Review based on Intermediate Accounting (Part 1) by Kieso, Weygandt et al
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
Notes Payable
$75,816
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).
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Review based on Intermediate Accounting (Part 1) by Kieso, Weygandt et al
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)
Accumulated Depreciation
Loss on Disposal
Equipment (old)
Cash
13,000
4,000
2,000
12,000
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)
Accumulated Depreciation
Equipment (old)
Cash
15,000
4,000
12,000
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.
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Review based on Intermediate Accounting (Part 1) by Kieso, Weygandt et al
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
o
1000
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
Deferred Revenue-Government Grants
Revenue-Government Grants
Land
-
1000
200
200
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.
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Review based on Intermediate Accounting (Part 1) by Kieso, Weygandt et al
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
Building
Building
$50,000
50,000
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
Building
$25,789.47
25,789.47
Revaluation Surplus
Revaluation Loss
Building
30,000
4,210.53
34,210.53
-
The Fair Value model is explained in Chapter 9. Refer to Chapter 9 worksheet for detailed
explanation
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Review based on Intermediate Accounting (Part 1) by Kieso, Weygandt et al
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.
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