Chapter Nine

1
Chapter Nine

• Property
• Plant
• Equipment
• And Depreciation

2
General Comments on Fixed Assets

• Fixed assets are used for productive purposes
• If fixed assets are purchased for resale --put
  into an inventory account
• If fixed assets are idle, treat as an investment
• If not in productive use--depreciation stops

3
What is included in Land?

• Title cost, back taxes paid, present value of
  debt assumed, special assessments, demolition
  and any costs to prepare
• Old building to be retained , set up as a
  separate asset and depreciated
• Separate accounts should be set up for
  improvements, drives, and landscaping as each has
  a different depreciation period

4
What costs are included in Buildings?

• Includes Material, Labor and Interest during
  construction
• May include overhead
• Includes building permits and professional fees.
  (architect)

5
What costs are included in Equipment?

• Includes
• Purchase Price less discounts
• Freight cost
• Insurance while in transit
• Sales Taxes
• Installation costs
• Cost of Trial Runs
• Remember the terms reasonable and necessary

6
Self-Constructed Assets

• General rule is to capitalize avoidable costs
• Material
• Direct Labor
• At least specific and variable overhead, maybe
  fixed
• Could capitalize fixed which would have been
  applied
• No profit can be taken.
• Cannot exceed cost if constructed elsewhere.
• Look over Exercise 9-4 Decide amounts in Land,
  Building, Equipment and other

7
Interest During Construction

• Included because interest would be included if
  asset was purchased
• This concept apples to assets for own use and is
  limited in assets for resale
• One cannot capitalize more interest than actually
  paid
• Looked at interest as P x R x T now look at it as
  P x T x R

8
Simple ExampleFacts Start 3/1/x1 on land
purchased for 240,000 Payment on 6/1 of
840,000 Final payment on 10/1/x1-400,000-comple
tion date Construction rate is 10, other is 8

• Schedule of Weighted Average Expenditures
• Date Payment Weight Average
• 3/1 240,000 7/12 140,000
• 6/1 840,000 4/12 280,000
• 9/1 400,000 0/12 0
• Total 1,480,000 420,000

9
Simple ExampleFacts Weighted expenditures
420,000 Borrow 550,000 on 6/1, loan is due on
10/1

• Schedule of Weighted Borrowing--Amount must match
  weighted Expenditures
• Weighted
• Type Amount Weight Borrowing Rate Interest
• Const 550,000 4/12 183,333 .10 18,333
• Other 236,667 .08 18,933
• Totals 420,000 37,266
• Entry
• Debit Asset 37,266
• Credit Interest Expense 37,266

10
Simple ExampleFacts Weighted expenditures
420,000 Borrow 900,000 on 3/1 repay on
10/1--note larger loan

• Schedule of Weighted Borrowing--Amount must match
  weighted Expenditures
• Weighted
• Type Amount Weight Borrowing Rate Interest
• C 900,000 7/12 525,000
• But Limited to 420,000 .10 42,000
• Note that no adjustment has to be made to
  interest income for the interest earned on the
  extra money borrowed.

11
Simple ExampleFacts Weighted expenditures
420,000 Borrow 750,000 on 6/1 for one year

• Schedule of Weighted Borrowing--Amount must match
  weighted Expenditures
• Weighted
• Type Amount Weight Borrowing Rate Interest
• Const 750,000 7/12 437,500
• But Limited To 420,000 .10 42,000
• Notice that the extra time is adjusted.

12
Interest During Construction--Complex Example

• Computation of General Borrowing Rate
• 1,000,000 x 8 80,000
• 200,000 x 11 22,000
• 1,200,000 total bor 102,000 tot int
• 102,000/ 1,200,000 8.5

13
19X1 Schedule of Weighted Average Expenditures

• Schedule of Weighted Average Expenditures
• Date Payment Weight Average
• 9/1 800,000 4/12 266,667
• 9/1 160,000 4/12 53,333
• 11/1 900,000 2/12 150,000
• 1,860,000 470,000
• 800,000 in Land, 1,060,000 in Building under
  Construction

14
19X1 Schedule of Weighted Average Borrowing

• Schedule of Weighted Borrowing--Amount must match
  weighted Expenditures
• Weighted
• Type Amount Weight Borrowing Rate Interest
• Con 600,000 2/12 100,000 9 9,000
• O 370,000 8.5 31,450
• 470,000 40,450

15
19X1 Comparison of Potentially Capitalizable
interest to Actual

• Actual
• Construction 9,000
• Other 102,000
• Total 111,000
• Capitalizable
• Amount 40,450
• Entry
• Debit Casino (or construction )40,450
• Credit Interest Expense 40,450

16
19X2 Schedule of Weighted Average Expenditures

• Schedule of Weighted Average Expenditures
• Date Payment Weight Average
• 1/1 1,900,450 4/12 633,483
• 2/1 900,000 3/12 225,000
• 5/1 300,000 0/12 0
• 3,100,450 858,483
• land at 800,000, building at 2,300,450

17
19X2 Schedule of Weighted Average Borrowing

• Schedule of Weighted Borrowing--Amount must match
  weighted Expenditures
• Weighted
• Type Amount Weight Borrowing Rate Interest
• C 600,000 8/12 400,000
• C 600,000 7/12 350,000
• 750,000 9 67,500
• O 108,483 8.5 9,221
• 858,483 76,721

18
X2 Entry to Capitalize Interest

• Note This is smaller than actual interest paid
  so it is the amount taken
• Debit Casino 76,721
• Credit Interest expense 76,721
• Final Balance Land 800,000
• Building 2,377,171

19
Deferred Payment Contracts--Interest must be
imputed if over one year (facts on p. 7)

• Debit Equipment 27,591
• Debit Discount on Notes Pay 2,409
• Credit Cash 10,000
• Credit Notes Payable 20,000
• Now on to an amortization schedule
• Payment Interest Princ Balance
• Current Debt 17,591
• 10,000 1583 8417 9174
• 10,000 826 9174 0
• Using this amortization table can you make the
  necessary entries?

20
Lump-Sum Payments and Issuance of Stock

• A lump-sum payment made for several assets
  requires an allocation based upon the market
  values (appraisal) of the assets acquired. This
  is just like we did for cars in Chapter 8.
• If an asset is acquired for shares of stock where
  the shares are regularly traded- the selling
  price of the shares (not their par value) serves
  as a basis for the asset.

21
Assets acquired through contributions

• Assets received should be recognized as
  contribution revenue during the period given for
  their fair market balue
• If assets are given, the donation should be
  recorded as contributions expense and recorded at
  its fair market value recognizing any gain or
  loss.

22
Roberts Company Example

• A comparison of Book Value to Trade in Allowance
  indicates a gain of 8,000. This gain will not
  be recognized if assets similar.
• Entry for Dissimilar
• Debit Asset 70,000
• Debit Accum. Depn. 28,000
• Credit Asset 50,000
• Credit Cash 40,000
• Credit Gain on trade in 8,000
• Entry for Similar
• Debit Asset 62,000
• Debit Accum. Depn. 28,000
• Credit Asset 50,000
• Credit Cash 40,000

23
Roberta Company Example

• Debit Asset 55,000
• Debit A/D 12,000
• Debit Loss 3,000
• Credit Asset 35,000
• Credit Cash 35,000
• This entry is the same for both similar and
  dissimilar.

24
In Intermediate--dealing with trading down
(facts, Ex 1, p.9)

• Rules--on Dissimilar assets gains and losses are
  still fully recognized
• Joes Entry
• Debit Cash 6,000
• Debit Acc. Depn 3,000
• Debit Processor 12,000
• Credit Welder 15,000
• Credit Gain 3,000
• Bobs Entry
• Debit Welder 18,000
• Debit Acc Depn 1,000
• Debit Loss 2,000
• Credit Processor 15,000
• Credit Cash 6,000

25
Example 2, P. 10 Similar assets

• Know the gain/loss before you start
• Joe 2,000 Bob 3000 gets 1/9 333, def 2,667
• no rec, no gain 1/9 cash, 1/9 gain
• Joe Bob
• New (9000-2000)7000 New(8000-2667) 5333
• acc depr 4000 Cash 1000
• Old 10000 Acc Depr 6000
• Cash 1000
  Old 12000
• Gain 333

26
Major Expenditures

• Repairs--Keep in usable state. Some major ones
  are lumpy. May spread within year but not
  between years.
• Additions
• Excess cost over original may be loss especially
  where you see the destruction
• Depreciate separately, or reclassify whole asset
• Improvement/ Replacement
• What is the difference
• With foresight--component depreciation--Watch
  consistency of life
• Calculate new depreciation rate
• Cost -Accum. Depn - Salvage Value/Remaining life

27
Depreciation

• Is an allocation of cost over time. There is no
  attempt to look at market value.
• In smaller firms, the tax method will be used.
• Larger firms will practice tax allocation using a
  different method for book and tax.

28
Mainline Methods of Depreciation

• Activity or Units of Production--
• Physical wear is concern
• Depreciation becomes a variable cost
• Rate Cost -Salvage/ of units
• Straight Line (SL)
• Non high tech asset
• Sum of the Years Digits (SYD)
• Obsolescence a factor
• Balances out repairs and depreciation
• Declining Balance (DB)
• Rate applied to book value-salvage initially
  ignored.
• We will do a switch to straight to get to salvage

29
Comparison of Methods, 9,000 asset, salvage 0,
5 year life
30
Depreciation using your calculator

• Lets look at Exercise 9-16 and solve by using
  our calculator.
• Remember the calculator used on the CPA exam only
  adds, subtracts, multiplies, and divides. None
  of these fancy features.

31
Changes in estimates

• Common in practice when useful life or salvage or
  both change
• Changes in estimates are adjusted through the
  current and future periods. Do not go back to
  previous periods.
• Look Over Brief Exercise 9-14

32
Disposal of Assets

• We have already looked at asset exchanges
• Look over Brief Exercises 9-15 and 9-16 to recall
  the sale of assets. Remember depreciation has
  to be undated too.