SS9 R30 Long-Lived Assets

Question 1

LONG-LIVED ASSETS

Answer 1

include: tangible & intangible assets, and financial assets

Question 2

CAPITALIZED costs

Answer 2

expenditure recorded as an asset on balance sheet (typ. at fair value + costs to prepare asset for use); cost then allocated to income statement over asset’s life as depr or amort (see expensed costs)

Question 3

EXPENSED costs

Answer 3

in contrast to capitalized expenses, expensed costs reduce current period pretax income in income statment

Question 4

capitalizing/expensing effect on NET INCOME

Answer 4

capitalizing costs delays recognition of expense, leading to higher net income in the current period and lower net income in subsequent periods (due to depr); this method reduces variability of net income compared to expensing

total net income is identical

Question 5

capitalizing/expensing effect on S. EQUITY

Answer 5

capitalization results in higher net income in the current period, so it also results in higher SE since retained earnings are greater (A=L+E holds true as L is unaffected)

Question 6

capitalizing/expensing effect on CASH FLOW FROM OPERATIONS

Answer 6

capitalized costs - reported as outflow from INVESTING activities

expensed costs - reported as outflow from OPERATING activities

total CF remains the same; classification is the only difference

note: depr is a noncash expense and doesn’t affect operating cash flow

Question 7

capitalizing/expensing effect on FINANCIAL RATIOS

Answer 7

capitalizing initially leads to higher assets & equity
->
lower debt-to-assets & debt-to-equity
higher ROA & ROE in first year (result of higher net income) then lower for subsequent periods

*opposite effects for expensing in first period

Question 8

CAPITALIZED INTEREST

Answer 8

occurs when firm constructs asset for its own use

interest accrued during construction period is capitalized as part of asset’s cost

similar under US GAAP and IFRS, except:
*under IFRS income earned by temporarily investing borowed funds reduces the interesed eligible for capitalization (no reduction of cap int under US GAAP)

capitalized interest is not reported in the income statement as interest expense (interest cost allocated to I/S through depr if held for use or COGS if held for sale) reported in CF Statement as outflow from investing activities

interest expense is reported as an outflow from operating activities

Question 9

INTANGIBLE ASSETS

Answer 9

long-term assets without physical substance (eg. patents, brand names, copyrights, franchises)

can have indefinite or finite lives

not always reported on balance sheet, depending on how the asset was obtained or created

Question 10

IDENTIFIABLE v. UNIDENTIFIABLE intangible assets

Answer 10

identifiable: capable of separation from firm, controlled by firm, expected to provide future econ benefits
unidentifiable: cannot be purchased separately, may have indefinite life (eg. goodwill)

Question 11

intangible assets CREATED INTERNALLY

also: R&D, Software Development

Answer 11

costs to create intangible assets are EXPENSED as incurred

Exception: R&D Costs
Under IFRS, research costs are expensed and dev costs are capitalized. Under US GAAP, R&D are both expensed (except software development)

Software Devlopment:
Costs expensed until technological feasibility is established for software developed to SELL (both IFRS & US). Under US GAAP, costs are always capitalized if developed for OWN USE.

Question 12

intangible assets PURCHASED

Answer 12

recorded on balance sheet at cost (typically at fair value at acquisition)

Question 13

intangible assets OBTAINED IN A BUSINESS COMBINATION

ie. ACQUISITION METHOD

Answer 13

acquisition method: purchase price is allocated to identifiable assets and liablities of the acquired firm on the basis of fair value. Remaining amount of purchase price is recorded as GOODWILL (an unidentifiable asset).

Goodwill created in business combination is capitalized (internally generated goodwill is expensed).

Question 14

DEPRECIATION

Answer 14

systematic allocation of asset’s cost over time

a real and significant OPERATING EXPENSE

analysts should compare against economic depreciation

Question 15

CARRYING VALUE

BOOK VALUE

Answer 15

net value of asset/liability on balance sheet

for PPE: historical cost minus accumulated depr

Question 16

HISTORICAL COST

Answer 16

original purchase price, including installation and transportation costs

also called ‘gross investment in the asset’

Question 17

ECONOMIC DEPRECATION

Answer 17

actual decline in value of an asset over the period

analyst should watch for differences between this and reported depreciaiton expense (video rental store example)

Question 18

STRAIGHT-LINE DEPRECATION

Answer 18

depr exp = (original cost - salvage value)/depreciable life

same each year over asset’s life

Question 19

DOUBLE-DECLINING BALANCE (depr)

Answer 19

DDB depr in year x =
2*(book value at beg. year x/depr life in years)

salvage value not in formula
one asset reaches salvage value, no additional depr expense is recognized

Question 20

UNITS OF PRODUCTION (depr)

Answer 20

= (original cost - salvage value)*(output units in the period / life in output units)

called DEPLETION when applied to natural resources

Question 21

change in SALVAGE VALUE & USEFUL LIFE

Answer 21

a change in these accting estimates is put into effect PROSPECTIVELY

previous periods are not affected

Question 22

COMPONENT DEPRECIATION

Answer 22

IFRS requirement (seldom used under US GAAP)

useful life of each compnent is estimated and depr computed separately for each (eg. building separated into roof, walls, flooring, etc.)

Question 23

AMORTIZATION

Answer 23

only applies to intangible assets with FINITE lives

identical to depr of tangible assets

Question 24

intangible assets with

INDEFINITE LIFE

Answer 24

not amortized

tested for IMPAIRMENT AT LEAST ANNUALLY

can be renewed at minimal cost (eg. trademark)

Question 25

REVALUATION MODEL

Answer 25

IFRS’s alternative to reporting long-lived assets on balance sheet at depr cost (the cost model)

IFRS permits long-lived assets to be reported at FAIR VALUE, as long as active markets exists for the assets

rarely used in practice

not allowed under US GAAP

METHOD:
lower revaluation reported as loss in I/S
subsequent upward revaluation reported as gain in I/S
increase in value above historical cost is reported as REVALUATION SURPLUS

Question 26

IMPAIRMENT (IFRS)

Answer 26

asset is impaired when carrying value exceeds the RECOVERABLE AMOUNT

Written down to recoverable amount on B/S. Loss recorded in I/S equal to excess of carrying value over recoverable amount.

Question 27

RECOVERABLE AMOUNT

Answer 27

greater of:
fair value minus selling costs
or
value in use

Question 28

VALUE IN USE

Answer 28

present value of future CF stream from continued use

Question 29

IMPAIRMENT (US GAAP)

Answer 29

tested only when events and circumstances indicate firm may not be able to recover carrying value through future use

tested by RECOVERABILITY TEST:
impaired if carrying value is is greater than assets future UNDISCOUNTED CF stream (requires estimation and management discretion)

Written down to fair value on B/S. Loss equal to excess of carrying value over the fair value of asset (or dicounted value fo future CFs if fair value unknown) recorded in I/S.

loss recoveries NOT permitted under US GAAP

Question 30

CARRYING VALUE

Answer 30

original cost minus accumulated depr

Question 31

IMPAIRMENT for intangible assets with indefinite lives

Answer 31

not amortized

tested for impairment at least annually

impairment loss recognized when carrying value exceeds fair value

Question 32

IMPAIRMENT for long-lived assets held for sale

Answer 32

tested for impairment when firm reclassifies long-lived asset from ‘held for use’ to ‘held for sale’

impaired if carrying value exceeds its net realizable value (fair value minus selling costs)

written down to NRV and loss recognized on I/S

Under both accounting standards, loss can be reversed if value recovers, limited to original impairment loss (carrying value of asset after reversal can’t exceed caring value before impairment was recognized)

Question 33

NET REALIZABLE VALUE

Answer 33

fair value minus selling costs

Question 34

DERECOGNITION

sold, abandoned, exchanged

Answer 34

long-lived assets removed from balance sheet

occurs when assets are sold, exchanged, or abandoned

IF SOLD: difference between sale proceeds and carrying value (including impairment changes) reported as gain/loss on I/S

IF ABANDONED: no proceeds, record a loss in I/S equal to carrying value

IF EXCHANGED: gain/loss computed by comparing carrying value to fair value of old asset (or fair value of new asset if value is more evident); carrying value of old asset removed and new asset recorded to B/S at fair value

Question 35

IFRS DISCLOSURES (for PP&E and intangible assets)

Answer 35

for PP&E: basis of measurement, useful lives or depr rate, gross carrying value, accumulated depr, reconciliation of carrying values from beg and end of period, title restrictions and assets pledged as collateral, agreements to require PP&E in the future

also: revaluation rate, how fair value was determined, carrying value using historical cost model

for impaired assets:
amounts of impairment losses and reversals (by asset class), where losses and reversals are recognized in I/S, circumstances causing loss/reversal

Question 36

US GAAP DISCLOSURES (for PP&E and intangible assets)

Answer 36

depr expense by period, balances of meajor classes by nature and function, accumulated depr by major classes, general description of depreciation methods, estimate of amortization expense for next 5 years

for impaired assets:
descriptions of the assets, circumstances causing impairment, how fair value was determined, loss amount, where loss is recognized in I/S

Question 37

INVESTMENT PROPERTY

Answer 37

IFRS:
property that a firm owns for the purpose of collecting rental income or earning capital appreciation (or both)

US GAAP:
doesn’t distinguish this from other long-lived assets

Question 38

INVESTMENT PROPERTY (financial reporting compared to PP&E)

Answer 38

choice between COST MODEL or FAIR VALUE MODEL when valuing

cost model is same as PP&E

fair value model is different from the revaluation model: revaluation above historical cost is recognized as gain on I/S (instead of surplus)

must disclose valuation model

Question 39

transfers to and from INVESTMENT PROPERTY

Answer 39

Fair Value Model:

from owner-occupied to IP:
treat as revaluation

from inventory to IP:
recognize gain/loss if FV different from carrying value

IP to inventory or owner-occupied:
fair value of asset at date of transfer will be its cost