12. Lump-Sum Purchases Several assets are acquired for a single price that may be lower than the sum of the individual asset fair values. Asset 2 Asset 1 Asset 3 Allocation of the lump-sum price is based on relative fair values of the individual assets. Example: Exercise 10-8 (page 539)
28. Interest Capitalization Interest is capitalized based on Average Accumulated Expenditures (AAE). Qualifying expenditures (construction labor, material, and overhead) weighted for the number of months outstanding during the current accounting period. If the qualifying asset is financed through a specific new borrowing . . . use the specific rate of the new borrowing as the capitalization rate. If there is no specific new borrowing, and the company has other debt . . . use the weighted average cost of other debt as the capitalization rate.
Chapter 10: Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition This chapter and the one that follows address the measurement and reporting issues involving property, plant, and equipment and intangible assets. These long-lived tangible and intangible assets are used in the production of goods and services. Chapter 10 covers the valuation at date of acquisition and the disposition of these assets.
Part I. The costs to be capitalized for equipment include: the net purchase price, less discounts, taxes, transportation costs, installation costs, modification to a building necessary to install the equipment, testing and trial runs. Part II. The cost of land includes: the purchase price, real estate commissions, attorney’s fees, title search, title transfer fees, title insurance premiums, the cost of making the land ready for its intended use, including the cost of removing old buildings. Unlike other long-lived, revenue-producing assets in the property, plant and equipment category, land is not depreciated.
Part I. Land improvements are enhancements to property such as driveways, parking lots, fencing, landscaping, and private roads. These are separately identifiable costs that are recorded in the land improvement asset account rather than in the land account. Unlike land, land improvements are depreciated. Part II. The cost of buildings includes: the purchase price, real estate commissions, attorney’s fees, reconditioning costs to get the building ready for use.
Part I. The capitalized cost of natural resources includes the initial acquisition costs, exploration costs, development costs, and restoration costs. Part II. Intangible assets include patents, copyrights, trademarks, franchises, and goodwill. The initial cost of an intangible asset includes the purchase price and all other costs necessary to bring it to condition and location for use, such as legal and filing fees.
Intangible assets are assets without physical substance that provide the owner with exclusive rights that benefit the production of goods and services. The future benefits attributed to intangible assets usually are much less certain than those attributed to tangible assets.
Part I. Lump-sum purchases occur when a group of assets is acquired for a single purchase price. Part II. The lump-sum purchase price is allocated to assets based on relative fair values of the individual assets. Part III. Let’s look at an example of a lump-sum purchase involving land and a building. On May 13, we purchase land and building for $200,000 cash. The appraised value of the building is $162,500, and the land is appraised at $87,500. How much of the $200,000 purchase price will be allocated to the building account?
Part I. Property, plant, and equipment and intangible assets are sometimes acquired in exchanges for other assets. Trade-ins of old assets in exchange for new assets is probably the most frequent type of exchange. Cash is involved in the transactions to equalize fair values. The general principle to be followed is that the cost of the asset acquired is: equal to the fair value of asset given up plus cash paid or minus cash received, or equal to the fair value of asset acquired, if that is more clearly evident. A gain or loss is recognized for the difference between the fair value of the asset given up and its book value. Part II. We follow the general principle based on fair value in the exchange of assets except in rare situations in which the fair value cannot be determined or the exchange lacks commercial substance. When fair value cannot be determined or the exchange lacks commercial substance, the asset(s) acquired are valued at the book value of the asset(s) given up, plus (or minus) any cash exchanged. No gain is recognized. Let’s look at an example where fair value cannot be determined.
Part I. There are two difficult accounting issues that must be addressed when a company is constructing assets for its own use: determining the amount the company’s manufacturing overhead to be included in the asset’s cost. deciding on the proper treatment of interest incurred during the construction period. One approach to assigning overhead to self-constructed assets is the incremental approach, where actual incremental overhead costs are recorded in the asset account. However, the most commonly used method is to assign overhead using a predetermined overhead rate, based on an overhead cost driver activity, that is used to assign the company’s overhead to regular production. This approach is called the full cost approach. Unlike purchased assets, self-constructed assets may take a long period of time to be made ready for their intended use. The construction activities during this period require construction financing. Following our general rule for the cost of an asset, all costs necessary to make the asset ready for its intended use, including interest during the construction period, should be included in the asset’s cost. Part II. Interest is capitalized (included in the asset’s cost) for qualifying assets. Qualifying assets are: assets built for a company’s own use. assets constructed as discrete projects for sale or lease. Assets in this category are large construction projects such as a real estate development built for sale or lease. Only the portion of interest cost incurred during the construction period that could have been avoided if the construction had not been undertaken may be capitalized.
The interest capitalization period begins when the first qualifying construction expenditures are incurred for materials, labor, or overhead, and when interest costs are incurred. The interest capitalization period ends when the asset is substantially complete and ready for its intended use or when interest costs no longer are being incurred. Consider the following example of interest incurred on a self-constructed asset.
Part I. Interest is capitalized based on average accumulated expenditures during the construction period. Average accumulated expenditures is an amount based on a weighted average computation of the qualifying expenditures times the number of months from the incurrence of the qualifying expenditures to the end of the construction period. Qualifying expenditures include labor, material, and overhead incurred on the construction project during the accounting period. Part II. Interest capitalization on self-constructed assets does not require the company to borrow for the specific construction project. However, if the construction is financed through a specific new borrowing, the interest rate of the new borrowing is used for the capitalization rate. Part III. If the construction does not require specific new borrowing, but is financed with other debt, use the weighted-average interest rate on the other debt for the capitalization rate.
Part I. Research is a planned search or critical investigation aimed at discovery of new knowledge with the hope that the new knowledge will result in new, or the improvement of, existing, products, services or processes. Development is the translation of research findings into new, or the improvement of existing, products, services or processes. Most research and development costs are expensed as incurred. The costs are incurred with the intent of future benefits, but the future benefits are uncertain, and even if the benefits materialize, it is difficult to relate the benefits to revenues of future periods. Part II. An exception to the immediate expensing of research and development costs is provided for work done under contract for other companies. These research and development costs are capitalized as inventory and carried forward into future years. Income from these contracts can be recognized using either the percentage-of-completion method or the completed contract method. If operational assets are purchased for exclusive use in research and development, the cost is expensed, regardless of the length of the assets’ useful life. If the assets have alternative future uses beyond the research and development project period, the cost should be capitalized and depreciated or amortized over the current and future periods of use.
Part I. All costs incurred to establish the technological feasibility of computer software products are treated as research and development costs and expensed as incurred. Costs incurred after technological feasibility is established and before the software is available for release to customers are capitalized as an intangible asset. Technological feasibility is established when all planning, designing, coding, and testing activities have been completed to determine that the software meets its design specifications including functions, features, and technical performance requirements. Consider the following timeline to illustrate these concepts. Part II. Costs are expensed from the start of research and development until technological feasibility is established. Costs incurred after technological feasibility is established, but before the product is released, are capitalized as an intangible asset. Costs incurred after the product is available for release to customers are treated as operating costs.
Except for software development costs incurred after technological feasibility has been established, U.S. GAAP requires all research and development expenditures to be expensed in the period incurred. IAS No. 38 draws a distinction between research activities and development activities. Research expenditures are expensed in the period incurred. However, development expenditures that meet specified criteria are capitalized as an intangible asset. Under both U.S. GAAP and IFRS, any direct costs to secure a patent, such as legal and filing fees, are capitalized.
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