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Contents
1.
2.
3.
4.
5.
6.
7.
8.
Introduction
Acquisition of Long-Lived Assets
Depreciation and Amortization of Long-Lived Assets
The Revaluation Model
Impairment of Assets
Derecognition
Presentation and Disclosures
Investment Property
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1. Introduction
• Long-lived assets are defined as those assets which are expected to
provide future economic benefits extending more than one year
• These assets may be tangible, intangible, or financial assets
• Major questions:
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What value should be shown on the balance sheet?
How should the cost be allocated over the life of the asset?
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2. Acquisition of Long-Lived Assets
• Upon acquisition, long-term, tangible assets such as property, plant and equipment
are recorded on the balance sheet at cost which is typically the same as fair value.
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Asset’s costs might include expenditures in addition to purchase price
Should these costs be expenses or capitalized?
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• Intangible asset valuation depends on method of acquisition
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Developed internally
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Purchased
Though a business acquisition
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Property, Plant, and Equipment
• At acquisition, PPE is recorded at cost
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Cost includes all expenditures necessary to get the asset ready for intended use
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Subsequent costs are
 capitalized if they are expected to provide benefit beyond one year; otherwise
they are expensed
• Companies might have different approaches towards expensing/capitalizing costs
• An analyst should understand the impact of expensing/capitalizing decisions
on financial statements and ratios
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Effects of Capitalizing vs. Expensing
Capitalizing
Expensing
Total Assets
H
L
Equity
H
L
Income variability
L
H
Net income (1st year)
Net income (later)
H
L
L
H
CFO
H
L
CFI
L
H
D/E
L
H
Interest Coverage (1st year)
Interest Coverage (later years)
H
L
L
H
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Example
Acme Inc. purchased a machine for 10,000. In addition the following costs
were incurred:
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1.
2.
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200 for delivery
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300 for installation
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100 to train staff on using the machine
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1,000 to reinforce floor to support machine
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500 to have the factory painted
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Which expenses will be capitalized and which will be expensed
How will the treatment of these expenditures affect the company’s financial statements
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Capitalization of Interest Costs
• For constructed assets interest cost during construction
are capitalized as part of the asset cost
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Use rate on borrowing related to construction; if no construction
 debt is
outstanding interest rate is based on existing unrelated debt
Capitalized interest not reported as interest expense on I/S

IFRS: interest 
on short-term lending offsets capitalized costs (not allowed
in U.S. GAAP)
• Capitalized interest causes:
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

Higher net income
 and greater interest coverage ratios during the period
of capitalization
Higher asset values and depreciation lead to
lower net income, EBIT and
interest coverage over subsequent periods
Example
A company borrows 2,000,000 at an interest rate of 5 percent per year on 1
January 2011 to finance construction of a factory that will have a useful life of 40
years. Construction is completed after two years, during which time the company
earns 20,000 by temporarily investing the loan proceeds.
1. How much interest will be capitalized under IFRS and U.S. GAAP?
2. Where will the capitalized borrowing cost appear on the company’s
financial statements?
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Intangible Assets
Intangible assets lack physical substance. Classic examples include software,
customer lists, patents, copyrights and trademarks. Accounting for intangible asset
depends on how it is acquired.
Acquired in a business combination
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Recorded at fair value; similar to long-lived tangible assets
Determination of fair value requires judgment
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Purchased in situation other than business combinations
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Recorded at fair value
Developed internally
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Next slide
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Intangible Assets Developed Internally
• Under IFRS research costs are expensed as incurred and development costs
are capitalized; U.S. GAAP requires both research and development costs to
be expensed as incurred.
• Costs incurred to develop software for sale to others are expensed as
incurred until product’s technological feasibility has been established;
subsequent costs should be capitalized.
• Under IFRS costs incurred to develop software for internal use should be
capitalized once feasibility established. U.S .GAAP: capitalize all development
costs.
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Example
Acme Inc. starts an internal software development project on 1 January 2012. It
incurs expenditures of 10,000 per month during the fiscal year ended 31 December
2012. By 31 March it is clear that product will be developed successfully and will be
used as intended. How are the software development costs recorded before and
after 31 March according to IFRS? According to U.S. GAAP?
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3. Depreciation and Amortization of Long-Lived Assets
• Under the cost model of reporting long-lived assets, the capitalized cost of
a tangible (intangible) long-lived asset is expensed through a process called
depreciation (amortization)
• An asset’s carrying amount is the amount at which the asset is reported on
the balance sheet; carrying amount is also called net book value
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Carrying amount = historical cost – accumulated depreciation
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• Depreciation methods include
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Straight-line method: cost of asset allocated evenly over useful life
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Accelerated methods
Units-of-production method
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Example
Consider three companies with names based on their depreciation method:
1. Straight Line (SL) Inc.
2. Double Declining Balance (DDB) Inc.
3. Units of Production (UOP) Inc.
Each company purchases identical equipment for 10,000 and makes similar assumptions: estimated
useful life = 4 years; residual value = 1,000; productive capacity = 1,000 units. Production over 4
years: 300, 300, 200, 100. Complete the table below for each company.
Beginning Net
Book Value
Depreciation
Expense
Accumulated
Depreciation
Ending Net Book
Value
Year 1
Year 2
Year 3
Year 4
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Solution
Straight Line
Double Declining
Balance
Beg. Net Book Value Dep. Exp.
Acc. Dep.
End Net Book Value
Year 1
10,000
2,250
2,250
7,750
Year 2
7,750
2,250
4,500
5,500
Year 3
5,500
2,250
6,750
3,250
Year 4
3,250
2,250
9,000
1,000
Beg. Net Book Value Dep. Exp.
Acc. Dep.
End Net Book Value
Year 1
10,000
5,000
5,000
5,000
Year 2
5,000
2,500
7,500
2,500
Year 3
2,500
1,250
8,750
1,250
Year 4
1,250
250
9,000
1,000
Beg. Net Book Value Dep. Exp.
Acc. Dep.
End Net Book Value
Year 1
10,000
3,000
3,000
7,000
Year 2
7,000
3,000
6,000
4,000
Year 3
Year 4
4,000
2,000
2,000
1,000
8,000
9,000
2,000
1,000
Units of Production
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Example (Continued)
Given the data below, compute the asset turnover ratio, operating profit margin and operating
return on assets for SLD and DDB.
Sales
Op. Ex. (excluding Carrying Amount of total assets
depreciation)
(excluding equipment)
Year 1
400,000
300,000
30,000
Year 2
400,000
300,000
30,000
Year 3
400,000
300,000
30,000
Year 4
400,000
300,000
30,000
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Financial Statement Impact Summary
The relationships indicated in the table below are for the early years of an asset’s life
Straight Line
Accelerated (DDB)
Depreciation expense
Lower
Higher
Net income
Higher
Lower
Assets
Higher
Lower
Equity
Higher
Lower
Return on assets
Higher
Lower
Return on equity
Higher
Lower
Asset turnover
Lower
Higher
Operating profit margin
Higher
Lower
Above relationships reverse in the later years if the firm’s capital expenditure decline
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Component Method of Depreciation
• IFRS requires companies to use the component method of depreciation
depreciate each component separately

• U.S. GAAP allows component depreciation but the method is seldom used
in practice
• Example: a machine has two major components. Component 1 costs $10,000 and
has an estimated useful life of 10 years. Component 2 has a cost of $3,000 and has
an estimated useful life of 3 years. What is the depreciation expense for the first
year?
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Amortization and Calculation of Amortization Expense
Amortization is similar in concept to depreciation. The term amortization applies
to intangible assets, and term depreciation applies to tangible assets.
Intangible assets include customer lists, copyrights, patents and trademarks.
Intangible assets with finite useful lives are amortized over their useful lives.
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4. Revaluation Model
• The revaluation model is an alternative to the cost model for
the periodic valuation and reporting of long-lived assets.
• IFRS permit the use of either the revaluation model or the cost model
• U.S. GAAP does not allow revaluation model
• Revaluation changes the carrying amounts of classes of longlived assets to fair value.
• Carrying amounts are the fair values at the date of revaluation less
any subsequent accumulated depreciation or amortization
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Example
Scenario 1: Machine costs 10,000 at the start of Period 1. At the end of Period 1
the fair value of the machine is 12,000. At the end of Period 2 the fair value is
8,000. Show the impact on the financial statements.
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Example
Scenario 2: Machine costs 10,000 at the start of Period 1. At the end of Period 1
the fair value of the machine is 8,000. At the end of Period 2 the fair value is
12,000. Show the impact on the financial statements.
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5. Impairment of Assets
• Impairment charges reflect an unanticipated decline in the value of
an asset.
• Both IFRS and U.S. GAAP require companies to write down the
carrying amount of impaired assets.
• Impairment reversals are permitted under IFRS but not under
U.S. GAAP.
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Impairment Calculation
Under IFRS: Impairment loss = Carrying Value – Recoverable amount
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 Recoverable amount = greater of fair value less cost to sell and value in use
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Value in use is present value of cash flow from asset
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Under U.S. GAAP: First do the recoverability test to determine whether the asset is
impaired. Asset is impaired if the carrying value is greater than the asset’s future
undiscounted cash flows
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Impairment loss = Difference between fair value and carrying amount
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Example
Given the following data, what is the reported value under IFRS and U.S. GAAP.
• Carrying amount = 8,000
• Undiscounted expected future cash flows = 9,000
7500
• Present value of expected future cash flows = 6,000
• Fair value if sold = 7,000
• Costs to sell = 200
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Other Impairment Scenarios
• Impairment of Intangible Assets with a Finite Life
• Impairment of Intangibles Assets with Indefinite Lives
• Impairment of Long-lived Assets Held for Sale
• Reversals of Impairments of Long-lived Assets
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6. Derecognition
A company derecognizes an asset (i.e., removes it from the financial statements)
when the asset is disposed of or is expected to provide no future benefits from
either use or disposal.
A company may dispose of a long-lived operating asset by selling it, exchanging it,
or abandoning it.
Gain or loss on sales = sales proceeds – carrying amount
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Long-Lived Assets Disposed of Other than by a Sale
• Abandoned Assets are treated like sale with 0 proceeds

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Carrying value removed from balance sheet
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Loss recognized in income statement
• Exchanged Assets
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Carrying value removed from balance sheet
Record fair value of new asset
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Gain/loss computed by comparing carrying value of old asset with fair value of new asset
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7. Presentation and Disclosures
Under IFRS, for each class of property, plant and equipment, a company must
disclose the measurement bases, the depreciation method, the useful lives (or,
equivalently, the depreciation rate) used, the gross carrying amount and the
accumulated depreciation at the beginning and end of the period, and a
reconciliation of the carrying amount at the beginning and end of the period.
Under U.S. GAAP the requirements are less exhaustive. A company must disclose
the depreciation expense for the period, the balances of major classes of
depreciable assets, accumulated depreciation by major classes or in total, and a
general description of the depreciation method(s) used in computing depreciation
expense with respect to the major classes of depreciable assets.
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8. Investment Property
Investment property is defined as property that is owned (or, in some cases,
leased under a finance lease) for the purpose of earning rentals, capital
appreciation, or both.
Under IFRS, companies are allowed to value investment properties using either a
cost model or a fair value model. The cost model is identical to the cost model used
for property, plant, and equipment, but the fair value model differs from the
revaluation model used for property, plant, and equipment. Under the fair value
model, all changes in the fair value of investment property affect net income.
Under U.S. GAAP, investment properties are generally measured using the cost model.
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Example
What is the treatment of unrealized gains and losses for AFS securities, assets
valued using revaluation model, and assets valued using the fair value model?
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Summary
• Acquisition
• Impact of Expense versus Capitalize Decision
• Depreciation and Amortization
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Impact of different methods on financial statements and ratios
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• Impairment
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