(26) Long-Lived Assets

Question 1

LOS 29. a: Distinguish between costs that are capitalized and costs that are expensed in the period in which they are incurred.

Answer 1

When an asset is expected to provide benefits for only the current period, its cost is expensed on the income statement for the period. If an asset is expected to provide benefits over multiple period, it is capitalized rather than expensed.

Question 2

LOS 29. b: Compare the financial reporting of the following types of intangible assets: purchased, internally developed, acquired in a business combination. How are purchased finite-lived intangible assets amortized?

Answer 2

The cost of a purchased finite-lived intangible asset is amortized over its useful life.

Question 3

LOS 29. b: Compare the financial reporting of the following types of intangible assets: purchased, internally developed, acquired in a business combination. How are purchased indefinite-lived intangible assets amortized?

Answer 3

Indefinite-lived intangible assets are not amortized, but are tested for impairment at least annually.

Question 4

LOS 29. b: Compare the financial reporting of the following types of intangible assets: purchased, internally developed, acquired in a business combination. How do we deal with internally developed intangible assets costs?

Answer 4

The cost of internally developed intangible assets is expensed.

Question 5

LOS 29. b: Compare the financial reporting of the following types of intangible assets: purchased, internally developed, acquired in a business combination. Under IFRS, how do we deal with research and development costs?

Answer 5

Under IFRS, research costs are expensed but developed costs may be capitalized.

Question 6

LOS 29. b: Compare the financial reporting of the following types of intangible assets: purchased, internally developed, acquired in a business combination. Under U.S. GAAP, how do we deal with research and development costs?

Answer 6

Under U.S. GAAP, both research and development costs are expensed as incurred, except in the case of software created for sale to others.

Question 7

LOS 29. b: Compare the financial reporting of the following types of intangible assets: purchased, internally developed, acquired in a business combination.

Answer 7

The acquisition method is used to account for assets acquired in a business combination. The purchased price is allocated to the fair value of identifiable assets of the acquired firm less its liabilities. Any excess of the purchase price above the fair value of the acquired firm’s net assets is recorded as goodwill, an unidentifiable intangible asset that cannot be separated from the business itself.

Question 8

LOS 29. c: Explain and evaluate how capitalizing versus expensing costs in the period in which they are incurred affects financial statements and ratios.

Answer 8

With capitalization, the asset value is put on the balance sheet and the cost is expensed through the income statement over the asset’s useful life through either depreciation or amortization. Compared to expensing the asset cost, capitalization results in:

• Lower expense and higher net income in period of acquisition, higher expense (depreciation or amortization) and lower net income in each of the remaining years of the asset’s life.
• Higher assets and equity
• Lower CFI and higher CFO because the cost of a capitalized asset is classified as an investing cash outflow.
• Higher ROE and ROA in the initial period, and lower ROE and ROA in subsequent periods because net income is lower and both assets and equity are higher.
• Lower debt-to-assets and debt-to-equity ratios because assets and equity are higher.

Question 9

Answer 9

Question 10

LOS 29. d: Describe the different depreciation methods for property, plant, and equipment and calculate depreciation expense.

Answer 10

Depreciation methods

Straight-line: Equal amount of expense each period.

Accelerated (declining balance): Higher depreciation expense in the early years and lower depreciation expense in the later years of an asset’s life.

Units-of-production: Expense based on percentage usage rather than time.

Question 11

LOS 29. d: Describe the different depreciation methods for property, plant, and equipment and calculate depreciation expense. Equations.

Answer 11

Question 12

LOS 29. d: Describe the different depreciation methods for property, plant, and equipment and calculate depreciation expense. When is special about IFRS in regards to depreciation methods?

Answer 12

IFRS requires component depreciation, in which significant parts of an asset are identified and depreciated separately.

Question 13

LOS 29. e: Describe how the choice of depreciation method and assumptions concerning useful life and residual value affect depreciation expense, financial statements, and ratios.

Answer 13

In the early years of an asset’s life, accelerated depreciation results in higher depreciation expense, lower net income, and lower ROA and ROE compared to straight-line depreciation. Cash flow is the same assuming tax depreciation is unaffected by the choice of method for financial reporting.

Firms can reduce depreciation expense and increase net income by using longer useful lives and higher salvage values.

Question 14

LOS 29. f: Describe the different amortization methods for intangible assets with finite lives and calculate amortization expense.

Answer 14

Amortization methods for intangible assets with finite lives are the same as those for depreciation: Straight line, accelerated, or units of production. Calculation of amortization expense for each asset is the same with the depreciation expense.

Question 15

LOS 29. g: Describe how the choice of amortization method and assumptions concerning useful life and residual value affect amortization expense, financial statements, and ratios.

Answer 15

The choice of amortization method will affect expenses, assets, equity, and financial ratios in exactly the same way that the choice of depreciation method will.

Just as with the depreciation of tangible assets, increasing either the estimate of an asset’s useful life or the estimate of its residual value will reduce annual amortization expense, which will increase net income, assets, ROE, and ROA for a typical firm.

Question 16

LOS 29. h: Describe the revaluation model.

Answer 16

Under IFRS, firms have the option to revalue assets based on fair value under the revaluation model. U.S. GAAP does not permit revaluation.

The impact of revaluation on the income statement depends on whether the initial revaluation resulted in a gain or loss. If the initial revaluation resulted in a loss (decrease in carrying value), the initial loss would be recognized in the income statement and any subsequent gain would be recognized in the income statement only to the extent of the previously reported loss. Revaluation gains beyond the initial loss bypass the income statement and are recognized in shareholders’ equity as a revaluation surplus.

If the initial revaluation result in a gain (increase in carrying value), the initial gain would bypass the income statement and be reported as a revaluation surplus. Later revaluation losses would first reduce the revaluation surplus.

Question 17

LOS 29. i: Explain the impairment of property, plant, and equipment and intangible assets. Under IFRS.

Answer 17

Under IFRS, an asset is impaired when its carrying value exceeds the recoverable amount. The recoverable amount is the greater of fair value less selling costs and the value in use (present value of expected cash flows). If impaired, the asset is written down to the recoverable amount. Loss recoveries are permitted, but not above historical cost.

Question 18

LOS 29. i: Explain the impairment of property, plant, and equipment and intangible assets. Under U.S. GAAP

Answer 18

Under U.S. GAAP, an asset is impaired if its carrying value is greater than the asset’s undiscounted future cash flows. If impaired, the asset is written down to fair value. Subsequent recoveries are not allowed for assets held for use.

Question 19

LOS 29. i: Explain the impairment of property, plant, and equipment and intangible assets. Where are asset impairments reflected?

Answer 19

Asset impairments result in losses in the income statement. Impairments have no impact on cash flow as they have no tax or other cash flow effects until disposal of the asset.

Question 20

LOS 29. j: Explain the derecognition of property, plant, and equipment and intangible assets. Sold

Answer 20

When a long-lived asset is sold, the difference between the sale proceeds and the carrying (book) value of the asset is reported as a gain or loss in the income statement.

Question 21

LOS 29. j: Explain the derecognition of property, plant, and equipment and intangible assets. Abandoned

Answer 21

When a long-lived asset is abandoned, the carrying value is removed from the balance sheet and a loss is recognized in that amount.

Question 22

LOS 29. j: Explain the derecognition of property, plant, and equipment and intangible assets. Exchanged for another asset

Answer 22

If a long-lived asset is exchanged for another asset, a gain or loss is computed by comparing the carrying value of the old asset with fair value of the old asset (or fair value of the new asset if more clearly evident).

Question 23

LOS 29. k: Explain and evaluate how impairment, revaluation, and derecognition of property, plant, and equipment and intangible assets affect financial statements and ratios.

Answer 23

Impairment charges decrease net income, assets, and equity, which results in lower ROA and ROE and higher debt-to-equity and debt-to-assets ratios for a typical firm.

Question 24

LOS 29. k: Explain and evaluate how impairment, revaluation, and derecognition of property, plant, and equipment and intangible assets affect financial statements and ratios.

Answer 24

Upward revaluation increases assets and equity, and thereby decreases debt-to-assets and debt-to-equity ratios. A downward revaluation has opposite effects. The effect on net income and related ratios depends on whether the revaluation is to a value above or below cost.

Question 25

LOS 29. k: Explain and evaluate how impairment, revaluation, and derecognition of property, plant, and equipment and intangible assets affect financial statements and ratios.

Answer 25

Derecognition of assets can result in either a gain or loss on the income statement. A loss will reduce net income and assets, while a gain will increase net income and assets.

Question 26

LOS 29. l: Describe the financial statement presentation of and disclosures relating to property, plant, and equipment and intangible assets.

Answer 26

There are many differences in the disclosures requirements for tangible and intangible assets under IFRS and U.S. GAAP. However, firms are generally required to disclose:

• Carrying values for each class of asset.
• Accumulated depreciation and amortization.
• Title restrictions and assets pledged as collateral.
• For impairment assets, the loss amount and the circumstances that caused the loss.
• For revalued assets (IFRS only), the revaluation date, how fair value was determined, and the carrying value using the historical cost model.

Question 27

LOS 29. m: Analyze and interpret financial statement disclosers regarding property, plant, and equipment and intangible assets.

Answer 27

Analysts can use disclosure of the historical cost, accumulated depreciation (amortization), and annual depreciation (amortization) expense to estimate average age of assets, total useful life of assets, and remaining useful life of assets. These estimates are more accurate for firms that use straight-line depreciation.

Question 28

LOS 29. m: Analyze and interpret financial statement disclosers regarding property, plant, and equipment and intangible assets. Average age equation.

Answer 28

Question 29

LOS 29. m: Analyze and interpret financial statement disclosers regarding property, plant, and equipment and intangible assets. Total useful life.

Answer 29

Question 30

LOS 29. m: Analyze and interpret financial statement disclosers regarding property, plant, and equipment and intangible assets. Remaining useful life.

Answer 30

Question 31

LOS 29. n: Compare the financial reporting of investment property with that of property, plant, and equipment.

Answer 31

Under IFRS (but not U.S. GAAP), investment property is defined as property owned for the purpose of earning rent, capital appreciation, or both. Firms can account for investment property using the cost model or the fair value model. Unlike the revaluation model for property, plant, and equipment, increases in the fair value of investment property above its historical cost are recognized as gains on the income statement if the firm uses the fair value model.

Question 32

Answer 32

Question 33

LOS 29. o: Explain and evaluate how leasing rather than purchasing assets affects financial statements and ratios.

Answer 33

For a lessee, the accounting treatment of a finance (capital) lease is like that of purchasing the asset with debt. The leased asset is recorded on the lessee’s balance sheet and depreciated over its life. The present value of the lease payment is a liability that is amortized over the term of the lease. The interest portion of the lease payment and the depreciation of the asset are recorded as expenses on the income statement. On the cash flow statement, the interest portion of the lease payment is an operating cash outflow and the principal portion is a financing cash outflow.

With an operating lease, the full lease payment is reported as rental expense on the lessee’s income statement and as an operating cash outflow. No asset or liability is reported on the balance sheet.

Question 34

LOS 29. p: Explain and evaluate how finance leases and operating leases affect financial statements and ratios from the perspective of both the lessor and the lessee.

Answer 34

With an operating lease, the asset remains on the balance sheet of the lessor and is depreciated. The lease payments are rental income. For a finance lease, the lessor removes the asset from the balance sheet and replaces it with a lease receivable. The interest portion of the lease payment is interest income to the lessor and the remainder of the payment is a principal repayment that decreases the lease receivable on the lessor’s balance sheet.

Compared to an operating lease, a finance lease adds the asset and the related lease liability to the lessee’s balance sheet so that equity is initially unchanged. The leased asset is depreciated over the lease term. Depreciation and interest expense comprise the lease expenses recorded on the income statement and will exceed the lease payment in the early years of the lease and be less than the lease payment in the later years of the lease. This results in less profit for the lessee in the early years of a lease and greater profit in the later years.

Question 35

Answer 35

Question 36

Answer 36

Question 37

Understand?

Answer 37

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Question 38

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Answer 38

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Question 39

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Answer 39

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