ACCT 265 Chapter 10 Review This chapter deals with the accounting for Property Plant & Equipment (PPE) or Capital Assets. When recording cost of PPE, the price of the asset is not the only cost recorded in the balance sheet. Costs to bring the asset to its location, and get it ready for use are also capitalized. The general criteria for recognition of PPE are: - the item s associated future economic benefits will flow to the entity - its costs can be reliably measured Costs associated with different types of assets may have different capitalization criteria: Self-Constructed Assets - Costs directly associated with the construction process such as direct labour and construction material are capitalized - NO fixed overhead costs are included Borrowing Costs - Some assets require financing to be brought into place. Cost of financing such as interest are included in the cost of the asset Dismantling and Restoration Costs - Asset retirement costs are also capitalized Measurement of Cost of Asset Cash Discounts - When a cash discount is offered by the supplier, the cost of the asset is effectively reduced. Therefore, the discounted price is recorded in the books. Deferred Payment Terms - If the asset is to be paid off in installments, the present value of future payments is recognized in the balance sheet. - Assume company XYZ purchases a machine by issuing a $100,000 notes payable. The current market interest rate is 10%, and the company plans on paying off the note in five $20,000 payments annually. Journal entry & calculations: First step is to determine the present value of an ordinary annuity factor. Table A-4 on the back of your book has all the factors. Looking up 10% for 5 years in the table gives us a factor of 3.79079. Second step is calculating the present value of five $20,000 annual payments. The present value turns out to be $75,816 ($20,000 x 3.79079). Equipment $75,816 Notes Payable 75,816 Lump Sum Purchases - Sometimes an entity buys a number of assets as part of a packaged deal. Assume XYZ decides to buy several assets from a company for a total cost of $100,000. The assets include land (fair value 20,000), building (fair value 50,000), and equipment (fair value 50,000). Calculation: First step is to total the fair values of the assets being purchased. The total fair value is $120,000 (20,000+50,000+50,000). 1
Second step is to find the proportion which should be allocated for each asset by dividing the fair value of the asset by the total fair value, and then multiplying it by the lump sum payment. Land= (20,000/120,000) x 100,000 = $16,666.67 The cost of land is recorded as $16,666.67 in the books. Similar steps are taken for other assets. Non-monetary Exchanges - Sometimes a company buys its assets by issuing shares to the supplier. In such a case, an entry of debit to asset and credit to common shares is made. The fair value of the asset is used as the amount to record. If this fair value is not determinable, the fair value of the common shares is used. - At other times, a company will directly exchange one asset with another. At this time a company must determine if the transaction has commercial substance i.e. would the transaction significantly change the future cash-flows. Assume XYZ is exchanging its existing equipment for a new one from a supplier. The new equipment list price is $16,000. The old equipments cost was $12,000 and has been depreciated by $4,000 since acquisition, and has a fair value of $6,000. The supplier has offered a trade-in allowance of $9,000 i.e. XYZ must pay $7,000 (16,000-9000) in addition to giving up the old equipment for the new equipment. - First let s assume the transaction has commercial substance. The calculation and journal entry is: Cost of new machine = fair value of assets given up The fair value of assets being given up is the $7,000 cash and $6,000 old equipment. Therefore: Cost of new equipment = $13,000 (7,000+6,000). The gain (loss) on disposal is fair value of asset - book value of asset. In this case we have a loss of $2,000 (6,000-8,000). Journal entry: Equipment (new) 13,000 Accumulated Depreciation 4,000 Loss on Disposal 2,000 Equipment (old) 12,000 Cash 7,000 - Now let s assume the transaction above does not have commercial substance. In this case the cost of new equipment is simply the book value of asset being given up plus the fair value of any other asset being given up (in this case 7,000 cash). Journal Entry: Equipment (new) 15,000 Accumulated Depreciation 4,000 Equipment (old) 12,000 Cash 7,000 Contributed Assets & Government Grants - Sometimes a company receives grants, gifts or donations from sources - There are two questions associated with this: how to measure, and where to recognize the transaction. o Asset s fair value should be used as the cost of transaction - Two methods associated with where to recognize: the cost reduction method and the deferral method. 2
o Cost reduction method assumes that the amount of assistance received simply decreases the cost of the asset. Assume government gives $1,000 grant on your fuelefficient hybrid. Cash $1000 Fuel-efficient Hybrid 1000 o The deferral method amortizes the assistance over the years it will be useful. Now assume that the company chooses to use deferral method. It amortizes the fuel-efficient hybrid for 5 years. The second entry shows the amortization. Cash $1000 Deferred Revenue-Government Grants 1000 Deferred Revenue-Government Grants 200 Revenue-Government Grants 200 Land - Purchase price, closing costs such as legal fees, costs incurred to condition the land, costs of assuming any liens, and any additional land improvements with indefinite life are capitalized into the Land account o Costs associated with the demolition of an old building on the land are included in the cost of land o Land improvements with finite life are recorded separately and amortized o Land does not depreciate Buildings - Like previously mentioned, cost of demolishing building is added to the cost of land o However, if the company intends to raze a building it already owns to build a new one, these costs are EXPENSED Leasehold Improvements - Cost of any improvements made on leased property is added to a separate account called leasehold improvements. These are amortized over the life of the lease or economic useful life, which ever is shorter. Equipment - The cost of equipment includes purchase price, freight and handling, assembly costs, insurance costs while in transit, and costs of making any adjustments Natural Resource Properties - Costs associated with acquired rights, and the exploration, evaluation, and development are capitalized Biological Assets - Biological assets are measured initially at cost, and then at fair value less cost to sell at every balance sheet date. o The change in value of the biological asset is recognized in income. 3
Measurement after Acquisition - Under IFRS, PPE is measured under two methods after acquisition: cost and revaluation model. o Investment property is measured using cost and fair value model - Cost model is simply depreciating the asset every year i.e. cost less accumulated amortization - Under the revaluation model, the assets are carried at their fair value at the date of the revaluation less any subsequent accumulated depreciation and any subsequent impairment losses. o Revaluation date is determined by the management. Any increase in the asset amount is recorded under an equity account known as Revaluation Surplus, unless the increase reverses a previously recorded loss (from a decrease in the revaluation). o Assume company XYZ has a building worth$975,000 (original cost $1,000,000, less accumulated depreciation 25,000) on its books, purchased last year. The useful life of the building is 40 years. Assume the assets fair value on the balance sheet date this year is $980,000. The calculation and journal entry is as follows: The accumulated depreciation amount at the end of the year should be $50,000 (1000000/40 x 2). The Revaluation surplus is calculated as: 30,000 [980,000 - (1,000,000-50,000)] Accumulated Depreciation $50,000 Building 50,000 Building 30,000 Revaluation Surplus 30,000 o Now assume that end of next year, the fair value of the building is 920,000. Management decides to revaluate the building. First we record the depreciation of the building. Depreciation is 25,789.47(980,000/38). Since the revaluation entry last year left the Accumulated amortization balance as zero, the book value of building is 954,210.53 (980,000 building, 25,789.47 accumulated depreciation). The revaluation is calculated as -34,210.53 [920,000 954,210.53]. Journal entry: Accumulated Depreciation $25,789.47 Building 25,789.47 Revaluation Surplus 30,000 Revaluation Loss 4,210.53 Building 34,210.53 - The Fair Value model is explained in Chapter 9. Refer to Chapter 9 worksheet for detailed explanation 4
Costs Incurred after Acquisition - Some costs incurred after the acquisition can be capitalized - The criterion is that these costs INCREASE economic future benefits of the asset. o Costs which are merely a restoration cost are not capitalized, but are expensed - Additions include adding new PPE by purchasing more assets. These costs are automatically capitalized. - Rearrangement and Reinstallation costs are expensed. This is because during the acquisition of the asset, installation costs were already paid. - Repair costs are expensed in the period they are incurred. 5