Intermediate Accounting, Ch 10 Terms

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Intermediate Acct, Ch 10, Kieso, 15th Ed.

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Describe property, plant, and equipment the major characteristics of property, plant, and equipment are as follows: 1) they are acquired for use in operations and not for resale 2) they are long-term in nature and usually subject to depreciation 3) they possess physical substance
Identify the costs to include in initial of property, plant, and equipment: Cost of land Includes all expenditures made to acquire land and to ready it for use. Land costs typically include: (1) the purchase price, (2) closing costs, such as title to 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 on the property, (5) any additional land improvements that have an indefinite life
Identify the costs to include in initial of property, plant, and equipment: Cost of Buildings Includes all expenditures related directly to their acquisition or construction. These costs include (1) materials, labor, and overhead costs incurred during construction, and (2) professional fees and building permits
Identify the costs to include in initial of property, plant, and equipment: Cost of equipment Includes the purchase price, freight and handling charges incurred, insurance on the equipment while in transit, cost of special foundations if required, assembling and installation costs, and costs of conducting trial runs
Describe the accounting problems associated with self-constructed assets indirect costs of manufacturing create special problems because companies cannot easily trace these costs directly to work and material orders related to the constructed assets. Companies might handle these costs in one of two ways, (1) assign no fixed overhead to the cost of the constructed asset, or (2) assign a portion of all overhead to the construction process. Companies use the second method extensively
Describe the accounting problems associated with interest capitalization only actual interest (with modifications) should be capitalized. The rationale for this approach is that during construction, the asset is not generating revenue and therefore companies should defer (capitalize) interest cost. Once construction is completed, the asset is ready for its intended use and revenues can be recognized. Any interest cost incurred in purchasing an asset that is ready for its intended use should be expensed
Understand accounting issues related to acquiring and valuing plant assets: Cash Discounts whether taken or not, they are generally considered a reduction in the cost of the asset; the real cost of the asset is the cash or cash equivalent price of the asset
Describe the accounting treatment for the disposal of property, plant, and equipment regardless of the time of disposal, companies take depreciation up to the date of disposition and then remove all accounts related to the retired asset. Gains or losses on the retirement of plant assets are shown in the income statement along with other items that arise from customary business activities. Gains or losses on involuntary conversions, if unusual and infrequent, may be reported as extraordinary items
Understand accounting issues related to acquiring and valuing plant assets: Deferred-payment contracts Companies account for assets purchased on long-term credit contracts at the present value of the consideration exchanged between the contracting parties
Understand accounting issues related to acquiring and valuing plant assets: Lump-sum purchase allocate the total cost among the various assets on the basis of their relative fair values
Understand accounting issues related to acquiring and valuing plant assets: Issuance of stock if the stock is actively traded, the market price of the stock issued is a fair indication of the cost of the property acquired. If the market price of the common stock exchanged is not determinable, establish the fair values of the property and use it as the basis for recording the asset and issuance of the common stock
Understand accounting issues related to acquiring and valuing plant assets: Exchanges of nonmonetary assets the accounting for exchanges of nonmonetary assets depends on whether the exchange has commercial substance
Understand accounting issues related to acquiring and valuing plant assets: Contributions record at the fair value of the asset received, and credit revenue for the same amount
Major characteristics of PPE : They are acquired for use in operations and not for resale only assets used in normal business operations are classified as property, plant, and equipment. For example, an idle building is more appropriately classified separately as an investment. Land developers or subdividers classify land as inventory
Major Characteristics of PPE: They are long-term in nature and usually depreciated Property, plant, and equipment yield services over a number of years. Companies allocate the cost of the investment in these assets to future periods through periodic depreciation charges. The exception is land, which is depreciated only if a material decrease in value occurs, such as a loss in fertility of agricultural land because of poor crop rotation, drought, or soil erosion
Major Characteristics of PPE: They possess physical substance Property, plant, and equipment are tangible assets characterized by physical existence or substance. This differentiates them from intangible assets, such as patents or goodwill. Unlike raw material, however, property, plant, and equipment do not physically become part of a product held for resale
Historical cost: def measures the cash or cash equivalent price of obtaining the asset and bringing it to the location and condition necessary for its intended use
historical cost: Ex Company allocates costs ( purchase price, freight costs, sales taxes, and installation costs of a productive asset as part of the asset's cost)
Should not write up PPE to reflect fair value when it is above cost, because 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
Cost of land all expenditures made to acquire land and ready it for use typically include: 1) the purchase price 2) closing costs, such as title to 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 on the property 5) any additional land improvements that have an indefinite life
Removal of Old Buildings clearing, grading, and filling- is a land cost because this activity is necessary to get the land in condition for its intended purpose
reductions in the price of land salvage receipts on the demolition of an old building or the sale of cleared timber
back taxes and linens (cost of land) the cost of land is paid for it, plus encumbrances
special assessments pavements, street lights, sewers, and drainage systems should be charged to land account because they are relatively permanent in nature
land held for resale should classify as inventory, it is an investment
Costs of building includes all expenditures related directly to their acquisition or construction, all costs incurred from excavation to completion Ex:1) materials, labor and overhead costs incurred during construction 2) professional fees and building permits
Cost of Equipment Cost of Equipment includes the purchase price, freight and handling charges incurred, insurance on the equipment while in transit, cost of special foundations if required, assembling and installation costs, and costs of conducting trial runs includes all expenditures incurred in acquiring the equipment and preparing it for use
Self-constructed asset without a purchase price or contract price, the company must allocate costs and expenses to arrive at the cost of...
Self-constructed direct/indirect Direct: traced costs directly to work and material orders related to the fixed assets constructed with no problem Indirect: Overhead or burden, includes power, heat, light, insurance, property taxes on factory buildings and equipment, factory supervisory labor, depreciation of fixed assets, and supplies are a problem
Indirect costs: Assign no fixed overhead to the cost of the constructed asset the major argument for this treatment is that indirect overhead is generally fixed in nature. It does not increase as a result of a company constructing its own plant or equipment. This approach assumes that the company will have the same costs regardless of whether it constructs the asset or not. Therefore, to charge a portion of the overhead costs to the equipment will normally reduce current expenses and consequently overstate income of the current period. However, the company would assign to the cost of the constructed asset variable overhead costs that increase as a result of the construction
Indirect costs: Assign a portion of all overhead to the construction process this approach is called a full-costing approach, follows the belief that costs should attach to all products and assets manufactured or constructed. Under this approach, a company assigns a portion of all overhead to the construction process, as it would to normal production. Advocates say that failure to allocate overhead costs understates the initial cost of the asset and results in an inaccurate future allocation
a pro rata portion to determine its cost a company should assign this companies use this treatment extensively because many believe that it results in a better recognition of these costs in periods benefited
allocated overhead results in excess construction costs If the allocated overhead results in recording construction costs in excess of the costs that an outside independent producer would charge, 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 fair value
Interest costs during construction: Capitalize no interest charges during construction under this approach, interest is considered a cost of financing and not a cost of construction. Some contend that if a company had used stock (equity) financing rather than debt, it would not incur this cost. The major argument against this approach is that the use of cash, whatever its source, has an associated implicit interest cost, which should not be ignored
Interest costs during construction: Charge construction with all costs of funds employed, whether identifiable or not this method maintains that the cost of construction should include the cost of financing, whether by cash, debt, or stock. Its advocates say that 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. A major criticism of this approach is that imputing the cost of equity capital (stock) is subjective and outside the framework of an historical cost system
Interest costs during construction: Capitalize only the actual interest costs incurred during construction this approach agrees in part with the logic of the second approach--that interest is just as much a cost as are labor and materials. But this approach capitalizes only interest costs incurred through debt financing. (That is, it does not try to determine the cost of equity financing.) Under this approach, a company that uses debt financing will have an asset of higher cost than a company that uses stock financing. Some consider this approach unsatisfactory because they believe the cost of an asset should be the same whether it is financed with cash, debt, or equity
GAAP- capitalize only the actual interest costs incurred during construction method follows the concept that 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 to implement consider: qualifying assets, capitalization period, amount to capitalize
Qualifying assets to qualify for interest capitalization, assets must require a period of time to get them ready for their intended use starts with first expenditure related to asset, and continues until the asset is at its intended use ex: assets under construction for a company's own use (buildings, plants, large machinery) and assets intended for sale or lease that are constructed or otherwise produced as discrete projects (ships or real estate developments
not qualify for interest capitalization 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 the activities necessary to get them ready for use EX: land remaining undeveloped and assets not used because of obsolescence, excess capacity, or need for repair
capitalization period the period of time during which a company must capitalize interest conditions: 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 continues as these are present
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
amount to capitalize the amount of interest to capitalize is limited to the lower of actual interest cost incurred during the period or avoidable interest
potential amount of interest that it may capitalize multiply the interest rate by the weighted-average accumulated expenditures for qualifying assets during the period
Weighted-average accumulated expenditures 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
Interest Rate principles 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 THE 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
Weighted average interest rate Total Interest / Total principal
Expenditures for land for particular use interest costs associated with those expenditures qualify for interest capitalization
Expenditures for land for a structure interest costs capitalized during the period of construction are part of the cost of the plant, not the land
expenditures for land for lot sale it includes any capitalized interest cost as part of the acquisition cost of the developed land. However, it should NOT capitalize interest costs involved in purchasing land held for speculation because the asset is ready for its intended use
Interest revenue companies should not net or offset interest revenue against interest cost; companies should capitalize the interest incurred on qualifying assets whether or not they temporarily invest excess funds in short-term securities
Valuation of PPE companies should record PPE at the fair value of what they give up or at the fair value of the asset received whichever is more clearly evident
long-term credit to properly reflect cost, companies account or assets purchased on long-term credit contracts at the present value of the consideration exchanged between the contracting parties at the date of the transaction
Lump-sum price the company allocates the total cost among the various assets on the basis of their relative fair values when purchased at lump sum. assumption is that costs will vary in direct proportion to fair value
Issuance of stock the par or stated value of such stock fails to properly measure property cost when companies acquire property by issuing securities. if trading of the stock is active, the market price 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
exchange of nonmonetary assets basis of the fair value of the asset given up or the fair value of the asset receive, 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 recognized
commercial substance if the two parties economic positions change
Type: Commercial Substance recognize gains and losses immediately
Type: Lacks Commercial substance--no cash received Defer gains; recognize losses immediately
Type: Lacks Commercial substance---cash received recognize partial gain; recognize losses immediately
exchange lacks commercial substance if the company receives no cash in such an exchange, it defers recognition of a gain. If the company receives cash in such an exchange, it recognizes part of the gain immediately
Exchanges: Loss Situation recognizes the loss immediately Rationale: companies should not value assets at more than their cash equivalent price. If the loss were deferred, assets would be overstated. Therefore, companies recognize a loss immediately whether the exchange has commercial substance or not
Loss Situation JE Equipment XXX Accumulated Depreciation-Equipment XXX Loss on Disposal of Equipment XXX Equipment XXX Cash XXX
loss on disposal of machine fair value Less: Book Value =Loss on disposal
Exchanges: Gain Situation with Commercial substance a company usually records the cost of a nonmonetary asset acquired in exchange for another nonmonetary asset at the fair value of the asset given up and 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
Gain Situation with commercial substance JE Trucks (semi) XXX Accumulated Depreciation-Trucks XXX Trucks (used) XXX Gain on Disposal of Trucks XXX Cash XXX
Gain on disposal of truck Fair Value Cost of used truck Less: Accumulated depreciation Book Value =Gain on disposal
Exchanges: Gain Situation lacks commercial substance no cash the company recognizes the gain (reflected in the basis of the semi-truck) through lower depreciation expense or when it later sells the semi-truck, not at the time of the exchange
Gain Situation lacks commercial substance no cash JE Trucks (semi) XXX Accumulated Depreciation-Trucks XXX Trucks (used) XXX Cash XXX
Gain Situation computations Fair value Less: Gain deferred = Basis of semi-truck Book Value Plus: Cash paid = Basis of semi-truck
Exchanges: Gain Situation lacks commercial substance some cash receives a "boot" in an exchange that lacks commercial substance, it must immediately recognize a portion of the gain
Gain Situation lacks commercial substance some cash JE Cash XXX Machinery (new) XXX Accumulated Depreciation-machinery XXX Machinery (old) XXX Gain on Disposal of Machinery XXX
Recognized Gain equation cash received (boot) / cash received (boot) + Fair value of other assets received *Total gain
Total gain on exchange-calculation Fair value of machine given up Less: Book value of machine given up =total gain
rationale of partial gain before a nonmonetary exchange that includes some cash, a company has an unrecognized gain, which is the difference between the book value and the fair value of the old asset. When the exchange occurs, a portion of the fair value is converted to a more liquid asset. The ratio of this liquid asset to the total consideration received is the portion of the total gain that the company realizes. Thus, the company recognizes and records that amount
Contribution some type of asset, such as cash, securities, land, buildings, or use of facilities, but it also could be the forgiveness of a debt
nonreciprocal transfers transfer assets in one direction
assets as donations valuation of asset should be zero. However, a departure from the historical cost principle seems justified; the only costs incurred (legal fees and other relatively minor expenditures) are not a reasonable basis of accounting for the assets acquired. To record nothing is to ignore the economic realities of an increase in wealth and assets. Therefore, companies use the fair value of the asset to establish its value on the books
FASB position on contributions companies should recognize contributions received as revenues in the period received, measure at the fair value
Promise immediately? 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
Promise immediately? conditional the company recognizes expense in the period benefited by the contribution, generally when it transfers the asset
prudent cost 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
Costs subsequent to acquisition costs incurred to achieve greater future benefits should be capitalized, whereas expenditures that simply maintain a given level of services should be expensed
costs subsequent to acquisition: conditions one of three must be present 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
additions increase or extension of existing assets; companies capitalize any addition to plant assets because a new asset is created
improvements and replacements substitution of an improved asset for an existing one
rearrangement and re-installation movement of assets from one location to another
repairs expenditures that maintain assets in condition for operation
difference between improvements and replacements improvement: betterment-is 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 use if the carrying amount of the old asset is available. it is simple matter to remove the cost of the old asset and replace it with the cost of the new asset -if company cannot determine carrying amount of the old asset, it adopts one of other two approaches
capitalize the new cost another approach capitalizes the imporvement and keeps the carrying amount of the old asset on the books. The justification for this approach is that the item is sufficiently depreciated to reduce its carrying amount almost to zero. Although this assumption may not always be true, the differences are often insignificant. Companies usually handle improvements in this manner
charge to accumulated depreciation in cases when a 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 an asset account. The theory behind this approach is that the replacement extends the useful life of the asset and thereby recaptures some or all of the past depreciation. The net carrying amount of the asset is the same whether debiting the asset or accumulated depreciation
if the expenditure increase the future service potential of the asset... a company should capitalize it handled 3 ways: use the substitution approach, capitalize the new cost, charge to accumulated depreciation
rearrangement and re-installation costs if estimated original installation cost and the accumulated depreciation to date-handles as a replacement otherwise, should capitalize the new costs as an asset to be amortized over the future periods expected to benefit (material) If immaterial, if they cannot be separated from other operating expenses, or if their future benefit is questionable, the company should immediately expense them
ordinary repairs charged to expense account in the period incurred, on the basis that it is the primary period benefited -used to maintain plant assets in operation conditions
major repair such as overhaul, several periods will benefit -handled as an addition, improvement or replacement
Disposition of PPE depreciation is an estimate of cost allocation and not a process of valuation. The gain or loss is really a correction of net income
Sale of plant assets companies record depreciation for the period of time between the date of the last depreciation entry and the date of sale records depreciation to the date of sale: Depreciation Expense Accumulated Depreciation
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