Financial Accounting

(PGDM- 2018-20)

Sessions -14 &15: Accounting for Long-lived Assets

Sriranga Vishnu
Faculty (F&A Area)
 Asset Reporting

• Criteria for recognition of an asset:

– The firm owns or controls the resources
– Resources are expected to provide future benefits
– These economic benefits can be measured

• Recognition and Valuation of an Asset is difficult

when-
– Ownership or control of a resource is uncertain
– Derivable economic benefits are difficult to quantify
– The value of resources have changed
 Asset Reporting

• Uncertainty of Ownership/ Control of Resources: In

certain cases, determination of the ownership and control
over a resource is difficult
– Training and Development of Employees - ownership and
measurement issues – hence expensed
– Lease arrangements – difficult to sub-classify the Lease
into Operating (relatively lower stake) and Capital Lease
(higher stake of the lessee)
– Operating Leases are expensed; Capital Leases are shown
at present value of the lease payments and depreciated over
lease term
 Asset Reporting
• Criteria for Capital Lease determination:
– Ownership is transferred in the end
– The lease contains a bargain purchase clause
– Lease term is 75% or more of the useful life of the asset
– Present value of lease payments is 90% or more of the fair
value of the asset
 Asset Reporting

• Derivable benefits are uncertain/ difficult to quantify:

• Tangible Assets – Benefits of Capital Budgeting decisions are
difficult to determine due to future uncertainties; but market
research can be done before capital budgeting decisions to
mitigate the risk; hence, plant & machinery are treated as asset

• Intangible Assets– Benefits that can derived from Goodwill,

R&D, advertising, etc, are difficult to measure
– R&D for drugs are expensed
– R&D for Software development is capitalized when product feasibility
is certain,
– Advertising is expensed normally
 Asset Reporting
• Changes in future economic benefits: Asset value
changes with time leading to revaluation

• As per conservatism concept, assets whose values have

impaired should be written down and removed

• Some countries (UK, Australia) permit revaluation of

fixed assets, but generally such assets are shown at
historical costs

• Marketable securities are shown at current prices

 Long-lived Assets

• Tangible Assets-
– Building, Plant, Machinery, Furniture, etc.
– Depreciate over a period of time

• Intangible Assets-
– Non-physical entities – Patents, Software, Goodwill, etc.
– Amortized over a period

• Natural Resources-
– Land, Coal, Oil, etc.
– Deplete with passage of time (except land)
 Accounting for Land

• Like other fixed assets, land is recorded in the accounting

records at the acquisition cost plus the cost needed to
upgrade it to the condition necessary for its intended use

• Purchase price, taxes, cost of clearing, cost of developing

drainage, etc. are all included in the cost of the land

• In contrast to other fixed assets, land is not depreciated

and is held at the original cost until it is sold, traded or
abandoned
 Accounting for Natural Resources
• For natural resources, the term ‘Depletion’ is used. When
extracted, they are treated as inventory

• If purchased, the asset cost is cost of acquisition and

purchase

• Cost allocation for extraction of natural resources:

– Full cost method – all costs are capitalized
– Successful efforts method – success costs are capitalized,
others are expensed

• Depletion of natural resources is generally shown by

units-of-production method. For tax, percentage of
revenue is taken
 Accounting for Intangible Assets

• For intangible assets having limited useful life,

amortization is done –Patents and copyrights
– They should be amortized according to legal provisions

• If the intangible asset has indefinite useful life, periodic

impairment is done – Goodwill

• Improvements in lease occupations should be amortized by the

end of probable lease life
 Accounting for Intangible Assets

• R&D expenses are treated as period costs – expensed

because future benefits are very uncertain (matching and
conservatism concepts)

• If R&D is done for a client, it is treated as revenue- costs

are charged as expense

• In case of Software development, costs are capitalized

when product feasibility is assured
 Acquiring Plant and Equipments

• Low Cost Items– Generally expensed; Limit varies

– Capitalized facility may contain low cost items; expensed when
replaced

• Maintenance and Betterment- Maintenance is upkeep;

Generally expensed. Betterment is up-gradation over the
initial; Treated as asset and capitalized

• Replacement– Can be an asset or expanse

– Replacement of entire asset is capitalized. Replacement of a
component / part of asset is expensed
 Acquiring Plant and Equipments

• Items included in cost – All expenditure done in order to

make an equipment ready to use.
– Capitalization is higher if all costs are included
– For simplicity and property tax purposes, only purchase price is
considered

• For self-constructed assets- All material, direct labour

and fair amount of indirect costs are added. Interest cost
is also added for capitalization
– If Interest cost is capitalized and not expensed, current year
Income increases but decreases for subsequent years of assets
useful life ???
 Acquiring Plant and Equipments

• Non-Cash Acquisitions– During exchanges (common

stock), fair market value of the consideration is estimated;
if not possible, value of similar new asset is used

• Assets acquired through donations or at substantially low

prices should be recorded at fair value. Both, the total
assets and total capital increases (donated capital)

• Basket Purchase– A group of items clubbed together.

The firm should make prudent estimates to separate the
cost of items component-wise
 Accounting for Depreciation
• Depreciation– Expensing the capitalized item
– Deterioration and Obsolescence limit the life of an asset
• Residual or Salvage value
• Useful life of the asset –Service Life

• Methods of Depreciation-
– Straight Line
– Declining Balance (Written Down method)
– Sum of years' digit method
– Units of Production method
 Methods of Depreciation
• Straight Line Method– Net acquisition cost is expensed
over useful life of asset in equal amounts
– Calculation is relatively simple
– Useful for assets that depreciate mainly with time

• Written Down Method– A depreciation percentage is

applied on the acquisition cost at the beginning of the
accounting period. Asset is never completely written-off
– The amount for final period is simply written off
– The method matches the services provided by an asset
– Risk of obsolescence is reduced
– Lower income in the initial years, higher subsequently
 Methods of Depreciation
• Sum of years' digit method – Similar to Written down
method. Depreciation is applied to net cost. The rate of
depreciation is determined by dividing the remaining
useful life of the asset by the sum of the useful life

• Units-of-Production method– The depreciation rate is

determined by dividing the net cost by the estimated total
no. of units that will be produced during useful life. This
rate is then multiplied by no. of units produced/year
– This method is related with usage of assets
– Depreciation is matched with level of activity
– Estimation of products to be produced is difficult
 Accounting for Depreciation

• For tax purposes, firms normally use the written-down

method, For Financial Reporting, any of the methods can
be chosen consistently

• For different kinds of assets, different methods can be

adopted. However, firms generally stick to a single
method

• If an item has been fully depreciated and is still in

possession of the firm, it is shown in B/S at zero amount