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31 Cards in this Set

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What are the characteristics of Property, Plant, and Equipment?
1) Acquired for use not resale
2) Long-term in nature
2a) Subject to Depreciation
3) Possess Physical Substance
What is the basis for valuing Property, Plant, and Equipment?
Historical Cost
DEFINED as:
1)the cash or cash equivalent price of obtaining the asset
2)transporting the asset to it's location
3) and work necessary to get the asset in a condition ready for it's intended use.
THEREFORE, historical cost includes:
Purchase Price, Freight Costs, Sales, Taxes, and Installation costs.
What is typically included in the Historical cost of Land?
1) the purchase price
2) closing costs -title to the land -attorney's fees - recording fees
3) costs incurred in getting the land ready for use -grading -filling -clearing -removal of an old building
3a) Any proceeds obtained in the process (ex. from the sale of timber cleared or scrap from the removal of the building) are recognized as reductions in the price of the land.
4) assumption of any liens, mortagages, back taxes, or encumberances on the property
5) any additional improvements that have an indefinite life (ex. special assessments for local improvements like pavements, street lights,sewers, drainage systems, which are relatively permenant and maintained and replaced by the local government, as well as landscaping)
What is typically included in the Historical cost of a building?
1)Materials, Labor, Overhead Costs incurred during construction
2)Professional Fees and buliding permits
What is typically included in the Historical cost of equipment?
1) purchase price
2) freight and handling charges incurred
3) insurance on equipment during transit
4) cost of special foundations if required
5) assembling and installation costs
6) costs of conducting trial runs
What are the accounting problems associated with self constructed assets?
The assignment of indirect manufacturing costs (Overhead) because costs cannot be traced to work and material orders related to the fixed assest constructed.
What are the 3 ways to account for indirect manufacturing costs of self constructed assets?
1) Assign no fixed overhead to the fixed assets constructed
2) Assign a portion of all overhead to construction in process *most common method
3) allocate on the basis of lost production
What is the rationale behind interest capitalization?
During construction the asset is not generating revenue. Therefore, the interest cost should be deferred (capitalized) and recognized (expensed) when it is ready for use.
What is the interest treatment on assets purchased and ready for use?
Interest costs are expensed
When acquiring and valuing plant assets, what needs to be condsidered?
1) Was there a cash discount?
2) Was the asset purchased on a long-term credit contract?
3) What the asset part of a lump sum purchase?
4) Was stock issued to obtain the asset?
5) Was there an exchange of property, plant, or equipment to obtain the asset?
6) Was the asset a contribution?
Aside from Historical Cost, what other methods have been considered for valuation?
1) constant dollar accounting (DEFINED as adjustments for general price level changes)
2) Current Cost accounting (DEFINED as adjustments for specific price level changes)
3) Net Realizable Value
4) Combination of constant dollar accounting and current cost or net realizable value
What are land improvements?
They are improvements with limited lives such as private driveways, walks, fences, and parking lots. As such these assets are recorded separately from the cost of land so that it can be depreciated over its estimated useful life.
If land is held for speculative purposes, how is it classified?
As an investment
If land is held by a real estate company for resale, how is it classified?
As inventory
Is the cost of removing an old building that of the land or the new building?
If the land is purchased with an old building on it, then the cost of demolition less its salvage value is the cost of the land rather then the new building.
In accounting what does the term "equipment" encompass?
-delivery equipment
-office equipment
-machinery
-furniture and fixtures
-furnishings
-factory equipment
-similar fixed assets
What is the rationale behind assigning no fixed overhead to the cost of the constructed asset?
BASIS: indirect overhead is generally fixed in nature and does not increase as a result of constructing one's own plant or equipment.
ASSUMPTION: company will have the same costs regardless of whether the company constructs the asset or not.
ARGUMENT: Charging a portion of overhead costs to equipment would relieve current expenses and consequently overstate income of the current period.
However, variable overhead costs that increase as a result of construction are assigned to the cost of the asset.
What is the rationale behind assigning a portion of all overhead to the construction process?
BASIS: full costing concept (appropriate if one believes that costs attach to all products and assets manufactured or constructed). So overhead costs are assigned to construction as it would to normal production.
ARGUMENT: failure to allocate overhead costs >understates the initial cost of the assets
>leads to innaccurate future allocataions.
What is the rationale behind allocating overhead on the basis of lost production to a constructed asset?
BASIS: Opportunity cost
ARGUMENT: the cost of any curtailed productionthat occurs because the asset is being built rather then purchased should be allocated to the asset. This is conceptually appealing but difficult to measure.
When allocated overhead on a pro rata basis to a constructed asset exceeds the cost cost charged by an outside independent producer, it should be recognized in the followin way:
step 1)
CONSTRUCTION COST
+ ALLOCATED OVERHEAD
- COST PER OUTSIDE PRODUCER
--------------------------
EXCESS DUE TO ALLOCATED OVERHEAD

step 2:
Record EXCESS DUE TO ALLOCATED OVERHEAD as a period loss rather then part of the capitalized asset

BASIS: to avoid capitalizing the asset at more then it's probable market value
GAAP recommends the Capitalize only the actual interest costs incurred during construction. To implement this there are 3 items to consider. What are they?
1)Qualifying Assets
2) Capitalization Period
3) Amount to capitalize
What are the characteristics of Qualifying Assets for interest capitalization?
The asset must require a period of time to get it ready for it's intended use.
Therefore, assets under construction for the company's own use (ex. buildings, plants, and large machinery) and assets intended for sale or lease that are constructed or otherwise proceded as discrete projects (ex. ships or real estate developments)
What assets do not qualify for interest capitalization?
1)assets that are in use or ready for their intended use
2) assets that are not being used in the earnings activities of the enterprise and that are not undergoing activities necessary to get them ready for use (ex. land that is not being developed and assets not being used because of obsolescence, excess capacity, or need for repair)
How is the capitalization period defined?
The period of time during which interest must be capitalized.
What are the three conditions that must be met for interest to begin capitalization?
1) Expenditures for assets have been made
2) Activities that are necessary to get the asset ready for it's intended use and progress
3) Interest Cost is being incurred.

Interest capitalization continues as long as all 3 conditions are present. It ends when the asset is substantially complete and ready for it's intended use.
The amount of interest to capitalize is determined as follows:
Interest capitaliation is limited to the LOWER of actual interest cost incurred during the period OR avoidable interest.
What is avoidable interest?
Avoidable Interest (DEFINED as: the amount of interest cost during the period that theoretically could have been avoided if expenditures for assets had not been made). It is determined by
the:
WEIGHTED AVERAGE ACCUMLATED EXPENDITURES FOR QUALIFYING ASSETS DURING THE PERIOD
x INTEREST RATE(s)
-----------------------------
AVOIDABLE INTEREST
What are the caveats to interest capitalization?
1) interest cost should never include a cost of capital charged for stockholder's equity
2)interest capitalization on a qualifying asset is only required if its effect is material compared to the effect of expensing the interest.
What are the steps in interest capitalization?
INTEREST CAPITALIATION
step 1:
compute WEIGHTED-AVERAGE ACCUMULATED EXPENDITURES
step 2:
compute AVOIDABLE INTEREST
step 3:
compute ACTUAL INTEREST COST
step 4: JOURNAL ENTRIES
step 5: REPORTED IN INCOME STATEMENT
step 6: DISCLOSURE IN NOTES TO THE FINANCIAL STATEMENTS
INTEREST CAPITALIZATION
What is the guidance on the selection of an interest rate to be applied to the weighted-average accumulated expenditures
1) For the portion of accumulated expenditures that is LESS THAN OR EQUAL to any amounts specifically borrowed to finance construction of assets-use the interest rate incurred on the specific borrowings
2)For the portion of accumulated expenditures that is GREATER THAN any debt incurred specifially to finance construction of assets -use a weighted average of interest rates incurred on all other debt during the period.
How is the WEIGHTED AVERAGE INTEREST RATE computed?
Rate Principle Interest
10% DEBT 1 $10 1.00
5% DEBT 2 $10 .50
15% DEBT 3 $10 1.50
----- -----
Total 30 3

Weighted Average Interest Rate= Total Interest/Total Principle
3/30=10%