Chapter 10

Issuance of Equity Securities •The fair value of the assets received by the corporation or. •The market value of the shares of corporations whose stock is actively traded.

Can occur when small companies incorporate and the owner or owners contribute assets to the new corporation in exchange for ownership securities. Transaction's exchange value either:

Fair value of the consideration given in exchange for the company (acquisition price) − Fair value of the identifiable net assets acquired

Capitalized Cost of Goodwill:

Purchase price $62,000 + Freight and handling 1,000 + Insurance during shipping 300 + Special foundation 1,200 + Trial runs 600 = $65,100 Capitalized

Central Machine Tools purchased industrial equipment to be used in its manufacturing process. The purchase price was $62,000. Central paid a freight company $1,000 to transport the equipment to its plant location plus $300 shipping insurance. In addition, the equipment had to be installed and mounted on a special platform built specifically for the equipment at a cost of $1,200. After installation, several trial runs were made to ensure proper operation. The cost of these trials including wasted materials was $600. What amount is capitalized?

1.Deferred payments (notes payable). 2.Issuance of equity securities. 3.Donated assets. 4.Exchanges of nonmonetary assets for other assets.

Companies can also acquire assets without paying cash at the time of the purchase by:

•Purchase price. •Realtor commissions and legal fees. •Reconditioning costs. •Refurbishing, remodeling, or otherwise modifying to suit the needs of the new owner.

Cost of Buildings Cost of acquiring a building usually includes:

Purchase price. •Any sales tax. •Transportation costs. •Expenditures for installation and testing. •Legal fees to establish title. •Any other costs to bring the asset to its condition and location for use. The sum of the above costs represents the initial amount to be capitalized (recorded as an asset) in the balance sheet.

Cost of Equipment includes:

Purchase price. Attorney fees. Real estate agent commissions. Costs related to title and title search. Recording fees. Any back taxes, liens, mortgages, or other obligations. •Current portion of property taxes are not included. Expenditures such as clearing, filling, draining, and even removing (razing) old buildings. Proceeds from the sale of salvaged materials after purchase reduce the cost of land.

Cost of Land Costs should include:

Purchase price. •Any other costs necessary to bring the asset to condition and location for use. Acquisition costs.•Exploration costs.•Development costs.•Restoration costs.

Cost of Natural Resources Natural Resources: •Includes timber tracts, mineral deposits, and oil and gas deposits. •Benefits are derived from their physical consumption. Costs of Natural Resources If purchased: If developed:

Purchase price +all expenditures necessary to bring the asset to its desired condition and location for use

Costs to be capitalized Initial cost =

clientele and reputation trained employees and management team favorable business location

Goodwill can emerge from a company's:

specific interest method

The method of determining the amount of interest to capitalize by using rates from specific loans to the extent of specific borrowings before using the average rate of other debt is called the

1.Inclusion of only the incremental overhead costs. 2.Full-cost approach.

The treatment of manufacturing overhead cost and its allocation:

Goodwill Typical acquisition costs: Excess of the fair value of the consideration exchanged for the company over the fair value of the net assets acquired.

The unique value of the company as a whole over and above all identifiable assets.

Deferred Payments

An obligation to make payment in the future.

the fair value of the assets given or the fair value of the assets received, whichever is more clearly evident.

Assets acquired in noncash transactions are valued at

Approximates the average debt necessary for construction.

Average Accumulated Expenditures:

Oil and Gas Deposits, Timber Tracts, and Mineral Deposits.

Natural resources:

•Begins when construction begins and the first expenditure is made as long as interest costs are actually being incurred.

Period of Capitalization:

Research:

Planned search or critical investigation to discover new knowledge that helps developing a new product or service or a new process or technique or improving an existing product or processes.

Commercial Substance: Example: Newer models of equipment can increase production or improve manufacturing efficiency causing an increase in revenue or a decrease in operating costs with a corresponding increase in future cash flows.

Present when future cash flows change as a result of the exchange.

Natural resources Typical acquisition costs: Acquisition, exploration, development, and restoration costs.

Productive assets that are physically consumed in operations such as timber, mineral deposits, and oil and gas reserves.

Properly, plant, and equipment Typical acquisition costs: All expenditures necessary to get the asset in condition and location for its intended use.

Productive assets that derive their value from long-term use in operations rather than from resale.

Intangible Assets Typical acquisition costs: All expenditures necessary to get the asset in condition and location for its intended use.

Productive assets that lack physical substance and have long-term but typically uncertain benefits.

Land, Buildings, Equipment, Machinery, Furniture, Autos, and Trucks.

Property, plant, and equipment:

•Recognition. •Measurement. •Present value calculations. Scope

Provisions of standards to address AROs:

R&D costs are capitalized as inventory and carried forward into future years until the project is completed.

R&D Performed for Others:

Land Typical acquisition costs: Purchase price, attorney's fees, title, recording fees, commissions, back taxes, mortgages, liens, clearing, filling, draining, and removing old buildings.

Real property used in operations (land held for speculative investment or future use is reported as investments or other assets).

Intangible Assets

Represent exclusive rights that provide benefits to the owner. •Lack physical substance. •Difficult to anticipate the timing and the existence of future benefits

Goodwill

Represents the unique value of a company as a whole over and above its identifiable tangible and intangible assets.

Trademarks 10

Right to display a word, a slogan, or a symbol, that distinctly identifies a company, product, or service. How many years?

Asset Retirement Obligation Example: Oil and gas exploration company might be required to restore land to its original condition after extraction is completed. •GAAP requires that an existing legal obligation associated with the retirement of a tangible, long-lived asset be recognized as a liability and measured at fair value, if value can be reasonably estimated.

A company may incur obligations associated with the disposition of property, plant, and equipment and natural resources .•This gives rise to an ______________which is defined as an existing legal obligation associated with the disposition/retirement of a tangible, long-lived asset.

Determining the amount of indirect manufacturing costs (overhead) to be allocated to the construction. Deciding on the proper treatment of interest (actual or implicit) incurred during construction.

A company might decide to construct an asset for its own use rather than buy an existing one. •Identifying the cost is difficult because there is no external transaction to establish an exchange price. Two Critical Issues

Franchises Typical acquisition costs: Franchise fee plus any legal fees.

A contractual arrangement under which a franchisor grants the franchisee the exclusive right to use the franchisor's trademark or tradename and certain product rights.

fair value. the fair value and book value of the asset given

An asset received in an exchange of nonmonetary assets generally is valued at _______. Gain or loss is recognized in these transactions for the difference between _____.

Equipment Typical acquisition costs: Purchase price (less discounts), taxes, transportation, installation, testing, trial runs, and reconditioning.

Broad term that includes machinery, computers and other office equipment, vehicles, furniture, and fixtures.

Salaries, wages, and other labor costs of R&D personnel. •Costs of materials consumed, equipment, facilities, and intangibles used in R&D projects .•Costs of services performed by others. •A reasonable allocation of indirect costs related to the R&D activities.

Determining R&D Cost Includes costs relevant to R&D projects, such as:

air values based on either an available market price or an appraisal value. Revenue

Donated Assets Recorded at _____________. __________is credited.

Land improvements Typical acquisition costs: Separately Identifiable costs.

Enhancements to property such as parking lots, driveways, private roads, fences, landscaping, and sprinkler systems.

•Engineering follow-through in an early phase of commercial production. •Quality control during commercial production including routine testing of products. •Routine ongoing efforts to refine, enrich, or otherwise improve on the qualities of an existing product. •Adaptation of an existing capability to a particular requirement or customer's need as a part of a continuing commercial activity.

Examples of Non-R&D Costs:

Laboratory research aimed at discovery of new knowledge. •Searching for applications of new research findings or other knowledge. •Design, construction, and testing of preproduction prototypes and models. •Modification of the formulation or design of a product or process

Examples of R&D costs:

Patent Typical acquisition costs: Purchase price, legal fees, filing fees, not including internal R&D.

Exclusive 20-year right to manufacture a product or use a process.

Franchises

Exclusive right by franchisor to franchisee to use the franchisor's trademark/product.

Copyrights life of the creator plus 70 years

Exclusive right of protection given to a creator of a published work.Ex: Song/film/book. How many years?

Copyrights Typical acquisition costs: Purchase price, legal fees, filing fees, not including internal R&D.

Exclusive right to benefit from a creative work such as a song, film, painting, photograph, or book.

Trademarks (tradenames) Typical acquisition costs: Purchase price, legal fees, filing fees, not including internal R&D.

Exclusive right to display a word, a slogan, a symbol, or an emblem that distinctively identifies a company, product, or a service.

Patents 20

Exclusive right to manufacture a product or to use a process. How many years?

Exploration costs to be capitalized as assets and expensed in future as oil and gas from the successful wells are removed from that area.

Full-cost method

Capitalize its fair value as a finite-life intangible asset and amortize that amount over its useful life. R&D costs incurred after the acquisition are expensed as incurred.

In case of purchased research and development Developed technology

Capitalize the fair value of in-process R&D as an indefinite-life intangible asset. R&D costs incurred after the acquisition are expensed as incurred.

In case of purchased research and development In-process research and development

Capital budgeting:

Includes decisions pertaining to acquisitions of property, plant, and equipment and intangible assets. •Requires management to forecast all future net cash flows generated by the asset(s).

Fixed Asset Turnover Ratio: (Net sales/Average fixed assets) Average fixed assets Beginning Book Value + Ending Book Value divided by 2. •The Book value, sometimes called carrying value or carrying amount is the cost less accumulated depreciation and depletion.

Indicates the level of sales generated by the company's investment in fixed assets.

•Patents.•Copyrights.•Trademarks.•Franchises.•Goodwill.

Intangible assets:

Assets that are constructed for a company's own use as well as assets constructed as discrete projects for sale or lease. •Only interest incurred during the construction period is eligible for capitalization.

Interest Capitalization Qualifying Assets:

.Capitalized and then allocated as depreciation.

Interest Capitalization:

Both U.S. GAAP and IFRS require that donated assets be valued at their fair values. Recorded as revenue in the period received.(GAAP) Deduct the amount of the grant in determining the initial cost of the asset, or Record the grant as a liability, deferred income, in the balance sheet and recognize it in the income statement systematically over the asset's useful life. (IFRS)

International Financial Reporting Standards—Government Grants

Separately identified and capitalized. •Depreciated over periods benefited by their use. Examples:•Cost of parking lots, driveways, private roads, fences, and sprinkler systems.

Land Improvements Usually have useful lives that are estimable. Costs:

Refers to one-time preopening costs. •Includes organization costs. •Expensed in the period incurred.

Start-Up Costs:

Companies are required to expense all the costs related to a company's start-up and organization activities in the period incurred, rather than capitalize those costs as an asset.

Start-up costs include organization costs related to organizing a new entity. How are they treated?

Buildings Typical acquisition costs: Purchase price, attorney's fees, commissions, and reconditioning.

Structures that include warehouses, plant facilities, and office buildings.

Exploration costs known not to have resulted in the discovery of oil or gas to be treated as expenses in the period the expenditures are made.

Successful efforts method

Purchase price of land & old building ($500,000) + title insurance ($3,000) + commissions ($16,000) + delinquent property taxes ($4,000) + cost of removing old building ($10,000) + cost of grading ($5,000) = $538,000

The Byers Structural Metal Company purchased a six-acre tract of land and an existing building for $500,000. The company plans to remove the old building and construct a new office building on the site. In addition to the purchase price, the company made the following expenditures at closing of the purchase: Title insurance $3,000 Commissions $16,000 Property taxes $6,000 **The $6,000 in property taxes included $4,000 of delinquent taxes paid by Byers on behalf of the seller and $2,000 attributable to the portion of the current fiscal year after the purchase date. Shortly after closing, Byers paid a contractor $10,000 to tear down the old building and remove it from the site. An additional $5,000 was paid to grade the land. What is the capitalized cost of land?

Step 1: Record the new asset at fair value. Fair value is determined based on the fair value of the asset(s) given up or the fair value of the asset received. In a normal exchange, we expect those two fair values to equal. Step 2: Remove the book value of the nonmonetary asset given. Book value equals the recorded cost of the old asset minus its accumulated depreciation. Step 3: Record any cash received or paid. Cash is used to equalize the fair values of the nonmonetary assets in the exchange. Step 4: Record any gain or loss. The gain or loss on the exchange equals the difference between fair value and book value of the asset given up in step 2. If fair value is greater, then a gain is recorded. If book value is greater, then a loss is recorded. The gain or loss also can be viewed as the "plug" that balances debits and credits in the journal entry.

The basic steps in recording nonmonetary asset exchanges follow:

The customer has a contractual right to take possession of the software without significant penalty, and. 2.The customer could run the software on its own or with an unrelated vendor. If either of these criteria is not met, the arrangement is treated as a service contract, and costs are expensed as incurred.

The costs of cloud computing arrangements are treated as the purchase of intangible assets if both:

Development:

Translation of research findings into a plan or design for a new product or process or improving existing product or processes, whether intended for sale or use.

Research and development activities are not treated distinctly from one another. (GAAP) Research expenditures are expensed in the period incurred. However, development expenditures that meet specified criteria are capitalized as an intangible asset. (IFRS) Under both U.S. GAAP and IFRS, any direct costs to secure a patent, such as legal and filing fees, are capitalized.

U.S. GAAP & IFRS Research activities and development activities

Depreciation or amortization of these assets is included as R&D expenses only in the periods the assets are used for R&D activities.

set purchased for more than a single R&D project:

Cost is considered R&D and expensed immediately in the current year.

set purchased for single R&D project: