Lecture Intermediate accounting (IFRS/e) - Chapter 11: Property, plant and equipment, investment property and intangible assets: Utilization and impairment

Chapter 11 completes the discussion of accounting for property, plant and equipment, investment property and intangible assets by addressing the subsequent valuation and allocation of the value of these assets to the periods benefitted by their use. Expenditures subsequent to acquisition and impairment are also covered in this chapter.

© 2013 The McGraw-Hill Companies, Inc.

PROPERTY, PLAND AND

EQUIPMENT,INVESTMENT PROPERTY, AND

INTANGIBLE ASSETS:

UTILIZATION AND

IMPAIRMENT

Chapter 11

Some of the cost is expensed each period.

Cost Allocation – An Overview

in periods when the future revenues are earned.

acquisition cost of property, plant and equipment, investment property and intangible assets be expensed

in periods when the future revenues are earned.

Depreciation, depletion, and amortization are cost allocation processes used to help meet the

matching principle requirements.

cost allocation processes used to help meet the

matching principle requirements.

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Asset Category Debit

Intangible Amortization Intangible Asset

Account Credited

Accumulated Depreciation

Property, Plant &

Equipment Depreciation

Natural Resource Depletion Natural Resource

Asset

are processes of cost allocation, not valuation!

Depreciation

on the Statement of Financial Position

Cost Allocation – An Overview

Cost allocation requires three pieces

of information for each asset:

The estimated expected

use from an asset

The estimated expected

use from an asset

Total amount of cost to be allocated.

Total amount of cost to be allocated.

Cost - Residual Value (at end of useful life)

The systematic approach used for allocation

The systematic approach used for allocation

Allocation Base

Allocation Base

Service Life

Service

Allocation Method

Measuring Cost Allocation

Group and composite methods

Tax depreciation

Tax depreciation

Depreciation

The most widely used

and most easily understood method.

The most widely used

and most easily understood method.

Results in the same amount of depreciation in each year of the asset’s

service life.

Results in the same amount of depreciation in each year of the asset’s

service life.

On January 1, we purchase equipment for $50,000 cash The equipment has an estimated service life of 5 years

and estimated residual value of $5,000

On January 1, we purchase equipment for $50,000 cash The equipment has an estimated service life of 5 years

and estimated residual value of $5,000

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Accumulated Accumulated Undepreciated Depreciation Depreciation Depreciation Balance Year (debit) (credit) Balance (book value)

Accelerated Methods

Note that total depreciation over the asset’s useful

life is the same as the straight-line method.

Accelerated methods result in more depreciation

in the early years of an asset’s useful life and less

depreciation in later years of an asset’s useful life.

Sum-of-the-years’-digits (SYD) depreciation

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2

Sum-of-the-Years’ Digits (SYD)

On January 1, we purchase equipment for $50,000 cash

The equipment has a service life of 5 years and an estimated residual value of $5,000 Using SYD depreciation, compute depreciation for the first two years.

Sum-of-the-Years’ Digits (SYD)

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Accumulated Undepreciated Depreciation Depreciation Balance

50,000

$ 5/15 $ 15,000 $ 15,000 35,000 4/15 12,000 27,000 23,000 3/15 9,000 36,000 14,000 2/15 6,000 42,000 8,000 1/15 3,000 45,000 5,000

Declining-Balance (DB) Methods

DB depreciation

• Based on the straight-line rate

multiplied by an acceleration factor

• Computations initially ignore

residual value.

Stop depreciating when:

BV = Residual Value

Double-Declining-Balance (DDB) depreciation

is computed as follows:

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On January 1, we purchase equipment for $50,000 cash The equipment has a service life of 5 years

and an estimated residual value of $5,000.

What is depreciation for the first two years using

double-declining-balance?

Declining-Balance (DB) Methods

Accumulated Undepreciated Depreciation Depreciation Balance

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Units-of-Production

On January 1, we purchased equipment for $50,000 cash The equipment is expected to produce 100,000 units during its life and has an estimated residual value of $5,000.

If 22,000 units were produced this year, what is the amount

of depreciation?

Units-of-Production

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Use of Various Depreciation Methods

U.S GAAP vs IFRS

estimated residual value from

cost Annual reviews of

residual values are not

required

• Each component of an item of

property, plant, and equipment

is depreciated separately if its cost is significant to the total cost of the item

• Depreciable base is

determined by subtracting estimated residual value from cost IFRS requires a review of residual values annually

Component Depreciation, Depreciable Base,

and Residual Value

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Group and Composite Methods

• Assets are grouped by common characteristics.

• An average depreciation rate is used.

• Annual depreciation is the average rate × the total

group acquisition cost.

• Accumulated depreciation records are not maintained for individual assets.

• Assets are grouped by common characteristics.

• An average depreciation rate is used.

• Annual depreciation is the average rate × the total

group acquisition cost.

• Accumulated depreciation records are not maintained for individual assets.

If assets in the group are sold, or new assets

added, the composite rate remains the same.

When an asset in the group is sold or retired,

debit accumulated depreciation for the

difference between the asset’s cost and the

proceeds

If assets in the group are sold, or new assets

added, the composite rate remains the same.

When an asset in the group is sold or retired,

debit accumulated depreciation for the

difference between the asset’s cost and the

proceeds

U.S GAAP vs IFRS

• Property, plant, and equipment

is reported in the statement of

financial position at cost less

(revaluation)

• If revaluation is chosen, all

assets within a class of property, plant, and equipment must be revalued on a regular basis

Valuation of Property, Plant, and Equipment

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Amortization of Intangible Assets

The amortization process also uses the straight-line method, but usually assumes residual value = 0.

Amortization period is the shorter of the asset’s legal or contractual life.

The amortization entry is:

A contra-asset account is generally not used when recording the amortization of intangible assets.

Amortization expense $$$

Intangible asset ……… $$$

To record amortization expense.

Torch, Inc has developed a new device Patent registration costs consisted of $2,000 in attorney fees and

$1,000 in federal registration fees The device has a contractual (useful) life of 5 years The legal life is 20

years.

For year 1, what is Torch’s amortization expense?

Amortization of Intangible Assets

Amortization expense 600

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Not amortized.

Subject to assessment for impairment of value and may be written down.

Goodwill and Trademarks

Intangible Assets not Subject to Amortization

U.S GAAP vs IFRS

• Intangible assets are reported

at cost less accumulated

amortization

• U.S.GAAP prohibits

revaluation of any intangible

asset

• Intangible assets may be

reported at (1) cost less accumulated amortization or (2) fair value, if fair value can

be determined in an active market

• If revaluation is chosen, all

assets within the class of intangibles must be revalued

on a regular basis

• Goodwill cannot be revalued

Valuation of Intangible Assets

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Partial-Period Depreciation

Half-Year Convention Take ½ of a year of depreciation in the year of acquisition, and the other ½ in

the year of disposal.

Half-Year Convention

year of acquisition, and the other ½ in

the year of disposal.

Pro-rating the depreciation based on the date of acquisition is time-consuming

and costly A commonly used

alternative is the

ESTIMATED service life

ESTIMATED

ESTIMATED residual value

Changes in estimates are accounted for prospectively The book value less any residual value at the date of change is depreciated over the remaining useful life A disclosure note should describe the nature and effect of a change.

On January 1, equipment was purchased that cost $30,000, has

a useful life of 10 years and no salvage value At the beginning

of the fourth year, it was decided that there were only 5 years

remaining, instead of 7 years

Calculate depreciation expense for the fourth

Changes in Estimates

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Asset cost $ 30,000 Accumulated depreciation

($3,000 per year × 3 years) 9,000 Remaining book value 21,000 Divide by remaining life ÷ 5 Revised annual depreciation $ 4,200

What happens if we change depreciation methods?

Changes in Estimates

Change in Depreciation Method

We account for these changes prospectively, , exactly as we would any other change in estimate.

We account for these changes prospectively, , exactly as we would any other change in estimate.

A change in depreciation, amortization, or depletion

method is considered a change in accounting estimate.

A change in depreciation, amortization, or depletion

method is considered a change in accounting estimate.

On January 1, 2011, Matrix, Inc., purchased equipment for $400,000 Matrix expected a residual value $40,000, and a service life of 5 years Matrix uses the double-declining-balance method to depreciate this type of asset During 2013, the company switched from double-declining balance to straight-line depreciation The residual value remained at $40,000 Let’s determine the amount of

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Depreciation - 2011 $ 160,000 ($400,000 × 40%) Depreciation - 2012 96,000 [($400,000 - $160,000) × 40%] Total Depreciation $ 256,000

Undepreciated balance $ 144,000 Less: residual value (40,000) New depreciable amount 104,000 Remaining service life ÷ 3 Annual depreciation $ 34,667

Change in Depreciation Method

statements.

 Reporting the correction as a prior period adjustment to Beginning R/E.

In addition, a disclosure note is needed to describe the nature

of the error and the impact of its correction on each financial

statement line item affected and earnings per share.

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Subsequent Changes in Fair Value

Cost Model

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Revaluation Model

revaluation deficit as

an expense to the income statement

Revaluation

Gain

• Part of the current revaluation gain is directly credited to the income statement, up to the total amount of revaluation deficit previously recognized as an expense

• revaluation surplus is reported as other comprehensive income and accumulated in a revaluation reserve

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Revaluation Model

Definition of Fair value:

The amount for which an asset could be exchanged between knowledgeable and willing parties in an arm’s length

transaction.

•For intangible assets, fair values must be determined with

reference to an active market

•For property, plant and equipment’s fair value can be

determined with reference to an active market, or it can be

estimated using an income or a depreciated replacement cost approach.

Revaluation Model

.

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Revaluation Model

Fair Value Model

The fair value model is only applicable to investment property and

NOT property, plant and equipment and intangible asset.

•Investment properties are initially measured at cost when acquired

• a company may then choose to adopt either a cost or fair value

model of accounting for them

• Selected cost model must be applied to all investment properties

• It is easier to switch to fair value model from the cost model than the other way round

•The difference between the carrying amount of the investment property and its fair value at the end of each financial year is recognized as either

a gain or a loss in the income statement

•Depreciation charges are not necessary

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Subsequent Changes in Use of

Property

Subsequent Changes in Use of

Property

Intangible with indefinite useful lives

Goodwill

Test for impairment

of value when considered for sale.

Test for impairment of value at least annually.

Test for impairment when events or changes in circumstances

indicate that book value may not be recoverable

Finite-life Assets to be Held and Used

An asset is impaired when

the recoverable value of

the asset or generating unit

cash-Measurement – Step 1

Its book value

<

• The recoverable amount = Higher of the asset’s fair

value less cost to sell and value in use

• A cash-generating unit is a group of assets for which

identifiable cash flows are largely independent of the

Case 2: $150 book value No loss recognized

Case 3: $275 book value.

Finite-life Assets to be Held and Used

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Finite-life Assets to be Held and Used

Step 1

$140 million < $200 million Impairment loss is indicated.

Because Acme Auto Parts has seen its sales steadily decrease due to the decline in new car sales, Acme’s management believes that equipment that originally cost $350 million, with a $200 million book value may not be recoverable Management estimates that the value in use associated with the equipment’s remaining useful life will be only $140 million, and that the equipment could be sold now for $120 million Has Acme suffered an impairment loss and if

so, how should it be recorded?

Finite-life Assets to be Held and Used

Step 2 Impairment loss = $200 million – $140 million = $60 million

Impairment loss 60,000,000

Accumulated depreciation 150,000,000

Because Acme Auto Parts has seen its sales steadily decrease due to the decline in new car sales, Acme’s management believes that equipment that originally cost $350 million, with a $200 million book value may not be recoverable Management estimates that the value in use associated with the equipment’s remaining useful life will be only $140 million, and that the equipment could be sold now for $120 million Has Acme suffered an impairment loss and if

so, how should it be recorded?

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U.S GAAP vs IFRS

• Assets are tested for

impairment when events or

changes in indicators suggest

that book value may not be

recoverable

• An impairment loss is required

when an asset’s book value

exceeds the undiscounted

sum of the estimated future

• An impairment loss is required

when an asset’s book value exceeds the higher of the asset’s value-in-use (present value of estimated future cash flow) and fair value less costs

to sell

Impairment of Value: Property, Plant, and Equipment and Finite-life Intangible Assets

U.S GAAP vs IFRS

• The impairment loss is the

difference between book value

and fair value

• Reversals of impairment

losses are prohibited

• The impairment loss is the

difference between book value and the recoverable amount, the higher of the asset’s value-in-use and fair value less costs

to sell

• An impairment loss is reversed

if the circumstances that caused the impairment is resolved

Impairment of Value: Property, Plant, and Equipment and Finite-life Intangible Assets

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Determine if impairment is

indicated and calculate the

amount of the impairment.

Determine if impairment is

indicated and calculate the

amount of the impairment.

Goodwill

Allocate Goodwill to Cash Generating Units.

Allocate Goodwill to Cash

Other Indefinite Life Intangibles

Other Indefinite Life Intangibles

One-step Process

If BV of asset >

RV, recognize impairment loss.

One-step Process

If BV of asset >

RV, recognize impairment loss.

Indefinite-life Intangibles

Test for impairment of

value at least annually