chapter 5 assets. 1. record the acquisition of property, plant, and equipment. 2. determine the cost...
TRANSCRIPT
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Chapter 5
AssetsAssets
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1. Record the acquisition of property, plant, and equipment.
2. Determine the cost of assets acquired by the exchange of other
assets.
3. Compute the cost of a self-constructed asset, including interest
capitalization.
4. Record costs subsequent to acquisition.
5. Record the disposal of property, plant, and equipment.
6. Understand the disclosures of property, plant, and equipment.
7. Explain the accounting for oil and gas properties. (appendix)
Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives
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8. Identify the factors involved in depreciation.
9. Explain the alternative methods of cost allocation, including activity and time-based methods.
10. Record depreciation.
11. Explain the conceptual issues regarding depreciation methods.
12. Understand the disclosure of depreciation.
13. Understand additional depreciation methods, including group and composite methods.
14. Compute depreciation for partial periods.
15. Explain the impairment of noncurrent assets.
16. Understand depreciation for income tax purposes.
17. Explain changes and corrections of depreciation.
18. Understand and record depletion.
Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives
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Actively Used in Operations
Expected to Benefit Future Periods
Tangible
PhysicalSubstance
Intangible
No PhysicalSubstance
Operational AssetsOperational AssetsOperational AssetsOperational Assets
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Expected to Benefit Future Periods
Actively Used in Operations
Examples
Tangible
PhysicalSubstance
Operational AssetsOperational AssetsOperational AssetsOperational Assets
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1. The asset must be held for use and not for investment.
2. The asset must have an expected life of more than one year.
3. The asset must be tangible in nature.
To be included in the property, plant, and equipment category, an asset must have three characteristics:
Characteristics of Property, Plant, and EquipmentCharacteristics of Property, Plant, and EquipmentCharacteristics of Property, Plant, and EquipmentCharacteristics of Property, Plant, and Equipment
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Actively Used in Operations
Expected to Benefit Future Periods• Value represented by rights that produce benefits
GoodwillPatentsCopyrightsTrademarks
• Assets subject to amortization
Examples
Intangible
No PhysicalSubstance
Operational AssetsOperational AssetsOperational AssetsOperational Assets
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General Rule
The historical cost of acquiring an asset includes the costs necessarily incurred to bring it to the condition and location necessary for its intended use.
Acquisition CostAcquisition CostAcquisition CostAcquisition Cost
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Contract priceContract price Remodeling and reconditioningRemodeling and reconditioning Excavating for the specific buildingExcavating for the specific building Architectural and building permit Architectural and building permit
costscosts Capitalized interestCapitalized interest Certain unanticipated costsCertain unanticipated costs
Contract priceContract price Remodeling and reconditioningRemodeling and reconditioning Excavating for the specific buildingExcavating for the specific building Architectural and building permit Architectural and building permit
costscosts Capitalized interestCapitalized interest Certain unanticipated costsCertain unanticipated costs
Cost of BuildingsCost of Buildings
Acquisition of Property,Acquisition of Property, Plant, and Equipment Plant, and EquipmentAcquisition of Property,Acquisition of Property, Plant, and Equipment Plant, and Equipment
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Installation costs Net purchase price Modification to building
necessary to install equipment
Transportation costs
Cost of Machinery, Furniture, and FixturesCost of Machinery, Furniture, and Fixtures
Acquisition of Property,Acquisition of Property, Plant, and Equipment Plant, and EquipmentAcquisition of Property,Acquisition of Property, Plant, and Equipment Plant, and Equipment
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Contract priceContract price Costs of closing the Costs of closing the
transaction, obtaining transaction, obtaining the title, options, legal the title, options, legal fees, title search, fees, title search, insurance, past due insurance, past due taxestaxes
Contract priceContract price Costs of closing the Costs of closing the
transaction, obtaining transaction, obtaining the title, options, legal the title, options, legal fees, title search, fees, title search, insurance, past due insurance, past due taxestaxes
Cost of LandCost of Land
Cost of surveysCost of surveys Clearing and grading Clearing and grading
property to get it ready property to get it ready for its intended usefor its intended use
Razing old buildings Razing old buildings (net of salvage)(net of salvage)
Cost of surveysCost of surveys Clearing and grading Clearing and grading
property to get it ready property to get it ready for its intended usefor its intended use
Razing old buildings Razing old buildings (net of salvage)(net of salvage)
Acquisition of Property,Acquisition of Property, Plant, and Equipment Plant, and EquipmentAcquisition of Property,Acquisition of Property, Plant, and Equipment Plant, and Equipment
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LandscapingLandscaping StreetsStreets SidewalksSidewalks SewersSewers
Cost of Land ImprovementsCost of Land Improvements
Acquisition of Property,Acquisition of Property, Plant, and Equipment Plant, and EquipmentAcquisition of Property,Acquisition of Property, Plant, and Equipment Plant, and Equipment
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DrivewaysDrivewaysParking lotsParking lotsFencingFencingLandscapingLandscaping
Cost of Land ImprovementsCost of Land Improvements
Acquisition of Property,Acquisition of Property, Plant, and Equipment Plant, and EquipmentAcquisition of Property,Acquisition of Property, Plant, and Equipment Plant, and Equipment
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Several assets are acquired for a single,lump-sum price that may be lower thanthe sum of the individual asset prices.
Asset 4Asset 3Asset 2Asset 1
Lump-Sum PurchaseLump-Sum PurchaseLump-Sum PurchaseLump-Sum Purchase
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Several assets are acquired for a single,lump-sum price that may be lower thanthe sum of the individual asset prices.
Asset 4Asset 3Asset 2Asset 1
Portions of the lump-sumprice attributable toparticular assets areassigned to those assets.
Lump-Sum PurchaseLump-Sum PurchaseLump-Sum PurchaseLump-Sum Purchase
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Several assets are acquired for a single,lump-sum price that may be lower thanthe sum of the individual asset prices.
Asset 4Asset 3Asset 2Asset 1
Allocation of theremaining lump-sumprice is based onrelative values ofthe individual assets.
Portions of the lump-sumprice attributable toparticular assets areassigned to those assets.
Lump-Sum PurchaseLump-Sum PurchaseLump-Sum PurchaseLump-Sum Purchase
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Lump-Sum PurchasesLump-Sum Purchases
1. Under the proportional method, the value of each asset is based on the proportion of it’s market value to the total market value of the group of assets being purchased.
2. The incremental method is used when market values are not available for all of the assets.
Acquisition of Property,Acquisition of Property, Plant, and Equipment Plant, and EquipmentAcquisition of Property,Acquisition of Property, Plant, and Equipment Plant, and Equipment
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Proportional MethodProportional Method
A company pays $120,000 for land and a building. The land and building are appraised at $50,000 and $75,000, respectively.
A company pays $120,000 for land and a building. The land and building are appraised at $50,000 and $75,000, respectively.
Appraisal Relative Fair Total Allocated Value Value x Cost = Cost
Land $ 50,000 $50,000/$125,000 x $120,000 = $ 48,000Building 75,000 $75,000/$125,000 x $120,000 = 72,000Total $125,000 $120,000
Acquisition of Property,Acquisition of Property, Plant, and Equipment Plant, and EquipmentAcquisition of Property,Acquisition of Property, Plant, and Equipment Plant, and Equipment
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Proportional MethodProportional Method
A company pays $120,000 for land and a building. The land and building are appraised at $50,000 and $75,000, respectively.
A company pays $120,000 for land and a building. The land and building are appraised at $50,000 and $75,000, respectively.
Land 48,000Building 72,000 Cash 120,000
Acquisition of Property,Acquisition of Property, Plant, and Equipment Plant, and EquipmentAcquisition of Property,Acquisition of Property, Plant, and Equipment Plant, and Equipment
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A company pays $120,000 for a truck and a used custom made machine. The truck has a value of $70,000 but the value of the machine is unknown.
A company pays $120,000 for a truck and a used custom made machine. The truck has a value of $70,000 but the value of the machine is unknown.
Truck 70,000Equipment 50,000 Cash 120,000
Incremental MethodIncremental Method
Incremental MethodIncremental MethodIncremental MethodIncremental Method
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When plant assets are used that require substantial costs of dismantling, removal, and site reclamation at the end of the asset’s useful life . . .
The present value of these costs should be
capitalized and the associated liability should be
recognized when the following criteria are met:
Capitalized ClosureCapitalized Closureand Removal Costsand Removal CostsCapitalized ClosureCapitalized Closureand Removal Costsand Removal Costs
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1. The cost can be estimated.
2. The liability is the result of the future requirement to close
or remove the asset, and cannot be satisfied until the
operation of the asset ceases.
3. The liability cannot be avoided if the asset is used as
intended.
Capitalized ClosureCapitalized Closureand Removal Costsand Removal CostsCapitalized ClosureCapitalized Closureand Removal Costsand Removal Costs
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• With cash
• On credit
• In exchange for equity securities of the acquiring
company
• Through donation from another entity
• Through construction
• In exchange for
nonmonetary assets
Asset AcquisitionAsset AcquisitionAsset AcquisitionAsset Acquisition
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The asset acquired is recorded at the
Cash equivalent price (market value)
or
Present value of future cash payments using the
prevailing market interest rate
Whichever is more objective and reliable. (APB Opinion No.
21)
Purchase on CreditPurchase on CreditPurchase on CreditPurchase on Credit
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On May 1, X6, Fesler, Inc. purchased equipment paying
$3,000 down and issuing a note payable. The note
requires four annual payments of $2,500 with the first
payment due on May 1, X7. The note is noninterest-
bearing. The prevailing market rate of interest on notes of
this nature is 12%.
Prepare the required journal entries on May 1, X6 and
December 31, X6 (year-end).
Purchase on CreditPurchase on CreditExampleExamplePurchase on CreditPurchase on CreditExampleExample
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Annuity payment 2,500$ PVA $1, n = 4, i = 12% 3.03735 PV of note (rounded) 7,593$ Down payment 3,000 Cost of equipment 10,593$
Purchase on CreditPurchase on CreditExampleExamplePurchase on CreditPurchase on CreditExampleExample
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GENERAL JOURNAL Page 1
Date Description PR Debit Credit
5/1 Equipment 10,593 Discount on Note Payable 2,407
Cash 3,000 Note Payable 10,000
Discount = $10,000 - $7,593
Purchase on CreditPurchase on CreditExampleExamplePurchase on CreditPurchase on CreditExampleExample
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GENERAL JOURNAL Page 1
Date Description PR Debit Credit
12/31 Interest Expense 607 Discount on Note Payable 607
$7,593 ×12% ×8/12 = $607
(rounded)
Purchase on CreditPurchase on CreditExampleExamplePurchase on CreditPurchase on CreditExampleExample
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• Asset acquired is recorded at the market value of the
asset or the market value of the securities, whichever is
more objective and reliable.
• If the securities are actively traded, market value can be
easily determined.
• If no objective and reliable value can be determined,
board of directors assigns a reasonable value.
Purchased With Equity SecuritiesPurchased With Equity SecuritiesPurchased With Equity SecuritiesPurchased With Equity Securities
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• Municipalities may donate land and buildings to
induce a company to locate in the area.
• SFAS No. 116 defines a contribution as
“an unconditional transfer of cash or other
assets to
an entity or a settlement or cancellation of its
liabilities in a voluntary nonreciprocal
transfer. . .”
Donated AssetsDonated AssetsDonated AssetsDonated Assets
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• SFAS NO.116:
Donated assets are capitalized at market
value and revenue from donated assets
is recognized.
Donated AssetsDonated AssetsDonated AssetsDonated Assets
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Assets Acquired by DonationAssets Acquired by Donation
The CEO of Hrouda Company donates a building worth $50,000 to the company.
The CEO of Hrouda Company donates a building worth $50,000 to the company.
Building 50,000 Gain from Donation of Land 50,000 (by a nongovernmental unit)
The gain is reported in the Other section of the income statement.
Donated AssetsDonated AssetsDonated AssetsDonated Assets
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Assets Acquired by DonationAssets Acquired by Donation
The City of Julesberg (a governmental unit) donates land worth $20,000 to the Klemme Company.
The City of Julesberg (a governmental unit) donates land worth $20,000 to the Klemme Company.
Land 20,000 Donated Capital 20,000
(by a governmental unit)
Donated AssetsDonated AssetsDonated AssetsDonated Assets
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• Contributed services that enhance nonfinancial assets
are recognized as expenses and revenues on receipt.
• Contribution of collectibles, like works of art for public
display, are disclosed, but not recognized in the
accounts.
Donated AssetsDonated AssetsDonated AssetsDonated Assets
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The cost of materials, labor, and overhead used in the self-construction of property, plant, and equipment intended for a firm’s production process are added to the cost of the asset.
The cost of materials, labor, and overhead used in the self-construction of property, plant, and equipment intended for a firm’s production process are added to the cost of the asset.
Self-Constructed AssetsSelf-Constructed AssetsSelf-Constructed AssetsSelf-Constructed Assets
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• The asset’s recorded cost must never exceed its fair
market value.
• If costs actually incurred exceed fair market value, a loss
must be recognized.
Self-Constructed AssetsSelf-Constructed AssetsSelf-Constructed AssetsSelf-Constructed Assets
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Assume that Kelvin Corporation complete a project with total construction costs as follows:
Material $ 200,000
Labor 500,000
Incremental overhead 60,000
Applied general overhead 40,000
Capitalized interest 100,000
Total $ 900,000
Self-Constructed AssetsSelf-Constructed AssetsSelf-Constructed AssetsSelf-Constructed Assets
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If the asset’s market value at completion
equals or exceeds $900,000:
Equipment 900,000
Equipment under construction 900,000
If the asset’s market value is only $880,000 Equipment 880,000
Loss on construction of equipment 20,000
Equipment under construction 900,000
Self-Constructed AssetsSelf-Constructed AssetsSelf-Constructed AssetsSelf-Constructed Assets
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• They must require a period of time to
make them ready for use.
• There are two types of qualifying
assets: 1. Assets under construction for use in
operations, and
2. Discrete assets intended for sale or lease.
41
Interest Capitalization - Qualifying AssetsInterest Capitalization - Qualifying Assets
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Interest cannot be capitalized for the following types of assets:
1. Inventories that are routinely manufactured or otherwise produced in large quantities on a repetitive basis.
2. Assets that are in use or ready for their intended use.
3. 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.
Interest Capitalization Interest Capitalization
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• Capitalization begins when . . .
Qualifying expenditures have been made, and
Construction activities are underway, and
Interest cost has been incurred.
• Capitalization ends when . . .
The asset is substantially complete and ready
for
its intended use.
Interest Capitalization Interest Capitalization
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– Avoidable interest
interest that could have been avoided if the asset
were not con-structed and the money used to retire
debt.
Interest Capitalization Interest Capitalization
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Determineweighted-averageaccumulatedexpenditures
1
Avoidable interest
Appropriateinterest rate(s)
2
Multiplyby
45
Interest Capitalization-Computing Avoidable Interest Capitalization-Computing Avoidable InterestInterestInterest Capitalization-Computing Avoidable Interest Capitalization-Computing Avoidable InterestInterest
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• Interest is capitalized on Average Accumulated
Expenditures (AAE)
Qualifying expenditures weighted for the number of months
outstanding during the current accounting period.
• Qualifying Expenditures
Cash payments for construction
Transfer of other assets
Incurrence of interest-bearing liabilities
Interest Capitalization Interest Capitalization
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Amber makes the following two payments in 2004: Jan 31: $24,000 July 31: $18,000Capitalization period ran from Jan 31 – Dec 31.What is the WAAE?
Jan 31: $24,000 × (11/12) $22,000July 31: $18,000 × (5/12) $ 7,500
WAAE $29,500
47
Determining Weighted-Average AccumulatedExpenditures (WAAE): Example
Determining Weighted-Average AccumulatedExpenditures (WAAE): Example
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• Interest Potentially Capitalizable (IPC)
Multiply the AAE by the capitalization rate or rates.
Interest Capitalization Interest Capitalization
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• Capitalization Rate(s)
If the qualifying asset is financed through a
specific new borrowing, the interest rate on the
new borrowing is used for the computation of IPC.
If the qualifying asset is internally financed, the
capitalization rate will be the weighted-average
cost of debt.
Use both rates, if partially financed with a new
borrowing.
Interest Capitalization Interest Capitalization
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AAE less than specific new borrowing
SpecificnewborrowingAAE
Capitalize AAEusing specificborrowing rate
Interest Capitalization Interest Capitalization
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AAE more than specific new borrowing
Specific newborrowing
AAECapitalize this part of AAE using specificborrowing rate
Other debt
Capitalize this part of AAEusing weighted averagerate of other debt
Interest Capitalization Interest Capitalization
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Steps in the capitalization process
1. Compute actual interest expense.
2. Compute AAE.
3. Compute IPC.
4. Capitalize the smaller of actual interest or IPC.
Interest Capitalization Interest Capitalization
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Welling, Inc. is constructing a building for its own use.
Construction activities started on May 1 and have continued
through Dec. 31. Welling made the following qualifying
expenditures: May 1, $125,000; July 31, $160,000, Oct. 1,
$200,000; and Dec. 1, $300,000.
Welling recorded total interest expense of $175,000 during
the year, including construction borrowing of $1,000,000 on
May 1, from Bub’s Bank for 10 years at 12%.
Interest CapitalizationInterest CapitalizationExampleExampleInterest CapitalizationInterest CapitalizationExampleExample
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Actual interest expense is $175,000.
Compute AAE:
Fraction ofDate Expenditure Year AAE5/1 125,000$ 8/12 83,333$
7/31 160,000 5/12 66,667 10/1 200,000 3/12 50,000 12/1 300,000 1/12 25,000
785,000$ 225,000$
Interest CapitalizationInterest CapitalizationExampleExampleInterest CapitalizationInterest CapitalizationExampleExample
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Compute IPC:
Since we have a specific new borrowing, and
the amount of the borrowing ($1,000,000)
exceeds the AAE ($225,000), we use the
interest rate on the specific new borrowing for
the capitalization.
IPC = AAE × Capitalization rate
IPC = $225,000 × 12% = $27,000
Interest CapitalizationInterest CapitalizationExampleExampleInterest CapitalizationInterest CapitalizationExampleExample
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Capitalize the smaller of actual interest or IPC.
Actual interest = $175,000
IPC = $27,000
Capitalize $27,000
Interest CapitalizationInterest CapitalizationExampleExampleInterest CapitalizationInterest CapitalizationExampleExample
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GENERAL JOURNAL Page 14
Date Description PR Debit Credit
12/31 Construction-In-Progress 27,000
Interest Expense 27,000
Interest CapitalizationInterest CapitalizationExampleExampleInterest CapitalizationInterest CapitalizationExampleExample
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GENERAL JOURNAL Page 14
Date Description PR Debit Credit
12/31 Construction-In-Progress 27,000
Interest Expense 27,000
ACCOUNT NAME: C-I-P Account No. 142
Date Description PR Debit Credit Balance
12/31 Balance 785,000
12/31 Capitalization of interest 27,000 812,000
Interest CapitalizationInterest CapitalizationExampleExampleInterest CapitalizationInterest CapitalizationExampleExample
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GENERAL JOURNAL Page 14
Date Description PR Debit Credit
12/31 Construction-In-Progress 27,000
Interest Expense 27,000
ACCOUNT NAME: Interest Expense Account No. 571
Date Description PR Debit Credit Balance
12/31 Balance 175,000
12/31 Capitalization of Interest 27,000 148,000
Interest CapitalizationInterest CapitalizationExampleExampleInterest CapitalizationInterest CapitalizationExampleExample
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• Update depreciation to date of disposal.
• Original cost of asset and accumulated depreciation are
removed from the accounts.
• The difference between book value of the asset and the
amount received in the disposal process is recorded as
a gain or loss.
Disposal of Plant AssetsDisposal of Plant AssetsDisposal of Plant AssetsDisposal of Plant Assets
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On June 30,2006, MeLo, Inc. sells equipment for
$6,350 cash. The equipment was purchased on
January 1, 19X1 at a cost of $15,000. The asset has a
useful life of 10 years and no salvage value. MeLo last
recorded depreciation on the equipment on December
31, 2005, its year-end.
Prepare the journal entries necessary to record the
disposal of this equipment.
Disposal of Plant AssetsDisposal of Plant AssetsExampleExampleDisposal of Plant AssetsDisposal of Plant AssetsExampleExample
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Update depreciation to date of sale.
GENERAL JOURNAL Page 9
Date Description PR Debit Credit
6/30 Depreciation Expense 750
Accumulated Depreciation 750
$15,000 ÷ 10 yrs. ÷ 2 = $750
Disposal of Plant AssetsDisposal of Plant AssetsExampleExampleDisposal of Plant AssetsDisposal of Plant AssetsExampleExample
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Remove asset and Accumulated Depreciation and
recognize gain or loss.
6/30 Accumulated Depreciation 8,250
Cash 6,350
Loss on Sale 400
Equipment 15,000
($15,000 ÷10 years) ×5.5years = $8,250
Disposal of Plant AssetsDisposal of Plant AssetsExampleExampleDisposal of Plant AssetsDisposal of Plant AssetsExampleExample
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The general exchange principle is that the cost of a nonmonetary asset acquired in exchange for another nonmonetary asset is the fair value of the asset surrendered.
The general exchange principle is that the cost of a nonmonetary asset acquired in exchange for another nonmonetary asset is the fair value of the asset surrendered.
Nonmonetary Asset ExchangesNonmonetary Asset ExchangesNonmonetary Asset ExchangesNonmonetary Asset Exchanges
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• Cost of asset acquired isFair value of asset transferred plus cash paid or
minus cash
received
or
Fair value of asset acquired, if it is more readily
determinable.
Nonmonetary Asset ExchangesNonmonetary Asset ExchangesNonmonetary Asset ExchangesNonmonetary Asset Exchanges
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The Company acquiring the asset recognizes a gain or loss on the exchange as the difference between the fair value of the asset surrendered and its book value.
The Company acquiring the asset recognizes a gain or loss on the exchange as the difference between the fair value of the asset surrendered and its book value.
Nonmonetary Asset ExchangesNonmonetary Asset ExchangesNonmonetary Asset ExchangesNonmonetary Asset Exchanges
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• A nonmonetary exchange is considered to
have commercial substance if the
company(1) Expects a change in future cash flows as a result
of
the exchange and
(2) That expected change is significant relative to the
fair value of the assets exchanged.
Nonmonetary Asset ExchangesNonmonetary Asset ExchangesNonmonetary Asset ExchangesNonmonetary Asset Exchanges
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A company would not recognize a gain if the transaction lacks “commercial substance; that is, future cash flows are not expected change significantly.
A company would not recognize a gain if the transaction lacks “commercial substance; that is, future cash flows are not expected change significantly.
Nonmonetary Asset ExchangesNonmonetary Asset ExchangesNonmonetary Asset ExchangesNonmonetary Asset Exchanges
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Commercial SubstanceCommercial Substance
Arnold Company Carbon Company
Cost $100,000Accum. depr. 54,000Fair value 40,000
Cost $60,000Accum. depr. 32,000Fair value 40,000
Assets Acquired by Assets Acquired by Exchange of Other AssetsExchange of Other AssetsAssets Acquired by Assets Acquired by Exchange of Other AssetsExchange of Other Assets
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Arnold Company
Cost $100,000Accum. depr. 54,000Fair value 40,000
Equipment 40,000Accum. depr. 54,000Loss 6,000 Building 100,000
Book value $46,000Fair value 40,000Loss $6,000
Commercial SubstanceCommercial Substance
Assets Acquired by Assets Acquired by Exchange of Other AssetsExchange of Other AssetsAssets Acquired by Assets Acquired by Exchange of Other AssetsExchange of Other Assets
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Company A
Equipment 40,000Accum. depr. 54,000Loss 6,000 Building 100,000
Cost $40,000 Book value $46,000Fair value 40,000Loss $6,000
Commercial SubstanceCommercial Substance
Assets Acquired by Assets Acquired by Exchange of Other AssetsExchange of Other AssetsAssets Acquired by Assets Acquired by Exchange of Other AssetsExchange of Other Assets
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Cost $60,000Accum. Depr. 32,000Fair value 40,000
Building 40,000Accum. Depr. 32,000 Equipment 60,000 Gain 12,000
Book value $28,000Fair value 40,000Gain $12,000
Commercial SubstanceCommercial Substance
Carbon Company
Assets Acquired by Assets Acquired by Exchange of Other AssetsExchange of Other AssetsAssets Acquired by Assets Acquired by Exchange of Other AssetsExchange of Other Assets
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Cost $40,000Book value $28,000Fair value 40,000Gain $12,000
Building 40,000Accum. Depr. 32,000 Equipment 60,000 Gain 12,000
Commercial SubstanceCommercial Substance
Carbon Company
Assets Acquired by Assets Acquired by Exchange of Other AssetsExchange of Other AssetsAssets Acquired by Assets Acquired by Exchange of Other AssetsExchange of Other Assets
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Commercial Substance with BootCommercial Substance with Boot
Arnold Company
Cost $100,000Accum. depr. 54,000Fair value 40,000Cash received 5,000
Cost $60,000Accum. depr. 32,000Fair value 35,000Cash paid 5,000
Carbon Company
Assets Acquired by Assets Acquired by Exchange of Other AssetsExchange of Other AssetsAssets Acquired by Assets Acquired by Exchange of Other AssetsExchange of Other Assets
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Arnold Company
Cost $100,000Accum. depr. 54,000Fair value 40,000Cash received 5,000
Equipment 35,000Accum. depr. 54,000Cash 5,000Loss 6,000 Building 100,000
Book value $46,000Fair value 40,000Loss $6,000
Commercial Substance with BootCommercial Substance with Boot
Assets Acquired by Assets Acquired by Exchange of Other AssetsExchange of Other AssetsAssets Acquired by Assets Acquired by Exchange of Other AssetsExchange of Other Assets
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Arnold Company Equipment 35,000Accum. depr. 54,000Cash 5,000Loss 6,000 Building 100,000
Cost $35,000
Commercial Substance with BootCommercial Substance with Boot
Assets Acquired by Assets Acquired by Exchange of Other AssetsExchange of Other AssetsAssets Acquired by Assets Acquired by Exchange of Other AssetsExchange of Other Assets
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Cost $60,000Accum. Depr. 32,000Fair value 35,000Cash paid 5,000
Building 40,000Accum. Depr. 32,000 Equipment
60,000 Cash
5,000 Gain
7,000
Book value $28,000Fair value 35,000Gain $7,000
Commercial Substance with BootCommercial Substance with Boot
Carbon Company
Assets Acquired by Assets Acquired by Exchange of Other AssetsExchange of Other AssetsAssets Acquired by Assets Acquired by Exchange of Other AssetsExchange of Other Assets
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Let’s change the subject.
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• If cost incurred increase future benefits,
capitalize costs.
• If costs maintain a given level of services,
expense costs.
79
Post-Acquisition ExpendituresPost-Acquisition ExpendituresPost-Acquisition ExpendituresPost-Acquisition Expenditures
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Extending the life of the asset.Extending the life of the asset. Improving the productivity.Improving the productivity. Producing the same product at lower Producing the same product at lower
cost.cost. Increasing the quality of the product.Increasing the quality of the product.
Extending the life of the asset.Extending the life of the asset. Improving the productivity.Improving the productivity. Producing the same product at lower Producing the same product at lower
cost.cost. Increasing the quality of the product.Increasing the quality of the product.
The future economic benefits of a productive asset or product can be increased by--
Post-Acquisition ExpendituresPost-Acquisition ExpendituresPost-Acquisition ExpendituresPost-Acquisition Expenditures
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• Maintenance and ordinary repairs.
• Improvements (betterments), replacements, and extraordinary repairs.
• Additions.
• Rearrangements and other adjustments.
Post-Acquisition ExpendituresPost-Acquisition ExpendituresPost-Acquisition ExpendituresPost-Acquisition Expenditures
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Normally we debit an expenseexpense account for amounts spent on:
Maintenance and Ordinary RepairsMaintenance and Ordinary Repairs
Post-Acquisition ExpendituresPost-Acquisition ExpendituresPost-Acquisition ExpendituresPost-Acquisition Expenditures
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Maintenance and Ordinary RepairsMaintenance and Ordinary Repairs
1. Incurred approach
2. Allocation approach Repair and maintenance expense xxx
Allowance for repairs and maintenance xxx
Post-Acquisition ExpendituresPost-Acquisition ExpendituresPost-Acquisition ExpendituresPost-Acquisition Expenditures
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Normally we debit the assetasset account for amounts spent on:
Improvements, Replacements,Improvements, Replacements,
and Extraordinary Repairsand Extraordinary Repairs
Concept: increase useful life or productivity of the original asset.
Post-Acquisition ExpendituresPost-Acquisition ExpendituresPost-Acquisition ExpendituresPost-Acquisition Expenditures
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A company decides to replace its oil furnace with a gas furnace.
The oil furnace is carried on the books at a cost of $50,000 with
an accumulated depreciation of $30,000. The scrap value of
the old furnace is $5,000, and the new furnace costs $70,000.
A company decides to replace its oil furnace with a gas furnace.
The oil furnace is carried on the books at a cost of $50,000 with
an accumulated depreciation of $30,000. The scrap value of
the old furnace is $5,000, and the new furnace costs $70,000.
Furnace 70,000Accumulated Depreciation: Furnace 30,000Loss on Disposal of Furnace 15,000 Furnace 50,000 Cash 65,000Substitution MethodSubstitution Method
Improvements and ReplacementsImprovements and ReplacementsImprovements and ReplacementsImprovements and Replacements
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A capital expenditure of $80,000 is incurred to enlarge a factory.
A capital expenditure of $80,000 is incurred to enlarge a factory.
Factory 80,000 Cash 80,000
Increase the Asset AccountIncrease the Asset Account
Improvements, Replacements and AdditionsImprovements, Replacements and AdditionsImprovements, Replacements and AdditionsImprovements, Replacements and Additions
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A capital expenditure of $60,000 is incurred in replacing a roof on a factory building.
A capital expenditure of $60,000 is incurred in replacing a roof on a factory building.
Accumulated Depreciation 60,000 Cash 60,000
Reduce Accumulated DepreciationReduce Accumulated Depreciation
Improvements and ReplacementsImprovements and ReplacementsImprovements and ReplacementsImprovements and Replacements
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Normally we debit the asset asset account for
amounts spent on:
AdditionsAdditions
Concept: expansion of an existing asset.
Post-Acquisition ExpendituresPost-Acquisition ExpendituresPost-Acquisition ExpendituresPost-Acquisition Expenditures
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Normally we debit an other asset other asset account
for amounts spent on:
Rearrangements and Other AdjustmentsRearrangements and Other Adjustments
Concept: increase efficiency of
operations.
Post-Acquisition ExpendituresPost-Acquisition ExpendituresPost-Acquisition ExpendituresPost-Acquisition Expenditures
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Bean Company has a machine that originally cost $10,000, has accumulated depreciation of $8,000 at the beginning of the current year, and is being depreciated at $1,000 per year. On December 30, the company sells the machine for $600.
Bean Company has a machine that originally cost $10,000, has accumulated depreciation of $8,000 at the beginning of the current year, and is being depreciated at $1,000 per year. On December 30, the company sells the machine for $600.
Depreciation 1,000 Accumulated Depreciation 1,000
To bring depreciation to point of sale.To bring depreciation to point of sale.
Disposal of Property, Plant,Disposal of Property, Plant,and Equipmentand EquipmentDisposal of Property, Plant,Disposal of Property, Plant,and Equipmentand Equipment
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Cash 600Accumulated Depreciation 9,000Loss on Disposal 400 Machine 10,000
To record disposal of machine for $600.To record disposal of machine for $600.
Bean Company has a machine that originally cost $10,000, has accumulated depreciation of $8,000 at the beginning of the current year, and is being depreciation at $1,000 per year. On December 30, the company sells the machine for $600.
Bean Company has a machine that originally cost $10,000, has accumulated depreciation of $8,000 at the beginning of the current year, and is being depreciation at $1,000 per year. On December 30, the company sells the machine for $600.
Disposal of Property, Plant,Disposal of Property, Plant,and Equipmentand EquipmentDisposal of Property, Plant,Disposal of Property, Plant,and Equipmentand Equipment
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• The acquisition cost of an operational asset represents a bundle of future services that help earn future revenues.
• The matching principle requires that part of the acquisition cost be expensed in periods when the future revenues are earned.
AcquisitionCost
Expense
(Unused) (Used)
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Depreciation, depletion, and amortization are cost allocation processes that systematically and rationally allocate acquisition costs of operational assets to periods benefited by their use.
Cost
Allocation
AcquisitionCost
Expense
(Unused) (Used)
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Type ofOperational Expense
Asset Debit Account Credited
Property, Plantand Equipment Depreciation Accumulated Depreciation
Natural Resource Depletion Natural Resource Asset
Intangible Amortization Intangible Asset
Depreciation is a cost allocation cost allocation process and has nothing to do with asset valuation.
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Depreciation Expense
• Temporary account, reported on the income statement.
• Balance in Depreciation Expense indicates how much depreciation has been recorded in the current year.
Accumulated Depreciation
• Permanent account, reported on the balance sheet as a deduction from plant assets.
• Balance in Accumulated Depreciation is a cumulative total of all depreciation recorded on an asset.
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Property, plant, and equipment: Land and buildings 150,000$ Machinery and equipment 200,000 Office furniture and equipment 175,000 Land improvements 50,000 Total 575,000$Less Accumulated depreciation (122,000) Net property, plant, and equipment 453,000$
Net property, plant, and equipment is the undepreciated cost (book value) of the plant assets.
Depreciation on the Balance SheetDepreciation on the Balance SheetDepreciation on the Balance SheetDepreciation on the Balance Sheet
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• Depreciation is a means of cost
allocation.
• It is not a method of valuation.
• Depreciation involves: allocating the cost of tangible assets to
expense in a systematic and rational manner
to periods expected to benefit from use of its
depreciable assets.
8
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Asset cost
Service life
Residual value
Method of cost allocation
Factors Involved in DepreciationFactors Involved in DepreciationFactors Involved in DepreciationFactors Involved in Depreciation
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Residual ValueResidual Value
Residual, or salvage value, is the net amount that can be expected to be obtained when the asset is disposed.
Residual, or salvage value, is the net amount that can be expected to be obtained when the asset is disposed.
Factors Involved in DepreciationFactors Involved in DepreciationFactors Involved in DepreciationFactors Involved in Depreciation
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Service LifeService Life
Service life is the measure of the number of units of service expected from the asset before its disposal.
Service life is the measure of the number of units of service expected from the asset before its disposal.
Factors Involved in DepreciationFactors Involved in DepreciationFactors Involved in DepreciationFactors Involved in Depreciation
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Service LifeService Life
The factors that limit the service life of an asset can be divided into two general categories.
The factors that limit the service life of an asset can be divided into two general categories.
Physical causesFunctional causes
Factors Involved in DepreciationFactors Involved in DepreciationFactors Involved in DepreciationFactors Involved in Depreciation
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Straight-line.
Based on inputs and outputs.
Service hours (SH) method.
Productive output (PO) or units-of-production method.
Accelerated methods.
Sum-of-the-years?digits (SYD).
Double-declining-balance (DB).
Tax depreciation.
Depreciation systems.
Inventory appraisal.
Group and composite.
Depreciation MethodsDepreciation MethodsDepreciation MethodsDepreciation Methods