10-1

PREVIEW OF CHAPTER 10

Intermediate Accounting
16th Edition
Kieso ● Weygandt ● Warfield
10-2
 10 Acquisition and Disposition of
Property, Plant, and Equipment
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1 Understand property, plant, 4 Understand accounting issues
and equipment and its related related to acquiring and valuing
costs. plant assets.
2 Describe the accounting 5 Describe the accounting
problems associated with self- treatment for costs subsequent to
constructed assets. acquisition.
3 Describe the accounting 6 Describe the accounting
problems associated with interest treatment for the disposal of
capitalization. property, plant, and equipment.

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 PROPERTY, PLANT, AND EQUIPMENT

Property, plant, and equipment are assets of a durable

nature. Other terms commonly used are plant assets and
fixed assets.
► “Used in operations” and not
Includes:
for resale.
 Land,
► Long-term in nature and  Building structures
(offices, factories,
usually depreciated.
warehouses), and
► Possess physical substance.  Equipment
(machinery, furniture,
tools).

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 PROPERTY, PLANT, AND EQUIPMENT

Acquisition of Property, Plant, and Equipment

Historical cost measures the cash or cash equivalent price
of obtaining the asset and bringing it to the location and
condition necessary for its intended use.

Main reasons for historical cost valuation:

 Historical cost is reliable.
 Companies should not anticipate gains
and losses but should recognize gains
and losses only when the asset is sold.

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 Acquisition of Property, Plant, and
Equipment
Cost of Land
Includes all expenditures to acquire land and ready it for
use. Costs typically include:
(1) purchase price;
(2) closing costs, such as title to the land, attorney’s fees, and
recording fees;
(3) costs of grading, filling, draining, and clearing;
(4) assumption of any liens, mortgages, or encumbrances on
the property; and
(5) additional land improvements that have an indefinite life.

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 Acquisition of Property, Plant, and
Equipment
Cost of Land
Improvements with limited lives, such as private
driveways, walks, fences, and parking lots, are recorded as
Land Improvements and depreciated.
 Land acquired and held for speculation is classified as
an investment.
 Land held by a real estate concern for resale should be
classified as inventory.

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 Acquisition of Property, Plant, and
Equipment
Cost of Buildings
Includes all expenditures related directly to acquisition or
construction. Costs include:

 materials, labor, and overhead costs incurred during

construction and

 professional fees and building permits.

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 Acquisition of Property, Plant, and
Equipment
Cost of Equipment
Include all expenditures incurred in acquiring the equipment
and preparing it for use. Costs include:
 purchase price,
 freight and handling charges,
 insurance on the equipment while in transit,
 cost of special foundations if required,
 assembling and installation costs, and
 costs of conducting trial runs.
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 Acquisition of Property, Plant, and
Equipment
Illustration: The expenditures and receipts below are related to land, land
improvements, and buildings acquired for use in a business enterprise.
Determine how the following should be classified:

(a) Money borrowed to pay building contractor Notes Payable

(b) Payment for construction from note proceeds Building
(c) Cost of land fill and clearing Land
(d) Delinquent real estate taxes on property
Land
assumed
(e) Premium on 6-month insurance policy during
Building
construction
(f) Refund of 1-month insurance premium because
(Building)
construction completed early

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 Acquisition of Property, Plant, and
Equipment
Illustration: The expenditures and receipts below are related to land, land
improvements, and buildings acquired for use in a business enterprise.
Determine how the following should be classified:

(g) Architect’s fee on building Building

(h) Cost of real estate purchased as a plant site
Land
(land $200,000 and building $50,000)
(i) Commission fee paid to real estate agency Land
(j) Installation of fences around property Land Improvements
(k) Cost of razing and removing building Land
(l) Proceeds from salvage of demolished building (Land)
(m) Cost of parking lots and driveways
Land Improvements
(n) Cost of trees and shrubbery (permanent)
Land
10-11 LO 1
 10 Acquisition and Disposition of
Property, Plant, and Equipment
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1 Understand property, plant, and 4 Understand accounting issues
equipment and its related costs. related to acquiring and valuing
2 Describe the accounting plant assets.
problems associated with self- 5 Describe the accounting
constructed assets. treatment for costs subsequent to
3 Describe the accounting acquisition.
problems associated with interest 6 Describe the accounting
capitalization. treatment for the disposal of
property, plant, and equipment.

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 Acquisition of Property, Plant, and
Equipment
Self-Constructed Assets
Costs include:
1) Materials and direct labor

2) Overhead can be handled in two ways:

1. Assign no fixed overhead.

2. Assign a portion of all overhead to the construction

process.

Companies use the second method extensively.

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 10 Acquisition and Disposition of
Property, Plant, and Equipment
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1 Understand property, plant, and 4 Understand accounting issues
equipment and its related costs. related to acquiring and valuing
2 Describe the accounting plant assets.
problems associated with self- 5 Describe the accounting
constructed assets. treatment for costs subsequent to
3 Describe the accounting acquisition.
problems associated with 6 Describe the accounting
interest capitalization. treatment for the disposal of
property, plant, and equipment.

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 Acquisition of Property, Plant, and
Equipment
Interest Costs During Construction
Three approaches have been suggested to account for the
interest incurred in financing the construction.

$0
Increase to Cost of Asset $?

Capitalize no Capitalize
interest during Capitalize actual
Capitalize actual all costs of
construction costs incurred
costs incurred during
during funds
construction
construction

ILLUSTRATION 10-1
Capitalization of Interest Costs GAAP

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 Acquisition of Property, Plant, and
Equipment
Interest Costs During Construction
 GAAP requires — capitalizing actual interest (with
modification).
 Consistent with historical cost.
 Capitalization considers three items:

1. Qualifying assets.

2. Capitalization period.

3. Amount to capitalize.

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 Interest Costs During Construction

Qualifying Assets
Require a period of time to get them ready for their intended
use.
Two types of assets:
 Assets under construction for a company’s own use.
 Assets intended for sale or lease that are constructed or
produced as discrete projects.

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 Interest Costs During Construction

Capitalization Period
Begins when:
1. Expenditures for the asset have been made.

2. Activities for readying the asset are in progress .

3. Interest costs are being incurred.

Ends when:
The asset is substantially complete and ready for use.

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 Interest Costs During Construction

Amount to Capitalize
Capitalize the lesser of:
1. Actual interest costs.

2. Avoidable interest - the amount of interest cost during

the period that a company could theoretically avoid if it
had not made expenditures for the asset.

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 Interest Costs During Construction

Interest Capitalization Illustration: Assume a company borrowed

$200,000 at 12% interest from State Bank on Jan. 1, 2017, for specific
purposes of constructing special-purpose equipment to be used in its
operations. Construction on the equipment began on Jan. 1, 2017, and
the following expenditures were made prior to the project’s completion on
Dec. 31, 2017:
Other general debt existing on
Actual Expenditures during 2017: Jan. 1, 2017:
January 1 $100,000
$500,000, 14%, 10-year
April 30 150,000
bonds payable
November 1 300,000
December 31 100,000 $300,000, 10%, 5-year
Total expenditures $650,000 note payable

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 Interest Costs During Construction

Step 1 - Determine which assets qualify for capitalization of

interest.
Special purpose equipment qualifies because it requires a period of
time to get ready and it will be used in the company’s operations.

Step 2 - Determine the capitalization period.

The capitalization period is from Jan. 1, 2017 through Dec. 31, 2017,
because expenditures are being made and interest costs are being
incurred during this period while construction is taking place.

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 Interest Costs During Construction

Step 3 - Compute weighted-average accumulated

expenditures. Weighted
Average
Actual Capitalization Accumulated
Date Expenditures Period Expenditures
Jan. 1 $ 100,000 12/12 $ 100,000
Apr. 30 150,000 8/12 100,000
Nov. 1 300,000 2/12 50,000
Dec. 31 100,000 0/12 -
$ 650,000 $ 250,000

A company weights the construction expenditures by the amount of time

(fraction of a year or accounting period) that it can incur interest cost on the
expenditure.

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 Interest Costs During Construction

Step 4 - Compute the Actual and Avoidable Interest.

Selecting Appropriate Interest Rate:

1. For the portion of weighted-average accumulated expenditures
that is less than or equal to any amounts borrowed specifically to
finance construction of the assets, use the interest rate incurred
on the specific borrowings.

2. For the portion of weighted-average accumulated expenditures

that is greater than any debt incurred specifically to finance
construction of the assets, use a weighted average of interest
rates incurred on all other outstanding debt during the
period.

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 Interest Costs During Construction
Step 4 - Compute the Actual and Avoidable Interest.
Actual Interest Interest Actual
Debt Rate Interest Weighted-average
Specific Debt $ 200,000 12% $ 24,000 interest rate on
general debt
General Debt 500,000 14% 70,000 $100,000 = 12.5%
300,000 10% 30,000 $800,000
$ 1,000,000 $ 124,000

Accumulated Interest Avoidable

Avoidable Interest Expenditures Rate Interest
$ 200,000 12% $ 24,000
Amount by which the weighted-
50,000 12.5% 6,250
average accumulated expenditures
exceeds the construction loan. $ 250,000 $ 30,250

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 Interest Costs During Construction

Step 5 – Capitalize the lesser of Avoidable interest or Actual

interest.

Avoidable interest $ 30,250

Actual interest 124,000

Journal entry to Capitalize Interest:

Equipment 30,250
Interest Expense 30,250

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 Interest Costs During Construction

Comprehensive Illustration: On November 1, 2016, Shalla

Company contracted Pfeifer Construction Co. to construct a building
for $1,400,000 on land costing $100,000 (purchased from the
contractor and included in the first payment). Shalla made the
following payments to the construction company during 2017.

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 Interest Costs During Construction

Pfeifer Construction completed the building, ready for occupancy, on

December 31, 2017. Shalla had the following debt outstanding at
December 31, 2017.
Specific Construction Debt
1. 15%, 3-year note to finance purchase of land and
construction of the building, dated December 31, 2016, with
interest payable annually on December 31 $750,000
Other Debt
2. 10%, 5-year note payable, dated December 31, 2013, with
interest payable annually on December 31 $550,000
3. 12%, 10-year bonds issued December 31, 2012, with
interest payable annually on December 31
$600,000

Compute weighted-average accumulated expenditures for 2017.

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 Interest Costs During Construction

Compute weighted-average accumulated expenditures for 2017.

ILLUSTRATION 10-4
Computation of Weighted-
Average Accumulated
Expenditures

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 Interest Costs During Construction

Compute the avoidable interest.

ILLUSTRATION 10-5
Computation of Avoidable Interest
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 Interest Costs During Construction

Compute the actual interest cost, which represents the maximum

amount of interest that it may capitalize during 2017. ILLUSTRATION 10-6
Computation of Actual
Interest Cost

The interest cost that Shalla capitalizes is the lesser of $120,228

(avoidable interest) and $239,500 (actual interest), or $120,228.

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 Interest Costs During Construction

Shalla records the following journal entries during 2017:

January 1 Land 100,000

Buildings (or CIP) 110,000
Cash 210,000
March 1 Buildings 300,000
Cash 300,000
May 1 Buildings 540,000
Cash 540,000
December 31 Buildings 450,000
Cash 450,000
Buildings (Capitalized Interest) 120,228
Interest Expense 119,272
Cash 239,500

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 Interest Costs During Construction

At December 31, 2017, Shalla discloses the amount of interest

capitalized either as part of the income statement or in the notes
accompanying the financial statements.
ILLUSTRATION 10-7
Capitalized Interest
Reported in the Income
Statement

Note 1: Accounting Policies. Capitalized Interest. During 2017, total interest cost was $239,500,
of which $120,228 was capitalized and $119,272 was charged to expense.
ILLUSTRATION 10-8
Capitalized Interest Disclosed in a Note
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 WHAT DO THE NUMBERS MEAN? WHAT’S
WHAT’S
WHAT IN YOUR
‘S I YOUR
YOUR INTEREST?
PRINCIPLE
INTEREST?

The requirement to capitalize interest Anadarko Petroleum Corporation

can significantly impact financial capitalized nearly 30 percent of its total
statements. For example, when earnings interest costs in a recent year and
of building manufacturer Jim Walter’s provided the following footnote related to
Corporation dropped from $1.51 to capitalized interest.
$1.17 per share, the company offset 11
cents per share of the decline by Financial Footnotes
capitalizing the interest on coal mining Total interest costs incurred during the
projects and several plants under year were $82,415,000. Of this amount,
the Company capitalized $24,716,000.
construction.
Capitalized interest is included as part of
How do statement users determine the cost of oil and gas properties. The
the impact of interest capitalization on a capitalization rates are based on the
company’s bottom line? They examine Company’s weighted-average cost of
the notes to the financial statements. borrowings used to finance the
Companies with material interest expenditures.
capitalization must disclose the amounts
of capitalized interest relative to total
interest costs. For example,
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 Interest Costs During Construction

Special Issues Related to Interest Capitalization

1. Expenditures for Land
 If the company purchases land as a site for a structure,
interest costs capitalized during the period of construction
are part of the cost of the plant, not the land.
 Conversely, if the company develops land for lot sales, it
includes any capitalized interest cost as part of the
acquisition cost of the developed land.

2. Interest Revenue
 In general, companies should not net or offset interest
revenue against interest cost.
10-34 LO 3
 10 Acquisition and Disposition of
Property, Plant, and Equipment
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1 Understand property, plant, and 4 Understand accounting issues
equipment and its related costs. related to acquiring and
2 Describe the accounting valuing plant assets.
problems associated with self- 5 Describe the accounting
constructed assets. treatment for costs subsequent to
3 Describe the accounting acquisition.
problems associated with interest 6 Describe the accounting
capitalization. treatment for the disposal of
property, plant, and equipment.

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 VALUATION OF PROPERTY, PLANT,
AND EQUIPMENT

Companies should record property, plant, and equipment:

 at the fair value of what they give up or
 at the fair value of the asset received,

whichever is more clearly evident.

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 VALUATION OF PP&E

Cash Discounts — Discount for prompt payment.

Deferred-Payment Contracts — Assets purchased on long-

term credit contracts at the present value of the consideration
exchanged.

Lump-Sum Purchases — Allocate the total cost among the

various assets on the basis of their relative fair market values.

Issuance of Stock — The market price of the stock issued is

a fair indication of the cost of the property acquired.

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 VALUATION OF PP&E

Exchanges of Nonmonetary Assets

Ordinarily accounted for on the basis of:
 the fair value of the asset given up or
 the fair value of the asset received,

whichever is clearly more evident.

Companies should recognize immediately any gains or losses on

the exchange when the transaction has commercial substance.

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 VALUATION OF PP&E

Meaning of Commercial Substance

Exchange has commercial substance if the future cash flows
change as a result of the transaction. That is, if the two parties’
economic positions change, the transaction has commercial
substance.
* If cash is 25%
or more of the
fair value of the
exchange,
recognize entire
gain because
earnings
process is
complete.
ILLUSTRATION 10-10
Accounting for Exchanges
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 VALUATION OF PP&E

Exchanges—Loss Situation
Companies recognize a loss immediately whether the exchange
has commercial substance or not.
Rationale: Companies should not value assets at more than their
cash equivalent price; if the loss were deferred, assets would be
overstated.

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 VALUATION OF PP&E

Illustration: Information Processing, Inc. trades its used machine for a

new model at Jerrod Business Solutions Inc. The exchange has
commercial substance. The used machine has a book value of $8,000
(original cost $12,000 less $4,000 accumulated depreciation) and a fair
value of $6,000. The new model lists for $16,000. Jerrod gives
Information Processing a trade-in allowance of $9,000 for the used
machine. Information Processing computes the cost of the new asset
as follows.

ILLUSTRATION 10-11
Computation of Cost of
New Machine

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 VALUATION OF PP&E

Illustration: Information Processing records this transaction as follows:

Equipment 13,000
Accumulated Depreciation—Equipment 4,000
Loss on Disposal of Equipment 2,000
Equipment 12,000
Cash 7,000

Loss on
Disposal

ILLUSTRATION 10-12
Computation of Loss on Disposal of Used Machine
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 VALUATION OF PP&E

Exchanges—Gain Situation
Has Commercial Substance. Company usually records the
cost of a nonmonetary asset acquired in exchange for
another nonmonetary asset at the fair value of the asset
given up, and immediately recognizes a gain.

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 VALUATION OF PP&E

Illustration: Interstate Transportation Company exchanged a number

of used trucks plus cash for a semi-truck. The used trucks have a
combined book value of $42,000 (cost $64,000 less $22,000
accumulated depreciation). Interstate’s purchasing agent,
experienced in the secondhand market, indicates that the used trucks
have a fair market value of $49,000. In addition to the trucks,
Interstate must pay $11,000 cash for the semi-truck. Interstate
computes the cost of the semi-truck as follows.

ILLUSTRATION 10-13
Computation of Semi-Truck Cost
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 VALUATION OF PP&E

Illustration: Interstate records the exchange transaction as follows:

Truck (semi) 60,000

Accumulated Depreciation—Trucks 22,000
Trucks (used) 64,000
Gain on Disposal of Trucks 7,000
Cash 11,000

Gain on
Disposal

ILLUSTRATION 10-14
Computation of Gain on Disposal of Used Trucks
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 VALUATION OF PP&E

Exchanges—Gain Situation
Lacks Commercial Substance—No Cash Received. Now
assume that Interstate Transportation Company exchange
lacks commercial substance.

Interstate defers the gain of $7,000 and reduces the basis of

the semi-truck.

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 VALUATION OF PP&E

Illustration: Interstate records the exchange transaction as

follows:

Trucks (semi) 53,000

Accumulated Depreciation—Trucks 22,000
Trucks (used) 64,000
Cash 11,000

ILLUSTRATION 10-15
Basis of Semi-Truck—Fair Value vs. Book Value

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 VALUATION OF PP&E

Exchanges—Gain Situation
Lacks Commercial Substance—Some Cash Received.
When a company receives cash (sometimes referred to as
“boot”) in an exchange that lacks commercial substance, it
may immediately recognize a portion of the gain. The
general formula for gain recognition when an exchange
includes some cash is as follows:

ILLUSTRATION 10-16
Formula for Gain Recognition, Some Cash Received

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 VALUATION OF PP&E

Illustration: Queenan Corporation traded in used machinery

with a book value of $60,000 (cost $110,000 less accumulated
depreciation $50,000) and a fair value of $100,000. It receives in
exchange a machine with a fair value of $90,000 plus cash of
$10,000.

ILLUSTRATION 10-17
Computation of Total Gain

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 VALUATION OF PP&E

The portion of the gain a company recognizes is the ratio of

monetary assets (cash in this case) to the total consideration
received.

ILLUSTRATION 10-18
Computation of Gain Based on Ratio of Cash Received to Total Consideration Received

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 VALUATION OF PP&E

Queenan would record the following entry. ILLUSTRATION 10-19

Computation of Basis

Cash 10,000
Machine (new) 54,000
Accumulated Depreciation—Machinery 50,000
Machine 110,000
Gain on Disposal of Machinery 4,000

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 VALUATION OF PP&E

Summary of Gain and Loss Recognition on

Exchanges of Non-Monetary Assets ILLUSTRATION 10-20

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 VALUATION OF PP&E

Illustration: Santana Company exchanged equipment used in its

manufacturing operations plus $2,000 in cash for similar equipment
used in the operations of Delaware Company. The following
information pertains to the exchange.

Santana Delaware
Equipment (cost) $28,000 $28,000
Accumulated depreciation 19,000 10,000
Fair value of equipment 13,500 15,500
Cash given up 2,000

Instructions: Prepare the journal entries to record the exchange on

the books of both companies.

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 VALUATION OF PP&E

Calculation of Gain or Loss

Santana Delaware
Fair value of equipment received $15,500 $13,500
Cash received / paid (2,000) 2,000
Less: Book value of equipment
($28,000-19,000) (9,000)
($28,000-10,000) (18,000)
Gain or (Loss) on Exchange $4,500 ($2,500)

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 VALUATION OF PP&E
Has Commercial Substance
Santana:
Equipment 15,500
Accumulated Depreciation 19,000
Cash 2,000
Equipment 28,000
Gain on Exchange 4,500

Delaware:
Cash 2,000
Equipment 13,500
Accumulated Depreciation 10,000
Loss on Exchange 2,500
Equipment 28,000

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 VALUATION OF PP&E

Santana (Has Commercial Substance):

Equipment 15,500
Accumulated Depreciation 19,000
Cash 2,000
Equipment 28,000
Gain on Disposal of Equipment 4,500

Santana (LACKS Commercial Substance):

Equipment (15,500 – 4,500) 11,000
Accumulated Depreciation 19,000
Cash 2,000
Equipment 28,000

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 VALUATION OF PP&E

Delaware (Has Commercial Substance):

Cash 2,000
Equipment 13,500
Accumulated Depreciation 10,000
Loss on Disposal of Equipment 2,500
Equipment 28,000

Delaware (LACKS Commercial Substance):

Cash 2,000
Equipment 13,500
Accumulated Depreciation 10,000
Loss on Disposal of Equipment 2,500
Equipment 28,000

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 WHAT DO THE NUMBERS MEAN? WHAT ‘SABOUT
WHAT’S I YOUR THOSE SWAPS
PRINCIPLE
YOUR INTEREST?

In a press release, Roy Olofson, former vice But Global Crossing and Qwest, among
president of finance for Global Crossing, others, counted as revenue the money
accused company executives of improperly received from the other company in the swap.
describing the company’s revenue to the (In general, in transactions involving leased
public. He said the company had improperly capacity, the companies booked the revenue
recorded long-term sales immediately rather over the life of the contract.) Some of these
than over the term of the contract, had companies then treated their own purchases
improperly booked as cash transactions as capital expenditures, which were not run
swaps of capacity with other carriers, and had through the income statement. Instead, the
fi red him when he blew the whistle. spending led to the addition of assets on the
The accounting for the swaps involves balance sheet (and an inflated bottom line).
exchanges of similar network capacity. The SEC questioned some of these
Companies have said they engage in such capacity exchanges, because it appeared
deals because swapping is quicker and less they were a device to pad revenue. This
costly than building segments of their own reaction was not surprising, since revenue
networks, or because such pacts provide growth was a key factor in the valuation of
redundancies to make their own networks companies such as Global Crossing and
more reliable. In one expert’s view, an Qwest during the craze for tech stocks in the
exchange of similar network capacity is the late 1990s and 2000.
equivalent of trading a blue truck for a red Source: Adapted from Henny Sender, “Telecoms Draw
truck-it shouldn’t boost a company’s revenue. Focus for Moves in Accounting,” Wall Street Journal
(March 26, 2002), p. C7.

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 VALUATION OF PP&E

Accounting for Contributions

Companies should use:
 the fair value of the asset to establish its value on the
books and
 should recognize contributions received as revenues in the
period received.

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 VALUATION OF PP&E

Contributions
Illustration: Max Wayer Meat Packing, Inc. has recently
accepted a donation of land with a fair value of $150,000 from
the Memphis Industrial Development Corp. In return Max Wayer
Meat Packing promises to build a packing plant in Memphis. Max
Wayer’s entry is:

Land 150,000
Contribution Revenue 150,000

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 VALUATION OF PP&E

Contributions
When a company contributes a non-monetary asset, it should
record the amount of the donation as an expense at the fair
value of the donated asset.

Illustration: Kline Industries donates land to the city of Los

Angeles for a city park. The land cost $80,000 and has a fair
value of $110,000. Kline Industries records this donation as
follows.

Contribution Expense 110,000

Land 80,000
Gain on Disposal of Land 30,000
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 10 Acquisition and Disposition of
Property, Plant, and Equipment
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1 Understand property, plant, and 4 Understand accounting issues
equipment and its related costs. related to acquiring and valuing
2 Describe the accounting plant assets.
problems associated with self- 5 Describe the accounting
constructed assets. treatment for costs
3 Describe the accounting subsequent to acquisition.
problems associated with interest 6 Describe the accounting
capitalization. treatment for the disposal of
property, plant, and equipment.

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 COSTS SUBSEQUENT TO ACQUISITION

In general, costs incurred to achieve greater future benefits

should be capitalized, whereas expenditures that simply
maintain a given level of services should be expensed.

In order to capitalize costs, one of three conditions

must be present:
1. useful life must be increased,

2. quantity of units produced must be increased, and

3. quality of units produced must be enhanced.

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 COSTS SUBSEQUENT TO ACQUISITION

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 WHAT DO THE NUMBERS MEAN? WHAT’S DISCOUNNECTED
WHAT ‘S I YOUR
YOUR PRINCIPLE
INTEREST?

It all started with a check of the books by an internal auditor for

WorldCom Inc. The telecom giant’s newly installed chief executive
had asked for a financial review, and the auditor was spot-checking
records of capital expenditures. She found the company was using
an unorthodox technique to account for one of its biggest expenses:
charges paid to local telephone networks to complete long-distance
calls.
Instead of recording these charges as operating expenses,
WorldCom recorded a significant portion as capital expenditures.
The maneuver was worth hundreds of millions of dollars to
WorldCom’s bottom line. It effectively turned a loss for all of 2001
and the first quarter of 2002 into a profit. The graph below compares
WorldCom’s accounting to that under GAAP. Soon after this
discovery, WorldCom filed for bankruptcy.

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 WHAT DO THE NUMBERS MEAN? WHAT’S DISCOUNNECTED
WHAT ‘S I YOUR
YOUR PRINCIPLE
INTEREST?

Source: Adapted from Jared Sandberg, Deborah Solomon, and Rebecca Blumenstein, “Inside
WorldCom’s Unearthing of a Vast Accounting Scandal,” Wall Street Journal (June 27, 2002), p. A1.

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 COSTS SUBSEQUENT TO ACQUISITION
ILLUSTRATION 10-21
Summary Summary of Costs Subsequent to Acquisition of Property, Plant, and Equipment

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 10 Acquisition and Disposition of
Property, Plant, and Equipment
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1 Understand property, plant, and 4 Understand accounting issues
equipment and its related costs. related to acquiring and valuing
2 Describe the accounting plant assets.
problems associated with self- 5 Describe the accounting
constructed assets. treatment for costs subsequent to
3 Describe the accounting acquisition.
problems associated with interest 6 Describe the accounting
capitalization. treatment for the disposal of
property, plant, and equipment.

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 DISPOSITION OF PP&E

A company may retire plant assets voluntarily or dispose of

them by
 Sale,
 Exchange,
 Involuntary conversion, or
 Abandonment.

Depreciation must be taken up to the date of disposition.

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 DISPOSITION OF PP&E

Sale of Plant Assets

Illustration: Barret Company recorded depreciation on a
machine costing $18,000 for 9 years at the rate of $1,200 per
year. If it sells the machine in the middle of the tenth year for
$7,000, Barret records depreciation to the date of sale as:

Depreciation Expense ($1,200 x 1/2) 600

Accumulated Depreciation 600

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 DISPOSITION OF PP&E

Illustration: Barret Company recorded depreciation on a

machine costing $18,000 for 9 years at the rate of $1,200 per
year. If it sells the machine in the middle of the tenth year for
$7,000, Barret records depreciation to the date of sale. Record
the entry to record the sale of the asset:

Cash 7,000
Accumulated Depreciation 11,400
Machinery 18,000
Gain on Disposal of Machinery 400

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 DISPOSITION OF PP&E

Involuntary Conversion
Sometimes an asset’s service is terminated through some type
of involuntary conversion such as fire, flood, theft, or
condemnation.
Companies report the difference between the amount
recovered (e.g., from a condemnation award or insurance
recovery), if any, and the asset’s book value as a gain or loss.
They treat these gains or losses like any other type of
disposition.

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 DISPOSITION OF PP&E

Illustration: Camel Transport Corp. had to sell a plant located on

company property that stood directly in the path of an interstate highway.
For a number of years, the state had sought to purchase the land on
which the plant stood, but the company resisted. The state ultimately
exercised its right of eminent domain, which the courts upheld. In
settlement, Camel received $500,000, which substantially exceeded the
$200,000 book value of the plant and land (cost of $400,000 less
accumulated depreciation of $200,000). Camel made the following entry.

Cash 500,000
Accumulated Depreciation—Plant Assets 200,000
Plant Assets 400,000
Gain on Disposal of Plant Assets 300,000

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 COPYRIGHT

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