Chapter 10

Describe the 2 alternative ways a company can include overhead costs in the cost of a self-constructed asset.

1. Allocate a portion of the overhead to the asset 2. Include only the incremental overhead in the cost

4 steps to determine the amount of interest that should be capitalized

1. Determine the weighted average accumulated expenditures for the period 2. Determine the appropriate interest rate 3. Compute avoidable interest by applying the appropriate interest rate to the weighted average accumulated expenditures 4. Capitalize the lesser of avoidable interest or actual interest

FASB's 3 alternatives to account for interest during the construction of property, plant, and equipment.

1. Do not capitalize any interest during construction 2. Capitalize an amount of interest for all funds used for construction 3. Capitalized the actual interest on incremental funds borrowed for the construction

Describe the 3 issues to use GAAP's incremental approach

1. Does the asset qualify for interest capitalization? 2. Over what period can interest be capitalized? 3. What amount of interest can be capitalized?

Describe the 3 characteristics property, plant, equipment must have.

1. Must be held for use in operations and not for investment 2. Must have an expected life of more than one year 3. Must be tangible in nature

3 ways to increase future economic benefit

1. extending the life of the asset 2. improving productivity of the asset by enabling the asset to produce more goods at the same cost or by producing the same quantity of goods at a lower cost 3. increasing the quality of the product

3 Effects of capitalizing interest instead of expensing

1.The company will report higher amounts for property, plant, and equipment due to the capitalized interest being added to the acquisition cost of the equipment. 2.The company does not report the capitalized amount of interest as interest expense during the construction period. Therefore, the company will report higher income than it otherwise would if it had expensed the full amount of interest. 3.All things being equal, the capitalized interest will result in higher depreciation expense in future periods.

Cost of Asset Acquired Formula

= Fair Value of Asset Surrendered + Cash Paid

How to allocate lump-sum acquisition price

A company allocates the lump-sum acquisition price based on the relative fair values of the individual assets. If part of the purchase price can be identified with a specific asset, the specifically identified cost should be assigned to that asset with the remainder allocated among the remaining assets based on their relative fair values.

Describe asset-retirement obligation

A legal obligation related to the retirement of property, plant, and equipment—is required to be capitalized at fair value on the date the obligation is incurred, with a corresponding increase in a liability. In subsequent periods, a company depreciates the asset using a systematic and rational method and increases the liability over time by recognizing interest expense (accretion expense).

Define Nonreciprocal Transfer

A receipt of assets without directly paying value in exchange.

What is a nonmonetary exchange?

A reciprocal transfer between a company and another entity in which the company acquires nonmonetary assets or services by surrendering other nonmonetary assets or services .

credit to Cash for $75,000.

ABC Company decides to replace its old elevator. The elevator has a book value of $30,000 ($50,000 cost and $20,000 accumulated depreciation). The new elevator will cost $75,000. The journal entry to record this transaction will include credit to Elevator for $75,000. credit to Cash for $75,000. debit to accumulated depreciation of $30,000. debit to loss on disposal for $25,000.

$23,000

ABC Company owns a truck with book value of $18,000 and a fair value of $20,000. ABC exchanges the truck and $5,000 cash for a similar new truck with a fair value of $26,000. The exchange has noncommercial substance. What should ABC Company record the new truck on its books for? $26,000 $25,000 $20,000 $23,000

$35,000 debit to Building

ABC Company pays interest on an outstanding note of $165,000. $35,000 of this interest would have been avoidable had ABC Company not been constructing a building. The journal entry to record the $165,000 interest payment will include $35,000 debit to Building $130,000 debit to Building $35,000 debit to Interest Expense $165,000 debit to Interest Expense

Building or Accumulated Depreciation for $50,000.

ABC Company replaced the roof on one of its warehouses for $50,000. Although it was an unplanned replacement, the new roof will extend the life of the factory. Which of the following two options would be acceptable debits in the journal entry for this transaction? Accumulated Depreciation or Cash for $50,000. Building or Cash for $50,000. Building or Accumulated Depreciation for $50,000. Accounts Payable or Building for $50,000.

When an asset is being constructed for a firm's own use.

According to GAAP, interest cost incurred to finance construction of an asset must be capitalized in which of the following situations? When the asset is inventory that is routinely manufactured in large quantities on a repetitive basis. When an asset is used in other than the earning activities of the firm. When an asset is ready for its intended use. When an asset is being constructed for a firm's own use.

Classification of subsequent expenditures

Additions, improvements and replacements, rearrangements, and repairs and maintenance.

Define Full-Cost Method

All costs incurred in the exploration and discovery of oil and gas—even the costs associated with dry wells—are capitalized as part of the cost of the oil and gas reserves that are discovered, and amortized as the oil and gas is produced.

Identify the costs to be included in the acquisition of property, plant, and equipment.

All costs necessary to obtain the benefits to be derived from the asset or to obtain the asset and put it in operating condition

Compute the cost of a self-constructed asset, including capitalized interest.

All expenditures necessary to build the asset and put it in operating condition. Includes direct material, direct labor, variable overhead, and a pro rata share of fixed overhead.

estimates of quantities of unproven oil and gas reserves.

All of the following are U.S. GAAP disclosure requirements except captializable cost related to oil and gas activities. estimates of quantities of unproven oil and gas reserves. results of operations of oil- and gas-producing activities. change is standardized future cash flows.

Define Operating Expenditure

An expenditure that does not increase the economic benefits but is incurred to maintain the existing benefits and is expensed in the period incurred.

Define Capital Expenditure

An expenditure to acquire property, plant, and equipment or to increase the expected future economic benefits of the asset above those that originally were expected

Competitor requirements to enter its market.

Asset retirement obligations may arise from all of the following except environmental responsibilities. laws. legal arrangements. Competitor requirements to enter its market.

How is property, plant, and equipment initially recorded?

At acquisition or historical cost, which is subsequently allocated as an expense to each period in which the asset is used, and provides a benefit to the company.

How does GAAP require property, plant, and equipment to be reported?

At depreciated cost (cost minus accumulated depreciation)

Examples of acquisition costs

Contract Price-Discounts Taken+Freight; Assembly; Installation; Testing Costs; Costs Associated with Asset Retirement

What is the book value of an asset?

Cost minus accumulated depreciation

What does work in progress represent?

Cost of self-constructed property, plant, and equipment that has not been completed yet

$77,000

During the year, Ruby Company purchased three pieces of equipment at an auction for the lump sum of $200,000. It cost Ruby $20,000 to have the equipment delivered and installed. The equipment was appraised as follows: Machine 1, $120,000; Machine 2, $105,000; and Machine 3, $75,000. Machine 2 should be recorded on Ruby's books at $105,000 $120,000 $77,000 $70,000

Define Addition

Enlarging an existing asset by adding a new component.

Describe the accounting for expenditures incurred subsequent to acquisition.

If the expenditure is expected to increase the future economic benefits of the asset, it should be capitalized (recorded as an asset). Otherwise, it should be recorded as an expense.

1977

In _____________, U.S. GAAP required the use of the successful-efforts method. In a politically motivated decision, the SEC decided not to support FASB's position on this. 1975 1977 1979 1981

Define Successful-Efforts Method

Only those exploration costs that result in the discovery of oil and gas are capitalized as part of the oil and gas reserve and amortized as the oil and gas is produced. The costs of a dry well—exploration that does not result in the discovery of oil or gas—are expensed in the current period.

Describe the characteristics of property, plant, and equipment.

Plant or fixed asset; Tangible; Long-lived

capitalized as part of the cost of the land.

Rusty recently purchased a building and the tract of land on which it is located. Rusty plans to raze the building immediately and to erect a new building on the site. The value of the original building should be written off as an extraordinary loss in the year the building is razed. capitalized as part of the cost of the land. depreciated over the period from the date of acquisition to the date that the building is actually razed. capitalized as part of the cost of the new building.

Define Avoidable Interest

The amount of interest capitalized for a qualifying asset which represents the portion of the interest cost that could have been avoided if the construction had not occurred. It is determined by applying an appropriate interest rate to the weighted average accumulated expenditures for the qualifying asset during the capitalization period.

the successful-efforts method.

The cost of drilling an unsuccessful well are expensed under the successful-efforts method. the full-cost method. both the successful-efforts method and the full-cost methods. neither the successful-efforts method nor the full-cost method

How is a gain or loss recognized on a nonmonetary exchange?

The difference between the fair value of the asset surrendered and its book value

Determine the cost of property, plant, and equipment obtained by a nonmonetary exchange of assets.

The fair value of the asset surrendered. If the fair value of the asset received is more clearly evident than the fair value of the asset surrendered, it can be used to measure the cost of the asset acquired.

repairing equipment to keep it producing current quantities at their current cost.

The following are all examples of future economic benefits being increased except repairing equipment to keep it producing current quantities at their current cost. extending the life of an asset. improving productivity of the asset by enabling the asset to produce more goods at the same cost. increasing the quality of the product

Define Accretion Expense

The increase of the asset retirement obligation due to the passage of time, computed by multiplying the book value of the asset retirement obligation by the appropriate discount rate. It is classified as an operating expense

a credit to a liability account.

The journal entry to recognize an asset retirement obligation includes a debit to loss account. a debit to a liability account. a credit to a liability account. a credit to the asset with the obligation

debit Building for $250,000 and credit Gain for $250,000.

The president of Red Corporation donated a building to Maroon Corporation. The building had an original cost of $500,000, a book value of $175,000, and a fair market value of $250,000. To record this donation, Maroon will make a memorandum entry. debit Building for $175,000 and credit Gain for $175,000. debit Building for $250,000 and credit Gain for $250,000. debit Building for $500,000 and credit Gain for $500,000.

Define Improvement/Betterment

The substitution of a better asset for the one currently used.

Define Renewal/Replacement

The substitution of an equivalent asset.

Define Weighted Average Accumulated Expenditures

The sum of the construction expenditures weighted by the amount of time that interest cost has been incurred on those expenditures during the construction period

Routine maintenance

Under GAAP, which of the following types of costs should not be capitalized? Rearrangements Routine maintenance Replacements Additions

the asset surrendered.

When exchanging nonmonetary assets with another company, the preferred approach is to value the transaction based upon fair value of the asset surrendered or asset received whichever is most evident. the asset surrendered unless the fair value of the asset received is easier to determine. the asset surrendered except for certain conditions. the asset surrendered.

What is the relationship between the book value and the fair value of an asset during the life of the asset?

When the asset becomes impaired such that its fair value is less than its book value, the asset must be written down to fair value. Under U.S. GAAP, companies are not allowed to write up an asset if its fair value is above its historical cost. However, IFRS do allow such upward revaluations of property, plant, and equipment.

Land improvements, like land should never be depreciated.

Which of the following is false? Land improvements, like land should never be depreciated. The recorded cost of land should include surveys, title searches, and past due taxes. The recorded cost of equipment should include sales tax paid, transportation costs, and installation costs. The value of leasehold improvements is depreciated over the life of the lease.

The full-cost method is the most widely used of the two methods of accounting for oil and gas exploration.

Which of the following statements is false? Proponents of the successful-efforts method argue that a direct relationship between costs incurred and specific reserves discovered is required before costs are recorded as assets. The basic difference between the successful-effort and full-cost methods focuses on the nature of the asset. The full-cost method is the most widely used of the two methods of accounting for oil and gas exploration. Establishing a direct cause-and-effect relationship between drilling costs incurred and specific reserves discovered is not relevant to the full-cost method.