Acct-322 Chapter 10 Questions

Home / Essays / Acct-322 Chapter 10 Questions

Chapter 10 Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition Questions for Review of Key Topics Question 10-1 The difference between tangible and intangible long-lived, revenue-producing assets is that intangible assets lack physical substance and they primarily refer to the ownership of rights. Question 10-2

The cost of property, plant, and equipment and intangible assets includes the purchase price (less any discounts received from the seller), transportation costs paid by the buyer to transport the asset to the location in which it will be used, expenditures for installation, testing, legal fees to establish title, and any other costs of bringing the asset to its condition and location for use. Question 10-3 The cost of a developed natural resource includes the acquisition costs for the use of land, the exploration and development costs incurred before production begins, and the restoration costs incurred during or at the end of extraction.

Question 10-4 Purchased intangibles are valued at their original cost to include the purchase price and all other necessary costs to bring the asset to condition and location for use. Research and development costs incurred to internally develop an intangible asset are expensed in the period incurred. Filing and legal costs for both purchased and developed intangibles are capitalized. Question 10-5 Goodwill represents the unique value of the company as a whole over and above all identifiable tangible and intangible assets.

This value results from a company’s clientele and reputation, its trained employees and management team, its unique business location, and any other unique features of the company that can’t be associated with a specific asset. Because goodwill can’t be separated from a company, it is not possible for a buyer to acquire it without also acquiring the whole company or a substantial portion of it. Goodwill will appear as an asset in a balance sheet only when it was paid for in connection with the acquisition of another company.

The capitalized cost of goodwill equals the purchase price of the acquired company less the fair value of the net assets acquired. The fair value of the net assets equals the fair value of all identifiable tangible and intangible assets less the fair value of any liabilities of the selling company assumed by the buyer. Answers to Questions (continued) Question 10-6 A lump-sum purchase price generally is allocated based on the relative fair values of the individual assets. The relative fair value percentages are multiplied by the lump-sum purchase price to arrive at the initial valuation of each of the separate assets.

Question 10-7 Assets acquired in exchange for deferred payment contracts are valued at their fair value or the present value of payments using a realistic interest rate. Theoretically, both alternatives should lead to the same valuation. Question 10-8 Assets acquired through the issuance of equity securities are valued at the fair value of the securities if known; if not known, the fair value of the assets received is used. Question 10-9 Donated assets are valued at their fair values. Question 10-10

When an item of property, plant, and equipment is sold, a gain or loss is recognized for the difference between the consideration received and the asset’s book value. Retirements and abandonments are handled in a similar fashion. The only difference is that there will be no monetary consideration received. A loss is recorded for the remaining book value of the asset. Question 10-11 The basic principle used to value assets acquired in a nonmonetary exchange is to use the fair value of asset(s) given up plus (minus) monetary consideration – cash – paid (received).

Question 10-12 The two exceptions are (1) when fair value is not determinable and (2) when the exchange lacks commercial substance. Question 10-13 GAAP require the capitalization of interest incurred during the construction of assets for a company’s own use as well as for assets constructed for sale or lease. Assets qualifying for capitalization exclude inventories that are routinely manufactured in large quantities on a repetitive basis and assets that are in use or ready for their intended purpose. Only assets that are constructed as discrete projects qualify for nterest capitalization. Answers to Questions (continued) Question 10-14 Average accumulated expenditures for a period is an approximation of the average amount of debt the company would have had outstanding if it borrowed all of the funds necessary for construction. If construction expenditures are incurred equally throughout the period, the average accumulated expenditures for the period can be estimated by adding the accumulated expenditures at the beginning of the period to the accumulated expenditures at the end of the period and dividing by two.

If expenditures on the project are unequal throughout the period, individual expenditures, perhaps expenditures grouped by month, should be weighted by the amount of time outstanding until the end of the construction period or the end of the company’s fiscal year, whichever comes first. Question 10-15 Applying the specific interest method, the interest rate on any construction related debt is used up to the amount of the construction debt and any excess average accumulated expenditures is multiplied by a weighted-average interest rate of all other debt.

The weighted-average method multiplies average accumulated expenditures by the weighted-average interest rate of all debt, including any construction-related debt. Question 10-16 GAAP defines research and development as follows: Research is planned search or critical investigation aimed at discovery of new knowledge with the hope that such knowledge will be useful in developing a new product or service or a new process or technique or in bringing about a significant improvement to an existing product or process. Development is the translation of research findings or other knowledge nto a plan or design for a new product or process or for a significant improvement to an existing product or process whether intended for sale or use. Question 10-17 GAAP specifically excludes from current R&D expense the cost of property, plant, and equipment and intangible assets that have “alternative future uses” beyond the current R&D project. However, the depreciation or amortization of these assets will be included as R&D expenses in the future periods the assets are used for R&D activities. If the asset has no alternative future use, its cost is expensed as R&D immediately.

Question 10-18 GAAP requires the capitalization of software development costs incurred after technological feasibility is established. Technological feasibility is established “when the enterprise has completed all planning, designing, coding, and testing activities that are necessary to establish that the product can be produced to meet its design specifications including functions, features, and technical performance requirements. ” Costs incurred after technological feasibility but before the product is available for general release to customers are capitalized as an intangible asset.

These costs include coding and testing costs and the production of product masters. Costs incurred after commercial production begins usually are not R&D expenditures. Answers to Questions (concluded) Question 10-19 The cost of developed technology is capitalized and expensed over its expected useful life. Developed technology relates to those projects that have reached technological feasibility. Before 2009, the cost of in-process R&D was expensed in the period of the acquisition. Now, the cost of in-process R&D is capitalized and treated as an indefinite life intangible asset and not amortized.

If the R&D project is completed successfully, we switch to the way we account for developed technology and amortize the capitalized amount over the estimated period the product or process developed will provide benefits. If the project instead is abandoned, we expense the entire balance immediately. Research and development costs incurred after the acquisition to complete the project are expensed as incurred, consistent with the treatment of any other R&D not acquired in an acquisition. Question 10-20 Other than 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. Question 10-21 The periodic amortization percentage for capitalized computer software development costs under U. S. GAAP is the greater of (1) the ratio of current revenues to current and anticipated revenues or (2) the straight-line percentage over the useful life of the software.

This approach is allowed under IFRS, but not required. Question 10-22 The successful efforts method allows companies to capitalize only exploration costs resulting in successful wells. The full-cost method allows companies to capitalize all exploration costs incurred within a geographical area. BRIEF EXERCISES Brief Exercise 10-1 Capitalized cost of the machine: Purchase price$35,000 Freight1,500 Installation3,000 Testing 2,000 Total cost$41,500 Note: Personal property taxes on the machine for the period after acquisition are not part of acquisition cost. They are expensed in the period incurred.

Brief Exercise 10-2 Capitalized cost of land: Purchase price$600,000 Broker’s commission30,000 Title insurance3,000 Miscellaneous closing costs6,000 Demolition of old building 18,000 Total cost$657,000 All of the expenditures, including the costs to demolish the old building, are included in the initial cost of the land. Brief Exercise 10-3 Cost of land and building: Purchase price$600,000 Broker’s commission30,000 Title insurance3,000 Miscellaneous closing costs 6,000 Total cost$639,000 The total must be allocated to the land and building based on their relative fair values: | | | | | | | |Initial | | | |Percent of Total Fair Value |Valuation | | | | |(Percent x | |Asset |Fair Value | |$639,000) | |Land |$420,000 | 60% |$383,400 | |Building | 280,000 | 40 | 255,600 | | |$700,000 | 100% | $639,000 | | | | | | Brief Exercise 10-4 Cost of silver mine: Acquisition, exploration, and development$5,600,000 Restoration costs 429,675 † $6,029,675 $500,000 x 20% = $100,000 550,000 x 45% =247,500 650,000 x 35% = 227,500 $575,000 x . 74726* = $429,675 *Present value of $1, n = 5, i = 6% (from Table 2) Brief Exercise 10-5 After one year, the liability will increase to $455,456. ($429,675† + ($429,675 x 6%) = $455,456) †$500,000 x 20% = $100,000 550,000 x 45% =247,500 650,000 x 35% = 227,500 $575,000 x . 74726* = $429,675 *Present value of $1, n = 5, i = 6% (from Table 2) Actual restoration costs$596,000 Less: Asset retirement liability(575,000) Loss on retirement$ (21,000) Brief Exercise 10-6 Calculation of goodwill: Consideration exchanged$14,000,000 Less fair value of net assets:

Book value of assets$8,300,000 Plus: Excess of fair value over book value of intangible assets 2,500,000(10,800,000) Goodwill$ 3,200,000 Brief Exercise 10-7 The initial value of machinery and note will be the present value of the note payment: PV = $60,000 (. 85734) = $51,440 Present value of $1: n = 2, i = 8% (from Table 2) Interest expense for July 1 to December 31, 2011: $51,440 x 8% x 6/12 = $2,058 Brief Exercise 10-8 The cost of the patent equals the fair value of the stock given in exchange: 50,000 x $22 = $1,100,000 Brief Exercise 10-9 Average PP&E for 2011 = ($740,000 + 940,000) ? 2 = $840,000 Net sales ? Average PP&E = Fixed-asset turnover ratio ? ? 840,000 = 3. 25 Average PP&E x Fixed-asset turnover ratio = Net sales $840,000 x 3. 25 = $2,730,000 Brief Exercise 10-10 Proceeds$16,000 Less book value:$80,000 (71,000) 9,000 Gain on sale of equipment$ 7,000 Journal entry (not required): Cash16,000 Accumulated depreciation (account balance) 71,000 Gain (difference)7,000 Equipment (account balance)80,000 Brief Exercise 10-11 Pickup trucks = Fair value of machinery plus cash paid $17,000 + 8,000 = $25,000 Loss on exchange = $20,000 (book value) – 17,000 (fair value) = $3,000 Journal entry (not required): Pickup trucks (determined above) 25,000

Accumulated depreciation (account balance) 45,000 Loss (difference)3,000 Cash 8,000 Machinery (account balance)65,000 Brief Exercise 10-12 Pickup trucks = Fair value of machinery plus cash paid $24,000 + 8,000 = $32,000 Gain on exchange = $24,000 (fair value) – 20,000 (book value ) = $4,000 Journal entry (not required): Pickup trucks (determined above) 32,000 Accumulated depreciation (account balance) 45,000 Cash 8,000 Gain (difference)4,000 Machinery (account balance)65,000 Brief Exercise 10-13 Pickup trucks = Book value of machinery plus cash paid $20,000 + 8,000 = $28,000 No gain is recognized in this situation. Journal entry (not required): Pickup trucks (determined above) 28,000

Accumulated depreciation (account balance) 45,000 Cash 8,000 Machinery (account balance)65,000 Brief Exercise 10-14 Average accumulated expenditures: January 1 $500,000 x12/12=$ 500,000 March 31 600,000 x9/12=450,000 June 30 400,000 x6/12=200,000 October 30 600,000 x2/12= 100,000 $1,250,000 Interest capitalized: $1,250,000 – 700,000 x 7% =$49,000 $ 550,000 x 6. 75%* = 37,125 $ 86,125 = interest capitalized * Weighted-average rate of all other debt: $3,000,000x 8% =$240,000 5,000,000x 6% = 300,000 $8,000,000$540,000 $540,000 = 6. 75% weighted average $8,000,000 Brief Exercise 10-15 Average accumulated expenditures:

January 1, 2011 $500,000 x12/12=$ 500,000 March 31, 2011 600,000 x9/12=450,000 June 30, 2011 400,000 x6/12=200,000 October 30, 2011 600,000 x2/12= 100,000 $1,250,000 Interest capitalized: $1,250,000 x 6. 77%* = $84,625 * Weighted-average rate of all other debt: $ 700,000x 7% =$ 49,000 3,000,000x 8% =240,000 5,000,000x 6% = 300,000 $8,700,000$589,000 $589,000 = 6. 77% weighted average $8,700,000 Brief Exercise 10-16 Research and development: Salaries$220,000 Depreciation on R & D facilities and equipment125,000 Utilities and other direct costs66,000 Payment to another company 120,000 Total R & D expense$531,000

Note: The patent filing and related legal costs and the costs of adapting the product to a particular customer’s needs are not included as research and development expense. EXERCISES Exercise 10-1 Capitalized cost of land: Purchase price$60,000 Demolition of old building$4,000 Less: Sale of materials(2,000)2,000 Legal fees for title investigation 2,000 Total cost of land$64,000 Capitalized cost of building: Construction costs$500,000 Architect’s fees12,000 Interest on construction loan 5,000 Total cost of building$517,000 Note: Property taxes on the land for the period after acquisition are not part of acquisition cost. They are expensed in the period incurred. Exercise 10-2

To record the purchase of a machine. Machine ($45,000 + 2,200 + 700 + 1,000)48,900 Accounts payable47,200 Cash1,700 To record prepaid insurance for the machine. Prepaid insurance900 Cash900 Exercise 10-3 Requirement 1 Cost of land and building: Purchase price$4,000,000 Title search and insurance16,000 Legal fees5,000 State transfer fees 4,000 Total cost$4,025,000 Note: The pro-rated property taxes for the period after acquisition are not included in the initial valuation of the land and building. They are recorded instead as prepaid taxes and expensed over the related period. The total is allocated to the land and building based on their relative fair values: | | | | | | | |Initial | | | |Percent of Total Fair Value |Valuation | | | | |(Percent x | |Asset |Fair Value | |$4,025,000) | |Land |$3,300,000 | 75% |$3,018,750 | |Building | 1,100,000 | 25 | 1,006,250 | | |$4,400,000 | 100% | $4,025,000 | | | | | | Assets: Land$3,018,750 Building1,006,250 Land improvements: Parking lot82,000 Landscaping40,000 Exercise 10-3 (concluded) Requirement 2 Cost of land: Purchase price$4,000,000 Title search and insurance16,000 Legal fees5,000 State transfer fees 4,000 Demolition of old building$250,000

Less: Sale of materials (6,000)244,000 Clearing and grading costs 86,000 Total cost of land$4,355,000 Land improvements: Parking lot82,000 Landscaping40,000 Exercise 10-4 Requirement 1 Cost of copper mine: Mining site$1,000,000 Development costs600,000 Restoration costs 303,939 † $1,903,939 †$300,000 x 25% = $ 75,000 400,000 x 40% =160,000 600,000 x 35% = 210,000 $445,000 x . 68301* = $303,939 *Present value of $1, n = 4, i = 10% (from Table 2) Requirement 2 Copper mine (determined above)1,903,939 Cash ($1,000,000 + 600,000)1,600,000 Asset retirement liability (determined above) 303,939 Equipment (cost)120,000 Cash120,000 Exercise 10-5

Organization cost expense ($12,000 + 3,000)15,000 Patent ($20,000 + 2,000)22,000 Pre-opening expenses 40,000 Furniture30,000 Cash107,000 Exercise 10-6 Calculation of goodwill: Consideration exchanged$17,000,000 Less fair value of net assets: Assets$23,000,000 Less: Liabilities assumed (9,500,000)(13,500,000) Goodwill$ 3,500,000 Exercise 10-7 Calculation of goodwill: Consideration exchanged$11,000,000 Less fair value of net assets: Book value of net assets$7,800,000 Plus: Fair value in excess of book value: Property, plant, and equipment 1,400,000 Intangible assets1,000,000 Less: Book value in excess of fair value: Receivables (200,000) 10,000,000 Goodwill$ 1,000,000 Exercise 10-8 | | | | | | | |Initial | | | |Percent of Total Fair Value |Valuation | | | | |(Percent x | |Asset |Fair Value | |$900,000) | |Land |$ 300,000 | 30% |$270,000 | |Building A | 450,000 | 45 | 405,000 | |Building B | 250,000 | 25 | 225,000 | | |$1,000,000 | 100% | $900,000 | | | | | | Exercise 10-9 Requirement 1 Tractor ($5,000 cash + 18,783† present value of note)23,783 Discount on note payable (difference) 6,217 Cash5,000 Note payable (face amount)25,000 † Present value of note payment: PV = $25,000 (. 75131) = $18,783 Present value of $1: n = 3, i = 10% (from Table 2) Requirement 2 2011: Interest expense ($18,783 x 10%) = $1,878 2012: Interest expense [($18,783 + 1,878) x 10%] = 2,066 Requirement 3 2011: $25,000 – ($6,217 – 1,878) =$20,661 2012: $25,000 – ($6,217 – 1,878 – 2,066) = 22,727 Exercise 10-10 Land: Purchase price$1,200,000

Demolition and removal of old building80,000 Clearing and grading150,000 Closing costs 42,000 Total cost of land$1,472,000 Building: Architect’s fees$ 50,000 Construction costs 3,250,000 Total cost of building$3,300,000 Machinery: Purchase price$860,000 Freight charges32,000 Special platforms and wire installation 12,000 Cost of trial runs 7,000 Total cost of machinery$911,000 Land improvements: Landscaping$45,000 Sprinkler system5,000 Fork lifts: PV = $16,000 + 70,000 (. 93458) = $81,421 Present value of $1: n = 1, i = 7% (from Table 2) Prepaid insurance:$24,000 Exercise 10-11 To record the acquisition of land in exchange for common stock. February 1, 2011 Land 90,000

Common stock (5,000 shares x $18)90,000 To record the acquisition of a building through purchase and donation. November 2, 2011 Building 600,000 Cash 400,000 Revenue – donation of asset (difference)200,000 Exercise 10-12 Requirement 1 ($ in millions) Average PP for 2009 = ($4,043 + 4,151) ? 2 = $4,097 Net sales ? Average PP = Fixed-asset turnover ratio $36,117 ? $4,097 = 8. 82 Requirement 2 The fixed-asset turnover ratio indicates the level of sales generated by the company’s investment in fixed assets. Cisco is able to generate $8. 82 in sales for every $1 invested in property, plant, and equipment. Exercise 10-13 Requirement 1 Cash3,000

Accumulated depreciation – tractor (account balance)26,000 Loss on sale of tractor (difference)1,000 Tractor (account balance)30,000 Requirement 2 Cash10,000 Accumulated depreciation – tractor (account balance)26,000 Tractor (account balance)30,000 Gain on sale of tractor (difference)6,000 Exercise 10-14 Equipment – new ($200,000 + 60,000)260,000 Accumulated depreciation (account balance)220,000 Cash60,000 Equipment – old (account balance)400,000 Gain ($200,000 – 180,000)20,000 Exercise 10-15 Equipment – new ($170,000 + 60,000)230,000 Loss ($180,000 – 170,000)10,000 Accumulated depreciation (account balance)220,000 Cash60,000 Equipment – old (account balance)400,000 Exercise 10-16 Requirement 1

Fair value of land + Cash given = Fair value of equipment $150,000 + 10,000 = $160,000 Requirement 2 Equipment ($150,000 + 10,000)160,000 Cash10,000 Land (book value)120,000 Gain ($150,000 – 120,000)30,000 Exercise 10-17 Requirement 1 Fair value of land – Cash received = Fair value of equipment $150,000 – 10,000 = $140,000 Requirement 2 Equipment ($150,000 – 10,000)140,000 Cash10,000 Land (book value)120,000 Gain ($150,000 – 120,000)30,000 Exercise 10-18 Requirement 1 Fair value of old land + Cash given = Fair value of new land $72,000 + 14,000 = $86,000 Requirement 2 Land–new ($72,000 + 14,000)86,000 Cash14,000 Land – old (book value)30,000 Gain ($72,000 – 30,000)42,000

Requirement 3 Land–new ($30,000 + 14,000)44,000 Cash14,000 Land – old (book value)30,000 Exercise 10-19 1. To record the purchase of equipment on account. Equipment ($25,000 x 98%)24,500 Accounts payable24,500 2. To record the acquisition of equipment in exchange for a note. Equipment (determined below)24,545 Discount on note payable (difference)2,455 Note payable (face amount)27,000 PV = $27,000 (. 90909) = $24,545 Present value of $1: n=1, i=10% (from Table 2) 3. To record the exchange of old equipment for new equipment. Equipment – new ($2,500 + 22,000)24,500 Loss ($6,000 – 2,500)3,500 Accumulated depreciation 8,000 Cash22,000 Equipment – old14,000 4.

To record the acquisition of equipment by the issuance of stock. Equipment24,000 Common stock24,000 Exercise 10-20 Requirement 1 The Codification topic number for nonmonetary transactions is FASB ASC 845: “Nonmonetary Transactions. ” Requirement 2 The specific citations that describe the required disclosures for nonmonetary transactions are FASB ASC 845–10–50–1 to 2: “Nonmonetary Transactions–Overall–Disclosure. ” Requirement 3 Disclosure of accounting policies shall identify and describe the accounting principles followed by the entity and the methods of applying those principles that materially affect the determination of financial position, cash flows, or results of operations.

In general, the disclosure shall encompass important judgments as to appropriateness of principles relating to recognition of revenue and allocation of asset costs to current and future periods; in particular, it shall encompass those accounting principles and methods that involve any of the following: a. A selection from existing acceptable alternatives b. Principles and methods peculiar to the industry in which the entity operates, even if such principles and methods are predominantly followed in that industry c. Unusual or innovative applications of GAAP. Disclosure of accounting policies shall identify and describe the accounting principles followed by the entity and the methods of applying those principles that materially affect the determination of financial position, cash flows, or results of operations.

In general, the disclosure shall encompass important judgments as to appropriateness of principles relating to recognition of revenue and allocation of asset costs to current and future periods; in particular, it shall encompass those accounting principles and methods that involve any of the following: a. A selection from existing acceptable alternatives b. Principles and methods peculiar to the industry in which the entity operates, even if such principles and methods are predominantly followed in that industry c. Unusual or innovative applications of GAAP. Disclosure of accounting policies shall identify and describe the accounting principles followed by the entity and the methods of applying those principles that materially affect the determination of financial position, cash flows, or results of operations.

In general, the disclosure shall encompass important judgments as to appropriateness of principles relating to recognition of revenue and allocation of asset costs to current and future periods; in particular, it shall encompass those accounting principles and methods that involve any of the following: a. A selection from existing acceptable alternatives b. Principles and methods peculiar to the industry in which the entity operates, even if such principles and methods are predominantly followed in that industry c. Unusual or innovative applications of GAAP. a. The fair value measurements at the reporting date b. The level within the fair value hierarchy in which the fair value measurements in their entirety fall, segregating fair value measurements using any of the following: 1. Quoted prices in active markets for identical assets or liabilities (Level 1) 2.

Significant other observable inputs (Level 2) 3. Significant unobservable inputs (Level 3). c. For fair value measurements using significant unobservable inputs (Level 3), a reconciliation of the beginning and ending balances, separately presenting changes during the period attributable to any of the following: 1. Total gains or losses for the period (realized and unrealized), segregating those gains or losses included in earnings (or changes in net assets), and a description of where those gains or losses included in earnings (or changes in net assets) are reported in the statement of income (or activities) 2. Purchases, sales, issuances, and settlements (net) 3.

Transfers in and/or out of Level 3 (for example, transfers due to changes in the observability of significant inputs). d. The amount of the total gains or losses for the period in (c)(1) included in earnings (or changes in net assets) that are attributable to the change in unrealized gains or losses relating to those assets and liabilities still held at the reporting date and a description of where those unrealized gains or losses are reported in the statement of income (or activities) e. In annual periods only, the valuation technique(s) used to measure fair value and a discussion of changes in valuation techniques, if any, during the period. f. The fair value measurements at the reporting date

An entity that engages in one or more nonmonetary transactions during a period shall disclose in financial statements for the period all of the following: a. The nature of the transactions b. The basis of accounting for the assets transferred c. Gains or losses recognized on transfers. In accordance with paragraph 845-10-50-1, entities shall disclose, in each period’s financial statements, the amount of gross operating revenue recognized as a result of nonmonetary transactions. Exercise 10-21 The FASB Accounting Standards Codification represents the single source of authoritative U. S. generally accepted accounting principles. The specific citation for each of the following items is: 1.

The disclosure requirements in the notes to the financial statements for depreciation on property, plant, and equipment: FASB ASC 360–10–50–1: “Property, Plant, and Equipment–Overall–Disclosure. ” Because of the significant effects on financial position and results of operations of the depreciation method or methods used, all of the following disclosures shall be made in the financial statements or in notes thereto: a. Depreciation expense for the period b. Balances of major classes of depreciable assets, by nature or function, at the balance sheet date c. Accumulated depreciation, either by major classes of depreciable assets or in total, at the balance sheet date d.

A general description of the method or methods used in computing depreciation with respect to major classes of depreciable assets. Exercise 10-21 (continued) 2. The criteria for determining commercial substance in a nonmonetary exchange: FASB ASC 845–10–30–4: “Nonmonetary Transactions–Overall–Initial Measurement. ” A nonmonetary exchange has commercial substance if the entity’s future cash flows are expected to significantly change as a result of the exchange. The entity’s future cash flows are expected to significantly change if either of the following criteria is met: a. The configuration (risk, timing, and amount) of the future cash flows of the asset(s) received differs significantly from the configuration of the future cash flows of the asset(s) transferred.

The configuration of future cash flows is composed of the risk, timing, and amount of the cash flows. A change in any one of those elements would be a change in configuration. b. The entity-specific value of the asset(s) received differs from the entity-specific value of the asset(s) transferred, and the difference is significant in relation to the fair values of the assets exchanged. An entity-specific value (referred to as an entity-specific measurement in FASB Concepts Statement No. 7, Using Cash Flow Information and Present Value in Accounting Measurements) is different from a fair value measurement. As described in paragraph 24(b) of Concepts Statement No. , an entity-specific value attempts to capture the value of an asset or liability in the context of a particular entity. For example, an entity computing an entity-specific value of an asset would use its expectations about its use of that asset rather than the use assumed by marketplace participants. If it is determined that the transaction has commercial substance, the exchange would be measured at fair value, rather than at the entity-specific value. A qualitative assessment will, in some cases, be conclusive in determining that the estimated cash flows of the entity are expected to significantly change as a result of the exchange. Exercise 10-21 (continued) 3. The disclosure requirements for interest capitalization:

FASB ASC 835–20–50–1: “Interest Capitalization–Overall–Disclosure. ” An entity shall disclose the following information with respect to interest cost in the financial statements or related notes: a. For an accounting period in which no interest cost is capitalized, the amount of interest cost incurred and charged to expense during the period b. For an accounting period in which some interest cost is capitalized, the total amount of interest cost incurred during the period and the amount thereof that has been capitalized. Exercise 10-21 (concluded) 4. The elements of costs to be included as R&D activities: FASB ASC 730–10–25–2: “Research & Development–Overall–Recognition. Elements of costs shall be identified with research and development activities as follows: a. Materials, equipment, and facilities. The costs of materials (whether from the entity’s normal inventory or acquired specially for research and development activities) and equipment or facilities that are acquired or constructed for research and development activities and that have alternative future uses (in research and development projects or otherwise) shall be capitalized as tangible assets when acquired or constructed. The cost of such materials consumed in research and development activities and the depreciation of such equipment or facilities used in those activities are research and development costs.

However, the costs of materials, equipment, or facilities that are acquired or constructed for a particular research and development project and that have no alternative future uses (in other research and development projects or otherwise) and therefore no separate economic values are research and development costs at the time the costs are incurred. b. Personnel. Salaries, wages, and other related costs of personnel engaged in research and development activities shall be included in research and development costs. c. Intangible assets purchased from others. The costs of intangible assets that are purchased from others for use in research and development activities and that have alternative future uses (in research and development projects or otherwise) shall be accounted for in accordance with Topic 350. The amortization of those intangible assets used in research and development activities is a research and development cost.

However, the costs of intangibles that are purchased from others for a particular research and development project and that have no alternative future uses (in other research and development projects or otherwise) and therefore no separate economic values are research and development costs at the time the costs are incurred. d. Contract services. The costs of services performed by others in connection with the research and development activities of an entity, including research and development conducted by others in behalf of the entity, shall be included in research and development costs. e. Indirect costs. Research and development costs shall include a reasonable allocation of indirect costs.

However, general and administrative costs that are not clearly related to research and development activities shall not be included as research and development costs. Exercise 10-22 Average accumulated expenditures: $6,000,000 = $3,000,000 2 Interest capitalized: $3,000,000 – 1,500,000 x 10% =$150,000 1,500,000 x 7%* = 105,000 $255,000 = interest capitalized * Weighted-average rate of all other debt: $2,000,000x 9% =$180,000 4,000,000x 6% = 240,000 $6,000,000$420,000 $420,000 = 7% $6,000,000 Exercise 10-23 Average accumulated expenditures for 2011: January 1, 2011 $500,000 x12/12=$ 500,000 March 1, 2011 600,000 x10/12=500,000

July 31, 2011 480,000 x5/12=200,000 September 30, 2011 600,000 x3/12= 150,000 December 31, 2011 300,000 x0/12= – 0 – $1,350,000 Interest capitalized: $1,350,000 x 8% = $108,000 Exercise 10-24 Average accumulated expenditures for 2011: January 1, 2011 $ 600,000 x 12/12 =$ 600,000 March 31, 2011 1,200,000 x 9/12 =900,000 June 30, 2011 800,000 x 6/12 =400,000 September 30, 2011 600,000 x 3/12 = 150,000 December 31, 2011 400,000 x 0/12 = – 0 – $2,050,000 Interest capitalized: $2,050,000 – 1,500,000 x 8. 0% =$120,000 550,000 x 10. 5%* = 57,750 $177,750 = interest capitalized Weighted-average rate of all other debt: $5,000,000 x 12% =$600,000 3,000,000 x 8% = 240,000 $8,000,000$840,000 $840,000 = 10. 5% $8,000,000 Exercise 10-25 To expense R costs incorrectly capitalized. Research and development expense (below)3,180,000 Patent3,180,000 Research and development expenditures: Basic research to develop the technology$2,000,000 Engineering design work680,000 Development of a prototype300,000 Testing and modification of the prototype 200,000 Total$3,180,000 To capitalize cost of equipment incorrectly capitalized as patent. Equipment60,000 Patent60,000 To record depreciation on equipment used in R projects.

Research and development expense10,000 Accumulated depreciation – equipment10,000 Exercise 10-26 Research and development expense: Salaries and wages for lab research$ 400,000 Materials used in R projects200,000 Fees paid to outsiders for R projects320,000 Depreciation on R equipment 120,000 Total$1,040,000 The patent filing and legal costs are capitalized as the cost of the patent. The salaries, wages, and supplies for R performed for another company are included as inventory and expensed as cost of goods sold using either the completed contract or percentage-of-completion method. Exercise 10-27 Requirement 1 According to U. S.

GAAP, the following costs would be expensed as R: Research for new formulas$2,425,000 Development of a new formula 1,600,000 Total$4,025,000 The legal and filing fees are capitalized as an intangible asset. Requirement 2 According to IFRS, only the $2,425,000 in research costs would be expensed as R. Both the development costs incurred after feasibility is established and the legal and filing fees are capitalized as intangible assets. . Exercise 10-28 List AList B f 1. Depreciationa. Exclusive right to display a word, a symbol, or an emblem. d 2. Depletionb. Exclusive right to benefit from a creative work. i 3. Amortizationc. Assets that represent rights. g 4.

Average accumulatedd. The allocation of cost for natural resources. expenditures h 5. Revenue – donation of assete. Purchase price less fair value of net identifiable assets. j 6. Nonmonetary exchangef. The allocation of cost for plant and equipment. k 7. Natural resourcesg. Approximation of average amount of debt if all construction funds were borrowed. c 8. Intangible assetsh. Account credited when assets are donated to acorporation. b 9. Copyrighti. The allocation of cost for intangible assets. a 10. Trademarkj. Basic principle is to value assets acquired using fair value of assets given. e 11. Goodwillk. Wasting assets. Exercise 10-29 Requirement 1 $ in millions) Research and development expense4 Software development costs2 Cash6 Requirement 2 (1) Percentage-of-revenue method: $4,000,000 = 40% x $2,000,000 = $800,000 $10,000,000 (2) Straight-line method: 1/5 or 20 % x $2,000,000 = $400,000. The percentage-of-revenue method is used since it produces the greater amortization, $800,000. Requirement 3 Software development costs$2,000,000 Less: Amortization to date (800,000) Net$1,200,000 Exercise 10-30 Requirement 1 Oil wells 450,000 Cash450,000 Requirement 2 Oil wells ($50,000 + 60,000 + 80,000)190,000 Exploration expense260,000 Cash450,000 cpa / cma rEVIEW qUESTIONS CPA Exam Questions 1. d.

Simons Company should value the land at $170,500. All expenditures incurred to purchase land should be part of the capitalized asset. $150,000 + ($150,000 x . 07) + $5,000 + $5,000 2. c. Costs attributable to land: $60,000 + $2,000 + $5,000 – $3,000 = $64,000 Costs attributable to building: $8,000 + $350,000 = $358,000 3. d. There are eight payments due, the first one due immediately, and the remaining seven due each year on December 31. Therefore, the correct factor to use is the present value of an annuity in advance (annuity due) for 8 periods, or 5. 712 x $20,000 = $114,240, the present value at the inception of the note and therefore the initial value of the machine.

Another way to calculate the answer is to view the annuity as a 7 period ordinary annuity, with a down payment today of $20,000. This would yield a calculation of $20,000 + ($20,000 x 4. 712) or $114,240. 4. b. The recorded cost of the new asset is equal to the fair value of the asset given up, $20,000. In this case, there are two new assets acquired, new truck, $15,000, and cash, $5,000. The gain on the trade is $8,000 (FV old truck $20,000 – $12,000 book value). 5. c. Dahl Corporation should capitalize the materials, engineering fees, and labor and electricity for construction and testing: ($20,000 + $5,000 + $3,000 + $1,000 + $1,000 + $1,000).

The labor and electricity to run the machine should not be capitalized. These should be expensed because they are not part of the construction costs and were not incurred prior to activating the asset. CPA Exam Questions (concluded) 6. b. The interest cost capitalized is the lesser of the formula amount based on average accumulated expenditures or the actual interest cost incurred. In this case the formula amount ($40,000) is the smaller amount and should be the amount capitalized as part of the cost of the building. 7. a. Amortization of capitalized software is the greater of the amount calculated using the percentage-of-revenue method and the straight-line method.

In this case, the straight-line percentage is 20% (1/5) and the percentage-of-revenue method is 30%. Therefore, we amortize 30% of the cost yielding book value of 70%. 8. d. All of the expenditures are considered research and development. CMA Exam Questions 1. a. The costs of fixed assets (plant and equipment) are all costs necessary to acquire these assets and to bring them to the condition and location required for their intended use. These costs include shipping, installation, pre-use testing, sales taxes, interest, capitalization, etc. The original cost of the machinery to be recorded in the books is the sum of the purchase price, installation, and delivery charges. 2. d.

GAAP states that the basic principle to be followed in these exchanges is to value the asset received at fair value and to recognize gain or loss (the difference between the fair value and the book value of the asset given up). Harper’s used machine has a book value of $64,000 ($162,500 cost – $98,500 accumulated depreciation). The fair value of the used machine is $80,000 resulting in a gain of $16,000 ($80,000 – 64,000). The only exceptions to using fair value are (1) when fair value is not determinable and (2) when the exchange lacks commercial substance. 3. c. The answer is the same as question 2. PROBLEMS Problem 10-1 1. To record the acquisition of land and building. Land (determined below)62,500 Building (determined below)37,500 Cash100,000 | | |Initial | | | |Percent of Total Fair Value |Valuation | | | | |(Percent x | |Asset |Fair Value | |$100,000) | |Land |$ 75,000 | 62. 5% |$ 62,500 | |Building | 45,000 | 37. 5 | 37,500 | | |$120,000 | 100. % |$100,000 | | | | | | 2. To record the acquisition of equipment for cash and a note. Equipment (determined below)37,037 Discount on note payable (difference)2,963 Note payable (face amount)40,000 Present value of note payments: PV = $40,000 (. 92593) = $37,037 Present value of $1: n = 1, i=8% (from Table 2) 3. To record the acquisition of a truck by donation. Truck2,500 Revenue – donation of asset2,500 Problem 10-1 (concluded) 4. To capitalize organization costs. Organization cost expense3,000 Cash3,000 5.

To record the purchase of machinery. Machinery ($15,000 + 500)15,500 Cash15,500 6. To record the acquisition of office equipment by the issuance of common stock. Office equipment5,500 Common stock5,500 7. To record the acquisition of land in exchange for cash and a note. Land20,000 Cash2,000 Note payable18,000 Problem 10-2 Requirement 1 Blackstone Corporation LAND ACCOUNT (Site Number 11) As of September 30, 2012 Acquisition cost$600,000 Real estate broker’s commission36,000 Legal fees6,000 Title insurance18,000 Cost of razing existing building 75,000 Balance, September 30, 2012$735,000 Requirement 2 Blackstone Corporation CAPITALIZED COST OF OFFICE BUILDING

As of September 30, 2012 Contract cost$3,000,000 Plans, specifications, and blueprints12,000 Architects’ fees for design and supervision95,000 Capitalized interest for 2011: $900,000 x 14% x 10/12105,000 Capitalized interest for 2012: $2,300,000 x 14% x 9/12 241,500 Total capitalized cost, September 30, 2012$3,453,500 Problem 10-3 Requirement 1 Pell Corporation ANALYSIS OF CHANGES IN PLANT ASSETS For the Year Ended December 31, 2011 Balance Balance 12/31/10 Increase Decrease 12/31/11 Land$ 350,000$438,000 [1]$ 788,000 Land improvements180,000180,000 Building1,500,0001,500,000 Machinery and equipment1,158,000287,000 [2]$58,0001,387,000

Automobiles 150,000 19,000 [3] 18,000 151,000 Totals$3,338,000$744,000$76,000$4,006,000 Explanation of Amounts: [1]Cost of land acquired 11/1/11: Pell stock exchanged (10,000 shares x $38)$380,000 Legal fees and title insurance23,000 Razing existing building 35,000 $438,000 [2]Cost of machinery and equipment purchased 1/2/11: Invoice cost$260,000 Installation cost 27,000 $287,000 [3]Cost recorded for new automobile 12/31/11: Fair value of trade-in $ 3,750 Cash paid 15,250 $ 19,000 Problem 10-3 (concluded) Requirement 2 Pell Corporation GAIN OR LOSS FROM PLANT ASSET DISPOSALS For the Year Ended December 31, 2011 Sale of machine on 3/31/11: Selling price$36,500

Less: Book value of machine ($58,000 – 24,650) (33,350) Gain on sale of machine$ 3,150 Trade-in of automobile on 12/31/11: Book value of trade-in ($18,000 – 13,500)$ 4,500 Less: Fair value of trade-in (3,750) Loss on trade-in$ 750 Problem 10-4 To reclassify various expenditures incorrectly charged to the intangible asset account. Organization cost expense7,000 Prepaid insurance6,000 Copyright20,000 Research and development expense40,000 Patent ($3,000 + 12,000)15,000 Franchise40,000 Advertising expense16,000 Intangible asset144,000 To reclassify amount paid for Stiltz Corp. incorrectly charged to the intangible asset account. Receivables100,000 Equipment350,000

Patent150,000 Goodwill (determined below)120,000 Note payable220,000 Intangible asset500,000 Calculation of goodwill: Consideration exchanged$500,000 Less: Fair value of net assets(380,000) Goodwill$120,000 Problem 10-5 1. To expense R costs. Research and development expense12,000 Cash12,000 2. To expense legal fees for unsuccessful defense of patent. Legal fees expense7,500 Cash7,500 3. To capitalize the cost of equipment. Equipment (cash price)23,000 Discount on note payable (difference)1,000 Cash (amount paid)6,000 Note payable (face amount)18,000 4. To capitalize cost of the sprinkler system. Building – sprinkler system28,000 Cash28,000 5.

To capitalize legal fees for successful defense of patent. Patent12,000 Cash12,000 Problem 10-5 (concluded) 6. To record the trade-in of an old machine for a new machine. Machine – new ($2,000* + 8,000)10,000 Accumulated depreciation – machine ($7,400 – 3,000)4,400 Loss on trade-in ($3,000 – 2,000*)1,000 Cash8,000 Machine – old7,400 *Fair value of old machine (Fair value of new machine – Cash given): $10,000 – 8,000 = $2,000 Problem 10-6 Southern Company: Cash140,000 Building – new ($1,400,000 – 140,000)1,260,000 Accumulated depreciation – building (account balance)1,200,000 Building – old (account balance)2,000,000 Gain ($1,400,000 – 800,000)600,000 Eastern Company:

The fair value of Eastern’s building is $1,260,000 ($1,400,000 fair value of Southern’s building less $140,000 cash given). Building – new ($1,260,000 + 140,000)1,400,000 Accumulated depreciation – building (account balance)650,000 Cash140,000 Building – old (account balance)1,600,000 Gain on exchange of buildings ($1,260,000 – 950,000)310,000 Problem 10-7 Robers: Cash5,000 New equipment ($75,000 – 5,000)70,000 Accumulated depreciation – old asset (account balance)55,000 Old equipment (account balance)120,000 Gain on exchange of assets ($75,000 – 65,000)10,000 Phifer: New equipment ($70,000 + 5,000)75,000 Accumulated depreciation – old asset (account balance)63,000 Loss $77,000 – 70,000) 7,000 Cash5,000 Old equipment (account balance)140,000 Problem 10-8 Case A. Requirement 1 Book value less fair value = loss on exchange $12,000 – 9,000 = $3,000 loss Fair value of old tractor + cash given = Initial value of new tractor $9,000 + 20,000 = $29,000 Journal entry (not required): New tractor ($9,000 + 20,000)29,000 Accumulated depreciation – old asset (account balance)16,000 Loss ($12,000 – 9,000) 3,000 Cash 20,000 Old tractor (account balance)28,000 Requirement 2 Fair value less book value = gain on exchange $14,000 – 12,000 = $2,000 gain

Fair value of old tractor + cash given = Initial value of new tractor $14,000 + 20,000 = $34,000 Journal entry (not required): New tractor ($14,000 + 20,000)34,000 Accumulated depreciation – old asset (account balance)16,000 Cash 20,000 Old tractor (account balance)28,000 Gain ($14,000 – 12,000) 2,000 Problem 10-8 (continued) Case B. Requirement 1 Fair value less book value = gain on exchange $700,000 – 500,000 = $200,000 gain Fair value of old land + cash given = Initial value of new land $700,000 + 50,000 = $750,000 Journal entry (not required): New land ($700,000 + 50,000)750,000 Cash 50,000 Old land (account balance)500,000 Gain ($700,000 – 200,000) 200,000 Requirement 2

Book value less fair value = loss on exchange $500,000 – 400,000 = $100,000 loss Fair value of old land + cash given = Initial value of new land $400,000 + 50,000 = $450,000 Journal entry (not required): New land ($400,000 + 50,000)450,000 Loss ($500,000 – 400,000) 100,000 Cash 50,000 Old land (account balance)500,000 Problem 10-8 (concluded) Requirement 3 If the exchange lacked commercial substance, no gain is recognized. Book value of old land + cash given = Initial value of new land $500,000 + 50,000 = $550,000 Journal entry (not required): New land ($500,000 + 50,000)550,000 Cash 50,000

Old land (account balance)500,000 Problem 10-9 Requirement 1 2011: Expenditures for 2011: January 1, 2011$1,000,000 x 12/12 = $1,000,000 March 1, 2011600,000 x 10/12 =500,000 June 30, 2011800,000 x 6/12 =400,000 October1, 2011 600,000 x 3/12 = 150,000 Accumulated expenditures (before interest) -$3,000,000 Average accumulated expenditures -$2,050,000 Interest capitalized: $2,050,000 x 10% = $205,000 = Interest capitalized in 2011 2012: January 1, 2012 ($3,000,000 + 205,000)$3,205,000 x 9/9 = $3,205,000 January 31, 2012270,000 x 8/9 =240,000 April 30, 2012585,000 x 5/9 =325,000 August 31, 2012 900,000 x 1/9 = 100,000

Accumulated expenditures (before interest) -$4,960,000 Average accumulated expenditures -$3,870,000 Interest capitalized: $3,870,000 – 3,000,000 x 10. 0% x 9/12 =$225,000 870,000 x 7. 2%* x 9/12 = 46,980 $271,980 = Interest capitalized in 2012 * Weighted-average rate of all other debt: $ 4,000,000 x 6% =$240,000$720,000 6,000,000 x 8% = 480,000 = 7. 2% $10,000,000$720,000$10,000,000 Problem 10-9 (concluded) Requirement 2 Accumulated expenditures 9/30/12 before interest capitalization (above)$4,960,000 2012 interest capitalized (above) 271,980 Total cost of building$5,231,980 Requirement 3 2011 $3,000,000 x 10% =$ 300,000 ,000,000 x 6% =240,000 6,000,000 x 8% = 480,000 Total interest incurred1,020,000 Less: Interest capitalized (205,000) 2011 interest expense$ 815,000 2012 Total interest incurred$1,020,000 Less: Interest capitalized (271,980) 2012 interest expense$ 748,020 Problem 10-10 Requirement 1 2011 Expenditures for 2011 January1, 20111,000,000 x 12/12 =$1,000,000 March 1, 2011600,000 x 10/12 =500,000 June 30, 2011800,000 x 6/12 =400,000 October1, 2011 600,000 x 3/12 = 150,000 Accumulated expenditures (before interest) —$3,000,000 Average accumulated expenditures -$2,050,000 Interest capitalized: $2,050,000 x 7. 5%* = $160,925 = Interest capitalized in 2011 * Weighted-average rate of all debt: $ 3,000,000 x 10% =$ 300,000$1,020,000 4,000,000 x 6% =240,000 = 7. 85% (rounded) 6,000,000 x 8% = 480,000$13,000,000 $13,000,000$1,020,000 2012: January1, 2012 ($3,000,000 + 160,925)$3,160,925 x 9/9 =$3,160,925 January 31, 2012270,000 x 8/9 =240,000 April 30, 2012585,000 x 5/9 =325,000 August31, 2012 900,000 x 1/9 = 100,000 Accumulated expenditures (before interest) —$4,915,925 Average accumulated expenditures -$3,825,925 Interest capitalized: $3,825,925 x 7. 85% x 9/12 =$225,251 = Interest capitalized in 2012 Problem 10-10 (concluded) Requirement 2

Accumulated expenditures 9/30/12, before interest capitalization (above)$4,915,925 2012 interest capitalized (above) 225,251 Total cost of building$5,141,176 Requirement 3 2011: $3,000,000 x 10% =$ 300,000 4,000,000 x 6% =240,000 6,000,000 x 8% = 480,000 Total interest incurred1,020,000 Less: Interest capitalized (160,925) 2011 interest expense$ 859,075 2012: Total interest incurred$1,020,000 Less: Interest capitalized (225,251) 2012 interest expense$ 794,749 Problem 10-11 To capitalize the cost of equipment to be used on future projects incorrectly charged to R expense. Equipment400,000 Research and development expense400,000