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10-1
Actively Used in OperationsActively Used in Operations
Tangible
Property, Plant, Equipment &
Natural Resources
Tangible
Property, Plant, Equipment &
Natural Resources
Intangible
No PhysicalSubstance
Intangible
No PhysicalSubstance
Types of Operational Assets
Expected to Benefit Future PeriodsExpected to Benefit Future Periods
10-2
Costs to be Capitalized
General Rule
The initial cost of an operational asset includes the purchase price and all
expenditures necessary to bring the asset to its desired condition and location for use.
General Rule
The initial cost of an operational asset includes the purchase price and all
expenditures necessary to bring the asset to its desired condition and location for use.
10-3
Net purchase price Taxes Transportation costs Installation costs Modification to building necessary
to install equipment Testing and trial runs
Net purchase price Taxes Transportation costs Installation costs Modification to building necessary
to install equipment Testing and trial runs
Costs to be CapitalizedEquipment
Recurring & maintenance costs may not be capitalized
10-4
Brief Exercise 10-1
Beaverton Lumber purchased a milling machine for $35,000. In addition to the purchase price, Beaverton made the following expenditures: freight, $1,500;
installation, $3,000;
testing, $2,000;
Annual personal property tax (not sales or use related) on the machine for the first year, $500.
What is the initial cost of the machine?
10-5
Brief Exercise 10-1
Capitalized cost of the machine: Purchase price $35,000 Freight 1,500 Installation 3,000 Testing 2,000 Total cost $41,500 Note: Personal property taxes on the machine
for the period after acquisition are not part of acquisition cost. They are expensed in the period incurred.
10-6
Land is not depreciable.Land is not depreciable.
Purchase price Real estate commissions Attorney’s fees Title search Title transfer fees Title insurance premiums Removing old buildings
Purchase price Real estate commissions Attorney’s fees Title search Title transfer fees Title insurance premiums Removing old buildings
Costs to be CapitalizedLand
10-7
Separately identifiable costs ofDriveways
Parking lots
Fencing
Landscaping
Private roads
Separately identifiable costs ofDriveways
Parking lots
Fencing
Landscaping
Private roads
Costs to be CapitalizedLand Improvements
These will be depreciated
10-8
Purchase price Attorney’s fees Commissions Reconditioning
Purchase price Attorney’s fees Commissions Reconditioning
Costs to be CapitalizedBuildings
Long term leasehold improvements are also capitalized.
10-9
Brief Exercise 10-2
Fullerton Waste Management purchased land and a warehouse for $600,000. In addition to the purchase price, Fullerton made the following expenditures related to the acquisition: broker’s commission, $30,000; title insurance, $3,000 miscellaneous closing costs, $6,000. The warehouse was immediately demolished at a cost of
$18,000 in anticipation of the building of a new warehouse.
Determine the amounts Fullerton should capitalize as the cost of the land and the building.
10-10
Brief Exercise 10-2
Capitalized cost of land: Purchase price $600,000 Broker’s commission 30,000 Title insurance 3,000 Misc. closing costs 6,000 Demolition of old building 18,000
Total cost $657,000 All of the expenditures, including the costs to
demolish the old building, are included in the initial cost of the land.
10-11
Several assets are acquired for a single, lump-sum price that may be lower than the
sum of the individual asset prices.
Several assets are acquired for a single, lump-sum price that may be lower than the
sum of the individual asset prices.
Lump-Sum Purchases
Asset 2Asset 1 Asset 3
Allocation of the lump-sumprice is based on relative
values of the individual assets.
Allocation of the lump-sumprice is based on relative
values of the individual assets.
10-12
On May 13, we purchase land and building for $200,000 cash. The appraised value of the
building is $162,500, and the land is appraised at $87,500.
How much of the $200,000 purchase price will be charged to the building account?
On May 13, we purchase land and building for $200,000 cash. The appraised value of the
building is $162,500, and the land is appraised at $87,500.
How much of the $200,000 purchase price will be charged to the building account?
Lump-Sum Purchases
10-13
Appraised % of Purchase AssignedAsset Value Value Price Cost
(a) (b)* (c) (b × c)Land 87,500$ 35% 200,000$ 70,000$ Building 162,500 65% 200,000 130,000 Total 250,000$ 200,000$
* $87,500÷$250,000 = 35%
The building will be apportioned $130,000of the total purchase price of $200,000.
The building will be apportioned $130,000of the total purchase price of $200,000.
Lump-Sum Purchases
Prepare the journal entry to record the purchase.Prepare the journal entry to record the purchase.
10-14
Lump-Sum Purchases
Page 14
Date Description PR Debit Credit
May 13 Land 70,000
Building 130,000
Cash 200,000
GENERAL JOURNAL
10-15
Brief Exercise 10-3
Refer to the situation described in BE 10-2. Assume that Fullerton decides to use the warehouse rather than demolishing it. An independent appraisal estimates the market values of the land and warehouse at $420,000 and $280,000, respectively.
Determine the amounts Fullerton should capitalize as the cost of the land and the building.
10-16
Brief Exercise 10-3
Cost of land and building: Purchase price $600,000 Broker’s commission
30,000 Title insurance
3,000 Miscellaneous closing costs
6,000 Total cost $639,000The total must be allocated to the land and
building based on their relative market values:
10-17
Brief Exercise 10-3
10-18
Purchase price, exploration and development costs of: Timber Mineral deposits Oil and gas reserves
Purchase price, exploration and development costs of: Timber Mineral deposits Oil and gas reserves
Costs to be Capitalized Natural Resources
10-19
Asset Retirement Obligations
Recognize as a liabilityand a corresponding
increase in the related asset.
Recognize as a liabilityand a corresponding
increase in the related asset.
Record at fair value, usually thepresent value of future cash
outflows associated with thereclamation or restoration.
Record at fair value, usually thepresent value of future cash
outflows associated with thereclamation or restoration.
Often encountered with natural resource extraction when the land must berestored to a useable condition.
Often encountered with natural resource extraction when the land must berestored to a useable condition.
10-20
BE 10-4Smithson Mining operates a silver mine in Nevada. Acquisition, exploration, and development costs totaled $5.6 million. After the silver is extracted in approximately five years, Smithson is obligated to restore the land to its original condition, including constructing a wildlife preserve.
The company’s controller has provided the following three cash flow possibilities for the restoration costs: (1) $500,000, 20% probability; (2) $550,000, 45% probability; and (3) $650,000, 35% probability. The company’s credit-adjusted, risk-free rate of interest is 6%.
What is the initial cost of the silver mine?
10-21
Solution
10-22
BE 10-5
Refer to the situation described in BE 10-4. What is the carrying value of the asset retirement liability at the end of one year?
Assuming that the actual restoration costs incurred after extraction is completed are $596,000, what amount of gain or loss will Smithson recognize on retirement of the liability?
10-23
Solution BE10-5
Or 429,675 x 1.06
10-24
Noncash Acquisitions
Issuance of equity securities Deferred payments Donated assets Exchanges
Issuance of equity securities Deferred payments Donated assets Exchanges
The asset acquired is recorded at
the fair value of the consideration given
or
the fair value of the asset acquired,
whichever is more clearly evident.
The asset acquired is recorded at
the fair value of the consideration given
or
the fair value of the asset acquired,
whichever is more clearly evident.
10-25
Intangible Assets
Lack physicalsubstance.
Lack physicalsubstance.
Future benefitsless certain thantangible assets.
Future benefitsless certain thantangible assets.
Exclusive Rights.
Exclusive Rights.
Usually acquired for operational
use.
Usually acquired for operational
use.
IntangibleAssets
IntangibleAssets
10-26
Patents Copyrights Trademarks Franchises Goodwill
Patents Copyrights Trademarks Franchises Goodwill
Record at current cash equivalent cost, including purchase price, legal fees, and
filing fees.
Costs to be Capitalized Intangible Assets
10-27
An exclusive right recognized by law and granted by the US Patent Office for 20 years.
Holder has the right to use, manufacture, or sell the patented product or process without interference or infringement by others.
R & D costs that lead to aninternally developed patentare expensed in the periodincurred.
An exclusive right recognized by law and granted by the US Patent Office for 20 years.
Holder has the right to use, manufacture, or sell the patented product or process without interference or infringement by others.
R & D costs that lead to aninternally developed patentare expensed in the periodincurred.
Patents
10-28
Torch, Inc. has developed a new device. Research and development costs totaled
$30,000. Patent registration costs consisted of $2,000 in attorney fees and $1,000 in
federal registration fees.
What is Torch’s patent cost?
Torch, Inc. has developed a new device. Research and development costs totaled
$30,000. Patent registration costs consisted of $2,000 in attorney fees and $1,000 in
federal registration fees.
What is Torch’s patent cost?
Torch’s cost for the new patent is $3,000. The $30,000 R & D cost is expensed as
incurred.
Torch’s cost for the new patent is $3,000. The $30,000 R & D cost is expensed as
incurred.
Patents
10-29
A form of protection given by law to authors of literary, musical, artistic, and similar works.
Copyright owners have exclusive rights to print, reprint, copy, sell or distribute, perform and record the work.
Generally, the legal life of a copyright is the life of the author plus 70 years.
A form of protection given by law to authors of literary, musical, artistic, and similar works.
Copyright owners have exclusive rights to print, reprint, copy, sell or distribute, perform and record the work.
Generally, the legal life of a copyright is the life of the author plus 70 years.
Copyrights
10-30
A symbol, design, or logo associated with a business.
If internally developed, trademarks have no recorded asset cost.
If purchased, a trademark is recorded at cost.
Registered with U.S. Patent Office and renewable indefinitely in 10-year periods.
A symbol, design, or logo associated with a business.
If internally developed, trademarks have no recorded asset cost.
If purchased, a trademark is recorded at cost.
Registered with U.S. Patent Office and renewable indefinitely in 10-year periods.
Trademarks
10-31
Right to sell products or provide services purchased by franchisee from franchisor.
Right to sell products or provide services purchased by franchisee from franchisor.
Franchises
10-32
Occurs when onecompany buys
another company.
The amount by which thepurchase price exceeds the fair
market value of net assets acquired.
Only purchased goodwill is an
intangible asset.
Goodwill
Goodwill
Generally, this represents the present value of future earnings
10-33
Eddy Company paid $1,000,000 to purchase all of James Company’s
assets and assumed James Company’s liabilities of $200,000. James
Company’s assets were appraised at a fair value of $900,000.
Eddy Company paid $1,000,000 to purchase all of James Company’s
assets and assumed James Company’s liabilities of $200,000. James
Company’s assets were appraised at a fair value of $900,000.
Goodwill
10-34
What amount of goodwill should be recorded on Eddy Company books?
a. $100,000b. $200,000
c. $300,000
d. $400,000
What amount of goodwill should be recorded on Eddy Company books?
a. $100,000b. $200,000
c. $300,000
d. $400,000
Goodwill
10-35
What amount of goodwill should be recorded on Eddy Company books?
a. $100,000b. $200,000
c. $300,000
d. $400,000
What amount of goodwill should be recorded on Eddy Company books?
a. $100,000b. $200,000
c. $300,000
d. $400,000
FMV of Assets 900,000$ Debt Assumed 200,000
FMV of Net Assets 700,000$ Purchase Price 1,000,000
Goodwill 300,000$
Goodwill
10-36
Goodwill - Brief Exercise 10-6
Pro-tech Software acquired all of the outstanding stock of Reliable Software for $14 million. The book value of Reliable’s net assets (assets minus liabilities) was $8.3 million. The fair values of Reliable’s assets and liabilities equaled their book values with the exception of certain intangible assets whose fair values exceeded book values by $2.5 million*. Calculate the amount paid for goodwill.
Fair value of separately identified intangibles are excluded from goodwill.
10-37
Goodwill - Brief Exercise 10-6
10-38
Deferred Payments
Let’s consider an example where we must computethe present value of a noninterest-bearing note.
Let’s consider an example where we must computethe present value of a noninterest-bearing note.
Note payableNote payable
Market interestrate
Market interestrate
Record asset atface value of noteRecord asset at
face value of note
Less than market rateor noninterest bearingLess than market rateor noninterest bearing
Record asset at presentvalue of future cash flows.Record asset at present
value of future cash flows.
10-39
Deferred Payments
On January 2, 2012, Midwestern Corporation purchased equipment by signing a
noninterest-bearing requiring $50,000 to be paid on December 31, 2013. The prevailing market rate of interest on notes of this nature
is 10%.
Prepare the required journal entries for Midwestern on January 2, 2012; December
31, 2012 (year-end), and December 31, 2013 (year-end).
On January 2, 2012, Midwestern Corporation purchased equipment by signing a
noninterest-bearing requiring $50,000 to be paid on December 31, 2013. The prevailing market rate of interest on notes of this nature
is 10%.
Prepare the required journal entries for Midwestern on January 2, 2012; December
31, 2012 (year-end), and December 31, 2013 (year-end).
10-40
Face amount of note 50,000$ × PV of $1, n=2, i=10% 0.82645 = PV of note (rounded) 41,323$
Deferred Payments
Since we do not know the cash equivalent price in this example, we must use the
present value of the future cash payment.
GENERAL JOURNAL Page 73
Date Description PR Debit CreditJan. 2 Equipment 41,323
Discount on Note Payable 8,677 Note Payable 50,000 Discount = $50,000 - $41,323
10-41
GENERAL JOURNAL Page 74
Date Description PR Debit Credit
Dec. 31 Interest Expense 4,132 2012 Discount on Note Payable 4,132
Interest = 10% of $41,323
Dec. 31 Interest Expense 4,545 2013 Discount on Note Payable 4,545
Interest = 10% of ($41,323 + $4,132)
Dec. 31 Note Payable 50,000 2013 Cash 50,000
Deferred Payments
10-42
Brief Exercise 10-7 On June 30, Kimberly Farms purchased custom-
made harvesting machinery from a local producer. In payment, Kimberly signed a noninterest-bearing note requiring the payment of $60,000 in two years. The fair value of the machinery is not known, but an 8% interest rate properly reflects the time value of money for this type of loan agreement.
At what amount will Kimberly initially value the machinery?
How much interest expense will Kimberly recognize in its income statement for this note for the year ended December 31?
10-43
Brief Exercise 10-7
The initial value of machinery and note will be the present value of the note payment:
PV = $60,000 (.85734)1 = $51,440 1Present value of $1: n = 2, i = 8% (from Table 2)
Interest expense for 2009:$51,440 x 8% x 6/12 = $2,058
10-44
Fixed-Asset Turnover Ratio
This ratio measures how effectively a company or its unit managers uses its
fixed assets to generate revenue.
This ratio measures how effectively a company or its unit managers uses its
fixed assets to generate revenue.
Net sales Average fixed assets
Fixed assetturnover
ratio=
10-45
Dell vs. Apple comparisonDell vs. Apple comparison
2004 2003 2004 2003Property, plant, and equipment (net) 1,517$ 913$ 707$ 669$ Net sales 41,444 8,279
Dell Apple
Compute the fixed asset turnoverratio for both companies
Receivables Management
(All dollar amounts in millions)
10-46
Receivables Management
Dell
$41,444($1,517 + $913)/2
= 34.1
Apple
$8,279($707 + $669)/2
= 12.0
2004 2003 2004 2003Property, plant, and equipment (net) 1,517$ 913$ 707$ 669$ Net sales 41,444 8,279
Dell Apple
Net sales Average fixed assets
Fixed assetturnover
ratio=
Dell generated nearly three times the salesdollars for each dollar invested in fixed assets.
Dell generated nearly three times the salesdollars for each dollar invested in fixed assets.
10-47
Dispositions
Update depreciation or amortization to date of disposal. Remove original cost of asset and accumulated
depreciation or amortization from the books. The difference between book value of the asset and the
amount received is recorded as a gain or loss.
On June 30, 2013, MeLo Inc. sold equipment for $6,350 cash. The equipment was purchased on January 1, 2008, at a cost of $15,000. The equipment was depreciated using the straight-line method over an estimated 10-year life with zero
residual value. MeLo last recorded depreciation on the equipment on December 31, 2012, its year-end.
Prepare the journal entries necessary torecord the disposition of this equipment.
10-48
Update depreciation to date of sale.Dispositions
June 30, 2013:Depreciation expense ($15,000 ÷ 10 years) × ½) ....... 750
Accumulated depreciation ………………........ 750To update depreciation to date of sale.
Remove original asset cost and accumulated depreciation.
Record the gain or loss.June 30, 2013:Accumulated depreciation ............................................ 8,250Cash ………………………….……………...................... 6,350Loss on sale …………………………………………….… 400
Equipment …………………………...............… 15,000To record sale of equipment.
($15,000 ÷ 10 years) × 5½) = $8,250
10-49
ExchangesGeneral Valuation Principle: Cost of asset acquired
is: fair value of asset given up plus cash paid or
minus cash received or fair value of asset acquired, if it is more clearly
evident In the exchange of assets fair value is used except in rare situations in which the fair value cannot be
determined or the exchange lacks commercial substance.
When fair value cannot be determined or the exchange lacks commercial substance, the asset(s)
acquired are valued at the book value of the asset(s) given up, plus (or minus) any cash exchanged. No
gain or loss is recognized.
10-50
Fair Value Not Determinable
Matrix Inc. exchanged used equipment for newer equipment. Due to the nature of the assets
exchanged, Matrix could not determine the fair value of the asset given up or received. The asset
given up originally cost $600,000, and had an accumulated depreciation balance of $400,000 at the time of the exchange. Matrix exchanged the
asset and paid $100,000 cash.Let’s record this unusual transaction.
Matrix Inc.Cost of asset given up 600,000$ Accumulated depreciation 400,000 Book value 200,000$
10-51
Self-Constructed Assets
When self-constructing an asset, two accounting issues must be addressed:Overhead allocation to the self-
constructed asset. Incremental overhead only Full-cost approach
Proper treatment of interest incurred during construction
When self-constructing an asset, two accounting issues must be addressed:Overhead allocation to the self-
constructed asset. Incremental overhead only Full-cost approach
Proper treatment of interest incurred during construction
10-52
Capitalization begins when construction begins interest is incurred, and qualifying expenses are incurred.
Capitalization ends when . . . The asset is substantially complete and ready
for its intended use, or when interest costs no longer are being
incurred.
Capitalization begins when construction begins interest is incurred, and qualifying expenses are incurred.
Capitalization ends when . . . The asset is substantially complete and ready
for its intended use, or when interest costs no longer are being
incurred.
Interest Capitalization
10-53
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 borrowed $1,000,000 on May 1, from Bub’s Bank for 10 years at 10 percent to finance the
construction. The loan is related to the construction project and the company uses the specific interest
method to compute the amount of interest to capitalize.
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 borrowed $1,000,000 on May 1, from Bub’s Bank for 10 years at 10 percent to finance the
construction. The loan is related to the construction project and the company uses the specific interest
method to compute the amount of interest to capitalize.
Interest Capitalization
10-54
Average Accumulated Expenditures
Fraction ofDate Expenditure Year AAE5/1 125,000$ 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 Capitalization
10-55
Since the $1,000,000 of specific borrowing is sufficient to cover the $225,000 of average accumulated expenditures for
the year, use the specific borrowing rate of 10 percent to determine the amount of interest to capitalize.
Interest = AAE × Specific Borrowing Rate
Interest = $225,000 × 10% = $22,500
Since the $1,000,000 of specific borrowing is sufficient to cover the $225,000 of average accumulated expenditures for
the year, use the specific borrowing rate of 10 percent to determine the amount of interest to capitalize.
Interest = AAE × Specific Borrowing Rate
Interest = $225,000 × 10% = $22,500
Interest Capitalization
Page 14
Date Description PR Debit Credit
Dec. 31 Construction-In-Progress 22,500
Interest Expense 22,500
GENERAL JOURNAL
10-56
ResearchPlanned search or critical investigation aimed at
discovery of new knowledge . . .
DevelopmentThe translation of research findings or other
knowledge into a plan or design . . .
Most R&D costs are expensed as incurred. (Must be disclosed if material.)
ResearchPlanned search or critical investigation aimed at
discovery of new knowledge . . .
DevelopmentThe translation of research findings or other
knowledge into a plan or design . . .
Most R&D costs are expensed as incurred. (Must be disclosed if material.)
Research and Development (R&D)
10-57
R&D costs incurred under contract for other companies are expensed against revenue from the contract.
Operational assets used in R&D should be capitalized if they have alternative future uses.
R&D costs incurred under contract for other companies are expensed against revenue from the contract.
Operational assets used in R&D should be capitalized if they have alternative future uses.
Research and Development (R&D)
10-58
Start ofR&D
Activity
TechnologicalFeasibility
Date ofProductRelease
Sale of Product
CostsExpensedas R&D
CostsCapitalized
Operating Costs
All costs incurred to establish the technological feasibility of a computer software product are treated as R&D and expensed as incurred.
Costs incurred after technological feasibility is established and before the software is available for release to customers are capitalized as an intangible asset.
All costs incurred to establish the technological feasibility of a computer software product are treated as R&D and expensed as incurred.
Costs incurred after technological feasibility is established and before the software is available for release to customers are capitalized as an intangible asset.
Software Development Costs
10-59
Software Development Costs
Balance Sheet The unamortized portion of capitalized computer
software cost is an asset.
Income Statement Amortization expense associated with computer software
cost. R&D expense associated with computer software
development cost.
Balance Sheet The unamortized portion of capitalized computer
software cost is an asset.
Income Statement Amortization expense associated with computer software
cost. R&D expense associated with computer software
development cost.
Disclosure
Amortization of capitalized computer software costs starts when the product begins to be marketed.
Two methods, the percentage-of-revenue method and the straight-line method, are compared and the method producing the largest amount of amortization is used.
Amortization of capitalized computer software costs starts when the product begins to be marketed.
Two methods, the percentage-of-revenue method and the straight-line method, are compared and the method producing the largest amount of amortization is used.
10-60
U.S. GAAP vs. IFRS
Except for software development costs incurred after technological feasibility, all research and development expenditures are expensed in the period incurred.
Direct costs to secure a patent are capitalized.
Research and Development Expenditures
Research expenditures are expensed in the period incurred. Development expenditures that meet specified criteria are capitalized as an intangible asset.
Direct costs to secure a patent are capitalized.
10-61
Brief Exercise 10-16
Maxtor Technology incurred the following costs during the year related to the creation of a new type of personal computer monitor:
What amount should Maxtor report as research and development expense in its income statement?
10-62
Brief Exercise 10-16
Research and development: Salaries $220,000 Depreciation R&D 125,000 Utilities and other direct costs 66,000 Payment to another company 120,000 Total R & D expense $531,000
Note: The patent filing and related legal costs and the costs of adapting the product to a particular customer’s needs are not included as research and development expense.
