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CHAPTER 10
Acquisition and Disposition
of Property, Plant, and Equipment
ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)
Topics Questions
Brief Exercises Exercises Problems
Concepts for Analysis
- Valuation and classification of land, buildings, and equipment.
- Self-constructed assets, capitalization of overhead.
- Capitalization of interest. 6, 8, 9, 10, 11, 13, 21
- Exchanges of assets. 12, 16, 17 8, 9, 10, 11, 12
- Lump-sum purchases, issuance of stock, deferred- payment contracts.
- Costs subsequent to acquisition.
- Alternative valuations. 22 12 3
- Disposition of assets. 23 14, 15 24, 25 4 1
ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)
Learning Objectives Questions
Brief Exercises Exercises Problems
Concepts for Analysis
- Understand property, plant, and equipment and its related costs.
- Describe the accounting problems associated with self-constructed assets.
- Describe the accounting problems associated with interest capitalization.
- Understand accounting issues related to acquiring and valuing plant assets.
- Describe the accounting treatment for costs subsequent to acquisition.
- Describe the accounting treatment for the disposal of property, plant, and equipment.
ASSIGNMENT CHARACTERISTICS TABLE (Continued)
Item Description
Level of Difficulty
Time (minutes)
CA10-1 Acquisition, improvements, and sale of realty. Moderate 20– CA10-2 Accounting for self-constructed assets. Moderate 20– CA10-3 Capitalization of interest. Moderate 30– CA10-4 Nonmonetary exchanges. Moderate 30– CA10-5 Costs of acquisition. Simple 20– CA10-6 Cost of land vs. building—ethics. Moderate 20–
ANSWERS TO QUESTIONS
- The major characteristics of plant assets are (1) that they are acquired for use in operations and not for resale, (2) that they are long-term in nature and usually subject to depreciation, and (3) that they have physical substance.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
- The company should report the asset at its historical cost of $450,000, not its current value. The main reasons for this position are (1) at the date of acquisition, cost reflects fair value; (2) historical cost involves actual, not hypothetical transactions, and as a result is extremely reliable; and (3) gains and losses should not be anticipated but should be recognized when the asset is sold.
LO: 1, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
- (a) The acquisition costs of land may include the purchase or contract price, the broker’s commis- sion, title search and recording fees, assumed taxes or other liabilities, and surveying, demolition (less salvage), and landscaping costs.
(b) Machinery and equipment costs may properly include freight and handling, taxes on purchase, insurance in transit, installation, and expenses of testing and breaking-in.
(c) If a building is purchased, all repair charges, alterations, and improvements necessary to ready the building for its intended use should be included as a part of the acquisition cost. Building costs in addition to the amount paid to a contractor may include excavation, permits and licenses, architect’s fees, interest accrued on funds obtained for construction purposes (during construction period only) called avoidable interest, insurance premiums applicable to the cons- truction period, temporary buildings and structures, and property taxes levied on the building during the construction period.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
- (a) Land. (b) Land. (c) Land. (d) Machinery. The only controversy centers on whether fixed overhead should be allocated as a cost to the machinery. (e) Land Improvements, should be depreciated. (f) Buildings. (g) Buildings, provided the benefits in terms of information justify the additional cost involved in providing the information. (h) Land. (i) Land.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
- (a) The position that no fixed overhead should be capitalized assumes that the construction of plant (fixed) assets will be timed so as not to interfere with normal operations. If this were not the case, the savings anticipated by constructing instead of purchasing plant assets would be nullified by reduced profits on the product that could have been manufactured and sold. Thus, construction of plant assets during periods of low activity will have a minimal effect on the total amount of overhead costs. To capitalize a portion of fixed overhead as an element of the cost of constructed assets would, under these circumstances, reduce the amount assignable to operations and therefore overstate net income in the construction period and understate net income in subsequent periods because of increased depreciation charges.
Questions Chapter 10 (Continued)
- The total interest cost incurred during the period should be disclosed, indicating the portion capitalized and the portion charged to expense.
Interest revenue from temporarily invested excess funds should not be offset against interest cost when determining the amount of interest to be capitalized. The interest revenue would be reported in the same manner customarily used to report any other interest revenue.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
- (a) Assets acquired by issuance of capital stock—when property is acquired by issuance of common stock, the cost of the property is not measured by par or stated value of such stock. If the stock is actively traded on the market, then the market value of the stock is a fair indication of the cost of the property because the market value of the stock is a good measure of the current cash equivalent price. If the market value of the common stock is not determinable, then the market value of the property should be established and used as the basis for recording the asset and issuance of common stock.
(b) Assets acquired by gift or donation—when assets are acquired in this manner a strict cost concept would dictate that the valuation of the asset be zero. However, in this situation, accountants record the asset at its fair value. The credit should be made to Contribution Revenue. Contributions received should be credited to revenue unless the contribution is from a governmental unit. Even in that case, we believe that the credit should be to Contribution Revenue.
(c) Cash discount—when assets are purchased subject to a cash discount, the question of how the discount should be handled occurs. If the discount is taken, it should be considered a reduction in the asset cost. Different viewpoints exist, however, if the discount is not taken. One approach is that the discount must be considered a reduction in the cost of the asset. The rationale for this approach is that the terms of these discounts are so attractive that failure to take the discount must be considered a loss because management is inefficient. The other view is that failure to take the discount should not be considered a loss, because the terms may be unfavorable or the company might not be prudent to take the discount. Presently both methods are employed in practice. The former approach is conceptually correct.
(d) Deferred payments—assets should be recorded at the present value of the consideration exchanged between contracting parties at the date of the transaction. In a deferred payment situation, there is an implicit (or explicit) interest cost involved, and the accountant should be careful not to include this amount in the cost of the asset.
(e) Lump sum or basket purchase—sometimes a group of assets are acquired for a single lump sum. When a situation such as this exists, the accountant must allocate the total cost among the various assets on the basis of their relative fair value.
(f) Trade or exchange of assets—when one asset is exchanged for another asset, the accountant is faced with several issues in determining the value of the new asset. The basic principle involved is to record the new asset at the fair value of the new asset or the fair value of what is given up to acquire the new asset, whichever is more clearly evident. However, the accountant must also be concerned with whether the exchange has commercial substance and whether monetary consideration is involved in the transaction. The commercial substance issue rests on whether the expected cash flows on the assets involved are significantly different. In addition, monetary consideration may affect the amount of gain recognized on the exchange under consideration.
LO: 4, 5, Bloom: K, Difficulty: Simple, Time: 5-10, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Questions Chapter 10 (Continued)
- The cost of such assets includes the purchase price, freight and handling charges incurred, insurance on the equipment while in transit, cost of special foundations if required, assembly and installation costs, and costs of conducting trial runs. Costs thus include all expenditures incurred in acquiring the equipment and preparing it for use. When plant assets are purchased subject to cash discounts for prompt payment, the question of how the discount should be handled arises. The appropriate view is that the discount, whether taken or not, is considered a reduction in the cost of the asset. The rationale for this approach is that the real cost of the asset is the cash or cash equivalent price of the asset. Similarly, assets purchased on long-term payment plans should be accounted for at the present value of the consideration exchanged between the contracting parties at the date of the transaction.
LO: 5, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
- Fair value of land X Cost = Cost allocated to land Fair value of building and land
$500,000 (^) X $2,200,000 = $440,000 (Cost allocated to land) $2,500,
$2,000,000 (^) X $2,200,000 = $1,760,000 (Cost allocated to building) $2,500,
LO: 4, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
LO: 5, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
- Ordinarily accounting for the exchange of nonmonetary assets should be based on the fair value of the asset given up or the fair value of the asset received, whichever is more clearly evident. Thus any gains and losses on the exchange should be recognized immediately. If the fair value of either asset is not reasonably determinable, the book value of the asset given up is usually used as the basis for recording the nonmonetary exchange. This approach is always employed when the exchange has commercial substance. The general rule is modified when exchanges lack commercial substance. In this case, the enterprise is not considered to have completed the earnings process and therefore a gain should not be recognized. However, a loss should be recognized immediately. In certain situations, gains on an exchange that lacks commercial substance may be recorded when monetary consideration is received. When monetary consideration is received, it is assumed that a portion of the earnings process is completed, and therefore, a partial gain is recognized.
LO: 4, Bloom: K, Difficulty: Simple, Time: 5-7, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
- In accordance with GAAP which requires losses to be recognized immediately, the entry should be:
Trucks (new) ....................................................................................... 42, Accumulated Depreciation .................................................................. 9,800* Loss on Disposal of Trucks ................................................................. 4,200** Trucks (old) ................................................................................... 30, Cash ............................................................................................. 26,
*[($30,000 – $6,000) X 49 months/120 months = $9,800] **(Book value $20,200 – $16,000 trade-in = $4,200 loss)
LO: 4, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
Questions Chapter 10 (Continued)
- (a) Overhead of a business that builds its own equipment. Some accountants have maintained that the equipment account should be charged only with the additional overhead caused by such construction. However, a more realistic figure for cost of equipment results if the plant asset account is charged for overhead applied on the same basis and at the same rate as used for production.
(b) Cash discounts on purchases of equipment. Some accountants treat all cash discounts as financial or other revenue, regardless of whether they arise from the payment of invoices for merchandise or plant assets. Others take the position that only the net amount paid for plant assets should be capitalized on the basis that the discount represents a reduction of price and is not income. The latter position seems more logical in light of the fact that plant assets are purchased for use and not for sale and that they are written off to expense over a long period of time.
(c) Interest paid during construction of a building. GAAP requires that avoidable or actual interest cost, whichever is lower, be capitalized as part of the cost of acquiring an asset if a significant period of time is required to bring the asset to a condition and location necessary for its intended use.
(d) Cost of a safety device installed on a machine. This is an addition to the machine and should be capitalized in the machinery account if material.
(e) Freight on equipment returned before installation, for replacement by other equipment of greater capacity. If ordering the first equipment was an error, whether due to judgment or otherwise, the freight should be regarded as a loss. However, if information became available after the order was placed which indicated purchase of the new equipment was more advantageous, the cost of the return freight may be viewed as a necessary cost of the new equipment.
(f) Cost of moving machinery to a new location. Normally, only the cost of one installation should be capitalized for any piece of equipment. Thus the original installation and any accumulated depreciation relating thereto should be removed from the accounts and the new installation costs (i.e., cost of moving) should be capitalized. In cases where this is not possible and the cost of moving is substantial, it is capitalized and depreciated appropriately over the period during which it makes a contribution to operations.
(g) Cost of plywood partitions erected in the remodeling of the office. This is a part of the remodeling cost and may be capitalized as part of the remodeling itself is of such a nature that it is an addition to the building and not merely a replacement or repair.
(h) Replastering of a section of the building. This seems more in the nature of a repair than anything else and as such should be treated as an expense.
(i) Cost of a new motor for one of the trucks. This probably extends the useful life of the truck. As such it may be viewed as an extraordinary repair and charged against the accumulated depreciation on the truck. The remaining service life of the truck should be estimated and the depreciation adjusted to write off the new book value, less salvage, over the remaining useful life. A more appropriate treatment is to remove the cost of the old motor and related depreciation and add the cost of the new motor if possible.
LO: 1, 2, Bloom: K, Difficulty: Simple, Time: 5-10, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
- This approach is not correct since at the very minimum the investor should be aware that certain assets are used in the business, which are not reflected in the main body of the financial statements. Either the company should keep these assets on the balance sheet or they should be recorded at salvage value and the resulting gain recognized. In either case, there should be a clear indication that these assets are fully depreciated, but are still being used in the business.
LO: 4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
- Gains or losses on plant asset retirements should be shown in the income statement along with other items that arise from customary business activities-usually as other revenues and gains or other expenses and losses.
LO: 6, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
BRIEF EXERCISE 10-
Trucks ($80,000 X .68301) ...................................... 54,
Discount on Notes Payable ................................... 25,
Notes Payable................................................ 80,
LO: 4, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
BRIEF EXERCISE 10-
Fair Value % of Total Cost
Recorded
Amount
Land $ 60,000 60/360 X $315,000 $ 52,
Building 220,000 220/360 X $315,000 192,
Equipment 80,000 80/360 X $315,000 70,
LO: 4, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
BRIEF EXERCISE 10-
Land (2,000 X $40) .................................................. 80,
Common Stock (2,000 X $10) ....................... 20,
Paid-in Capital in Excess of Par—
Common Stock ......................................... 60,
LO: 4, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
BRIEF EXERCISE 10-
Equipment............................................................... 3,
Accumulated Depreciation—Trucks ..................... 18,
Trucks ............................................................ 20,
Cash ............................................................... 500
Gain on Disposal of Trucks .......................... 800
LO: 4, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
LO: 4, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
- E10- 1 Acquisition costs of realty. Moderate 15 – (minutes)
- E10- 2 Acquisition costs of realty. Simple 10 –
- E10- 3 Acquisition costs of trucks. Simple 10 –
- E10- 4 Purchase and self-constructed cost of assets. Moderate 20 –
- E10- 5 Treatment of various costs. Moderate 30 –
- E10- 6 Correction of improper cost entries. Moderate 15 –
- E10- 7 Capitalization of interest. Moderate 20 –
- E10- 8 Capitalization of interest. Moderate 20 –
- E10- 9 Capitalization of interest. Moderate 20 –
- E10- 10 Capitalization of interest. Moderate 20 –
- E10- 11 Entries for equipment acquisitions. Simple 10 –
- E10- 12 Entries for asset acquisition, including self-construction. Simple 15 –
- E10- 13 Entries for acquisition of assets. Simple 20 –
- E10- 14 Purchase of equipment with zero-interest-bearing debt. Moderate 15 –
- E10- 15 Purchase of computer with zero-interest-bearing debt. Moderate 15 –
- E10- 16 Asset acquisition. Moderate 25 –
- E10- 17 Nonmonetary exchange. Simple 10 –
- E10- 18 Nonmonetary exchange. Moderate 20 –
- E10- 19 Nonmonetary exchange. Moderate 15 –
- E10- 20 Nonmonetary exchange. Moderate 15 –
- E10- 21 Analysis of subsequent expenditures. Moderate 20 –
- E10- 22 Analysis of subsequent expenditures. Simple 15 –
- E10- 23 Analysis of subsequent expenditures. Simple 10 –
- E10- 24 Entries for disposition of assets. Moderate 20 –
- E10- 25 Disposition of assets. Simple 15 –
- P10- 1 Classification of acquisition and other asset costs. Moderate 35 –
- P10- 2 Classification of acquisition costs. Moderate 40 –
- P10- 3 Classification of land and building costs. Moderate 35 –
- P10-5 Classification of costs and interest capitalization. Moderate 20–
- P10-6 Interest during construction. Moderate 25–
- P10-7 Capitalization of interest. Moderate 20–
- P10-8 Nonmonetary exchanges. Moderate 35–
- P10-9 Nonmonetary exchanges. Moderate 30–
- P10-10 Nonmonetary exchanges. Moderate 30–
- Moderate 35– nonmonetary exchanges.
- BRIEF EXERCISE 10-
- Equipment ($3,300 – $800) 2,
- Accumulated Depreciation—Trucks 18,
- BRIEF EXERCISE 10-
- Equipment 5,
- Accumulated Depreciation—Machinery 3,
- Loss on Disposal of Machinery 4,
- BRIEF EXERCISE 10- LO: 4, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
- Trucks (new) 37,
- Accumulated Depreciation—Trucks 27,
- Loss on Disposal of Trucks 2,
- Trucks (used) 30,
- Cash 36,
- BRIEF EXERCISE 10- LO: 4, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
- Trucks (new) 35,
- Accumulated Depreciation—Trucks 17,
- Loss on Disposal of Trucks 1,
- Trucks (used) 20,
- Cash 33,
SOLUTIONS TO EXERCISES
EXERCISE 10-1 (15–20 minutes)
Item Land
Land
Improvements Building Other Accounts
(a) ($275,000) Notes Payable
(b) $275,
(c) $ 8,
(d) 7,
(e) 6,
(f) (1,000)
(g) 22,
(h) 250,
(i) 9,
(j) $ 4,
(k) 11,
(l) (5,000)
(m) 13,
(n) 19,
(o) 14,
(p) 3,
LO: 1, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
EXERCISE 10-2 (10–15 minutes)
The allocation of costs would be as follows:
Land Building
Land $400,
Razing costs 42,
Salvage (6,300)
Legal fees 1,
Survey $ 2,
Plans 68,
Title insurance 1,
Liability insurance 900
Construction 2,740,
Interest 170,
LO: 1, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
EXERCISE 10-3 (10–15 minutes)
1. Trucks ...................................................................13,900.
Cash ............................................................. 13,900.
2. Trucks ...................................................................14,727.26*
Discount on Notes Payable ................................. 1,272.
Cash ............................................................. 2,000.
Notes Payable ............................................. 14,000.
*PV of $14,000 @ 10% for 1 year =
$14,000 X .90909 = $12,727.
3. Trucks ...................................................................15,200.
Cost of Goods Sold .............................................12,000.
Inventory ..................................................... 12,000.
Sales Revenue ............................................ 15,200.
[Note to instructor: The selling (retail) price of the computer system
appears to be a better gauge of the fair value of the consideration
given than is the list price of the truck as a gauge of the fair value of
the consideration received (truck). Vehicles are very often sold at a
price below the list price.]
4. Trucks ...................................................................13,000.00*
Common Stock ........................................... 10,000.
Paid-in Capital in Excess of Par –
Common Stock......................................... 3,000.
* (1,000 shares X $13 = $13,000)
LO: 1, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
EXERCISE 10-5 (30–40 minutes)
Land Buildings M & E Other
Abstract fees $ 520
Architect’s fees $ 3,
Cash paid for land
and old building 87,
Removal of old building
($20,000 – $5,500) 14,
Interest on loans during
construction 7,
Excavation before
construction
Machinery purchased $53,900 $1,100 —Misc. expense
Freight on machinery 1,340 (Discount Lost)
Storage charges caused by
noncompletion of building 2,180 —Misc. expense (Loss)
New building 485,
Assessment by city 1,
Hauling charges—machinery 620 —Misc. expense
Installation—machinery 2,000 (Loss)
Landscaping 5,
$109,020 $514,570 $57,240 $3,
LO: 1, 2, 3, Bloom: AP, Difficulty: Moderate, Time: 30-40, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
EXERCISE 10-6 (15–25 minutes)
1. Land ..................................................................... 131,
Buildings .............................................................. 306,
Equipment ............................................................ 262,
Cash ............................................................. 700,
$700,000 X
= $131,250 Land
$700,000 X
= $306,250 Buildings
$700,000 X
= $262,500 Equipment
EXERCISE 10-6 (Continued)
2. Equipment ........................................................... 25,
Cash ............................................................ 2,
Note Payable .............................................. 23,
3. Equipment ........................................................... 19,
Accounts Payable ($20,000 X .98) ............. 19,
4. Land ..................................................................... 27,
Contribution Revenue ................................ 27,
5. Buildings.............................................................. 600,
Cash ............................................................ 600,
LO: 2, 4, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
EXERCISE 10-7 (20–25 minutes)
(a) Avoidable Interest
Weighted-Average
Accumulated Expenditures X Interest Rate = Avoidable Interest
Weighted-average interest rate computation Principal Interest
10% short-term loan $1,400,000 $140,
11% long-term loan 1,000,000 110,
Total Interest
Total Principal $2,400,
