Business & Finance Case Study: IFRS Adoption in the U.S. Assignment
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Chapter11-Long-LivedAssets.pptxLong-Lived Assets
Revsine/Collins/Johnson/Mittelstaedt/Soffer: Chapter 11
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Learning Objectives 1 After studying this chapter, you will understand:
Why depreciated historical cost is used to measure long-lived assets.
What specific costs can be capitalized and how joint costs are allocated.
How generally accepted accounting principles (G A A P) measurement rules can complicate both trend analysis and cross-company analysis.
Why balance sheet carrying amounts for internally developed intangibles differ from their real values.
How to address long-lived asset impairments.
How to account for asset retirement obligations and assets held for sale.
How different depreciation methods are computed.
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Learning Objectives 2 After studying this chapter, you will understand:
How analysts can adjust for different depreciation assumptions.
How to account for exchanges of long-lived assets.
The key differences between G A A P and I F R S requirements for long-lived asset accounting.
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Long-Lived Assets 1
Operating assets expected to yield their economic benefits (or service potential) over a period longer than one year are called long-lived assets.
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Long-Lived Assets 2
EXHIBIT 11.1 Exxon Mobil: Partial Consolidated Statement of Financial Position—December 31, 2017
| ($ in millions) | Percentage | |
| Assets | ||
| Cash and cash equivalents | $ 3,177 | |
| Notes and accounts receivable, less estimated doubtful accounts | 25,597 | |
| Inventories | ||
| Crude oil, products and merchandise | 12,871 | |
| Materials and supplies | 4,121 | |
| Other current assets | 1,368 | |
| Total current assets | 47,134 | 13.5% |
| Investments, advances and long-term receivables | 39,160 | 11.2 |
| Property, plant, and equipment, at cost, less accumulated depreciation and depletion | 252,630 | 72.5 |
| Other assets, including intangibles, net | 9,767 | 2.8 |
| Total assets | $348,691 | 100.0% |
Long-lived assets comprise 72.5% of ExxonMobil’s total assets.
Source: Exxon Mobil Corporation 2017 financial statements and supplemental information.
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Measurement of the Carrying Amount of Long-Lived Assets
There are two ways that long-lived assets could be measured on balance sheets:
Expected Benefit Approach
| $$ | Discounted present value. Net realizable value. |
Estimated value in an output market where the asset is sold
Economic Sacrifice Approach
| $$ | Historical cost. Replacement cost. |
Estimated value in an input market where the asset is purchased
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The Approach Used by G A A P 1
Assume a truck originally costing $100,000, is two years old, has a remaining life of 8 years, is being depreciated on a straight-line basis, and is expected to have no salvage value.
The hypothetical range of long-lived asset carrying amounts as measured under each approach—expected benefit versus economic sacrifice—is shown in 11.3.
U.S. G A A P uses historical cost—an economic sacrifice approach—to measure long-lived assets in most circumstances.
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The Approach Used by G A A P 2
EXHIBIT 11.3 Hypothetical Long-Lived Asset Carrying Amounts (10-year life, 8 years remaining)
Expected Benefit Approach Examples
Discounted present value:
Expected net operating cash inflows = $16,275 per year (assumed) for eight remaining
years, discounted at a 10% (assumed) rate
Net realizable value:
Current resale price from an over-the-road equipment listing (Purple Book) for the specific vehicle model
$85,000 (assumed)
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The Approach Used by G A A P 3
Economic Sacrifice Approach Examples
Replacement cost:
Replacement cost of a two-year-old vehicle in equivalent condition
Historical cost less accumulated depreciation:
* Discount factor for an ordinary annuity for eight years at 10%. See “Present Value of an Ordinary Annuity of $1” table in end-of-book appendix.
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Long-Lived Asset Measurement Rules
The initial balance sheet carrying amount of a long-lived asset is governed by two rules:
All costs necessary to acquire the asset and make it ready for use are included in the asset account; that is, they are capitalized costs. (Expenditures excluded from asset categories are “expensed” to income.)
Capitalized
| $$ | Price paid for land |
| $$ | Cost of clearing land |
Expensed
| $$ | Monthly equipment rental |
| $$ | Cost to repair damaged equipment |
Joint costs incurred in acquiring more than one asset are apportioned among the acquired assets on a relative fair value basis or some other rational basis.
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Long-Lived Asset Measurement Rules Illustrated 1
Background information:
Canyon Corporation acquired a tract of land on 6/1/X1, by paying $6,000,000 and by assuming an existing mortgage of $1,000,000 on the land.
Canyon demolished an empty structure on the property at a cost of $650,000.
Bricks and other materials from the demolished building were sold for $10,000.
Regrading and clearing the land cost $35,000.
Architectural fees were $800,000, and the payments to contractors for building a new factory on the site totaled $12,000,000.
Canyon negotiated a bank loan for the construction. Interest payments over the construction period totaled $715,000.
Legal fees incurred in the transaction totaled $57,000:
$17,000 was attributable to both examination of title and legal issues linked to the assumption of the existing mortgage.
The remaining $40,000 of legal fees related to contracts with the architect and the construction companies.
The construction project was completed on 12/31/X1.
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Long-Lived Asset Measurement Rules Illustrated 2
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Computing Avoidable Interest
G A A P requires capitalizing what are called avoidable interest payments on self-constructed assets; this interest is defined as that “could have been avoided . . . if expenditures for the assets had not been made.”
Avoidable interest = Cumulative weighted average expenditures on the constructed asset x I interest rate
Canyon’s calculation of avoidable interest:
| Date and Amount | Portion of Year | Cumulative Weighted Average Expenditures | |||
| June 1 | $10,000,000 | × | 58.630%* | — | $5,863,000 |
| August 22 | 3,558,788 | × | 36.164%† | — | 1,287,000 |
| $7,150,000 |
Construction expenditures
Avoidable interest = $7,150,000 × 10% = 715,000
| DR Construction in progress | $715,000 | |
| CR Interest expense | $715,000 |
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Limits on the Amount of Interest Capitalized
G A A P limits the amount of interest that can be capitalized to the lower of (1) interest actually incurred or (2) avoidable interest.
Case 1:
Case 2:
Actual interest is less in this case
Therefore only $600,000 would be capitalized
Capitalization is restricted to interest arising from actual borrowings from outsiders.
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Tax Versus Financial Reporting Incentives
How costs are allocated between land and building affects the amount of income that will be reported in future periods.
Allocation 1:
Higher depreciation
Lower net income
Lower taxes
Allocation 2:
Lower depreciation
Higher net income
Higher taxes
For tax purposes, the incentives for allocating costs between land and building asset categories are completely different because the objective of most firms is to minimize tax payments, not to “correctly” allocate costs.
The higher the costs allocated to land for tax purposes, the higher the future taxable income becomes because land cannot be depreciated.
However, U.S. income tax rules generally parallel financial reporting rules and require cost allocations between land and buildings that are similar to U.S. G A A P rules. The same is true for interest capitalization.
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Capitalization Criteria—An Extension
G A A P capitalizes expenditures that increase an assets usefulness—that is, increases the carrying amount of a long-lived asset—when the expenditure causes any of the following conditions:
The useful life of the asset is extended.
The capacity of the asset is increased.
The efficiency of the asset is increased.
There is any other type of increase in the economic benefits (or future service potential) of the asset that results as a consequence of the expenditure.
When the expenditure does not meet any of these conditions, it must be treated as a period expense and be charged to income.
Routine equipment maintenance is one example.
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Capitalization criteria: Costs incurred after initial use 1
EXHIBIT 11.6 Winger Enterprises: Determination of Capitalized Costs
On January 1, 20X1, Winger Enterprises purchased a machine that will be used in operations. Its cash purchase price was $80,000. The freight cost to transport the machine to Winger's factory was $1,200. During the month of January 20X1, Winger's employees spent considerable time calibrating the machine and making adjustments and test runs to get it ready for use. Costs incurred in doing this were:
| Allocated portion of production manager's salary for coordinating machine adjustments | $2,200 |
| Hourly wages of production workers engaged in test runs of the machine | 3,600 |
| Cost of raw materials that were used in test runs (the output was not salable) | 1,500 |
Given these facts, on January 1, 20X1, the capitalized amount of the machine would be the total of the shaded costs ($80,000 + $1,200 + $2,200 + $3,600 + $1,500 = $88,500).
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Capitalization criteria: Costs incurred after initial use 2
Suppose that in January 20X4, Winger spends an additional $8,000.
$6,000 for the installation of a new component that allowed the machine to consume less raw material and operate more efficiently
Capitalized in 20X4 and added to the carrying amount of the machine
$2,000 for ordinary repairs and maintenance
Treated as a period expense
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Deferred Costs
Incremental costs related to the successful negotiation of a contract (such as sales commissions) should be capitalized.
The asset is then systematically amortized over the life of the contract, including expected renewals.
To be capitalized, the costs must meet all of the following criteria:
Relate to a specific contract.
Generate or enhance resources that will be used to satisfy performance obligations in the future.
Expected to be recovered.
Expenses that would have been incurred without the contract signing are expensed immediately.
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Intangible Assets
Intangible assets are long-lived assets that do not have physical substance.
The category includes the following types of assets.
Patents.
Copyrights.
Trademarks.
Brand names.
Customer lists.
Licenses.
Technology.
Franchises.
Employment contracts.
The accounting for acquired intangible assets is straight-forward:
The acquired intangible asset is first recorded at the arm’s length transaction price.
Most acquired intangible assets are amortized (depreciated) on a straight-line basis over their expected useful economic lives and reviewed for impairment.
Some intangible assets, known as indefinite-lived intangible assets, have indefinite lives and are not amortized. Instead, they are evaluated annually for impairment.
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Research and Development (R&D)
Difficult financial reporting issues exist when the intangible asset is developed internally instead of being purchased from another company.
These difficulties arise because it is uncertain whether current expenditures will ultimately lead to valuable patents or trademarks.
The recoverability of research and development (R&D) expenditures is highly uncertain at the start of a project.
Consequently, the G A A P requires that virtually all R&D expenditures be charged to expense immediately.
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Computer Software Products
Prior to establishing the technological feasibility of a computer software product, companies are required to expense all R&D costs incurred to develop it.
After technological feasibility is established, additional costs incurred to ready the product for general release to customers are supposed to be capitalized.
The capitalization of additional costs ceases when the final product is available for sale.
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Asset Impairment: Tangible and Amortizable Intangible Assets
Figure 11.1
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Asset Impairment Illustration 1
Solomon Corporation manufactures a variety of computer products. The growing popularity of tablets is expected to reduce the demand for Solomon’s notebook computers. The notebook computers are produced on an assembly line consisting of five special purpose assets with a carrying amount (cost of $5,300,000 less accumulated depreciation of $3,300,000) of $2,000,000.
Solomon’s management believes that this change in the business climate threatens the recoverability of these assets’ carrying amount; accordingly, their answer to the question in Stage A is yes.
Consequently, to apply Stage B, they prepare the following estimate of future undiscounted cash flows over the expected 3-year remaining life of the notebook computer assembly line:
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Asset Impairment Illustration 2
Impairment possible?
Yes
Undiscounted net
cash flows expected
$1,500,000
Are cash flows lower
than carrying amount?
Yes ($1,500,000 > $2,000,000)
Impairment loss
$2,000,000 – $750,000 = $1,250,000
| Net operating cash flows | |
| 20X1 | $ 800,000 |
| 20X2 | 400,000 |
| 20X3 | 200,000 |
| Expected salvage value | 100,000 |
| Total undiscounted cash flows | $1,500,000 |
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Asset Impairment Illustration 3
To record the loss, Solomon would make the following entry:
| DR Impairment loss | $1,250,000 | |
| CR Equipment | $1,250,000 |
The impairment loss decreases both assets and net income.
Though it does not affect current cash from operations, the loss has negative implications for future revenue and cash flow.
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Indefinite-Lived Intangible Assets
Indefinite-lived intangible assets must be evaluated for impairment at least annually.
A two-step evaluation process is allowed by G A A P:
Firm first assesses qualitative factors to determine whether it is necessary to perform a quantitative impairment test.
If based on this qualitative evaluation, management believes that it is more likely than not that an indefinite-lived intangible asset has been impaired, then it must go to the second step.
Perform a quantitative assessment by calculating the fair value of the intangible asset.
If the book value of the asset exceeds the fair value, then the asset is considered impaired.
The firm then reduces the book value of the asset to its estimated fair value and records a loss.
The book value of the asset cannot be increased later if the fair value recovers.
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Management Judgments and Impairments
Impairment write-downs present managers another set of potential earnings management opportunities.
Auditors and other financial statement analysts should be alert to the potential use of write-offs opportunistically by managers.
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Obligations Arising From Retiring Long-Lived Assets 1
EXAMPLE
Kalai Oil Corporation constructs an oil drilling rig off the Texas coast, which is placed into service on January 1, 20X1. The rig cost $300 million to build. Texas law requires that the rig be removed at the end of its estimated useful life of five years. Kalai estimates that the cost of dismantling the rig will be $12 million and its credit-adjusted risk-free rate is 8%. The liability’s discounted present value is $8,167,000. Assume that Kalai has already capitalized the $300 million cost of the rig in the account Drilling rig.
Kalai records the asset retirement obligation (A R O) when the asset is placed into service:
| DR Drilling rig (asset retirement cost) | $8,167,000 | |
| CR A R O liability | $8,167,000 |
This results in additional depreciation expense:
| DR Depreciation expense | $1,633,400* | |
| CR Accumulated depreciation—drilling rig | $1,633,400 |
*$8,167,000/5 yrs. = $1,633,400.
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Obligations Arising from Retiring Long-Lived Assets 2
The liability is initially recorded at its present value but increases over time as retirement nears.
| (a) Present Value of the Liability at Start of Year | (b) Accretion Expense [8% × Column (a) Amount] | (c) Present Value of the Liability at Year-End [Column (a) + Column (b)] | |
| 20X1 | $8,167,000 | $653,360 | $8,820,360 |
| 20X2 | 8,820,360 | 705,629 | 9,525,989 |
| 20X3 | 9,525,989 | 762,079 | 10,288,068 |
| 20X4 | 10,288,068 | 823,045 | 11,111,113 |
| 20X5 | 11,111,113 | 888,887* | 12,000,000 |
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Obligations Arising From Retiring Long-Lived Assets 3
The entry to record the increase in the liability in 20X1:
| DR Accretion expense | $653,360 | |
| CR ARO liability | $653,360 |
Assume that an outside contractor dismantles the rig early in January 20X5 at a cost of $11,750,000.
| DR ARO liability | $12,000,000 | |
| CR Cash | $11,750,000 | |
| CR Gain on settlement of ARO liability | 250,000 |
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Assets Held for Sale
When firms actively try to sell assets they own, the asset groups should be classified on the balance sheet as “held for sale.”
When assets are held for sale, they are reported at the lower of book value or fair market value minus costs to sell.
So, these assets would be shown on the balance sheet at $2,304,000.
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Depreciation
The costs of productive assets must be apportioned to the periods in which they provide benefits.
In financial reporting, the cost to be allocated to periods is the asset’s original historical cost minus its expected salvage value.
Computing depreciation requires the reporting entity to estimate three things:
The expected useful life (in years or units) of the asset.
The depreciation pattern that will reflect the asset’s declining service potential.
The expected salvage value that will exist at the time the asset is retired.
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Depreciation: Straight-Line Depreciation Method
The straight-line (S L) depreciation method simply allocates cost minus salvage value evenly over the asset’s expected useful life.
EXHIBIT 11.10 Depreciation Example
Facts
| Cost of the asset | $ 10,500 |
| Expected salvage value | $ 500 |
| Expected useful life | 5 years |
| Expected units | 20,000 |
Straight-Line Depreciation (S L)
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Depreciation: Units of Production Method 1
The units-of-production (U P) depreciation method allocates cost minus salvage over the expected units to be produced instead of the expected useful life.
EXHIBIT 11.10 Depreciation Example
Facts
| Cost of the asset | $ 10,500 |
| Expected salvage value | $ 500 |
| Expected useful life | 5 years |
| Expected units | 20,000 |
Units-of-Production (U P)
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Depreciation: Units of Production Method 2
EXHIBIT 11.10 Depreciation Example
| Year | Unit Rate ($10,500 − $500)/20,000 | Units Produced (Assumed) | Depreciation |
| 1 | $0.50 | 4,200 | $ 2,100 |
| 2 | 0.50 | 3,400 | 1,700 |
| 3 | 0.50 | 6,000 | 3,000 |
| 4 | 0.50 | 3,300 | 1,650 |
| 5 | 0.50 | 3,100 | 1,550 |
| Total | 20,000 | $10,000 |
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Depreciation: Double-Declining Balance Method 1
The depreciation rate for the double-declining balance (D D B) method is double the straight-line rate. Applying a constant D D B depreciation percentage to a declining balance will produce a book value at the end of the asset’s economic life that is above or below the salvage value.
Apply twice the S L rate to the book value of the assets without subtracting the salvage value.
Once the D D B depreciation amount falls below what it would be with S L, a firm might use the straight-line method for the remaining years.
Double-Declining Balance Depreciation (D D B)
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Depreciation: Double-Declining Balance Method 2
| Year | Beginning-of-Year Book Value | Depreciation (40% of Beginning-of-Year Book Value) | Year-End Book Value |
| 1 | $10,500.00 | $4,200.00 | $6,300.00 |
| 2 | 6,300.00 | 2,520.00 | 3,780.00 |
| 3 | 3,780.00 | 1,093.33* | 2,686.67 |
| 4 | 2,686.67 | 1,093.33 | 1,593.34 |
| 5 | 1,593.34 | 1,093.34 | 500.00 |
* Year 3: Switch to straight-line method (as explained in the text).
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Depreciation: Sum=of-the-Years’ Digits Method 1
The sum-of-the-years’ digits (S Y D) method is another accelerated depreciation method. It depreciates an asset to precisely its salvage value.
Sum-of-the-Years’ Digits Depreciation (S Y D)
† The formula for determining the sum-of-the-years' digits is n(n + 1 )/2 where n equals the estimated life of the asset. In our example: 5(5 + 1)/2= 15. This, of course, is the answer we get by tediously summing the years‘ digits—that is, 5 + 4 + 3 + 2 + 1 = 15.
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Depreciation: Sum=of-the-Years’ Digits Method 2
| Year | Depreciation Basis ($10,500 − $500) | Applicable Fraction | Depreciation |
| 1 | $10,000 | 5/15 | $ 3,333.33 |
| 2 | 10,000 | 4/15 | 2,666.67 |
| 3 | 10,000 | 3/15 | 2,000.00 |
| 4 | 10,000 | 2/15 | 1,333.33 |
| 5 | 10,000 | 1/15 | 666.67 |
| Total | 15/15 | $10,000.00 |
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Depreciation: Alternative Depreciation Methods
Figure 11.2 Alternative depreciation methods
Annual depreciation charges
Total depreciation expenses is the same under all methods
Net book value
Ending book values are the same under all methods
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Disposition of Long-Lived Assets
When individual long-lived assets are disposed of before their useful lives are completed, any difference between the net book value of the asset and the disposition proceeds is treated as a gain or loss.
Assume the asset in Exhibit 11.10 is being depreciated using the D D B method and is sold at the end of Year 2 for $5,000 when its book value is $3,780.
The entry to record the disposition removes the asset and its accumulated deprecation from the books:
| DR Cash | $5,000 | |
| DR Accumulated depreciation | 6,720 | |
| CR Long-lived asset | $10,500 | |
| CR Gain on sale of asset | 1,220 |
Gain (loss) = $5,000 − ($10,500 − $6,720) = $1,220
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Financial Analysis and Depreciation Differences
Most U.S. firms use straight-line depreciation for financial reporting purposes.
Nevertheless, making valid comparisons across firms is often hindered by other depreciation assumptions, especially differences in useful lives.
To improve comparisons of profitability of firms, an analyst could standardize the average useful life used to compute depreciation expense.
This adjustment process relies on several assumptions.
The useful life differences are artificial and do not reflect real differences in expected asset longevity.
The salvage value proportions are roughly equivalent for all firms in the industry
The dollar breakdown within the asset categories are similar across the firms being compared.
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Exchanges of Nonmonetary Assets 1
Sometimes firms exchange one nonmonetary asset like inventory or equipment for another nonmonetary asset.
Unless certain exceptions apply, the recorded cost of the acquired asset is the fair market value of the asset given up.
Rohan Department Store exchanges a delivery truck with a fair value of $70,000 for 10 checkout scanners from Electronic Giant Warehouse, Inc. The truck's book value is $60,000—original cost of $80,000 minus accumulated depreciation of $20,000. In addition to the truck, Rohan pays Electronic Giant $15,000.
| DR Store equipment | $85,000 | |
| DR Accumulated depreciation—delivery truck | 20,000 | |
| CR Delivery truck | $80,000 | |
| CR Cash | 15,000 | |
| CR Gain on exchange | 10,000 |
F M V of truck plus cash
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Exchanges of Nonmonetary Assets 2
Asset exchange rules were subject to manipulation. To prevent a repeat of these abuses, the F A S B issued rules that now require companies to record certain exchanges of nonmonetary assets at the existing book value of the relinquished asset if any of the following conditions apply:
The fair value of neither the asset(s) received nor the asset(s) relinquished is determinable within reasonable limits.
The transaction lacks commercial substance.
The exchange transaction is made to facilitate sales to customers. Specifically, the transaction is an exchange of inventory or property held for sale in the ordinary course of business for other inventory or property to be sold in the same line of business.
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Exchanges Recorded at Book Value: Fair Value Not Determinable
What if the fair value of neither the asset(s) received nor the asset(s) relinquished cannot be determined?
The new asset received is recorded at the sum of the at the sum of the book value of the old asset that was given up plus the cash given.
Denver Construction Corporation (a fictional company) agrees to swap with Cody Company (another fictional company) one type of crane in exchange for a slightly different model whose features are better suited for a highway bridge project it is currently engaged in. The old crane Denver is exchanging has a book value of $600,000 at the time of the transaction. Its original cost was $700,000, and accumulated depreciation is $100,000. Denver also pays Cody $40,000 to complete the transaction. It is not possible to measure the fair value of either crane within reasonable limits.
| DR Construction crane (new) | $640,000 | |
| DR Accumulated depreciation—construction crane (old) | 100,000 | |
| CR Construction crane (old) | $700,000 | |
| CR Cash | 40,000 |
B V of old crane plus cash
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The Commercial Substance Criterion
Booking exchange transactions at fair value introduces the possibility of gains (or losses) on the transaction.
G A A P requires that the transaction must possess commercial substance. An exchange transaction has commercial substance when the firm’s future cash flows are expected to change significantly as a result of the exchange.
A significant cash flow change exists if either:
The configuration (risk, timing, and amount) of the future cash flows of the asset(s) received differs significantly from the configuration of the future cash flows of the asset(s) transferred.
The entity-specific value of the asset(s) received differs from the entity-specific value of the asset(s) transferred, and the difference is significant in relation to the fair values of the assets exchanged.
If both conditions are not met, the transaction must be recorded using the book value of the asset(s) relinquished.
This precludes any gain recognition.
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Exchange Transaction to Facilitate Sales to Customers
Sometimes firms exchange assets with other firms—even competitors—to balance inventories:
Lee Electronics faces a shortage of plasma television sets but has an excess of liquid crystal display (L C D) sets. It agrees to swap L C Ds with a fair value of $50,000 and a book value of $40,000 for plasma sets with a fair value of $52,000 from Bonnie Enterprises.
Because the exchange does not culminate an earnings process, the plasma sets are recorded as:
| DR Inventory—plasma sets | $40,000 | |
| CR Inventory—LCDs | $40,000 |
Book value of asset surrendered with no gain or loss recorded
The $12,000 gain on the swap (= $52,000 fair value − $40,000 book value) will be recognized only when the plasma sets are ultimately sold to customers.
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Exchange Transaction to Facilitate Sales to Customers: Cash Received—A Special Case 1
Let’s assume instead that Lee Electronics also receives cash representing 10% of the proceeds.
Lee Electronics faces a shortage of plasma television sets but has an excess of liquid crystal display (L C D) sets. It agrees to swap L C Ds with a fair value of $50,000 and a book value of $40,000 for plasma sets with a fair value of $52,000 from Bonnie Enterprises
| DR Cash | $ 5,778 | |
| DR Inventory—plasma sets | 36,000 | |
| CR Inventory—L C Ds | $40,000 | |
| CR Recognized gain on exchange | 1,778 |
10% of ($52,000 + $5,778 − $40,000)
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Exchange Transaction to Facilitate Sales to Customers: Cash Received—A Special Case 2
| Fair value of plasma sets | $52,000 | |
| Less: Portion of gain deferred: | ||
| Total gain | $17,778 | |
| Gain recognized | (1,778) | |
| Gain deferred | (16,000) | |
| Inventory—plasma sets | $36,000 |
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Global Vantage Point: Comparison of I R F S and G A A P Long-Lived Asset Accounting 1
Although there are many similarities between U.S. G A A P and I F R S, numerous important differences exist. I F R S allows more choice in valuation models and has different specific guidance for issues such as depreciation and impairments.
Tangible Long-Lived Assets:
I A S 16 allows two different models for tangible long-lived assets:
Cost Method (same as U.S. G A A P)
Revaluation Method – Asset is carried at a revalued amount reflecting fair market value at the revaluation date.
Subsequent depreciation is based on fair value, not original cost.
The amount of the write-up is credited to an owners’ equity account called Revaluation Surplus (equivalent to Accumulated other comprehensive income).
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Global Vantage Point: Comparison of I R F S and G A A P Long-Lived Asset Accounting 2
Intangible Long-Lived Assets:
The accounting under I A S 38 is similar to U.S. G A A P.
Generally, acquired assets are carried at amortized cost.
A revaluation method is allowed, but an active market must be available for the intangible.
There is a difference regarding internally developed intangibles.
Research is expensed.
Some development expenditures may be capitalized.
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Global Vantage Point: Comparison of I R F S and G A A P Long-Lived Asset Accounting 3
Impairments:
I A S 36, “Impairment of Assets,” provides the guidelines for impairments of long-lived tangible and intangible assets other than investment property measured at fair value.
For tangible assets and amortizable intangible assets:
Events that require an impairment review are similar to the U.S. G A A P events mentioned in Stage A. However, Stage C differs in that an impairment loss occurs if the carrying value exceeds the recoverable amount, defined as the higher of the asset’s fair value (less costs to sell) and its value in use, which is the discounted net cash flows identified in Stage B.
I F R S rules also permit reversals of previously recognized impairment losses when there has been a change in the estimates that were previously used to measure the loss. The reversal increases net income.
I F R S accounting for indefinite-lived intangible assets is similar to G A A P.
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Summary 1
U.S. G A A P for long-lived assets is far from perfect. The need for unbiased, accurate, cost-effective, and verifiable numbers causes these assets to be measured in terms of the economic sacrifice incurred to obtain them—their historical cost—rather than in terms of their current expected benefit—or economic worth—to the firm.
Changes in the amount of capitalized interest from one period to the next can distort earnings trends. A thorough understanding of how the G A A P measurement rules are applied allows statement readers to avoid pitfalls in trend analysis when investment in new assets is sporadic.
Incremental costs, such as sales commissions, associated with acquiring a contract may be deferred and amortized over the life of the contract.
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Summary 2
Because it is uncertain whether future benefits result from research and brand development costs, these costs are generally expensed in the period incurred. Consequently, balance sheet carrying amounts for intangible assets often differ from their real value to the firm. Analysts must scrutinize disclosures of R&D expenses to undo the overly conservative accounting.
When comparing return on assets (R O A) ratios across firms, one must remember that historical cost leads to an upward drift in reported R O A as assets age. So, analysts must determine whether the average age of the long-lived assets for firms being analyzed is stable or rising. Inflation also injects an upward bias into reported R O A.
Asset impairment write-downs depend on subjective forecasts and could be used to manage earnings.
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Summary 3
An understanding of differences in depreciation choices across firms permits better interfirm comparisons. When making interfirm comparisons, analysts should use note disclosures to overcome differences in the long-lived asset useful lives chosen by each firm and, when possible, in their depreciation patterns.
International practices for long-lived assets are sometimes very different from those in the United States. Statement users who make cross-country comparisons must exercise caution. I F R S allows much greater use of fair value than does U.S. G A A P.
Some of the key differences between I F R S and U.S. G A A P relate to the revaluation of tangible assets, investment property, capitalization of intangible development costs, and impairment losses.
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Accessibility Content: Text Alternatives for Images
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Long-Lived Asset Measurement Rules Illustrated 2 – Text Alternative 1
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Land section includes:
Cash payment of $6,000,000
Mortgage assumed of 1,000,000
Demolition of existing structure, $650,000
Less: Salvage value of material, (10,000)
These last two lines subtotal to 640,000
Regrading and clearing land, 35,000
Legal fees allocated, 17,000
Capitalized land costs, $7,692,000
Building section includes:
Architectural fees of $800,000
Building costs, 12,000,000
Interest capitalized, 715,000
Legal fees allocated, 40,000
Capitalized building costs, $13,555,000
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Long-Lived Asset Measurement Rules Illustrated 2 – Text Alternative 2
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Callouts identify key amounts. The $6,000,000 cash and 1,000,000 mortgage are the purchase price. Preparation costs include the 640,000 demolition minus salvage and the 35,000 regrading line item. The 17,000 legal fees are joint cost. The architectural fees of 800,000, building costs of 12,000,000, and interest at 715,000 are all construction costs. The 40,000 legal fees under building are also joint cost. An additional notation is by this figure that reads Special GAAP rules apply.
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Computer Software Products – Text Alternative
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Left side lists Before Development expenditures, to be expensed as incurred. And at the right is listed After Development expenditures, to be capitalized and amortized. Midway point represents technological feasibility established.
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Asset Impairment: Tangible and Amortizable Intangible Assets – Text Alternative
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The flowchart contains five levels. Stage A: Have events or changes in circumstances raised the possibility that certain long-lived assets may be impaired?
If Yes, go to Stage B.
If No, No impairment write-down is necessary.
Stage B: Estimate the future undiscounted net cash flows expected from the use and the disposal of the asset. Stage C: Are these future undiscounted net cash flows lower than the carrying amount of the asset?
If Yes, go to Stage D.
If No, No impairment write-down is necessary.
Stage D: The impaired asset must be written down. Stage E: The impairment loss is the difference between the fair value of the asset and the carrying amount of the asset.
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Assets Held for Sale – Text Alternative
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On the left is Book value at $2,500,000. In the middle is Fair value: $2,350,000. And at the right is Expected cost to sell: $46,000.
The last two boxes are connected showing the equation of $2,350,000 minus $46,000 equals $2,304,000.
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Depreciation – Text Alternative
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Depreciation is made up of Buildings and Equipment. Amortization includes Intangibles. Depletion would apply to Mineral deposits and Wasting assets.
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Depreciation: Alternative Depreciation Methods – Text Alternative
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In the first graph, year (1 through 5) is marked on the horizontal axis, and depreciation expenses in dollars are indicated on the vertical axis. The graph has four lines: straight line; sum-of-the-years’ digits; units-of-production; and double-declining balance.
Straight line depreciation is a horizontal line that remains at $2,000 for all five years.
Sum-of-the-years’ digits is a downward-sloping line that begins at $3,333 in year 1 and ends at $667 in year 5.
Units-of-production begins at $2,100 in year 1, with varying values for the remaining four years: $1,700, $3,000, $1,650, and $1,550.
Double-declining balance begins at $4,200 in year 1, $2,520 in year 2, and remains at $1,093 for years 3, 4, and 5.
In the Net Book Value graph, end of year (1 through 5) is displayed on the x-axis and Book value in dollars (0 through 9000) is displayed on the y-axis. The Straight line method starts at about 8700 and declines in a straight line to roughly 700 in year 5. The sum of the years' digits starts at just above 7000 in year 1, declines to about 4700 in year 2, and 2700 in year 3. The drop then becomes more gradual to just above 1000 in year 4 and then finishes with the other methods in year 5. The units of production line starts near the straight line method at approximately 8600. It virtually mirrors the straight line method at about 6700 in year 2. It drops more dramatically in year 3 to about 3700, then slopes less steeply to approximately 2000 in year 4, before ending with the others at about 700. The double-declining balance method starts lower than all the others at approximately 6400 and declines sharply to about 3800 in year 2. The line then declines much less steeply to just under 3000 in year 3, around 1700 in year 4 and then ending with the other methods.
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