Accounting Chapter 10 Homework Illustration 1014 Retirements And Abandonments Are

GOODWILL

(continued)

The Smithson Corporation acquired all of the outstanding common stock

of the Rider Corporation in exchange for $18 million in cash. Smithson

assumed all of Rider’s long-term debt which had a fair value of $12

million at date of acquisition. The fair values of all identifiable assets of

Rider are as follows ($ in millions):

Receivables $ 5

The cost of the goodwill resulting from the acquisition is $5 million:

Fair value of consideration exchanged $18

Less: Fair value of assets acquired

The following journal entry captures the effect of the acquisition on

Smithson’s assets and liabilities:

Receivables (fair value) …………………………………. 5

Inventory (fair value) …………………………………….. 7

Illustration 10-8

T10-9 (continued)

10-22 Intermediate Accounting, 8/e

LUMP-SUM PURCHASES

➢ The purchase price is allocated in proportion to the relative

fair values of the assets acquired.

The Smyrna Hand & Edge Tools Company purchased an existing

factory for a single sum of $2,000,000. The price included title to the

land, the factory building, and the manufacturing equipment in the

building, a patent on a process the equipment uses, and inventories of

raw materials. An independent appraisal estimated the fair values of

the assets (if purchased separately) at $330,000 for the land, $550,000

for the building, $660,000 for the equipment, $440,000 for the patent

and $220,000 for the inventories. The lump-sum purchase price of

$2,000,000 is allocated to the separate assets as follows:

Fair values

Land $ 330,000 15%

Building 550,000 25

Illustration 10-9

DEFERRED PAYMENTS

On January 2, 2016, the Midwestern Steam Gas Corporation

purchased an industrial furnace. In payment, Midwestern signed

a noninterest-bearing note requiring $50,000 to be paid on

December 31, 2017. If Midwestern had borrowed cash to buy the

furnace, the bank would have required an interest rate of 10%.

The furnace should be recorded at its real cost, $41,323, as follows:

Furnace (determined above) ……………………. 41,323

Illustration 10-10

T10-11

10-24 Intermediate Accounting, 8/e

ISSUANCE OF EQUITY SECURITIES

➢ Assets acquired by issuing equity securities are valued at the

fair value of the securities or the fair value of the assets;

whichever is more clearly evident.

On March 31, 2016 the Elcorn Company issued 10,000 shares of

its nopar common stock in exchange for land. On the date of the

transaction, the fair value of the common stock, evidenced by its

market price, was $20 per share. The journal entry to record this

transaction is:

Illustration 10-12

 If the fair value of the common stock had not been reliably

determinable, the value of the land as determined through an

T10-12

DONATED ASSETS

➢ Donated assets are valued at their fair values.

➢ Revenue is recorded for the amount contributed by an

unrelated party.

The Elcorn Company decided to relocate its office headquarters

to the city of Westmont. The city agreed to pay 20% of the $20

million cost of building the headquarters in order to entice Elcorn

to relocate. The building was completed on May 3, 2016. Elcorn

paid its portion of the cost of the building in cash. Elcorn records

the transaction as follows:

Illustration 10-13

T10-13

10-26 Intermediate Accounting, 8/e

INTERNATIONAL FINANCIAL REPORTING STANDARDS

Government Grants. Both U.S. GAAP and IFRS require that companies value

donated assets at their fair values. For government grants, though, the way that value

is recorded is different under the two sets of standards. Unlike U.S. GAAP, donated

assets are not recorded as revenue under IFRS. IAS No. 20 requires that government

grants be recognized in income over the periods necessary to match them on a

systematic basis with the related costs that they are intended to compensate. So, for

example, IAS No. 20 allows two alternatives for grants related to assets:

1. Deduct the amount of the grant in determining the initial cost of the asset.

2. 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.

In Illustration 10-13, if a company chose the first option, the building would be

recorded at $16 million. If instead the company chose the second option, the building

would be recorded at $20 million, but rather than recognizing $4 million in revenue as

with U.S. GAAP, a $4 million credit to deferred income would be recorded and

recognized as income over the life of the building

Siemens, a global electronics and electrical engineering company based in Germany,

prepares its financial statements according to IFRS, and sometimes receives

government grants for the purchase or production of fixed assets. The following

disclosure note included with recent financial statements indicates that Siemens uses

the first option, deducting the amount of the grant from the initial cost of the asset.

Government Grants (in part)

Expenditures Grants awarded for the purchase or the production of fixed assets

(grants related to assets) are generally offset against the acquisition or productions

costs of the respective assets and reduce future depreciations accordingly.

T10-14

DECISION MAKERS’ PERSPECTIVE

➢ The property, plant, and equipment and intangible asset

acquisition decision, often referred to as capital budgeting, is

among the most significant decisions that management must

make.

➢ Investors and creditors monitor a company’s investment in

property, plant, and equipment by calculating the fixed-asset

turnover ratio. The ratio measures a company’s effectiveness

in managing property, plant, and equipment.

Fixed-asset turnover ratio = Net sales

Average fixed assets

T10-15

10-28 Intermediate Accounting, 8/e

DISPOSITION OF ASSETS

➢ When assets are sold, a gain or loss is recognized for the

difference between the consideration received and the asset’s

book value.

Illustration 10-14

➢ Retirements and abandonments are treated similarly. The only

difference is that there will be no monetary consideration

received. A loss is recorded for the remaining book value of

the asset.

NONMONETARY EXCHANGES

An asset acquired in a nonmonetary exchange generally is

recorded at the fair value of the assets exchanged.

➢ If we can’t determine the fair value of either asset in the

exchange, the asset received is valued at the book value of the

asset given.

➢ In exchanges that lack commercial substance, the asset

received is valued at the book value of the asset given.

T10-17

10-30 Intermediate Accounting, 8/e

NONMONETARY EXCHANGES

(continued)

The Elcorn Company traded its laser equipment for the newer air-cooled ion lasers

manufactured by American Laser Corporation. The old equipment had a book value

of $100,000 (cost of $500,000 less accumulated depreciation of $400,000) and a fair

value of $150,000. To equalize the fair values of the assets exchanged, in addition

to the old equipment, Elcorn paid American Laser $430,000 in cash. This means

that the fair value of the new laser equipment is $580,000. We know this because

American Laser was willing to trade the new lasers in exchange for old lasers worth

$150,000 plus $430,000 in cash. The following journal entry records the

transaction:

Illustration 10-15A

T10-17 (continued)

NONMONETARY EXCHANGES

(continued)

Exchange Lacks Commercial Substance

The Elcorn Company traded a tract of land to Sanchez Development for a similar

tract of land. The old land had a book value of $2,500,000 and a fair value of

$4,500,000. To equalize the fair values of the assets exchanged, in addition to the

land, Elcorn paid Sanchez $500,000 in cash. This means that the fair value of the

land acquired is $5,000,000. The following journal entry records the transaction,

assuming that the exchange lacks commercial substance:

Illustration 10-16

T10-17 (continued)

10-32 Intermediate Accounting, 8/e

INTEREST CAPITALIZATION

➢ Interest is capitalized during the construction period for (a)

assets built for a company’s own use as well as for (b) assets

constructed as discrete projects for sale or lease (a ship or a

real estate development, for example).

➢ Excludes inventories routinely manufactured in large

quantities on a repetitive basis and assets already in use or

ready for intended use.

INTEREST CAPITALIZATION ILLUSTRATION

On January 1, 2016, the Mills Conveying Equipment Company

began construction of a building to be used as its office

headquarters. The building was completed on June 30, 2017.

Expenditures on the project, mainly payments to subcontractors,

were as follows:

Illustration 10-17

T10-19

10-34 Intermediate Accounting, 8/e

INTEREST CAPITALIZATION ILLUSTRATION

(continued)

2016:

Step 1: Determine the average accumulated expenditures.

Actual Time-weighted

Expenditures Expenditures

Step 2: Calculate the amount of interest to be capitalized. Use the construction loan

rate because average accumulated expenditures is less than the specific

construction loan rate. This is known as the specific interest method.

➢ Interest capitalized is limited to interest incurred.

Step 3: Compare calculated interest with actual interest incurred.

Actual Calculated

Loans Rate Interest Interest

$1,000,000 x 8% = $ 80,000

T10-19 (continued)

INTEREST CAPITALIZATION ILLUSTRATION

(continued)

2017:

Step 1: Determine the average accumulated expenditures.

Actual Time-weighted

Expenditures Expenditures

Step 2: Calculate the amount of interest to be capitalized. The weighted-average

interest rate on all other debt is applied to the excess of average accumulated

expenditures over specific construction borrowings.

Loans Rate Interest

$2,000,000 x 6% = $120,000

Average

Accumulated Annual Fraction

Expenditures Rate of Year Interest

$2,176,000

T10-19 (continued)

10-36 Intermediate Accounting, 8/e

INTEREST CAPITALIZATION ILLUSTRATION

(continued)

Step 3: Compare calculated interest with actual interest incurred.

Actual Calculated

Loans Rate Interest Interest

$1,000,000 x 8% x 6/12 = $ 40,000

➢ For the first six months of 2017, $98,800 interest would be

capitalized, bringing the total capitalized cost of the building