Chapter Nine Property Plant & Equipment And Depreciation 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 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 What costs are included in Buildings? Includes Material, Labor and Interest during construction May include overhead Includes building permits and professional fees. (architect) 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” 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. Self-Constructed Assets – Look over Exercise 9-4 Decide amounts in Land, Building, Equipment and other 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 Simple Example Facts: 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-completion 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 Simple Example Facts: 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 Const 550,000 4/12 183,333 Other 236,667 Totals 420,000 Rate Interest .10 18,333 .08 18,933 37,266 Entry Debit Asset Credit Interest Expense 37,266 37,266 Simple Example Facts: 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 Type Amount Weight C 900,000 7/12 But Limited to Weighted Borrowing 525,000 420,000 Rate Interest .10 42,000 Note that no adjustment has to be made to interest income for the interest earned on the extra money borrowed. Simple Example Facts: Weighted expenditures = 420,000 Borrow 750,000 on 6/1 for one year Schedule of Weighted Borrowing--Amount must match weighted Expenditures Type Amount Weight Const 750,000 7/12 Weighted Borrowing 437,500 Rate Interest But Limited To 420,000 .10 42,000 Notice that the extra time is adjusted. 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% 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 19X1 Schedule of Weighted Average Borrowing Schedule of Weighted Borrowing--Amount must match weighted Expenditures Type Amount Weight Con600,000 2/12 O Weighted Borrowing 100,000 370,000 470,000 Rate Interest 9% 9,000 8.5% 31,450 40,450 19X1 Comparison of Potentially Capitalizable interest to Actual Actual – Construction – Other – Total 9,000 102,000 111,000 40,450 Capitalizable – Amount Entry – Debit Casino (or construction )40,450 – Credit Interest Expense 40,450 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 19X2 Schedule of Weighted Average Borrowing Schedule of Weighted Borrowing--Amount must match weighted Expenditures Type Amount Weight C 600,000 8/12 C 600,000 7/12 O Weighted Borrowing 400,000 350,000 750,000 108,483 858,483 Rate Interest 9% 67,500 8.5% 9,221 76,721 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 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? 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. 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. 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 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. In Intermediate--dealing with tradingDissimilar (facts, Exand losses down assets gains 1, p.9) Rules--on are still fully recognized Joe’s Entry – Debit Cash 6,000 – Debit Acc. Depn 3,000 – Debit Processor 12,000 – Credit Welder – Credit Gain Bob’s Entry – Debit Welder 18,000 – Debit Acc Depn 1,000 – Debit Loss 2,000 – Credit Processor – Credit Cash 15,000 3,000 15,000 6,000 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 Bob New(8000-2667) 5333 Cash 1000 Acc Depr 6000 Old 12000 Gain 333 Joe New (9000-2000)7000 acc depr 4000 Old 10000 Cash 1000 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 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. 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 Comparison of Methods, $9,000 asset, salvage = 0, 5 year life 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 Yr 1 Yr 2 Yr3 Yr4 Yr 5 SL SYD DDBX Depreciation using your calculator Let’s 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. 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 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.