CFA 30: Long-Lived Assets Flashcards
long-lived assets
Acquisition of Long-Lived Assets
Also referred to as non-current assets or long-term assets, are assets that are expected to provide economic benefits over a future period of time, typically greater than one year. Long-lived assets may be tangible, intangible, or financial assets.
Examples of long-lived tangible assets, typically referred to as property, plant, and equipment and so sometimes as fixed assets, include land, buildings, furniture and fixtures, machinery and equipment, and vehicles.
Examples of long-lived intangible assets include patents and trademarks; and examples of long-lived financial assets include investments in equity or debt securities issued by other companies.
2 issues: Figuring out cost at acquisition, and how to allocate the cost to expense over time.
The two main types of long-lived assets with costs that are typically not allocated over time are land, which is not depreciated, and those intangible assets with indefinite useful lives.
3 criteria for intangible assets under IFRS
Acquisition of Long-Lived Assets
1) Identifiable (either capable of being separated from the entity or arising from contractual or legal rights)
2) Under the control of the company
3) Expected to generate future economic benefits
In addition, two recognition criteria must be met:
1) It is probable that the expected future ecnomic benefits of the asset will flow to the company
2) The cost of the asset can be reliably measured
accounting for intangible assets purchased in situations other than business combinations
Acquisition of Long-Lived Assets
Intangible assets purchased in situations other than business combinations, such as buying a patent, are treated at acquisition the same as long-lived tangible assets; they are recorded at their fair value when acquired, which is assumed to be equivalent to the purchase price. If several intangible assets are acquired as part of a group, the purchase price is allocated to each asset on the basis of its fair value.
accounting for intangible assets developed internally
Acquisition of Long-Lived Assets
The costs to internally develop intangible assets are generally expensed when incurred.
The general requirement that costs to internally develop intangible assets be expensed should be compared with capitalizing the cost of acquiring intangible assets in situations other than business combinations. Because costs associated with internally developing intangible assets are usually expensed, a company that has internally developed such intangible assets as patents, copyrights, or brands through expenditures on R&D or advertising will recognize a lower amount of assets than a company that has obtained intangible assets through external purchase.
In addition, on the statement of cash flows, cost of internally developing intangible assets are classifed as operating cash outflows wereas costs of acquiring intangible assets are classified as investing cash outflows. Differences in strategy (developing versus acquiring intangible assets) can thus impact financial ratios.
IFRS require that expenditures on research (or during the research phase of an internal project) be expensed rather than capitalized as an intangible asset.
US GAAP, generally, require that both research and development costs be expensed as incurred but require capitalization of certain costs related to software development.
Costs incurred to develop a software product for sale are expensed until the product’s technological feasibility is established and are capitalized thereafter. Similarly, companies expense costs related to the development of software for internal use until it is probable that the project will be completed and that the software will be used as intended.
Thereafter, development costs are capitalized. The probability that the project will be completed is easier to demonstrate than is technological feasibility. The capitalized costs, related directly to developing software for sale or internal use, include the costs of employees who help build and test the software. The treatment of software development costs under US GAAP is similar to the treatment of all costs of internally developed intangible assets under IFRS.
accounting for intangible assets acquired in a business combination (AQUISTION METHOD)
Acquisition of Long-Lived Assets
When one company acquires another company, the transaction is accounted for using the acquisition method of accounting. Under the acquisition method, the company identified as the acquirer allocates the purchase price to each asset acquired (and each liability assumed) on the basis of its fair value. If the purchase price exceeds the sum of the amounts that can be allocated to individual identifiable assets and liabilities, the excess is recorded as goodwill. Goodwill cannot be identified separately from the business as a whole.
Under IFRS, the acquired individual assets include identifiable intangible assets that meet the definitional and recognition criteria. Otherwise, if the item is acquired in a business combination and cannot be recognized as a tangible or identifiable intangible asset, it is recognized as goodwill.
Under US GAAP, there are two criteria to judge whether an intangible asset acquired in a business combination should be recognized separately from goodwill: The asset must be either an item arising from contractual or legal rights or an item that can be separated from the acquired company. Examples of intangible assets treated separately from goodwill include the intangible assets previously mentioned that involved exclusive rights (patents, copyrights, franchises, licenses), as well as such items as internet domain names and video and audiovisual materials.
revaluation model
The Revaluation Model
The alternative model of reporting long-lived assets permitted under IFRS but not under US GAAP. Under the revaluation model, a company reports the long-lived asset at fair value rather than at acquisition cost (historical cost) less accumulated depreciation or amortization, as in the cost model.
Longer version:
The revaluation model is an alternative to the cost model for the periodic valuation and reporting of long-lived assets. IFRS permit the use of either the revaluation model or the cost model, but the revaluation model is not allowed under US GAAP.
Revaluation changes the carrying amounts of classes of long-lived assets to fair value (the fair value must be measured reliably). Under the cost model, carrying amounts are historical costs less accumulated depreciation or amortization. Under the revaluation model, carrying amounts are the fair values at the date of revaluation less any subsequent accumulated depreciation or amortization.
IFRS allow companies to value long-lived assets either under a cost model at historical cost minus accumulated depreciation or amortization or under a revaluation model at fair value. In contrast, US accounting standards require the cost model be used.
*A key difference between the two models is that the cost model allows only decreases in the values of long-lived assets compared with historical costs, but the revaluation model may result in increases in the values of long-lived assets to amounts greater than historical costs.
IFRS allow a company to use the cost model for some classes of assets and the revaluation model for others, but the company must apply the same model to all assets within a particular class of assets and must revalue all items within a class to avoid selective reevaluation. Examples of different classes of assets include land, land and buildings, machinery, motor vehicles, furniture and fixtures, and office equipment.
The reevaluation model may be used for classes of intangible assets but only if an active market for the assets exists, because the revaluation model may only be used if the fair values of the assets can be measured reliably. For practical purposes the revaluation model is rarely used for either tangible or intangible assets, but its use is especially rare for intangible assets.
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Under the revaluation model, whether an asset revaluation affects earnings depends on whether the revaluation initially increases or decreases an asset class’ carrying amount.
IF a revaluation INITIALLY DECREASES the carrying amount of the asset class, the decrease is recognized in profit or loss.
LATER,
IF the carrying amount of the asset class INCREASES, the increase is recognized in profit or loss to the extent that it reverses a revaluation decrease of the same asset class previously recognized in profit or loss.
Any increase in excess of the reversal amount will NOT be recognized in the income statement but will be recorded directly to EQUITY in a revaluation surplus account. An upward revaluation is treated the same as the amount in excess of the reversal amount.
In other words, if a reevaluation initially increases the carrying amount of the asset class, the increase in the carrying amount of the asset class bypasses the income statement and goes directly to equity under the heading of revaluation surplus. Any subsequent decrease in the asset’s value first decreases the reevaluation surplus THEN goes to income.
Impairment of Assets IFRS and US GAAP
Impairment of Assets
In contrast with depreciation and amortization charges, which serve to allocate the depreciable cost of a long-lived asset over its useful life, impairment charges reflect an unanticipated decline in the value of an asset. Both IFRS and US GAAP require companies to write down the carrying amount of impaired assets. Impairment reversals are permitted under IFRS but not under US GAAP.
An asset is considered to be impaired when its carrying amount exceeds its recoverable amount, or under US GAAP, when its carrying amount exceeds its fair value.
Under US GAAP, however, impairment losses are only recognizable when the carrying amount of the impaired asset is determined to be not recoverable.
Therefore, in general, impairment losses are recognized when the asset’s carrying amount is not recoverable. However, IFRS and US GAAP define recoverability differently.
Under IFRS, an impariment loss is measured as the excess of carrying amount over the recoverable amount of the asset. The recoverable amount of an asset is defined as “the higher of its fair value less costs to sell and its value in use”. Value in use is a discounted measure of expected future cash flows.
Under US GAAP, assessing recoverability is separate from measuring the impairment loss. An asset’s carrying amount is considered not recoverable when it exceeds the undiscounted expected future cash flows. If the asset’s carrying amount is considered not recoverable, the impairment loss is measured as the difference between the asset’s fair value and carrying amount.
impairment of intangible assets with a finite life
Impairment of Assets
Intangible assets with a finite life are amortized (carrying amount decreases over time) and may become impaired. As is the case with property, plant, and equipment, the assets are not tested annually for impairment. Instead, they are tested only when significant events suggest the need to test. The company assesses at the end of each reporting period whether a significant event suggesting the need to test for impairment has occurred.
Examples of such events include a significant decrease in the market price or a significant adverse change in legal or economic factors. Impairment accounting for intangible assets with a finite life is essentially the same as for tangible assets; the amount of the impairment loss will reduce the carrying amount of the asset on the balance sheet and will reduce net income on the income statement.
impairment of intangibles with indefinite lives
Impairment of Assets
Intangible assets with indefinite lives are not amortized. Instead, they are carried on the balance sheet at historical cost but are tested at least annually for impairment. Impairment exists when the carrying amount exceeds its fair value.
impairment of long-lived assets held for sale
Impairment of Assets
A long-lived (non-current) asset is reclassified as held for sale rather than held for use when it ceases to be used and management’s intent is to sell it. For instance, if a building ceases to be used and management’s intent is to sell it, the building is reclassified from property, plan, and equipment to non-current assets held for sale.
At the time reclassification, assets previously held for use are tested for impairment. If the carrying amount at the time of reclassification exceeds the fair value less costs to sell, an impairment loss is recognized and the asset is written down to fair value less costs to sell. Long-lived assets held for sale cease to be depreciated or amortized.
reversals of impairments of long-lived assets
Impairment of Assets
After an asset has been deemed impaired and an impairment loss has been reported, the asset’s recoverable amount could potentially increase. For instance, a lawsuit appeal may successfully challenge a patent infringement by another company, with the result that a patent previously written down has a higher recoverable amount.
IFRS permit impairment losses to be reversed if the recoverable amount of an asset increases regardless of whether the asset is classified as held for use or held for sale. Note that IFRS permit the reversal of impairment losses only. IFRS do not permit the revaluation to the recoverable amount if the recoverable amount exceeds the previous carrying amount.
Under US GAAP, the accounting for reversals of impairments depends on whether the asset is classified as held for use or held for sale. Under US GAAP, once an impairment loss has been recognized for assets held for use, it cannot be reversed. In other words, once the value of an asset held for use has been decreased by an impairment charge, it cannot be increased. For assets held for sale, if the fair value increases after an impairment loss, the loss can be reversed.
definition of derecognition
Derecognition
A company derecognizes an asset (i.e. removes it from the financial statements) when the asset is disposed of or is expected to provide no future benefits from either use or disposal. A company may dispose of a long-lived operating asset by selling it, exchanging it, or abandoning it. As previously described, non-current assets that are no longer in use and are to be sold are reclassified as non-current assets held for sale.
sale of long-lived assets
Derecognition
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. An asset’s carrying amount is typically the net book value (i.e. the historical cost minus accumulated depreciation), unless the asset’s carrying amount has been changed to reflect impairment and/or revaluation, as previously discussed.
A gain or loss on the sale of an asset is disclosed on the income statement, either as a component of other gains and losses or in a separate line item when the amount is material. A company typically discloses further detail about the sale in the management discussion and analysis and/or financial statement footnotes. In addition, a statement of cash flows prepared using the indirect method adjusts net income to remove any gain or loss on the sale form operating cash flow and to include the amount of proceeds from the sale in cash from investing activities. Recall that the indirect method of the statement of cash flows begins with net income and makes all adjustments to arrive at cash from operations, including removal of gains or losses from non-operating activities.
long-lived assets disposed of other than by a sale
Derecognition
Long-lived assets to be disposed of other than by a sale (e.g. abandoned, exchanged for another asset, or distributed to owners in a spin-off) are classified as held for use until disposal. Thus, the long-lived assets continue to be depreciated and tested for impairment, unless their carrying amount is zero, as required for other long-lived assets owned by the company.
When an asset is retired or abandoned, the accounting is similar to a sale, except that the company does not record cash proceeds. Assets are reduced by the carrying amount of the asset at the time of retirement or abandonment, and a loss equal to the asset’s carrying amount is recorded.
When an asset is exchanged, accounting for the exchange typically involves removing the carrying amount of the asset given up, adding a fair value for the asset acquired, and reporting any difference between the carrying amount and the fair value as a gain or loss.
The fair value used is the fair value of the asset given up, adding a fair value for the asset acquired, and reporting any difference between the carrying amount ad the fair value as a gain or loss. The fair value used is the fair value of the asset given up unless the fair value of the asset acquired is more clearly evident. If no reliable measure of fair value exists, the acquired asset is measured at the carrying amount of the asset given up.
A gain is reported when the fair value used for the newly acquired asset exceeds the carrying amount of the asset given up. A loss is reported when the fair value used for the newly acquired asset is less than the carrying amount of the asset given up. If the acquired asset is valued at the carrying amount of the asset given up because no reliable measure of fair value exists, no gain or loss is reported.
When a spin-off occurs, typically, an entire cash generating unit of a company with all its assets is spun off.
accounting for presentation and disclosures
Presentation and Disclosures
Under IFRS, for each class of property, plant, and equipment, a company must disclose the measurement bases, the depreciation method, the useful lives (or, equivalently, the depreciation rate) used, the gross carrying amount and the accumulated depreciation at the beginning and end of the period, and a reconciliation of the carrying amount at the beginning and end of the period.
In addition, disclosures of restrictions on title and pledges as security of property, plan, and equipment and contractual agreements to acquire property, plant, and equipment are required. If the revaluation model is used, the date of revaluation, details of how the fair value was obtained, the carrying amount under the cost model, and revaluation surplus must be disclosed.
The disclosure requirements under US GAAP are less exhaustive. A company must disclose the depreciation expense for the period, the balances of major classes of depreciable assets, accumulated depreciation by major classes or in total, and a general description of the depreciation method(s) used in computing depreciation expense with respect to the major classes of depreciable assets.
Under IFRS, for each class of intangible assets, a company must disclose whether the useful lives are indefinite or finite. If finite, for each class of intangible asset, a company must disclose the useful lives (or, equivalently, the amortization rate) used, the amortization methods used, the gross carrying amount and the accumulated amortization at the beginning and end of the period, where amortization is included on the income statement, and a reconciliation of the carrying amount at the beginning and end of the period.
If an asset has an indefinite life, the company must disclose the carrying amount of the asset and why it is considered to have an indefinite life.
Similar to property, plant, and equipment, disclosures of restrictions on title and pledges as security of intangible assets and contractual agreements to acquire intangible assets are required. If the revaluation model is used, the date of revaluation, details of how the fair value was obtained, and the carrying amount under the cost model, and the revaluation surplus must be disclosed.
Under US GAAP, companies are required to disclose the gross carrying amounts and accumulated amortization in total and by major class of intangible assets the aggregate amortization expense for the period, and the estimated amortization expense for the next five fiscal years.
The disclosures related to impairment losses also differs under IFRS and US GAAP. Under IFRS, a company must disclose for each class of assets the amounts of impairment losses and reversals of impairment losses recognized in the period and where those are recognized on the financial statements. The company must also disclose in aggregate the main classes of assets affected by impairment losses and reversals of impairment losses and the main events and circumstances leading to recognition of these impairment losses and reversals of impairment losses.
Under US GAAP, there is no reversal of impairment losses. The company must disclose a description of the impaired asset, what led to the impairment, the method of determining fair value, the amount of the impairment loss, and where the loss is recognized on the financial statements.
