AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 1 Property-Plant-Equipment: Module 2 Slide 1 Hi everyone. In the previous module we talked about the idea of capitalization and the fact that the asset when it is purchased must be recorded on the balance sheet at its cost. In this module I’d like to build on that.AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 2 Slide 2 And I want to start by talking about what’s called a lump sum or a basket purchase. A lump sum purchase is when you purchase more than one asset for one lump sum amount. So maybe you purchase two or three different assets all for one lump sum. What we need to be able to do is take that lump sum amount that we paid to purchase more than one asset and assign some of that cost to each of the assets that are purchased. So some of that lump sum amount—some of that lump sum cost—needs to be assigned to each asset acquired in the purchase. The way in which you do that is you determine a percentage of total market value that each asset made up of the purchase. And then we’re going to use that percentage to allocate some of the purchase price to each of the assets acquired. It’s actually a fairly easy example.AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 3 Slide 3 Take a look at our website problem. And here’s what it says, example number 2. On April 21st of 2001, XYZ Company acquired the following assets for $70,000. So XYZ purchased land, a building, and some equipment and a lump sum price of 70,000 was paid to purchase all of those assets. Now what they’ve given us is the market value of each asset. But we know assets aren’t reported on the balance sheet at their value. They’re reported at their cost. So what we have to do is find a way of figuring out how much of the $70,000 purchase price should be assigned to each asset acquired. And the way we do that is we use a percentage of market value. So for example, the land. The land had a market value of 16,000. Divide that by the total market of all assets acquired, 80,000. And we’ll use that percentage multiplied by the purchase price. And we’re able to figure out the cost assigned to the land, $14,000. We’ll do the same thing for the other assets in the lump sum purchase. The building, market value of 24,000 over the totalAMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 4 value of 80,000. Take that percentage times the purchase price, $70,000. The cost assigned to the building, $21,000. And the same story for the equipment. Its value of 40,000 over the total of 80, multiplied by the purchase price. The cost assigned to the equipment, $35,000. Allocating out a lump sum purchase is really pretty straightforward. Take the value of the individual asset over the total value of all assets and then multiply that percentage by the purchase price.AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 5 Slide 4 The journal entry to record that transaction would be a debit to each asset acquired. Now we know that we have three different assets. So I have three debits: land, building, equipment. And the amounts in the journal entry are the cost of each asset, which we just finished calculating. And the credit is of course to cash for the $70,000 that was paid. That’s how to record the acquisition of assets. Assets when they are purchased are recorded at their cost.AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 6 Slide 5 Let’s think about how that basic transaction affects our financial statements. How does the acquisition of an asset impact the income statement, balance sheet, and statement of cash flows? The income statement, no effect. There is no revenue in that entry. There is no expense in that entry. We’re purchasing three assets and giving up cash. The balance sheet really has no overall effect. What is occurring is we’re increasing one set of assets, our property, plant, and equipment, the land, the building, and the equipment. But we’re simultaneously decreasing another asset, cash. So one set of assets goes up, P, P, and E. Another asset goes down, cash. Overall, no change to your balance sheet. The statement of cash flows I know is affected because we’re paying money and I know that the cash paid to purchase long-term assets, such as P, P, and E, classified as an investing outflow.AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 7 So that’s how to record the acquisition of assets and the financial statement effects. That was accountable event number one that we saw in the previous set of modules.AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 8 Slide 6 Accountable event number two dealt with recording expenditures that happen once the asset is in use. And that’s what I’d like to finish up this module and talk about. How do we handle expenditures that occur during the life of the asset? There are two types of expenditures that happen once the asset is in use. We have what are called capital expenditures and we have what are called revenue expenditures.AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 9 Slide 7 Let’s start with the capital expenditures. A capital expenditure is a cost that is incurred that will serve really one of three functions. It will increase the operating efficiency of the asset. It’ll increase the productive capacity of the asset, or it will increase the expected useful life of the asset. If the expenditure does one of those three things, it is thus classified as a capital expenditure. And the classification is important because these capital expenditures, which are typically substantial in amount, and they typically do not occur frequently, these capital expenditures are capitalized. That means they are recorded as part of the cost of the asset on the balance sheet. They are incurred to improve or better the asset. Hence they become part of the cost of that asset. It’s no surprise they are referred to as capital expenditures because these expenditures are capitalized.AMIS 212 – Introduction to Accounting II AMIS 212 – Marc Smith 10 Slide 8 Let’s indicate the financial statement effects of a capital expenditure. How does a capital expenditure impact the income