Solution Manual For Intermediate Accounting Reporting and Analysis 1st Edition by Wahlen

Solution Manual for Intermediate Accounting
Reporting and Analysis 1st Edition by Wahlen
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Solution Manual for Intermediate Accounting Reporting and Analysis 1st Edition by Wahlen
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CHAPTER 10
Property, Plant, and Equipment: Acquisition and Subsequent Investments
CONTENT ANALYSIS OF END-OF-CHAPTER ASSIGNMENTS
TIME
NUMBER TOPIC CONTENT LO ADAPTED DIFFICULTY EST. AACSB AICPA BLOOM’S
Property, Plant, and Characteristics for potential

Q10-1 Equipment balance sheet inclusion 1 Easy 5 Analytic Measurement Comprehension
Property, Plant, and Definition of book value of
Q10-2 Equipment asset 1 Easy 5 Analytic Measurement Comprehension
Relationship between fair
Q10-3 Property, Plant, and value and book value of an 1 Easy 5 Analytic Measurement Comprehension
Equipment asset
Property, Plant, and Criteria for potential balance
10-1
Q10-4 Equipment sheet inclusion 2 Easy 5 Analytic Measurement Comprehension

Land Held as Classification on balance
Q10-5 Investment sheet 2 Easy 5 Analytic Reporting Comprehension
Leasehold Classification on balance
Q10-6 Improvements sheet 2 Easy 5 Analytic Measurement Comprehension
Asset Retirement Classification on balance
Q10-7 Obligations sheet 2 Easy 5 Analytic Measurement Comprehension
Lump-Sum Purchase Allocation of cost among
Q10-8 of Assets various assets acquired 2 Easy 5 Analytic Measurement Comprehension
Acquisition of Asset in
Q10-9 Exchange for Determination of acquisition 2 Easy 5 Analytic Measurement Comprehension
Securities cost
Differences between
Q10-10 Property, Plant, and accounting and reporting of 2 Easy 5 Analytic Measurement Comprehension
Equipment IFRS and GAAP
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TIME
Accounting for trading of

Q10-11 Exchange of Assets nonmonetary assets 2 Easy 5 Analytic Measurement Comprehension
Recognition of gains and
Q10-12 Exchange of Assets losses in exchange of 3 Easy 5 Analytic Measurement Comprehension
nonmonetary assets
Accounting for overhead
Q10-13 Self-Construction costs during self-construction 4 Easy 5 Analytic Measurement Comprehension
Conditions for capitalizing
Q10-14 Interest During interest during self- 4 Easy 5 Analytic Measurement Comprehension
Construction construction
Amount of interest to
Q10-15 Interest During capitalize during self- 4 Easy 5 Analytic Measurement Comprehension
Relevant time period where
10-2
Q10-16 Interest During interest can be capitalized 4 Easy 5 Analytic Measurement Comprehension
Construction during self-construction
Interest During Differences between U.S.
Q10-17 Construction GAAP and IFRS 5 Easy 5 Analytic Measurement Comprehension
Distinguish between capital
Q10-18 Capital and and operating expenditures; 5 Easy 5 Analytic Measurement Comprehension
Operating accounting differences
Expenditures between each
Events Subsequent to Accounting for additions and
Q10-19 Acquisition improvements/replacements 5 Easy 5 Analytic Measurement Comprehension
Events Subsequent to Accounting for major repairs
Q10-20 Acquisition vs. ordinary repairs 5 Easy 5 Analytic Measurement Comprehension
Oil and Gas Successful efforts, full-cost
Q10-21 Accounting methods 6 Easy 5 Analytic Measurement Comprehension
Allocation of cost among
M10-1 Lump-Sum Purchase various assets acquired 2 AICPA Easy 5 Analytic Measurement Comprehension
TIME
Accounting for donated

M10-2 Donation assets 2 AICPA Easy 10 Analytic Measurement Comprehension
Property, Plant, and
M10-3 Equipment Recording for purchase 2 AICPA Easy 10 Analytic Measurement Comprehension
Property, Plant, and Accounting for costs to tear
M10-4 Equipment down existing building 2 AICPA Easy 10 Analytic Measurement Comprehension
Recording for purchase
M10-5 Property, Plant, and under deferred payment 3 AICPA Easy 10 Analytic Measurement Comprehension
Equipment contract
Accounting for exchange
M10-6 Exchange of Assets with commercial substance 3 AICPA Easy 10 Analytic Measurement Comprehension
with a gain or loss
Amount of interest to
M10-7 Interest During capitalize during self- 4 AICPA Moderate 10 Analytic Measurement Application
10-3
M10-8 Acquisition vs. ordinary repairs 5 AICPA Moderate 10 Analytic Measurement Application
M10-9 Acquisition vs. ordinary repairs 5 AICPA Easy 10 Analytic Measurement Comprehension
Events Subsequent to Accounting for additions and
M10-10 Acquisition improvements/replacements 5 AICPA Moderate 10 Analytic Measurement Application
Accounting for the cost of
RE10-1 Land land 2 Easy 10 Analytic Measurement Comprehension
Property, Plant, and Accounting for the cost of a
RE10-2 Equipment building 2 Easy 10 Analytic Measurement Comprehension
Allocation of cost among
RE10-3 Lump-Sum Purchase various assets acquired 2 Easy 10 Analytic Measurement Comprehension
TIME
Recording of purchase of
RE10-4 Property, Plant, and equipment using non- 2 Easy 10 Analytic Measurement Application
Equipment interest-bearing note; journal
entries
Journal entry to record
RE10-5 Donation receipt of donated property 2 Easy 10 Analytic Measurement Application
Accounting for exchange
RE10-6 Exchange of Assets with commercial substance 3 Easy 10 Analytic Measurement Application
with a gain or loss
Computation of weighted
RE10-7 Interest During average expenditures 4 Easy 10 Analytic Measurement Application
Construction interest rate
Computation of weighted
RE10-8 Interest During average expenditures and 4 Moderate 10 Analytic Measurement Application
Construction capitalized interest
10-4
Interest During Computation of capitalized

RE10-9 Construction interest 4 Moderate 10 Analytic Measurement Application
Interest During Computation of capitalized
RE10-10 Construction interest 4 Moderate 10 Analytic Measurement Application
RE10-11 Events Subsequent to Accounting for 5 Moderate Analytic Measurement Application
Acquisition improvements 10
Analysis of various items for
E10-1 Inclusion in Property, potential balance sheet 1, Moderate 10 Analytic Measurement Analysis
Plant, and Equipment inclusion; conceptual 2
extension; next level
Analysis of numerous items to
E10-2 Determination of Cost determine whether or not to 2, Moderate 10 Analytic Measurement Analysis
include in property, plant, 4,
and equipment; next level 5
TIME
Compute total acquisition

E10-3 Acquisition Costs costs of machine; journal 2, Easy 5 Analytic Measurement Application
entries 5
E10-4 Acquisition Cost acquisition; discussion of 2 Moderate 10 Analytic Measurement Analysis
situation where price is not
available; conceptual
Determination of cost and
E10-5 Acquisition Cost journal entry to record 2 AICPA Easy 10 Analytic Measurement Application
acquisition
Computation of land and
E10-6 Acquisition of Land new building cost; 2 AICPA Moderate 10 Analytic Reporting Analysis
and Building conceptual extension; next
level
10-5
Cost assigned to land,

E10-7 Lump-Sum Purchase buildings, and equipment; 2 Moderate 10 Analytic Measurement Analysis
international journal entries;
IFRS
Asset Acquired by acquisition; conceptual 2 Moderate 15 Analytic Reporting Analysis
E10-8 Donation extension; financial
statement disclosure; time
differences for passage of
title; next level
No cash; journal entries when
E10-9 Exchange of Assets exchange does and does 3 Moderate 15 Analytic Measurement Application
not have commercial
substance; conceptual
TIME
Cash, gain, and loss;

E10-10 Exchange of Assets exchange with commercial 3 Moderate 15 Analytic Measurement Analysis
substance; journal entries
Exchange of Assets Cash, gain, and loss; 3 Moderate 15 Analytic Measurement Application
E10-11 exchange with commercial
Exchange of Assets No cash; exchange with 3 Moderate 15 Analytic Measurement Application
E10-12 commercial substance;
journal entries
Exchange of Assets Cash, gain, and loss; 3 Moderate 15 Analytic Measurement Analysis
E10-13 exchange with commercial
Exchange of Assets Determination of amount to 3 Easy 10 Analytic Measurement Analysis
E10-14 be shown in the accounting AICPA
records
10-6
Self-Construction Determination of amount to 4 Moderate 10 Analytic Measurement Analysis

E10-15 be capitalized; conceptual
extension; evaluation under
differing outside contractor’s
bids; next level
Interest During Computation of weighted 4 Moderate 10 Analytic Measurement Analysis
E10-16 Construction average expenditures and
capitalized interest
Interest During Compilation of amount to be 4 Moderate 10 Analytic Reporting Analysis
Construction capitalized; conceptual
E10-17 extension; financial
statement disclosure; next
level
TIME
Calculating Compute amount of 4 Moderate 15 Analytic Measurement Analysis

E10-18 Capitalized Interest capitalized interest and
interest revenue; IFRS
computations of capitalized
interest
Capital and Capital vs. operating; 5 Moderate 10 Analytic Measurement Analysis
E10-19 Operating classification of various items;
Expenditures IFRS differences
Expenditures After Capitalization vs. expensing 5 Moderate 10 Analytic Reporting Analysis
E10-20 Acquisition of expenditures incurred after
acquisition; journal entries;
conceptual extension; effect
on financial statements; next
level
Oil and Gas Successful efforts, full-cost 6 15 Analytic Reporting Analysis
10-7
E10-21 Accounting methods; determination of Moderate

expense and balance sheet
value
Acquisition Costs Reclassification of 2, Challenging 25 Analytic Measurement Analysis
P10-1 erroneously recorded items; 4
journal entries.
Asset Cost Journal entries to record 2, Moderate 30 Analytic Reporting Analysis
P10-2 Classification various transactions 5
Acquisition Cost Acquisition, replacement, 2, Moderate 25 Analytic Measurement Analysis
P10-3 purchase; journal entries to 5
record various transactions
Comprehensive: Preparation of schedules for 2, AICPA Challenging 30 Analytic Reporting Synthesis
Analysis of Changes changes in land, building, 5
P10-4 in Fixed Assets leasehold improvements,
and machinery and
equipment
TIME
Assets Acquired by Various situations dealing 3 Challenging 35 Analytic Measurement Synthesis

P10-5 Exchange with exchanges of
nonmonetary assets when
commercial substance exists;
journal entries
Assets Acquired by Various situations dealing 3 Challenging 35 Analytic Measurement Synthesis
P10-6 Exchange with exchanges of
nonmonetary assets when
commercial substance does
and does not exist; journal
entries; conceptual
Self-Construction Computation according to 4 CMA Challenging 40 Analytic Measurement Synthesis
P10-7 GAAP of amount to be
capitalized; conceptual
10-8
extension; identification of
alternative procedures; next
level
Interest During Computation of amount to 4 Moderate 25 Analytic Reporting Analysis
Construction be capitalized and amount
P10-8 to be depreciated; straight-
line depreciation;
conceptual extension;
effects on financial
statements; next level
Interest During Computation of amounts of 4 Moderate 50 Analytic Measurement Analysis
P10-9 Construction capitalized interest, interest
expense, and interest
revenue; journal entries to
record construction costs,
including interest; IFRS
differences
TIME
Events Subsequent to Replacement, repairs, 5 Moderate 25 Analytic Measurement Analysis

P10-10 Acquisition demolition; journal entries;
IFRS differences
Oil and Gas Successful efforts, full-cost 6 Moderate 15 Analytic Reporting Analysis
P10-11 Accounting Methods methods; financial statement
disclosure; next level
Acquisition Determining the cost of 2, AICPA Moderate 20 Analytic Measurement Analysis
C10-1 equipment by establishing 3,
value of what was traded to 5
acquire it
Capitalization Issues Analysis of various items for 2, AICPA Moderate 20 Analytic Measurement Analysis
C10-2 potential balance sheet 5
inclusion; conceptual
extension
Cost Issues Determination of cost to 2, AICPA Moderate 20 Analytic Reporting Analysis
10-9
C10-3 record acquisition; 5

accounting of maintenance
costs
Acquisition Costs Costs capitalized for land; 2, AICPA Moderate 20 Analytic Measurement Application
C10-4 recording plant asset 3
acquired by deferred
payments; accounting for
exchange of nonmonetary
assets
Capital and Revenue Accounting for capital and 2, AICPA Moderate 20 Analytic Measurement Analysis
C10-5 Expenditures operating expenditures; 5
decisions of what is
capitalized versus expensed
Interest Capitalization Developing policies for 4 Moderate 20 Analytic Measurement Synthesis
C10-6 capitalizing interest; earnings
management concerns
TIME
Capitalization of Accounting for purchase 2 Moderate 20 Analytic Measurement Analysis

C10-7 Purchase Options options
Donated Asset and Its Consideration for accounting 2 Moderate 20 Analytic Measurement Analysis
C10-8 Modification for donated assets
Exchange of Assets Lease options; asset 2, AICPA Moderate 20 Analytic Reporting Analysis
C10-9 exchange; evaluating 3
alternative accounting
scenarios
Ethics and Ethics; capitalizing overhead 4 Moderate 20 Analytic Measurement Analysis
C10-10 Construction Costs costs; capitalizable interest
during self-construction
Analyzing Coca- Using real company annual Moderate 20 Analytic Measurement Analysis
C10-11 Cola's Property, Plant, reports
and Equipment
10-10
Analyzing LVMH's Using real company annual Moderate 25 Analytic Measurement Application
C10-12 Property, Plant, and reports
Equipment
Researching GAAP Using the FASB Codification Moderate 25 Analytic Measurement Analysis
C10-13 System
Researching GAAP Using the FASB Codification Moderate 25 Analytic Measurement Analysis
C10-14 System
ANSWERS TO QUESTIONS
Q10-1 For a company to include an asset in the category of property, plant, and
equipment, the asset must: (1) be held for use in operations and not for investment;
(2) have an expected life of more than one year; and (3) be tangible in nature—that
is, having a physical substance that can be seen and touched.
Q10-2 The book value of an asset is the recorded acquisition cost less the accumulated
depreciation recorded to date.
Q10-3 At the date of acquisition, the acquisition cost is equal to the fair value. At the end of
the life of the asset, the book value should equal the residual value (a market value).
During the life of the asset, there is no defined relationship between the book value
and market value because depreciation is a process of cost allocation rather than of
valuation.
Q10-4 Generally, a company capitalizes the expenditures that are necessary to obtain the
benefits to be derived from the asset. Specifically, any expenditure necessary to
obtain the asset and put it in operating condition is capitalized, or recorded as part
of the cost of property, plant, and equipment. These expenditures include the
contract price, less any discounts taken, plus freight, assembly, installation, and
testing costs. In addition, any costs associated with an asset retirement obligation are
capitalized as property, plant, and equipment.
Q10-5 A company classifies land purchased for future use as an investment on the balance
sheet. It does not include the land as property, plant, and equipment because it is
not being used in the normal course of business in a productive capacity. Therefore,
classification of the land as an investment is more representationally faithful.
Q10-6 Leasehold improvements are improvements made by the lessee to leased property
that, unless specifically exempted in the lease agreement, revert to the lessor at the
end of the lease. A company capitalizes the cost of these improvements and
subsequently depreciates them over the economic life of the improvements or the
life of the lease (lease term), whichever is shorter.
Q10-7 Asset retirement obligations are legal obligations related to the retirement of an
asset. The fair value of an asset retirement obligation is recorded as a liability, with an
offsetting increase in the carrying value of the related asset. Generally, the fair value
is estimated by calculating the present value of the estimated future cash outflows
required to satisfy the obligation at the end of the asset’s useful life. The capitalized
amount is subsequently depreciated and accretion expense is periodically
recognized on the amount of the obligation. This subsequent accounting is discussed
in Chapter 11.
Q10-8 In a lump-sum purchase, the company allocates the total purchase price to the
individual assets based on their relative fair values. This allocation is necessary
because the purchased assets may have different characteristics (e.g., some may
be depreciable while others are not, the assets may have different economic lives
and salvage values) or may be depreciated by different methods.
10-11
Q10-9 When a company exchanges securities (e.g., common or preferred stock) for an
asset, the acquisition cost of that asset is either the fair value of the asset acquired or
the fair value of the stock issued, whichever is more clearly evident and
representationally faithful. In many situations, the company makes the choice on the
basis of the market value that is more representationally faithful – e.g., if the value is
readily observable in an active market. If neither of these amounts is known, the
company must assign the value that it believes to be the most faithful representation
of the transaction.
Q10-10 The primary difference between U.S. GAAP and IFRS is that IFRS allow a company to
subsequently value its property, plant, and equipment using either a cost model
(similar to U.S. GAAP) or a revaluation model. Under the revaluation model, a
company is allowed to write the value of its property, plant, and equipment up to fair
value if fair value can be reliably measured. If the property, plant, and equipment is
increased to fair value, the increase is recognized in other comprehensive income
and accumulated in shareholders’ equity as a revaluation surplus. If the fair value of
the asset decreases, a company must first reduce any previously recognized
revaluation surplus. Any remaining decrease is then recognized as an expense.
Q10-11 When nonmonetary assets are exchanged, a company records the cost of the
nonmonetary asset acquired at the fair value of the nonmonetary asset surrendered
plus (minus) cash paid (received). If the fair value of the nonmonetary asset received
is more clearly evident than the fair value of the asset surrendered, it can be used to
measure the cost of the nonmonetary asset acquired.
Q10-12 When nonmonetary assets are exchanged, the company recognizes a gain or loss
equal to the difference between the fair value and the book value of the
nonmonetary asset surrendered.
Q10-13 The two alternative treatments of fixed overhead costs are (1) to allocate a portion
of overhead to the self-constructed asset and (2) to include only the incremental
overhead in the cost of the self-constructed asset. Proponents in favor of the first
approach (the allocation of total overhead) argue that construction-related
overhead is a relevant component of the asset’s cost and should be accounted for
in the same way as regular products. In addition, this full-costing approach results in a
cost of a self-constructed asset that will be a more faithful representation of the cost
to acquire and prepare the asset for use. Similarly, this approach enhances
comparability with the cost of an equivalent purchased asset. Arguments in favor of
the second approach (including only the incremental overhead) are that, to be
representationally faithful, the cost of the asset should only include the additional
costs incurred to produce it. In addition, to be comparable, the allocation of
overhead to normal operations should not change because the overhead would
have been incurred whether or not the construction takes place. Therefore, to
allocate any amount other than incremental overhead would result in less overhead
being allocated to inventory, resulting in lower expenses and higher income.
10-12
Q10-14 A company capitalizes interest on the self-construction when:
• The asset is constructed for a company’s own use or as a discrete project for sale
or lease to others
• The asset requires a period of time to get it ready for its intended use during which
expenditures have been made, activities that are necessary to get the asset
ready for its intended use are in progress, and interest cost is being incurred
A company does not capitalize interest for the following types of assets:
• Inventories that are routinely manufactured or otherwise produced on a
repetitive basis
• Assets that are in use or ready for their intended use
• Assets that are idle (not being used in the earning activities of the company) and
are not undergoing the activities necessary to get them ready for use
Q10-15 The amount of interest capitalized for a self-constructed asset is that portion of the
interest cost that could have been avoided if the construction had not occurred. The
company determines the amount of interest that it capitalizes by applying an interest
rate to the weighted average accumulated expenditures for the qualifying asset
during the capitalization period.
Q10-16 Because activities that are necessary to get the asset ready for its intended use are in
progress, the asset qualifies for interest capitalization. The interest cost capitalized is
considered a cost of acquiring the building and is recorded in the building account.
Q10-17 While both U.S. GAAP and IFRS permit the capitalization of interest, IFRS allow for the
capitalization of the total amount of interest related to specific construction loans
while U.S. GAAP only allows capitalization of avoidable interest. In addition, IFRS allow
for interest revenue from the temporary investment of funds borrowed specifically for
construction to be offset against interest expense eligible for capitalization. This
offsetting is not allowed under U.S. GAAP.
Q10-18 The distinction between a capital expenditure and an operating expenditure is

based on whether the costs have increased the future economic benefits of the
asset above those that were originally expected. If the future economic benefits of
the asset are increased, the expenditure is a capital expenditure and is recorded as
an asset. The future economic benefits can be increased by extending the life of the
asset, improving productivity (producing a greater quantity at the same cost or
producing the same quantity of product at a lower cost), or increasing the quality of
the product. If the costs maintain the existing benefits, the expenditure is an
operating (or revenue) expenditure. For example, if a machine receives a major
overhaul that increases the benefits to be realized from the asset, the costs are
capitalized. Conversely, ordinary repairs do not increase the total benefits to be
realized but maintain the existing benefits. Therefore, these expenditures are
expensed. As another example, the cost of adding a new wing to an existing hospital
is capitalized since it increases the total benefits of the hospital, whereas repairing the
elevators does not increase the economic benefit of the hospital and is expensed.
10-13
Q10-19 An addition involves enlarging an existing asset by adding a new component. In
contrast, an improvement/replacement involves the substitution of a new part or
asset for an old one. In accounting for an addition, a company capitalizes the costs
of the addition, and removes from the accounts any portion of the old asset that is
demolished or removed. A company capitalizes improvement and replacement
costs using the substitution method when it knows the book value of the asset being
replaced. This method removes the book value of the old asset and records the cost
as a new asset. If a company does not know the old book value, it still capitalizes the
cost of the new asset, but with either a debit to the Accumulated Depreciation
account of the old asset (if the expenditure extends the service life of the asset) or a
debit to the old asset account (when the old asset has been sufficiently depreciated
to an immaterial amount).
Q10-20 The costs of ordinary repairs and maintenance are expenditures that do not increase
the future economic benefits of the asset but, instead, maintain the existing benefits
provided by the asset. These costs are expensed as they are incurred. Major repairs
are those that cannot be foreseen and do not occur in the usual course of
operations, such as emergency repairs to a machine that breaks down during
production. Usually, a company expenses these costs, but care should be taken to
note whether these repairs increase the future benefits of the asset. If they do, then
the company capitalizes the costs.
Q10-21 Under the successful-efforts method of accounting for oil and gas properties, a
company capitalizes only those costs incurred in drilling for successful wells while it
expenses the costs of unsuccessful wells. In contrast, under the full-cost method a
company capitalizes all costs of drilling wells, whether the drilling was successful or
not, and amortizes these costs as the oil and gas is produced.
ANSWERS TO MULTIPLE CHOICE
1. c 3. b 5. c 7. c 9. d
2. b 4. c 6. d 8. b 10. b
SOLUTIONS TO REVIEW EXERCISES
RE10-1
Cost of land: $55,000 + $2,000 + $7,500 = $64,500
RE10-2
Cost of building: $250,000 + $3,500 + $125,000 = $378,500
10-14
RE10-3
Appraisal Relative Total Allocated

Asset Value Fair Value  Cost = Cost
Land $100,000 25% $360,000 $ 90,000
Building 300,000 75% 360,000 270,000
Totals $400,000 $360,000
RE10-4
Amount to be paid off each year: $350,000  7 = $50,000
Use the Time Value of Money Module, Table 4 (Present Value of an Ordinary Annuity),
where n = 7, i = 10%, factor of 4.868419
$50,000  4.868419 = $243,421 (rounded)
Journey entry:
Equipment .................................................................................... 243,421
Discount on Notes Payable ........................................................ 106,579
Notes Payable ....................................................................... 350,000
RE10-5
Land............................................................................................... 400,000
Gain on Receipt of Donated Property ............................... 400,000
RE10-6
Cost of asset acquired = Fair value of asset surrendered – Cash received

Cost of asset acquired = $40,000 – $2,000
Cost of asset acquired = $38,000
Gain (loss) = Fair value of asset surrendered – Book value of asset surrendered
Gain (loss) = $40,000 – $25,000
Gain = $15,000
RE10-7
Weighted average interest rate:
$3,000,000  12% = $360,000

1,800,000  10% = 180,000
$4,800,000 $540,000
$540,000
= 11.25%
$4,800,000
10-15
RE10-8
Portion of Weighted Average

Expenditures Year Outstanding Accumulated Expenditures
Jan. 1 $ 300,000  12/12 = $ 300,000
Mar. 1 600,000  10/12 = 500,000
June 30 1,000,000  6/12 = 500,000
Nov. 1 480,000  2/12 = 80,000
$2,380,000 $1,380,000
RE10-9
Capitalized interest = Weighted average accumulated expenditures x Interest rate

Capitalized interest = $1,380,000  10%*
Capitalized interest = $138,000
*Because Dexter’s weighted average accumulated expenditures do not exceed its borrowing
on the project, Dexter uses the interest rate on the note specific to this project to calculate its
capitalized interest.
RE10-10
Capitalized interest:
$1,000,000  10% = $100,000

380,000  11.25% = 42,750
$1,380,000 $142,750
RE10-11
Note: Rick has two alternatives. The substitution method is not applicable to this situation
because the engines were improved and not replaced.
Alternative 1: Reduce accumulated depreciation

Accumulated Depreciation ....................................................... 55,000
Cash ........................................................................................ 55,000
Alternative 2: Increase the asset account

Trucks ............................................................................................. 55,000
Cash ........................................................................................ 55,000
10-16
SOLUTIONS TO EXERCISES
E10-1
1. The following are included in property, plant, and equipment:

b. Machinery kept on hand and used only when other machinery breaks
e. Progress payments on building being constructed
f. Fully depreciated assets still being used
g. Expenditures to improve leased property
j. Obligation to remove leasehold improvement at the termination of a lease
The following are not included in property, plant, and equipment:
a. Idle equipment awaiting sale
c. Land held for investment
d. The right to publish a literary work
h. Assets leased to others
i. Purchase of an asset with an expected life of nine months
2. a. Idle equipment awaiting sale is not being used in operations. It is normally

classified as an “other asset.”
c. Land held for investment is not being used in operations. It would be considered
an investment.
d. The right to publish a literary work is not tangible in nature. This copyright is
considered an intangible asset.
h. Equipment leased to others is classified as inventory.
i. To be classified as property, plant, and equipment, the asset must have an
expected life of more than one year.
E10-2
1. The following are included in the cost:

a. Contract price of a machine
c. Freight costs
f. Installation costs
g. Testing costs
h. Cost of major overhaul of equipment
i. Costs of grading land prior to construction
j. Tax assessment for street improvements
k. Delinquent property taxes on property acquired
m. Cost of insurance during construction (could be expensed)
n. Avoidable interest costs during construction (not imputed interest)
o. Landscaping costs
q. Cost of tearing down a building on newly acquired land
r. Replacement of an electric motor in a machine (if benefits are increased)
s. Expansion of the heating/cooling system
10-17
E10-2 (concluded)
The following are not included in the cost:

b. List price
d. Discounts taken
e. Discounts not taken*
l. Cost of tearing down an old building (already owned)
p. Severance pay for employees dismissed because of acquisition
t. Purchase price of a service contract for 2 years on the acquired asset
u. Cost of training new employees
*Note: GAAP allows discounts not taken to either be included as part of the cost of
property, plant, and equipment or excluded and reported as an expense. Because
most companies report this an expense, we exclude discounts not taken from the cost
of property, plant, and equipment.
2. In general, if incurring a cost will provide economic benefits for the company beyond the
current period, it should be capitalized as part of the asset that is associated with the
increased benefit.
E10-3
Machine ........................................................................................ 213,000*

Repair and Maintenance Expense............................................ 1,000
Cash ........................................................................................ 214,000
*$200,000 – ($200,000  0.02) + $5,000 + $10,000 + $2,000
E10-4
1. The cost of the machine is determined as the fair value of the asset acquired or the sum
of the fair value of the note payable and the preferred stock issued, whichever is more
clearly evident. In this case, the fair value of the asset is considered to be the cash price
of $215,000. This amount is more clearly evident than the sum of the fair value of the
liability and the fair value of the preferred stock. Therefore, the machine is recorded at
$215,000.
2. Because the cost of the machine is $215,000 and a $55,000 cash down payment is
made, the remaining $160,000 has to be allocated between the note and the preferred
stock. In most situations, it would be considered that the 10% fair value of the note is
more clearly evident than the fair value of the preferred stock (an agreed-upon value is
not an independent and verifiable estimate of fair value). The fair value of the note
payable is determined as:
Present value of note:
Four annual payments of $ 30,000
Present value factor n = 4, I = 10%*  3.169865
$ 95,095.95
*Factor from Table 4 of TVM Module
10-18
E10-4 (concluded)
Therefore, the note payable is valued at $95,095.95 and the preferred stock is valued at
the remaining amount of $64,904,05 ($160,000 – $95,095.95). The journal entry to record
this acquisition is:
Machine ........................................................................................ 215,000.00
Discount on Notes Payable ($120,000 – $95,095.95) ............... 24,904.05
Notes Payable ....................................................................... 120,000.00
Preferred Stock, $100 par ($100  600) ............................... 60,000.00
Additional Paid-in Capital on Preferred Stock .................. 4,904.05
Cash ........................................................................................ 55,000.00
3. If the $215,000 cash price were not known, the fair value of the note and the agreed
value of the preferred stock would be used to determine the cost of the machine.
Machinery [($120,000 – $24,904.05) + $55,000 + $60,000] ....... 210,095.95
Discount on Notes Payable ........................................................ 24,904.05
Notes Payable ....................................................................... 120,000.00
Preferred Stock, $100 par ..................................................... 60,000.00
Cash ........................................................................................ 55,000.00
E10-5 [AICPA Adapted]
Cash equivalent price ................................................................. $9,500

Installation costs ........................................................................... 300
Capitalized cost ........................................................................... $9,800
Machine ........................................................................................ 9,800

Cash ($1,000 + $300) ............................................................. 1,300
Notes Payable (2,500  4) .................................................... 10,000
The asset should be recorded at its cash equivalent price of $9,500 plus installation costs of $300.
The imputed interest related to the note is recognized as a discount on the note payable.
1. Land:
Purchase price .......................................................... $50,000
Demolition of old building ....................................... 4,000
Legal fees .................................................................. 2,000
Salvaged materials .................................................. (3,000)
$53,000
Building:
Architect’s fees ......................................................... $ 20,000
Construction costs .................................................... 500,000
$520,000
10-19
E10-6 (concluded)
2. If a portion of the cost of the building was misclassified as land, the amount reported for
building would be understated and the amount reported for land would be overstated.
However, in total, the initial amount reported for property, plant, and equipment would
be correctly stated. Because depreciation would not be taken on the costs misclassified
as land, property, plant, and equipment would be overstated in future periods. In
addition, future income statements would understate depreciation expense, resulting in
an overstatement of net income and shareholders’ equity.
E10-7
1. Acquisition cost ............................................................... $200,000

Appraisal .......................................................................... 20,000
Total cost .......................................................................... $220,000
Appraisal
Values % of Total
Land.................................................................................. $100,000 40%
Building ............................................................................. 125,000 50%
Equipment ....................................................................... 25,000 10%
Total value ....................................................................... $250,000 100%
Cost assigned to:

Land 40%  $220,000 = $ 88,000
Building 50%  $220,000 = 110,000
Equipment 10%  $220,000 = 22,000
Total cost assigned $220,000
2. With regard to the land, Garrett will recognize the increase in fair value as follows:
Land.................................................................................. 22,000
Revaluation Surplus .................................................. 22,000
With regard to the buildings, Garrett will first eliminate any previously recorded
depreciation:
Accumulated Depreciation .......................................... 6,000*
Buildings ..................................................................... 6,000
*Original cost of $110,000 less book value of $104,000
Next, the increase in value from $104,000 to $106,000 is recorded as follows:

Buildings ........................................................................... 2,000
Revaluation Surplus ................................................. 2,000
With regard to the equipment, Garrett records the decrease in value from $18,000 to
$15,000 as a current period loss:
Loss on Impairment ......................................................... 3,000
Equipment ................................................................. 3,000
Note to Instructor: Impairments will be discussed more fully in Chapter 11.
10-20
E10-8
1. Land.................................................................................. 65,000
Building ............................................................................. 44,000
Gain on Receipt of Donated Property .................. 109,000
2. The agreement to employ 350 people for 10 years is disclosed in a note to the financial
statements, if material.
3. Even though title would not pass to the company for 10 years, the land and building is still
recorded on the books of the company. Disclosure of the contingency associated with
the title is included in the notes to the financial statements.
Note to Instructor: Contingencies were discussed in Chapter 9.
E10-9
1. Denver Company
Building (Warehouse (new)) .......................................... 30,000a
Accumulated Depreciation: Building .......................... 55,000
Loss on Exchange .......................................................... 5,000b
Building (Warehouse (old)) ..................................... 90,000
aCost = Fair value of asset surrendered
bLoss = Fair value of asset surrendered – Book value of asset surrendered
= $30,000 – $35,000
Bristol Company
Gain on Exchange ................................................... 10,000b
bGain = Fair value of asset surrendered – Book value of asset surrendered
= $30,000 – $20,000
2. Denver Company
Loss on Exchange ........................................................... 5,000b
= $30,000 – $35,000
10-21
E10-9 (concluded)
Bristol Company
Building (Warehouse (new)) .......................................... 20,000*
*Cost = Fair value of asset surrendered – Gain
where:
Gain = Fair value of asset surrendered – Book value of asset surrendered
= $30,000 – $20,000
3. The different accounting is justified because when an exchange has commercial

substance, the economic position of the two companies has changed and the
company’s future cash flows are expected to significantly change as a result of the
exchange. Therefore, any gains and losses are recognized at the time of the exchange.
However, when the exchange lacks commercial substance, the two companies are in
the same economic position. Therefore, while conservatism allows losses to be
recognized, a company will defer any gains until a transaction which alters the
company’s cash flows occurs.
E10-10
Denver Company
Building (Warehouse (new)) ....................................................... 30,000a
Accumulated Depreciation: Building ....................................... 55,000
Loss on Exchange ........................................................................ 7,000b
Building (Warehouse (old)) .................................................. 90,000
Cash ........................................................................................ 2,000
= $28,000 – $35,000
aCost = Fair value of asset surrendered + Cash paid
= $28,000 + $2,000
Bristol Company
Cash .............................................................................................. 2,000
Gain on Exchange ................................................................ 10,000b
aCost = Fair value of asset surrendered – Cash received
= $30,000 – $2,000
= $30,000 – $20,000
10-22
E10-11
Denver Company
Loss on Exchange ........................................................................ 2,000b
Cash .............................................................................................. 3,000
= $33,000 – $3,000
= $33,000 – $35,000
Bristol Company

Cash ........................................................................................ 3,000
= $30,000 + $3,000
= $30,000 – $20,000
E10-12
Goodman Company
Truck .............................................................................................. 9,000a
Accumulated Depreciation: Machine ..................................... 24,000
Machine ................................................................................. 30,000
= $9,000 – $6,000
Harmes Company
Machine ........................................................................................ 9,000a
Accumulated Depreciation: Truck ............................................ 4,000
Truck ........................................................................................ 12,000
aCost = Fair value of asset surrendered ($9,000, since no cash paid or received)
= $9,000 – $8,000
10-23
E10-13
Goodman Company
Truck .............................................................................................. 9,000a
Accumulated Depreciation: Machine ..................................... 24,000
Machine ................................................................................. 30,000
Cash ........................................................................................ 500
aCost = Fair value of asset surrendered + Cash paid = $8,500 + $500
= $8,500 – $6,000
Harmes Company
Machine ........................................................................................ 8,500a
Cash .............................................................................................. 500
Truck ........................................................................................ 12,000
= $9,000 – $500
= $9,000 – $8,000
Minor will value Smith’s contract at $150,000. Better will value Doe’s contract at $150,000. Minor
will report a gain of $5,000 and Doe will report a gain of $10,000.
E10-15
1. Common practice allocates both variable overhead and a pro rata share of fixed
overhead to the cost of the constructed asset. Following this practice, the cost of the
constructed asset should be as follows:
Materials and supplies $20,000
Direct labor 48,000
Supervisor’s overtime 4,000
Overhead (50% of direct labor) 24,000
$96,000
2. Allocating a portion of overhead to the cost of the self-constructed asset is a full-costing

approach that treats construction in the same manner as regular products. Under this
approach, the cost of the constructed asset will more closely approximate the cost of an
equivalent purchased asset.
10-24
E10-15 (concluded)
3. If the bid from the outside contractors was $80,000, it is questionable whether the use of
the full overhead rate is appropriate as the cost of the asset appears to be greater than
its fair value. The incremental approach seems more reasonable in this situation. If
Harshman does use a full-cost approach and the $80,000 bid is determined to be the fair
value of the asset, Harshman has incurred excessive costs to construct the building. The
building should be recorded at its fair value of $80,000 and the excess costs should be
recorded as a loss in the current period.
E10-16
1. Weighted average accumulated expenditures are calculated as:

Portion of Year Weighted Average
Expenditures Outstanding Accumulated Expenditures
Jan. 1 $ 252,000  10/12 = $210,000
May 1 310,000  6/12 = 155,000
July 1 420,000  4/12 = 140,000
Oct. 31 276,000  0/12 = 0
$1,258,000 $505,000
Note: Interest costs related to the expenditure for land qualify for interest capitalization.
Any interest costs capitalized are included as part of the cost of the building, not the
land.
Avoidable interest is calculated as:

$505,000  8% = $40,400
Actual interest is calculated as:

$1,000,000  8% = $ 80,000
500,000  9% = 45,000
800,000  10% = 80,000
$205,000
Because avoidable interest is less than actual interest, avoidable interest of $40,400 is
capitalized.
2. If the expenditures are incurred evenly throughout the year, the expenditures eligible for
interest capitalization are the average accumulated expenditures of $629,000 [($0 +
$1,258,000) ÷ 2].
Under this assumption, avoidable interest of $50,320 ($629,000  0.08) is capitalized as
part of the cost of the building.
10-25
E10-17

Apr. 1 $ 396,000  9/12 = $297,000
July 1 400,000  6/12 = 200,000
Sept. 1 510,000  4/12 = 170,000
Dec. 1 120,000  1/12 = 10,000
$1,426,000 $677,000

$ 500,000  12% = $60,000
177,000  8 1/3%* 14,750
$ 677,000 $74,750
Total interest $250,000
*Weighted average interest rate = = = 8 1/3%
Total principal $3,000,000

$ 500,000  12% = $ 60,000
2,000,000  8% = 160,000
1,000,000  9% = 90,000
$310,000
capitalized.
2. In the current period, the capitalization of interest increases the cost of the building,
decreases expenses (interest expense is not recorded for the amount of interest
capitalized), increases net income, and increases shareholders’ equity. However, in
future periods, the higher amount recorded as an asset increases depreciation expense
each year of the assets’ life, which lowers future net income and shareholders’ equity.
E10-18

Jan. 1 $1,000,000  12/12 = $1,000,000
April 1 1,600,000  9/12 = 1,200,000
Oct. 1 1,200,000  3/12 = 300,000
Dec. 31 500,000  0/12 = 0
$4,300,000 $2,500,000

$2,500,000  12% = $300,000
10-26
E10-18 (concluded)

$5,000,000  12% = $600,000
capitalized.
2. Interest revenue from the temporary investment of the borrowed amounts is:
Amount Interest Portion Interest
Date Available Rate of Year Revenue
January 1 $4,000,000 11% 3/12 $110,000
April 1 2,400,000 11% 6/12 132,000
Oct. 1 1,200,000 11% 3/12 33,000
$275,000
3. Under IFRS, the total interest costs of loans obtained specifically for the purpose of
constructing a qualifying asset are eligible for interest capitalization. Therefore, the total
interest expense of construction-related borrowing of $600,000 is eligible for interest
capitalization. In addition, interest revenue from the temporary investment of amounts
borrowed specifically for construction is offset against interest costs eligible for
capitalization. Therefore, Kit would capitalize $325,000 ($600,000 – $275,000).
E10-19
1. The following are recorded as capital expenditures:

a. Cost of installing machinery
b. Cost of moving machinery
d. Cost of major overhaul
e. Installation of safety device (unless no economic benefits are realized)
g. Replacement of a roof on a factory building
h. Cost of rearranging offices
The following are recorded as operating expenditures:
c. Repairs as a result of an accident
f. Property taxes on land and buildings
i. Cost of repainting offices
j. Ordinary repairs
2. Under IFRS, the cost of relocating or reorganizing PP&E is expensed. Therefore, the
company would record the cost of moving machinery and the cost of rearranging
offices as operating expenditures. The company would record the remaining costs in the
same way as it would under U.S. GAAP.
10-27
E10-20
1. April 9 Air Conditioning System (New) ............................................ 83,000

Accumulated Depreciation:
Air Conditioning System (Old) .......................................... 72,000
Loss on Disposal of Property, Plant, and Equipment ......... 2,000
Air Conditioning System (Old) ....................................... 74,000
Cash ................................................................................. 83,000
June 29 Repair & Maintenance Expense ......................................... 38,000
Cash ................................................................................. 38,000
Sept. 12 Accumulated Depreciation: Building ................................. 65,000
Cash ................................................................................. 65,000
Dec. 28 Building ................................................................................... 275,000
Cash ................................................................................. 275,000
2. a. If the addition had been expensed instead of capitalized, assets and net income
would be have been understated by $275,000 in the year of the addition.
However, in future years, because no asset was recorded, there would be no
additional depreciation expense related to the addition. Therefore, income
would be higher in future periods.
b. If the maintenance expenditures had been capitalized, assets and net income
would be overstated in the year of the expenditure. In future periods, this asset
would be depreciated, causing income to be understated.
E10-21
1. a. Successful-efforts method. 40% of drilling is unsuccessful. Therefore:
40%  $4,000,000 = $1,600,000 is expensed
b. Full-cost method. All costs are capitalized, so no drilling expense is recognized.
2. Value of Oil and Gas Properties on balance sheet (before recording depletion):
a. Successful-efforts method. 60% of drilling efforts are successful. Therefore:

60%  $4,000,000 = $2,400,000 appears on the balance sheet as oil and gas
properties
b. Full-cost method. All drilling costs are capitalized; therefore, $4,000,000 appears
on the balance sheet as oil and gas properties.
10-28
SOLUTIONS TO PROBLEMS
P10-1
Adjusting entries at December 31, 2013, to correct the books. All original entries must be reversed
out of the Land and Buildings account and recorded in the correct accounts.
1. Land............................................................................................... 26,500
Land and Buildings ................................................................ 26,500
To record purchase, demolition of old building, and legal
fees in separate Land account.
2. Building .......................................................................................... 2,900

To record interest on loan for construction.
3. Building .......................................................................................... 53,000

To record cost of construction in separate Building account.
4. Land............................................................................................... 1,200
To record sewer assessment.
5. Land (or Land Improvements*) .................................................. 3,500

To record cost of landscaping.
*If the landscaping has a limited life, the cost should be recorded in the Land
Improvements account.
6. Equipment .................................................................................... 18,800

To record excavation equipment purchase.
7. Building .......................................................................................... 15,000

To record fixed overhead incurred during construction of
building (alternatively, this item could be charged to regular
production through Work in Process).
8. Building .......................................................................................... 1,000

To record cost of insurance during construction.
9. Profit (Gain) on Construction...................................................... 12,000

To reverse profit improperly recognized.
10-29
P10-1 (concluded)
10. Loss Due to Worker’s Injury .......................................................... 3,000

To expense cost to compensate construction worker.
11. Loss Due to Modifications to Building ........................................ 7,500

To expense avoidable costs required by inspectors due to
planning error.
12. Land............................................................................................... 2,500

To record delinquent property tax expense on land.
P10-2
1. Investment in Land ...................................................................... 74,000

Cash ........................................................................................ 74,000
2. Land............................................................................................... 50,000a
Buildings ........................................................................................ 150,000b
Common Stock, $3 par......................................................... 60,000
Additional Paid-in Capital on Common Stock .................. 140,000
a($60,000  $240,000)  $200,000
b($180,000  $240,000)  $200,000
3. Equipment .................................................................................... 153,000*

Repair and Maintenance Expense............................................ 2,000
Cash ........................................................................................ 155,000
*$120,000 + $7,000 + $10,000 + $16,000
4. Land Improvements .................................................................... 30,000

Cash ........................................................................................ 30,000
5. Land............................................................................................... 60,000a
Buildings ........................................................................................ 78,000b
Investment in Land ................................................................ 37,000
Cash ........................................................................................ 101,000
a$37,000 + (26,000 – $3,000)
b$60,000 + $18,000 (imputed interest is ignored)
6. Leasehold Improvements ........................................................... 20,000

Cash ........................................................................................ 20,000
7. Equipment .................................................................................... 32,000

Cash ........................................................................................ 32,000
Royalty Expense ........................................................................... 12,000
Cash ........................................................................................ 12,000
10-30
P10-3
1. Stock exchanged: 1,000 shares at $24/share = $24,000

Land............................................................................................... 24,000
Common Stock, $10 par....................................................... 10,000
Additional Paid-in Capital on Common Stock .................. 14,000
2. A charge (debit) to Accumulated Depreciation is the best method for this replacement
since a separate value for the old engine is not known.
Cash (or Accounts Payable) ............................................... 1,000
3. Land is acquired:
Land............................................................................................... 60,000
Preferred Stock, $50 par ....................................................... 25,000
Additional Paid-in Capital on Preferred Stock .................. 35,000
The value of $55,000 may be the most conservative, but the value of $60,000 is a more
faithful representation of the fair value of the property and has the advantage of greater
verifiability. The value at which the stock was traded 2 months ago is out of date or
“stale” market value and is not a faithful representation of the fair value of the land at
the date of the exchange.
4. The present value of the 2-year non-interest-bearing note, using the 10% imputed interest
rate, is: $10,000  0.826446 (factor from Table 3 of TVM Module) = $8,264
Machine ........................................................................................ 8,264
Notes Payable ....................................................................... 10,000
P10-4 [AICPA Adapted]
1. TOWNSAND COMPANY
Analysis of Land Account
For 2013
Balance at January 1, 2013 ............................. $ 100,000
Land site number 621:
Acquisition cost ........................................ $1,000,000
Commission to real estate agent .......... 60,000
Clearing costs .......................................... $15,000
Less: Amounts recovered ....................... (5,000) 10,000
Total land site number 621 ..................... 1,070,000
Land site number 622:
Land value ............................................... $ 200,000
Building value ........................................... 100,000
Demolition cost ........................................ 30,000
Total land site number 622 ..................... 330,000
Balance at December 31, 2013 ...................... $1,500,000
10-31
P10-4 (concluded)
TOWNSAND COMPANY
Analysis of Buildings Account
For 2013
Balance at January 1, 2013 ................................................. $800,000
Cost of new building constructed on land site
number 622:
Construction costs ....................................................... $150,000
Excavation fees ........................................................... 11,000
Architectural design fees............................................ 8,000
Building permit fee ...................................................... 1,000 170,000
Balance at December 31, 2013 .......................................... $970,000
TOWNSAND COMPANY
Analysis of Leasehold Improvements Account
For 2013
Balance at January 1, 2013 ........................................................................ $500,000
Electrical work ............................................................................................... 35,000
Construction of extension to current work area ( $80,000  ½) .............. 40,000
Office space ................................................................................................. 65,000
Balance at December 31, 2013 ................................................................. $640,000
TOWNSAND COMPANY
Analysis of Machinery and Equipment Account
For 2013
Balance at January 1, 2013 ................................................. $700,000
Cost of new machines acquired:
Invoice price ................................................................ $75,000
Freight costs.................................................................. 2,000
Unloading charges ...................................................... 1,500 78,500
Balance at December 31, 2013 .......................................... $778,500
2. Items in the fact situation which were not used to determine the answer to Requirement
1 above, and where, or if, these items should be included in Townsand’s financial
statements are as follows:
a. Land site number 623, which was acquired for $600,000, should be included on
Townsand’s balance sheet as land held for resale (an investment).
b. Painting of ceilings for $10,000 should be included as a normal operating expense
on Townsand’s income statement.
c. Royalty payments of $13,000 should be included as a normal operating expense
on Townsand’s income statement.
10-32
P10-5
1. Machine (new) ..................................................................... 10,000

Accumulated Depreciation: Machine .............................. 28,000a
Loss on Exchange ................................................................. 4,000b
Machine (old) ................................................................. 40,000
Cash ................................................................................. 2,000
aAccumulated depreciation = Original cost – Book value
= $40,000 – $12,000
= ($10,000 – $2,000) – $12,000
2. Building ................................................................................... 55,000

Land ................................................................................. 35,000
Cash ................................................................................. 5,000
Gain on Exchange ......................................................... 15,000*
*Gain = Fair value of asset surrendered – Book value of asset surrendered
= ($55,000 – $5,000) – $35,000
3. Machine (new) ..................................................................... 20,000

Accumulated Depreciation: Machine .............................. 2,000a
Machine (old) ................................................................. 13,000
Cash ................................................................................. 5,000
Gain on Exchange ......................................................... 4,000b
aAccumulated depreciation = Original cost – Book value
= $13,000 – $11,000
= ($20,000 – $5,000) – $11,000
4. Equipment (Car) ................................................................... 15,800a

Accumulated Depreciation: Truck ..................................... 5,000
Cash ....................................................................................... 1,000
Equipment (Truck) .......................................................... 20,000
Gain on Exchange ......................................................... 1,800b
= $16,800 – $1,000
= $16,800 – $15,000
10-33
P10-6
1. a. Machine (new) ...................................................................... 34,000a

Accumulated Depreciation: Machine ............................... 15,000b
Machine (old) ........................................................... 40,000
Cash ........................................................................... 4,000
Gain on Exchange ................................................... 5,000c
= $30,000 + $4,000
bAccumulated depreciation = Original cost – Book value
= $40,000 – $25,000
cGain =Fair value of asset surrendered – Book value of asset surrendered
= $30,000 – $25,000
b. Machine (new) ...................................................................... 34,000a

Loss on Exchange .................................................................. 3,000c
Machine (old) ........................................................... 40,000
Cash ........................................................................... 4,000
= $30,000 + $4,000
= $40,000 – $33,000
cLoss = Fair value of asset surrendered – Book value of asset surrendered
= $30,000 – $33,000
c. Machine (new) ...................................................................... 27,000a

Cash ........................................................................................ 5,000
Machine (old) ........................................................... 45,000
= $32,000 – $5,000
= $45,000 – $20,000
cGain = Fair value of asset surrendered – Book value of asset surrendered
= $32,000 – $20,000
10-34
P10-6 (continued)
d. Machine (new) ...................................................................... 27,000a

Cash ........................................................................................ 5,000
Machine (old) ........................................................... 45,000
= $32,000 – $5,000
= $45,000 – $36,000
= $32,000 – $36,000
e. Machine (new) ...................................................................... 90,000a

Machine (old) ........................................................... 150,000
= $90,000
= $150,000 – $80,000
cGain = Fair value of asset surrendered – Book value of asset surrendered
= $90,000 – $80,000
f. Machine (new) ...................................................................... 90,000a

Machine (old) ........................................................... 150,000
= $90,000
= $150,000 – $94,000
= $90,000 – $94,000
g. Building .................................................................................... 200,000a

Land ........................................................................... 130,000
= $200,000
= $200,000 – $130,000
10-35
P10-6 (concluded)
h. Building .................................................................................... 230,000a

Cash ........................................................................... 30,000
Land ........................................................................... 130,000
= $200,000 + $30,000
= $200,000 – $130,000
i. Building .................................................................................... 180,000a

Cash ........................................................................................ 20,000
Land ........................................................................... 130,000
= $200,000 – $20,000
= $200,000 – $130,000
2. For requirement (e), the lack of commercial substance requires that the gain be
deferred. Therefore, the journal entry would be:
Machine (new) ............................................................... 80,000*
Accumulated Depreciation: Machine ........................ 70,000
Machine (old) ........................................................... 150,000
*Gain =Fair value of asset surrendered – Book value of asset surrendered
= $90,000 – $80,000
Cost = Fair value of asset surrendered – Gain
= $90,000 –$10,000
3. The different accounting is justified because when an exchange has commercial

substance, the economic position of the two companies has changed and the
company’s future cash flows are expected to significantly change as a result of the
exchange. Therefore, any gains and losses are recognized at the time of the exchange.
However, when the exchange lacks commercial substance, the two companies are in
the same economic position. Therefore, while conservatism allows losses to be
recognized, a company will defer any gains until a transaction which alters the
company’s cash flows occurs.
10-36
P10-7 [CMA Adapted]
1. Raw materials:
Iron castings ........................................................................... $61,040
Other raw materials .............................................................. 50,200 $111,240
Direct labor:
Layout (90  $5.00) ................................................................ $ 450
Electricians [(380 – 80)  $9.00] ............................................ 2,700
Machinery [(1,100 – 200)  $8.00] ........................................ 7,200
Heat treatment (100  $7.50) ............................................... 750
Assembly [(450 – 100)  $7.00] ............................................. 2,450
Testing [(180 – 20)  $8.00] .................................................... 1,280
Additional testing labor [(180 – 20)  $5.00) ....................... 800 15,630
Factory overhead:
Layout and electricians ($3,150  0.70) .............................. $ 2,205
Machining, heat treatment, assembly, testing
($12,480  1.00) ................................................................ 12,480 14,685
Interest paid.................................................................................. 4,260
Total amount to be capitalized ................................................. $145,815
2. Alternate procedures are possible for two costs—rework costs (affects direct labor,
repairs and maintenance, and factory overhead) and factory overhead.
a. Rework costs should be treated as a cost of the period when they are abnormal.
Rework costs arising from errors that ought not to have occurred should be
treated as losses of the period. Apparently, this was the case in this situation
because the damage resulted from a type of error that was not expected.
Consequently, rework costs and related repairs and maintenance expenses
($1,340) were not capitalized in Requirement 1.
Rework costs can be capitalized when they are considered normal and can be
explained by errors resulting from the uncertainties associated with the new
machine design. When this occurs, rework and repairs and maintenance are
necessary to make the machine operational.
b. There are two alternate ways to allocate overhead costs to self-constructed

assets. The method followed in Requirement 1 was to assign a portion of all
overhead costs to the self-constructed asset. The reasoning justifying this
treatment is that all productive output should absorb its proportionate share of all
factory overhead costs. In addition, this method results in a cost of the
constructed asset that tends to more closely approximate the cost of the
equivalent purchased asset.
A second method is to capitalize the incremental overhead (variable and
traceable fixed overhead) that increases as a result of the construction. (Note,
however, there was no traceable fixed overhead in this problem). This approach
includes the additional costs incurred to produce the fixed asset as part of the
cost of the asset. Because variable and traceable fixed overheads are incurred
to build the asset and will benefit future periods, these costs should be
capitalized. Nontraceable fixed overhead costs would have been incurred in any
case so that there is no causal relationship between the fixed overhead costs
and the self-constructed asset; therefore, these overhead costs would not be
capitalized.
10-37
P10-8
1. Weighted average accumulated expenditures for 2013 are calculated as:

Jan. 1 $ 540,000  12/12 = $ 540,000
May 1 465,000  8/12 = 310,000
Oct. 1 600,000  3/12 = 150,000
$1,605,000 $1,000,000

$1,000,000  12% = $120,000

$ 1,500,000  12% = $ 180,000
$ 6,000,000  14% = 840,000
$14,000,000  8% = 1,120,000
$2,140,000
capitalized.
Weighted average accumulated expenditures for 2014 are calculated as:

Jan. 1 $1,725,000*  6/12 = $ 862,500
Mar. 1 1,500,000  4/12 = 500,000
June 30 600,000  0/12 = 0
$1,362,500
*$1,605,000 expenditures + $120,000 capitalized interest from 2013.

$1,362,500  12% = $163,500

$ 1,500,000  12% = $ 180,000
$ 6,000,000  14% = 840,000
$14,000,000  8% = 1,120,000
$2,140,000
capitalized.
10-38
P10-8 (concluded)
2. Total costs = Expenditures + Capitalized interest

= ($1,605,000 + $2,100,000) + ($120,000 + $163,500)
= $3,988,500
Cost Estimated residual value
Straight-line depreciation =
Estimated service life
$3,998,500 $0
=
20
= $199,925 in 2013
= $199,925  1/2* = $99,962.50 in 2014
*Note: 1/2 year of depreciation is taken because the asset was not placed into service
until July 1.
3. The interest capitalization has the following effects on the financial statements:
Income Statement
2013: Interest expense decreased by $120,000. Net income increased by $120,000.
2014: Interest expense decreased by $163,500. Net income increased by $163,500.
In addition, the capitalization of interest increases the amount of depreciation expense
recognized in 2014 relative to what would be recognized if interest had not been
capitalized.
Balance Sheet
December 31, 2013: Asset (construction in progress) increased by $120,000.
Retained earnings increased by $120,000.
December 31, 2014: Asset (construction in progress) increased by $163,500
for a total of $283,500. Retained earnings increased by
$163,500, for a total of $283,500. Accumulated depreciation would
be increased by a half year of depreciation in 2014, from the
interest capitalization in 2013 and 2014. Retained earnings would
be decreased by 2014 depreciation expense on the interest
capitalization.
Statement of Cash Flows

If the company is producing the asset for its own use, the cash paid for the interest that is
capitalized is included in cash outflows for investing activities instead of cash flows from
operating activities. There would be no effect if the company was producing the asset
for sale to others. In addition, the capitalization of interest would increase the
depreciation adjustment in the operating section of the statement of cash flows under
the direct method (see Chapter 21 for additional details).
10-39
P10-9
Supporting computations
Construction costs, (excluding capitalized interest):
2013: $ 6,000,000
2014: $11,460,000
2015: $ 1,800,000
Average costs = [(Beginning cumulative costs + Ending cumulative costs)  2]
2013
Average costs = $3,000,000 [($0 + $6,000,000)  2]
Capitalized interest = $3,000,000  12%  9/12a

= $270,000
aBecause activities were suspended for 3 months, interest is only capitalized for 9 months.
2014
Average costs = [($6,000,000 + $270,000) + ($6,270,000 + $11,460,000)]  2
= $12,000,000
Capitalized interest = ($10,000,000  12%) + ($2,000,000  8.5%b)
= $1,370,000
( $20,000,000 ) + ( $60,000,000 )
b
 10%  8%
$80,000,000 $80,000,000
2015
Average costs = [($6,270,000 + $11,460,000 + $1,370,000) + ($19,100,000 + $1,800,000)]  2
= $20,000,000
Capitalized interest = [($10,000,000  12%) + ($10,000,000  8.5%)]  3/12c

= $512,500
cBecause the project is completed on March 31, 2015, interest for three months is capitalized.
Interest revenue, 2013 = ($10,000,000 – $3,000,000)  11%

= $770,000
Interest expense, 2013 = ($20,000,000  10%) + ($60,000,000  8%) +

($10,000,000  12%) – $270,000
= $2,000,000 + $4,800,000 + $1,200,000 – $270,000
= $7,730,000
2014 = $2,000,000 + $4,800,000 + $1,200,000 – $1,370,000
= $6,630,000
2015 = $2,000,000 + $4,800,000 + $1,200,000 – $512,500
= $7,487,500
10-40
P10-9 (concluded)
1. Journal entries, 2013:

Construction in Progress .............................................................. 6,000,000
Cash ........................................................................................ 6,000,000
Cash [($10M – $3M)  0.11]......................................................... 770,000
Interest Revenue ................................................................... 770,000
Interest Expense ........................................................................... 7,730,000
Construction in Progress .............................................................. 270,000
Cash [($10M  0.12) + ($20M  0.10) + ($60M  0.08)] ....... 8,000,000
Journal entries, 2014:

Cash ........................................................................................ 11,460,000
Cash ........................................................................................ 8,000,000
Journal entries, 2015:

Cash ........................................................................................ 1,800,000
Construction in Progress .............................................................. 512,500
Cash ........................................................................................ 8,000,000
Building .......................................................................................... 21,412,500*
Construction in Progress ....................................................... 21,412,500
*$6,000,000 + $270,000 + $11,460,000 + $1,370,000 + $1,800,000 + $512,500
2. Under IFRS, the total interest costs of loans obtained specifically for the purpose of
constructing a qualifying asset are eligible for interest capitalization. Therefore, the total
interest expense of construction-related borrowing of $1,200,000 ($10,000,000  12%) is
eligible for interest capitalization. In addition, interest revenue from the temporary
investment of amounts borrowed specifically for construction is offset against interest
costs eligible for capitalization. Therefore, Foothills would capitalize $430,000 ($1,200,000 –
$770,000).
P10-10
1. 2013
Jan. 10 Accumulated Depreciation: Machinery ............... 2,400
Cash (or Accounts Payable) ............................ 2,400
Replacement of motor.
Feb. 14 Repair and Maintenance Expense ........................ 700

Cash (or Accounts Payable) ............................ 700
Repairs to machine.
10-41
P10-10 (concluded)
Mar. 10 Repair and Maintenance Expense ........................ 2,000

Repairs due to accident.
19 Machine .................................................................... 900
Cash (or Accounts Payable) ............................ 900
Replacement of motor.
27 Furniture and Fixtures ............................................... 700
Office Expenses ........................................................ 500
Office rearrangement and painting.
2. Under IFRS, the cost of reorganizing PP&E is expensed. Therefore, the journal entry on
March 27 would be:
Mar. 27 Office Expenses ........................................................ 1,200
Office rearrangement.
P10-11
1. a. Successful-efforts method: The cost of dry wells, $3,000,000 (50%  $6 million), is

expensed in 2013. The cost of successful wells, $3,000,000 (50%  $6 million), is
capitalized in 2013 and expensed over the life of the wells.
On the income statement for 2014, depletion is reported at $300,000 (10%  $3
million). [Depletion is discussed in more detail in Chapter 11]
On the 2014 ending balance sheet, the asset is reported at a net value of
$2,700,000 (the $3,000,000 cost less the $300,000 depletion).
b. Full-cost method: The total cost of $6 million is capitalized in 2013.

On the income statement for 2014, depletion is reported at $600,000 (10%  $6
million). [Depletion is discussed in more detail in Chapter 11]
On the 2014 ending balance sheet, the asset is reported at a net value of
$5,400,000 (the $6 million cost less the $600,000 depletion).
2. Small oil companies generally prefer the full-cost method because it results in higher
asset values on the balance sheet and delays the recognition of expenses on the
income statement.
10-42
ANSWERS TO CASES
C10-1 [AICPA Adapted]
1. The expenditures that are capitalized when equipment is acquired for cash include the
invoice price of the equipment (net of discounts) plus all expenditures relating to its
purchase or preparation for use, such as insurance during transit, freight, duties,
ownership search, ownership registration, installation, and breaking-in costs. Any
available discounts, whether taken or not, should be deducted from the cost of the
equipment.
2. a. When the market value of the equipment is not determinable by reference to a

similar cash purchase, the cost of equipment purchased with bonds having an
established market price is the market value of the bonds.
b. When the market value of the equipment is not determinable by reference to a
similar cash purchase, and the common stock used in the exchange does not
have an established market price the cost of equipment is the equipment’s
estimated fair value if that is more clearly evident than the fair value of the
common stock. Independent appraisals may be used to determine the fair values
of the assets involved.
c. When the market value of equipment acquired is not determinable by reference
to a similar cash purchase, the cost of equipment purchased by exchanging
similar equipment having a determinable market value is the market value of the
equipment given up.
3. The factors that determine whether expenditures relating to property, plant, and
equipment already in use are capitalized relate to whether the expenditures increase
the future economic benefits of the asset. These future economic benefits can be
increased by:
• Extending the useful life of the property, plant, and equipment
• Improving the productivity of the property, plant, and equipment
• Increasing the quality of the product produced
Expenditures are capitalized when they benefit future periods. The cost to acquire the land is
capitalized and classified as land, a nondepreciable asset. Because tearing down the small
factory is readying the land for its intended use, its cost is part of the cost of the land and is
capitalized and classified as land. As a result, this cost is not depreciated as it would be if it was
classified as part of the cost of the building.
Because the rock blasting and removal is required for the specific purpose of erecting the
building, its cost is capitalized as part of the cost of the building. This cost is depreciated over the
estimated useful life of the building.
10-43
C10-2 (concluded)
The road is a land improvement, and its cost is capitalized and classified separately as a land
improvement. This cost is depreciated over its estimated useful life.
The added four stories is an addition, and its cost is capitalized as part of the cost of the building.
This cost is depreciated over the remaining life of the original office building because that life is
shorter than the estimated useful life of the addition.
1. The acquisition cost includes all expenditures necessary to obtain the benefits of the
asset. Specifically, any expenditure necessary to obtain the asset and put it in operating
condition is capitalized. Such cost may include delivery and installation. The acquisition
cost represents the cash equivalent price and accordingly would not include interest
charges.
2. Normal maintenance performed on the new machine should not be capitalized as part
of the machine’s cost. It should be expensed as incurred if the machine is not used in the
manufacturing process or should be inventoried as part of factory overhead if the
machine is used in the manufacturing process. Normal maintenance does not enhance
the service potential of the machine.
3. The wing added to the manufacturing building should be capitalized. The addition
should be depreciated over its estimated useful life or the remaining useful life of the
building of which it is an integral part, whichever is shorter. The addition should be
included in the property, plant, and equipment section of the balance sheet.
4. The leasehold improvements made to the office space should be capitalized. The
leasehold improvements should be depreciated (amortized) over their estimated useful
lives or the term of the lease, whichever is shorter. The unamortized portion of the
leasehold improvements could be included as a separate caption in the property, plant,
and equipment section or the intangible assets section of the balance sheet. The
amortized portion of the leasehold improvements would be shown as an expense on the
income statement.
1. The following costs, if applicable, should be capitalized as a cost of land:

a. Contract price (or negotiated purchase price)
b. Brokers’ commission
c. Legal fees
d. Title fees
e. Recording fees
f. Escrow fees
g. Surveying fees
h. Existing unpaid taxes, interest, or liens assumed by the buyer
i. Clearing, grading, landscaping, and subdividing
j. Cost of removing old building (less salvage)
k. Special assessments such as lighting or sewers if they are permanent in nature
10-44
C10-4 (concluded)
2. A plant asset acquired on a deferred-payment plan should be recorded at its fair value
or the fair value of the liability at the date of the transaction. To measure fair value, the
present value of the deferred payments, discounted at the stated or imputed interest
rate, can be used. Note that this measurement excludes interest from the cost of the
asset. The interest portion (stated or imputed) of the contract price should be charged to
interest expense over the life of the contract.
3. In general, plant assets received in exchange for other nonmonetary assets should be
measured at the fair value of the asset surrendered or the fair value of the asset
received, whichever is more clearly evident. When a small amount of cash is also
exchanged, the plant asset should be recorded at the fair value of the asset surrendered
plus (minus) cash paid (received). A gain or loss will be recognized as the difference
between the fair value and book value of the asset surrendered.
1. Capital expenditures increase the future economic benefits of an asset above those that
were originally expected. Operating (revenue) expenditures maintain the existing
economic benefits.
2. a. The purchase price of the land should be capitalized. The land should be shown
as a noncurrent asset on the balance sheet at its original cost and it is not subject
to depreciation.
b. The cost of constructing the factory should be capitalized and depreciated over
the expected life of the factory. This cost, net of accumulated depreciation,
should be shown as a noncurrent asset on the balance sheet.
c. The cost of grading and paving the parking lot (a land improvement) should be
capitalized and depreciated over the expected life of either the factory or
parking lot, whichever is shorter. The land improvement expenditures, net of
accumulated depreciation, should be shown as a noncurrent asset on the
balance sheet.
d. The cost of maintaining the factory once production has begun is a “revenue
type” expenditure.
C10-6
1. There is no doubt that the first 2,000 acres qualifies for interest capitalization because it
meets the various criteria of GAAP. It meets the criteria of a qualifying asset and the
three criteria for the start of the capitalization period—expenditures have been made,
activities are in progress, and interest cost is being incurred.
The remaining 3,000 acres of the initial 5,000 acres also qualify for interest capitalization.
GAAP specifies that the term “activities” is to be construed broadly and should include
more than physical construction. Since the 5,000 acres were acquired for a single
development, “activities” are in progress on the entire 5,000 acres.
10-45
C10-6 (concluded)
It is less definite whether the adjacent parcel of land qualifies for interest capitalization.
The decision will probably be determined by how the company has developed its plans.
If the plans indicate that the entire project is a single integrated development on which
design work has been performed and permits obtained, then the adjacent parcel of
land would also qualify for interest capitalization. On the other hand, if the company’s
plans indicate that the additional acreage was acquired for speculative reasons and the
design work and permits do not include this additional acreage, then the adjacent
parcel of land does not qualify for interest capitalization.
The development also qualifies for interest capitalization because it meets the criteria of
GAAP.
2. The company could commence activities on all the land by starting such activities as
planning the future expansion. Since GAAP states that the term activities is to be
construed broadly, such actions would allow the company to compute the interest
capitalized on the amounts borrowed to acquire all the land. This would increase the
interest capitalized and the asset value, thereby reducing interest expense and
increasing net income.
C10-7
Capitalize at $100,000: The option costs are not applicable to the purchase price and are,
therefore, not a cost of the land. Rather, they are an expense incurred during the year required
to make a decision and should not be capitalized. The option was for a period of one year and
thus its usefulness has expired and should not be capitalized.
Capitalize at $105,000: Because the option cost of $5,000 was necessary in order to purchase the
desired site, this amount should be capitalized along with the contract price of $100,000. The
option for the site not chosen has no usefulness once the other site was purchased and should
be expensed.
Capitalize at $110,000: In order for the company to make the best choice as to sites, it was
necessary to acquire both options. Therefore, regardless of which site was chosen, the total cost
of both options should be capitalized along with the contract price.
C10-8
According to GAAP, donated assets are recorded at their fair value. The controller’s argument
of no payment by the company is what makes the acquisition a nonreciprocal transfer and thus
governed by GAAP. This procedure also makes the recording of the asset consistent with the
treatment of other assets that are recorded at their fair value at the date of acquisition.
The alteration costs of $15,000 are necessary in order for the company to put the building into
operating condition. These are considered a cost of the building and are capitalized. The
possibility of the building being returned to the city is not relevant to the capitalization of these
costs under GAAP, unless the return is considered probable. The argument that exclusion of the
$15,000 will closer approximate the market value of the building is invalid. There is no relationship
between an asset’s recorded value and its fair value, except by coincidence. The issue of
reducing income taxes is also not relevant to financial reporting.
10-46
1. The valuation of assets that are acquired by a corporation in exchange for its own
common stock is sometimes difficult because of:
a. The absence of a readily determinable fair value for the assets acquired because
they are not traded actively
b. The absence of a readily determinable fair value for the securities given in
exchange, either because they are not traded actively or because the
proportion of the number of shares in this single issue to all shares being traded is
large enough to affect the market price substantially
c. The absence of arm’s length or independent bargaining leading to the
exchange
d. Widely varying estimates of the value of the asset acquired because of its nature
(for example, unexplored or unproved mineral deposits, manufacturing rights,
and patents)
e. The common presumption that when common stock has a par or stated value it
imputes a value to the assets for which it is exchanged
2. The directors of Brahe Corporation appraised the leases at $600,000, and the transaction
involving the stock issuance to Moses and Price supports that appraisal. In the exchange
transaction, a price of $6 per share was imputed to the Brahe Corporation common
stock when 75,000 shares were given to Moses and Price ($6  75,000 = $450,000) in
exchange for assets worth $200,000 and options which, based on the appraisal of the
directors, were worth $250,000. This transaction was followed by a public sale of 180,000
shares of Brahe Corporation common stock at $6 per share, the same price that was
imputed to the stock earlier when Moses and Price obtained 75,000 shares in connection
with the exchange. The fact that the public was willing to purchase, and did purchase,
substantial shares at the same price would indicate that the appraisal value of leases
recorded on the books is a reasonable one. Furthermore, the law allows boards of
directors broad discretion in establishing values, provided there is no fraud.
3. Brahe Corporation might have taken additional steps to demonstrate the

reasonableness of the $600,000 appraisal of leases so that more information would be
available if questions were raised about their possible overvaluation. Because the
appraisal was based solely upon the lease price of certain other acreage in the area, it
would have been wise to obtain supplementary appraisals by independent competent
technicians to support the value. This is particularly true because the board was not
independent, having been elected by Moses and Price, who were the sole shareholders,
and also the parties who were offering the options to Brahe Corporation. In addition,
Brahe Corporation could have compiled data to substantiate beyond doubt the reasons
why an acceptable bargain purchase did exist here in permitting the purchase with
options for only $350,000 of leases worth the substantially higher amount of $600,000.
4. Based on available information, Brahe Corporation should charge 1/10 of the value of
the leases against income at December 31, 2013, in accordance with generally
accepted accounting principles. However, this should not be done if (a) the total lease
acreage can be regarded as a unitary whole or (b) the investment was made with
anticipation that some portion of the total acreage obtained would prove worthless.
10-47
C10-10
Note to Instructor: This case does not have a definitive answer. From a financial reporting
perspective, GAAP is identified and summarized. From an ethical perspective, various issues are
raised for discussion purposes.
From a financial reporting perspective, there are 3 issues. The first issue relates to when interest
capitalization begins. Under GAAP, it begins when (1) expenditures for the asset have been
made, (2) activities that are necessary to get the asset ready for its intended use are in progress,
and (3) interest cost is being incurred. Assuming that the company has debt and that the
architect has been paid (often a retainer is paid), then the three conditions probably were met
in 2012. A second issue is the costs that can be included. The expenditures on which interest is
capitalized are the cumulative capitalized expenditures on the project. This would allow
including 1/12 of the accountant’s salary and similar expenditures, although it would be
necessary to have documentation that such costs were directly related to the project. The third
issue is how to report the interest cost if there was no capitalization in 2012. If interest was not
capitalized, then this is an error because there was a misapplication of accounting principles.
The error would be accounted for as a prior-period adjustment. So, the CEO has to accept the
“good” of maximizing the interest capitalization in 2013 and the “bad” of admitting to an error in
applying accounting principles (even though income in 2012 will be increased by the error
correction). Of course, the suggestion of including 2012’s interest capitalization in 2013 is not
appropriate.
From an ethical perspective, the issue is whether it is appropriate to “dump” costs into the
project so that the costs are maximized, interest capitalized is maximized, interest expense and
other expenses are minimized, and net income is maximized. The primary stakeholders are the
company’s current and potential shareholders and creditors. Accounting principles allow for
judgment on these issues and expect that professional judgment be exercised. On the other
hand, if the net income amount is not grounded in economic reality, current and potential
shareholders may be misled about the value of an investment in the company. Also, the CEO
should be reminded that the higher cost of the building will result in higher depreciation
expense, although that long-term perspective may be of no concern.
C10-11
1. Coca Cola reported property, plant, and equipment at a cost of $21,706 million, net of
accumulated depreciation of $6,979 million. Therefore, the net amount of property,
plant, and equipment is $14,727 million.
2. Coca Cola reports the following items of property, plant, and equipment with the
reported cost in parenthesis: land ($1,122 million); buildings and improvements ($4,883
million); machinery, equipment and vehicle fleet ($9.834 million); cold drink equipment
($3,587 million); containers ($826 million); and construction in progress ($1,454 million).
3. Construction in progress represents the cost of self-constructed property, plant, and

equipment that has not yet been completed. Note that Coca Cola does not depreciate
construction in progress until the asset is ready for service. At that time, the cost of the
asset will be transferred to the appropriate fixed asset account.
10-48
C10-11 (concluded)
4. The capitalization of interest in 2010 resulted in a decrease in interest expense reported

on the income statement and an increase in property, plant, and equipment and
shareholders’ equity. This capitalized interest will be depreciated over the expected lives
of the related assets.
5. According to the statement of cash flows, $2,215 million of property, plant, and
equipment were purchased in 2010.
6. As disclosed in footnote 1, repair and maintenance costs that do not improve service
potential or extend economic life are expensed as incurred.
7. Coca Cola’s fixed asset turnover ratio is (amounts in millions):

Net Sales $35,119
= = 2.89
Average Fixed Assets ($9,561+$14,727)/2
This ratio indicates that for each dollar of fixed assets, Coca Cola generates $2.89 of
sales. Generally, the higher the ratio, the more efficiently a company is using its fixed
assets.
C10-12
1. LVMH reported gross property, plant, and equipment of €11,354 million, net of
depreciation and impairment of €4,621 million. Therefore, the net amount of property,
plant, and equipment is €6,733 million.
2. LVMH reports the following items and net amounts of property, plant, and equipment:
Land (€916 million); vineyard land and producing vineyards (€1,828 million); buildings
(€988 million); investment property (€297 million); machinery and equipment (€1,704
million); and other tangible fixed assets, including assets in progress (€1,000 million).
3. With the exception of vineyard land, the gross value of property, plant, and equipment is
stated at acquisition cost, with any borrowing costs incurred during construction
capitalized as part of the asset. Vineyard land is recognized at market value on the
balance sheet date (the revaluation model) with the change in market value
recognized in equity in an account called “Revaluation reserves”. If the market value
falls below acquisition cost, an impairment loss is recognized on the income statement.
For 2010, the market value of the vineyard land increased €206 million.
10-49
ANSWERS TO USING CODIFICATION
C10-13
Note to Instructor: Students are expected to cite references to GAAP in their research of this
issue. While they might use various sources to conduct their research, the FASB Accounting
Standards Codification, which is the primary source of GAAP, is cited.
1. To: President, Tenth National Bank
From: Student
I have researched the issue of how to account for the costs of removing the asbestos
from the two buildings. According to the FASB Statement of Financial Accounting
Concepts No. 6, par. 25 and 26, assets are probable future economic benefits obtained
or controlled by a particular entity as a result of past transactions or events. Also, an asset
involves a capacity to contribute directly or indirectly to future cash flows.
First, I will deal with the office building that was purchased with a known asbestos
problem. The $2 million cost of removing the asbestos may be considered to be a cost
that was necessary to prepare the building for its intended use. It may also be argued
that the cost of $2 million indirectly contributes to the future cash inflows because without
the cost the building could not be used. Both these arguments assume that the selling
price was reduced because of the known estimated costs of removing the asbestos.
Based on these issues, I recommend that the $2 million be capitalized to the cost of the
building.
Note that a counter argument is that the $2 million is a “maintenance” cost that does
not extend the useful life or improve the physical structure beyond the state in which it
was originally intended to be used. Under this argument, the cost would be expensed.
The second issue is the shopping mall in which the asbestos problem was not known at
the time the building was acquired. The following alternatives may be considered:
a. Expense the $1 million because it is a “maintenance” cost that does not extend
the useful life or improve the property beyond its original state. Instead the cost
returns the building to its normal state of repair. Also, it may be argued that the
“extra” cost does not benefit future periods.
b. Capitalize the $1 million for the reasons outlined earlier for the office building.
Also, it may be argued that incurring the costs has extended the life of the mall
because without the costs the life would be very short. However, these arguments
assume that the mall can be sold at a profit; that is, the $1 million can be
recovered through a sale. If a loss is expected, the cost must be expensed.
c. Capitalize the portion of the $1 million that relates to “normal” replacement of
the affected portions of the building and expense any “special” costs incurred
because of the asbestos problem.
I recommend that the $1 million be expensed (unless it can be demonstrated that the
amount will be recovered through a sale which seems unlikely since the building was
obtained through a foreclosure).
10-50
C10-13 (concluded)
Another issue is how to classify the expense. Three alternatives are:

a. Report it as an extraordinary item because it is considered to be unusual and
infrequent (FASB ASC 225-20-45). This alternative is difficult to justify because of the
numerous asbestos problems affecting large numbers of buildings.
b. Report it as an unusual or infrequent item that is disclosed as a separate line item
on the income statement. This alternative is easier to justify because asbestos
problems have occurred infrequently for this bank.
c. Report it as an operating expense with no special disclosure on the income
statement.
I recommend that the $1 million be classified as an operating expense with no special

disclosure on the income statement because asbestos problems have become so
widespread and banks frequently repossess buildings, thereby making the cost neither
unusual nor infrequent. However, disclosure in the notes to the financial statements may
be appropriate.
Note that this recommendation does not consider the value at which the repossessed
shopping mall is carried.
2. Students may raise ethical issues, such as:

a. Conflicts between the interests of different stakeholders—particularly
management, shareholders, and the government.
b. The disclosure responsibilities of sellers.
c. The liability exposure of professionals who provide estimates of future costs.
10-51
Solution Manual for Intermediate Accounting Reporting and Analysis 1st Edition by Wahlen
C10-14
Note to Instructor: Students are expected to cite references to GAAP in their research of this
issue. While they might use various sources to conduct their research, the FASB Accounting
Standards Codification, which is the primary source of GAAP, is cited.
1. To: President, Perry Park Company
From: Student
I have researched the various issues involved in the exchange of the shares for the land
and building. I will address each of the major issues you raised:
a. Does the transaction qualify as an exception to the general rule to use fair value.
Since no cash was exchanged, it is a nonmonetary exchange. However,
according to FASB ASC 845-10-30, a company would recognize the exchange
transaction at book value if (1) neither the fair value of the asset received or
given up is reasonably determinable, (2) the transaction is an exchange of
inventory to facilitate sales to a third party, or (3) the transaction lacks
commercial substance. Clearly, the second and third exceptions do not apply. It
would be very difficult to argue that the fair value was not determinable since the
two parties negotiated a transaction and an appraisal of the land and building
could be obtained. An appraisal of the company’s shares could also be
obtained but would probably be more costly and less reliable since the company
is privately held.
b. What is the value to place on the transaction and its components? According to
FASB ASC 845-10-30, either the value of the shares or the value of the land and
building should be used, whichever is the most reliable. If both values are equally
unreliable, it is preferable to use the value of the assets because it is independent
of the value of the shares. A final alternative is to have the Board of Directors
place a value on the transaction.
2. Students may raise ethical issues, such as:

a. Conflicts between the interests of different stakeholders—particularly
management, shareholders, and the government
b. How value assigned by each entity will affect net income and perhaps
management compensation such as bonuses
c. The allocation of a tax basis to each depreciable asset and the effect of that
choice on the depreciation deduction used to compute taxable income
10-52
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Property, Plant, and Equipment: Acquisition and Subsequent Investments

CONTENT ANALYSIS OF END-OF-CHAPTER ASSIGNMENTS

Property, Plant, and Characteristics for potential

Q10-4 Equipment sheet inclusion 2 Easy 5 Analytic Measurement Comprehension

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Accounting for trading of

Accounting for donated

Interest During Computation of capitalized

Compute total acquisition

Cost assigned to land,

Cash, gain, and loss;

Self-Construction Determination of amount to 4 Moderate 10 Analytic Measurement Analysis

Calculating Compute amount of 4 Moderate 15 Analytic Measurement Analysis

E10-21 Accounting methods; determination of Moderate

Assets Acquired by Various situations dealing 3 Challenging 35 Analytic Measurement Synthesis

Events Subsequent to Replacement, repairs, 5 Moderate 25 Analytic Measurement Analysis

C10-3 record acquisition; 5

Capitalization of Accounting for purchase 2 Moderate 20 Analytic Measurement Analysis

Q10-18 The distinction between a capital expenditure and an operating expenditure is

ANSWERS TO MULTIPLE CHOICE

SOLUTIONS TO REVIEW EXERCISES

Cost of land: $55,000 + $2,000 + $7,500 = $64,500

Cost of building: $250,000 + $3,500 + $125,000 = $378,500

Appraisal Relative Total Allocated

Amount to be paid off each year: $350,000  7 = $50,000

$50,000  4.868419 = $243,421 (rounded)

Cost of asset acquired = Fair value of asset surrendered – Cash received

Weighted average interest rate:

$3,000,000  12% = $360,000

Portion of Weighted Average

Capitalized interest = Weighted average accumulated expenditures x Interest rate

$1,000,000  10% = $100,000

Alternative 1: Reduce accumulated depreciation

Alternative 2: Increase the asset account

1. The following are included in property, plant, and equipment:

2. a. Idle equipment awaiting sale is not being used in operations. It is normally

1. The following are included in the cost:

The following are not included in the cost:

Machine ........................................................................................ 213,000*

E10-5 [AICPA Adapted]

Cash equivalent price ................................................................. $9,500

Machine ........................................................................................ 9,800

E10-6 [AICPA Adapted]

1. Acquisition cost ............................................................... $200,000

Cost assigned to:

Next, the increase in value from $104,000 to $106,000 is recorded as follows:

3. The different accounting is justified because when an exchange has commercial

Building (Warehouse (new)) ....................................................... 33,000a

E10-14 [AICPA Adapted]

2. Allocating a portion of overhead to the cost of the self-constructed asset is a full-costing

1. Weighted average accumulated expenditures are calculated as:

Avoidable interest is calculated as:

Actual interest is calculated as:

1. Weighted average accumulated expenditures are calculated as:

Avoidable interest is calculated as:

Actual interest is calculated as:

1. Weighted average accumulated expenditures are calculated as:

Avoidable interest is calculated as:

Actual interest is calculated as: