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Chapter10: Property, Plant, and Equipment and Intangible Assets: Acquisition and Disposition

Broaden Your Perspective

p. 550

Apply your critical-thinking ability to the knowledge you've gained. These cases will provide you an opportunity to develop your research, analysis, judgment, and communication skills. You also will work with other students, integrate what you've learned, apply it in real world situations, and consider its global and ethical ramifications. This practice will broaden your knowledge and further develop your decision-making abilities.

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Judgment Case 10-1
 
Acquisition costs
 
 LO1 LO3 LO6

A company may acquire property, plant, and equipment and intangible assets for cash, in exchange for a deferred payment contract, by exchanging other assets, or by a combination of these methods.

Required:

1.

 

Identify six types of costs that should be capitalized as the cost of a parcel of land. For your answer, assume that the land has an existing building that is to be removed in the immediate future in order that a new building can be constructed on the site.

2.

 

At what amount should a company record an asset acquired in exchange for a deferred payment contract?

3.

 

In general, at what amount should assets received in exchange for other nonmonetary assets be valued? Specifically, at what amount should a company value a new machine acquired by exchanging an older, similar machine and paying cash?

(AICPA adapted)

Research Case 10–2
 
FASB codification; locate and extract relevant information and cite authoritative support for a financial reporting issue; restoration costs; asset retirement obligation
 
 LO1

Your client, Hazelton Mining, recently entered into an agreement to obtain the rights to operate a coal mine in West Virginia for $15 million. Hazelton incurred development costs of $6 million in preparing the mine for extraction, which began on July 1, 2011. The contract requires Hazelton to restore the land and surrounding area to its original condition after extraction is complete in three years.

 

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   The company controller, Alice Cushing, is not sure how to account for the restoration costs and has asked your advice. Alice is aware of a recent accounting pronouncement addressing this issue, but is not sure of its provisions. She has narrowed down the possible cash outflows for the restoration costs to four possibilities:

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   Alice also informs you that the company's credit-adjusted risk-free interest rate is 9%. Before responding to Alice, you need to research the issue.

Required:

1.

 

Obtain the relevant authoritative literature on accounting for asset retirement obligations using the FASB's Codification Research System. You might gain access at the FASB website (www.fasb.org). Explain the basic treatment of asset retirement obligations. What are the specific citations that you would rely on to determine (a) the accounting treatment for an asset retirement obligation and (b) how to measure the obligation?

2.

 

Determine the capitalized cost of the coal mine.

3.

 

Prepare a summary journal entry to record the acquisition costs of the mine.

4.

 

How much accretion expense will the company record in its income statement for the 2011 fiscal year, related to this transaction? What are the specific citations from the FASB's Codification Research System that address (a) the calculation of accretion expense and (b) the classification of accretion expense in the income statement?

5.

 

Explain to Alice how Hazelton would account for the restoration if the restoration costs differed from the recorded liability in three years. By way of explanation, prepare the journal entry to record the payment of the retirement obligation in three years assuming that the actual restoration costs were $4.7 million.

6.

 

Describe to Alice the necessary disclosure requirements for the obligation. What is the specific citation from the FASB's Codification Research System that contains these disclosure requirements?

Judgment Case 10-3
 
Self-constructed assets
 
 LO7

Chilton Peripherals manufactures printers, scanners, and other computer peripheral equipment. In the past, the company purchased equipment used in manufacturing from an outside vendor. In March 2011, Chilton decided to design and build equipment to replace some obsolete equipment. A section of the manufacturing plant was set aside to develop and produce the equipment. Additional personnel were hired for the project. The equipment was completed and ready for use in September.

p. 551

Required:

1.

 

In general, what costs should be capitalized for a self-constructed asset?

2.

 

Discuss two alternatives for the inclusion of overhead costs in the cost of the equipment constructed by Chilton. Which alternative is generally accepted for financial reporting purposes?

3.

 

Under what circumstance(s) would interest be included in the cost of the equipment?

Judgment Case 10-4
 
Interest capitalization
 
 LO7

GAAP provides guidelines for the inclusion of interest in the initial cost of a self-constructed asset.

Required:

1.

 

What assets qualify for interest capitalization? What assets do not qualify for interest capitalization?

2.

 

Over what period should interest be capitalized?

3.

 

Explain average accumulated expenditures.

4.

 

Explain the two methods that could be used to determine the appropriate interest rate(s) to be used in capitalizing interest.

5.

 

Describe the three steps used to determine the amount of interest capitalized during a reporting period.

Research Case 10-5
 
Goodwill
 
 LO1

Accounting for purchased goodwill has been a controversial issue for many years. In the United States, the amount of purchased goodwill is capitalized and not amortized. Globally, the treatment of goodwill varies significantly, with some countries not recognizing goodwill as an asset. Professors Johnson and Petrone, in “Is Goodwill an Asset?” discuss this issue.

Required:

1.

 

In your library or from some other source, locate the indicated article in Accounting Horizons, September 1998.

2.

 

Does goodwill meet the FASB's definition of an asset?

3.

 

What are the key concerns of those that believe goodwill is not an asset?

Real World Case 10-6
 
Property, plant, and equipment; intangibles; Target
 
 LO1

Target Corporation, a major U.S. retailer, reported the following amounts in the asset section of its balance sheets for the years ended January 31, 2009, and February 2, 2008:

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Real World Financials

   In addition, the statement of cash flows for the year ended January 31, 2009, included the following items ($ in millions):

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Required:

What was the gain or loss Target recognized in the year ended January 31, 2009, from the sale of property and equipment?

Judgment Case 10-7
 
Goodwill
 
 LO1

Athena Paper Corporation acquired for cash 100% of the outstanding common stock of Georgia, Inc., a supplier of wood pulp. The purchase price of $4,500,000 was significantly higher than the book value of Georgia's net assets (assets less liabilities) of $2,800,000. The Athena controller recorded the difference of $1,700,000 as an asset, goodwill.

Required:

1.

 

Discuss the meaning of the term goodwill.

2.

 

In what situation would the Athena controller be correct in her valuation of goodwill?

Judgment Case 10-8
 
Research and development
 
 LO8

Prior to 1974, accepted practice was for companies to either expense or capitalize R&D costs. In 1974, the FASB issued a Standard that requires all research and development costs to be charged to expense when incurred. This was a controversial standard, opposed by many companies who preferred delaying the recognition of these expenses until later years when presumably the expenditures bear fruit.

p. 552

   Several research studies have been conducted to determine if the standard had any impact on the behavior of companies. One interesting finding was that, prior to 1974, companies that expensed R&D costs were significantly larger than those companies that capitalized R&D costs.

Required:

1.

 

Explain the FASB's logic in deciding to require all companies to expense R& D costs in the period incurred.

2.

 

Identify possible reasons to explain why, prior to 1974, companies that expensed R&D costs were significantly larger than those companies that capitalized R&D costs.

Judgment Case 10-9
 
Research and development
 
 LO8

Clonal, Inc., a biotechnology company, developed and patented a diagnostic product called Trouver. Clonal purchased some research equipment to be used exclusively for Trouver and subsequent research projects. Clonal defeated a legal challenge to its Trouver patent, and began production and marketing operations for the project.

   Corporate headquarters' costs were allocated to Clonal's research division as a percentage of the division's salaries.

Required:

1.

 

How should the equipment purchased for Trouver be reported in Clonal's income statements and statements of financial position?

2.

 

a.

 

Describe the matching principle.

b.

 

Describe the accounting treatment of research and development costs and consider whether this is consistent with the matching principle. What is the justification for the accounting treatment of research and development costs?

3.

 

How should corporate headquarters' costs allocated to the research division be classified in Clonal's income statements? Why?

4.

 

How should the legal expenses incurred in defending Trouver's patent be reported in Clonal's financial statements?

(AICPA adapted)

Communication Case 10-10
 
Research and development
 
 LO8

The focus of this case is the situation described in Case 10-9. What is the appropriate accounting for R&D costs? Do you believe that (1) capitalization is the correct treatment of R&D costs, (2) expensing is the correct treatment of R&D costs, or (3) that companies should be allowed to choose between expensing and capitalizing R&D costs?

Required:

1.

 

Develop a list of arguments in support of your view prior to the class session for which the case is assigned. Do not be influenced by the method required by the FASB. Base your opinion on the conceptual merit of the options.

2.

 

In class, your instructor will pair you (and everyone else) with a classmate who also has independently developed a position.

a.

 

You will be given three minutes to argue your view to your partner. Your partner likewise will be given three minutes to argue his or her view to you. During these three-minute presentations, the listening partner is not permitted to speak.

b.

 

Then after each person has had a turn attempting to convince his or her partner, the two partners will have a three-minute discussion in which they will decide which alternative is more convincing and arguments will be merged into a single view for each pair.

3.

 

After the allotted time, a spokesperson for each of the three alternatives will be selected by the instructor. Each spokesperson will field arguments from the class as to the appropriate alternative. The class will then discuss the merits of the alternatives and attempt to reach a consensus view, though a consensus is not necessary.

Communication Case 10-11
 
Research and development
 
 LO8

Thomas Plastics is in the process of developing a revolutionary new plastic valve. A new division of the company was formed to develop, manufacture, and market this new product. As of year-end (December 31, 2011), the new product has not been manufactured for sale; however, prototype units were built and are in operation.

   Throughout 2011, the new division incurred a variety of costs. These costs included expenses (including salaries of administrative personnel) and market research costs. In addition, approximately $500,000 in equipment (estimated useful life of 10 years) was purchased for use in developing and manufacturing the new valve. Approximately $200,000 of this equipment was built specifically for developing the design of the new product; the remaining $300,000 of the equipment was used to manufacture the preproduction prototypes and will be used to manufacture the new product once it is in commercial production.

   The president of the company, Sally Rogers, has been told that research and development costs must be expensed as incurred, but she does not understand this treatment. She believes the research will lead to a profitable product and to increased future revenues. Also, she wonders how to account for the $500,000 of equipment purchased by the new division. “I thought I understood accounting,” she growled. “Explain to me why expenditures that benefit our future revenues are expensed rather than capitalized!”

p. 553

Required:

Write a one-to two-page report to Sally Rogers explaining the generally accepted accounting principles relevant to this issue. The report should also address the treatment of the equipment purchases.

(AICPA adapted)

Ethics Case 10-12
 
Research and development
 
 LO8

Mayer Biotechnical, Inc., develops, manufactures, and sells pharmaceuticals. Significant research and development (R&D) expenditures are made for the development of new drugs and the improvement of existing drugs. During 2011, $220 million was spent on R&D. Of this amount, $30 million was spent on the purchase of equipment to be used in a research project involving the development of a new antibiotic.

   The controller, Alice Cooper, is considering capitalizing the equipment and depreciating it over the five-year useful life of the equipment at $6 million per year, even though the equipment likely will be used on only one project. The company president has asked Alice to make every effort to increase 2011 earnings because in 2012 the company will be seeking significant new financing from both debt and equity sources. “I guess we might use the equipment in other projects later,” Alice wondered to herself.

Required:

1.

 

Assuming that the equipment was purchased at the beginning of 2011, by how much would Alice's treatment of the equipment increase before tax earnings as opposed to expensing the equipment cost?

2.

 

Discuss the ethical dilemma Alice faces in determining the treatment of the $30 million equipment purchase.

IFRS Case 10-13
 
Research and development; comparison of U.S. GAAP and IFRS; Cadbury Schweppes
 
 LO8 LO9

Cadbury Schweppes, Plc., a U.K. company, is an international confectionery and beverage business that sells its products in almost every country in the world. The company prepares its financial statements according to IFRS.

 

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Required:

1.

 

Use the Internet to locate Cadbury's most recent annual report. The address is www.cadburyschweppes.com. Locate the significant accounting policies disclosure note.

2.

 

How does the company account for research and development expenditures? Does this policy differ from U.S. GAAP?

Analysis Case 10-14
 
Fixed-asset turnover ratio; National Semiconductor
 
 LO5

National Semiconductor Corporation, headquartered in Santa Clara, California, is a global semiconductor manufacturer. The company's 2009 fixed-asset turnover ratio, using the average book value of property, plant, and equipment (PP&E) as the denominator, was approximately 2.87. Additional information taken from the company's 2009 annual report is as follows:

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Real World Financials

   Equipment having a book value of $4 million was sold during 2009.

Required:

1.

 

How is the fixed-asset turnover ratio computed? How would you interpret National's ratio of 2.87?

2.

 

Use the data to determine National's net sales for 2009.

3.

 

Obtain annual reports from three corporations in the same primary industry as National Semiconductor (Intel Corporation and Advanced Micro Devices are two well-known competitors) and compare the management of each company's investment in property, plant, and equipment.

Note: You can obtain copies of annual reports from your library, from friends who are shareholders, from the investor relations department of the corporations, from a friendly stockbroker, or from EDGAR (Electronic Data Gathering, Analysis, and Retrieval) on the Internet (www.sec.gov).

Judgment Case 10-15
 
Computer software costs
 
 LO8

The Elegant Software Company recently completed the development and testing of a new software program that provides the ability to transfer data from among a variety of operating systems. The company believes this product will be quite successful and capitalized all of the costs of designing, developing, coding, and testing the software. These costs will be amortized over the expected useful life of the software on a straight-line basis.

p. 554

Required:

1.

 

Was Elegant correct in its treatment of the software development costs? Why?

2.

 

Explain the appropriate method for determining the amount of periodic amortization for any capitalized software development costs.

Real World Case 10-16
 
Property, plant, and equipment; Home Depot
 
 LO1 LO7

EDGAR, the Electronic Data Gathering, Analysis, and Retrieval system, performs automated collection, validation, indexing, and forwarding of submissions by companies and others who are required by law to file forms with the U.S. Securities and Exchange Commission (SEC). All publicly traded domestic companies use EDGAR to make the majority of their filings. (Some foreign companies file voluntarily.) Form 10-K, which includes the annual report, is required to be filed on EDGAR. The SEC makes this information available on the Internet.

Real World Financials

Required:

1.

 

Access EDGAR on the Internet. The web address is www.sec.gov.

2.

 

Search for Home Depot, Inc. Access the 10-K filing for the most recent fiscal year. Search or scroll to find the financial statements and related notes.

3.

 

Answer the following questions related to the company's property, plant, and equipment:

a.

 

Name the different types of assets the company lists in its balance sheet under property, plant, and equipment.

b.

 

How much cash was used for the acquisition of property, plant, and equipment during the year?

c.

 

What was the amount of interest capitalized during the year?

d.

 

Compute the fixed-asset turnover ratio for the fiscal year.

Analysis Case 10-17
 
Reporting property, plant, and equipment and intangible assets
 
 LO1 LO5

Refer to the financial statements and related disclosure notes of Dell Inc. in Appendix B located at the back of the text.

 

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Required:

1.

 

What categories of property, plant, and equipment and intangible assets does Dell report in its 2009 balance sheet?

2.

 

How much cash was used in 2009 to purchase property and equipment? How does this compare with purchases in previous years?

3.

 

The fixed-asset turnover ratio for Hewlett-Packard Company, a Dell competitor, is 9.84. How does this compare with Dell's ratio? What is the ratio intended to measure?

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