FAR SEC 8 Flashcards
What is the definition of Property, Plant, & Equipment (PPE)? (5 elements)
1) These assets are called property, plant, and equipment; fixed assets; or plant assets. They provide benefits from their use in the production of goods and services, not from their consumption.
2) PPE are tangible. They have physical existence.
3) PPE may be either personal property (something movable, e.g., equipment) or real property (such as land or a building).
4) PPE are used in the ordinary operations of an entity and are not held primarily for investment, resale, or inclusion in another product. But they are often sold.
5) PPE are noncurrent. They are not expected to be used up within 1 year or the normal operating cycle of the business, whichever is longer.
How is the carrying amount of PPE calculated?
The carrying amount of an item of PPE is the amount at which it is presented in the financial statements. This amount is equal to the historical cost minus accumulated depreciation and impairment losses.
[Historical or Initial Cost] -[Accumulated Depreciation] - [Impairment Losses] = PPE Asset’s Carrying Amount
What are the seven types of PPE?
1) Land
2) Buildings
3) Land improvements, such as landscaping, drainage, streets, street lighting, sewers, sidewalks, parking lots, driveways, and fences
4) Machinery and equipment, such as furniture, fixtures (personal property permanently attached to real property, such as a central heating system), and vehicles
5) Leasehold improvements, such as buildings constructed on, and other modifications made to, the leased property by a lessee
6) Internally constructed assets
7) Miscellaneous items, such as tools, patterns and dies, and returnable containers
What are the four relevant accounting principles for PPE?
1) PPE are initially measured at historical cost, which consists of
i) The amount paid to acquire the asset and
ii) The costs needed to bring the asset to the condition and location necessary for its intended use.
-The initial measurement embraces all other costs to acquire PPE, transport them to the sites of their intended use, and prepare them for operations.
-Freight-in (transportation-in), installation costs, renovation or reconditioning costs, expenses of tests or trial runs, and insurance and taxes during the preoperations period are capitalized to the initial cost of the asset.
2) Historical cost is adjusted for changes in utility over the life of the asset, e.g., depreciation and impairment.
i) In general, expenses should be recognized at the time related revenues are earned.
ii) However, no direct relationship ordinarily exists between the consumption of service potential and specific revenues. Thus, the depreciation expense must be systematically and rationally allocated to periods expected to be benefited.
3) Depreciation does not start until PPE are placed in operation and begin to contribute economic benefits.
4) Under GAAP, PPE are not revalued upward to reflect appraisal, market, current, or fair values that are above historical cost (or carrying amount) of PPE.
How is PPE initially recognized? (3 elements)
1) PPE are initially measured at historical cost, which consists of
2) The amount paid to acquire the asset and
3) The costs needed to bring the asset to the condition and location necessary for its intended use.
i) The initial measurement embraces all other costs to acquire PPE, transport them to the sites of their intended use, and prepare them for operations.
ii) Freight-in (transportation-in), installation costs, renovation or reconditioning costs, expenses of tests or trial runs, and insurance and taxes during the preoperations period are capitalized to the initial cost of the asset.
How is historical cost adjusted for changes in utility over the life of the asset? (2 elements)
Historical cost is adjusted for changes in utility over the life of the asset, e.g., depreciation and impairment.
1) In general, expenses should be recognized at the time related revenues are earned.
2) However, no direct relationship ordinarily exists between the consumption of service potential and specific revenues. Thus, the depreciation expense must be systematically and rationally allocated to periods expected to be benefited.
What are the six attributes of the initial cost of land for PPE?
1) The costs of acquiring and preparing land for its expected use are capitalized.
2) The price should include not only the cash price but also any encumbrances assumed (such as mortgages or tax liens).
3) The cost of land also includes transaction costs, e.g., surveying costs, legal fees, brokers’ commissions, title insurance, and escrow fees.
4) Site preparation costs [clearing, draining, filling, leveling the property, and razing existing buildings, minus any proceeds (such as timber sales)] are costs of the land, not of the building to be constructed on the land.
5) Certain permanent improvements of the land made by the entity that have indefinite lives are debited to the land account.
6) Land has an indefinite useful life and therefore is not depreciated.
For PPE, how is the initial cost of land improvements treated?
Land improvements with finite useful lives that are maintained and replaced by the reporting entity are capitalized separately from land and depreciated.
For PPE, how are the initial costs of buildings treated? (6 elements)
1) The costs that are necessary to the purchase or construction of a building and that will result in future economic benefits should be capitalized. These include
2) The purchase price, including any liens assumed by the purchaser, etc.
3) Costs of renovating and preparing the structure for its expected use.
4) The expenses of excavating the site to build the foundation (but not site preparation costs).
i) The costs of razing an old building are either debited to the land account or treated as an adjustment of a gain or loss on disposal. The accounting depends on whether the land was purchased as a site for the new structure or the old building was previously used in the entity’s operations.
ii) The carrying amount of an existing building previously used in the entity’s operations is not included in the cost of the new structure. It will not produce future benefits.
5) The materials, labor, and overhead costs of construction
6) Interest costs incurred during construction of a building for an entity’s own use should be capitalized. (The outline for capitalization of interest is in Subunit 8.2.)
For PPE, what are the two attributes of the treatment of excavating the site (building initial cost)?
The expenses of excavating the site to build the foundation (but not site preparation costs).
1) The costs of razing an old building are either debited to the land account or treated as an adjustment of a gain or loss on disposal. The accounting depends on whether the land was purchased as a site for the new structure or the old building was previously used in the entity’s operations.
2) The carrying amount of an existing building previously used in the entity’s operations is not included in the cost of the new structure. It will not produce future benefits.
For PPE, how is the initial cost of machinery and equipment treated? (3 elements)
Costs include
1) Purchase price (including sales taxes)
2) Freight-in, handling, insurance, and storage until use begins
3) Preparation, installation, and start-up costs, such as testing and trial runs
For PPE, how are the initial costs of leasehold improvements treated? (2 elements)
1) Leasehold improvements, such as buildings constructed on leased land, are accounted for by the lessee in the same way as property to which title is held. However, the term of the lease may limit the depreciation period.
2) If the useful life of the asset extends beyond the lease term and lease renewal is reasonably certain, the amortization period may include all or part of the renewal period. If renewal is uncertain, the useful life is the remaining term of the lease.
For PPE, what are the Other Factors affecting initial measurement? (2 elements)
1) Acquisition in exchange for a noncurrent obligation. If an item of PPE is acquired in exchange for a noncurrent note, its cost is the present value of the consideration paid (the note). But the note’s interest rate may be unstated or unreasonable, or the face amount may differ materially from the cash price of the PPE or the market value of the note. In these cases, the cost of the PPE should be the more clearly determinable of the cash price of the PPE or the market value of the note.
2) Donated assets. In general, contributions received should be recognized as (1) revenues or gains in the period of receipt and (2) assets, or decreases in liabilities or expenses. They are measured at fair value.
PPE $XXX
Contribution revenue $XXX
For PPE, how is the acquisition of a group of assets via a lump-sum purchase treated?
When two or more assets are acquired for a single price, the cost must be allocated to the individual assets in the group.
-Allocation is based on the relative fair values of the assets acquired.
For internally constructed assets, how is the capitalization of interest treated?
The costs necessary to bring an asset to the condition and location of its intended use are part of the historical cost. Interest incurred during construction is such a cost and must be capitalized as part of an asset’s initial cost. An imputed cost of equity capital is not recognized.
For internally constructed assets, is an imputed cost of equity capital recognized?
No, an imputed cost of equity capital is not recognized.
What are the three categories of qualifying internally constructed assets for capitalization of interest?
Qualifying assets are assets for which interest must be capitalized. The following are qualifying assets:
1) Assets that are constructed or produced by the entity for its own use
2) Assets that are constructed or produced for the entity by others for which deposits or progress payments have been made
3) Assets that are constructed or produced for sale or lease as separate projects, such as real estate developments or ships
What are three nonqualifying categories of internally constructed assets that are not qualified for interest capitalization?
The following are assets for which interest must not be capitalized (nonqualifying assets):
1) Inventories routinely produced in large quantities on a repetitive basis
2) Assets in use or ready for their intended use in earning activities
3) Assets not being used in earning activities that are not undergoing the activities necessary to ready them for use
For interest capitalization of internally constructed assets, what is the capitalization period for interest costs? (3 elements)
1) This period is the time required to carry out the activities necessary to bring a qualifying asset to the condition and location necessary for its intended use.
2) The period begins and continues as long as
i) Expenditures for a qualifying asset are being made,
ii) Activities necessary to make the asset ready for its intended use (i.e., construction) are in progress, and
iii) Interest cost is being incurred.
3) Capitalization ends when the asset is substantially complete and ready for its intended use. Also, interest capitalization must cease if substantially all asset-related activities are suspended.
For interest capitalization of internally constructed assets, what are the three conditions for the capitalization period to begin and continue?
The period begins and continues as long as
1) Expenditures for a qualifying asset are being made,
2) Activities necessary to make the asset ready for its intended use (i.e., construction) are in progress, and
3) Interest cost is being incurred.
For capitalization of interest for internally constructed assets, what is the limitation? (4 elements)
1) Interest cost includes interest (1) on obligations with explicit interest rates (including amortization of issue costs and discount or premium), (2) imputed on certain payables, and (3) on a finance lease.
2) Capitalizable interest is limited to the amount theoretically avoidable if expenditures for ICAs had not been made. For example, if the entity had not incurred costs for ICAs, it might have used the funds to repay debt or to avoid issuing new debts.
3) Interest capitalized may not exceed the actual total interest cost incurred during the period.
4) Interest earned on borrowed funds is ordinarily not offset against interest cost to determine either capitalization rates or limitations on interest costs to be capitalized.
For capitalized interest on internally constructed assets, what are the three interest costs?
1)Interest cost includes interest
(1) on obligations with explicit interest rates (including amortization of issue costs and discount or premium),
(2) imputed on certain payables, and
(3) on a finance lease.
For interest capitalization of internally constructed assets, how is the amount of interest to be capitalized determined? (3 elements)
1) Capitalized interest equals the weighted average accumulated expenditures (AAE) for the qualifying asset during the capitalization period times the interest rate(s). The weighting is based on the time expenditures incurred interest.
2) If a specific new borrowing outstanding during the period can be identified with the asset, the rate on that obligation may be applied to the extent that the AAE do not exceed the amount borrowed.
3) To the extent that AAE exceed the amount of specific new borrowings, a weighted-average rate must be applied that is based on other (not the specific) borrowings outstanding during the period.
For interest capitalization of internally constructed assets, what disclosures are requried?
If no interest cost is capitalized, the amount incurred and expensed during the period should be reported. If some interest cost is capitalized, the total incurred and the amount capitalized should be disclosed.
What are the three accounting issues for subsequent expenditures for PPE?
1) The issues are to determine whether subsequent expenditures should be capitalized or expensed and to determine the accounting methods to be used.
2) Capital expenditures are capitalized. They provide additional benefits by improving the quality of services rendered by the asset, extending its useful life, or increasing its output.
3) Revenue expenditures (expenses) maintain an asset’s normal service capacity.
i) These costs are recurring, are not expected to benefit future periods, and are expensed when incurred.
ii) An entity usually specifies a materiality threshold below which all costs are expensed, thereby avoiding the burden of depreciating immaterial amounts.
For subsequent expenditures on PPE, how are extensions or expansions treated? (3 elements)
1) Substantial expenditures for extensions or expansions of existing assets are capitalized. An example is an additional floor for a building.
2) If the addition is essentially a separate asset, it is recorded in a separate account and depreciated over its own useful life. Otherwise, the addition should be debited to the original asset account and depreciated over the life of that asset.
3) The basic entry is
Asset (new or old) $XXX
Cash, etc. $XXX
For subsequent expenditures on PPE, how are replacements and improvements (betterments) treated? (3 elements)
Replacements and Improvements (Betterments)
1) A replacement substitutes a new component of an asset for a similar one, for example, a tile roof for a tile roof. But an improvement substitutes a better component, such as a more efficient heating system.
2) Substitution method. If the old component was recorded separately, e.g., recording a central air conditioning system separately from the building, the procedure is to remove it from the ledger, along with accumulated depreciation, and to substitute the cost of the new component. A loss may be recognized.
i) The new component will be depreciated over the shorter of its useful life or that of the entire asset.
ii) The basic entry is
New asset $XXX
Accumulated depreciation of old asset $XXX
Loss $XXX
Old asset $XXX
Cash, etc. $XXX
3) If (1) the component replaced or improved has not been separately accounted for or (2) the old component has been modified, the substitution method is not used.
i) If the replacement or improvement increases the asset’s service potential but does not extend its estimated useful life, the asset is debited. The carrying amount of the old component is not removed.
ii) If the replacement or improvement primarily extends the useful life without enhancing service potential, the entry is to debit accumulated depreciation. The expenditure is a recovery of depreciation, not an increase in the quality of service.
Accumulated depreciation $XXX
Cash, etc. $XXX
For subsequent expenditures for PPE in the treatment of replacements and improvements, what is the substitution method? (3 elements)
1) Substitution method. If the old component was recorded separately, e.g., recording a central air conditioning system separately from the building, the procedure is to remove it from the ledger, along with accumulated depreciation, and to substitute the cost of the new component. A loss may be recognized.
2) The new component will be depreciated over the shorter of its useful life or that of the entire asset.
3) The basic entry is
New asset $XXX
Accumulated depreciation of old asset $XXX
Loss $XXX
Old asset $XXX
Cash, etc. $XXX
For subsequent expenditures for PPE in the treatment of replacements and improvements, when should the substitution method not be used, and what is the alternative? (3 elements)
1) If (1) the component replaced or improved has not been separately accounted for or (2) the old component has been modified, the substitution method is not used.
2) If the replacement or improvement increases the asset’s service potential but does not extend its estimated useful life, the asset is debited. The carrying amount of the old component is not removed.
3) If the replacement or improvement primarily extends the useful life without enhancing service potential, the entry is to debit accumulated depreciation. The expenditure is a recovery of depreciation, not an increase in the quality of service.
Accumulated depreciation $XXX
Cash, etc. $XXX
For subsequent expenditures on PPE, what are the four attributes of rearrangements, reinstallations, and relocations?
1) Rearranging the configuration of plant assets, reinstalling such assets, or relocating operations may require material outlays that are separable from recurring expenses and provide probable future benefits.
2) The substitution method of accounting for these costs may be used if the original installation costs and accumulated depreciation are known.
3) Otherwise, if these costs are material, they should be debited to a new account and amortized over the period benefited.
4) Relocation (moving) costs often are expensed as incurred.
For subsequent expenditures on PPE, what are the two attributes of repairs and maintenance?
1) Routine, minor expenditures made to maintain the operating efficiency of PPE are ordinarily expensed as incurred. However, as the amounts involved become more significant and the benefits to future periods increase, treatment of a major repair as an addition, etc., may be more appropriate.
2) Although a repair or maintenance cost ordinarily should be allocated to a single annual period only, its full recognition at the interim date when incurred may distort the interim statements.
-Accordingly, an anticipated repair or maintenance cost may be allocated to the interim periods that will benefit.
For subsequent expenditures on PPE, what is the summary table?
What is the definition of depreciation?
Depreciation is the process of systematically and rationally allocating the depreciable base of a tangible capital asset over its expected useful life.
-It is not a process of valuation.
What is shown on the Measure of Exchange Summary Table?
What is shown on the table for determination of impairment loss? (3 elements)
