Chapter 3 - Measurement, Valuation and Disclosure (Long Term Assets)

Question 1

Depreciable base and Historical Cost

Answer 1

Historical cost - salvage value - impairment loss

Note: Land has indefinite useful life therefore is not depreciable.

Historical cost = net purchase price (minus trade discounts and rebates plus purchase taxes and import duties) + direct attributable costs to bring asset to service + borrowing costs if incurred before the acquisition (AFTER, THEY ARE EXPENSED)

Question 2

Depreciation Methods

Units of Output

vs

Accelerated (Declining balance and sum of year digitis (SYD)

Answer 2

1. Units of Output = Depreciable base * units produced in period / estimated total lifetime units
2. Accelerated

• ​Declining balance = carrying amount * declining balance percentage
  
  • ​Salvage value is ignored in determining carrying amount, but the asset is not deprecated below salvage value. Since it is the only method using carrying amount you cannot go below salvage value.
• ​Sum of the year digits = Depreciable base * (remaining years in useful life)/(sum of all years of useful life).

Question 3

When to capitalize interest for acquisition of PPE (and IFRS difference)

Answer 3

(1) assets constructed or otherwise produced for an entity’s own use, including those constructed or produced by others;
(2) assets intended for sale or lease that are constructed or produced as discrete projects (e.g., ships); and
(3) certain equity-based investments. An asset constructed for an entity’s own use qualifies for capitalization of interest if (1) relevant expenditures have been made, (2) activities necessary to prepare the asset for its intended use are in progress, and (3) interest is being incurred. The investee must have activities in progress necessary to commence its planned principal operations and be expending funds to obtain qualifying assets for its operations.

Note: in IFRS you have to also DEDUCT any investment INCOME earned on the temporary investment of such borrowing.

Question 4

More IFRS considerations in PPE

Answer 4

• Under IFRS, one can choose the cost model or the revaluation model, but selection has to be consistent across all assets.
• Under IFRS, a gain or loss from a change of fair value of investment property must be recognized in profit or loss for the period in which it arises = investment property that is accounted for according to theer fair value model is NOT depreciated.

Question 5

Gain or Loss From Disposal of Asset

Answer 5

Selling price - carrying amount = gain or loss

Carrying amount = historical cost - accumulated depreciation PLUS any impairment

Question 6

Impairment of fixed assets and intangible with finite useful lifes (TWO STEP APPROACH GAAP vs IFRS ONE STEP)

Answer 6

GAAP 2 step impairment test: (IMPAIRMENT LOSS CANNOT BE REVERSED)

1. Is the impairment required? Are the undiscounted cash flows less than the asset book value = carrying amount? If yes, then second step:
2. Now that it is impaired, what is the fair value? Then we subtract fair value of book value.

Finally this value is subtracted from carrying amount to get to new carrying amount after impairment recognition.

IFRS impairment test - 1 Step (IMPAIRMENT LOSS CAN BE REVERSED)

Is value in use less than carrying amount? Then impair.

Value in USE = MAX (fair value minus cost of sale, use value = present value of expected cashflows).

Question 7

Intangible Assets Initial Recognition (and IFRS differences)

Answer 7

​Intangible assets: does not physically exist and are not financial instruments, and give rights to the person (patents, licenses, patents, copyrights, franchises and trademarks).

1. Externally acquired intangible assets are recorded at cost plus additional costs (like legal fees and patent registration)
2. Internally developed are recorded at additional costs (legal fees and patent registration) other than those for research and development.
3. Research and development must be expensed NOT CAPITALIZED.

HOWEVER, in IFRS research and development might be recognized if some key deliverables establishing feasibility, intent and measurement capacity are met.

Question 8

Intangible assets with indefinite useful life (treatment and impairment test)

Answer 8

• Intangible asset with indefinite useful life is not amortized (but carrying amount can still be impacted by impairment)
• Intangible asset with indefinite useful life needs also to be reviewed annualyy doing a qualitative test (is it 50% more likely to be impaired then not) and quantitative test (carrying amount - fair value) - no two step because it is an indefinite life and present value of cash flow is not doable.
• Note: for IFRS there is no qualitatitve assignment.

Question 9

Patent Considerations

Answer 9

Patent – the amortization period for a patent is the shorter of:

• Useful life (usually can be shorter)
• Legal life remaining after acquitsition.

Legal DEFENSE Of A PATENT IS CAPITALIZED IF THE LITIGATION IS SUCCESSFUL.

Question 10

IFRS , intangible assets and subsequent remeasurement via revaluation

Answer 10

Fair value must be determined based on active market

Question 11

Criteria for Finance Lease Classification

Answer 11

Attend at least 1 of the following criteria:

• There is transferal of ownership at the end of the lease.
• There is an option to purchase that the lessee is certainly reasonable to exercise.
• The leased asset is so specialized that there is no alternate use to the lessor at the end of the lease term.
• The lease term is for the major part (>75%)of the remaining economic life.
• The present value of the sum of the lease payments and any residual vaue guaranteed by the lessee equals or exceeds substantially (>90%) all of the fair value

Question 12

Short term lease

Answer 12

• Has a term of 12 months or less and does not contain a purchase option that the lessee is reasonably certain to exercise
• Lesse may not account to recognize RUA and lease liability, and SIMPLY EXPENSED equally distributing (SL) rent payments.
• Short term lease is a type of off-balance-sheet financing since the lessee has the right to use the leased asset, but nothing is recorded in financial statements.

Question 13

Leases and IFRS

Answer 13

The lessee has no option to classify the lease an operating lease (also called direct financing lease for the lessor), BUT he can treat low-value assets and short term leases as expenses.

Question 14

Recognizing Financial Leases (Initial and Subsequent Measurement)

Answer 14

INITIAL MEASUREMENT

• Lease liability: present value of the lease payments discounted by implicit lease rate or incremental borrowing rate from lessee
  
  • If the lease includes a purchase option, it includes the rental payments plus exercise price of the purchase option.
  • If no purchase exists: you can have rental payments, any penalties for terminating the lease, amounts probable of being owed by the lessee under residual value guarantees.
  • FOR THE SUBSTANTIAL ALL OF THE FAIR VALUE CRITERIA THE PRESENT VALUE OF FULL AMOUNT OF THE RESIDUAL VALUE GUARANTEED BY THE LESSEE IS INCLUDED IN THE TEST BUT FOR MEASURES, ONLY THE PROBABLE OF BEING OWED IS CONSIDERED.
• Right of use asset: measured at the amount at which the lease liability was recognized plus initial direct costs incurred by the lessee. if no direct cost, matches lease liability.

SUBSEQUENT MEASUREMENT

• Interest expense and lease liabiliy amortization: IF the first periodic payment is done at the commencement date there is only lease liability amortization.
  
  • Intererest expense: effective interest method: carrying amount times discount rate implicit in the lease.
  • Reduction of lease: periodic lease payment – interest expense.
• Amortization of a right of use asset: ALWAYS ON A STRAIGHT LINE BASIS. Amortized over the shorter of its useful life and the lease term. However, if 1) the ownership of the leased asset is transferred to the lesse 2) the lessee is reasonably certain to exercise the purchase option, the amotization period is the useful life of the lead asset.

IT IMPACTS INCOME STATEMENT AS TWO LINES (AMORTIZAITON AND INTEREST)

• Differences in accounting for financial and operational lease:
  
  • Subsequent ammortizaiton of the right of use of asset.
  • Income statement presentation of interest expense and amortization of the right of use asset.

Question 15

Lease (Annuity Due vs Ordinary Annuity for using tables)

Answer 15

Annuity due means the payment happened on the beginning.

Ordinary annuity means that payment happens in the end of the period.

Question 16

Taxes (Interperiod Tax Allocation)

Answer 16

>> Interperiod tax allocation happens when the GAAP basis (financial statement) and tax basis (tax return) of an asset and liability differ, due to:

1. Temporary differences: result in deferred tax amounts.
2. Permanent differences: do not result in deferred tax amounts, like:

• Payments or fines or penalties are recognized as an expense in the financial statements but are not deducted in the tax return.
• Interest on state or municpial bonds is recognized as income but is also not deducted.

Question 17

Deferred tax assets (DTA) and liabilities (DTL) (only temporary differences)

GAAP MAIOR, ADVANTAGE >> LIABILITY

GAAP MENOR, DISADVANTAGE >> ASSET

PLUS NOL

Answer 17

DTL : Arises when there is an excess of GAAP (paying less now on TAX side)

INCOME UNDER GAAP > Taxable Income IMPLIES in FUTURE TAXABLE AMOUNTS

1. revenue or gains are recognized in GAAP before they are included in taxable income (you are taking advantage).
   
   • Equity income is one example: income recognized under equity method first, but taxable requires on distributed dividends which come after.
2. expenses or losses are deductible for tax purposes before they are recognized under GAAP.
   
   • Accelerated depreciation can be chosen for tax purposes.

DTA: Arises when there is an excess of taxable income .

Taxable Income > Income Under GAAP implies in FUTURE TAXABLE AMOUNTS

• a. Revenues or gains are included in taxable income before they are recognized in GAAP.*
• I) Unearned revenue received in advance, you pay tax over cash now although you will only recognize in the future.*
• b. Expenses or losses are recognized in GAAP before they are deductible for tax. You should pay less taxes in t, but are required to pay full in t, in the future can be deducted.*

I) Bad debt expense under allowance method and warranty costs. You have to pay taxes over the full amount since you cannot deduct warranty costs accrued.

DTAs are also linked to NOL carryforward.

Question 18

Income tax expense or benefit formula

Answer 18

>> Current tax expense = taxable income * tax rate + deferred tax expense

deferrred tax expense = Changes in DTL - Changes in DTA (ADDING MORE DEFERRED TAXEX).

Question 19

When to use an alternate tax rate?

Answer 19

Only when a new one is enacted by law.

Question 20

Term bond

vs

Serial Bond

vs

Debenture

vs

Income Bonds

vs

Revenue Bonds

vs

Zero-coupon Bonds

Answer 20

Term bond - common one when there is a single maturity date.

Serial bond - matures in stated intervals (flexible to investor’s choice).

Income bond - pay interest contingent on company’s profitability, or only if the company has earned the interest.

Zero coupon bonds - no cash payments, but still need to amortize the bond with interest expense that corresponds to the full periodic amortized amount.

Question 21

Operating Lease Considerations

Answer 21

Single Periodic Lease Expense = Interest Expense on Lease Liability + Amortization of assets.

Question 22

Bonds (amortization of premium and discount)

Answer 22

Ammortized Premium or Discount = Interest expense (carrying amount vs effective interest rate) - cash interest paid (based on bond coupon)