CHAPTER 10 ACQUISITION AND DISPOSITION OF PROPERTY PLANT AND EQUIPMENT Overview This chapter and the one that follows address the measurement and reporting issues involving property plant and equipment It covers the valuation at date of acquisition and the disposition of these assets In Chapter 11 we discuss the allocation of the cost of property plant and equipment to the periods benefited by their use the treatment of expenditures made over the life of these assets to maintain and improve them and impairment Learning Objectives LO10 1 Identify the various costs included in the initial cost of property plant and equipment and natural resources LO10 2 Determine the initial cost of individual property plant and equipment acquired as a group for a lump sum purchase price LO10 3 Determine the initial cost of property plant and equipment acquired in exchange for a deferred payment contract LO10 4 Determine the initial cost of property plant and equipment acquired in exchange for equity securities or through donation LO10 5 Calculate the fixed asset turnover ratio used by analysts to measure how effectively managers use property plant and equipment LO10 6 Explain how to account for dispositions and exchanges for other nonmonetary assets LO10 7 Identify the items included in the cost of a self constructed asset and determine the amount of capitalized interest LO10 9 Discuss the primary differences between U S GAAP and IFRS with respect to the acquisition and disposition of property plant and equipment and intangible assets TYPES OF ASSETS For financial reporting purposes long lived revenue producing assets typically are classified in two categories Property plant and equipment Assets in this category include land buildings equipment machinery autos and trucks Natural resources such as oil and gas deposits timber tracts and mineral deposits also are included Intangible assets Unlike property plant and equipment and natural resources these assets lack physical substance and the extent and timing of their future benefits typically are highly uncertain They include patents copyrights trademarks franchises and goodwill Intangible assets are discussed in depth in Chapter 12 COSTS TO BE CAPITALIZED Property plant and equipment can be acquired through purchase exchange lease donation self construction or a business combination If purchased the initial cost includes the purchase price and all expenditures necessary to bring the asset to its desired condition and location for use Costs are capitalized rather than expensed if they are expected to produce benefits beyond the current period COST OF EQUIPMENT The cost of equipment 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 and testing Legal fees to establish title Any other costs of bringing the asset to its condition and location for use COST OF EQUIPMENT continued Central Machine Tools purchased an industrial lathe to be used in its manufacturing process The purchase price was 62 000 Central paid a freight company 1 000 to transport the machine to its plant location plus 300 shipping insurance In addition the machine had to be installed and mounted on a special platform built specifically for the machine at a cost of 1 200 After installation several trial runs were made to ensure proper operation The cost of these trials including wasted materials was 600 At what amount should Central capitalize the lathe Purchase price Freight and handling Insurance during shipping Special foundation Trial runs 62 000 1 000 300 1 200 600 65 100 Each of the expenditures described was necessary to bring the machine to its condition and location for use and should be capitalized and expensed in the future periods in which the asset is used LAND IMPROVEMENTS It s important to distinguish between the cost of land and the cost of land improvements because land has an indefinite life and land improvements usually do not Land improvements include the cost of parking lots driveways and private roads and the costs of fences and lawn and garden sprinkler systems Costs are separately identified and capitalized Cost depreciates over periods benefited by their use COST OF NATURAL RESOURCES Natural resources include timber tracts mineral deposits and oil and gas deposits Benefits are derived from their physical consumption rather than through their use in the production of goods and services Initial valuation can include Acquisition costs Amounts paid to acquire the rights to explore for undiscovered natural resources or to extract proven natural resources Exploration costs Such as drilling a well or excavating a mine as well as any other costs of searching for natural resources Development costs Expenditures incurred after the resource has been discovered but before production has begun such as the costs of tunnels wells and shafts Restoration costs Costs to restore land or other property to its original condition after extraction of the natural resource Equipment and other assets used during drilling or excavation usually are considered depreciable plant and equipment If the asset cannot be moved and has no alternative use its depreciable life is limited by the useful life of the natural resource COST OF NATURAL RESOURCES continued The Jackson Mining Company paid 1 000 000 for the right to explore for a coal deposit on 500 acres of land in Pennsylvania Costs of exploring for the coal deposit totaled 800 000 and intangible development costs incurred in digging and erecting the mine shaft were 500 000 In addition Jackson purchased new excavation equipment for the project at a cost of 600 000 After the coal is removed from the site the equipment will be sold Jackson is required by its contract to restore the land to a condition suitable for recreational use after it extracts the coal The company has provided the following three cash flow possibilities A B and C for the restoration costs to be paid in three years after extraction is completed A B C Cash Outflow 500 000 600 000 700 000 Probability 30 50 20 The company s credit adjusted risk free interest rate is 8 Total capitalized cost for the coal deposit is Purchase of rights to explore Exploration costs Development costs Restoration costs Total cost of coal deposit 1 000 000 800 000 500 000 468 360 2 768 360 Present value of expected cash outflow for restoration