Power Point Ppe Utilization

Chapter 7
Property, Plant,, and

Equipment, Investment
Property, and Intangible
Assets:
Utilization and Impairment
Copyright © 2018 McGraw-Hill Education Asia Pty Ltd

Spiceland et al., Intermediate Accounting, Global Edition 2
7-1
LO7-1
Cost Allocation—Overview
• Property, plant, and equipment and intangible assets are
purchased with the expectation that they will provide future
benefits, usually for several years.
• These assets are acquired to be used as part of revenue-
generating operations.
• The acquisition cost of these assets should be allocated to
periods benefited by their use.
Depreciation
• For plant and equipment
Cost allocation Depletion

known as • For natural resources
Amortization
• For intangible assets
7-2
LO7-1
Measuring Cost Allocation

• The process of cost allocation requires that three
factors be established at the time the asset is put to
use. These factors are:
Service life
• The estimated use that the company expects to receive
from the asset.
Allocation base
• The cost of the asset expected to be consumed during
its service life.
Allocation method
• The pattern in which the allocation base is expected to
be consumed.
7-3
LO7-1
Service Life
• Amount of use that the company expects to obtain
from an asset before its disposal
• Expressed in units of time or in units of activity
Example:
The estimated service life of a delivery truck could be
expressed in terms of years or in terms of the number
of miles that the company expects the truck to be
driven before disposition.
– For a depreciable asset, physical life provides the
upper bound for service life.
– Physical life will vary according to the purpose for
which the asset is acquired and the environment in
which it is operated.
7-4
LO7-1
Service Life (continued)

Service life of an asset < Physical life of an asset
Reasons
For tangible assets
(1) Expected rate of technological change
(2) Suppliers are expected to develop new technologies that
are more efficient
(3) Sold in market that frequently demands new products
(4) Economically not feasible
(5) Management intent
For intangible assets
Legal or contractual life provides the upper bound for service life
7-5
LO7-1
Allocation Base
• Allocation base is the amount of cost to be allocated
over an asset’s service life.
Allocation Initial value of the Residual (salvage)

= −
base asset at its acquisition value
The amount expected to be received for the asset at the

end of its service life less any anticipated disposal costs
• Estimating residual value for many assets can be very

difficult due to the uncertainty about the future.
• Residual values sometimes are immaterial and are
assumed to be zero.
7-6
LO7-1
Allocation Method
• A method should be selected that corresponds to the
pattern of benefits received from the asset’s use
– To determine how much cost to allocate to periods over the
asset’s service life
• The chosen method should allocate the asset’s cost “as
equitably as possible to the periods during which services
are obtained from [its] use.”
• Method should produce cost allocation in a “systematic and
rational manner.”
Time-based method
• Allocates the depreciable base according
Allocation to the passage of time
approaches Activity-based method
• Allocates the depreciable base using a
measure of the asset’s input or output
7-7
LO7-2
Depreciation Methods
• Straight-line (SL) method
– Allocates an equal amount of depreciable base to
each year of the asset’s service life
• Accelerated methods
– Declining pattern of depreciation, with higher
Time-Based depreciation in the earlier years of the asset’s life
Depreciation and lower depreciation in later years
Methods – Sum-of-the-years’-digits (SYD) method
• Multiplies depreciable base by a declining
fraction
– Declining balance methods
• Multiplies beginning-of-year book value by an
annual rate that is a multiple of the SL rate
Activity- • Units-of-production method

Based – Computes a depreciation rate per measure of
Depreciation activity and then multiplies this rate by actual
MethodsCopyright © 2018 McGraw-Hillactivity
Educationto
Asiadetermine
Pty Ltd
periodic depreciation 7-8
LO7-2
Decision Makers’ Perspective—

Selecting a Depreciation Method
• Straight-line method is easy
• Straight-line method results in less depreciation in the
earlier years of an asset’s life compared to accelerated
methods
– Positive effect on net income in earlier years
– Negative effect on net income in later years
• Accelerated methods result in more depreciation in the
earlier years of an asset’s life
– Taxation benefits derived through greater depreciation
deduction
– Unlike the LIFO conformity rule for inventory valuation, no
constraints in using different depreciation methods for financial
reporting and tax reporting
• Activity-based depreciation typically provides a better
7-9
match of revenues and expenses
LO7-2
Depreciation of Investment Property

• If cost method is adopted
– Follows the depreciation for property, plant, and
equipment and intangible assets
• If fair value method is adopted
– No need to depreciate

7-10
Intangible Assets Subject to LO7-3
Amortization
Useful life
• Legal, regulatory, or contractual provisions often
limit the useful life of an intangible asset.
• Useful life might sometimes be less than the
asset’s legal or contractual life.
Residual value
• Expected residual value of an intangible asset
usually is zero.
• The residual value is not zero if at the end of the
asset’s useful life to the reporting entity the asset
will benefit another entity.
Allocation method
• The method of amortization should reflect the
pattern of use of the asset in generating benefits.
7-11
LO7-3
Intangible Assets Not Subject to
Amortization
• An intangible asset that is determined to have an
indefinite useful life is not subject to periodic
amortization.
– Useful life is considered indefinite if there is no
foreseeable limit on the period of time over which the
asset is expected to contribute to cash flows of the
entity.
• Indefinite does not necessarily mean permanent.
• Intangible assets with indefinite useful lives are
subject to impairment.
Examples of indefinite-life intangibles assets:
Goodwill, trademarks, and tradenames
7-12
LO7-3
Additional Issues Related to Cost

Allocation: Partial Period Depreciation
• When acquisition and/or disposal occurs at times

other than the beginning or the end of a company’s
fiscal year
• Depreciation, depletion, and amortization is
recorded for the part of the year that the asset
actually is used
• Half-year convention:
– A convention where one-half of a full year’s
depreciation is recorded in the year of acquisition
and another half in the year of disposal

7-13
LO7-4
Change in Estimates
• Accounted for prospectively
• Reflected in the financial statements of the current
and future periods
• A disclosure note should describe the effect of a
change in estimate for the current period on:
– Net income
– Related per share amounts

7-14
LO7-4
Change in Depreciation or
Amortization Method
• Change in accounting estimate that is achieved by a
change in accounting principle
• Accounted for in the same way as any other change
in accounting estimate
• Requires a clear justification as to why the new
method is preferable
– Because this change in estimate is a result of a
change in accounting principle

7-15
LO7-5
Error Correction
• Errors involving property, plant, and equipment and
intangible assets include:
– Computational errors in the calculation of depreciation,
depletion, or amortization
– Mistakes made in determining whether expenditures
should be capitalized or expensed
• Treatment of material errors occurring in a previous year:
– Previous years’ financial statements are retrospectively
restated.
– Account balances are corrected.
– If retained earnings requires correction, the correction is
reported as a prior period adjustment.
– A note describes the nature of the error and the impact
of the correction on income.
7-16
LO7-6
Subsequent Changes in Fair Value

Subsequent Change in Fair Value
Cost Model Revaluation Model Fair Value Model

7-17
LO7-6
Cost Model
●
Ignore all subsequent changes in fair
Carry at cost value of the assets
Allocation ●
Depreciation or amortization
Required recognized every period
●
required when the fair values of its assets are
Disclosures materially different from the assets’ carrying amounts
●
Assets are not exempted from
Impairment impairment analysis

7-18
LO7-6
Revaluation Model
All assets within a class of property, plant, and equipment and intangible assets
must be revalued on a regular basis. Records the difference between
(1) the book value of a revalued asset and (2) its fair value
at the end of each financial period
A revaluation surplus is reported as

other comprehensive income and Revaluation deficit is recognized as an
accumulated in a revaluation surplus expense in the income statement
account in equity unless a revaluation unless there is a balance in the
deficit has been charged to the revaluation surplus account.
income statement previously.

7-19
LO7-6
Revaluation Model
Previous
Net Revaluation
Period/Current Net Revaluation Deficit
Surplus
Period
• Balance in the
revaluation reserve is
eliminated before
Revaluation • Loss is recognized as an
charging the
Loss expense
revaluation deficit as
an expense to the
income statement.
• Part of the current

revaluation gain is directly • Revaluation surplus
credited to the income is reported as other
Revaluation statement, up to the total comprehensive
Gain amount of revaluation deficit income and
previously recognized as an accumulated in a
expense. revaluation reserve.
• The rest is will be as per..

7-20
LO7-6
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.

7-21
LO7-6
Revaluation Model
.
Depreciation or amortization has to be recognized in the

current financial year before computing revaluation surplus
or deficit.
●
Eliminated against the gross carrying amount of asset before restating that net amount to the revalued amount
●
Restated proportionally with the gross carrying amount of the asset so that the difference between the restated
accumulated depreciation or amortization and the restated carrying amount is equal to the revalued amount
The accumulated depreciation or amortization can either be:

7-22
LO7-6
Revaluation Model
Derecognition
●
Asset’s carrying amount, accumulated depreciation or amortization,
and accumulated impairment are written off
●
Any gain or loss on disposal is recognized.
Realizing revaluation surplus as the

relating asset is being used
●
The realized amount is the difference between (1) the depreciation or amortization based on the revalued amount
and (2) the depreciation and amortization based on the asset’s original historical cost.
●
The realized surplus is transferred directly from the assets revaluation reserve account to the retained earnings.
●
It is not compulsory for companies to realized the revaluation surplus as the relating asset is being used.

7-23
LO7-6
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.

7-24
LO7-7
Subsequent Changes in Use of

Property
Transfer at book value on the date of the change in us e
Investment property is
Transfer accounted for using the
cost model before transfer
No change to the c ost of the inves tment property
from
investment
property to Investment property is
Transferred at its fair value
on the date of the change in
property,
use
accounted for using the fair
value model before transfer The fair value is deemed to
be the property’s cost after
plant, and
transfer
equipment
7-25
LO7-7
Subsequent Changes in Use of

Property
Carrying value of the

Investment property will be
Transfer accounted for using the
property, plant, and
equipment or inventory
will be deemed the
cost model after transfer cost of the investment
from
property on the date of
change in use
property,
plant, and
equipment to Investment property will be
accounted for using the fair
Property, plant, and equipment or inventory brought to fair
value on the date of change in use.
investment value model after transfer

Any revaluation surplus in the equity account brought to retained
earnings only when the investment property is derecognized
property

7-26
LO7-6
Impairment of Value
• Implicit assumption in allocating the cost of an asset over its
useful life:
There has been no significant reduction in the anticipated
total benefits or service potential of the asset.
• Situations can arise that cause a significant decline or
impairment of those benefits or service potentials.
Example:
Building destroyed by fire before the asset is fully depreciated.
• Remaining book value of the asset is written off as a loss.
• Recognizing and measuring an impairment loss depends on
whether the assets are:
– to be held and used or
– being held for sale.
7-27
LO7-6
Impairment of Value:
Assets Held and Used
• Should be written down if there has been a
significant impairment of value
Example:
In 2015, Murphy Oil Corporation recorded impairment
charges of $2.4 billion. The charges reflect the decline in
asset values associated with lower oil and gas prices.
• A write-down can provide important information
about the future cash flows that a company can
generate from using the asset.

7-28
LO7-6
Impairment of Value:
Assets Held and Used (continued)
• Even if the significant impairment of value has
occurred, it often is difficult to measure the amount of
the required write-down.
For assets to be held and used, different guidelines
are applied to:
Property, plant, and
equipment and intangible • Subject to depreciation,
assets with finite useful depletion, or amortization
lives
Intangible assets with • Not subject to
indefinite useful lives amortization
7-29
LO7-6
Impairment of Value: Property, Plant, and

Equipment and Finite-Life Intangible Assets
• According to GAAP, assets are grouped at the lowest

level for which identifiable cash flows are largely
independent of the cash flows of other assets.
• When to Test for Impairment
– Tested for impairment only when events or changes
in circumstances indicate that the book value of the
asset may not be recoverable.

7-30
LO7-6
Potential Events or Changes in Circumstance

• Some examples of changes in circumstances indicating that
an asset may be impaired:
– A significant decrease in market price
– A significant adverse change in how the asset is being used or
in its physical condition
– A significant adverse change in legal factors or in the business
climate
– An accumulation of costs significantly higher than the amount
originally expected for the acquisition or construction of an
asset
– A current-period loss combined with a history of losses or a
projection of continuing losses associated with the asset
– A realization that the asset will be disposed of significantly
before the
Copyright © 2018end of Education
McGraw-Hill its estimated
Asia Pty Ltd
useful life 7-31
LO7-6
Impairments and Cash Flow

Estimates
• Undiscounted estimates of cash flows are used to
determine whether an impairment loss has occurred.
• Discounted estimates of cash flows often are used to
estimate fair value to determine the amount of the loss.
• A disclosure note is needed to describe the impairment
loss. The note should include:
– description of the impaired asset or asset group,
– the facts and circumstances leading to the impairment,
– the amount of the loss if not separately disclosed on
the face of the income statement, and
– the method used to determine fair value.
7-32
LO7-6
Indefinite-Life Intangible Assets

Other Than Goodwill
• Tested for impairment annually and more frequently if
events or changes in circumstances indicate that it is more
likely than not that the asset is impaired.
• A company has the option of first undertaking a qualitative
assessment to avoid the quantitative test.
• Measurement of an impairment loss is a one-step process.
• If book value exceeds fair value, an impairment loss is
recognized for the difference.
• There is no recoverability test.
• If an impairment loss is recognized, the written-down book
value becomes the new cost base for future cost allocation.
7-33
LO7-6
Goodwill
• It is a unique intangible asset.
• Unlike other assets, its cost:
– can’t be directly associated with any specific identifiable
right and
– is not separable from the company as a whole.
• Impairment of goodwill can’t be measured in the same
way as other long-lived assets.
• Level of testing is the reporting unit:
– A reporting unit is an operating segment of a company or a
component of an operating segment for which discrete
financial information is available and segment
management regularly reviews the operating results of
that component.
7-34
LO7-6
Measuring Goodwill Impairment

• Two-step process for measuring goodwill impairment is:
Step 1:
A goodwill impairment loss is indicated when the fair value
of the reporting unit is less than its book value.
Step 2:
A goodwill impairment loss is measured as the excess of
the book value of the goodwill over its “implied” fair value.
7-35
LO7-6
Goodwill: When to Test for Impairment
• FASB now allows companies the option of performing a

qualitative assessment to possibly avoid step 1.
• If the fair value of the reporting unit is below book
value, the company performs step 2 to measure the
amount of goodwill impairment.

7-36
LO7-6
Assets to be Sold
• These are assets that management has actively
committed to immediately sell in their present
condition and for which sale is probable.
• If book value exceeds fair value less cost to sell, an
impairment loss is recognized for the difference.
• These assets are not depreciated or amortized.
• They are reported separately in the balance sheet.

7-37
LO7-6
Summary of Asset Impairment Guidelines

7-38
LO7-6
Impairment Losses and Earnings Quality

• An analyst must decide whether to consider asset impairment
losses as transitory in nature or as a part of permanent
earnings.
• By writing off large amounts of assets:
– Earnings are significantly reduced in the write-off year.
– Future earnings are increased by lowering future depreciation,
depletion, or amortization.
• If a company underestimates future net cash flows, fair value is
understated.
• Two effects of understating fair value are as follows:
– Current year’s income is unrealistically low due to the impairment
loss being overstated.
– Future income is unrealistically high because depreciation,
depletion, and amortization are based on understated asset
values.
7-39
LO7-8
Expenditures Subsequent to Acquisition

• Many long-lived assets require expenditures to repair,
maintain, or improve them after their acquisition.
• Expenditures that produce benefits beyond the current fiscal
year are capitalized (increase in net assets).
• Expenditures that maintain a given level of benefits are
expensed in the period they are incurred.
Increasing the asset’s book value

Capitalizing
Creating a new asset
versus
Expensing Maintaining given level of benefits

7-40
LO7-8
Expenditures Can Increase Future Benefits
1. An extension of the useful life of the asset

2. An increase in the operating
Future efficiency of the asset resulting in:
Benefits • Increase in the quantity of goods or
services produced
• Decrease in future operating costs
3. An increase in the quality of the goods or services
produced by the asset

7-41
LO7-8
Repairs and Maintenance

• Made to maintain a given level of benefits provided by the
asset
• Do not increase future benefits
• Future benefits are not provided beyond those originally
anticipated
• Expenditures for these activities should be expensed in the
period incurred
Example:
The cost of an engine tune-up or the repair of an engine part
for a delivery truck allows the truck to continue its
productive activity. If the maintenance is not performed, the
truck will not provide the benefits originally anticipated. In
that sense, future benefits are provided; without the repair,
the truck will no longer operate.
7-42
LO7-8
Additions
• Adding a new major component to an existing asset
should be capitalized because future benefits increased.
Example:
Adding a refrigeration unit to a delivery truck increases the
capability of the truck, thus increasing its future benefits.
– Capitalized cost includes all necessary expenditures
that are required to bring the addition to a condition
and location for use.
Example:
For a building addition, this might include the costs of
tearing down and removing a wall of the existing building.

7-43
LO7-8
Improvements
• Involves the replacement of a major component of an
asset
Replacement
New component with the same characteristics as the old
New component with enhanced operating capabilities
component
• In either case, the cost of the improvement usually

increases future benefits.
• It should be capitalized by increasing the book value of
the related asset and depreciated over the useful life of
the improved asset.
7-44
LO7-8
Three Methods to Record the Cost of

Improvements
• Disposition of the old component
Substitution • Acquisition of the new component
• The cost of the improvement is included as a

debit to the related asset account.
• The original cost and accumulated depreciation
Capitalization of the original component are not removed.
of new cost • Acceptable only if the book value of the original
component has been reduced to an immaterial
amount through prior depreciation.
• Asset account is left unaltered but its related

Reduction of accumulated depreciation is decreased.
accumulated • Book value is same as in capitalization of cost
method, but the cost and the accumulated
depreciation depreciation amounts both differ under the
two methods.
7-45
LO7-8
Expenditures Subsequent to
Acquisition—Accounting Treatment

7-46

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Chapter 7

Property, Plant,, and

Copyright © 2018 McGraw-Hill Education Asia Pty Ltd

Cost allocation Depletion

Measuring Cost Allocation

Service Life (continued)

Allocation Initial value of the Residual (salvage)

The amount expected to be received for the asset at the

• Estimating residual value for many assets can be very

Activity- • Units-of-production method

Decision Makers’ Perspective—

Depreciation of Investment Property

Copyright © 2018 McGraw-Hill Education Asia Pty Ltd

Additional Issues Related to Cost

• When acquisition and/or disposal occurs at times

Copyright © 2018 McGraw-Hill Education Asia Pty Ltd

Copyright © 2018 McGraw-Hill Education Asia Pty Ltd

Copyright © 2018 McGraw-Hill Education Asia Pty Ltd

Subsequent Changes in Fair Value

Cost Model Revaluation Model Fair Value Model

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Copyright © 2018 McGraw-Hill Education Asia Pty Ltd

A revaluation surplus is reported as

Copyright © 2018 McGraw-Hill Education Asia Pty Ltd

• Part of the current

Copyright © 2018 McGraw-Hill Education Asia Pty Ltd

•For intangible assets, fair values must be determined with

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

Copyright © 2018 McGraw-Hill Education Asia Pty Ltd

Depreciation or amortization has to be recognized in the

The accumulated depreciation or amortization can either be:

Copyright © 2018 McGraw-Hill Education Asia Pty Ltd

Realizing revaluation surplus as the

Copyright © 2018 McGraw-Hill Education Asia Pty Ltd

Fair Value Model

•Investment properties are initially measured at cost when acquired

•The difference between the carrying amount of the investment property

•Depreciation charges are not necessary.

Copyright © 2018 McGraw-Hill Education Asia Pty Ltd

Subsequent Changes in Use of

Transfer at book value on the date of the change in us e

Subsequent Changes in Use of

Carrying value of the

investment value model after transfer

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Copyright © 2018 McGraw-Hill Education Asia Pty Ltd

Impairment of Value: Property, Plant, and

• According to GAAP, assets are grouped at the lowest

Copyright © 2018 McGraw-Hill Education Asia Pty Ltd

Potential Events or Changes in Circumstance

Impairments and Cash Flow

Indefinite-Life Intangible Assets

Measuring Goodwill Impairment

Goodwill: When to Test for Impairment

• FASB now allows companies the option of performing a

Copyright © 2018 McGraw-Hill Education Asia Pty Ltd

Copyright © 2018 McGraw-Hill Education Asia Pty Ltd

Summary of Asset Impairment Guidelines

Copyright © 2018 McGraw-Hill Education Asia Pty Ltd

Impairment Losses and Earnings Quality

Expenditures Subsequent to Acquisition

Increasing the asset’s book value

Expensing Maintaining given level of benefits