Question

(Purchases by Deferred Payment, Lump-Sum, and Nonmonetary Exchanges) Klamath Company, a manufacturer of ballet shoes, is experiencing a period of sustained growth. In an effort to expand its production capacity to meet the increased demand for its product, the company recently made several acquisitions of plant and equipment. Rob Joffrey, newly hired in the position of fixed-asset accountant, requested that Danny Nolte, Klamath’s controller, review the following transactions.

Transaction 1: On June 1, 2017, Klamath Company purchased equipment from Wyandot Corporation. Klamath issued a \(28,000, 4-year, zero-interest-bearing note to Wyandot for the new equipment. Klamath will pay off the note in four equal installments due at the end of each of the next 4 years. At the date of the transaction, the prevailing market rate of interest for obligations of this nature was 10%. Freight costs of \)425 and installation costs of \(500 were incurred in completing this transaction. The appropriate factors for the time value of money at a 10% rate of interest are given below.

Future value of \)1 for 4 periods	1.46
Future value of an ordinary annuity for 4 periods	4.64
Present value of \(1 for 4 periods	0.68
Present value of an ordinary annuity for 4 periods	3.17

Transaction 2: On December 1, 2017, Klamath Company purchased several assets of Yakima Shoes Inc., a small shoe manufacturer whose owner was retiring. The purchase amounted to \)220,000 and included the assets listed below. Klamath Company engaged the services of Tennyson Appraisal Inc., an independent appraiser, to determine the fair values of the assets which are also presented below.

	Yakima Book Value	Fair Value
Inventory	\( 60,000	\) 50,000
Land	40,000	80,000
Buildings	70,000	120,000
	\(170,000	\)250,000

During its fiscal year ended May 31, 2018, Klamath incurred \(8,000 for interest expense in connection with the financing of these assets.

Transaction 3: On March 1, 2018, Klamath Company exchanged a number of used trucks plus cash for vacant land adjacent to its plant site. (The exchange has commercial substance.) Klamath intends to use the land for a parking lot. The trucks had a combined book value of \)35,000, as Klamath had recorded \(20,000 of accumulated depreciation against these assets. Klamath’s purchasing agent, who has had previous dealings in the secondhand market, indicated that the trucks had a fair value of \)46,000 at the time of the transaction. In addition to the trucks, Klamath Company paid $19,000 cash for the land.

Instructions

1. Plant assets such as land, buildings, and equipment receive special accounting treatment. Describe the major characteristics of these assets that differentiate them from other types of assets.
2. For each of the three transactions described above, determine the value at which Klamath Company should record the acquired assets. Support your calculations with an explanation of the underlying rationale.
3. The books of Klamath Company show the following additional transactions for the fiscal year ended May 31, 2018.
   1. Acquisition of a building for speculative purposes.
   2. Purchase of a 2-year insurance policy covering plant equipment.
   3. Purchase of the rights for the exclusive use of a process used in the manufacture of ballet shoes.

For each of these transactions, indicate whether the asset should be classified as a plant asset. If it is a plant asset, explain why it is. If it is not a plant asset, explain why not, and identify the proper classification.

Short answer

1. Tangible assets have a physical existence, whereas intangible assets do not.
2. Transactions:

1. Asset cost: $23,115

2. Cost paid to finance acquisition: $8,000

3. Cost of land $65,000

3. In the books of the Klamath Company

1. The building is not treated like a plant used for speculative purpose

2. Plant as it has no physical existence and sustainability.

3. The rights should be classified as intangible assets.

Step-by-step solution

Meaning of Acquisition of Cost

In accounting terms, acquisition cost alludes to acquiring a particular thing. There are three common trade contexts when it is utilized: mergers and acquisitions, fixed resources, and client acquisition.

(a) Explaining major characteristics of plant assets

The primary qualities that distinguish plant assets from other types of assets are listed below:

1. It is not for resale that plant assets are acquired. They are used in the regular operations of a business.
2. It is essential to distinguish tangible assets such as patents and goodwill from intangible assets such as property, plants, and equipment.Plant, machinery, and equipment are not physically part of the product for sale, as opposed to other assets that have physical substance (like raw materials).
3. In most cases, durable long-term assets are liable to depreciation.

(Transaction 1) Determining the value at which Klamath Company should record the acquired assets

Assets bought under deferred payment contracts should be valued at the present value of the consideration exchanged between the contracting parties at the consideration date to represent cost accurately. Interest must be credited at a rate that approximates the rate agreed in an arms-length transaction where no interest rate is indicated. In addition, any expenditures associated with preparing the asset for its intended use are called asset costs.

Working notes:

Calculation of asset cost

$\begin{array}{rcl}\mathrm{Asset}\cos & =& \mathrm{Present}\mathrm{value}\mathrm{of}\mathrm{the}\mathrm{note}+\mathrm{Freight}+\mathrm{Installation}\\ & =& \frac{\$28,000}{4}\times 3.17+\$425+\$500\\ & =& \$22,190+925\\ & =& \$23,115\\ & & \end{array}$

(Transaction 2) Determining the value at which Klamath Company should record the acquired assets

The entire cost of a lump-sum acquisition of a collection of assets should be allocated among the individual assets based on their respective fair valuations. The $8,000 in interest costs paid to finance the acquisition is a period cost and is not included in the asset cost calculation.

Assets	Calculation	Amount
Inventory	$\$220,000\times \left(\frac{\$50,000}{\$250,000}\right)$	$ 44,000
Land	$\$220,000\times \left(\frac{\$80,000}{\$250,000}\right)$	$ 70,400
Building	$220,000 x ($120,000/$250,000)	$105,600

(Transaction 3) Determining the value at which Klamath Company should record the acquired assets

The asset’s fair value and any cash paid should be recorded as the cost of a nonmonetary item acquired in a commercially significant transaction. In addition, any profit made on the trade is recorded.

The fair value of trucks	$46,000
Cash paid	19,000
Cost of land	$65,000

(c1) Explaining the acquisition situation of a building for speculative purposes

As it is not used in routine operations, a structure acquired for speculative reasons is not a plant asset. The structure would be better described as an investment.

(c2) Explaining the purchase of a 2-year insurance policy covering plant equipment

Since it has no physical substance and is not durable, the two-year insurance policy covering plant equipment is not a plant asset. This insurance should be classed as a current asset (for the portion used within the next 12 months) and another asset (for the amount used over the following 12 months).

(c3) Explaining the purchase of the rights for the exclusive use of a process used to manufacture ballet shoes

The exclusive right to use the process used in the manufacture of ballet shoes is not a property because they have no physical substance. Intangible assets are those that should be treated as rights.