Property, Plant, and Equipment and Intangible Assets: Acquisition PDF

Chapter 10 Property, Plant, and Equipment and Intangible Assets:...

Chapter 10 Property, Plant, and Equipment and Intangible Assets: Acquisition Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 1 Types of Assets Long-lived, revenue-producing assets Property, plant, and Intangible assets: equipment: Patents Land, Buildings, Copyrights Equipment, Trademarks Machinery, Franchises Furniture, Autos, Goodwill and Trucks Natural resources: Oil and Gas Deposits, Timber 10-02 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  Property, Plant, and LO10- 1 Equipment—Microsoft Corporation Note 7. Property, Plant, and Equipment (in part): The components of property and equipment were as follows: ($ in millions) June 30, 2020 2019 Land $ 1,823 $ 1,540 Buildings and improvements 33,995 26,288 Leasehold improvements 5,487 5,316 Computer equipment and 41,261 33,823 software Furniture and equipment 4,782 4,840 Total, at cost 87,348 71,807 10-03 Accumulated depreciation (43,197) (35,330) Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 1 Intangible Assets—Microsoft Corporation NOTE 10 – INTANGIBLE ASSETS (in part) The components of intangible assets, all of which are finite- lived, were as follows: ($ in millions) June 30, 2020 2019 Technology-based $ $ 1,920 1,779 Customer-related 2,647 2,924 Marketing-related 2,570 2,838 Contract-based 42 68 Total $7,038 $7,750 10-04 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 1 Property, Plant, and Equipment and Their Acquisition Costs Asset Description Typical Acquisition Costs Property, Productive assets that derive their All expenditures necessary to get plant, and value from long-term use in the asset in condition and location equipment operations rather than from resale for its intended use Equipment Broad term that includes Purchase price (less discounts), machinery, computers, and other taxes, transportation, installation, office equipment, vehicles, testing, trial runs, and reconditioning furniture, and fixtures Land Real property used in operations Purchase price, attorney’s fees, title, (land held for speculative recording fees, commissions, back investment or future use is reported taxes, mortgages, liens, clearing, as investments or other assets) filling, draining, and removing old buildings Land Enhancements to property such as Separately identifiable costs improveme parking lots, driveways, private nts roads, fences, landscaping, and sprinkler systems Buildings Structures that include warehouses, Purchase price, attorney’s fees, plant facilities, and office buildings commissions, and reconditioning Natural Productive assets that are Acquisition, exploration, resources physically consumed in operations development, and restoration costs Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw 10-05  LO10- 1 Intangible Assets and Their Acquisition Costs Asset Description Typical Acquisition Costs Intangible Productive assets that lack physical All expenditures necessary to get Assets substance and have long-term but the asset in condition and location typically uncertain benefits for its intended use Patents Exclusive 20-year right to Purchase price, legal fees, filing manufacture a product or use a fees, not including internal R&D process Copyrights Exclusive right to benefit from a Purchase price, legal fees, filing creative work such as a song, film, fees, not including internal R&D painting, photograph, or book Trademarks Exclusive right to display a word, a Purchase price, legal fees, filing (tradename slogan, a symbol, or an emblem fees, not including internal R&D s) that distinctively identifies a company, product, or a service 10-06 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 1 Intangible Assets and Their Acquisition Costs (continued) Asset Description Typical Acquisition Costs Franchises A contractual arrangement under Franchise fee plus any legal fees which a franchisor grants the franchisee the exclusive right to use the franchisor’s trademark or tradename and certain product rights Software Costs incurred to develop or Costs incurred after technological developmen purchase computer software to be feasibility but before product release t costs sold, leased, or otherwise marketed (or costs incurred after application (or to develop computer software to development stage is reached for be used internally) internal software) Acquired Developed technologies or in- Fair value of the R&D on the date of research process R&D purchased in a acquisition and business acquisition developmen t Goodwill The unique value of the company Excess of the fair value of the as a whole over and above all consideration given for a company identifiable assets over the fair value of the identifiable assets acquired There are many other types of intangible assets, such as the acquisition of customer lists, brand names, internet domain names, licenses, servicing contracts, trade secrets, 10-07 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw etc. Each of these intangible assets is recorded at its purchase price on the date of  LO10- 1 Costs to Be Capitalized Property, plant, and equipment and intangible assets Can be acquired by: Purchase Donation Exchange Self- Business Lease construction combinatio n all expenditures Initial = Purchase + necessary to cost price bring the asset to its desired condition and Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw 10-08  LO10- 1 Cost of Equipment 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 represent the initial amount to be capitalized (recorded as an asset) in the balance sheet. 10-09 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 1 Capitalized Cost of Equipment 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,Purchase was $600.price $62,00 Freight and handling 0 Insurance during shipping v 1,000 Special foundation 300 Trial runs 1,200 Capitaliz 600 $65,10 ed 0 10-10 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- Concept Check: Cost of 1 Equipment The following expenditures relate to equipment purchased by Symington Corporation: Purchase price $48,000 Transportation costs 2,400 Installation and special wiring 1,500 Testing 6,000 For what amount will Symington record the purchase of equipment? The correct answer is b: a. $51,900 $48,000 (purchase price) + $2,400 (transportation costs) + $1,500 (installation and wiring) + $6,000 b. $57,900 (testing) = $57,900 c. $50,800 d. $48,000 10-11 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 1 Cost of Land Costs should include: 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, Proceeds draining, from and the even sale of(razing) removing salvaged old materials buildingsafter purchase reduce the cost of land 10-12 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 1 Capitalized Cost of Land The Buffalo 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 Delinquent property taxes 4,000* Current-year property taxes 2,000 *The property taxes included $4,000 of delinquent taxes paid by Buffalo on behalf of the seller and $2,000 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw 10-13  LO10- 1 Capitalized Cost of Land (continued) Shortly after closing, Buffalo 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. Purchase price of land (and old $500,00 building) 0 Title insurance 3,000 Commissions 16,000 Delinquent property taxes 4,000 Cost of removing old building 10,000 Cost of grading 5,000 Capitalized cost of land Related to $538,00 Property taxes = $6,000 − $2,000 the current 0 period 10-14 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 1 Land Improvements Usually have useful lives that are estimable Costs: – Separately identified and capitalized – Depreciated over periods benefited by their use Examples: – Cost of parking lots, driveways, private roads, fences, and sprinkler systems 10-15 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 1 Cost of Buildings Cost of acquiring a building usually includes: – Purchase price – Realtor commissions and legal fees – Reconditioning costs – Refurbishing, remodeling, or otherwise modifying to suit the needs of the new owner 10-16 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 1 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 Acquisition costs Any other costs Exploration costs necessary to bring Development costs the asset to Restoration costs condition and location for use 10-17 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 1 Asset Retirement Obligations A company may incur obligations associated with the disposition of property, plant, and equipment and natural resources This gives rise to an Asset Retirement Obligation which is defined as an existing legal obligation associated with the disposition/retirement of a tangible, long-lived asset 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 10-18 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 1 Asset Retirement Obligations (continued) Provisions of standards to address AROs Scope Recognition Measurement Present value calculations 10-19 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 1 Asset Retirement Obligations (continued) Provisions of standards to address AROs Scope ‒ Only from legal obligations associated with the retirement of a tangible long-lived asset that result from the acquisition, construction, or development and (or) normal operation of a long-lived asset Recognition ‒ Might arise at the inception of an asset’s life or during its operating life Measurement ‒ A company recognizes the fair value of an ARO in the period it’s incurred. The amount of the liability increases the valuation of the related asset. Usually, the fair value is estimated by calculating the present value of estimated future cash outflows Present value calculations ‒ Expected cash flow approach – adjust the cash flows, not the discount rate, for the uncertainty or risk of those cash flows 10-20 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 1 Asset Retirement Obligations (cont. 2) The Canyon Mining Company paid $1,000,000 for the right to explore for a copper deposit on 500 acres of land in Pennsylvania. Costs of exploring for the copper deposit totaled $800,000 and intangible development costs incurred in digging and erecting the mine shaft were $500,000. In addition, Canyon purchased new excavation equipment for the project at a cost of $600,000. After the copper is removed from the site, the equipment will be sold. Canyon is required by its contract to restore the land to a condition suitable for recreational use after it extracts the copper. The company has provided the following three cash flow possibilities (A, B, and C) for the restoration costs to be paid in three years, after extraction is completed: Cash Outflow Probability A $500,000 30% B 600,000 50% C 700,000 20% The company’s credit-adjusted risk-free interest rate is 8%. Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw 10-21  LO10- 1 Asset Retirement Obligations (cont. 3) Total capitalized cost of the copper deposit: Purchase of rights to explore $1,000,000 Exploration costs 800,000 Development costs 500,000 Restoration costs 468,360 Capitalized cost of the copper deposit $2,768,36 Present value of expected cash outflow for 0 restoration costs (asset retirement obligation): $500,000 × 30% = $150,00 600,000 × 50% = 0300,000 700,000 × 20% = 140,000 $590,000 ×.79383 = $468,360 (.79383 is the present value of $1, n = 3, i = 8%) 10-22 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 1 Asset Retirement Obligations (cont. 4) Total capitalized cost of the copper deposit: Purchase of rights to explore $1,000,00 0 Exploration costs 800,000 Development costs 500,000 Restoration costs 468,360 Capitalized cost of the copper deposit $2,768,3 Journal Entry Debit Credit60 Copper mine 2,768,360 Cash 2,300,000 Asset retirement liability 468,360 Excavation equipment 600,000 Cash (cost) 600,000 10-23 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- Asset Retirement 1 Obligations (cont. 5 ) Accretio Increase Asset Yea n in Retirement r Expense Balance Obligation 468,36 1 8% (468,360) = 37,46 0 505,82 2 37,469 8% (505,829) = 9 40,46 9 546,29 3 40,466 8% (546,295) = 6 43,70 5 590,00 43,705* *Rounded 5 0 Journal Entry Debit Credit Accretion expense 37,469 Asset retirement liability 37,469 10-24 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 1 Asset Retirement Obligations (concluded) If the actual restoration costs are more (less) than the $590,000, we recognize a loss (gain) on retirement of the obligation for the difference. For example, suppose the actual restoration costs were $625,000: Accretio Increase Asset Yea n in Retirement r Expense Balance Obligation 468,36 1 8% (468,360) = 37,46 0 505,82 2 37,469 8% (505,829) = 9 40,46 9 546,29 3 40,466 8% (546,295) = 6 43,70 5 590,00 43,705 5 0 Journal Entry Debit Credit Asset retirement liability 590,000 Loss 35,000 Cash 625,000 Loss = $625,000 − $590,000= 10-25 $35,000 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 1 Concept Check: Cost of Land The Winderl Mining Co. paid $50 million for the right to explore and extract copper from land owned by the state of Wyoming. To obtain the rights, Winderl agreed to restore the land to a suitable condition for other uses after its exploration and extraction activities. Winderl incurred exploration and development costs of $15 million on the project. The company’s credit-adjusted risk-free interest rate is 6%. It estimates the possible cash flows for restoring the land, three years after its extraction activities begin, as follows: Cash outflow Probability $ 5 million 40% $10 million 60% What is the initial cost of the copper mine? a. $65,000,000 The correct answer is c: Expected cash outflow = $8 million b. $73,000,000 [($5 million × 40%) + ($10 million × 60%)] c. $71,716,960 Restoration costs = $8 million × 0.83962* = $6,716,960 d. $95,000,000 *(PV factor, i = 6, n = 3) Cost of mine: $50,000,000 + 15,000,000 + 6,716,960 = $71,716,960 10-26 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 1 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 Purchase attributable intangible toassets many intangible from other Compani assets es can entities either: Ex: Existing patent, copyright, Develop trademark intangible assets internally Ex: Develop a new product that is then patented Amorti Finite useful lives zed Not Indefinite useful Amorti lives zed all other costs Cos =Purchase + necessary to get the t price asset Copyright © 2023 McGraw Hill LLC. All rights reserved. ready No reproduction or distribution for use without prior 10-27 written consent of McGraw  Intangible Assets LO10- 1 (concluded) Specifically identifiable Patents Copyrights Trademarks Franchises Right to display a Exclusive right of word, a slogan, Exclusive right Exclusive right protection given or a symbol, that by franchisor to to manufacture to a creator of a distinctly franchisee to use a product or to published work. identifies a the franchisor’s use a process Ex: company, trademark/produ Song/film/book product, or ct service. Granted by the Granted by the Registered with Franchisor U.S. Patent and U.S. Copyright U.S. Patent and grants it for a Trademark Office Office for the life Trademark Office specified for a period of of the creator for a period of 10 period of time to 20 years plus 70 years years the franchisee Initial payment Costs include Costs include Costs include plus periodic purchase price, purchase price, purchase price, payments legal fees, filing legal fees, filing legal fees, filing over the life of fees, not fees, not fees, not the franchise including including internal including internal agreement and internal Copyright research © 2023 McGraw Hill LLC. Allresearch & reproduction or rights reserved. No research & prior written distribution without anyconsent legal costs of McGraw 10-28  LO10- 1 Goodwill Represents the unique value of a company as a whole over and above its identifiable tangible and intangible assets Goodwill can emerge from a company’s: Clientele Trained Favorable and employees business reputation and location managem ent team 10-29 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 1 Goodwill (continued) Because goodwill can’t be separated from a company, it’s not possible for a buyer to acquire it without also acquiring the whole company or a portion of it Capitalized Cost of Goodwill: Fair value of the consideration Fair value of the given in exchange − identifiable net for the company assets acquired (acquisition price) The fair value of all identifiable tangible and intangible assets (less) The fair value of any liabilities of the selling 10-30 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 1 Goodwill (cont. 2) The Knight Corporation acquired all of the outstanding common stock of the Rider Corporation in exchange for $180 million cash. Knight assumed all of Rider’s long-term liabilities, which have a fair value of $120 million at the date of acquisition. The fair values of all identifiable assets of Rider are as follows: receivables of $50 million, inventory of $70 million, property, plant, and The equipment cost of the of $90 million, goodwill resulting and patent from the of $40 million. acquisition Fair value of consideration given $180 Less: (cash)Fair value of identifiable net assets acquired: Fair value of identifiable assets acquired Less: Fair value of liabilities assumed $250 (130 Goodwill (120) $) 50 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- Goodwill (concluded) 1 The Knight Corporation acquired all of the outstanding common stock of the Rider Corporation in exchange for $180 million cash. Knight assumed all of Rider’s long-term liabilities, which have a fair value of $120 million at the date of acquisition. The fair values of all identifiable assets of Rider are as follows: receivables of $50 million, inventory of $70 million, property, plant, Difference and equipment of $90 million, and patent of $40 Journal Entry Debit Credit million). Receivables 50 Inventory 70 Property, plant, and equipment 90 Patent 40 Goodwill 50 Liabilities 120 Cash 180 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 1 Concept Check: Goodwill The Deardon Golf Ball Company acquired all of the outstanding common stock of Sanderson Golf for $1,750,000. The book values and fair values of Sanderson’s assets and liabilities on the date of purchase were as follows: Book Value Fair Value Current assets $ 430,000 $ 415,000 Property, plant, and equipment 1,500,000 1,470,000 Liabilities 300,000 300,000 Deardon should record goodwill of: a. $165,000 b. $470,000 c. $170,000 The correct answer is a: d. $0 $1,750,000 − ($415,000 + 1,470,000 − 300,000) = $165,000 10-33 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 2 Lump-Sum Purchases Refers to the acquisition of a group of assets for a single sum Valuation of these assets differs when: Each asset is indistinguishable Example: 10 identical delivery trucks purchased for a lump- sum price of $150,000 Assets: have Allocate thecharacteristics different lump-sum acquisition and different price among useful lives the separate items Example: Acquisition of a factory that includes assets that are significantly different such as land, building, and equipment Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw 10-34  LO10- 2 Lump-Sum Purchases (continued) 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) as follows: Fair Allocatio Values n Land $ = Building 550,000 330,000 15% 25 Equipment 660,000 30 Patent 440,000 20 Inventories 220,000 10 Total $2,200,0 $2,200,00 100 00 0 % Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw 10-35  LO10- 2 Lump-Sum Purchases (cont. 2) The relative fair value percentages are multiplied by the lump-sum purchase price to determine the initial valuation of each of the separate assets. Consideratio Initial Valuation n Paid of Each Asset Land 15% $ Building 25 = 500,000 300,000 Equipment $2,000,000 30 = 600,000 Patent × 20 = 400,000 Inventories 10 = 200,000 Total 100 = $2,000,0 % 00 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw 10-36  LO10- 2 Lump-Sum Purchases (concluded) Initial Valuation Consideratio n Paid of Each Asset Land 15% $ Building 25 = 500,000 300,000 Equipment $2,000,00 30 = 600,000 Patent 0× 20 = 400,000 Inventories 10 = 200,000 Total 100 = $2,000,0 % 00 Journal Entry Debit Credit Land 300,00 Building 500,00 0 Equipment 600,00 0 Patent 400,00 0 Inventories 200,00 0 Cash 0 2,000,0 00 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw 10-37  LO10- 2 Concept Check: Lump-Sum Purchases Cirrus Corporation acquired a manufacturing facility on five acres of land for a lump-sum price of $32,000,000. The land included land improvements such as landscaping, a sprinkler system, and a parking lot. According to independent appraisals, the fair values were $18,000,000, $12,000,000, and $10,000,000 for the building, land, and land improvements, respectively. The initial values of the building, land, and land improvements would be: Building Land Land improvements a. $18,000,000 $12,000,000 $10,000,000 b. $18,000,000 $12,000,000 $ 2,000,000 c. $14,400,000 $ 9,600,000 $ 8,000,000 The correct answer is c: d. TotalAll fair of these value answer choices are incorrect = $40,000,000 Building: $18,000,000 ÷ $40,000,000 = 45% × $32,000,000 = $14,400,000 Land: $12,000,000 ÷ $40,000,000 = 30% × $32,000,000 = $9,600,000 Land improvements: $10,000,000 ÷ $40,000,000 = 25% × $32,000,000 = $8,000,000 10-38 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 3 Noncash Acquisitions Companies can also acquire assets without paying cash at the time of the purchase by: 1. Deferred payments (notes payable) 2. Issuance of equity securities 3. Donated assets 4. Exchanges of nonmonetary assets for other assets Assets acquired in noncash transactions are valued at the fair value of the assets given or the fair value of the assets received, whichever is more clearly evident 10-39 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 3 Deferred Payments An obligation to make payment in the future Example: Suppose equipment is selling for $41,323. Instead of paying cash immediately, the buyer signs a note on January 2, 2024, requiring payment in two years plus annual interest of 10% (a realistic rate). The equipment would be recorded for $41,323, and interest would be recognized over time. After two years, the company would pay $50,000 for the equipment January and 2, interest. Equipment 2024 41,323 Notes payable (face 41,323 amount) 31, December Interest expense ($41,323 × 2024 4,132 Interest payable 10%) 4,132 December 31, 2025 Interest expense [($41,323 + $4,132) 4,545 Interest × 10%] payable 4,132 Notes payable (face 41,323 Cash amount) 50,000 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw 10-40  LO10- Asset Acquired with Debt—Present 3 Value of Note Indicative of Fair Value On January 2, 2024, the Midwestern Steam Gas Corporation purchased industrial equipment. In payment, Midwestern signed a noninterest-bearing note requiring $50,000 to be paid on December 31, 2025 (two years later). If Midwestern had borrowed cash to buy the equipment, the bank would have required an interest rate of 10%. The equipment is custom built, so its fair value January (cash price) 2, is2024 unavailable. Debit Credit Equipment (determined below) 41,323 Discount on notes payable 8,677 Notes payable (face amount) (difference) 50,000 PV = $50,000 × 0.82645 = (Fair value of $41,323 note) Present value of $1: n = 2, Discount on note payable = $50,000 − $41,323 i = 10% Copyright= $8,677 © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw 10-41  Asset Acquired with Debt—Present LO10- 3 Value of Note Indicative of Fair Value (concluded) Adjusting entries for Midwestern’s fiscal year- ends: Journal Entry Debit Credit December 31, 2024 Interest expense($41,323 × 4,132 Discount on notes payable 10%) 4,132 December 31, 2025 ($41,323 + $4,132) × 4,545 Interest expense Discount on notes payable 10% 4,545 Notes payable (face amount) 50,000 Cash 50,000 Interest Expense Discount on notes payable Dec. 31, 4,132 2024 Jan. 1, 8,677 2024 Dec. 31, 4,545 2025 Dec. 31, 2024 4,132 Dec. Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction 31, 2025 or distribution 4,545 without prior written consent of McGraw 10-42  LO10- 3 Noninterest-Bearing Note—Fair Value of Asset Is Known On January 2, 2024, Dennison, Inc. purchased equipment and signed a noninterest-bearing note in payment. The note requires the company to pay $100,000 on December 31, 2026. Dennison is not sure what interest rate appropriately reflects the time value of money. However, price lists indicate the equipment could have been purchased for cash at a priceJournal Entry of $79,383. Debit Credit Equipment (cash 79,383 Discount onprice) note payable 20,617 Note payable (face 100,000 amount) PV = Face amount × PV Factor Implicit rate of PV Factor = $79,383 ÷ $100,000 = 0.79383 interest Present value of $1: n = 2, i = ? (from Table PV table, Discount on notei=8%) payable = $100,000 – 10-43 $79,383 = $20,617 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- Concept Check: Deferred 3 Payments On January 2, 2024, Edgar, Inc., purchased equipment and signed a noninterest-bearing note in payment. The note requires the company to pay $200,000 on December 31, 2026. Edgar is not sure what interest rate appropriately reflects the time value of money. However, price lists indicate the equipment could have been purchased for cash at a price of $120,000. Edgar records the asset at what price on January 2: a. $120,000 The correct answer is a. Sometimes, the fair value of an b. $200,000 asset acquired in a noncash transaction is readily c. $80,000 available from price lists, previous purchases, or otherwise. In that case, this fair value may be more d. $20,000 clearly evident than the fair value of the note and it would serve as the best evidence of the exchange value of the transaction. The answer is $120,000. 10-44 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 4 Issuance of Equity Securities 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: – The fair value of the assets received by the corporation or – The market value of the shares of corporations whose stock is actively traded 10-45 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 4 Asset Acquired by Issuing Equity Securities On March 31, 2024, the Elcorn Company issued 10,000 shares of its no-par common stock in exchange for land. On the date of the transaction, the fair value of the common stock, evidencedJournal by its market Entry price, was $20 per Debit Credit share. Land 200,00 Common stock 0 200,00 0 10,000 shares @ $20 per share = $200,000 10-46 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 4 Donated Assets The donation usually is an enticement to do something that benefits the donor Recorded at their fair values based on either an available market price or an appraisal value Revenue is credited 10-47 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 4 Asset Donation Elcorn Enterprises 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, 2024. Elcorn paid its portion of the cost of the buildingEntry Journal in cash. Debit Credit Building 20,000,0 Cash 00 16,000,0 Revenue—donation of asset 4,000,0000 0 Donation = $20,000,000 × 20% = $4,000,000 10-48 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- Concept Check: Donated 4 Assets Shackelford Corporation acquired a patent from its founder, Jim Shackelford, in exchange for 50,000 shares of the company’s no-par common stock. On the date of the exchange, the common stock had a fair value of $22 per share. Determine the cost of the patent. a. $22,000,000 b. $12,800,000 c. $50,000 d. $1,100,000 The correct answer is d. When the common stock is actively traded, the market value of the shares is the best indication of fair value. The market value of stock is 50,000 shares × $22 = $1,100,000. 10-49 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 9 International Financial Reporting Standards—Government Grants U.S. GAAP IFRS Government Grants Both U.S. GAAP and IFRS require that donated assets be valued at their fair values Deduct the amount of the grant in determining the initial cost of the asset, or Recorded as revenue in the Record the grant as a liability, period received deferred income, in the balance sheet and recognize it in the income statement systematically over the asset’s useful life 10-50 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 9 Concept Check: IFRS The County of Santa Clara gave a parcel of land to the 49ers Company as part of an agreement requiring the 49ers to construct its football stadium on the donated land. The land cost the county $12,800,000 when purchased several years ago and had an appraised value of $20,000,000 on the date it was given to the 49ers. As a result of the donation, the 49ers should record: a. A credit to retained earnings of $20,000,000 b. A debit to land of $12,800,000 c. A credit to revenue of $20,000,000 d. All of these answer choices are incorrect The correct answer is c. GAAP requires that if a company receives a donated asset it must record revenue at an amount equal to the fair value of that asset. In this case fair value is $20,000,000. 10-51 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 5 Decision Makers’ Perspective Capital budgeting: Includes decisions pertaining to acquisitions of property, plant, and equipment and intangible assets Requires management to forecast all future net cash flows generated by the asset(s) Net present value model Present value of Initial > future net cash acquisition cost flows 10-52 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 5 Fixed-Asset Turnover Ratio Fixed-Asset Turnover Ratio: Indicates the level of sales generated by the company’s investment in fixed assets Net sales Fixed-asset turnover ratio = Average fixed assets Average fixed assets  Beginning book value + Ending book value divided by 2. The book value, sometimes called carrying value or carrying amount is the cost less accumulated depreciation and depletion. 10-53 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 5 Fixed-Asset Turnover Ratio (continued) ($ in millions) Gap Ross Stores 2020 2019 2020 2019 Property, plant, and $2,91 $2,65 $2,47 equipment (net) $3,122 2 3 5 Net sales—2020 Gap $16,383 Ross Stores $16,039 Fixed- = $16,383 $16,039 asset $3,017 $2,564 turnover = $5.43 $6. ratio 26 ($2,912 (2020) + ($2,653 + $3,122) ÷ 2 $2,475) ÷ 2 10-54 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 5 Concept Check: Fixed-Asset Turnover Ratio Huebert Corporation and Winslow Corporation reported the following information. Calculate each company’s fixed-asset turnover ratio. Huebert Winslow 2024 2023 2024 2023 Property, plan and $210 $220 $680 $650 equipment (net) Net Sales—2024 $1,850 $5,120 a. 8.6, 7.7 The correct answer is a: The fixed asset turnover ratio for Huebert is 8.6 ($1,850 ÷ [(210 + 220) ÷ 2]). This can b. 7.7, 8.6 be compared to the turnover of Winslow of 7.7 ($5,120 c. 210, 680 ÷ [($680 + 650) ÷ 2]). d. 220, 650 10-55 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 6 Exchanges An asset received in an exchange of nonmonetary assets generally is valued at fair value. Old Traded- New asset asset (Fair in acquired (Fair value) value) Difference Paid in cash or other asset Gain or loss is recognized in these transactions for the difference between the fair value and book value of the asset given 10-56 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 6 Exchanges (continued) The basic steps in recording nonmonetary asset exchanges follow: 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 net increase or decrease in total assets from the exchange. 10-57 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- Nonmonetary Asset 6 Exchange (Gain) The Elcorn Company traded its old laser equipment for the newer air-cooled ion laser equipment 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. Elcorn also paidJournal American Laser $430,000 inDebit Entry cash as part Credit of the exchange. Equipment—new Step 580,000 Accumulated depreciation—old1 400,000 Step Equipment—old 500,000 2 Cash (amount paid) Step 430,000 Gain on exchange of assets3(to Step 50,000 balance) 4 Fair value of new equipment = $580,000 ($150,000 + $430,000) Gain = Fair value ($150,000) − Book value ($100,000) = $50,000 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw 10-58  LO10- Nonmonetary Asset 6 Exchange (Loss) The Elcorn Company traded its old laser equipment for the newer air-cooled ion laser equipment 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 $75,000. Elcorn also paid American Laser $430,000 in cash as part of Journal Entry Debit Credit the exchange. Equipment—new 505,000 Accumulated depreciation—old 400,000 Loss on exchange of assets (to 25,000 Equipment—old balance) 500,000 Cash (amount paid) 430,000 Fair value of new equipment = $505,000 ($75,000 + $430,000) Loss = Fair value ($75,000) − Book value ($100,000) = Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw 10-59  LO10- 6 Nonmonetary Asset Exchange (Fair Value Not Determinable) The Elcorn Company traded its laser equipment for the newer air-cooled ion laser equipment 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). The fair value of both the new and old equipment is not Entry determinable. Elcorn paid American Journal Debit Credit Laser $430,000 in cash. Equipment—new 530,000 Accumulated depreciation—old 400,000 Equipment—old 500,000 Cash (amount paid) 430,000 New equipment = $530,000 [Book Value ($100,000) + Cash paid ($430,000)] No Gain or Loss would be recognized 10-60 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 6 Exchange Lacks Commercial Substance Commercial Substance: Present when future cash flows change as a result of the exchange 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 Exchange Lacks Commercial Substance Gain Situation Loss Situation Book value of the old Fair value of old asset is asset is used to record used to record the the exchange exchange (unlikely situation) 10-61 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 6 Nonmonetary Asset Exchange— 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. Elcorn also paid Sanchez $500,000 in cash. (Note the exchange lacks commercial substance) Journal Entry Debit Credit Land—new 3,000,00 Land—old 02,500,000 Cash (amount paid) 500,000 New land = $3,000,000 ($2,500,000 + $500,000) No gain is recognized. 10-62 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 6 Exchange Summary Type of Exchange Fair value Determinable Fair Value Lack of and Commercial Not Commercial Substance Determinable Substance Step 1: FV given + cash paid BV given + If gain, BV given + Record (or − cash received). cash paid (or − cash paid (or − new asset cash received). cash received) + gain recognized.* If loss, FV given + cash paid (or − cash received). Step 2: BV of cost minus Same Same Remove accumulated old asset depreciation. Step 3: Amount paid or Same Same Record received. cash Step 4: FV given − BV given No gain or loss Calculate gain10-63 to Record Copyright gain Hill(Gain © 2023 McGraw LLC. All if FVreserved. rights > BV;NoLoss if recognized. reproduction bewritten or distribution without prior recognized.* consent of McGraw  LO10- 6 Concept Check: Exchange Arizona Pharmaceuticals exchanged laser equipment with a book value of $70,000 and a fair value of $75,000 for the newer model of laser equipment. In addition to the old equipment, $90,000 in cash was given. Arizona should recognize: a. A loss of $5,000 b. A gain of 15,000 c. A gain of $5,000 d. No gain or loss The correct answer is c. A gain is recognized for the difference between the fair value of the old equipment and the equipment’s book value: $75,000 − 70,000 = $5,000. 10-64 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- Concept Check: Recording an 6 Exchange Arizona Pharmaceuticals exchanged laser equipment with a book value of $70,000 and a fair value of $75,000 for the newer model of laser equipment. In addition to the old equipment, $90,000 in cash was given. Arizona should record the new laser equipment at: a. $ 95,000 b. $165,000 c. $160,000 d. All of these answer choices are incorrect The correct answer is b. The new laser equipment is recorded at an amount equal to the fair value of the old equipment plus the cash given: $75,000 + 90,000 = $165,000. 10-65 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 7 Self-Constructed Assets 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 exchangeTwoprice Critical Issues Determining the Deciding on the amount of indirect proper treatment of manufacturing costs interest (actual or (overhead) to be implicit) incurred allocated to the during construction construction 10-66 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10- 7 Self-Constructed Assets (continued) Overhead Allocation The treatment of manufacturing overhead cost and its allocation: 1. Inclusion of only the incremental overhead costs 2. Full-cost approach Interest Capitalization 1. Capitalized and then allocated as depreciation 10-67 Copyright © 2023 McGraw Hill LLC. All rights reserved. No reproduction or distribution without prior written consent of McGraw  LO10-