CHAPTER 9
PROPERTY, PLANT, AND EQUIPMENT: ACQUISITION AND DISPOSAL
CONTENT ANALYSIS OF EXERCISES AND PROBLEMS
Time Range
NumberContent (minutes)
E9-1Determination of Cost. Analysis of numerous items 5-10
to determine whether or not to include in property,
plant, and equipment.
E9-2Property, Plant, and Equipment. Analysis of various 5-10
items for potential balance sheet inclusion.
E9-3Acquisition Costs. Compute total acquisition costs 5-10
of machine and prepare journal entry to record.
E9-4Acquisition Cost. Journal entry to record acquisition. 5-15
Analysis of entry if price not available.
E9-5(AICPA adapted). Acquisition Cost. Determination 5-15
of cost and journal entry to record acquisition.
E9-6(AICPA adapted). Acquisition of Land and Building.10-15
Computation of land and new building cost.
E9-7Lump Sum Purchase. Cost assigned to land, buildings,10-15
and equipment.
E9-8Exchange of Assets. No boot, similar productive10-15
assets. Journal entries.
E9-9Exchange of Assets. Boot, similar productive assets,10-15
loss. Journal entries.
E9-10Exchange of Assets. Boot, similar productive assets,10-15
gain. Journal entries.
E9-11Exchange of Assets. No boot, dissimilar productive10-15
assets. Journal entries.
E9-12Exchange of Assets. Boot, dissimilar productive10-15
assets. Journal entries.
E9-13(AICPA adapted). Exchange of Assets. No boot, 5-10
similar productive assets. Determination of
amount to be shown in the accounting records.
Time Range
NumberContent (minutes)
E9-14Self-Construction. Determination of amount to be10-15
capitalized. Evaluation under differing outside
contractor's bids.
E9-15Donation. Journal entry to record acquisition.10-20
Financial statement disclosure. Time differences
for passage of title.
E9-16Interest During Construction. Compilation of amount 5-15
to be capitalized. Financial statement disclosure.
E9-17Interest During Construction. Compute amount of 5-15
capitalized interest and interest revenue.
E9-18Expenditures. Capital vs. operating. Classification 5-10
of various items.
E9-19(Appendix). Oil and Gas Accounting. Successful 10-20
efforts, full-cost methods. Determination of
expense and balance sheet value.
P9-1Acquisition Costs. Reclassification of erroneously20-30
recorded items. Journal entries.
P9-2Costs Subsequent to Acquisition. Adjusting entries45-60
to correct the books from improperly recorded costs.
Acquisition, legal fees, insurance, additions, repairs.
P9-3Cost Classification. Journal entries to record25-35
various transactions. Acquisition, parking lot,
sale, lease, freight, installation, taxes.
P9-4(CMA adapted). Self-Construction. Computation30-45
according to GAAP of amount to be capitalized.
Identification of any alternative procedures.
P9-5Acquisition Cost. Acquisition, replacement,20-30
purchase. Journal entries to record various
transactions.
P9-6(AICPA adapted). Comprehensive: Analysis of25-35
Changes in Fixed Assets. Preparation of schedules
for changes in land, building, leasehold improvements,
and machinery and equipment.
P9-7Assets Acquired by Exchange. Various situations40-60
dealing with similar or dissimilar productive
assets and boot. Journal entries.
Time Range
NumberContent (minutes)
P9-8Assets Acquired by Exchange. Various situations30-45
dealing with similar or dissimilar productive assets,
boot, and changing fair value. Journal entries.
P9-9Interest During Construction. Computation of amount20-30
to be capitalized and amount to be depreciated.
Straight-line. Effects on financial statements.
P9-10Comprehensive: Interest Capitalization. Computation40-60
of amounts of capitalized interest, interest expense,
and interest revenue. Journal entries to record
construction costs, including interest.
P9-11Events Subsequent to Acquisition. Replacement, 20-30
repairs, demolition. Journal entries to record
various transactions.
P9-12(AICPA adapted). Comprehensive: Adjusting Entries.40-60
Analysis of machinery and equipment account. Schedules
to show effect of additions and retirements on
account balances. Journal entries.
P9-13(AICPA adapted). Adjusting Entries. Analysis of40-60
the building account. Journal entries to adjust
the account as necessary. Supporting computations.
P9-14(Appendix). Oil and Gas Accounting. Successful 10-20
efforts, full-cost methods. Financial statement
disclosure.
ANSWERS TO QUESTIONS
Q9-1For a company to include an asset in the category of property, plant, and equipment, the asset must: (1) be held for use in the normal course of business; (2)have an expected useful life of more than one year; and (3)be tangible property - that is, the asset must have physical substance.
Q9-2Generally, a company capitalizes the expenditures that are necessary to obtain the benefits to be derived from the asset and includes them as a cost of property, plant, and equipment. The expenditures include the costs incurred in the acquisition of an asset and in putting the asset into operating condition. The company expenses the costs of maintaining the benefits at the levels originally expected.
Q9-3A company classifies land held for investment on the balance sheet as an investment. It does not include the land as property, plant, and equipment, since it is not being used in the normal course of business in a productive capacity.
Q9-4The book value of an asset is the recorded acquisition cost less the accumulated depreciation recorded to date.
Q9-5At the date of acquisition, the acquisition cost is equal to the market value. At the end of the life of the asset, the book value should equal the residual value (a market value). During the life of the asset, there is no defined relationship between the book value and market value because depreciation is a process of cost allocation, not of market valuation.
Q9-6In a lump-sum purchase, the company allocates the total purchase price to the individual assets on the basis of their relative fair values. This allocation is necessary because some of the assets may have different economic lives, may not be depreciable, or may be depreciated by different methods.
Q9-7When a company exchanges securities for an asset, the acquisition cost of that asset is either the fair value of the securities given up or the fair value of the asset acquired. The company makes the choice on the basis of the market that is more reliable. If neither of these amounts is known, it may use an appraisal of the asset, or, as a final solution, the company's board of directors may place a value on the transaction.
Q9-8The distinction between similar and dissimilar productive assets is that similar productive assets are of the same general type and perform the same basic function and are used in the same line of business. This distinction is made because, in the exchange of similar productive assets, the earning process is not considered completed, and thus the accounting for the transaction is different than when dissimilar productive assets are exchanged.
Q9-9When similar productive assets are exchanged, the company recognizes a gain to the extent that it receives "boot" along with the asset. The company recognizes a loss in accordance with the conservatism principle of accounting.
When dissimilar productive assets are exchanged, the earning process is considered completed and the company recognizes both gains and losses.
Q9-10The term "boot" refers to monetary consideration either paid or received. For the special rules to apply, the boot must be less than 25% of the fair value of the transaction.
Q9-11The general principle underlying accounting for dissimilar productive assets is that the earning process has been completed and thus gains or losses are recognized. On the other hand, in accounting for similar productive assets the earning process has not been completed. The company is in the same relative position, so gains on the exchange is deferred (except to the extent that boot is received). Losses are recognized in accordance with the conservatism principle.
Q9-12According to the provisions of FASB Statement No. 34, a company capitalizes interest on the acquisition of an asset if the asset requires a period of time to get it ready for its intended use - a criterion that is met for the self-construction of an asset. Specifically, the company does not capitalize interest for the following types of assets:
1.Inventories that are routinely manufactured or otherwise produced on a repetitive basis.
2.Assets that are in use or ready for their intended use.
3.Assets that are not being used in the earning activities of the company and are not undergoing the activities necessary to get them ready for use.
Since imputed interest is not capitalized, the company must have borrowed funds to finance the self-construction of the asset.
In contrast, interest on a note payable (that is not associated with the construction of an asset) is expensed as incurred.
Q9-13A company bases the amount of interest capitalized for a self-constructed asset on the actual amounts borrowed and the cost of those borrowings. The amount is intended to be that portion of the interest cost incurred during the asset's construction period that theoretically could have been avoided. The company determines the amount that it capitalizes by applying an interest rate to the average amount of the expenditures on the self-constructed asset during the capitalization period.
Q9-14Since activities that are necessary to get the asset ready for its intended use are in progress, the asset qualifies for interest capitalization. The company capitalizes interest to the building account unless it makes specific expenditures that are normally added to the land account, as discussed at the beginning of this chapter.
Q9-15Three alternative treatments of fixed overhead costs are (1)to allocate a portion of the total fixed overhead to the cost of the asset being constructed, (2) to include only the incremental fixed overhead that is attributable to construction in the cost of the self-constructed asset, or (3) to include no fixed overhead in the cost of the self-constructed asset. Proponents of the allocation of total overhead argue that construction should be treated the same as any other production process that receives a portion of overhead costs. This method is appropriate when the company is operating at full capacity and regular production is reduced by the self-construction. Arguments in favor of including only the incremental increase are that normal production costs should include the same amount of overhead whether construction is going on or not, the normal overhead would be incurred anyway, and that the cost of an asset and the decision to construct it should be based on additional and incremental costs incurred. This method is appropriate when the company is in an excess capacity situation. The argument in favor of including no fixed overhead is that the fixed overhead does not change as a result of the construction. Therefore, to include some overhead would result in less overhead being expensed in the current period, and an increase in income.
Q9-16Under generally accepted accounting principles, a company may not recognize profit on the self-construction of an asset. The revenue recognition principle allows recognition of profit on asset use and disposal, not on the acquisition or construction of an asset. If construction costs are materially greater than the fair value of the asset, then the convention of conservatism requires the company to write-down the capitalized costs and recognize a loss.
Q9-17The distinction between a capital expenditure and an operating expenditure is whether the costs have increased the future economic benefits of the asset above those that were originally expected. The future economic benefits can be increased by extending the life of the asset, improving productivity, producing the same product at a lower cost, or increasing the quality of the product. For example, if a machine receives a major overhaul that increases the benefits to be realized from the asset, the costs are capitalized. Conversely, ordinary repairs are of a maintenance type that do not increase the total benefits to be realized, and, therefore, are expensed. As another example, the cost of adding a new wing to an existing hospital is capitalized since it increases the total benefits of the hospital, whereas repairing the elevators does not increase the economic benefit of the hospital and so is expensed.
Q9-18An addition is a new asset that is being "added" or utilized in conjunction with an old asset. In contrast, an improvement/ replacement involves the substitution of a new part or asset for an old one. In accounting for an addition, a company capitalizes the costs of the addition, and takes out of the old asset account any portion of the old asset that is demolished or removed. A company capitalizes improvement and replacement costs using the substitution method when it knows the book value of the asset being replaced, by replacing the old book value with the cost of the new asset. If it does not know the old book value, then it still capitalizes the cost of the new asset, but with either a debit to the Accumulated Depreciation account of the old asset or a debit to the old Asset account.
Q9-19The costs of ordinary repairs and maintenance are expenses incurred routinely to keep the asset in operating condition. Since these costs do not increase the future benefits of the asset, a company expenses them as they are incurred. For interim financial reporting, the use of an Allowance account is appropriate in order to even out the expenses. However, this account is closed at the end of the year. Extraordinary repairs are those that cannot be foreseen and do not occur in the usual course of operations, such as emergency repairs to a machine that breaks down during production. Usually, a company expenses these costs, but care should be taken to note whether these repairs increase the future benefits of the asset. If they do, then the company capitalizes the costs.
Q9-20Leasehold improvements are improvements made to leased property that, upon termination of the lease, will revert back to the lessor. A company capitalizes the cost of these improvements and subsequently amortizes them over the economic life of the improvements or the lease term, whichever is shorter.
Q9-21An Allowance for Repairs account appears only on balance sheets of interim financial statements if a company incurs repair costs unevenly. At year-end, this account is closed; thus, it does not appear on a year-end balance sheet.
Q9-22A company accounts for the disposal of an asset by removing both the asset and accumulated depreciation to date from the ledger, recording the receipt of cash, if any, and also recording any gain or loss. It reports this gain or loss in ordinary income (in the category of Other Items) on the income statement unless it meets the criteria for an extraordinary item.
Q9-23Under the successful-efforts method of accounting for oil and gas properties, a company capitalizes only those costs incurred in drilling for successful wells while it expenses the costs of unsuccessful wells. In contrast, under the full-costing method a company capitalizes all costs of drilling wells, whether the drilling was successful or not.
ANSWERS TO CASES
C9-1 (AICPA adapted solution)
1.The expenditures that are capitalized when equipment is acquired for cash include the invoice price of the equipment (net of discounts) plus all incidental outlays relating to its purchase or preparation for use, such as insurance during transit, freight, duties, ownership search, ownership registration, installation, and breaking-in costs. Any available discounts, whether taken or not, should be deducted from the capitalizable cost of the equipment.
2.a.When the market value of the equipment is not determinable by reference to a similar cash purchase, the capitalizable cost of equipment purchased with bonds having an established market price is the market value of the bonds.
b.When the market value of the equipment is not determinable by reference to a similar cash purchase, and the common stock used in the exchange does not have an established market price, the capitalizable cost of equipment is the equipment's estimated fair value if that is more clearly evident that the fair value of the common stock. Independent appraisals may be used to determine the fair values of the assets involved.
c.When the market value of equipment acquired is not determinable by reference to a similar cash purchase, the capitalizable cost of equipment purchased by exchanging similar equipment having a determinable market value is the lower of the recorded amount of the equipment relinquished or the market value of the equipment exchanged.
C9-1 (continued)
3.The factors that determine whether expenditures relating to property, plant, and equipment already in use are capitalized are as follows:
•Expenditures are relatively large in amount.
•They are nonrecurring in nature.
•They extend the useful life of the property, plant, and equipment.
•They increase the usefulness of the property, plant, and equipment.
4.The net book value at the date of the sale (cost of the property, plant, and equipment less the accumulated depreciation) is removed from the accounts. The excess of cash from the sale over the net book value removed is accounted for as a gain on the sale, while the excess of net book value removed over cash from the sale is accounted for as a loss on the sale.
C9-2 (AICPA adapted solution)
1.Expenditures are capitalized when they benefit future periods. The cost to acquire the land is capitalized and classified as land, a nondepreciable asset. Since tearing down the small factory is readying the land for its intended use, its cost is part of the cost of the land and is capitalized and classified as land. As a result, this cost is not depreciated as it would be if it was classified with the capitalizable cost of the building.
Since the rock blasting and removal is required for the specific purpose of erecting the building, its cost is part of the cost of the building and is capitalized and classified with the capitalizable cost of the building. This cost is depreciated over the estimated useful life of the building.
The road is a land improvement, and its cost is capitalized and classified separately as a land improvement. This cost is depreciated over its estimated useful life.
The added four stories is an addition, and its cost is capitalized and classified with the capitalizable cost of the building. This cost is depreciated over the remaining life of the original office building because that life is shorter than the estimated useful life of the addition.
2.The gain is recognized on the sale of the land and building because income is realized whenever the earning process is complete and the sale takes place.
The book value at the date of the sale is composed of the capitalized cost of the land, the land improvement, and the building, as determined above, less the accumulated depreciation on the land improvement and the building. The excess of the proceeds received from the sale over the net book value at the date of sale is accounted for as part of income from continuing operations in the income statement.
C9-3 (AICPA adapted solution)