CH9 Long-Lived Assets

CHAPTER 9
LONG-LIVED ASSETS
Lecture by: Say Vichheka

COSTS THAT ARE CAPITALIZED AND COSTS
THAT ARE EXPENSED WHEN INCURRED
• Long-lived assets (noncurrent assets or long-term assets)
- Assets that are expected to provide economic benefits over a future
period of time, typically greater than one year.
- May be tangible (plant, property, and equipment, or PP&E),
intangible, or financial assets.
• At acquisition, capitalize
- purchase price and
- expenditures necessary to prepare asset for intended use.
• Subsequent expenditures are
- capitalized if expected to provide benefits beyond one year (extend
life or capacity).
- expensed otherwise.
Copyright © 2013 CFA Institute 2

ACQUISITION OF PP&E: EXAMPLE
Which of the following expenditures are capitalized?
• Related to purchase of towel and tissue roll machine:

- €10,900 purchase price including taxes
- €200 for delivery of the machine
- €300 for installation and testing of the machine
- €100 to train staff on maintaining the machine
- €350 paid to a construction team to reinforce the factory floor and
ceiling joists to accommodate the machine’s weight
• Maintenance:
- €1,500 for roof repair; expected to extend useful life of the factory by
5 years.
- €1,000 for repainting exterior of the factory and adjoining offices;
repainting neither extends the life of factory and offices nor improves
their usability.

ACQUISITION OF INTANGIBLE ASSETS
• Intangible assets:
- Assets lacking physical substance.
- Include items that involve exclusive rights, such as patents,
copyrights, trademarks, and franchises.
• Accounting for an intangible asset depends on how it is acquired.
We will consider three ways:
- Purchased in situations other than business combinations,
- Developed internally, and
- Acquired in business combinations.

ACQUISITION OF INTANGIBLE ASSETS
How Acquired Treatment at Acquisition

Intangible assets Recorded at fair value, which is assumed to be
purchased in situations equivalent to the purchase price (same as long-
other than business lived tangible assets).
combinations.
Intangible assets Generally expensed when incurred, although

developed internally. capitalized in some situations.
Intangible assets Identifiable assets are recorded at fair value.

acquired in a business If acquisition price exceeds the sum of amounts
combination. allocable to individual identifiable assets and
liabilities, the excess is recorded as goodwill.

INTANGIBLE ASSETS DEVELOPED INTERNALLY
• Generally expensed when incurred, although capitalized in some
situations.
• IFRS
- Expenditures on research are expensed.
- Expenditures on development are capitalized.
• U.S. GAAP
- Generally, both research and development costs are expensed.
- For costs related to software development:
- Products for sale: Both research and development expenditures are
expensed until technology feasibility is established; they are
subsequently capitalized.
- Software for internal use: Both research and development
expenditures are expensed until probable completion is
demonstrated; they are subsequently capitalized.

INTANGIBLE ASSETS DEVELOPED INTERNALLY:
EXAMPLE
Assume REH AG, a hypothetical company, incurs expenditures of
€1,000 per month during the fiscal year ended 31 December 2009 to
develop software for internal use.
Question: What is the accounting impact of the company being able to

demonstrate that the software met the criteria for recognition as an
intangible asset on 1 February versus 1 December?
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

INTANGIBLE ASSETS DEVELOPED INTERNALLY:
EXAMPLE
Assume REH AG, a hypothetical company, incurs expenditures of €1,000 per
month during the fiscal year ended 31 December 2009 to develop software for
internal use.
Question: What is the accounting impact of the company being able to
demonstrate that the software met the criteria for recognition as an intangible
asset on 1 February versus 1 December?
Expense €1,000 Expense €11,000

Asset €11,000 Asset €1,000
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

CAPITALIZE VERSUS EXPENSE:
EFFECT ON FINANCIAL STATEMENTS
Income Statement of
Item Balance Sheet Statement Cash Flow
Costs that are capitalized

Increase Investing cash
−−−−
• At acquisition assets outflow
Expensed via
−−−− −−−−
• Subsequently depreciation
Immediately
Costs that are expensed −−−− reduce net Operating cash
when incurred income outflow
All else being equal,

• Capitalizing results in higher profitability ratios (return on equity and net profit
margin) in the first year and lower profitability ratios in subsequent years.
• Expensing will give the appearance of greater subsequent growth in profits.

DEPRECIATION METHODS
Accelerated
Straight-Line
Depreciation
Expense ($)
1 2 3 4 5 6 7 8 9 10
Useful Life of Asset
• Straight-line method: When the cost of the asset is allocated to expense evenly
over its useful life.
• Accelerated method: When the allocation of cost is greater in earlier years.
• Units-of-production method: When the allocation of cost corresponds to the
actual use of an asset in a particular period.

CALCULATE DEPRECIATION EXPENSE:
EXAMPLE
• At the beginning of Year 1, the company buys box manufacturing
equipment for $2,300.
• Estimated residual value: $100.
• Estimated useful life: 4 years.
• For each year, what are the beginning and ending net book value
(carrying amount), end-of-year accumulated depreciation, and annual
depreciation expenses?

STRAIGHT-LINE METHOD EXAMPLE
• At the beginning of Year 1, a company buys box manufacturing equipment for
$2,300.
• Estimated residual value: $100, and estimated useful life: 4 years.
• For each year, what are the beginning and ending net book values (carrying
amount), end-of-year accumulated depreciation, and annual depreciation
expenses?
Year 1: Cost.
Thereafter: Prior
year ending book
value.
Accumulated
Beginning Net Depreciation Year-End Ending Net
Book Value Expense Depreciation Book Value
Year 1 $2,300 $550 $550 $1,750
Year 2 1,750 550 1,100 1,200
Year 3 1,200 550 1,650 650
Year 4 650 550 2,200 100

$2,300.
expenses?
(Cost – Residual
value)/Useful life
Beginning Accumulated
Net Book Depreciation Year-End Ending Net
Value Expense Depreciation Book Value
Year 1 $2,300 $550 $550 $1,750
Year 2 1,750 550 1,100 1,200
Year 3 1,200 550 1,650 650
Year 4 650 550 2,200 100

$2,300.
expenses?
Accumulated
depreciation +
Expense for year
Beginning
Net Book Depreciation Accumulated Year- Ending Net
Value Expense End Depreciation Book Value
Year 1 $2,300 $550 $550 $1,750
Year 2 1,750 550 1,100 1,200
Year 3 1,200 550 1,650 650
Year 4 650 550 2,200 100

$2,300.
expenses?
Cost –
Accumulated
depreciation
Accumulated
Year 1 $2,300 $550 $550 $1,750
Year 2 1,750 550 1,100 1,200
Year 3 1,200 550 1,650 650
Year 4 650 550 2,200 100

CALCULATE DEPRECIATION EXPENSE: DOUBLE-
DECLINING BALANCE METHOD EXAMPLE

$2,300.
expenses? Year 1: Cost.
Thereafter: Prior
year ending book
value
Accumulated
Year 1 $2,300 $1,150 $1,150 $1,150
Year 2 1,150 575 1,725 575
Year 3 575 288 2,013 287
Year 4 287 187 2,200 100

$2,300.
expenses?
Beginning net
book value ×
Depreciation
rate until…
Accumulated
Year 1 $2,300 $1,150 $1,150 $1,150
Year 2 1,150 575 1,725 575
Year 3 575 288 2,013 287
Year 4 287 187 2,200 100


$2,300.
expense?
Accumulated
depreciation +
Expense for year
Beginning
Year 1 $2,300 $1,150 $1,150 $1,150
Year 2 1,150 575 1,725 575
Year 3 575 288 2,013 287
Year 4 287 187 2,200 100

$2,300.
expense?
Cost –
Accumulated
depreciation
Accumulated
SOONER, Beginning Net Depreciation Year-End Ending Net Book
Inc. Book Value Expense Depreciation Value
Year 1 $2,300 $1,150 $1,150 $1,150
Year 2 1,150 575 1,725 575
Year 3 575 288 2,013 287
Year 4 287 187 2,200 100

UNITS-OF-PRODUCTION METHOD EXAMPLE
$2,300.
• Total estimated productive capacity: 800 boxes.
• Production in Years 1, 2, 3, 4: 200, 300, 200, and 100 boxes
Year 1: Cost.
Thereafter: Prior
year ending book
value
Accumulated
Beginning Net Book Depreciation Year-End Ending Net
Value Expense Depreciation Book Value
Year 1 $2,300 $550 $550 $1,750
Year 2 1,750 825 1,375 925
Year 3 925 550 1,925 375
Year 4 375 275 2,200 100

$2,300.
• Production in Years 1, 2, 3, 4: 200, 300, 200, and 100 boxes.
Actual units
produced × Per
unit cost
Accumulated
Year 1 $2,300 $550 $550 $1,750
Year 2 1,750 825 1,375 925
Year 3 925 550 1,925 375
Year 4 375 275 2,200 100

$2,300.
Accumulated
depreciation +
Expense for year
Beginning
Year 1 $2,300 $550 $550 $1,750
Year 2 1,750 825 1,375 925
Year 3 925 550 1,925 375
Year 4 375 275 2,200 100

$2,300.
Cost –
Accumulated
depreciation
Beginning Accumulated
Net Book Depreciation Year-End Ending Net Book
Value Expense Depreciation Value
Year 1 $2,300 $550 $550 $1,750
Year 2 1,750 825 1,375 925
Year 3 925 550 1,925 375
Year 4 375 275 2,200 100

IMPACT ON RESULTS AND RATIOS
Method: The accelerated method, compared with the straight-line

method, will result in
- Higher depreciation expense in earlier periods, so lower operating
profit margin and operating return on assets (ROA) in the early
periods and higher operating profit margin and operating ROA in the
later periods.
- Lower average total assets in earlier periods and thus higher asset
turnover ratio.
Assumptions:
- Longer useful life compared with shorter useful life: lower annual
depreciation expense.
- Higher salvage value compared with lower salvage value: lower
annual depreciation expense.

AMORTIZATION
• Amortization: Allocation of the cost of an intangible asset over its

useful life.
• An intangible asset with an indefinite useful life is not amortized.
• An intangible asset with a finite useful life is amortized using the same
methods as depreciation. Calculating amortization requires
- The original amount at which the intangible asset is recognized,
- The estimated length of its useful life, and
- The estimated residual value at the end of its useful life.

REVALUATION MODEL:
PERMITTED UNDER IFRS
Revaluation model:
• Alternative to historical cost model permitted under IFRS.
• Long-lived assets measured at fair value.
• May be used only if the fair values of the assets can be measured
reliably.
• Unlike historical cost, may result in increases or decreases in value of
long-lived assets.
• May be used for some classes of assets while historical cost is used
for other classes, but the same model must be applied to assets within
a particular class.
• Permitted for intangible assets, but only if an active market for the
asset exists.
• In practice, use of revaluation model is relatively rare for either tangible
or intangible and is especially rare for intangibles.

REVALUATION MODEL: EXAMPLE
• Assume a company has elected to use the revaluation model for an item of
machinery (the company’s only long-lived asset). The machine was purchased
on the first day of the fiscal period, and measurement date occurs
simultaneously with the company’s fiscal period-end.
• Cost to purchase machine: €10,000.
• At the end of the first fiscal period after acquisition, assume the fair value of the
machine is determined to be €11,000. How will the company’s financial
statements reflect the revaluation?
Answer
• The balance sheet shows
- The asset at a value of €11,000.
- A revaluation surplus (an equity component) of €1,000.
• Other comprehensive income: €1,000 increase in the value of the asset.
• No impact on profit and loss.

REVALUATION MODEL: EXAMPLE
• The cost to purchase a machine was €10,000. Fair value at the end of the first
fiscal period was €11,000.
• At the end of the second fiscal period after acquisition, assume the fair value of
the machine is determined to be €7,500. How will the company’s financial
statements reflect the revaluation (total decrease in the carrying amount of the
asset is €3,500 (€11,000 – €7,500)?
Answer
• Balance sheet
- Asset at a value of €7,500.
- Revaluation surplus (an equity component) of €0.
• Other comprehensive loss of €1,000, reversing previous increase in the value
of the asset.
• In profit and loss (i.e., income statement), loss of €2,500.

REVALUATION MODEL: EXAMPLE 2
• Assume a company has elected to use the revaluation model for an item of
machinery (the company’s only long-lived asset). The machine was purchased
on the first day of the fiscal period, and the measurement date occurs
simultaneously with the company’s fiscal period-end.
• Cost to purchase machine: €10,000.
• At the end of the first fiscal period after acquisition, assume the fair value of the
machine is determined to be €7,500. How will the company’s financial
statements reflect the revaluation?
Answer
• Balance sheet shows the asset at a value of €7,500.
• Profit and loss (i.e., income statement) shows a €2,500 loss.

REVALUATION MODEL: EXAMPLE 2
• The cost to purchase the machine was €10,000. Fair value at the end of the
first fiscal period was €7,500.
• At the end of the second fiscal period after acquisition, assume the fair value of
the machine is determined to be €11,000. How will the company’s financial
statements reflect the revaluation (total increase in the carrying amount of the
asset is €3,500 (€11,000 – €7,500)?
Answer
• Balance sheet shows
- The asset at a value of €11,000.
- A revaluation surplus (an equity component) of €1,000.
• Profit and loss (i.e., income statement): Profit of €2,500 reversing previous
loss.
• Other comprehensive income of €1,000.

IMPAIRMENT
• Impairment charges reflect an unanticipated decline in the value of an

asset.
• In general, when an asset’s carrying amount is not recoverable:
- The carrying amount of the impaired asset is written down, and
- An impairment loss is recognized.
• IFRS vs. U.S. GAAP
- IFRS and U.S. GAAP define recoverability differently.
- Impairment reversals are permitted under IFRS but not under U.S.
GAAP.

IMPAIRMENT: PP&E
• At the end of each reporting period, a company assesses whether there are
indications of asset impairment (e.g., evidence of obsolescence, decline in
demand for products, or technological advancements).
• If no indication of impairment, no test for impairment.
• If there is an indication of impairment, test for impairment.
• Under IFRS, impairment loss is measured as the excess of carrying amount of
the asset over its recoverable amount.
- Recoverable amount: “The higher of its fair value less costs to sell and its
value in use.”
- Value in use: Discounted expected future cash flows.
• Under U.S. GAAP
- Assess recoverability: If not recoverable (carrying amount exceeds
undiscounted expected future cash flows), then measure impairment loss.
- Impairment loss is measured as the excess of the carrying amount of the
asset over its fair value.

IMPAIRMENT OF PP&E: EXAMPLE
• Company has a machine used to produce a single product. The
demand for the product has declined substantially since the
introduction of a competing product. The following information pertains
to the machine:
• Carrying amount £18,000
• Undiscounted expected future cash flows £19,000
• Present value of expected future cash flows £16,000
• Fair value if sold £17,000
• Costs to sell £2,000
What would the company report for the machine under IFRS versus U.S.
GAAP?

IMPAIRMENT OF PPE: EXAMPLE
• A company has a machine used to produce a single product. The demand for
the product has declined substantially since the introduction of a competing
product. The following information pertains to the machine:
Recoverable
• Present value of expected future cash flows £16,000 amount: Higher
• Fair value if sold £17,000 of value in use
and fair value
less cost to sell.
What would the company report for the machine under IFRS versus U.S. GAAP?
Recoverable amount: £16,000

Carrying amount: £18,000
Impairment loss: £2,000

IMPAIRMENT OF PP&E: EXAMPLE
• A company has a machine used to produce a single product. The demand for
the product has declined substantially since the introduction of a competing
product. The following information pertains to the machine:
Recoverable?
• Present value of expected future cash flows £16,000
• Fair value if sold £17,000
What would the company report for the machine under IFRS versus U.S. GAAP?
Yes, it is recoverable because the amount of undiscounted

expected future cash flows exceeds the carrying amount.
No impairment loss is recognized.

DERECOGNITION
• Derecognition of an asset: Remove it from the financial statements.

• Derecognition occurs when the asset is disposed of or is expected to
provide no future benefits from either use or disposal.
• Disposal of a long-lived asset:
- Sale
- Gain or loss = Sales proceeds – Carrying amount of asset.
- Nonoperating gain or loss.
- Exchange
- Abandonment

DISCLOSURES ABOUT LONG-LIVED ASSETS
• Disclosures about long-lived assets appear throughout the financial

statements.
• Balance sheet reports the carrying value of the asset.
• Income statement shows depreciation expense as a separate line item in some
instances.
• Statement of cash flows:
- Acquisitions and disposals of fixed assets in the investing section
- Depreciation and amortization in the operating section
• Notes to financial statement:
- Accounting methods
- Amount of annual depreciation expense
- Range of estimated useful lives by main category of fixed asset
- Historical cost by main category of fixed asset
- Accumulated depreciation by main category of fixed asset

RATIOS USED IN ANALYZING FIXED ASSETS
• Fixed asset turnover ratio:

- Calculated as total revenue divided by average net fixed assets.
- Shows the relationship between total revenues and investment in PP&E.
- The higher this ratio, the higher the amount of sales a company is able to
generate with a given amount of investment in fixed assets.
- A higher asset turnover ratio is often interpreted as an indicator of greater
efficiency.
• Asset age ratios are broad indicators of a company’s need to reinvest in
productive capacity.
- The average age of the asset base is estimated as the accumulated
depreciation divided by the depreciation expense.
- The average remaining life of a company’s asset base is estimated as the
net PP&E divided by the depreciation expense.
- The total useful life of PP&E is estimated as the total historical cost of PP&E
divided by the annual depreciation expense.

ASSET AGE RATIOS
Historical cost: $100, estimated useful life: 10 years, estimated salvage value: $0.
100
90
80
70
60
50
40
30
20
10
Historical cost($100)/ Accumulated Net PP&E ($70)/

Annual depreciation depreciation ($30)/ Annual depreciation
expense ($10) = Total Annual depreciation expense ($10) =
useful life (10 years) expense ($10) = Estimated remaining
Estimated age (3 life (7 years)
years)

INVESTMENT PROPERTY
IFRS
• Investment property is defined as property that is owned for the
purpose of earning rentals or capital appreciation or both.
• Investment property can be valued using either a cost model or a fair
value model.
- Cost model: Identical to PP&E.
- Fair value model: All changes in the fair value of the asset affect net
income.
U.S. GAAP
• No specific definition of investment property.
• Most operating companies and real estate companies that hold
investment-type property use the historical cost model.

LEASES
• Lease: Contract between the owner of an asset—the lessor—and another

party seeking use of the asset—the lessee.
- The lessor grants the right to use the asset to the lessee.
- In exchange for the right to use the asset, the lessee makes periodic lease
payments to the lessor.
• Advantages to leasing an asset compared with purchasing it:
• Leases can provide less costly financing, usually require little, if any, down
payment, and are often at fixed interest rates.
• The negotiated lease contract may contain less restrictive provisions than
other forms of borrowing.
• Leasing can reduce the risks of obsolescence, residual value, and
disposition to the lessee.
• Certain types of leases have perceived financial reporting advantages.
• Lease accounting is currently a joint IASB/FASB project.

SUMMARY
• Expenditures related to long-lived assets are capitalized as part of the cost of
assets if they are expected to provide future benefits and expensed otherwise.
• Capitalizing versus expensing an expenditure can significantly affect financial
statements and ratios.
• Financial statements and ratios can be significantly affected by choice of
depreciation/amortization method and by assumptions about useful life and
residual value.
• IFRS (but not U.S. GAAP) permit the use of either the cost model or the
revaluation model for the valuation of long-lived assets.
• Impairment charges reflect an unexpected decline in the fair value of an asset
to an amount lower than its carrying amount.
• IFRS (but not U.S. GAAP) permit impairment losses to be reversed.
• Ratios used in analyzing fixed assets include the fixed asset turnover ratio and
several asset age ratios.

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CHAPTER 9

Lecture by: Say Vichheka

Copyright © 2013 CFA Institute 2

• Related to purchase of towel and tissue roll machine:

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How Acquired Treatment at Acquisition

Intangible assets Generally expensed when incurred, although

Intangible assets Identifiable assets are recorded at fair value.

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Question: What is the accounting impact of the company being able to

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Expense €1,000 Expense €11,000

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Costs that are capitalized

All else being equal,

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Useful Life of Asset

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• At the beginning of Year 1, a company buys box manufacturing equipment for

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• At the beginning of Year 1, a company buys box manufacturing equipment for

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Method: The accelerated method, compared with the straight-line

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• Amortization: Allocation of the cost of an intangible asset over its

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• Impairment charges reflect an unanticipated decline in the value of an

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Recoverable amount: £16,000

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Yes, it is recoverable because the amount of undiscounted

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• Derecognition of an asset: Remove it from the financial statements.

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• Disclosures about long-lived assets appear throughout the financial

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• Fixed asset turnover ratio:

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Historical cost($100)/ Accumulated Net PP&E ($70)/

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• Lease: Contract between the owner of an asset—the lessor—and another

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