A3032-Review notes of ch10 Exam
A3032-Review notes of ch10 Exam ACCT 3032
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This 22 page Study Guide was uploaded by Doris.Shaw on Saturday September 3, 2016. The Study Guide belongs to ACCT 3032 at University of Cincinnati taught by Professor Bruns in Fall 2016. Since its upload, it has received 50 views. For similar materials see Intermediate_Accounting II in Accounting (ACCT) at University of Cincinnati.
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Date Created: 09/03/16
Summary of Chapter 10: Property, Plant and Equipment and Intangible Assets: Acquisition and Disposition Know the following for the chapter 10 exam: ❖ Characteristics and initial valuation of tangible and intangible assets. 1. Property, plant and Equipment = fixed assets Eg: buildings, land, office furniture, manufacturing machinery, fax machines etc. 2. Intangible assets = Assets that lack a physical presences Patents, franchises, servicing rights, trademarks, copyrights, timber or coal reserves, and goodwill. From Ch 10 Outlines— REFER TO ILLUSTRATION 103 FOR A COMPREHENSIVE DESCRIPTION OF THE TYPE OF ASSET, AND ITS TYPICAL ACQUISITION COSTS. Summary of Chapter 10: Property, Plant and Equipment and Intangible Assets: Acquisition and Disposition ★ Unique characteristics 1. Are acquired for use in the business operations, not for resale. It is important to distinguish between investment type fixed assets and regular fixed assets. 2. Are longterm in nature and usually subject to depreciation, amortization or depletion. They are intended to service the business for several years. If they were not, most companies would have a hard time making the monetary commitment. ★ Initial valuation Costs to be Capitalized 1. Fixed assets and intangibles should be valued on the balance sheet at historical cost. Historical cost is measured by the cash or cash equivalent price of obtaining the asset and bringing it to the location and condition necessary for its intended use. Any costs that ready the property for its intended use are capitalized as part of the asset rather than expensed. Eg: sales tax on the purchase, insurance to ship it from the purchase location to your business, shipping charges, installation charges, attorney fees to defend a patent, Improvements or replacements that provide future service potential to the asset, etc. are all capitalized as part of the asset. These costs are lumped into the cost of the asset and are written off as part of the asset through future depreciation, depletion or amortization charges. ★ Journal Entry ❏ When the asset is purchased it is capitalized (recorded) on the balance sheet as follows: ❏ The investment in these assets is then written off over several years through periodic (yearly) depreciation, depletion or amortization charges as follows. ➔ The exception is land. Land is not depreciated. If there is a substantial loss in value land can be depreciated. However, this is a rare occurrence. Summary of Chapter 10: Property, Plant and Equipment and Intangible Assets: Acquisition and Disposition ❖ How to calculate the initial historical cost of the asset including which includes all costs necessary to get the asset ready for its intended purpose. 1. Cost of Land All costs associated with the purchase of land and getting it ready for its intended use are to be added together and capitalized as part of the land account. Including purchase price, closing costs such as title, attorneys fees and recording fees, grading, filling, draining and clearing, assumptions of any liens such as back property taxes and any land improvements that have an indefinite life. If land is purchased with an old building on it the cost of demolition of the building is part of the cost of the land account, not the building because it is a cost in getting the land ready for its intended use. 2. Cost of Buildings Including the purchase price, materials, labor and overhead costs of construction, professional fees and building permits. 3. Cost of Equipment Including sales tax, delivery charges and installation. 4. Purchased Intangibles All purchased intangibles are capitalized (recorded on the balance sheet) at historical cost. When several intangibles or a combination of intangibles and tangibles are brought in a “basket purchase” the cost should be allocated on the basis of fair market values or on the basis of relative fair market values as follows. This allocation must be computed when the purchase price is less than the combined fair market value of all the assets included in the basket purchase. 5. Patents Two types:Product patents cover actual physical products whether created internally or purchased. Process patents cover processes. Process patents can be purchased or the process itself could be internally created. The legal right of exclusive use extends for 20 years. Costs associated with securing or defending a successful patent such as legal fees and patent registration fees are capitalized (recorded on the balance sheet) and amortized. Summary of Chapter 10: Property, Plant and Equipment and Intangible Assets: Acquisition and Disposition Research and development associated with a patent that is internally developed (selfcreated rather than by purchase) is expensed as incurred. 6. Copyrights A copyright is federally granted to the creator of such artistic works for the life of the creator plus 70 years. A copyright gives the owner or heirs the exclusive right to use or reproduce the asset only until it expires since it is nonrenewable. For these reasons a copyright is generally assumed to have a definite life and is therefore amortized. 7. Trademarks Whether it is registered or not the right to use the trademark or trade name rests exclusively with the original user as long as they continue to use it. Registration affords the user an indefinite number of tenyear renewals. It is proper accounting to treat trademarks and trade names as indefinite life intangible assets because whether it is registered or not it has an indefinite life. Therefore assume trademarks and trade names are indefinite life intangibles unless otherwise stated in the problem. If a trademark or trade name is acquired, the purchase price is capitalized (put on the balance sheet). 8. Franchises The enterprise securing a franchise, license or right carries an intangible asset entitled Franchise or License on their books ONLY if there are up front costs such as a lump sum payment in advance or legal fees and other expenditures that are identifiable with the acquisition of the operating right. The cost of a franchise or license with a limited life should be amortized over the life of the asset. The cost of a franchise or license with an indefinite life or a perpetual franchise should carried on the balance sheet at historical cost and NOT amortized. Annual payments made under the franchise agreement are written off to the period incurred as an operating expense because they do not relate to future periods – only to the period in which incurred (similar to rent expense). 9. Goodwill Goodwill is often one of the most difficult intangible assets to account for. Goodwill can only be identified with the business as a whole and be recorded as an asset on the balance sheet (capitalized) only in a business combination (i.e. when an entire business is purchased). Goodwill is valuable only in the sense that the entity is a “going concern” valuation. Internally created goodwill may NOT be capitalized in the accounts. Summary of Chapter 10: Property, Plant and Equipment and Intangible Assets: Acquisition and Disposition The cost of goodwill is measured as the difference between the purchase price of a group of assets or enterprise acquired less the sum of the fair market value (FMV) of individual tangible and identifiable intangible assets acquired minus any liabilities assumed. This method of valuation is a residual method. Goodwill only occurs if the purchase price is greater than the sum of the fair market value of all individual assets (tangible and identifiable intangible) combined. Remember, the recording of goodwill can only happen when an entire business is purchased. Therefore, when several intangibles or a combination of intangibles and tangibles are brought in a “basket purchase” and no goodwill exists, the cost should be allocated on the basis of fair market values. The following is the examples. Summary of Chapter 10: Property, Plant and Equipment and Intangible Assets: Acquisition and Disposition ❖ Allocation of the purchase price of a lump sum purchase of assets where the total fair market value of all identifiable tangible and intangible assets is lower OR higher than the purchase price. ★ Lump Sum Purchase of Assets In the purchase of assets in a lump sum transaction the purchase price is allocated on the basis of relative fair market values. 1. Disposition In a normal sale transaction the buyer and seller exchange cash (selling price) for an asset and a gain or loss is recognized on the disposition. ★ The gain or loss is calculated as follows: ★ Journal Entry: Summary of Chapter 10: Property, Plant and Equipment and Intangible Assets: Acquisition and Disposition ❖ Exchanges of nonmonetary assets with commercial substance. Know how to calculate the gain or loss, whether it should be recognized, how to calculate the basis of the asset acquired and how to record the journal entry to remove the old asset and capitalize the new asset. The most common example of an exchange of nonmonetary transactions is a "trade in". It can be assumed that the fair market value of the asset being received is equal to the fair market value of the asset being given up plus whatever the holder of the new asset is willing to receive in cash. 1. Commercial Substance One of two ways should be used to determine if the transaction has commercial substance as follows: 1.) Determine if the risk, timing and amount of future cash flows change as a result of the transaction OR 2.) Determine if with the exchange versus without the exchange cash flows are affected. Keep in mind that materiality is always a factor. ★ Summary of Chapter 10: Property, Plant and Equipment and Intangible Assets: Acquisition and Disposition ❖ Exchanges of nonmonetary assets that lack commercial substance. Know how to calculate the gain or loss, whether it should be recognized, how to calculate the basis of the asset acquired and how to record the journal entry to remove the old asset and capitalize the new asset. 1. Exchanges that lack Commercial Substance However to preclude a company from engaging in this type of transaction, only to recognize the increase in the fair market value of an asset as a gain, a special category or exchanges exists exchanges that lack commercial substance. Exchanges that lack commercial substance (i.e. do not change the financial position of the parties involved) should be exchanged at book value and no gain should be recorded. A LOSS ON AN EXCHANGE OF NONMONETARY ASSETS SHOULD BE RECOGNIZED WHETHER THE EXCHANGE HAS COMMERCIAL SUBSTANCE OR NOT! This is because any time a revenue producing asset loses value to the point where it is stated at more than it's cash equivalent price then assets would be overstated. 2. Cash Received but Lacks Commercial Substance If a transaction lacks commercial substance and cash is received (rather than paid) to equalize the fair market value of the assets exchanged then GAAP considers this a partial sale and some of the gain will be permitted to be recognized. Recall revenue recognition "received or receivable". alculating the gain to be received: The portion of the "old" asset presumed sold: ❖ You should always be able to determine the impact of a journal entry on the various financial statements and their components. For example, the impact on net income, retained earnings, assets, liabilities so on and so forth.(see the examples)
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