3.8 Long lived assets

Question 1

how to input the cost or value of a PPE asset on the balance sheet?

Answer 1

When property, plant, and equipment (PPE) is purchased, it is initially carried at cost on the balance sheet.

In addition to the purchase price, the asset’s initial book value includes any costs that were incurred to get the asset ready for its intended use, such as freight and installation costs.

Expenses that are incurred to extend the asset’s useful life may also be capitalized.

Borrowing costs may be capitalized if the borrowing is directly related to an asset that takes a long time to prepare for its intended use.

Question 2

Intangible assets

Answer 2

like patents and trademarks, lack physical substance

Question 3

Under IFRS, the following criteria must be met to be included as an identifiable intangible asset:

Answer 3

Identifiable

Under the control of the company

Expected to generate future economic benefits that will flow to the company

Cost of the asset can be readily measured

Question 4

Intangible Assets Purchased in Situations Other Than Business Combinations

Answer 4

Intangible assets purchased directly (i.e., not acquired as part of a merger) are recorded at fair value when acquired, which is similar to tangible assets.

However, it is typically more difficult to estimate the true value of intangible assets.

Analysts should be aware that companies exercise significant judgment when valuing intangible assets.

Question 5

Intangible Assets Developed Internally

Answer 5

The costs associated with developing intangible assets internally are typically expensed as they are incurred.

This means financial statements for companies that purchase intangible assets will differ from statements of those that create them internally.

Some situations do permit the capitalization of internally developed intangible assets.

IFRS allows expenses associated with the development to be capitalized, but not those associated with research.

U.S. GAAP requires expensing of both research and development, except for software development costs after feasibility has been established.

Question 6

Intangible Assets Acquired in a Business Combination

Answer 6

Under the acquisition method of accounting, the purchase price is allocated to each asset acquired.

Under IFRS, any identifiable intangible assets must be included in this allocation process.

Any amount of the purchase price in excess of the fair value of the acquired company’s assets is allocated to goodwill, which is an intangible asset that is not separately identifiable.

Goodwill is not amortized because it has an indefinite useful life.

Under US GAAP, an asset is excluded from goodwill if it either arises from contractual/legal rights (e.g., patents) or can be separated from the acquired firm.

Question 7

Capitalizing versus Expensing: Impact on Financial Statements and Ratios

Capitalization affects many items on the financial statements, so it can significantly impact trend analysis and company comparisons. The following highlights the effects of capitalizing rather than expensing an item:

Answer 7

Profits (and taxes) are higher in the current period because expenses are lower. This is positive for management that often has a short-term focus.

Profits are lower in later periods due to depreciation or amortization. However, there is no effect on the total net income over all the years.

Assets are higher because costs are capitalized on the balance sheet.

Shareholders’ equity is greater in the early years.

Operating cash flows are higher because the costs are capitalized and treated as investing cash flows. Management may use this approach in an effort to artificially increase operating cash flows.

Question 8

Capitalization of Interest Costs

Answer 8

Companies often borrow money to construct assets that take a long time to build.

The interest costs are treated differently if the asset is capitalized. If the asset is capitalized, the interest costs will be depreciated along with the long-lived asset and not part of interest expense.

When these interest costs are expensed over time, they are treated as investing cash flows rather than operating cash flows.

Question 9

when do we use depreciation vs amortization

Answer 9

depreciation (for tangible assets) or amortization (for intangible assets).

Question 10

The cost model

Answer 10

used under both IFRS and US GAA

calls for long-lived assets to be carried at historical cost less accumulated depreciation.

Question 11

the revaluation model (intro)

Answer 11

allowed under IFRS

assets are reported at fair value

The revaluation model is not permitted under US GAAP.

The revaluation model may be used for any asset – tangible or intangible, operating or non-operating – that has a readily identifiable fair value.

Under the revaluation model, adjustments can be reversed if there is a subsequent change in the asset’s fair value

Question 12

Depreciation Methods and Calculation of Depreciation Expense

Answer 12

straight-line

accelerated

units-of-production

Question 13

straight-line method

Answer 13

the same amount is depreciated each period of the asset’s useful life

The total depreciable amount is the cost less residual value.

Question 14

accelerated method

Answer 14

allocates more depreciation to earlier periods and less to later periods

Residual value is not deducted when calculating annual depreciation costs for accelerated schedules

Question 15

units-of-production method

Answer 15

the amount of depreciation in each period is proportional to the production during the period.

Question 16

Amortization Methods and Calculation of Amortization Expense

Answer 16

Amortization applies to intangible assets, but it works like depreciation.

It is only used for intangible assets with finite useful lives, such as customer lists or patents.

As with physical assets, intangible assets may have a residual value that will affect amortization costs.

Question 17

Under the revaluation model, adjustments can be reversed if there is a subsequent change in the asset’s fair value. These changes have the following impact on the company’s financial statements:

Answer 17

If the value of an asset is written down, the amount of the write-down will be recorded as a loss on the income statement. Any subsequent reversal, up to the amount of the write-down, is recognized as a gain on the income statement. Any further increase in value bypasses the income statement and is treated as other comprehensive income (OCI). It appears in the equity section of the balance sheet as a revaluation surplus.

If an asset initially increases in value, the gain is treated as OCI and recognized in the revaluation surplus account on the balance sheet. Subsequent decreases in value reduce the amount of this revaluation surplus. Any decline in value beyond the amount of the original gain is recognized as a loss on the income statement.

Question 18

It is important for analysts to recognize the potential impact on financial statements and ratios of The Revaluation Model:

Answer 18

By recognizing increases in the fair value of fixed assets, companies will increase the book value of their equity and reduce their financial leverage (Assets/Equity).

In isolation, upward revisions above initial cost actually reduce net income because the gains are treated as OCI (i.e., they bypass the income statement) and depreciation expense increases. Looking at the bigger picture, the increase in fair value is likely due to a more optimistic assessment of how much revenue the asset is expected to generate, which would presumably offset the higher depreciation cost.

A decrease in an asset’s carrying amount can reduce current net income, but it can potentially increase net income in future years through reversals.

Analysts should be aware of whether revaluations are conducted internally or by independent third parties. It is also important to note how often companies conduct these appraisals.

Question 19

Impairment charges

Answer 19

represent unanticipated decreases in the value of long-lived assets

If recognized, impairment results in a lower carrying value on the balance sheet and an equivalent loss on the income statement.

Question 20

how does the IFRS calculate Impairment loss

Answer 20

Carrying amount - Recoverable amount

Recoverable amount = Max (Value in use, Fair value - Selling costs)

Value in use is a discounted measure of expected future cash flows.

Question 21

how does the US GAAP calculate Impairment loss

Answer 21

An asset’s carrying amount is considered not recoverable if it exceeds the total value of undiscounted expected future cash flows.

If it is determined that an asset’s carrying value is unrecoverable, then an impairment loss is calculated as follows:

impairment loss = Carrying amount - Fair value

Question 22

Impairment of Intangible Assets with a Finite Life

Answer 22

Intangible assets with finite lives are treated in the same manner as tangible long-lived assets.

An assessment for signs of impairment is performed at the end of each reporting period and testing is done if evidence of impairment is discovered.

Question 23

Impairment of Intangible Assets with Indefinite Lives

Answer 23

Intangible assets with indefinite lives are tested at least annually for impairment.

Question 24

Impairment of Long-Lived Assets Held for Sale

Answer 24

When management intends to sell a long-lived asset, it gets reclassified as held for sale and is no longer used.

At the time of reclassification, the asset is tested for impairment and it is no longer depreciated or amortized.

If the asset is deemed to be impaired, its carrying value is written down to fair value less selling cost, and a loss is recognized on the income statement.

Question 25

Reversals of Impairments of Long-Lived Assets

Answer 25

Under US GAAP, reversals of impairment losses are permitted for assets that have been reclassified as held for sale, but it is not permitted for assets that are currently in use.

Reversals of impairment losses are permitted under IFRS, regardless of whether the asset is in use or held for sale. However, the magnitude of any potential reversal is limited to the amount of the previously recognized impairment. In other words, the asset cannot be carried above its pre-impairment value.

Question 26

Long-lived assets are derecognized (i.e., removed from the company’s financial statements) when one of the following conditions is met:

Answer 26

1. The asset is disposed of (e.g., sold, abandoned, exchanged).
2. The asset is expected to provide no future benefits from use or disposal.

If an asset is expected to be sold, it is deemed to be no longer in use and reclassified as held for sale.

Question 27

Sale of Long-Lived Assets

Answer 27

When an asset is sold, a gain or loss is recorded on the income statement based on the difference between the sale proceeds and the asset’s carrying amount at the time of sale.

Question 28

Under IFRS, companies must disclose the following information for each asset class of PP&E:

Answer 28

Measurement base

Depreciation method

Useful life

Gross carrying amount

Accumulated depreciation

Question 29

what do we do with Properties that are sold in the ordinary course of business (e.g., by residential construction companies)

Answer 29

they are carried on the balance sheet as inventory, not as investment properties.

Question 29

An investment property

Answer 29

held to generate rental income and/or capital appreciation.

Question 29

The gain or loss on a sale of a long-lived asset to which the revaluation model has been applied is most likely calculated using sales proceeds less:

A
carrying amount.

B
carrying amount adjusted for impairment.

C
historical cost net of accumulated depreciation.

Answer 29

A
carrying amount.

The gain or loss on the sale of long-lived assets is computed as the sales proceeds minus the carrying amount of the asset at the time of sale.

This is true under the cost and revaluation models of reporting long-lived assets.

In the absence of impairment losses, under the cost model, the carrying amount will equal historical cost net of accumulated depreciation.

Question 29

Costs incurred for intangible assets are generally expensed when they are:

A
internally developed.

B
individually acquired.

C
acquired in a business combination.

Answer 29

A
internally developed.

the costs to internally develop intangible assets are generally expensed when incurred.

Question 30

A company is most likely to:

A
use a fair value model for some investment property and a cost model for other investment property.

B
change from the fair value model when transactions on comparable properties become less frequent.

C
change from the fair value model when the company transfers investment property to property, plant, and equipment.

Answer 30

C
change from the fair value model when the company transfers investment property to property, plant, and equipment.

A company will change from the fair value model to either the cost model or revaluation model when the company transfers investment property to property, plant, and equipment.

Question 30

Which of the following is a required financial statement disclosure for long-lived intangible assets under US GAAP?

A
The useful lives of assets

B
The reversal of impairment losses

C
Estimated amortization expense for the next five fiscal years

Answer 30

C
Estimated amortization expense for the next five fiscal years