Chapter 10 Property, Plant and Equipment and intangible assets: acquisition and disposition Sommers ACCT 3311

1. Chapter 10 Property, Plantand Equipmentand intangible assets: acquisition and dispositionSommers � ACCT 3311 Chapter 1: Environment and Theoretical Structure of Financial Accounting.Chapter 1: Environment and Theoretical Structure of Financial Accounting.

2. Discussion Questions Q10�10 When an item of property, plant, and equipment is disposed of, how is gain or loss on disposal computed?

3. Dispositions Steps: Update depreciation to date of disposal. Remove original cost of asset and accumulated depreciation from the books. Record what you received. The difference between book value of the asset and the amount received is recorded as a gain or loss. Part I. After using property, plant, and equipment and intangible assets, companies dispose of them by sale, retirement, or exchanging them for other assets. Three accounting steps are involved in dispositions: ? update depreciation to the date of disposal. ? remove the original cost of the asset and its accumulated depreciation from the books. ? record a gain or loss for the difference between the book value of the asset and  the amount received. Consider the following example where an asset is sold for cash. Part II. On June 30, 2011, MeLo, Inc. sold equipment for $6,350 cash. The equipment was purchased on January 1, 2006 at a cost of $15,000. The equipment was depreciated using the straight-line method over an estimated ten-year life with zero salvage value. MeLo last recorded depreciation on the equipment on December 31, 2010, its year-end. Prepare the journal entries necessary to record the disposition of this equipment. Part I. After using property, plant, and equipment and intangible assets, companies dispose of them by sale, retirement, or exchanging them for other assets. Three accounting steps are involved in dispositions: ? update depreciation to the date of disposal. ? remove the original cost of the asset and its accumulated depreciation from the books. ? record a gain or loss for the difference between the book value of the asset and the amount received. Consider the following example where an asset is sold for cash. Part II. On June 30, 2011, MeLo, Inc. sold equipment for $6,350 cash. The equipment was purchased on January 1, 2006 at a cost of $15,000. The equipment was depreciated using the straight-line method over an estimated ten-year life with zero salvage value. MeLo last recorded depreciation on the equipment on December 31, 2010, its year-end. Prepare the journal entries necessary to record the disposition of this equipment.

4. Exchanges Generally cost of asset acquired is: fair value of asset given up plus cash paid or minus cash received or fair value of asset acquired, if it is more clearly evident In the exchange of operational assets, fair value is used except in rare situations in which the fair value cannot be determined or the exchange lacks commercial substance. When fair value cannot be determined or the exchange lacks commercial substance, the asset(s) acquired are valued at the book value of the asset(s) given up, plus (or minus) any cash exchanged. No gain is recognized. Part I. Operational assets are sometimes acquired in exchanges for other operational assets. Trade-ins of old assets in exchange for new assets is probably the most frequent type of exchange. Cash is involved in the transactions to equalize fair values. The general principle to be followed is that the cost of the asset acquired is: equal to the fair value of asset given up plus cash paid or minus cash received, or equal to the fair value of asset acquired, if that is more clearly evident. A gain or loss is recognized for the difference between the fair value of the asset given up and its book value. Part II. We follow the general principle based on fair value in the exchange of operational assets except in rare situations in which the fair value cannot be determined or the exchange lacks commercial substance. When fair value cannot be determined or the exchange lacks commercial substance, the asset(s) acquired are valued at the book value of the asset(s) given up, plus (or minus) any cash exchanged. No gain is recognized. Let�s look at an example where fair value cannot be determined. Part I. Operational assets are sometimes acquired in exchanges for other operational assets. Trade-ins of old assets in exchange for new assets is probably the most frequent type of exchange. Cash is involved in the transactions to equalize fair values. The general principle to be followed is that the cost of the asset acquired is: equal to the fair value of asset given up plus cash paid or minus cash received, or equal to the fair value of asset acquired, if that is more clearly evident. A gain or loss is recognized for the difference between the fair value of the asset given up and its book value. Part II. We follow the general principle based on fair value in the exchange of operational assets except in rare situations in which the fair value cannot be determined or the exchange lacks commercial substance. When fair value cannot be determined or the exchange lacks commercial substance, the asset(s) acquired are valued at the book value of the asset(s) given up, plus (or minus) any cash exchanged. No gain is recognized. Let�s look at an example where fair value cannot be determined.

5. P10-6 Southern Company owns a building that it leases. The building�s fair value is $1,400,000 and its book value is $800,000 (original cost of $2,000,000 less accumulated depreciation of $1,200,000). Southern exchanges this for another building owned by the Eastern Company. The building�s book value on Eastern�s books is $950,000 (original cost of $1,600,000 less accumulated depreciation of $650,000). Eastern also gives Southern $140,000 to complete the exchange. The exchange has commercial substance for both companies. Prepare the journal entries to record the exchange on the books of Southern.

6. P10-6 Southern Company owns a building that it leases. The building�s fair value is $1,400,000 and its book value is $800,000 (original cost of $2,000,000 less accumulated depreciation of $1,200,000). Southern exchanges this for another building owned by the Eastern Company. The building�s book value on Eastern�s books is $950,000 (original cost of $1,600,000 less accumulated depreciation of $650,000). Eastern also gives Southern $140,000 to complete the exchange. The exchange has commercial substance for both companies. Prepare the journal entries to record the exchange on the books of Eastern.

7. Exchange Lacks Commercial Substance When exchanges are recorded at fair value, any gain or loss is recognized for the difference between the fair value and book value of the asset(s) given-up. To preclude the possibility of companies engaging in exchanges of appreciated assets solely to be able to recognize gains, fair value can only be used in legitimate exchanges that have commercial substance. A nonmonetary exchange is considered to have commercial substance if the company: expects a change in future cash flows as a result of the exchange, and that expected change is significant relative to the fair value of the assets exchanged. Part I. When exchanges are recorded at fair value, any gain or loss is recognized for the difference between the fair value and book value of the asset(s) given-up. To preclude the possibility of companies engaging in exchanges of appreciated assets solely to be able to recognize gains, fair value can only be used in legitimate exchanges that have commercial substance. Part II. A nonmonetary exchange is considered to have commercial substance if the company: expects a change in future cash flows as a result of the exchange, and the expected change in cash flows is significant relative to the fair value of the assets exchanged. If the exchange does not meet these two conditions, it lacks commercial substance and, book value is used to value the asset(s) acquired. No gain is recognized. Let�s look at an example, first with commercial substance, and then without commercial substance. Part I. When exchanges are recorded at fair value, any gain or loss is recognized for the difference between the fair value and book value of the asset(s) given-up. To preclude the possibility of companies engaging in exchanges of appreciated assets solely to be able to recognize gains, fair value can only be used in legitimate exchanges that have commercial substance. Part II. A nonmonetary exchange is considered to have commercial substance if the company: expects a change in future cash flows as a result of the exchange, and the expected change in cash flows is significant relative to the fair value of the assets exchanged. If the exchange does not meet these two conditions, it lacks commercial substance and, book value is used to value the asset(s) acquired. No gain is recognized. Let�s look at an example, first with commercial substance, and then without commercial substance.

8. E10-18 The Tinsley Company exchanged land that it had been holding for future plant expansion for a more suitable parcel located farther from residential areas. Tinsley carried the land at its original cost of $30,000. According to an independent appraisal, the land currently is worth $72,000. Tinsley gave $14,000 in cash to complete the transaction. What is the fair value of the new parcel of land received by Tinsley?

9. E10-18 The Tinsley Company exchanged land that it had been holding for future plant expansion for a more suitable parcel located farther from residential areas. Tinsley carried the land at its original cost of $30,000. According to an independent appraisal, the land currently is worth $72,000. Tinsley gave $14,000 in cash to complete the transaction. Prepare the journal entry to record the exchange assuming the exchange has commercial substance.

10. E10-18 The Tinsley Company exchanged land that it had been holding for future plant expansion for a more suitable parcel located farther from residential areas. Tinsley carried the land at its original cost of $30,000. According to an independent appraisal, the land currently is worth $72,000. Tinsley gave $14,000 in cash to complete the transaction. Prepare the journal entry to record the exchange assuming the exchange lacks commercial substance.

11. Self-Constructed Assets When self-constructing an asset, two accounting issues must be addressed: overhead allocation to the self-constructed asset. incremental overhead only full-cost approach proper treatment of interest incurred during construction Under certain conditions, interest incurred on qualifying assets is capitalized. Asset constructed is for a company�s own use and is a discrete project for sale or lease. Capitalize interest that could have been avoided if the asset were not constructed and the money used to retire debt. Part I. There are two difficult accounting issues that must be addressed when a company is constructing assets for its own use: determining the amount the company�s manufacturing overhead to be included in the asset�s cost. ? deciding on the proper treatment of interest incurred during the construction period.One approach to assigning overhead to self-constructed assets is the incremental approach, where actual incremental overhead costs are recorded in the asset account. However, the most commonly used method is to assign overhead using a predetermined overhead rate, based on an overhead cost driver activity, that is used to assign the company�s overhead to regular production. This approach is called the full cost approach. Unlike purchased assets, self-constructed assets may take a long period of time to be made ready for their intended use. The construction activities during this period require construction financing. Following our general rule for the cost of an asset, all costs necessary to make the asset ready for its intended use, including interest during the construction period, should be included in the asset�s cost. Part II. Interest is capitalized (included in the asset�s cost) for qualifying assets. Qualifying assets are: assets built for a company�s own use. assets constructed as discrete projects for sale or lease. Assets in this category are large construction projects such as a real estate development built for sale or lease. Only the portion of interest cost incurred during the construction period that could have been avoided if the construction had not been undertaken may be capitalized. Part I. There are two difficult accounting issues that must be addressed when a company is constructing assets for its own use: determining the amount the company�s manufacturing overhead to be included in the asset�s cost. ? deciding on the proper treatment of interest incurred during the construction period.One approach to assigning overhead to self-constructed assets is the incremental approach, where actual incremental overhead costs are recorded in the asset account. However, the most commonly used method is to assign overhead using a predetermined overhead rate, based on an overhead cost driver activity, that is used to assign the company�s overhead to regular production. This approach is called the full cost approach. Unlike purchased assets, self-constructed assets may take a long period of time to be made ready for their intended use. The construction activities during this period require construction financing. Following our general rule for the cost of an asset, all costs necessary to make the asset ready for its intended use, including interest during the construction period, should be included in the asset�s cost. Part II. Interest is capitalized (included in the asset�s cost) for qualifying assets. Qualifying assets are: assets built for a company�s own use. assets constructed as discrete projects for sale or lease. Assets in this category are large construction projects such as a real estate development built for sale or lease. Only the portion of interest cost incurred during the construction period that could have been avoided if the construction had not been undertaken may be capitalized.

12. Discussion Questions Q10�15 Explain the difference between the specific interest method and the weighted-average method in determining the amount of interest to be capitalized.

13. Interest Capitalization Capitalization begins when: construction begins interest is incurred, and qualifying expenses are incurred. Capitalization ends when: the asset is substantially complete and ready for its intended use, or when interest costs no longer are being incurred. The interest capitalization period begins when the first qualifying construction expenditures are incurred for materials, labor, or overhead, and when interest costs are incurred. The interest capitalization period ends when the asset is substantially complete and ready for its intended use or when interest costs no longer are being incurred. Consider the following example of interest incurred on a self-constructed asset. The interest capitalization period begins when the first qualifying construction expenditures are incurred for materials, labor, or overhead, and when interest costs are incurred. The interest capitalization period ends when the asset is substantially complete and ready for its intended use or when interest costs no longer are being incurred. Consider the following example of interest incurred on a self-constructed asset.

14. Interest Capitalization Interest is capitalized based on Average Accumulated Expenditures (AAE). Qualifying expenditures (construction labor, material, and overhead) weighted for the number of months outstanding during the current accounting period. If the qualifying asset is financed through a specific new borrowing . . . use the specific rate of the new borrowing as the capitalization rate. If there is no specific new borrowing, and the company has other debt . . . use the weighted average cost of other debt as the capitalization rate. Part I. Interest is capitalized based on average accumulated expenditures during the construction period. Average accumulated expenditures is an amount based on a weighted average computation of the qualifying expenditures times the number of months from the incurrence of the qualifying expenditures to the end of the construction period. Qualifying expenditures include labor, material, and overhead incurred on the construction project during the accounting period. Part II. Interest capitalization on self-constructed assets does not require the company to borrow for the specific construction project. However, if the construction is financed through a specific new borrowing, the interest rate of the new borrowing is used for the capitalization rate. Part III. If the construction does not require specific new borrowing, but is financed with other debt, use the weighted-average interest rate on the other debt for the capitalization rate. Part I. Interest is capitalized based on average accumulated expenditures during the construction period. Average accumulated expenditures is an amount based on a weighted average computation of the qualifying expenditures times the number of months from the incurrence of the qualifying expenditures to the end of the construction period. Qualifying expenditures include labor, material, and overhead incurred on the construction project during the accounting period. Part II. Interest capitalization on self-constructed assets does not require the company to borrow for the specific construction project. However, if the construction is financed through a specific new borrowing, the interest rate of the new borrowing is used for the capitalization rate. Part III. If the construction does not require specific new borrowing, but is financed with other debt, use the weighted-average interest rate on the other debt for the capitalization rate.

15. P10-9 On January 1, 2011, the Mason Manufacturing Company began construction of a building to be used as its office headquarters. The building was completed on September 30, 2012. Expenditures on the project were as follows: January 1, 2011 $1,000,000 January 31, 2012 $270,000 March 1, 2011 600,000 April 30, 2012 585,000 June 30, 2011 800,000 August 31, 2012 900,000 October 1, 2011 600,000 On January 1, 2011, the company obtained a $3 million construction loan with a 10% interest rate. The loan was outstanding all of 2011 and 2012. The company�s other interest- bearing debt included two long- term notes of $4,000,000 and $6,000,000 with interest rates of 6% and 8%, respectively. Both notes were outstanding during all of 2011 and 2012. Interest is paid annually on all debt. The company�s fiscal year-end is December 31. Calculate the amount of interest that Mason should capitalize in 2011 and 2012 using the specific interest method. What is the total cost of the building? Calculate the amount of interest expense that will appear in the 2011 and 2012 income statements.

16. P10-9 Expenditures for 2011: � Interest capitalized:

17. P10-9 Expenditures for 2012: Weighted-average rate of all other debt: �Interest capitalized:

18. P10-9 Cost of Building: Interest Expense for 2011: Interest Expense for 2012:

19. P10-10 On January 1, 2011, the Mason Manufacturing Company began construction of a building to be used as its office headquarters. The building was completed on September 30, 2012. Expenditures on the project were as follows: January 1, 2011 $1,000,000 January 31, 2012 $270,000 March 1, 2011 600,000 April 30, 2012 585,000 June 30, 2011 800,000 August 31, 2012 900,000 October 1, 2011 600,000 On January 1, 2011, the company obtained a $3 million construction loan with a 10% interest rate. The loan was outstanding all of 2011 and 2012. The company�s other interest- bearing debt included two long- term notes of $4,000,000 and $6,000,000 with interest rates of 6% and 8%, respectively. Both notes were outstanding during all of 2011 and 2012. Interest is paid annually on all debt. The company�s fiscal year-end is December 31. Calculate the amount of interest that Mason should capitalize in 2011 and 2012 using the weighted-average method. What is the total cost of the building? Calculate the amount of interest expense that will appear in the 2011 and 2012 income statements.

20. P10-10 Weighted-average rate of all debt: Expenditures for 2011: � Interest capitalized:

21. P10-9 Expenditures for 2012: �Interest capitalized:

22. P10-9 Cost of Building: Interest Expense for 2011: Interest Expense for 2012:

23. Research and Development (R&D) Research Planned search or critical investigation aimed at discovery of new knowledge . . . Development The translation of research findings or other knowledge into a plan or design . . . Most R&D costs are expensed as incurred. (Must be disclosed if material.) R&D costs incurred under contract for other companies are capitalized as inventory and carried forward into future years. Costs of assets purchased for R&D purposes are expensed in the period unless they have alternative future uses. Part I. Research is a planned search or critical investigation aimed at discovery of new knowledge with the hope that the new knowledge will result in new, or the improvement of, existing, products, services or processes. Development is the translation of research findings into new, or the improvement of existing, products, services or processes. Most research and development costs are expensed as incurred. The costs are incurred with the intent of future benefits, but the future benefits are uncertain, and even if the benefits materialize, it is difficult to relate the benefits to revenues of future periods. Part II. An exception to the immediate expensing of research and development costs is provided for work done under contract for other companies. These research and development costs are capitalized as inventory and carried forward into future years. Income from these contracts can be recognized using either the percentage-of-completion method or the completed contract method. If operational assets are purchased for exclusive use in research and development, the cost is expensed, regardless of the length of the assets� useful life. If the assets have alternative future uses beyond the research and development project period, the cost should be capitalized and depreciated or amortized over the current and future periods of use. Part I. Research is a planned search or critical investigation aimed at discovery of new knowledge with the hope that the new knowledge will result in new, or the improvement of, existing, products, services or processes. Development is the translation of research findings into new, or the improvement of existing, products, services or processes. Most research and development costs are expensed as incurred. The costs are incurred with the intent of future benefits, but the future benefits are uncertain, and even if the benefits materialize, it is difficult to relate the benefits to revenues of future periods. Part II. An exception to the immediate expensing of research and development costs is provided for work done under contract for other companies. These research and development costs are capitalized as inventory and carried forward into future years. Income from these contracts can be recognized using either the percentage-of-completion method or the completed contract method. If operational assets are purchased for exclusive use in research and development, the cost is expensed, regardless of the length of the assets� useful life. If the assets have alternative future uses beyond the research and development project period, the cost should be capitalized and depreciated or amortized over the current and future periods of use.

24. E10-25 In 2011, Space Technology Company modified its model Z2 satellite to incorporate a new communication device. The company made the following expenditures: Basic research to develop the technology $2,000,000 Engineering design work 680,000 Development of a prototype device 300,000 Acquisition of equipment 60,000 Testing and modification of the prototype 200,000 Legal fees for patent application on the new communication system 40,000 Legal fees for successful defense of the new patent 20,000 Total $3,300,000 The equipment will be used on this and other research projects. Depreciation on the equipment for 2011 is $10,000. During your year-end review of the accounts related to intangibles, you discover that the company has capitalized all of the above as costs of the patent. Management contends that the device simply represents an improvement of the existing communication system of the satellite and, therefore, should be capitalized. Prepare correcting entries that reflect the appropriate treatment of the expenditures.

25. E10-25 Basic research to develop the technology $2,000,000 Engineering design work 680,000 Development of a prototype device 300,000 Acquisition of equipment 60,000 Testing and modification of the prototype 200,000 Legal fees for patent application on the new communication system 40,000 Legal fees for successful defense of the new patent 20,000 Total $3,300,000

26. Discussion Questions Q10�20 Identify any differences between U.S. GAAP and International Financial Reporting Standards in the treatment of research and development expenditures. Other than software development costs incurred after technological feasibility has been established, U.S. GAAP requires all research and development expenditures to be expensed in the period incurred. IAS No. 38 draws a distinction between research activities and development activities. Research expenditures are expensed in the period incurred. However, development expenditures that meet specified criteria are capitalized as an intangible asset.

27. U.S. GAAP vs. IFRS Except for software development costs incurred after technological feasibility, all research and development expenditures are expensed in the period incurred. Direct costs to secure a patent are capitalized. Research expenditures are expensed in the period incurred. Development expenditures that meet specified criteria are capitalized as an intangible asset. Direct costs to secure a patent are capitalized. Except for software development costs incurred after technological feasibility has been established, U.S. GAAP requires all research and development expenditures to be expensed in the period incurred. IAS No. 38 draws a distinction between research activities and development activities. Research expenditures are expensed in the period incurred. However, development expenditures that meet specified criteria are capitalized as an intangible asset. Under both U.S. GAAP and IFRS, any direct costs to secure a patent, such as legal and filing fees, are capitalized. Except for software development costs incurred after technological feasibility has been established, U.S. GAAP requires all research and development expenditures to be expensed in the period incurred. IAS No. 38 draws a distinction between research activities and development activities. Research expenditures are expensed in the period incurred. However, development expenditures that meet specified criteria are capitalized as an intangible asset. Under both U.S. GAAP and IFRS, any direct costs to secure a patent, such as legal and filing fees, are capitalized.

28. Software Development Costs All costs incurred to establish the technological feasibility of a computer software product are treated as R&D and expensed as incurred. Costs incurred after technological feasibility is established and before the software is available for release to customers are capitalized as an intangible asset. Part I. All costs incurred to establish the technological feasibility of computer software products are treated as research and development costs and expensed as incurred. Costs incurred after technological feasibility is established and before the software is available for release to customers are capitalized as an intangible asset. Technological feasibility is established when all planning, designing, coding, and testing activities have been completed to determine that the software meets its design specifications including functions, features, and technical performance requirements. Consider the following timeline to illustrate these concepts. Part II. Costs are expensed from the start of research and development until technological feasibility is established. Costs incurred after technological feasibility is established, but before the product is released, are capitalized as an intangible asset. Costs incurred after the product is available for release to customers are treated as operating costs. Part I. All costs incurred to establish the technological feasibility of computer software products are treated as research and development costs and expensed as incurred. Costs incurred after technological feasibility is established and before the software is available for release to customers are capitalized as an intangible asset. Technological feasibility is established when all planning, designing, coding, and testing activities have been completed to determine that the software meets its design specifications including functions, features, and technical performance requirements. Consider the following timeline to illustrate these concepts. Part II. Costs are expensed from the start of research and development until technological feasibility is established. Costs incurred after technological feasibility is established, but before the product is released, are capitalized as an intangible asset. Costs incurred after the product is available for release to customers are treated as operating costs.

29. Software Development Costs Amortization of capitalized computer software costs starts when the product begins to be marketed. Two methods, the percentage of revenue method and the straight-line method, are compared and the method producing the largest amount of amortization is used. Disclosure Balance Sheet The unamortized portion of capitalized computer software cost is an asset. Income Statement Amortization expense associated with computer software cost. R&D expense associated with computer software development cost. Part I. Amortization of capitalized computer software costs starts when the product begins to be marketed. Two methods, the percentage of revenue method and the straight-line method, are compared and the method producing the largest amount of amortization is used. The periodic amortization percentage is the greater of: the ratio of current revenues to current and anticipated revenues (the percentage of revenues method). the straight-line percentage over the useful life of the asset. (the straight-line method). Part II. The unamortized portion of capitalized computer software cost is reported in the balance sheet as an asset. The periodic amortization expense associated with the capitalized computer software cost is reported in the income statement. The research and development expense associated with computer software development is reported in the income statement. Part I. Amortization of capitalized computer software costs starts when the product begins to be marketed. Two methods, the percentage of revenue method and the straight-line method, are compared and the method producing the largest amount of amortization is used. The periodic amortization percentage is the greater of: the ratio of current revenues to current and anticipated revenues (the percentage of revenues method). the straight-line percentage over the useful life of the asset. (the straight-line method). Part II. The unamortized portion of capitalized computer software cost is reported in the balance sheet as an asset. The periodic amortization expense associated with the capitalized computer software cost is reported in the income statement. The research and development expense associated with computer software development is reported in the income statement.

30. U.S. GAAP vs. IFRS The percentage used to amortize software development costs is the greater of (1) the ratio of current revenues to current and anticipated revenues or (2) the straight-line percentage over the useful life of the software. The same approach is allowed, but not required. The percentage we use to amortize computer software development costs under U.S. GAAP is the greater of (1) the ratio of current revenues to current and anticipated revenues or (2) the straight-line percentage over the useful life of the software. The approach is allowed under IFRS, but not required. The percentage we use to amortize computer software development costs under U.S. GAAP is the greater of (1) the ratio of current revenues to current and anticipated revenues or (2) the straight-line percentage over the useful life of the software. The approach is allowed under IFRS, but not required.

31. Appendix 10 - Oil and Gas Accounting Two acceptable accounting alternatives Successful efforts method � Exploration costs resulting in unsuccessful wells (dry holes) are expensed. Full-cost method � Exploration costs resulting in unsuccessful wells may be capitalized. Political pressure prevented the FASB from requiring all companies to use the successful efforts method. Appendix 10 � Oil and Gas Accounting Part I. There are two generally accepted methods that companies can use to account for oil and gas exploration costs. The successful efforts method requires expensing of exploration costs that result in unsuccessful wells (called dry holes). Only the exploration costs that result in successful, producing wells are capitalized. The full-cost method allows the exploration costs incurred in a wide geographical area, with many unsuccessful wells, to be capitalized if some successful wells are drilled in the area. For both methods, capitalized costs are expensed in future periods as oil and gas is removed. Part II. Political pressure prevented the FASB from requiring all companies to use the successful efforts method.Appendix 10 � Oil and Gas Accounting Part I. There are two generally accepted methods that companies can use to account for oil and gas exploration costs. The successful efforts method requires expensing of exploration costs that result in unsuccessful wells (called dry holes). Only the exploration costs that result in successful, producing wells are capitalized. The full-cost method allows the exploration costs incurred in a wide geographical area, with many unsuccessful wells, to be capitalized if some successful wells are drilled in the area. For both methods, capitalized costs are expensed in future periods as oil and gas is removed. Part II. Political pressure prevented the FASB from requiring all companies to use the successful efforts method.