Intermediate Accounting
Thomas H. Beechy
Schulich School of
Business,
York University
Joan E. D. Conrod
Faculty of Management
Dalhousie University
Powerpoint slides by:
Chapter 11Michael
L. Hockenstein  Commerce Department • Vanier College
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Amortization, Impairment, and Revaluation
Chapter 11
11-2
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Introduction

Significant areas of accounting policy choice:
 Amortization Method
Companies are relatively free to choose the
amortization method that best suits their
financial reporting objectives
 Impairment in Value
Lower of Cost or Market where market is related
to a projection of future cash flows: it is
subjective at best
There is lots of room for the motivations of
management to be reflected in the financial
statements
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Definitions


Capital assets (both tangible and intangible)
 produce revenue through use rather than through
resale
 can be viewed as quantities of economics service
potential to be consumed over time in the earning
of revenues
Accounting principles call for the matching of costs of
all types of operational assets against revenue over
their useful lives
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Definitions (cont.)
 Amortization: allows for the periodic
allocation of the cost of capital assets
against revenue earned

Amortization is called depreciation
when it is associated with tangible capital
assets, and depletion when associated
with natural resources
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Definitions (cont.)
 The net book value (carrying value) of an
asset: the original cost plus any capitalized postacquisition cost less accumulated amortization to date
 Amortizable cost:
the total amount of amortization
to be recognized over the useful life of the asset---it
equals total capitalized asset cost less estimated
residual value
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Definitions (cont.)
 Depreciation (i.e., on tangible capital assets) is
recorded in an accumulated depreciation account---a
contra account that is deducted from the related asset
account for balance sheet presentation
 Amortization of other assets has generally been
recorded as a direct credit to the asset account,
particularly for intangible capital assets
11-7
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Nature of Amortization




Amortization is an allocation of capital cost,
expensed over the useful life of the asset
Amortization applies to all items of limited life
that appear on the balance sheet
Amortization does not
 represent cash set aside for
replacement of plant assets
 measure the decline in market
value during the period
Net Book Value does not equal market value
11-8
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The Conceptual Basis of
Amortization
 The eventual decline in value and decline in


utility of capital assets is caused by:
 physical factors, mainly usage (wear
and tear from operations, action of time
and the elements, and deterioration and decay)
 obsolescence (the result of new technology)
Technological change does not automatically render
older equipment obsolete
If the older equipment meets the present needs of
the company, obsolescence is not a factor
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The Requirement to Recognize
Amortization Expense


The general requirement for periodic amortization is
based firmly on the matching concept and on the
underlying assumption that a primary objective of
financial reporting is to match the cost of providing
services to the revenue generated
Generally, capital assets must be amortized
11-10
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The Requirement to Recognize
Amortization Expense (cont.)
 There are three categories that do
not have to be amortized
 land
 intangible capital assets with an
indefinite life
 goodwill
11-11
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Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
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Accounting Policy Choice

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The CICA Handbook requires only that the method of
amortization chosen be rational and systematic, and
appropriate to the nature of the capital asset and its
use [CICA 3061.28]
The choices are
 based on equal allocation to each time period (the
straight-line SL method)
 based on inputs and outputs (variable charge)
- service-hours (SH) method
- productive output (PO),or units-of-production,
method
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Accounting Policy Choice (cont.)
 accelerated methods (decreasing charge)
- declining balance (DB) methods
- sum-of-the-years’-digits (SYD) method
 sinking fund methods (increasing charge)
11-13
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Policy Choices in Practice

Financial Reporting in Canada 2000 reports the
following about choice of amortization policy:
Amortization Policy
Straight-line
Declining balance
Units of production
Sinking fund
Number
180
57
44
9
290
Proportion
62%
20%
15%
3%
100%
11-14
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Factors Influencing Choice
 Nature and use of asset
 Corporate reporting objectives
 Industry norms
 Parent company preferences
 Minimize deferred taxes
 Accounting information system costs
11-15
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Estimates Required
 All amortization methods require that the
following estimates are made:
 acquisition cost
 estimated residual value
 estimated useful life
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Exhibit 11-1
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Straight Line


The straight-line (SL) method is based on the
assumption that a plant asset provides equivalent
service, or value in production, each year of its life
The SL method relates amortization directly to the
passage of time rather than to the asset's use,
resulting in a constant amount of amortization
1400
recognized per time
1200
period
1000
800
600
400
200
0
1997
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1998
1999
Depreciation
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2000
Straight Line (cont.)


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The SL method is logically appealing as well as
rational and systematic
The SL method is the most popular method in use, as
the CICA’s corporate reporting survey demonstrates
Ease of use partially explains the method’s popularity
11-19
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Methods Based on Inputs and Outputs

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Amortization methods that associate periodic
amortization with a measurable attribute of capital
assets include the service-hours method and
productive output method (also called the units-ofproduction method)
The input-output methods are rational and systematic
and logically match expense and revenue if the asset's
utility is measurable in terms of service time or units of
output
11-20
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Methods Based on Inputs and Outputs
(cont.)


If obsolescence is a factor, an asset’s utility decreases
whether used or not, and these methods will not
portray this reality
The service-hours and productive output methods can
produce different results, depending on the ratio of
machine-hours to units produced
1800
1600
1400
1200
1000
800
600
400
200
0
1997
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1998
Depreciation
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1999
Units
2000
Accelerated Amortization Methods

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Accelerated amortization methods recognize greater
amounts of amortization early in the useful life of
capital assets and lesser amounts later
Accelerated methods are based on the assumption
that newer assets produce more benefits per period
because they are more productive and require less
maintenance and repair
The declining balance method is the accelerated
method widely used in Canada
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Sinking Fund Amortization



Produces a pattern of increasing amortization---less in
the initial years, and more in later years
This amortization method has gained a toehold in real
estate companies that hold apartment buildings
These properties are usually highly levered---lots of
debt that translates into lots of interest
2000
1500
1000
500
0
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1997
1998
1999
Depreciation
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2000
Additional Amortization Issues
 Additional amortization issues include:
 a minimum amortization test
 fractional-year amortization
 site restoration costs
 amortization systems
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Fractional-Year Amortization
 Is necessary when capital asset acquisitions and

disposals do not coincide with the fiscal year
Is computed on a whole-year basis
 the appropriate fraction of a period is applied to the
amortization for the relevant whole year of the
asset’s life
 Some firms apply an accounting convention and
do not record non-material fractional amortization
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Site Restoration Costs
 Must be accrued over the life of a capital


asset so affected
When these are minor, they are netted
with residual value
When these are major, such costs are
accrued as a liability and separately
disclosed
11-26
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Impairment of Capital Assets and Goodwill



Capital assets are subject to the same sort of “lower
of cost or market value” assessment as other assets
Overvaluation of any asset is a major issue in our
GAAP model
One has to critically examine capital assets
periodically and ask, “Do they still have the ability to
generate revenue commensurate with their net book
value?”
11-27
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Impairment of Capital Assets and Goodwill
(cont.)
 Impairment of value: the loss of a portion of
the utility or value in the context of capital assets
and goodwill
11-28
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Revaluation of Capital Assets
 Historical cost has long been the generally
accepted basis for reporting capital assets in
Canada
 On rare occasions, however, a company may
restate one or more of its capital assets
upward, generally by using appraisal values
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Comprehensive Revaluation
 Comprehensive revaluation of assets and
liabilities to market value can occur, but only if
there is a change in control resulting from a
financial reorganization
 Revaluation to market value also occurs in
push-down accounting after a business
combination
11-30
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Disclosure of Amortization
 CICA Handbook recommends “for each major
category of capital assets there should be
disclosure of. . .the amortization method used,
including the amortization period or rate” [CICA
3060.54]
 Other recommended disclosures relating to capital
asset amortization are:
 the amount of any impairment or write-down during
the period
 the amount of amortization charged to income for
the period
11-31
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Disclosure of Amortization (cont.)
 the accumulated amortization of each major
category of capital assets
 details about comprehensive revaluations
11-32
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