Reading 28: Long-Lived Assets

Depreciation Methods

1. Straight Line Depreciation 2. Accelerated Depreciation =>Double-declining balance (DDB) 3. Units of Production

Long-Lived Assets Types

1. Tangible Assets 2. Intangible Assets 3. Financial Assets

Remaining Useful Life

= ending net PP&E / annual depreciation expense Net PP&E is equal to original cost (gross PP&E) minus accumulated depreciation. The remaining useful life can also be approximated by subtracting the average age from the average depreciable life.

Average Age

=(Accumulated Depreciation)/(Annual Depreciation Expense) This calculation is more accurate for a firm that uses straight-line depreciation. The calculation can be significantly affected by the mix of assets

Total Useful Life

=(Historical Cost)/(Annual Depreciation Expense) Historical cost is gross PP&E before deducting accumulated depreciation.

Capitalization effects on CFO

A capitalized expenditure is usually reported in the cash flow statement as an outflow from investing activities. If immediately expensed, the expenditure is reported as an outflow from operating activities. Thus, capitalizing an expenditure will result in higher operating cash flow and lower investing cash flow compared to expensing. Assuming no differences in tax treatment, total cash flow will be the same. The classification of the cash flow is the only difference When an expenditure is capitalized, depreciation expense is recognized in subsequent periods. =>Depreciation is a noncash expense and, aside from any tax effects, does not affect operating cash flow.

A change in accounting estimate

A change in an accounting estimate, such as useful life or salvage value, is put into effect in the current period and prospectively. =>That is, the change in estimate is applied to the asset's carrying (book) value and depreciation is calculated going forward using the new estimate. =>The previous periods are not affected by the change. Estimates are also involved when a manufacturing firm allocates depreciation expense between COGS and SG&A. =>While the allocation does not affect a firm's operating margin, it affects the firm's gross margin (which is computed before SG&A expense) and operating expenses

Finance Lease

A finance lease is, in substance, a purchase of an asset that is financed with debt. At the inception of the lease, the lessee will add equal amounts to both assets and liabilities on the balance sheet. Over the term of the lease, the lessee will recognize depreciation expense on the asset and interest expense on the liability. =>This is the same treatment as if the asset were purchased with borrowed funds at the same asset value and terms as the finance lease.

Salvage Value

A higher estimate of the salvage value will also decrease depreciation and increase net income, while a lower estimate of the salvage value will increase depreciation and decrease net income.

Lease

A lease is a contractual arrangement whereby the lessor, the owner of an asset, allows a lessee to use the asset for a specified period of time in return for periodic payments. 1. Finance Lease =>In the United States, a finance lease is known as a capital lease. 2. Operating Lease

Useful Life

A longer estimated useful life decreases annual depreciation and increases reported net income, while a shorter estimated useful life will have the opposite effect

Revaluation Model

Allowed under IFRS as an alternative to the cost model. Under the revaluation model, an asset is carried at its depreciated cost, but at each revaluation date, the balance sheet value is adjusted to fair value. Between revaluation dates, depreciation is recorded for the asset. Revaluation to fair value must be done sufficiently often that the reported value is not significantly different from fair value. Whether a revaluation affects the income statement, rather than only affecting equity, depends on previous revaluations.

Expensing vs. Capitalizing Costs

Although it may make no operational difference, the choice between capitalizing costs and expensing them will affect: 1. net income 2. shareholders' equity 3. total assets 4. cash flow from operations 5. cash flow from investing 6. numerous financial ratios

Appraisals with Revaluation

An analyst should check the source of the appraisal that supports the revaluation. Appraisals from independent sources are usually more reliable than appraisals by management.

Recoverability GAAP

An asset is considered impaired if the carrying value (original cost less accumulated depreciation) is greater than the asset's future undiscounted cash flow stream. Because the recoverability test is based on estimates of future undiscounted cash flows, tests for impairment involve considerable management discretion.

Capitalization

An expenditure that is capitalized is initially recorded as an asset on the balance sheet at cost =>typically its fair value at acquisition plus any costs necessary to prepare the asset for use. Except for land and intangible assets with indefinite lives (such as acquisition goodwill), the cost is then allocated to the income statement over the life of the asset as 1.depreciation expense (for tangible assets) or 2. amortization expense (for intangible assets with finite lives).

Analysis of Impairments

An impairment loss is an indication that the firm has not recognized sufficient depreciation or amortization expense, and has overstated earnings as a result. Judgment required in determining asset impairments gives management considerable discretion about the timing and amounts of impairment charges =>impairment decisions present an opportunity for management to manipulate earnings. =>Waiting to recognize an impairment loss until a period of relatively high earnings would tend to smooth earnings.

Purchased Intangible Assets

An intangible asset purchased from another party is initially recorded on the balance sheet at cost, typically its fair value at acquisition. If the intangible asset is purchased as part of a group, the total purchase price is allocated to each asset on the basis of its fair value

Operating Lease

An operating lease is essentially a rental arrangement. No asset or liability is reported by the lessee and the periodic lease payments are simply recognized as rental expense in the income statement. **Accounting standards scheduled to take effect in 2019 will require operating leases to appear on the balance sheets of lessees.

Unidentifiable Intangible Assets

An unidentifiable intangible asset is one that cannot be purchased separately and may have an indefinite life. The most common example of an unidentifiable intangible asset is goodwill. =>Goodwill is the excess of purchase price over the fair value of the identifiable assets (net of liabilities) acquired in a business combination.

Trademarks

Another example of an intangible asset with an indefinite life is a trademark that may have a specific expiration date, but can be renewed at minimal cost. In this case, the trademark is considered to have an indefinite life and no amortization is required.

ratio of annual capital expenditures to depreciation expense

Another popular metric is the ratio of annual capital expenditures to depreciation expense. This ratio provides information about whether the firm is replacing its PP&E at the same rate as its assets are being depreciated.

Methods of Estimating Age or Useful Life

Because assets are often grouped by their useful lives, the following methods of estimating the average age, economic life, and remaining useful life of a firm's assets do not produce precise values, but they can highlight issues for further investigation. Three useful calculations (in years) for an analyst are: 1. Average Age 2. Total Useful Life 3. Remaining Useful Life

Estimating Useful Life and Salvage Value

Calculating depreciation expense requires estimating an asset's useful life and its salvage (residual) value. Firms can manipulate depreciation expense, and therefore net income, by increasing or decreasing either of these estimates.

Capitalization Effects on Shareholder's Equity

Capitalization results in higher net income in the period of the expenditure compared to expensing, it also results in higher shareholders' equity because retained earnings are greater. Total assets are greater with capitalization and liabilities are unaffected, so the accounting equation (A = L + E) remains balanced. As the cost is allocated to the income statement in subsequent periods, net income, retained earnings, and shareholders' equity will be reduced.

Capitalizing Expenses Effects on Net Income

Capitalizing an expenditure delays the recognition of an expense in the income statement In the period that an expenditure is capitalized, the firm will report higher net income compared to immediately expensing. In subsequent periods, the firm will report lower net income compared to expensing, as the capitalized expenditure is allocated to the income statement through depreciation expense. =>This allocation process reduces the variability of net income by spreading the expense over multiple periods Total net income is identical whether the asset's cost is capitalized or expensed. =>Timing of the expense recognition in the income statement is the only difference.

Finite-Lived Intangible Assets

Cost of a finite-lived intangible asset is amortized over its useful life.

Intangible Assets Created Internally

Costs to create intangible assets are expensed as incurred. =>Important exceptions are research and development costs (under IFRS) and software development costs

Units-of-production Method

Depreciation under the units-of-production method is based on usage rather than time. Depreciation expense is higher in periods of high usage. The units-of-production method applied to natural resources is referred to as depletion.

Derecognition of Assets

Derecognition of an asset refers to its disposal by sale, exchange for another asset, or abandonment. Under the cost model: =>the carrying (book) value of a long-lived asset is its historical cost minus accumulated depreciation or amortization, adjusted for any impairment charges taken. Under the revaluation model: =>the carrying value of an asset is its value as of the last revaluation date, less any subsequent depreciation or amortization. The difference between the sale price and the carrying value is reported as a gain or loss on the income statement. =>Such gains and losses may be reported in other income or losses or as a separate line item if the amount is material. =>When an asset is abandoned, the treatment is the same, but the sale price is zero and the loss is equal to the carrying value. If an asset is exchanged for another asset, the sale price is taken to be the fair value of the asset exchanged, or the value of the asset acquired if that value is more readily available. =>There are no cash flows with an exchange of assets, but gains or losses, based on the difference between the carrying value and the "price" received for the exchanged asset, are reported on the income statement (as they are with a sale). =>If the fair values of the assets cannot be reliably estimated, the price of the acquired asset is taken to be the carrying value of the exchanged asset and no gains or losses are recorded.

GAAP Disclosure Requirments for Intangibles

Disclosure requirements for intangible assets are similar to those for PP&E. In addition, the firm must provide an estimate of amortization expense for the next five years.

Professor's Note on Revaluation

Do not confuse the revaluation model with fair-value reporting of trading securities or some types of inventory, under which all gains and losses flow through the income statement.

Derecognition

Eventually, long-lived assets are removed from the balance sheet. Derecognition occurs when assets are sold, exchanged, or abandoned.

Management and Impairment Decisions

Existing managements may take more impairment charges in periods when earnings will be poor due to external (macroeconomic or industry) factors. New managements may also choose to take more or greater impairment charges when they take over. In either case, the resulting low earnings might not be perceived as the "fault" of management, and lower values for assets and equity give a boost to ROA and ROE going forward.

Financial Statement Analysis from Disclosures

Financial statement disclosures provide an analyst considerable information about a company's fixed assets and depreciation (amortization) methods. An analyst can use these data to estimate the average age of the firm's assets. The average age is useful for two reasons: 1. Older, less-efficient assets may make a firm less competitive. 2. The average age of assets helps an analyst to estimate the timing of major capital expenditures and a firm's future financing requirements.

Financial Statement Effects of Capitalizing Intangibles

Financial statement effects of capitalizing intangible assets are the same as the effects of capitalizing other expenditures. Capitalizing results in: 1. higher net income in the first year 2. lower net income in the subsequent years. 3. Assets, equity, and operating cash flow are all higher when expenditures are capitalized.

Disclosure of Investment Property valuation models

Firms are required to disclose which valuation model they use for investment property. Firms that use the fair value model must state how they determine the fair value of investment property and reconcile its beginning and ending values. Firms that use the cost model must disclose the fair value of their investment property, along with the disclosures that are required for other types of long-lived assets

Analytical Purposes of Purchased Intangibles

For analytical purposes, an analyst is usually more interested in the type of asset acquired rather than the value assigned on the balance sheet. =>For example, recently acquired franchise rights may provide insight into the firm's future operating performance. In this case, the allocation of cost is not as important.

Capitalizing Expenditures for Growing Firms

For growing firms, capitalizing expenditures may result in earnings that are higher over many periods compared to an otherwise identical expensing firm. This is because the amount of depreciation from previously capitalized expenditures is less than the amount of additional costs that are being newly capitalized each period.

Disclosure Requirements for Impaired Assets GAAP

For impaired assets, the firm must disclose: 1. A description of the impaired asset. 2. Circumstances that caused the impairment. 3. How fair value was determined. 4. The amount of loss. 5. Where the loss is recognized in the income statement.

IFRS Disclosure Requirements for Impaired Assets

For impaired assets, the firm must disclose: 1. Amounts of impairment losses and reversals by asset class. 2. Where the losses and loss reversals are recognized in the income statement. 3. Circumstances that caused the impairment loss or reversal.

Recovering Impairment Losses for Long-Lived Assets Held for Sale

For long-lived assets held for sale, the loss can be reversed under IFRS and U.S. GAAP if the value of the asset recovers in the future. However, the loss reversal is limited to the original impairment loss. =>The carrying value of the asset after reversal cannot exceed the carrying value before the impairment was recognized. This is an exception to normal GAAP rules

Investment Property Reporting IFRS

IFRS gives firms the choice of using a cost model or a fair value model when valuing investment property, if a fair value for the property can be established reliably. A firm generally must use the same valuation model (cost or fair value) for all of its investment properties.

Component Depreciation

IFRS requires firms to depreciate the components of an asset separately, thereby requiring useful life estimates for each component. For example, a building is made up of a roof, walls, flooring, electrical systems, plumbing, and many other components. Under component depreciation, the useful life of each component is estimated and depreciation expense is computed separately for each. Component depreciation is allowed under U.S. GAAP but is seldom used.

Expensing Costs effects on Net Income

If a firm expenses an expenditure in the current period, net income is reduced by the after-tax amount of the expenditure. In subsequent periods, no allocation of cost is necessary. Thus, net income in future periods is higher than if the expenditure had been capitalized. Total net income is identical whether the asset's cost is capitalized or expensed. =>Timing of the expense recognition in the income statement is the only difference.

Long-Lived Assets Held for Sale

If a firm reclassifies a long-lived asset from held for use to held for sale because management intends to sell it, the asset is tested for impairment. At this point, the asset is no longer depreciated or amortized. The held-for-sale asset is impaired if its carrying value exceeds its net realizable value (fair value less selling costs). If impaired, the asset is written down to net realizable value and the loss is recognized in the income statement

Derecognition of Abandoned Assets

If a long-lived asset is abandoned, the treatment is similar to a sale, except there are no proceeds. The carrying value of the asset is removed from the balance sheet and a loss of that amount is recognized in the income statement.

Derecognition of Exchanged Assets

If a long-lived asset is exchanged for another asset, a gain or loss is computed by comparing the carrying value of the old asset with fair value of the old asset (or the fair value of the new asset if that value is clearly more evident). The carrying value of the old asset is removed from the balance sheet and the new asset is recorded at its fair value.

Loss Measurement

If impaired, the asset's value is written down to fair value on the balance sheet and a loss, equal to the excess of carrying value over the fair value of the asset (or the discounted value of its future cash flows if the fair value is not known), is recognized in the income statement.

Expensing Effects on Shareholders' Equity

If the expenditure is immediately expensed, retained earnings and shareholders' equity will reflect the entire reduction in net income in the period of the expenditure.

IFRS Disclosures under Revaluation Model

If the revaluation (fair value) model is used, the firm must also disclose: 1. The revaluation date. 2. How fair value was determined. 3. Carrying value using the historical cost model.

Impairment, derecognition and revaluation effects on financial statments

Impairment reduces an asset's carrying value on the balance sheet. =>An impairment charge is recognized as a loss in the income statement, reducing assets and equity (retained earnings). =>In the year of impairment, ROA and ROE will decrease because the impairment charge reduces net income. In subsequent periods: =>net income will be higher than it would have been without the impairment charge because depreciation will be lower (the asset has a lower depreciable value). =>Both ROA and ROE will increase in periods after the impairment charge because both equity and assets will fall as a result of the impairment charge. =>Asset turnover will increase in the period in which the impairment charge is taken, and in subsequent periods as well. Asset impairment has no impact on cash flow because the impairment does not reduce taxable income; it is an unrealized loss until the asset is disposed of.

Changing Classification of an investment property

In some cases, a firm may change its use of a property such that it becomes investment property or is no longer classified as investment property. For example, a firm may move its offices out of a building it owns and begin renting the space to others. If the firm uses the fair value model, the financial statement treatment of the asset's value depends on the nature of the change. If the firm uses the cost model, the property's carrying amount does not change when it is transferred into or out of investment property.

Straight-line vs. Accelerate Depreciation

In the early years of an asset's life, compared to straight-line depreciation, using an accelerated depreciation method will result in higher depreciation expense and lower net income, total assets, and shareholders' equity For a single long-lived asset, these effects reverse in the later years of its useful life. For a fast-growing firm, however, these effects will persist over time as long as the firm is acquiring more depreciable assets than it is derecognizing. Return on assets and return on equity are higher with straight-line depreciation compared to accelerated methods. =>This is because the effect on the numerator (higher net income) is relatively larger than the effect on the denominators (higher assets and equity). =>Asset turnover ratios (revenue / average assets) are lower with straight-line depreciation. Assuming that the depreciation method for tax is unchanged, the choice of depreciation method for financial reporting will not affect cash flows.

Indefinite-Lived Intangible Assets

Indefinite-lived intangible assets are not amortized, but are tested for impairment at least annually. If impaired, the reduction in value is recognized in the income statement as a loss in the period in which the impairment is recognized.

Amortization of Intangible Assets

Intangible assets with finite lives are amortized over their useful lives. Amortization is identical to the depreciation of tangible assets. The same methods, straight-line, accelerated, and units-of-production, are permitted. The calculation of amortization expense also requires estimates of useful lives and salvage values =>estimating useful lives is complicated by many legal, regulatory, contractual, competitive, and economic factors that may limit the use of the intangible assets. As with depreciation, the total amount of amortization is the same under all of the methods. Timing of the amortization expense in the income statement is the only difference.

Intangible Assets With Indefinite Lives

Intangible assets with indefinite lives are not amortized; rather, they are tested for impairment at least annually. An impairment loss is recognized when the carrying amount exceeds fair value.

Intangible Assets Reported on the Balance Sheet

Not all intangible assets are reported on the balance sheet. Accounting for an intangible asset depends on whether the asset was created internally, purchased externally, or obtained as part of a business combination.

Double-Declining Balance Method

Note that salvage value is not in the formula for double-declining balance depreciation. => However, once the carrying (book) value of the asset reaches the salvage value, no additional depreciation expense is recognized.

Subsequent Revaluation Dates

On a revaluation date after the first revaluation, if fair value is greater than the carrying value, a gain is first reported on the income statement to the extent it reverses any previously recorded loss from revaluation. If the revaluation gain is greater than prior losses reported in the income statement that have not been reversed, the excess is reported in the revaluation surplus account If fair value on a revaluation date after the first revaluation date is less than the carrying value, the difference first goes to reduce any existing balance in the revaluation surplus account. =>Any remaining difference in excess of the balance in the revaluation surplus account is reported on the income statement as a loss.

Related expenditures to a capitalized expense

Once an asset is capitalized, subsequent related expenditures that provide more future economic benefits (e.g., rebuilding the asset) are also capitalized. Subsequent expenditures that merely sustain the usefulness of the asset (e.g., regular maintenance) are expensed when incurred.

Goodwill

Only goodwill created in a business combination is capitalized on the balance sheet. The costs of any internally generated "goodwill" are expensed in the period incurred.

Straight-line Depreciation

Predominant method of computing depreciation for financial reporting. Depreciation is the same amount each year over the asset's estimated life: =(Original Cost-Salvage Value)/(Depreciable Life)

Capitalization Effects on Financial Ratios

Results in higher assets and higher equity compared to expensing. =>Debt-to-assets ratio and the debt-to-equity ratio are lower Capitalizing an expenditure will initially result in higher return on assets (ROA) and higher return on equity (ROE). This is the result of higher net income in the first year. In subsequent years, ROA and ROE will be lower for a capitalizing firm because net income is reduced by the depreciation expense. Because an expensing firm recognizes the entire expense in the first year, ROA and ROE will be lower in the first year and higher in the subsequent years. After the first year, net income (numerator) is higher, and assets and equity (denominators) are lower, than they would be if the firm had capitalized the expenditure. Analysts must be careful when comparing firms because immediately expensing an expenditure gives the appearance of growth after the first year. The interest coverage ratio (EBIT / interest expense) measures a firm's ability to make required interest payments on its debt. In the year of the expenditure, capitalizing interest results in lower interest expense compared to expensing. The result is a higher interest coverage ratio (smaller denominator) when interest is capitalized. Many analysts calculate the interest coverage ratio based on total interest expense, including capitalized interest. Because the interest is a required payment, this may be a better measure of the firm's solvency. Treating the capitalized interest as interest expense for analytical purposes reduces the interest coverage ratio. Bond rating agencies often make this adjustment.

Effects of Revaluing an Asset Upward

Revaluing an asset's value upward will result in: 1. Higher total assets and higher shareholders' equity. 2. Lower leverage ratios as measured by the debt ratio (total debt / total assets) and the debt-to-equity ratio (higher denominators). 3. Higher depreciation expense and thus lower profitability in periods after revaluation. 4. Lower ROA and ROE in periods after revaluation (lower numerators and higher denominators). =>If the increase in the asset value is the result of higher operating capacity, such higher capacity should result in higher revenues and thus higher earnings.

Intangibles Obtained in Business Acquisition

The acquisition method is used to account for business combinations. Under the acquisition method, the purchase price is allocated to the identifiable assets and liabilities of the acquired firm on the basis of fair value. Any remaining amount of the purchase price is recorded as goodwill. =>Goodwill is said to be an unidentifiable asset that cannot be separated from the business itself

Economic Depreciation

The analyst must decide whether the reported depreciation expense is more or less than economic depreciation, which is the actual decline in the value of the asset over the period. One chain of video rental stores was found to be overstating income by depreciating its stock of movies by equal amounts each year. =>In fact, a greater portion of the decrease in the value of newly released movies occurs in the first year. =>Depreciating the rental assets by a greater amount during the first year would have better approximated economic depreciation and reduced reported income.

Effects of Amortization Methods

The choice of amortization method will affect expenses, assets, equity, and financial ratios in exactly the same way that the choice of depreciation method will. Just as with the depreciation of tangible assets, increasing either the estimate of an asset's useful life or the estimate of its residual value will reduce annual amortization expense, which will increase net income, assets, ROE, and ROA for the typical firm.

Cost model for investment property

The cost model for investment property is the same as the cost model for valuing property, plant, and equipment.

Testing for Impairment vs. Measuring Impairment

The difference between testing for impairment and measuring the impairment loss can be confusing. In testing for impairment, undiscounted cash flows are used. =>Using undiscounted cash flows to test for impairment keeps PP&E assets from becoming "impaired" by increases in the discount rate when interest rates increase. Once impairment has been detected, the loss is based on fair value or the discounted expected future cash flows.

Fair Value Model for investment property

The fair value model is different from the revaluation model we described earlier Under the revaluation model, an increase in an asset's carrying value is recognized as revaluation surplus in owners' equity (unless it reverses a previously recognized loss). For investment property, however, an upward revaluation is recognized as a gain on the income statement.

Carrying (book) Value

The net value of an asset or liability on the balance sheet. For property, plant, and equipment, carrying value equals historical cost minus accumulated depreciation.

Historical Cost

The original purchase price of the asset including installation and transportation costs. Historical cost is also known as gross investment in the asset.

Recoverable Amount

The recoverable amount is the greater of its fair value less any selling costs and its value in use. =>The value in use is the present value of its future cash flow stream from continued use.

Identifiable Intangible Assets

Under IFRS, an identifiable intangible asset must be: 1. Capable of being separated from the firm or arise from a contractual or legal right. 2. Controlled by the firm. 3. Expected to provide future economic benefits. In addition, the future economic benefits must be probable and the asset's cost must be reliably measurable

Recovering an Impairment Loss under IFRS

Under IFRS, an impairment loss on an identifiable long-lived asset can be reversed if the asset's value recovers in the future. However, the loss reversal is limited to the original impairment loss. =>The carrying value of the asset after reversal cannot exceed the carrying value before the impairment loss was recognized.

Long-Lived Asset Reporting IFRS

Under IFRS, most long-lived assets are also reported at depreciated cost (the cost model ). IFRS provides an alternative, the revaluation model, that permits a long-lived asset to be reported at its fair value, as long as an active market exists for the asset so its fair value can be reliably (and somewhat objectively) estimated. Firms must choose the same treatment for similar assets (e.g., land and buildings) so they cannot revalue only specific assets that are more likely to increase than decrease in value. The revaluation model is rarely used in practice by IFRS reporting firms

Investment Property

Under IFRS, property that a firm owns for the purpose of collecting rental income, earning capital appreciation, or both, is classified as investment property. U.S. GAAP does not distinguish investment property from other kinds of long-lived assets.

IFRS Disclosure Requirements for Intangible Assets

Under IFRS, the disclosure requirements for intangible assets are similar to those for PP&E, except that the firm must disclose whether the useful lives are finite or indefinite.

Impairments under IFRS

Under IFRS, the firm must annually assess whether events or circumstances indicate an impairment of an asset's value has occurred. An asset is impaired when its carrying value (original cost less accumulated depreciation) exceeds the recoverable amount. If impaired, the asset's value must be written down on the balance sheet to the recoverable amount. =>An impairment loss, equal to the excess of carrying value over the recoverable amount, is recognized in the income statement.

Leased and Fixed Asset Disclosures IFRS

Under IFRS, the firm must disclose the following for each class of property, plant, and equipment (PP&E): 1. Basis for measurement (usually historical cost). 2. Useful lives or depreciation rate. 3. Gross carrying value and accumulated depreciation. 4. Reconciliation of carrying amounts from the beginning of the period to the end of the period. 5. Title restrictions and assets pledged as collateral. 6.Agreements to acquire PP&E in the future.

Research and Development Costs (IFRS)

Under IFRS: Research costs, which are costs aimed at the discovery of new scientific or technical knowledge and understanding, are expensed as incurred Development costs may be capitalized. =>Development costs are incurred to translate research findings into a plan or design of a new product or process =>To recognize an intangible asset in development, a firm must show that it can complete the asset and intends to use or sell the completed asset, among other criteria.

Impairments under GAAP

Under U.S. GAAP, an asset is tested for impairment only when events and circumstances indicate the firm may not be able to recover the carrying value through future use. Determining an impairment and calculating the loss potentially involves two steps. In the first step, the asset is tested for impairment by applying a recoverability test. If the asset is impaired, the second step involves measuring the loss. Under U.S. GAAP, loss recoveries are typically not permitted.

Research and Development Costs (GAAP)

Under U.S. GAAP, both research and development costs are generally expensed as incurred. The costs of creating software for sale to others are treated in a manner similar to the treatment of research and development costs under IFRS. =>Costs incurred to develop software for sale to others are expensed as incurred until the product's technological feasibility has been established, after which the costs of developing a salable product are capitalized.

Long-Lived Asset Reporting GAAP

Under U.S. GAAP, most long-lived assets are reported on the balance sheet at depreciated cost =original cost less accumulated depreciation and any impairment charges There is no fair value alternative for asset reporting under U.S. GAAP

Revaluation under US GAAP and IFRS

Under U.S. GAAP, most long-lived assets are reported on the balance sheet at depreciated cost using the cost model (original cost less accumulated depreciation and impairment charges). =>Revaluing long-lived assets upward is generally prohibited. =>One exception relates to long-lived assets held for sale, for which prior impairment losses can be reversed. Under IFRS, firms can choose to use the revaluation model and report long-lived assets at their fair values. =>Firms can choose depreciated cost for some asset classes and fair value for others.

Leased and Fixed Asset Disclosures GAAP

Under U.S. GAAP, the PP&E disclosures include: 1. Depreciation expense by period. 2. Balances of major classes of assets by nature and function, such as land, improvements, buildings, machinery, and furniture. 3. Accumulated depreciation by major classes or in total. 4. General description of depreciation methods used.

Capitalized Interest

When a firm constructs an asset for its own use or for resale, the interest that accrues during the construction period is capitalized as a part of the asset's cost treatment of construction interest is similar under U.S. GAAP and IFRS Capitalized interest is not reported in the income statement as interest expense. =>Once construction interest is capitalized, the interest cost is allocated to the income statement through depreciation expense (if the asset is held for use), or COGS (if the asset is held for sale).

Capitalization vs. Expensing

When a firm makes an expenditure, it can either capitalize the cost as an asset on the balance sheet or expense the cost in the income statement in the period incurred. As a general rule, an expenditure that is expected to provide a future economic benefit over multiple accounting periods is capitalized; however, if the future economic benefit is unlikely or highly uncertain, the expenditure is expensed in the period incurred

Derecognition for a sold asset

When a long-lived asset is sold, the asset is removed from the balance sheet and the difference between the sale proceeds and the carrying value of the asset is reported as a gain or loss in the income statement. =>The carrying value is equal to original cost minus accumulated depreciation and any impairment charges. The gain or loss is usually reported in the income statement as a part of other gains and losses, or reported separately if material. **If the firm presents its cash flow statement using the indirect method, the gain or loss is removed from net income to compute cash flow from operations because the proceeds from selling a long-lived asset are an investing cash inflow.

First Revaluation Date

When there have been no prior revaluations and fair value is less than the carrying value (cost minus accumulated depreciation as of the first revaluation date), a loss is recorded on the income statement, much like an impairment charge. If fair value at the first revaluation date is greater than the carrying value of the asset, the difference is recorded as revaluation surplus, a component of equity, so net income is not affected.

Accelerate Depreciation

With an accelerated depreciation method, more depreciation expense is recognized in the early years of an asset's life and less depreciation expense in the later years. => results in lower net income in the early years of an asset's life and higher net income in the later years, compared to straight-line depreciation One often-used accelerated depreciation method is the double-declining balance (DDB)

Expenditure that is immediately Expensed

if an expenditure is immediately expensed, current period pretax income is reduced by the amount of the expenditure

Revaluation Surplus

an increase in an assets fair value above carrying cost is not reported as a gain in the income statement but as a component of shareholders' equity in the revaluation surplus account

Capitalized Interest Reported on the Cash Flow Statement

capitalized interest is reported in the cash flow statement as an outflow from investing activities. interest expense is reported as an outflow from operating activities. Interest expense can be reported on the cash flow statement as either an operating activity or financing activity under IFRS.

Intangible Assets

long-term assets that lack physical substance, such as patents, brand names, copyrights, and franchises. Some intangible assets have finite lives while others have indefinite lives. Can also be classified as: 1. Identifiable Intangible Assets 2. Unidentifiable Intangible Assets

Depreciation

the systematic allocation of an asset's cost over time. 1. Carrying (book) Value 2. Historical Cost Depreciation is a real and significant operating expense. =>doesnt require cash expenditures