CHAPTER 10
2. Discuss the accounting problems associated with interest capitalization.
4. Describe the accounting treatment for costs subsequent to acquisition.
1. Chapter 10 presents a discussion of the basic accounting problems associated with the
incurrence of costs related to property, plant, and equipment; and the accounting methods
2. (L.O. 1) Property, plant, and equipment possess certain characteristics that distinguish
them from other assets owned by a business enterprise. These characteristics may be
3. Property, plant, and equipment accounts are valued at historical cost, the cash or cash
equivalent price of obtaining the asset, bringing it to the location, and getting it ready for its
4. In subsequent periods, property, plant, and equipment is valued at either cost or fair
value. Companies can apply either method to all items of property, plant, and equipment
5. Land acquired for operational use is classified as property, plant, and equipment. Land
costs include (a) purchase price; (b) closing costs; (c) cost of grading, filling, draining and
clearing; (d) assumption of any liens, mortgages, or encumbrances on the property; and
6. The cost of buildings depends on how the building was acquired. If purchased, cost
includes the purchase price, any closing costs, and the broker’s commission. If constructed,
the building ready for its intended use are not capitalized. This includes start-up costs and
general administrative expenses.
7. The cost of equipment includes all expenditures incurred in purchasing the equipment
and preparing it for its intended use. Examples include purchase price, freight and
8. When machinery and equipment to be used by an entity are constructed rather than
purchased, a problem exists concerning the allocation of overhead costs. These costs
9. (S.O. 2) Capitalization of interest cost incurred in connection with financing the construction
or acquisition of property, plant, and equipment generally follows the rule of capitalizing
10. To qualify for interest capitalization, assets must require a substantial period of time to get
them ready for their intended use. Assets that qualify for interest cost capitalization
include assets under construction for an enterprise’s own use (such as buildings, plants,
11. The amount of interest to capitalize is limited to the lower of (a) actual interest cost incurred
during the period or (b) the amount of interest cost incurred during the period that
12. Examples which demonstrate computation of the weighted-average accumulated expenditures
and selecting the appropriate interest rate are included in the chapter. In addition, a
13. Two special issues relate to interest capitalization. If a company purchases land as a site
for a structure, interest costs capitalized during the period of construction are part of the
14. (L.O. 3) A number of accounting problems are involved in the acquisition and valuation of
fixed assets. In general, an asset should be recorded at the fair market value of what is
15. The purchase of a plant asset is often accompanied by a cash discount for prompt
payment. If the discount is taken, it results in a reduction in the purchase price of the
asset. However, when the discount is allowed to lapse, should a loss be recorded or
should the asset be recorded at a higher purchase price? Currently, while the “loss
16. Plant assets purchased on long-term credit contracts should be accounted for at the
present value of the consideration exchanged on the date of purchase. When the
17. In some instances a company may purchase a group of plant assets at a single lump
sum price. The best way to allocate the purchase price of the assets to the individual
18. Non-monetary assets such as property, plant, and equipment are items whose price
19. Ordinarily, companies account for the exchange of non-monetary assets on the basis of
the fair value of the asset given up or the fair value of the asset received, whichever is
has commercial substance if the future cash flows change as a result of the transaction.
20. Companies immediately recognize losses they incur on all exchanges. The accounting for
21. A gain or loss on the exchange on nonmonetary assets is computed by comparing the
book value of the asset given up with the fair value of that same asset. The examples
shown below are designed to demonstrate the various situations where exchanges of
nonmonetary assets are included.
Exchange with Commercial Substance
Machine ………………………………………….. 54,000
Gain on Machine Disposal …………………. 10,000
Cash ………………………………………………. 8,000
Gain verification:
Fair market value of machine ……………………. €36,000
Cash payment due ………………………………….. 23,000
Fair value of drill press A ………………………….. 8,000
Cost of drill press B …………………………..……… €31,000
Journal entry:
Equipment …………………………..………………….. 31,000
will trade four Dodge Caravans for four Ford Freestars owned by Peg Company. The fair
value of the Caravans is €51,000 with a book value of €38,000 (cost €65,000 less
€27,000 accumulated depreciation). The Freestars have a fair value of €66,000 and AlM
Company gives €15,000 in cash in addition to the Caravans.
Computation of Gain:
22. Government grants are assistance received from a government in the form of some type
of asset, or forgiveness of debt, or loans at below-market interest rates. The accounting
basis that matches them with the related costs that they are intended to compensate.
This is accomplished by (a) recording the grant as Deferred Grant Revenue, which is
23. Grants given to pay amounts owed to creditors for past losses should be recorded as
24. Grants providing loans at below-market interest rates should be accounted for in two
steps: (a) record the note at its present value using the recipient’s incremental borrowing
25. When a company contributes a non-monetary asset, the donation is recorded as an
expense at the fair value of the donated asset. Any difference between the asset’s fair
26. (L.O. 4) Costs related to plant assets that are incurred after the asset is placed in use are
either added to the asset account (capitalized) or charged against operations (expensed)
when incurred. In general, costs incurred to achieve greater future benefits from the asset
27. Generally, expenditures related to plant assets being used in a productive capacity may
28. Improvements and replacements are substitutions of one asset for another. Improvements
substitute a better asset for the one currently used, whereas a replacement substitutes a
similar asset. The major problem in accounting for improvements and replacements
29. Rearrangement and reorganization costs for existing property, plant and equipment are
expensed as incurred under IFRS. Ordinary repairs are expenditures made to maintain
30. (L.O. 5) Plant assets may be retired voluntarily or disposed of by sale, exchange,
involuntary conversion, or abandonment. When a plant asset is disposed of,
LECTURE OUTLINE
2. Capitalization of interest cost during construction: Students generally have difficulty
with the computational procedures required.
3. Nonmonetary exchanges: This is a difficult topic for some students. Students should be
2. Long-term in nature and subject to depreciation, except for land.
1. Historical cost is the usual basis for valuation. This is the cash or cash equivalent price
of obtaining the asset and getting it ready for its intended use.
3. Components of cost.
a. Cost of Land: All expenditures made to acquire the land and prepare it for use
(1) The net cost of removing any existing structures is a reduction of the land cost.
(2) Land held for speculative purposes should be classified as an investment.
b. Cost of Buildings: All expenditures related directly to acquisition or construction
are capitalized. This includes attorneys’ and architects’ fees, building permits, and all
costs incurred beginning with excavation and ending with completion of the building.
1. Basic principle: Interest cost incurred during construction of plant assets is part of the
2. Describe the computational steps involved in determining the amount of interest to be
capitalized.
a. Determine which assets qualify for capitalization of interest.
3. Special issues related to interest capitalization.
a. Interest costs incurred in the purchase of land to be used for a building site are
1. Cash Discounts: The asset should be recorded at the current cash equivalent price at
2. Deferred-Payment Contracts: Assets purchased on long-term credit contracts should
be accounted for at the present value of the consideration exchanged. When no interest
3. Lump Sum Purchases: Total cost should be allocated based on relative fair values.
4. Issuance of Stock: Market value of stock issued is used as an indication of the cost of
5. Exchanges of property, plant, and equipment (nonmonetary assets). In presenting this
topic, it is important to emphasize both the basic accounting procedures and the basic
(1) Record depreciation up to date of disposal.
(3) Compute the realized gain or loss.
6. A government grant is some type of asset provided as a subsidy to a company, or the
(1) Record the grant as deferred revenue and recognize it as income on a
systematic basis over the life of the asset.
(2) Deduct the grant from the carrying value of the assets received from the
grant. The grant is recognized in income as a reduction of depreciation
(2) Recognize Deferred Grant Revenue in the amount of the interest element for
the note.
(4) Decrease Deferred Grant Revenue and increase Grant Revenue by an amount
equal to the computed interest expense.
7. Contributions of non-monetary assets are recorded as an expense at the fair value of
the donated asset.
a. Take depreciation up to date of contribution.
1. In order to capitalize costs, one of three conditions must be present:
3. Improvements and Replacements. Capitalize cost if expenditure increases the future
service potential of the asset.
5. Repairs.
a. Ordinary repairs should be expensed in the period incurred.
1. Sale of Plant Assets.
2. Involuntary Conversion. Gains or losses are the same in any other type of disposition