ACCT 5010 Chapter 10

amount of interest to capitalize

a firm capitalizes the lower of actual interest costs incurred during the period or avoidable interest

unclear purchase price

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 clear)

acquisition of PPE

PPE goes on the balance sheet at historical cost, subsequent to acquisition any costs incurred that provide future service potential (additions, improvements, or replacements) are also capitalized, subsequent to acquisition companies shouldn't write up PPE to reflect fair value when it is above cost because: (1) historical cost involves actual (not hypothetical) transactions and so its the most reliable and (2) companies shouldn't anticipate gains and losses but should recognize gains and losses only when the asset is disposed of

record new asset of non-monetary exchange

= (FMV of asset given) +/- (cash paid/received) - (any deferred gain)

avoidable interest

(=sum of (weighted average accumulated expenditures x some interest rate)) the amount of interest cost during the period that a company could theoretically avoid if it had not made expenditures for the asset/paid down debt

non-monetary exchange, LCS, cash is <25%

(gain=FMV of asset given - BV of asset given) if you are paying cash then there is no gain, however if you are receiving cash there is a partial gain, partial gain recognized = (FMV of asset given - BV of asset given) x (cash/FMV of total assets received, including cash received)

IFRS

1. IFRS allows managers to mark fixed assets at FMV if they choose (must elect FMV at inception and keep going until disposition for all similar assets -> use FMV once one of the similar assets is placed on the balance sheet using FMV) 2. under US GAAP qualifying assets for interest capitalization is restricted, but IFRS says anything besides inventory qualifies (any type of project, not just discreet)

weighted average accumulated expenditures

a company takes all expenditures made in the current period for the asset (even land) and weights them based on the amount of time that it could incur interest cost on them which is based on when the expenditure is made and only includes the time period during which the capitalization period is in effect

contributions/gifts of assets

asset is recorded at FMV (cr. contribution revenue), the giver of the asset removes the asset at book value (dr. contribution expense at FMV) and difference with book value will be a gain/loss

plant/fixed assets

assets of a durable nature that are referred to as property, plant, and equipment (PPE), includes: land, building structures (offices, factories, warehouses), and equipment (machinery, furniture, tools)

cost of building

cost should include all expenditures related directly to acquisition and/or construction, typically includes: materials, labor, and overhead costs incurred during construction (if self-constructed)/price paid, professional fees, building permit fees, cost renovations (painting, extensions), and cost of installation, assembly, testing, and trial run, if construction was contracted include all costs incurred from excavation to completion, if a company purchases land with an old building on it then the cost of demolition (less salvage value) is a cost of getting the land (not building) ready

overhead

indirect manufacturing costs, includes: power, heat, light, insurance, property taxes on factory buildings and equipment, factory supervisory labor, depreciation of fixed assets, managers salary, and supplies

interest costs during construction

interest is a necessary expense in practical form and because of opportunity costs of firms with enough cash who don't need to borrow (interest is built into the purchase price of non-self-constructed assets), only capitalize interest (with modifications) during construction because asset isn't producing revenues, once asset is completed interest costs are no longer necessary to get asset ready so expense interest as incurred after construction is complete, only capitalize interest of qualifying assets during the interest capitalization period and can only capitalize a limited amount of interest, interest cost should never include cost of capital charge for stockholder's equity not should interest revenue ever offset interest expense

net method for deferred payment

liability is recorded at present value of all current and future payments

deferred payment contracts

purchasing an asset but not paying for it fully up front, portion is financed, firms account for assets like this based on present value of all current and future payments, interest is determined using current factors (market rate) and a discount/premium may occur with a formal note, two methods: net and gross method

characteristics of PPE

1. assets that are acquired for use in normal operations and not for resale or investment 2. assets that are long-term (>12 months or operating cycle, whichever is longer) in nature and usually depreciated (except land) 3. assets that possess physical substance (tangible)

weighted average interest rate

= ((sum of all interest expense)/(sum of the principal amounts of loans outstanding)), do not include project specific borrowing in this calculation, only include debt outstanding as of year/period end

commercial substance

an exchange has commercial substance if the future cash flows change as a result of the transaction (two parties economic positions change), this can still happen with the exchange of similar assets, when this is present immediately recognize gains/losses, if this doesn't exist a firm should still immediately recognize a loss (always immediately recognize losses) but generally defer a gain

qualifying assets for interest capitalization

assets must require a period of time to get them ready for use, a company capitalizes interest costs starting with the first expenditure relating to the asset (asset not idle but not yet in use) and continues until the company substantially readies the asset for use, asset must be: (1) for firms own use or (2) intended for sale or lease and constructed as a discrete/infrequent project, asset doesn't qualify if: (1) already in its intended use, (2) idle assets, (3) assets not used in earning activities

non-monetary assets

assets whose price in terms of the monetary unit may change over time

accounting for gains with non-monetary exchanges (LCS)

company receives no cash: defer gain company receives some cash: recognize a portion of the gain if cash is < 25% (cash / FMV of total assets received, including cash received), if cash > 25% this becomes a monetary exchange and total gain must be recognized

disposition of PPE

depreciation taken up to date of disposition, remove the asset at historical cost less accumulated depreciation, and record any cash received (and resulting gain/loss which is ordinary in nature unless disposition is irregular/infrequent) and companies must report historical cost of assets that have been fully depreciated in the financial statements

land improvements

examples: pavements, street lights, sewers, drainage systems, landscaping, parking lot, fence, and utilities, these costs should be capitalized to the land account when they are permanent in nature/ infinite life or when the improvement is maintained by local government (even if it has finite life) and these won't be depreciated with land, if the improvement has a finite life (won't be maintained by government/the firm is responsible for the maintenance) ->costs capitalized to "land improvements" and depreciated over useful life

exchanges of non-monetary assets

firms account for the exchange of non-monetary assets on the basis of fair value of the asset given up or the fair value of the asset received, whichever is more clear, thus a company should recognize immediately any gains/losses on the exchange, rational is that most transactions have commercial substance so gains/losses should be recognized

gross method for deferred payment

liability is recorded at the sum of all current and future payments (including interest)

historical cost (PPE)

measures the cash or cash equivalent price of obtaining the asset and bringing it to the location and condition necessary for its intended use, includes: price paid on acquisition date and all costs made to ready the asset before it was put into its intended use (freight costs, sales tax, and installation costs)

self-constructed assets

no purchase or contract price, includes: direct materials and labor costs of construction, allocated overhead/indirect costs, and certain interest

interest capitalization period

the period of time during which a company must capitalize interest and begins with the presence of three conditions and ends when at least one is not longer present: (1) expenditures for the asset have been made at some point in the past (not just a plan), (2) activities that are necessary to get the asset ready for its intended use are in progress (not idle), and (3) interest cost is actually being incurred on some debt during the current period

cost of land

typically include: (purchase price, closing/transaction costs, title fees, attorneys fees, recording fees, commissions, insurance costs, costs incurred in getting the land in condition for intended use (grading, filling, draining, and clearing costs), assumption of any liens, mortgages, or encumbrances on the property, and any additional land improvements that have an indefinite life) less (any salvage revenue realized from the land)

issuance of stock for asset

use par value to determine common stock entry, if the trading stock is active use the market price to record a paid in capital in excess of par, if no trading stock is active or market price can't be determined then use fair value of asset to record the common stock

some interest rate

use rates in the following order: (1) for the portion of WAAE that is less than or equal to any amount borrowed specifically to finance construction of the asset, use the contract/actual interest rate incurred for project specific borrowing, (2) for the portion of WAAE that is greater than any project specific debt incurred, use a weighted average of interest rates incurred on all other outstanding debt during the period