Depreciation & Impairment under GAAP and IFRS

William Davis Nicole Lunt

Depreciation under GAAP

Current Authoritative Source? Codification topic 360-10-05 (Covers Depreciation & Impairment).
Depreciation: A Means of Cost Allocation

Depreciation under GAAP contd

Three Steps of the Depreciation Process:
Find depreciable base of the asset

Original Cost $XXXX Less: Salvage Value XXXX Depreciable Base $XXXX
Estimate assets useful life

Depreciation under GAAP contd

Choose a method of cost apportionment

that best matches revenue flow from the asset

Activity (units of use or production) Straight-line Accelerated - sum-of-the-years-digits - declining-balance (150% / 200%)

Depreciation under GAAP contd

Three Important Notes About Depreciation:
PP&E held for sale is not depreciated

PP&E is not written up by an enterprise to

reflect appraisal, market, or current values which are above cost to the enterprise

Depreciation under GAAP contd

Estimates of useful life and residual value,

and the method of depreciation, are reviewed only when events or changes indicate that the current estimates or depreciation method no longer are appropriate

Depreciation under IFRS

Current Authoritative Source IAS 16

Same as GAAP except for two main differences:

Depreciation under IFRS contd

Estimates of useful life and residual value,

and the method of depreciation, are reviewed at least at each annual reporting date

For a company currently using GAAP a change to IFRS could result in a greater frequency of revisions in depreciation rates, which in turn could mean less predictable depreciation expense

Depreciation under IFRS contd

IFRS allows a company to choose between

two different models in order to value PP&E after it has been recognized on the books:

Cost model this model is like GAAP where PP&E is carried at its cost less any accumulated depreciation and any accumulated impairment losses

Depreciation under IFRS contd

Revaluation model this model allows a company to revalue PP&E on its books to fair value if fair value can be reliably measured

For a company currently using GAAP a change to IFRS and the use of the revaluation model could lead to a substantial increase in asset values on the balance sheet as well as a corresponding substantial increase in depreciation expense

Example
Facts: At the beginning of the year a company has a building with a carrying value of $100,000 and a remaining useful life of 10 years that was recently valued at $300,000 Under GAAP depreciation expense for the year would be $10,000 (assuming straight-line)
Under IFRS depreciation expense for the year could be either $30,000 or $10,000

Depreciation under IFRS contd

Three Important Notes About Depreciation: If an item of PP&E is revalued, the entire class of PP&E to which the asset belongs has to be revalued
Examples of separate classes: land, machinery, motor vehicles, office equipment Items in a class of PP&E are revalued simultaneously to avoid selective revaluation of assets

Depreciation under IFRS contd

If an asset is revalued up, the increase is

credited directly to equity under the heading of revaluation surplus

An increase is recognized in P&L to the extent that it reverses a revaluation decrease of the same asset previously recognized in P&L

When PP&E is revalued, any accumulated

depreciation can be treated in one of two ways:

Example
Facts: A company using IFRS (revaluation model) has a piece of equipment with a cost of $10,000 and acc. depr. of $2,000. The equipment is revalued to a FMV of $20,000 Balance Sheet Presentation: Before After Equipment $10,000 $25,000 Less: acc depr 2,000 5,000 Carrying value $8,000 $20,000

Impairment under GAAP

Current Authoritative Source (SFAS No. 144supersedes SFAS No. 121)
For purpose of this discussion, impairment

does not include goodwill or intangible assets that are not amortized, which are covered in SFAS No. 142

Impairment under GAAP contd

Five central questions must be answered in order to understand impairment under GAAP:

Impairment under GAAP contd

What is impairment?

Impairment is the condition that exists when the carrying amount of a long-lived asset exceeds its fair value

When is an impairment loss recognized?

An impairment loss is recognized only if the carrying amount of a long-lived asset is not recoverable and exceeds its fair value

Impairment under GAAP contd

When is the carrying amount not

recoverable?
When the carrying amount exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset Undiscounted cash flows = [ future cash inflows (including sale of the asset) future cash outflows (including maintenance costs, but not interest charges)]

Impairment under GAAP contd

How is an impairment loss measured?

An impairment loss is the amount by which the carrying amount of a long-lived asset exceeds its fair value

When is a long-lived asset tested for

recoverability?

Whenever events or changes in circumstances indicate that its carrying amount may not be recoverable

Impairment under GAAP contd

Important Note About Impairment:
Restoration of a previously impaired loss is

prohibited unless the long-lived asset is to be disposed of by sale

Impairment under IFRS

Current Authoritative Source IAS 36

Four central questions must be answered in order to understand impairment under IFRS:

Impairment under IFRS contd

What is impairment?

Impairment is the condition that exists when the carrying amount of a long-lived asset exceeds its recoverable amount

Recoverable amount of a long-lived asset is the higher of its fair value and discounted cash flows Discounted cash flows are calculated the same way as for GAAP except that a discount rate is applied to the cash flows

Impairment under IFRS contd

When is an impairment loss recognized?

An impairment loss is recognized only if the carrying amount of a long-lived asset is more than its recoverable amount

How is an impairment loss measured?

An impairment loss is the amount by which the carrying amount of a long-lived asset exceeds its recoverable amount

Impairment under IFRS contd

When is a long-lived asset tested for

recoverability?

An entity must assess at the end of each reporting period whether there is any indication that a long-lived asset may be impaired

For a company currently using GAAP a change to IFRS could result in smaller, more frequent, impairment charges

Impairment under IFRS contd

The one big difference between IFRS and GAAP:
Impairments of long-lived assets that are not

being held for sale can be fully reversed !!!

For a company currently using GAAP a change to IFRS could result in greater fluctuations in net income and asset valuations on the balance sheet

Example
Facts: A company owns a piece of machinery that has a carrying value of $50,000 at year end and recent developments in machine technology have called into question the recoverability of the machines carrying amount.

Example contd
FMV = $42,000 / Discounted CFs = $37,000 Undiscounted CFs = $39,000 / Recoverable Amount = $42,000 GAAP IFRS CV $50,000 $50,000 - 42,000(FMV) - 42,000(R Amt) Impairment $8,000 $8,000

Example contd
FMV = $36,000 / Discounted CFs = $37,000 Undiscounted CFs = $39,000 / Recoverable Amount = $37,000 GAAP IFRS CV $50,000 $50,000 - 36,000(FMV) - 37,000(R Amt) Impairment $14,000 $13,000

Questions?