Chapter 10 Property Plant and Equipment and Intangible Assets Acquisition and Disposition The allocation of asset cost over time is called depreciation for plant and equipment amortization for intangible assets and depletion for natural resources VALUATION AT ACQUISITION Types of Assets Long lived and revenue producing assets are classified in 2 categories 1 Property plant and equipment Assets include land buildings equipment machinery autos and trucks Natural resources such as oil and gas deposits timber tracts and i mineral deposits Intangible assets IA Lack physical substance and the extent and timing of 1 their future benefits are typically uncertain i Include patents copyrights trademarks franchises and goodwill Some companies report intangibles as part of PPE Some include intangible assets in the other asset category in the B S and others show intangibles as a separate B S category Costs to Be Capitalized PPE and intangibles can be acquired through purchase exchange lease donation self construction or a business combination Assets are valued on the basis of their original costs The initial cost of PPE and IA includes the purchase price and all expenditures necessary to bring the asset to its desired condition and location for use Our objective in identifying the costs of an asset is to distinguish the expenditures that produce future benefits from those that product benefits only in the current period o The costs in the second group are recorded as expenses but in the first group are capitalized that is they are recorded as an asset and expensed in future periods Property Plant and Equipment COST OF EQUIPMENT The cost of equipment includes the purchase price plus any sales tax 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 testing legal fees to establish title and any other costs of bringing the asset to its condition and location for use They should be included in the asset s initial valuation rather than expensed currently Illustration 10 4 Initial Cost of Equipment COST OF LAND The cost of land also should include expenditures needed to get the land ready for its intended use These include the purchase price plus closing costs such as fees for the attorney real estate commissions title and title search and recording If the property is subject to back taxes liens mortgages or other obligations these amounts are included also In addition any expenditures such as clearing filling draining and even removing razing old buildings that are needed to prepare the land for its intended use are part of the land s cost Proceeds from the sale of salvaged materials from old buildings torn down after purchase reduce the cost of land Illustration 10 5 Initial Cost of Land LAND IMPROVEMENTS Land has an indefinite life Land improvements usually have useful lives and are estimable Costs of these assets are separately identified and capitalized We depreciate their cost over periods benefited by their use COST OF BUILDINGS The cost of acquiring a building usually includes realtor commissions and legal fees in addition to the purchase price COST OF NATURAL RESOURCES Natural resources that provide long term benefits are reported as PPE These include timber tracts mineral deposits and oil and gas deposits They can be distinguished from other assets by the fact that their benefits are deprived from their physical consumption Equipment land and buildings produce benefits for a company through their use in the production of goods and services Sometimes a company buys natural resources from another company In that case initial valuation is simply the purchase price plus any other costs o necessary to bring the asset to condition and location for use More frequently though the company will develop these cost assets The initial valuation can include a acquisition costs b exploration costs c development costs d restoration costs o Acquisition costs the amounts paid to acquire the rights to explore for undiscovered natural resources or to extract proven natural resources o Exploration costs expenditures such as drilling a well or excavating a mine or any other costs of searching for natural resources o Development costs incurred after the resource has been discovered but before production begins It s not unusual for the cost of a natural resource either purchased or developed also to include estimated restoration costs o These costs are used to restore land or other property to its original condition after extraction of the natural resource ends o Because restoration expenditures occur later after production begins they initially represent an obligation incurred in conjunction with an asset retirement o Restoration costs are one example of asset retirement obligations ASSET RETIREMENT OBLIGATIONS Sometimes a company incurs obligations associated with the disposition of PPE and natural resources often as a result of acquiring those assets Before 2001 there was considerable diversity in the ways companies accounted for these obligations Some companies recognize these asset retirement obligations AROs gradually over the life of the asset while others didn t recognize the obligations until the asset was retired or sold GAAP now require that an existing legal obligation associated with the retirement of a tangible long lived asset be recognized as a liability and measured at fair value if value can be reasonable estimated o When the liability is credited the offsetting debit is to the related asset Some of the provisions of the standard that addressed these obligations are below Scope AROs arise only from legal obligations associated with the retirement of a tangible long lived asset that result from the acquisition construction or development and or normal operation of a long lived asset Recognition A retirement obligation might arise at the inception of an asset s life or during its operating life Measurement A company recognizes the fair value of an ARO in the period it s incurred The liability increases the valuation of the related asset Usually the fair value is estimated by calculating the PV of estimated future cash outflows Present value calculations Traditionally the way uncertainty has been considered in PV calculations has been by discounting the best estimate of future cash flows applying a discount rate that has been adjusted to reflect the uncertainty or risk of