1. They are acquired for use in operations and not for resale.

-Normal business operations

2. They are long-term in nature and usually depreciated.

-Allocate the cost of the investment in the assets to future periods through depreciation.

3. They possess physical substance.

Measures the cash or cash equivalent price of obtaining the asset and bringing it to the location and condition necessary for its intended use.

(Purchase price, freight costs, sales taxes, and installation costs of a productive asset as part of the asset's cost)

Generally, also add to the asset's cost any related cost incurred after the asset's  acquisition, such as additions, improvements, or replacements IF THEY PROVIDE FUTURE SERVICE POTENTIAL

1. Historical cost involves actual, not hypothetical, transactions and so is the most reliable.

2. Companies should not anticipate gains and losses but should recognize gains and losses only when the asset is sold.

-Difficulty of developing a reliable fair value for these types of assets.

1. Purchase Price

2. Closing costs, such as title of the land, attorney's fees, and recording fees

3. Costs incurred in getting the land in condition for its intended use, such as grading, filling, draining and clearing.

4. Assumption of any liens, mortgages, or encumbrances of property

5. Any additional land improvements that have an indefinite life.

-All costs incurred up to the excavation for the new building as land costs.

It is a land cost because the activity is necessary to get the land in condition for its intended purpose.

-Any proceeds from getting the land ready for its intended use, such as salvage receipts on the demolition of an old building or the sale of cleared timber, as reductions in the price of the land.

Pavements, street lights, sewers and drainage systems.

Charge these costs to land.

-Any permanent improvements it makes, such as landscaping to land

Land Improvements

-Depreciated over their estimated lives

If the major purpose of acquiring and holding land is speculative, a company classifieds the land as an investment

-If real estate concern holds the land for resale, it should classify the land as inventory

-Capitalize costs

1. Materials, labor, and overhead costs incurred during construction.

2. Professional fees and building permits.

-All costs incurred, excavation to completion, as part of building costs

Indirect costs of manufacturing

-Power, heat, light, insurance, property taxes on factory buildings and equipment, factory supervisory labor, depreciation of fixed assets, and supplies.

1. Assign no fixed overhead to the cost of the constructed asset.

-Indirect overhead is generally fixed in nature (does not increase as a result of constructing one's own plant or equipment)

-Assumes the company will have the same costs whether it constructs the asset or not.

2. Assign a portion of all overhead to the construction process (Full costing-Approach)

-If one believes that costs attach to all products and assets manufactured or constructed.

-Company assigns a portion of all overhead to the construction process, as it would to normal production.

A proportionate allocation

Companies should assign to the asset a pro rata portion of the fixed overhead to determine its cost.

-Better matching of costs with revenues.

The company should record the excess overhead as a period loss rather than capitalize it.

-This avoids capitalizing the asset at more than its probable market value.

1. Capitalize no interest charges during construction

-Interest is considered a cost of financing and not a const of construction.

-Major argument against this approach, the use of cash, whatever its source, has an associated implicit interest cost, which should not be ignored.

2. Charge construction with all costs of funds employed, whether identifiable or not

-All costs necessary to get an asset ready for its intended use, including interest, are part of the asset's cost.

-Interest, whether actual or imputed, is a cost, just as are labor and materials.

GAAP 3. Capitalize only the actual interest costs incurred during construction

-Capitalizes only interest incurred through debt financing.

-A company that uses debt financing will have an asset of higher cost than a company that uses stock financing.

Capitalize only the actual interest costs incurred during construction

The historical cost of acquiring an asset includes all costs (including interest) incurred to bring the asset to the condition and location necessary for its intended use.

-During construction, an asset is not generating revenues, therefore a company should defer (capitalize) interest costs.

Once construction is complete, the asset is ready for its intended use and a company earns revenues. At this point the company should report interest as an expense and match it to these revenues.

To qualify for interest capitalization, assets must require a period of time to get them ready for their intended use.

-Assets that qualify for interest cost capitalization include assets under construction for a company's own use (including buildings, plants, and large machinery) and assets intended for sale or lease that are constructed or otherwise produced as discrete projects (ships or land developments)

1. Assets that are in use or ready for their intended use

2. assets that the company does not use in its earnings activities and that are not undergoing activities necessary to get them ready for use. (Land remaining undeveloped and assets not used because of obsolescence, excess capacity, or need for repair)

The period of time during which a company must capitalize interest.

1. Expenditures for the asset have been made.

2. Activities that are necessary to get the asset ready for its intended use are in progress.

3. Interest cost is being incurred.

Interest capitalization occurs as long as these three conditions are present.

Ends when substantially complete and ready for its intended use.

Avoidable interest is the amount of interest cost during the period that a company could theoretically avoid if it had not made expenditures for the asset.

If the actual cost for the period is $90,000 and the avoidable interest is $80,000, the company capitalizes only $80,000.

If actual costs 90 and avoidable 80 only capitalize 80.

A company weights the construction expenditures by the amount of time( fraction of a year or accounting period) that it can incur interest cost on the expenditure.

A company weights the expenditures by the amount of time that it can incur cost on each one.

1. For the portion of weighted-average accumulated expenditures that is less than or equal to any amounts borrowed specifically to finance construction of the assets, use interest rate incurred on the specific borrowing.

2. For the portion of weighted-average accumulated expenditures that is greater than any debt incurred specifically to finance construction of the assets, use a weighted average of interest rates incurred on all other outstanding debt during the period.

When a company purchases land with the intention of developing it for a particular use, interest costs associated with those expenditures qualify for interest capitalization.

If it purchases land as a site for a structure (such a plant site)

Interest costs capitalized during the period of construction are part of the cost of the plant, not the land.

If the company develops land for lot sales, it includes any capitalized interest cost as part of the acquisition cost of developed land.

Should not capitalize interest cost involved in purchasing land held for speculation because the asset is ready for its intended use.

Temporarily invest excess borrowed funds in interest-bearing securities until they need the funds to pay for construction.

Companies should not net or offset interest revenue against interest cost.

-Companies should capitalize interest incurred on qualifying assets whether or not they temporarily invest excess funds in short-term securities.

If it takes the discount, the company should consider the discount as a reduction in the purchase price of the asset.

Two views -

Discount- reduction in the cost of an asset

Discuss Deferred-Payment contracts?

Companies frequently purchase plant assets on long-term credit contracts, using notes, mortgages, bonds, or equipment obligations.

To properly reflect costs, companies account for assets purchased on long-term credit contracts at the present value of the consideration exchange between the contracting parties at the date of the transaction.

The company uses the cash exchange price of the asset acquired (if determinable) as the basis for recording the asset and measuring the interest claim.

The company allocates the total cost among the various assets on the basis of their relative fair values.

-Costs will vary in direct proportion to fair value.

If trading the stock, the market value of the stock issued is a fair indication of the cost of the property acquired. The stock is a good measure of the current cash equivalent price.

Land 60,000

Common Stock 50,000

Paid-in Capital in Excess of Par 10,000

-If the company determine the market value of the common stock exchanged, it establishes the fair value of the property.

Ordinarily companies account for the exchange of nonmonetary assets on the basis of the fair value of the asset given up or the fair value of the asset received, whichever is clearly more evident.

-Companies should recognize immediately any gains or losses on the exchange.

-The rationale for immediate recognition is that most transactions have commercial substance, and therefore gains and losses should be recognize.

An exchange has commercial substance if the future cash flows change as a result of the transaction.

-If the two parties' economic positions change, the transaction has commercial substance.

Exchanging equipment for land, cash flows arising for land will differ significantly from the cash flows arising form the equipment.

Exchange has commercial substance - Recognize gains and losses immediately

Exchanges lacks commercial substance (no cash received) - Defer gains; recognize losses immediately.

Exchange lacks commercial substance (cash received) - Recognize partial gain; recognize losses immediately

If the exchange has commercial substance, the company recognizes the gain the immediately.

The rule for recognition when an exchange lacks commercial substance: If the company receives no cash in such exchange, it deters recognition of a gain.

If the company receives cash in such an exchange, it recognizes part of the gain immediately.

The company recognizes the loss immediately, whether it has commercial substance or not.

-Companies should not value assets ad more than their cash equivalent price; if the loss were deferred, assets would be overstated.

Record the cost of a non-monetary asset acquired in exchange for another non-monetary asset at  the fair value of the asset given up, immediately recognizes a gain.

The company should use the fair value of the asset received only if it is more clearly evident than the fair value of the asset given up.

Transfer of assets in one direction.

Companies use FAIR VALUE OF THE ASSET to establish its value on the books.

Companies should recognize contributions as revenues in the period received.

Receives

Land 150,000

Contributed Revenue 150,000

Contributes

Kline industries donates land to the city of Los Angeles for a city park. The land cost 80,000 and has a fair market value of 110,000. Kline industries records this donation as:

Contribution Expense 110,000

Land 80,000

Gain on Disposal of Land 30,000

If the promise is unconditional (Depends only on the passage of time or on demand by the recipient for performance, the company should report the contribution expense and related payable immediately.

If the promise is conditional, the company recognizes expenses in the period benefited by the contribution, generally when it transfers the asset.

This concept states that if for some reason a company ignorantly paid too much for an asset originally, it is theoretically preferable to charge a loss immediately.

Assume a company constructs an asset at a cost much greater than its present economic usefulness. 

-Appropriate to charge these excess costs as a loss to the current period, rather than capitalize them as part of the cost of the asset.

1. The useful life of the asset must be increased.

2. The quantity of units produced from the asset must be increased.

3. The quality of the units produced must be enhanced.

Increase or extension of existing assets.

Companies capitalize any addition to plant assets because a new asset is created.

(Addition of a wing to a hospital)

Capitalize such expenditures and match them against the revenues that will result in future periods.

Companies substitute one asset for another through improvements and replacements.

Improvement - the substitution of a better asset for the one currently used (say a concrete floor, for a wooden floor)

Replacement - The substitution of a similar asset (a wooden floor for a wooden floor)

Substitution Approach - (Correct if the carrying amount of the old asset is available)

-Remove cost of the old asset and replace it with the cost of the new asset. P. 510

Capitalize the new cost

-Capitalize the improvements and keep the carrying amount of the old asset on the books.

(Justification - the item is sufficiently depreciated to reduce its carrying amount almost to zero)

Charge to accumulated depreciation

In cases where company does not improve the quantity or quality of the asset itself, but instead extends its useful life, the company debits the expenditure to

Accumulated Depreciation (rather than to the asset account)

-The replacement extends the useful life of the asset and thereby recaptures some or all of the past depreciation.

If a company can determine or estimate the original installation cost and the accumulated depreciation to date, it handles the rearrangement and reinstallation cost as a replacement.

If not, capitalize the new costs (if material in amount) as an asset to be amortized over future periods expected to benefit.

-If these costs are immaterial, if they cannot be separated from other operating expenses, or if their future benefit is questionable, the company should immediately expense them.

A company makes ordinary repairs to maintain a plant asset in operating condition.

-It charges ordinary repairs to an expense account in the period incurred, on the basis that is is the primary period benefited.

(Replacing minor parts, lubricating and adjusting equipment, repainting, and cleaning)

A company should handle the cost as an addition improvement, or replacement.

-Companies are not permitted to accrue in advance for planned major overhaul costs for interim or annual periods.

Assume Barret Company recorded depreciation on a machine costing 18,000 for 9 years at the rate of 1,200 per year. If it sells the machine in the middle of the tenth year for 7,000, Barret records depreciation to the date of sale as

Depreciation Expense (1,200 x 1/2) 600

Accumulated Deprec. - Machinery      600

Cash    7,000

Accumulated Deprec. - Machinery    11,400

(1,200 x 9) + 600)

Machinery   18,000

Gain on Disposal of Machinery           400

Book value of machinery at time of sale is 6,600, Because the machinery sold for 7,000, gain is 400.

It recognizes a loss equal to the asset's book value.

If scrap value exists, the gain or loss that occurs is the difference between the assets scrap value and its book value.

Treat like any other type of disposition.

Eminent domain (plant in the way of a highway)

Camel received 500,000, book value is 200,000 of the plant and land (cost of 400,000 less accumulated depreciation of 200,000)

Cash 500,000

Accum Deprec. - Plant Assets 200,000

Plant Assets 400,000

Gain on Disposal of Assets 300,000

Add to either the useful life of the asset OR its productivity