Long Lived Assets Flashcards
Explain the effects of Capitalizing vs Expensing, and where it lands on statements
Expense - when benefits beyond one period are unlikely
Entire cost hits I/S in the current period
Capitalize - when benefits extend over multiple periods (includes subsequent purchases)
Explain the treatment of Capitalized Interest for US GAAP and IFRS
Capitalized interest is not reported in the income statement as interest expense. Once construction interest is capitalized, the interest cost is allocated to the income statement through depreciation expense (if the asset is held for use), or COGS (if the asset is held for sale).
Generally, capitalized interest is reported in the cash flow statement as an outflow from investing activities, while interest expense is reported as an outflow from operating activities under U.S. GAAP. Note, however, that interest expense can be an operating, financing, or investing cash flow under IFRS.
For an analyst, both capitalized and expensed interest should be used when calculating interest coverage ratios. Any depreciation of capitalized interest on the income statement should be added back when calculating income measures.
Explain depreciation for intangible assets
Indefinite life - tested annually for impairment
Finite life - amortized over its useful life.
Explain how intangible assets are recorded
Purchased: Cost
Obtained in Business transaction: Fair value
Explain how research and development costs are treated for US GAAP and IFRS
US GAAP
Research: Expensed
Development: Expense
Software created internally: Capitalize once technical feasibility established
Software for Internal use: Capitalize once probable project will be completed as intended
IFRS
Research: Expense
Development: Capitalize
How does capitalization work regarding B/S and I/s?
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:
What is the impact on statements / ratios of capitalizing as opposed to expensing?
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.
Calculate straight line depreciation
Cost - Salvage Value
/
Useful life
Calculate DDB Depreciation
Why do firms use DDB
(Cost - Acc Dep) x ( 2 / useful life)
Higher Dep. expense in early years. Makes sense to use for assets that use lots of life in early years.
Calculate units of production depreciation
(Cost - salvage value) x units used / total capacity
What is component depreciation and which reporting standard requires it?
IFRS : Significant parts of an asset are identified and depreciated separately.
This is seldom used under US GAAP
What are the impacts of different depreciation methods on the balance sheet?
In the early years of an asset’s life, accelerated depreciation results in:
Higher Depreciation expense
Lower NI, ROA and ROE (vs straight line)
Same = tax (assuming tax depreciation is unaffected)
Firms can reduce depreciation expense and increase net income by using longer useful lives and higher salvage values.
Explain amortization
Same effect as depreciation. Same ways (straight line, DDB, units of production)
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.
Explain revaluation under IFRS and USGAAP
IFRS
Firms have the option to revalue assets based on fair value under the revaluation model.
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 resulted 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.
U.S. GAAP does not permit revaluation.
Explain cost model vs revaluation
Who allows / who doesn’t allow
Under cost model, the asset is carried at its cost less accumulated depreciation less impartment loss
Under revaluation model, if fair value can be measured reliably; revalued amount is equal to Fair value at revaluation date minus any subsequent accumulated depreciation & impairment losses.
US GAAP doesn’t allow the revaluation model.
