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C H APT ER

Reporting and 1 Analyzing Long-Lived Assets

Study Objectives

Determine the cost of property, plant and equipment. Explain and calculate depreciation. Describe other accounting issues related to depreciation. Account for the disposal of property, plant and equipment. Identify the basic accounting issues for intangible assets and goodwill. Illustrate how long-lived assets are reported in the financial statements.

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Property, Plant, and Equipment

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Long-lived resources that:
Are controlled by the company
Have physical substance (a definite size and shape)

Are used in the operation of a business

Are not intended for sale to customers

Provide benefits over many years

Known by various names: property, plant, and equipment, fixed assets, capital assets.
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Determining the Cost of Property, Plant and Equipment 1

Record at cost, which includes:
Purchase price, including taxes and duties, less discounts or rebates
All expenditures necessary to bring asset to its intended location and make it ready for its intended use All of these costs are capitalized if it is probable that the company will receive an economic benefit in future from asset and this benefit can be measured (characteristics of asset)
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Types of Expenditures
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Operating expenditures
Only benefits the current period
Immediately charged against revenue as an expense

Any expenditures required to maintain an asset in its normal condition and often recur annually (not always)

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Types of Expenditures (Continued)

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Capital expenditures
Costs capitalized as an asset
Benefits future periods Costs that increase the life of an asset or its productivity or efficiency. These costs are normally larger than operating expenditures and occur less frequently. Determining which costs to capitalize is important and can be a difficult task!

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Land
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Cost of land can include:
Cash Purchase price
Closing costs such as title, legal fees and survey costs Additional costs to prepare land for its intended use (less any proceeds from salvage) such as cleaning, grading and filling. Once land ready for use, all costs associated with land recorded as operating expenses.

Land has an unlimited life, therefore it is not depreciated

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Land Improvements
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The costs of structural additions made to land that will decline in service potential, and require maintenance and replacement to keep their value
They are recorded separately from land Depreciated over their useful lives Examples: driveways, fences, sidewalks, parking lots, paving.

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Buildings
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All necessary expenditures related to the purchase or construction of a building When a building is purchased such costs include:
Purchase price
Closing costs (legal fees, title, insurance) All costs required to make building ready for its intended use (i.e. remodeling rooms and offices, and replacing or repairing the roof, floors, electrical wiring and plumbing.)
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Buildings (Continued)
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When a new building is constructed, its cost consists of:
Contract price Architect's fees

Building permits
Excavation cost Interest costs incurred to finance construction can be included in the asset cost but limited to construction period only.
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Equipment
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Equipment classification is broad and can include any of the following items:
Delivery equipment Office equipment

Machinery
Vehicles Furniture and fixtures

Other similar assets

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Equipment (Continued)
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Costs to capitalize can include:
Purchase price
Freight charges and insurance during transit paid by the purchaser

Assembling costs
Installation and testing costs

Annual costs such as licenses and insurance are operating expenditures

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Asset Retirement Costs

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Cost of any obligation to dismantle, remove or restore a long-lived asset when it is retired These costs are estimated in advance and included as part of the cost of the asset
Present value concepts used to measure

Why recorded? Because they are significant

Liability set up to show the asset retirement obligation and costs capitalized as asset Asset and Liability recorded in period when the legal obligation is created (i.e. when asset is acquired or when asset is used).

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Buy or Lease?
Advantages of leasing
Reduced risk of obsolescence 100% financing (leases do not usually require down payments) Income tax advantages Off-balance sheet financing for operating

Terminology
Lessor owner of asset for lease (e.g., landlord)
Lessee company leasing asset from owner (e.g. tenant)
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Buy or Lease? (Continued)

Operating lease

Treated as rental transaction by lessee (i.e. does not record an asset or liability on books) Periodic payment (dr. rent expense/cr. cash)

Finance lease
Treated as purchase by lessee where asset and liability recorded (dr. asset/cr. liability) Periodic payment (dr. liability and interest expense/cr. cash) Lessee depreciates leased asset just as would other long-lived assets
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Depreciation Defined
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Systematic allocation of the cost of property, plant and equipment over the assets useful life A process of cost allocation, not asset valuation Does not use or provide cash to replace the asset

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Depreciation Models
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Under IFRS two models available:
The cost model records PPE at cost at acquisition. Subsequent to acquisition, depreciation is recorded each period and assets are carried at cost less accumulated depreciation.
The revaluation model records PPE at cost at acquisition. Subsequent to acquisition, revalues PPE every period and records at fair value and any gains/losses recognized.

Under ASPE only cost model is allowed

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Factors In Calculating Depreciation

Illustration 9-2

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Depreciation Methods
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Straight-line
Used by the majority of Canadian publiclytraded companies
Most commonly used method

Simple and results in equal depreciation expense each year

Diminishing (declining)-balance
Used by companies with highly obsolete PPE or assets that need to be depreciated in large amounts in the beginning and less in future
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Example Depreciation Methods 1

A delivery van was bought on Jan. 1, 2012 by Perfect Pizza Ltd.
Cost $33,000 Estimated residual value $3,000 Estimated useful life (in years) 5 Estimated useful life (in kilometers) 100,000
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Straight-Line Method
Illustration 9-3 Depreciation is constant for each year of the asset's useful life

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Diminishing-Balance Method
Produces a decreasing annual depreciation expense over an assets useful life
Depreciation is calculated based on the assets carrying amount, which diminishes each year as accumulated depreciation increases
Results in more depreciation in early years

Annual depreciation expense is calculated by multiplying the carrying amount by the depreciation rate
Residual value is not included in the calculation

Can be applied using different rates

Depreciation rate = Straight-line rate x multiplier
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Diminishing-Balance Method (Continued)

Illustration 9-5

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Other Depreciation Issues Component Accounting

Significant components
May be depreciated separately Example: Aircraft parts

Individual components of an asset identified

Component accounting first introduced with IFRS standards; does not apply to ASPE

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Other Depreciation Issues Capital Cost Allowance

CRA allows deduction of a specified amount of depreciation called Capital Cost Allowance (CCA)
Single diminishing (declining) balance Groups assets into various classes and assigns specific CCA class rates for these assets Depreciation for accounting purposes is usually different than depreciation for income tax purposes (CCA) CCA is optional deduction, depreciation expense is not optional for calculating profit
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 Carrying value

Other Depreciation Issues Carrying Value vs. Fair Value 1

Assets cost less any accumulated depreciation since purchase date Carrying value is rarely the same as its fair value

Fair value is not relevant to the cost model

Assets are not purchased for resale but rather use in operations over the long-term It is accepted that PPE may be undervalued on Statement of Financial Position
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Impairment of Long-lived Assets

Impairment exists when:
Carrying amount of asset exceeds its recoverable amount Recoverable amount is higher of the assets fair value less costs to sell OR its value-in-use Impairment loss must be recorded if carrying amount > recoverable amount Journal entry to record impairment loss:

Dr Impairment Loss

xx
xx
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Cr Accumulated Depreciation
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Impairment of Long-lived Assets

Impairment Factors:

Companies must review their assets regularly for possible impairment or do so whenever a change in circumstances affects fair value

Reporting Impairment Losses:

As part of Profit from Continuing Operations and not as other expense on Income Statement

Assumption here is assets will continue to be used in regular operations

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Impairment of Long-lived Assets

Reversal of Impairment Losses

IFRS allows reversal of previously recorded impairment losses At year-end, company must determine whether or not an impairment loss still exists by measuring assets recoverable amount. If recoverable amount > current carrying amount, then a reversal is recorded

The reversal is limited to the amount required to increase the assets carrying amount to what it would have been if impairment loss had not been recorded
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Impairment of Long-Lived Assets

Example of Piniwa Corporation (from the textbook):

Piniwa reviews its equipment that costs $800,000 for possible impairment. The equipment has accumulated depreciation of $200,000 and currently the equipment has a recoverable amount of $550,000. Carrying amount ($800,000 - $200,000) Recoverable amount $600,000 550,000

Impairment loss

$ 50,000

The journal entry to record impairment loss is as follows: Impairment Loss 50,000 50,000 Accumulated Depreciation-Equipment (To record impairment loss on equipment)
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 Revaluation model

Other Depreciation Issues Cost vs. Revaluation Model 1

Revaluation model only allowed under IFRS Allows revaluation to fair market value Carrying Amount = FMV less subsequent accumulated depreciation and impairment loss Model only used for assets whose fair value can be reliably measured Revaluations must occur often enough so that the carrying amount is not materially different from assets fair value (i.e. at least annually)
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Revising Periodic Depreciation

Revisions needed if:
Capital expenditures during useful life Impairment losses Change in estimated useful life or residual value Change in the pattern in which the assets economic benefits are consumed

Accounted for as a change in estimate

Change made in current and future years (prospectively), but not to prior periods
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Disposals of Property, Plant, and Equipment (PPE) 1

1. Update depreciation
Depreciation for the fraction of the year to the date of disposal must be recorded

2. Calculate carrying amount

Carrying amount = Cost Accumulated depreciation

3. Calculate gain or loss

Proceeds carrying amount = gain (loss)
Proceeds > carrying amount = Gain (Cr.) Proceeds < carrying amount = Loss (Dr.)
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Disposals of Property, Plant, and Equipment (PPE) 1

4. Record disposal
Remove cost of asset and accumulated depreciation. Record proceeds (if any) and gain or loss on disposition (if any)
Cash Accumulated Depreciation (-) Asset (-) Gain on Disposal xxx xxx xxx xxx

Cash
Accumulated Depreciation (-) Loss on Disposal Asset (-)
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xxx
xxx xxx xxx
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Sale of an Asset Example

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Office furniture is purchased at a cost of $60,000 has accumulated depreciation of $33,000 as at Dec 31, 2012. Annual depreciation is $11,000 and the asset is sold July 1, 2013 for $25,000 cash. Step 1: Update depreciation ($11,000 x 6/12) Dr Depreciation Expense 5,500 Cr Accumulated depreciation-furniture 5,500 Step 2: Calculate carrying amount [($60,000) ($33,000 + $5,500)] = $21,500
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Sale of an Asset Example

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Step 3: Calculate gain or loss

($25,000 $21,500) = $3,500 (gain)

- Proceeds > carrying value Step 4: Record disposal (sale of furniture asset)

Dr Cash
Dr Accumulated depreciation Cr Asset Furniture Cr Gain on disposal

25,000
38,500 60,000 3,500

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Sale of an Asset Example

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Assume instead of receiving $25,00 in cash, proceeds of only $20,000 received in cash.

Step 1: Update depreciation (remains the same)

Step 2: Calculate carrying value (remains the same) Step 3: Calculate gain or loss ($20,000 $21,500) = -$1,500 (loss) Proceeds < carrying value 20,000 Step 4: Record disposal (sale of furniture asset) Dr Cash

Dr Accumulated depreciation
Dr Loss on disposal Cr Asset Furniture
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38,500
1,500 60,000
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Comparing IFRS and ASPE

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Comparing IFRS and ASPE (Continued)

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