1 Investments in Noncurrent Operating Assets-- Acquisitions

1

Investments Investments in in

Noncurrent Noncurrent Operating Operating Assets--Assets--

AcquisitionsAcquisitions

2

Identify those costs to be included in the acquisition cost of different types of noncurrent operating assets.

Properly account for noncurrent operating asset acquisitions using various special arrangements, including deferred payment, self-construction, and acquisition of an entire company.

Learning Objectives

3

Separate costs into those that should be expensed immediately and those that should be capitalized, and understand the accounting standards for research and development and oil and gas exploration costs.

Discuss the pros and cons of recording noncurrent operating assets at their current value.

Learning Objectives

4

Learning Objectives

Use the fixed asset turnover ratio as a general measure of how efficiently a company is using its property, plant, and equipment.

EXPANDED MATERIAL

Evaluate the different ways to compute capitalized interest and properly incorporate midyear loans into the capitalized interest calculations.

5

Time Line of Business and Accounting Issues Involved With Long-Term Operating

Assets

6

EVALUATE possible

acquisition of long-term

operating items

7

ACQUIRE long-term

operating assets

8

DISTINGUISH between those

items to be expensed and those

to be capitalized

9

RECORD long-term

operating assets at appropriate

amount

10

ESTIMATE and RECOGNIZE

periodic depreciation

11

MONITOR asset value for

possible decline

12

DISPOSE of asset

13

Valuation at Acquisition

• Initially record asset at cost; cost is actual cash price.

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

14

• Purchase price, commissions, legal fees, and escrow fees.

• Clearing and grading costs.

• Cost of removing unwanted structures.

• Assessments for water lines, sewers, and roads.

Acquisition Costs of Tangible Noncurrent Operating Assets

15

• Landscaping.

• Parking lots.

• Interior sidewalks.

• Light structures (for parking and sidewalks).

• Fencing.


16

• Purchase price.

• Taxes, freight, and insurance during shipping and installation.

• Special foundations or reinforcing of floors.

• Installation and testing.

Note: Any expenditure incurred in preparing the asset Note: Any expenditure incurred in preparing the asset for its intended use is charged to for its intended use is charged to Equipment.Equipment.

Note: Any expenditure incurred in preparing the asset Note: Any expenditure incurred in preparing the asset for its intended use is charged to for its intended use is charged to Equipment.Equipment.


17

• Purchase price.

• Commissions, legal fees, escrow fees, survey fees.

If ready for use:

• Contract price.

• Legal fees

If newly constructed by outsider:


If a building is self-constructed, the cost of

materials, labor, and overhead establishes the

cost of the asset.

If a building is self-constructed, the cost of

materials, labor, and overhead establishes the

cost of the asset.

18Acquisition Costs of Intangible Noncurrent Operating Assets

• Patent: Purchase price, filing and registry fees, cost of subsequent litigation to protect right. Does not include internal research and development costs.

• Copyright: Same as Patent.• Trademark and Trade Name: Same as Patent.• Franchise: Expenditures made to purchase the

franchise. Legal fees and other costs incurred in obtaining the franchise.

• Organization Costs: Expenditures to organize the corporation--cost of stock certificates, underwriting costs, state incorporation fees, legal fees.

continuedcontinuedcontinuedcontinued

19Acquisition Costs of Intangible Noncurrent Operating Assets

• Software Development Costs: Expenditures made after software is determined to be technologically feasible but before it is ready for commercial production.

• Goodwill: Portion of purchase price that exceeds the sum of the current market value for all identifiable net assets.

20Acquisition Other Than Simple Cash Transactions

Basket purchaseDeferred paymentLeasingExchange of nonmonetary assets Issuance of securitiesSelf-construction Donation or discoveryAcquisition of an entire company

21

Methods of Acquisition

Basket purchase: Allocate cash price to individual assets based on percentage of

appraised or fair market value.


appraised or fair market value.Land, buildings, and

equipment are acquired for $160,000. The appraisal values at the acquisition date are: land, $28,000;

buildings, $60,000; equipment, $12,000.

Land, buildings, and equipment are acquired for $160,000. The appraisal values at the acquisition date are: land, $28,000;

buildings, $60,000; equipment, $12,000.

22






Land $ 28,000

Buildings 60,000

Equipment 12,000

$100,000

$28/$100 x $160,000 = $ 44,800

$60/$100 x $160,000 = 96,000

$12/$100 x $160,000 = 19,200$160,000

23

Deferred paymentRecord asset at face value of note, plus any

cash paid.

Record note at fair market value of acquired asset if note’s value is not determinable or is unreasonable.

Deferred paymentRecord asset at face value of note, plus any

cash paid.

Record note at fair market value of acquired asset if note’s value is not determinable or is unreasonable.


Land is acquired on January 2, 2002 for $100,0000; $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%.

Land is acquired on January 2, 2002 for $100,0000; $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%.

24


June 30, 2002

Interest Expense 3,250Notes Payable 5,000

Cash 8,250

$65,000 x 0.05%

Deferred Payment IllustrationDeferred Payment Illustration

25


• Leasing: A capital lease is economically the same as a purchase. The acquiring company records the asset and liability at the present value of future lease payments.

• Exchange of nonmonetary assets: The new asset is valued at its fair market value or at the fair market value of the asset given up, whichever is more clearly determinable.

26


• Issuance of securities: Record the asset at the fair market value of the securities issued.

• Self-construction: Recorded at cost, including all expenditures incurred to build the asset and make it ready for its intended use.

27

Interest Capitalization

Capitalization of interest is required for assets that are being self-

constructed for an enterprise’s own use and assets that are intended to be leased or sold to others that can be identified as discrete projects.

Capitalization of interest is required for assets that are being self-

constructed for an enterprise’s own use and 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.

Interest should not be capitalized for inventories manufactured or produced

on a repetitive basis.

28Interest Capitalization--Qualification

Projects are discrete.Costs are separately accumulated.Construction covers an extended period

of time.Construction costs are substantial.

When assets are acquired by self-construction, interest incurred on funds borrowed to finance construction can be capitalized if the following conditions are met:

29

Maximum capitalization equals actual interest incurred during the period.

Interest capitalization is calculated on average amount of accumulated expenditures.

Interest rate used is (1) actual rate on debt incurred specifically for the project, then (2) weighted average interest rate on all borrowings not specifically for the project.

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

Interest Capitalization--Requirements

30Interest Capitalization--Example: Scenario

Bee Wood, Inc., a construction company, decides to build a new

warehouse. The following information is applicable to the project:

31

• Construction will begin January 1, 2001, and is expected to end December 31, 2002.

• Construction costs are estimated at $640,000.

• A 12%, 2-year loan of $200,000 has been obtained and will become effective on January 1, 2001.

Interest Capitalization--Example: Scenario

32

• Bee Wood, Inc.’s other debts are:– 5-year, 10% notes payable $ 75,000– 9% mortgage 120,000

• 2001 Expenditures were:– January 1: $ 100,000– July 1: 100,000– October 1: 100,000

• In 2002, expenditures of $340,000 occurred evenly throughout the year.

Interest Capitalization--Example: Scenario

33

Maximum Interest Capitalization

Debt Amount Rate Interest

Loan $ 200,000 12% $24,000

Note 75,000 10% 7,500

Mortgage 120,000 9% 10,800

Maximum interest capitalization $42,300

Interest Capitalization--Example: Solution

34

Weighted Average Rate:

Debt Amount RateInterest

Note $ 75,000 10% $ 7,500

Mortgage 120,000 9% 10,800

$195,000$18,300


Weighted Average Rate = 9.4%($ 18,300 ÷ $195,000 = 0.0938)

Weighted Average Rate = 9.4%($ 18,300 ÷ $195,000 = 0.0938)

35

1/1/01 $100,000 12/12 $100,000

7/1/01 100,000 6/12 50,000

10/1/01 100,000 3/12 25,000

. $300,000 $175,000

Weighted Average Expenditures--2001:

Weighted

Date Amount Ratio Average


Interest Capitalization--2001:

$ 175,000 x 12% (loan) = $ 21,000

Interest Capitalization--2001:

$ 175,000 x 12% (loan) = $ 21,000

36

Weighted Average Expenditures--2002

Acc. exp. 12/31/01 $300,000

2001 interest capitalized 21,000

Adjusted acc. exp. 12/31/01 $321,000

2002 expenditures 340,000

Acc. exp. 12/31/02 $661,000

Weighted average expenditures, 2002 $491,000


($321,000 + [$340,000 ÷ 2])($321,000 + [$340,000 ÷ 2])

37

Interest Capitalization--2002: $200,000 x 12% = $24,000 $291,000 x 9.4% = 27,400

Total interest $51,400Maximum interest $42,300


Interest Capitalized, $42,300

Interest Capitalized, $42,300

38Acquisition of an Entire Company--Business Combination

There are two ways to account for a business combination--

pooling of interest and purchase.

There are two ways to account for a business combination--

pooling of interest and purchase.

The purchase method raises a problem in how to allocate the purchase price to the various

assets acquired.

The purchase method raises a problem in how to allocate the purchase price to the various

assets acquired.

Compared to pooling of interest, the purchase method records

assets at their fair market value, which results in lower earnings in

subsequent years due to higher depreciation charges.

Compared to pooling of interest, the purchase method records

assets at their fair market value, which results in lower earnings in

subsequent years due to higher depreciation charges.

Despite opposition from the business community, the FASB has taken steps to eliminate the

pooling of interest method.

Despite opposition from the business community, the FASB has taken steps to eliminate the

pooling of interest method.

39

Goodwill

• Defined: “The excess amount paid for a company in a business combination over the fair market value of the company’s identifiable assets.”

• Recording Goodwill1. Write identifiable assets up to FMV.

2. Record excess purchase price over net assets at FMV as goodwill.

3. Amortize goodwill over its economic useful life -- not to exceed 40 years.

40

Expense/Asset Continuum

Oil and Gas Exploration

Land and Buildings

Software DevelopmentSupplies

Used

RepairsResearch and Development

Expense Asset

41

Postacquisition Expenditures

Expenditures to keep plant and equipment in good operating condition are

referred to as maintenance.

Expenditures to keep plant and equipment in good operating condition are

referred to as maintenance.

Expense as incurred

Expense as incurred

42


What about expenditures that do not extend the useful life or increase

future cash flows?

What about expenditures that do not extend the useful life or increase

future cash flows?

Expense as incurred

Expense as incurred

43


If the cost of the old component is known, remove its cost and

accumulated depreciation.

If the cost of the old component is known, remove its cost and

accumulated depreciation.

Next, record cost of the new component and

recognize a gain or loss.

Next, record cost of the new component and

recognize a gain or loss.

44


What if the cost of the old component

is not known?

What if the cost of the old component

is not known?

45

Then the cost of the new component is deducted

from accumulated depreciation.

Then the cost of the new component is deducted

from accumulated depreciation.


46

Research and Development

Research and development costs include those costs of materials, equipment, facilities, personnel, purchased intangibles, contract

services, and a reasonable allocation of indirect costs that are

specifically related to R & D activities and that have no

alternative future use.

Research and development costs include those costs of materials, equipment, facilities, personnel, purchased intangibles, contract

services, and a reasonable allocation of indirect costs that are

specifically related to R & D activities and that have no

alternative future use.

47

Research and Development

ExamplesExamples Research aimed at discovery of new knowledge.

Search for applications of research findings.

Search for possible product or process alternatives.

Design, construction, and testing of preproduction prototypes.

Design, construction, and operation of a pilot plant.

48Development of Successful Software

R & D Costs (Expense)

Deferred Costs Deferred Costs (Intangible (Intangible

Assets)Assets)

Inventory Costs

Software project initiated

Technologicalfeasibility established

Software available for commercial production

Software sold

49

Sales

Average Fixed AssetsFixed asset turnover =

Fixed Asset Turnover

Lamberson Company’s sales for 2001 totaled $46,381,530. Its beginning and ending

Property, Plant, and Equipment balances were $9,678,233 and $10,088,997, respectively.

Lamberson Company’s sales for 2001 totaled $46,381,530. Its beginning and ending

Property, Plant, and Equipment balances were $9,678,233 and $10,088,997, respectively.

Average fixed assets = ($9,678,233 + $10,088,997) 2

Average fixed assets = $9,883,615

$46,381,530

$9,883,615= 4.69

50

The EndThe End

Documents

1 Investments in Noncurrent Operating Assets-- Acquisitions