Intermediate Accounting: Seventeenth Edition

Intermediate Accounting
Seventeenth Edition
Kieso ● Weygandt ● Warfield
Chapter 10
Acquisition and Disposition of
Property, Plant, and Equipment
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Learning Objectives
After studying this chapter, you should be able to:
1. Identify property, plant, and equipment and its related costs.
2. Discuss the accounting problems associated with interest
capitalization.
3. Explain the accounting issues related to acquiring and valuing
plant assets.
4. Describe the accounting treatment for costs subsequent to
acquisition.
5. Describe the accounting treatment for the disposal of
property, plant, and equipment.
Copyright ©2019 John Wiley & Sons, Inc. 2
Preview of Chapter 10
Acquisition and Disposition of Property, Plant,
and Equipment
• Acquisition of property, plant, and equipment
• Cost of land
• Cost of buildings
• Cost of equipment
• Self-constructed assets
Interest Costs During Construction
• Qualifying assets
• Capitalization period
• Amount to capitalize
• Example
• Special issues
• Observations

Valuation of Property, Plant, and Equipment
• Cash discounts
• Deferred-payment contracts
• Lump-sum purchases
• Issuance of stock
• Exchanges of nonmonetary assets
• Other valuation methods

Costs Subsequent to Acquisition
• Additions
• Improvements and replacements
• Rearrangement and reinstallation
• Repairs
• Summary

Disposition of Property, Plant, and Equipment
• Sale of plant assets
• Involuntary conversion
• Miscellaneous problems

Learning Objective 1
Understand Property, Plant, and
Equipment and Its Related Costs
LO 1 Copyright ©2019 John Wiley & Sons, Inc. 8

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 for resale
• Long-term in nature and usually depreciated
• Possess physical substance
Includes land, building structures (offices, factories,
warehouses), and equipment (machinery, furniture,
tools).

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 asset is
sold

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 having an indefinite life.
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

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

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
• costs of conducting trial runs
Self-Constructed Assets
Costs include:
1. Materials and direct labor
2. Overhead can be handled in two ways:
• Assign no fixed overhead
• Assign a portion of all overhead to the
construction process
Companies use the second method extensively.

Illustration: The expenditures and receipts below are related to
land, land improvements, and buildings acquired for use.
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 assumed Land
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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g. Cost of parking lots and driveways Building
h. Commission fee paid to real estate agency Land
i. Installation of fences around property Land Improvements
j. Cost of razing and removing building Land
k. Cost of real estate purchased as a plant site (land Building
$200,000 and building $50,000)
l. Proceeds from salvage of demolished building (Land)
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m. Architect’s fee on building Land Improvements
n. Cost of trees and shrubbery (permanent) Land

Discuss the Accounting Problems
Associated with Interest Capitalization

Three approaches have been suggested to account for
the interest incurred in financing the construction.

Capitalization of Interest Costs
• 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.

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

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.

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.

Interest Capitalization Illustration: Assume a company borrowed
$200,000 at 12% interest from State Bank on Jan. 1, 2020, for
specific purposes of constructing special-purpose equipment to be
used in its operations. Construction on the equipment began on
Jan. 1, 2020, and the following expenditures were made prior to
the project’s completion on Dec. 31, 2020:
Actual Expenditures during 2020: Other general debt
January 1 $100,000 existing on Jan. 1, 2020:
April 30 150,000 $500,000, 14%, 10-year
November 1 300,000 bonds payable
December 31 100,000 $300,000, 10%, 5-year
Total expenditures $650,000 note payable
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, 2020 through Dec. 31,
2020, because expenditures are being made and interest costs
are being incurred during this period while construction is
taking place.

Step 3 - Compute weighted-average accumulated
expenditures.
Weighted Average
Actual Capitalization Accumulated
Date Expenditures Period Expenditures
Jan. 1 $100,000 x 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.
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.
Compute Actual and Avoidable Interest

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

Comprehensive Illustration
On November 1, 2019, 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 2020.
January 1 March 1 May 1 December 31 Total

$210,000 $300,000 $540,000 $450,000 $1,500,000

Comprehensive Illustration
Pfeifer Construction completed the building, ready for occupancy, on
December 31, 2020. Shalla had the following debt outstanding at
December 31, 2020.
Specific Construction Debt
1. 15%, 3-year note to finance purchase of land and
construction of the building, dated December 31,
2019, with interest payable annually on December 31 $750,000
Other Debt
2. 10%, 5-year note payable, dated December 31, 2016,
with interest payable annually on December 31 $550,000
3. 12%, 10-year bonds issued December 31, 2015, with
interest payable annually on December 31 $600,000

Computation of Weighted-Average Accumulated
Expenditures

Computation of Avoidable Interest

Computation of Actual Interest Cost
Compute the actual interest cost, which represents the maximum
amount of interest that it may capitalize during 2020.
The interest cost that Shalla capitalizes is the lesser of $120,228

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

Journal Entries for 2020
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

Capitalized Interest Reported in the Income Statement
At December 31, 2020, Shalla discloses the amount of interest
capitalized either as part of the income statement or in the notes
accompanying the financial statements.

Interest Capitalization - Special Issues
1. Expenditures for Land
• If the company purchases land as a site for a
structure, interest costs capitalized 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
• Companies should not net or offset interest
revenue against interest cost
Explain the Accounting Issues Related
to Acquiring and Valuing Plant Assets

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.

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.

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.

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.
Type of Exchange Accounting Guidance
Exchange has commercial substance. Recognize gains and losses immediately.
Exchange lacks commercial Defer gains; recognize losses
substance—no cash received. immediately.
Exchange lacks commercial Recognize partial gain; recognize losses
substance—cash received. immediately.*
* If cash is 25% or more of the fair value of the exchange, recognize entire
gain because earnings process is complete.
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.

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.
List price of new machine $16,000

Less: Trade-in allowance for used machine 9,000
Cash payment due 7,000
Fair value of used machine 6,000
Cost of new machine $13,000
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
Fair value of used machine $6,000

Loss on
Disposal Less: Book value of used machine 8,000
Loss on disposal of used machine $2,000
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.

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.
Fair value of trucks exchanged $49,000

Cash paid 11,000
Cost of semi-truck $60,000

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
Fair value of used trucks $ 49,000
Cost of used trucks, net of accumulated depreciation (42,000)
Gain on disposal of used trucks $ 7,000
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.

Lacks Commercial Substance—No Cash
Received
Illustration: Interstate records the exchange transaction as follows:
Truck (semi) 53,000
Accumulated Depreciation—Trucks 22,000
Trucks (used) 64,000
Cash 11,000

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:

Lacks Commercial Substance—Some
Cash Received
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.
Fair value of machine exchanged $100,000

Less: Book value of machine exchanged 60,000
Total gain $ 40,000

Cash Received
Computation of Gain
The portion of the gain a company recognizes is the ratio of
monetary assets (cash in this case) to the total consideration
received.

Cash Received
Computation of Basis

Cash Received
Journal Entry
Queenan would record the following entry.
Cash 10,000
Machine (new) 54,000
Accumulated Depreciation—Machinery 50,000
Machine 110,000
Gain on Disposal of Machinery 4,000

Summary of Gain and Loss Recognition
1. Compute the total gain or loss on the transaction. This amount is equal to
the difference between the fair value of the asset given up and the book
value of the asset given up.
2. If a loss is computed in Step 1, always recognize the entire loss.
3. If a gain is computed in Step 1,
(a) and the exchange has commercial substance, recognize the entire gain.
(b) and the exchange lacks commercial substance,
1) and no cash is involved, no gain is recognized.
2) and some cash is given, no gain is recognized.
3) and some cash is received, the following portion of the gain is
recognized:
*lf the amount of cash exchanged is 25% or more, both parties recognize entire gain or loss.

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
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)

Has Commercial Substance
Journal Entries
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
Loss on Exchange 2,500
Equipment 28,000

Santana
Santana (Has Commercial Substance):
Equipment 15,500
Cash 2,000
Equipment 28,000
Gain on Disposal of Equipment 4,500
Santana (LACKS Commercial Substance):

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

Delaware
Delaware (Has Commercial Substance):
Cash 2,000
Equipment 13,500
Equipment 28,000
Delaware (LACKS Commercial Substance):

Cash 2,000
Equipment 13,500
Equipment 28,000

Describe the Accounting Treatment for

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.

Major Types of Expenditures
Additions. Increase or extension of existing assets.
Improvements and Replacements. Substitution of an
improved asset for an existing one.
Rearrangement and Reinstallation. Movement of assets
from one location to another.
Repairs. Expenditures that maintain assets in condition
for operation.

Summary of Costs Subsequent to
Acquisition
Type of Expenditure Normal Accounting Treatment
Additions Capitalize cost of addition to asset account.
Improvements and (a) Carrying value known: Remove cost of and
replacements accumulated depreciation on old asset, recognizing
any gain or loss. Capitalize cost of improvement/
replacement.
(b) Carrying value unknown:
1. If the asset's useful life is extended, debit
accumulated depreciation for cost of
improvement/replacement.
2. If the quantity or quality of the asset's
productivity is increased, capitalize cost of
improvement/replacement to asset account.

Summary of Costs
Rearrangement and Reinstallation
Rearrangement and (a) If original installation cost is known, account for cost
reinstallation of rearrangement/reinstallation as a replacement
(carrying value known).
(b) If original installation cost is unknown and
rearrangement/reinstallation cost is material in
amount and benefits future periods, capitalize as an
asset.
(c) If original installation cost is unknown and
rearrangement/reinstallation cost is not material or
future benefit is questionable, expense the cost
when incurred.

Summary of Costs
Repairs
Repairs (a) Ordinary: Expense cost of repairs when incurred.
(b) Major: As appropriate, treat as an addition,
improvement, or replacement.

Describe the Accounting Treatment for
the Disposal of Property, Plant, and
Equipment

Disposition of Property, Plant, and
Equipment (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.

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:
Equipment ($1,200 x ½) 600

Accumulated Depreciation 600

Sale of Plant Assets
Journal Entry
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
Machinery 18,000
Gain on Disposal of Machinery 400

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.
Involuntary Conversion
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

Describe the Accounting for
Contributions

Appendix 10A: 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.

Accounting for Contributions
Contributions are either unconditional or conditional.
The criteria for evaluating whether contributions are
unconditional (and thus recognized immediately in
income) or conditional (for which income recognition is
deferred) depend on the terms of the gift or grant
agreement.
The focus is whether a gift or grant agreement has the
following terms.

Accounting for Contributions
Terms
1. Specifies a “barrier or hurdle” that the recipient
must overcome to be entitled to the resources. A
barrier is the inclusion of a measurable performance
requirement such as degree of completion or
specific output or outcome.
2. Releases the donor from its obligation to transfer
resources (or if assets are advanced, a right to
demand their return) if the barrier or hurdle is not
achieved by the recipient.

Conditional Contribution
Facts
State Insurance Company agrees to contribute $1,000,000 to DV to
provide specific career training to disabled veterans. The
contribution requires DV to provide training to at least 8,000
disabled veterans during the next fiscal year, with specified
minimum targets that must be met each quarter. State Insurance
Company requires a right of release stipulation from the obligation
in that it will only give DV $250,000 each quarter if DV
demonstrates that those services have been provided to at least
2,000 disabled veterans during the quarter.
State Insurance makes the payments at the end of each quarter.

Conditional Contribution
Journal Entries
Assuming the first quarter milestone is met, State Insurance
Company would make the following entry.
Contribution Expense 250,000

Land 250,000
DV would also make an entry in the first quarter as follows.
Cash 250,000
Contribution Revenue 250,000

Unconditional Contribution
Journal Entries
If the arrangement between State Insurance and DV is such that
the contribution is unconditional, the entries are as follows at the
time of the agreement.
State Insurance Company:
Contribution Expense 1,000,000
Accounts Payable (DV) 1,000,000
DV:
Accounts Receivable 1,000,000
Contribution Revenue 1,000,000

Exchange Transactions
If both the recipient and the resource provider agree on the
amount of assets transferred in goods or services—which are
essentially of the same value? In this case, the gift or grant is
no longer considered a contribution for accounting purposes
but is accounted for as an exchange.
The accounting for this transaction would follow the normal
rules for exchanges using the revenue recognition guidelines
discussed in Chapters 4 and 18.

Copyright
Copyright © 2019 John Wiley & Sons, Inc.
All rights reserved. Reproduction or translation of this work beyond that permitted in
Section 117 of the 1976 United States Act without the express written permission of the
copyright owner is unlawful. Request for further information should be addressed to the
Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies
for his/her own use only and not for distribution or resale. The Publisher assumes no
responsibility for errors, omissions, or damages, caused by the use of these programs or
from the use of the information contained herein.

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Intermediate Accounting

Kieso ● Weygandt ● Warfield

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Avoidable interest $ 30,250

Journal entry to Capitalize Interest:

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January 1 March 1 May 1 December 31 Total

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

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List price of new machine $16,000

Fair value of used machine $6,000

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Fair value of trucks exchanged $49,000

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Fair value of machine exchanged $100,000

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Santana (LACKS Commercial Substance):

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Delaware (LACKS Commercial Substance):

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