.) is $1,266,500. The difference between the cost of these items ($753,200) and the market is $513,300.

(continues)

10-60

(at book value)(at market)

(at market)(at market)

(at market)


c) Subtract $513,300 (step b) from $732,800 (step a) gives us the amount of Goodwill, which is $219,500.

10-61

Bargain Purchase

• When the amount paid for another company is less than the fair value of the net identifiable assets, this is a bargain purchase.

• Assume that the Speedy Freight acquisition was for $1,000,000 instead of $1,500,000. The acquisition would be recorded as shown next.

(continues)

10-62

Bargain Purchase

Note that a gain is recognizedNote that a gain is recognized

10-63

Valuation of Assets at Current Values

• In IFRS 16, concerns about permitting upward revaluations of noncurrent operating assets is reflected in the rules laid out: If a company revalues its noncurrent operating

assets to fair value, it must do so on a regular basis and must revalue entire classes of assets rather than just picking and choosing certain assets.

Downward revaluations are recorded as a loss. Upward revaluations are recorded as a debit to

the asset and a credit to a special “revaluation” equity account.

10-64

Sales

Average fixed assets

$102,481

Fixed Asset Turnover Ratio

Fixed asset turnover ratio =

General Electric’s manufacturing segments had sales for 2006 totaled $102,481. Its beginning and ending property, plant, and equipment balances were $16,504 and $12,675, respectively.

= $14,590

$14,590

($16,504 + $12,675) 2Average fixed assets =

= 7.02

10-65

Sales

Average fixed assets

$115,595

Fixed Asset Turnover Ratio

Fixed asset turnover ratio =

General Electric’s manufacturing segments had sales for 2007 totaled $115,595. Its beginning and ending property, plant, and equipment balances were $12,675 and $14,590, respectively.

= $13,409

$13,409

($12,675 + $14,590) 2Average fixed assets =

= 8.62

Investments in Noncurrent Operating Assets—Acquisition Intermediate Accounting,17E Stice | Stice |...

Documents

Transcript of Investments in Noncurrent Operating Assets—Acquisition Intermediate Accounting,17E Stice | Stice |...