 Hello and welcome to the session in which we would look at valuation of property, plant and equipment. And simply what does that mean? It means when we purchase the asset, how do we record those assets? Well, here are the rules. Property, plant and equipment are recorded at the fair value of the asset given up. What is given up? What did you give up? Usually, let's assume you paid $100,000 for an asset. You gave up $100,000 and you got the asset in return. That's pretty straightforward. What's the value of the asset? $100,000. And this is what we mean by the fair value of what you are given up. Or if you don't know this information, the fair value of the asset received. If we don't know how much we gave up, sometimes we may buy an asset other than cash, then if we don't know the value of that asset, the value of that thing, whatever that thing is, we look at the value of the other asset received. If we know the value of the asset received, we use the value of the asset received as the valuation basis. Why are we saying this? Well, there are many methods to acquiring property, plant and equipment, not only one method. Well, we set cash as the easiest method. If you know how much you paid for an item, that's pretty straightforward. Sometimes you might issue a loan or a debt or issue bonds to get the asset. Sometimes you might buy, you may pay one price. For example, you may pay $100,000 for one price and you might purchase many assets, asset one, asset two, asset three. How do you allocate those $100,000? Sometimes you might be issuing stocks to buy an asset. How do you value the asset? And sometimes you might be doing what's called an exchange of non-monetary asset. You are giving up an asset and receiving another asset. How do you record those assets? This topic is obviously covered in an intermediate accounting and on the CPA exam. Whether you are an accounting student or a CPA candidate, I strongly suggest you take a look at my website, farhatlectures.com. I don't replace your CPA review course. You keep it. I'm a useful addition to your CPA review course. I can help you understand the material better, a little bit more in depth. I can give you more examples. I can show you the theory behind the concept. Then in turn, your CPA review course will work better. Your risk is one month of subscription. You can give it a try. You like it. You find it helpful. You keep it. Otherwise, you cancel. Your potential gain is adding 10 to 15 points to your exam. Are you willing to take that risk? If not for anything, take a look at my website to find out how well or not well your university doing on the CPA exam. My CPA supplemental resources are aligned with your Becker, Roger, Wiley, Gleams or whatever CPA review course you are taking. You can go back and forth between my material. This is a list of all my accounting courses. I have lectures, multiple choice through false. So it's going to help you understand the material better. I have all the AI CPA previously released questions, almost 1500 with detailed solutions. It will help you tremendously if you're preparing for the exam. If you have not connected with me on LinkedIn, please do so. Take a look at my LinkedIn recommendation, like this recording, share it with other, connect with me on Instagram, Facebook, Twitter and Reddit. Let's start with cash transaction. Cash transaction are easy and straightforward. Adam Company purchases an equipment for 100,000. Debate the equipment for 100,000. Credit cash for 100,000. Sometime you might be asked, what happened if there is a discount? If a cash discount is available and the company took advantage of the discount, let's assume because we pay cash, they reduce the cost by 3,000 by 3%. Well, our cost becomes 97,000. Also, what happened if you don't take the discount? Well, if you don't take the discount, there are two school of thought and they're both acceptable. One is you reduce the cost of the asset. You'd say, I technically lost 3,000 because I did not take advantage of this. Reduce the cost or simply ignore the discount because the discount is worth it. Both are acceptable. Sometime we buy an asset rather than paying cash, we issue a notes payable. We promise to pay for this in the future. How do we deal with this type of transaction? Let's take a look at an example. Adam Company purchases a specialty delivery drone for 100,000 by issuing 0% interest-bearing loan payable and five annual installment of 20,000. The prevailing interest rate for similar loan is 8%. The fair value of the drone is not known. Well, here's what happened. We wanted to buy a drone, a delivery drone for our business. Well, we don't have the cash to pay for it up front. So we promise to pay 20,000, 20,000, 20,000, 20,000 and another 20,000, five installment payment. And that's the deal between us and the seller. Now, we don't know the fair value of the drone. Therefore, we cannot know the fair value of the drone. In other words, we have to know how much are we going to be given up to buy this asset? Well, we're going to be given up in total 100,000, five payments of 20,000. But remember, we are not paying the $100,000 today. If we were paying the $100,000 today, it's easy peasy, $100,000. That's not the case. So what we have to do now is we have to discount those 20,000, five payments to the present value. Simply put, the value of the equipment, the true value is the present value of the payments because what's embedded in those payment is an interest component. Now, they're giving us the interest rate as i. i is 8%. The interest rate is 8%. We know the annual payment. It's an annual payment of five years. What we have to do is we have to take the payment times the present value of the ordinary annuity. Now, in your textbook, you'll go to the present value table, the present value table of an annuity, and specifically, ordinary annuity. Ordinary annuity because the first payment starts a year from now. And what we find out if we take 20,000 times the present value of the ordinary annuity. Now, if you don't know what ordinary annuity is, what I'm doing here, you have to go to my time value chapter and know it in depth because you need to know the time value of money. Therefore, the true cost, simply the true cost of this drone is $79,854.20. Why? Well, what about we're paying $100,000? Well, the difference really is interest. You are financing this transaction. Therefore, what we do is we debit the equipment for only $79,854,020 and we have to pay in total $100,000. Hold on a second. We're missing $20,145.80. We call this discount on notes payable. Now, what is this discount on notes payable? This is the interest component. The discount is the interest component. Simply put, on this loan, on this loan, we're going to be incurring in total $20,145.80. But we cannot record the interest today because the interest accumulates over time. Therefore, for now, we book this interest and quote this interest in a discount. Then we're going to amortize the discount to interest expense and we'll see how. Simply put, this discount will turn into interest expense. But for now, it sits there as a discount. The first thing I want to show you is your loan balance. If I ask you, what is your loan balance? Well, the loan balance is the notes minus any unamortized discount. So your loan balance today is $79,854,020. It happens to be the same as the equipment. And you're going to see why I'm doing this. Let's make the first payment a year from now. The payment is $20,000. We're going to credit cash $20,000. Debit's notes payable $20,000. So let's create an account for notes payable. So this is an account for notes payable. We started the notes payable at $100,000 when we purchased the asset. Then now for the first payment, we reduced it by $20,000. Therefore, the notes payable is $80,000. Now we have to compute the interest. Remember, we have to allocate part of the cost. We have to allocate part of the discount to interest. How do we allocate the discount to the interest? Well, we're going to take the loan balance at the beginning of the period, which is $79,854 times the prevailing rate is 8%. And we're going to come up with interest expense of, this is going to give us $6,388.33. Therefore, we debit interest expense credit discount on notes $6,388.33. What am I going to do now? I'm going to show you what's going to happen to the note. Now the discount on notes payable, we have the discount on notes payable. The beginning balance was a debit of $20,145.80. And now we reduced it by $6,388.33. Now I need to know what my balance is. It's very important to keep track of your balance minus $6,300. So your balance is $13,756.87. So this is your balance after the first payment for the note as well as the discount. Now, why am I doing this? The reason I'm doing this is to show you your loan balance. Now your loan balance, your loan balance, when you start year two is $80,000 minus $13,756.87, which is equal to how much? Let me do this. It's very important to know this in case you are being asked about your interest expense, period two. Now your loan balance becomes $66,243.13. Now, when we're going to be making the second payment, the second payment, well, notes payable and cash is the same. This will be the same. However, what you have to do now, you have to compute your interest expense. Your interest expense will be the $66,243.08. Let me do this times .08, and that's going to give us interest of $5,299.45. Therefore, in year two, your interest expense will be $5,299.45, $5,299.45. Again, you'll have to reduce your note by 20. It becomes 60 now, and you have to reduce your discount by $5,299.45, and you will have a new balance for the discount, new balance for the note, and you compute your new balance, and you keep on going until you discount, until you amortize the whole discount. And we're going to revisit this topic a little bit more in detail how to amortize the loan and how to account for the interest expense in the liabilities chapter. But you have to notice in case you are being asked for the first payment, the second payment, the third payment, it does not matter. It all follow the same concept. Another way we can buy assets, property, planted equipment is through a lump sum purchase. How does it work? Let's assume we purchase a pizzeria for $100,000, and that pizzeria include land, building, and the kitchen equipment. Well, what do we have to do? Well, we have to allocate the $100,000 to the three assets. How do we do so? Let me show you how we do it. We use the relative fair value. Well, we said we value the asset. We bring in a praser, a specialty, and say, okay, value the land. Well, the land itself is worth 65. I'm sorry, the building itself is worth 65. The land is worth 55, and the equipment in the kitchen worth $10,000. So the total fair value of all the assets is $130,000. Now, what we do is we find the relative value of each asset. Building represents 65 out of 130, 65 out of 130, or 50%. The land represents 55 out of 130, which is 42.3, and the equipment represents 10,000 out of the 130, 7.33. Make sure your percentage adds up to 100%. You paid 100,000 for all of them. Therefore, what we do is we take the percentage times 100,000, the percentage times the 100,000, we're going to allocate $50,000 to the land, I'm sorry, to the building, $340,000 for the land, $740,000 for the building, and this is our $100,000. Therefore, the entry would look something like this. You debit the land, $100,000, you debit the building, $50,000, you debit the land, $42,300, you debit the equipment, $7,700, and you credit cash, $100,000. So what you did is you used the relative fair value. We looked at this and when we did inventory, and you're going to see the relative fair value and other concept. Very important and straightforward concept, relative fair value. Sometime we buy property, plant, and equipment by issuing stocks. Well, stocks are a good example of what we learned earlier. Property, plant, and equipment are recorded at the fair value of what's given up or the fair value of the asset received. First, we find out, do we know how much we are given up? If we know the fair value, that's easy. Again, think about cash. If we don't know the fair value of what we are given up, we look at the fair value of what we are receiving. Let's take a look at two examples to illustrate this concept. Amazon purchased a New Jersey on Route 35, a warehouse, a New Jersey on Route 35 by exchanging 800 shares of its common stock. So they wanted to buy a warehouse. They went to the seller and they told the seller, we'll give you 800 shares of our Amazon par value stock. The fair value of the Amazon stock was 3,580. The seller listed the warehouse for 3 million. Well, the seller can list the asset of how much they want to. Amazon know they exchange 800 shares and each share is worth 3,580. Therefore, as far as Amazon is concerned, if they gave up 800 shares and the fair value of the share is known, therefore, they're going to debit the warehouse for 2,864,000. The seller can list it for 10 million, for 20 billion, for a zillion, it does not matter. Amazon knows what they gave up and this is how much they gave up. So we went with the fair value of what the asset given up. Now we credit common stock for 800, which is the number of shares times the par value and anything left is additional paid in capital. Additional paid in capital, which is the difference between the two, which is 2,863,800. Now let's assume Wawa, rather than Amazon Wawa. Wawa is a private company. If you don't know what Wawa is, it's a convenience store. I love Wawa. It's my favorite store. So Wawa is a private company. So Wawa is a private company. Amazon is a public company and that's why we know the price of Amazon. So the private companies, their stock is not traded. So let's assume Amazon purchased the same house, the same warehouse and they gave the seller 2,000 shares of their Wawa stocks. The Wawa stock, let's assume it has no par value for simplicity. Wawa stock value is not known. As I mentioned, it's a private. However, the warehouse was appraised at 2,950,000. So the seller says, I'm listing it for 3 million. The seller can list it for whatever price. What Wawa would do or what this buyer and the seller would agree to do is to bring in appraiser, someone, an outside party and appraise the warehouse. We could also appraise Wawa stock if we want to, but that's going to take more time because you have to appraise the whole company to find out how much Wawa stock is worth. It's easier just to appraise the warehouse. Now, what we know, we know the warehouse is worth 2,950,000. Well, if the seller accepted 2,000 shares, then that's the value of the deal. The warehouse is 2,950,000 and common stock is 2,950,000. And in a sense, if you really think about it, if the seller accepted 2,000 shares of stock in exchange for a warehouse worth 2,950,000, what happened is they also price Wawa stock at 1,475. Why? Because if the seller accepted something worth for 2,950,000, accepted 2,000 shares of Wawa stock, it means each share is worth for the seller 1,475. And we can say that's the fair value of the stock at that point at least because each exchange, remember, and this is important for the next concept we're going to be talking about, we assume that the exchange is equal. When I give you something, and you give me something in return for both of us, the exchange is equal. So this is what we are saying. Now, the best way to learn about this is to work additional multiple choice, true false questions and exercises. And this is where my website will come very handy to help you understand this. At the end of this recording, I'm going to remind you whether you are an accounting student or a CPA candidate to take a look at my website. I can help you understand the material better. I can give you additional resources. I can supplement. I can supplement your education. I can supplement your CPA preparation. Invest in yourself. The CPA is worth it. Don't shortchange yourself and stay safe.