Accounting 13 Chapter 10 Acquisition and Disposition of Property, Plant, and Equipment
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.
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Shalla computed he weighted-average accumulated expenditures during 2014 as shown in illustration 10-4
Note that the expenditure made on December 31, the last day of the year, does not have any interest cost.
the plastic tubing costs $125,000.if instinct pays $124,000 for the new tubing after exchanging the old tubing, it makes the following entry:
Plant Assets (plumbing system) 125,000 Accumulated Depreciation-Plant Assets 135,000 Loss on Disposal of Plant Assets 14,000 ******plant assets 150,000 ******Cash ($125,000-$1,000) 124,000
2. 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 crop rotation, drought, or soil erosion.
3. THEY POSSES 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.
the proper accounting for interest costs has been a long-standing controversy.
Three approaches have been suggested to account for the interest incurred in financing the construction of property, plant, and equipment.
ordinarily, companies account for the exchange of nonmonetary asset on the basis of the fair value of the assert given up or the fair value of the asset received, whichever is clearly more evident. thus, 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.
GAAP requires the third approach--capitalizing actual interest "with modification." this 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.
the rationale for this approach is that during construction, the asset is not generating revenues. Therefore, a company should defer "capitalize" interest costs.
Generally, land is part of property, plant, and equipment. However, if the major purpose of acquiring and holding land is speculative, a company more appropriately classifies the land as an investment.
if a real estate concern holds the land for resale, it should classify the land as inventory.
Expenditures for Land. 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 as a plant site), interest costs capitalized during the period of construction are part of the cost of the plant, not the land.
when a company purchases plant assets subject to cash discounts for prompt payment, how should it report the discount?
if it takes the discount, the company should consider the discount as a reduction in the purchase price of the asset. but should the company reduce the asset cost even if it does not take the discount?
the amount of interest to capitalize is limited to the lower of actual interest cost incurred during the period or avoidable interest. 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 interest cost for the period is $90,000 and the avoidable interest is $80,000, the company capitalizes only $80,000.
one problem that arises in this area the accounting for any changes related to the existing structure as a result of the addition. is the cost incurred to tear down an old wall, to make a room for the addition, a cost of the addition or an expense or loss of the period? the answer is that it depends on the original intent.
if the company had anticipated building an addition later, then this cost of removal is a proper cost of the addition. but if the company had not anticipated this development, it should properly report the removal as a loss in the current period on the basis of inefficient planning.
companies expense most expenditures below an established arbitrary minimum amount, say, $100 or $500. Although conceptually this treatment may be incorrect, expediency demands it. otherwise, companies would set up depreciation schedules for an item such as wastepaper basket.
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companies sometimes receive or make contributions (donations or gifts). such contributions, nonrecriprocal transfers, transfer assets in one direction. a contribution is often some type of asset (such as cash, securities, land, building, or use of facilities), but it also could be the forgiveness of debt.
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however, it is possible to exchange similar assets but not have a significant difference in cash flows. that is, the company is in the same economic position as before the exchange. in that case, the company recognizes a loss but generally defers a gain.
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if the expenditure increases the future service potential of the asset, a company should capitalize it. the accounting is therefore handled in one of three ways, depending on the circumstances:
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in order to capitalize costs, one of three conditions 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.
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normally, the company retains the carrying amount of the old wall in the accounts, although theoretically the company should remove it.
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other argue that companies should report donations as revenues from contributions. Their reasoning is that only the owners of a business contribute capital. at issue in this approach is whether the company should report revenue immediately or over the period that the asset is employed.
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proponents of the other approach argue that failure to take the discount should not always be considered a loss. the terms may be unfavorable, or it might not be prudent for the company to take the discount. at present, companies use both method though most prefer the former method.
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some criticize this approach because a company can defer the interest cost but report the interest revenue in the current period.
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to apply the avoidable interest concept, a company determines the potential amount of interest that it may capitalize during an accounting period by multiplying the interest rate(s) by the weighted-average accumulated expenditures for qualifying assets during the period.
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use the substitution approach. conceptually, the substitution approach is correct if the carrying amount of the old asset is available. it is then a simple matter to remove the cost of the old asset and replace it with the cost of the new asset.
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weighted-average accumulated expenditures. in computing the 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.
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what then is the proper accounting for the credit in this transaction? some believe the credit should be made to Donated Capital ( an additional paid-in capital account). this approach views the increase in assets from a donation as contributed capital, rather than as earned revenue.
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what then is the proper accounting for the credit in this transaction? some believe the credit should be made to Donated Capital (an additional paid-in capital account). This approach views the increase in assets from a donation as contributed capital, rather than as earned revenue.
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a special problem of valuing fixed assets arises when a company purchases a group of plant assets at a single lump-sum price. when this common situation occurs, the company allocates the total cost among the various assets on the basis of their relative fair values.
the assumption is that costs will vary in direct proportion to fair value. this is the same principle that companies apply to allocate a lump-sum cost among different inventory items.
what if companies exchange similar assets, such as one truck for another truck? even in an exchange of similar assets, a change in the economic position of the company can result. for example, let's say the useful life of the truck received is significantly longer than that of the truck given up.
the cash flows for the trucks can differ significantly.as a result, the transaction has commercial substance, and the company should use fair value as a basis for measuring the asset received in the exchange.
to illustrate, instinct enterprises decides to replace the pipes in its plumbing system.a plumber suggests that the company use plastic tubing in place of the cast iron pipes and copper tubing.
the old pipe and tubing have a book value of $15,000"cost of $150,000 less accumulated depreciation of $135,000", and a scrap value of $1,000.
in some cases, companies promise to give (pledge) some type of asset in the future. should companies record this promise immediately or when they give the assets? 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 expense in the period benefited by the contribution, generally when it transfers the asset.
Subsequent to acquisition, companies should not write up property, plant, and equipment to reflect fair value when it is above cost. The main reasons for this position are as follows.
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.
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 posses physical substance.
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 borrowings.
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.
the capitalization period is the period of time during which a company must capitalize interest. it begins with the presence of three 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. interest capitalization continues as long as these three conditions are present. the capitalization period ends when the asset is substantially complete and ready for its intended use.
companies substitute one asset for another through improvements and replacements. What is the difference between an improvement and a replacement?
An improvement (betterment) is the substitution of a better asset for the one currently used (say, a concrete floor for a wooden floor). a replacement, on the other hand, is the substitution of a similar asset (a wooden floor for a wooden floor).
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.
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 cost 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.
INTEREST REVENUE. companies frequently borrow money to finance construction of assets. they temporarily invest the excess borrowed funds in interest-bearing securities until they need the funds to pay for construction.
During the early stages of construction, interest revenue earned may exceed the interest cost incurred on the borrowed funds.
1. 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.
like other assets, companies should record property, plant, and equipment at the fair value of what they give up or at the fair value of the asset received, whichever is more clearly evident. however, the process of asset acquisition sometimes obscures fair value.
For example, if a company buys land and buildings together for one price, how does it determine separate values for the land and buildings?
others argue that companies should report donations as revenues from contributions. their reasoning is that only the owners of a business contribute capital. at issue in this approach is whether the company should report revenue immediately or over the period that the asset is employed.
For example,to attract new industry a city may offer land, but the receiving enterprise may incur additional costs in the future "e.g., transportation or higher state income taxes" because the location is not the most desirable.
To compute the weighted accumulated expenditures, a company weights the expenditures by the amount of time that it can incur interest cost on each one. For the March 1 expenditure, the company associates 10 months' interest cost with the expenditure.
For the expenditure on July 1, it incurs only 6 months' interest costs. For the expenditure made on November 1, the company incurs only 2 months of interest cost.
For example, companies like Kellogg Co. consider the purchase price, freight costs, sales taxes, and installation costs of a productive asset as part of the asset's cost. it then allocates these costs to future periods through depreciation.
Further, Kellogg adds to the asset's original cost any related costs incurred after the asset's acquisition, such as additions, improvements, or replacements, if they provide future service potential. Otherwise, Kellog expenses these costs immediately.
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.
The cost of buildings should include 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.
Generally, companies contract others to construct their buildings. Companies consider all costs incurred, from excavation to completion, as part of the building costs.
the distinction between a capital expenditure (asset) and a revenue expenditure (expense) is not always clear-cut. yet, in most cases, consistent application of a capital/expense policy is more important than attempting to provide general theoretical guidelines for each transaction.
Generally, companies incur four major types of expenditures relative to existing assets.
Most companies use historical cost as the basis for valuing property, plant, and equipment.
Historical cost measures the cash or cash equivalent price of obtaining the asset and bringing it to the location and condition necessary for its intended use.
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 increases as a result of the construction.
In addition, Home Depot should charge any permanent improvements it makes, such as landscaping, to the Land account.
It records separately any improvements with limited lives, such as private driveways, walks, fences, and parking lots, as Land Improvements. These costs are depreciated over their estimated lives.
In that case, a reasonable valuation for the asset can be obtained based on the sales price. A long-lived asset is not depreciated if it is classified as held for sale. This is because such assets are not being used to generate revenues.
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MAJOR TYPES OF EXPENDITURES ADDITIONS: increase or extension of existing assets. IMPROVEMENTS AND REPLACEMENTS. Substitution of an improved asset for an existing one.
REARRANGEMENT AND REINSTALLATION. movement of assets from one location to another. REPAIRS. expenditures that maintain assets in condition for operation.
To illustrate the issues related to interest capitalization, assume that on November 1, 2013, Shalla company contracted Pfeifer construction Co. to construct a building for $1,400,000 on land costing $100,000 [purchased from the contractor and included in the first payment].
Shalla made the following payments to the construction company during 2014.
The interest cost that Shalla capitalizes is the lesser of $120,228 [avoidable interest] and $239,500 [actual interest], or $120,228.
Shalla records the following journal entries during 2014
However, the assignment of indirect costs of manufacturing creates special problems.
These indirect costs, called overhead or burden, include power, heat, light, insurance, property taxes on factory buildings and equipment, factory supervisory labor, depreciation of fixed assets, and supplies. companies can handle indirect costs in one of two ways:
However, if the fair value of the property, plant, and equipment is less than its carrying amount, the asset may be written down.
These situations occur when the asset is impaired and in situations where the asset is being held for sale. a long-lived asset classified as held for sale should be measured at the lower of its carrying amount of fair value less costs to sell.
assign a portion of all overhead to the construction process. This approach, 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.
companies like Boeing ,Target, and Starbucks use assets of a durable nature. Such assets are called property, plant and equipment. Other terms commonly used are plant assets and fixed assets.
We use these terms interchangebly. Property, plant, and equipment include land, building structures (offices, factories, warehouses), and equipment (machinery, furniture, tools). The major characteristics of property, plant, and equipment are as follows.
CAPITALIZE THE NEW COST. another approach capitalizes the improvement 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.
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 (e.g., ships or real estate development.)
the problem is determining the book value of the old asset. Generally, the components of a given asset depreciate at different rates. however, generally no separate accounting is made. for example, the tires, motor,
and body of a truck depreciate at different rates, but most companies use on rate for the entire truck. companies set separate depreciation rates, but it is often impractical. if a company cannot determine the carrying amount of the old asset, it adopts one of two other approaches.
when companies acquire assets a donations, a stick cost concept dictates that the valuation of the 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.
UNDERSTAND ACCOUNTING ISSUES RELATED TO ACQUIRING AND VALUING PLANT ASSETS. The following issues relate to acquiring and valuing plant assets. 1. 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. 2. 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.
Has Commercial Substance. now let's consider the situation in which a nonmonetary exchange has commercial substance and a gain is realized. in such a case, 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.
all expenditures made to acquire land and ready it for use are considered part of the land cost. Thus, when Wal-Mart Stores, Inc. or Home Depot purchases land on which to build a new store, its 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; and 5. any additional land improvements that have an indefinite life.
IDENTIFY THE COSTS TO INCLUDE THE INITIAL VALUATION OF PROPERTY, PLANT AND EQUIPMENT. the costs included in initial valuation of property, plant, 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) cost 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; and 5. any additional land improvements that have an indefinite life.
For example, to attract new industry a city may offer land, but the receiving enterprise may incur additional costs in the future (e.g., transportation or higher state income taxes)
because the location is not the most desirable. as a consequence, some argue that the company should defer the revenue and recognize it as the costs are incurred.
3. 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."
to qualify for interest capitalization, assets must require a period of time to get them ready for their intended use. a company capitalizes interest cost starting with the first expenditure related to the asset.
capitalization continues until the company substantially readies the asset for its intended use.
when no interest rate is stated or if the specified rate is unreasonable, the company imputes an appropriate interest rate. the objective is to approximate the interest rate that the buyer and seller would negotiate at arm's length in a similar borrowing transaction.in imputing an interest rate,
companies consider such factors as the borrower credit rating,the amount and maturity date of the note, and prevailing interest rates. the company uses the cash exchange price of the asset acquired (if determinable) as the basis for recording the asset and measuring the interest element.
ADDITIONS should present no major accounting problems. by definition, companies capitalize any addition to plant assets because a new asset is created. For example, the addition of a wing to a hospital, or of an air conditioning system to an office, increases the service potential of that facility.
companies should capitalize such expenditures and match them against the revenues that will result in future periods.
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.
many times improvements and replacements result from a general policy to modernize or rehabilitate an older building or piece of equipment. the problem is differentiating these types of expenditures from normal repairs.
does the expenditures increase the future service potential of the asset? or does it merely maintain the existing level of service? frequently, the answer is not a clear-cut. good judgement is required to correctly classify these expenditures.
Or, if the actual interest cost is $80,000 and the avoidable interest is $90,000, it still capitalizes only $80,000. in no situation should interest cost include a cost of capital charge for stockholders' equity.
furthermore, GAAP requires interest capitalization for a qualifying asset only if its effect, compared with the effect of expensing interest, is material.
The FASB's position is that in general, companies should recognize contributions received as revenues in the period received. Companies measure contributions at the fair value of the assets received. To illustrate, Max Wayer Meat Packing, Inc.
has recently accepted a donation of land with a fair value of $150,000 from the Memphis Industrial Development Corp. In return, Max Wayer Meat Packing promises to build a packing plant in Memphis. Max Wayer's entry is: Land 150,000 ****Contribution Revenue 150,000
conversely, if the company develops land for lot sales, it includes any capitalized interest cost as part of the acquisition cost of the develop land.
however, it should not capitalize interest costs involved in purchasing land held for speculation because the asset is ready for its intended use.
3. LUMP-SUM PURCHASE: allocate the total cost among the various assets on the basis of their relative fair values. 4. 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 value of the property and use it as the basis for recording the asset and issuance of the common stock.
when companies acquire property by issuing securities, such as common stock, the par or stated value of such stock fails to properly measure the property cost.
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.
two points of view exist on this question. one approach considers the discount--whether take or not--as 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.
in addition, some argue that the terms of cash discounts are so attractive that failure to take them indicates management error or inefficiency.
after installing plant assets and readying them for use, a company incurs additional costs that range from ordinary repairs to significant additions. The major problem is allocating these costs to the roper time periods.
in general, costs incurred to achieve greater future benefits should be capitalized, whereas expenditures that simply maintain a given level of services should be expensed.
2.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.
The term "equipment" in accounting includes delivery equipment, office equipment, machinery, furniture and fixtures, furnishings, factory equipment, and similar fixed assets. the cost of such assets includes the purchase rice, freight and handling charges incurred,
insurance on the equipment in transit, cost of special foundations if required, assembling and installation costs, and costs of conducting trial runs. Costs thus include all expenditures incurred in acquiring the equipment and preparing it for use.
1. 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.
once construction is complete, the asset is ready for its intended use an a company can earn revenues. At this point, the company should report interest as an expense and match it to these revenues.
it follows that the company should expense any interest cost incurred in purchasing an asset that is ready for its intended use.to implement this general approach, companies consider three items: 1. qualifying assets. 2. capitalization period. 3. amount to capitalize.
Home Depot also might incur SPECIAL ASSESSMENTS for local improvements, such as pavements, street lights, sewers, and drainage systems.
it should charge these costs to the Land account because they are relatively permanent in nature. That is, after installation, they are maintained by the local government.
For example, when Home Depot purchases land for the purpose of constructing a building, it considers all costs incurred up to the excavation for the new building as land costs. 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. Home Depot treats 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.
5. EXCHANGES OF NONMONETARY ASSETS. the accounting for exchanges of nonmonetary assets depends on whether the exchange has commercial substance. 6. CONTRIBUTION: record at the fair value of the asset received, and credit revenue for the same amount.
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INTEREST RATES. companies follow the below principles in selecting the appropriate interest rates to be applied to the weighted-average accumulated expenditures:
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Two issues related to interest capitalization merit special attention: 1. expenditures for land. 2. interest revenue.
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as a consequence, some argue that the company should defer the revenue and recognize it as the costs are incurred.
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1. 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.
should companies offset interest revenue against interest cost when determining the amount of interest to capitalize as part of the construction cost of assets? in general, companies should not net or offset interest revenue against interest cost.
temporary or short-term investment decisions are not related to the interest incurred as part of the acquisition cost of assets.therefore, companies should capitalize the interest incurred on qualifying assets whether or not they temporarily invest excess funds in short-term securities.
as indicated above, fair value is the basis for measuring an asset acquired in a nonmonetary exchange if the transaction has commercial substance. An exchange has commercial substance if the future cash flows change as a result of the transaction.
that is,if the two parties' economic positions change, the transaction has commercial substance.
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.
for example, Greathouse company purchases an asset today in exchange for a $10,000 zero-interest-bearing note payable four years from now. the company would not record the asset at $10,000. instead, the present value of the $10,000 note establishes the exchange price of
the transaction (the purchase price of the asset).assuming an appropriate interest rate of 9 percent at which to discount this single payment of $10,000 due four years from now, Greathouse records this asset at $7,084.30 ($10,000*.70843). for the present value of a single sum, PV=$10,000.
But how should companies account for an old building that is on the site of a newly proposed building? is the cost of removal of the old buildings a cost of the land or a cost of the new building? Recall that if a company purchases land with an old building on it,
then the cost of demolition less its salvage value is a cost of getting the land ready for its intended use ans relates to the land rather than to the new building. in other words, all costs of getting an asset ready for its intended use are costs of that asset.
A committee of the AICPA argues against allocation of overhead. Instead, it supports capitalization of only direct costs [costs directly related to the specific activities involved in the construction process]. AcSEC was concerned that the allocation of overhead costs may lead
to overly aggressive allocations and therefore misstatements of income. In addition, not reporting these costs as period costs during the construction period may affect comparisons of period costs and resulting net income from one period to the next.
companies frequently purchase plant assets on long-term credit contracts, using notes, mortgages, bonds, or equipment obligations.
to properly reflect cost, companies account for 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.