Long-Lived Assets

Topic 5
Long-Lived Assets (Non-Current Assets)
• Property, Plant, and Equipment
– Tangible, long-lived assets acquired for business operations
• e.g., land, building, equipment, etc
– Depreciation is the process of allocating the costs of these
assets over their estimated lives (not applicable to land)

• Intangible Assets
– Long-lived assets without physical substance that are used in
business
– Amortization is the process of allocating the costs of these
assets over their estimated useful lives (not applicable to
goodwill and intangibles with indefinite lives)
IFRS Vs. US GAAP
• US GAAP generally requires most assets to be valued at
their historical costs.

• Under IFRS, companies can choose to value their assets

at either cost or fair market values.
– Companies using the fair market approach will have to
periodically reassess the market values, and this could result in
adjustments to the assets’ valuation.
– Companies are not allowed to switch back and forth between
valuation methods.
Historical Cost Principle
• Carry an asset on the balance sheet at the amount paid for
the asset (i.e., at its cost).

• The initial cost of a long-term asset includes: the purchase

price, applicable taxes, purchase commissions, and all
other amounts paid to acquire the asset and ready it for its
intended use.

• But only up to the original intended use, not additional

improvements or additional cost (these are subsequent
costs)
Exercise
Trautschold Furniture Co. purchased land, paying $80,000 cash plus a $300,000
note payable. In addition, Trautschold paid property tax of $2,000, title insurance
costing $3,000, and $5,000 to level the land and remove an unwanted building.
Determine the cost of the land.
 Lump-Sum (Basket) Purchases
• Businesses often purchase several assets as a group, or a “basket,”
for a single lump-sum amount.
• Total cost is allocated to each asset based on its market value
• Example: When you purchase land and building for $2,800,000, how
do you determine the cost of each asset?

% of
total
Market Total market market Cost of
Asset value value value Total cost each asset
Land $300,000 $3,000,000 = 10% $2,800,000 $280,000

Building $2,700,000 $3,000,000 = 90% $2,800,000 $2,520,000

Total $3,000,000 100% $2,800,000

Exercise
Northwood Properties bought three lots for a lump-sum price.
An independent appraiser valued the lots as follows:

Northwood paid $150,000 in cash. Record the purchase in the

journal, identifying each lot’s cost in a separate Land account.

Immediately after making this purchase, Northwood sold lot 2

for its appraised value. What is the result of the sale?
Subsequent Costs of PPE

CAPITAL EXPENDITURES REVENUE EXPENDITURES

• Increase capacity or
extend useful life
• Cost is added to an asset
account
• It is “Capitalized”
• Do not extend capacity or
useful life
• Maintain or restore
working order
• Cost is recorded as an
expense

Distinction between the two requires judgment

 Subsequent Costs of PPE
• Capital Expenditures: increase the asset’s capacity or
efficiency or extend its useful life
– For example: Major engine overhaul, modification of body for new
use of truck, addition to storage capacity of truck
– Goes to balance sheet/ Debited to an asset account
• Revenue Expenditures: do not extend the asset’s capacity,
but merely maintain it or restore it to working order
– For example: Repair of transmission or other mechanism, regular
service (oil change, lubrication, etc), replacements (tires,
windscreen, etc), paint job
– Goes to income statement/ Debited to an expense account
Capital vs. Revenue Expenditures
Does the expenditure increase capacity
or extend useful life?
YES NO

Capital Expenditure Revenue Expenditure

Debit asset Debit repairs and maintenance
account expense
Income statement Effects Income statement Effects
Expense lower Expense higher
NI higher NI lower
Balance Sheet Effects BalanceAsset
Sheetvalues
Effects
Asset values higher higher
Asset values lower
 Exercise
Assume Candy Corner, Inc. purchased conveyor-belt machinery. Classify
each of the following expenditures as a capital expenditure or an immediate
expense related to machinery.

A. Sales tax paid on the purchase price

B. Transportation and insurance while machinery is in transit from seller to

buyer

C. Purchase Price

D. Installation

E. Training of personnel for initial operation of the machinery.

 Exercise - continued
F. Special reinforcement to the machinery platform.

G. Income tax paid on income earned from the sale of products

manufactured by the machinery

H. Major overhaul to extend the machinery’s useful life by three years

I. Ordinary repairs to keep the machinery in good working order

J. Lubrication of the machinery before it is placed in service

K. Periodic lubrication after the machinery is placed in service

 Capitalizing Interest Costs

• Borrowing costs that are directly attributable to the acquisition,

construction or production of a qualifying asset should be
capitalized as part of the cost of the asset
– Under IFRS – the amount capitalized is net interest cost
– Under US GAAP - the amount capitalized is gross interest cost

• Capitalization of interest cost :

– If constructing an asset for own use - capitalized interest on PPE
and expense through depreciation of the assets
– If constructing an asset for sale - capitalized interest on inventory
and expense off when assets are sold
Exercise
BILDA S.A., a hypothetical company, borrows $1,000,000 at an interest
rate of 10 percent per year on January 1, 2010 to finance the
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. What is the amount of interest that will be capitalized under IFRS

and under US GAAP?

2. Where will the capitalized borrowing cost appear on the company’s

financial statements?
Depreciation
• Depreciation is the allocation of a plant asset’s cost to expense over the
period the asset is used

• Depreciation matches an asset’s expense against the revenue generated

over the asset’s life
– PPE is a special case of prepaid expense
– PPE is consumed / used by the business in generating revenues.
– As the economic benefits of PPE is used, its cost is transferred from asset
account to expense account.

• Note that:
– Depreciation is not a process of valuation: It does not imply a decrease in market
value
– Does not mean that the business sets aside cash to replace assets as they wear
out (non-cash expense)
Depreciation
• Depreciation expense may vary from company to company, even for an
identical item of PPE, because the assumptions/estimates made by
management differ.

• To measure depreciation for a PPE, one must know the asset’s cost ($) and
estimated useful life (years, units of output, miles, or other measures)

• Other terminologies:
– Book Value (Carrying Amount):
For a long-term operating asset, book value is equal to the asset’s
original cost less any accumulated depreciation
– Residual Value (Salvage value, Scrap value):
The amount expected to be received when an asset is sold at the end of
its useful life (assume zero if not stated)
– Depreciable cost = Asset’s historical cost – salvage value
Depreciation Methods
• Straight-Line Method: The cost of the asset is allocated equally over
the periods of an asset’s estimated useful life
– Annual Depreciation = (Cost – Salvage Value) / Life

• Units-of-Production Method: The cost of an asset is allocated to

each period on the basis of the productive output or use of the asset
during the period
– Annual Depreciation = (Cost – Salvage Value) * (actual units /
total units)

• Double-Declining-Balance Method: An asset’s book value (carrying

amount) is multiplied by a constant depreciation rate (such as
straight line)
– Annual Depreciation = Book Value x (2 / Life)
Depreciation Example
• DVC purchased an equipment on January 1. The
following facts apply:
– Acquisition cost $24,000
Estimated salvage value $ 2,000
Estimated life (in years) 4 years
Estimated life (in “outputs”) 60,000 units
Units produced (actual data year by year) Year 1 (16,000), Year
2 (17,000), Year 3 (14,000) and Year 4 (13,000)

• Calculate the depreciation charges for Y1 to Y4 using all

three methods and the book value over the four years
Example: Straight-Line Method
Depreciable Amount = Cost – Salvage Value
= 24,000 -2,000 = 22,000

Annual Depreciation = 22,000 / 4 (years)

= 5,500

Straight Line
Year Calculation Depreciation Acc. Depn. Book Value
Y1 (24,000 - 2,000) / 4 5,500 5,500 18,500
Y2 (24,000 - 2,000) / 4 5,500 11,000 13,000
Y3 (24,000 - 2,000) / 4 5,500 16,500 7,500
Y4 (24,000 - 2,000) / 4 5,500 22,000 2,000

Salvage Value
Example: Straight-Line Method
Journal Entries

Y1: Depreciation Expense (+E, -SE) 5,500

Accumulated Depreciation (+XA, -A) 5,500
Accumulated Depreciation
Depreciation Expense (+E, -SE) 5,500
5,500 Y1
Y2: Accumulated Depreciation (+XA, -A) 5,500 5,500 Y2
Y3: Depreciation Expense (+E, -SE) 5,500 5,500 Y3
Accumulated Depreciation (+XA, -A) 5,500
5,500 Y4
Y4: Depreciation Expense (+E, -SE) 5,500 22,000
Accumulated Depreciation (+XA, -A) 5,500

Straight Line
Year Calculation Depreciation Acc. Depn. Book Value
Y1 (24,000 - 2,000) / 4 5,500 5,500 18,500
Y2 (24,000 - 2,000) / 4 5,500 11,000 13,000
Y3 (24,000 - 2,000) / 4 5,500 16,500 7,500
Y4 (24,000 - 2,000) / 4 5,500 22,000 2,000
Salvage Value
Example: Units of Production Method
Depreciable Amount = Cost – Salvage Value
= 24,000 -2,000 = 22,000

Annual Depreciation = Depreciable Amount * Depreciation Rate

Actual Units Produced

Depreciation Rate =
Estimated Units Produced over Life

Y1 Depreciation = 22,000 * (16,000 / 60,000)

Y2 Depreciation = 22,000 * (17,000 / 60,000)
Y3 Depreciation = 22,000 * (14,000 / 60,000)
Y4 Depreciation = 22,000 * (13,000 / 60,000)

Units of production
Year Calculation Depreciation Acc. Depn. Book Value
Y1 (24,000 - 2,000) x (16,000 / 60,000) 5,867 5,867 18,133
Y2 (24,000 - 2,000) x (17,000 / 60,000) 6,233 12,100 11,900
Y3 (24,000 - 2,000) x (14,000 / 60,000) 5,133 17,233 6,767
Y4 (24,000 - 2,000) x (13,000 / 60,000) 4,767 22,000 2,000
Salvage Value
Example: Units of Production Method
Journal Entries

Y1: Depreciation Expense (+E, -SE) 5,867

Accumulated Depreciation (+XA, -A) 5,867
Accumulated Depreciation
Depreciation Expense (+E, -SE) 6,233
5,867 Y1
Y2: Accumulated Depreciation (+XA, -A) 6,233 6,233 Y2
Y3: Depreciation Expense (+E, -SE) 5,133 5,133 Y3
Accumulated Depreciation (+XA, -A) 5,133
4,767 Y4
Y4: Depreciation Expense (+E, -SE) 4,767 22,000
Accumulated Depreciation (+XA, -A) 4,767

Units of production
Year Calculation Depreciation Acc. Depn. Book Value
Y1 (24,000 - 2,000) x (16,000 / 60,000) 5,867 5,867 18,133
Y2 (24,000 - 2,000) x (17,000 / 60,000) 6,233 12,100 11,900
Y3 (24,000 - 2,000) x (14,000 / 60,000) 5,133 17,233 6,767
Y4 (24,000 - 2,000) x (13,000 / 60,000) 4,767 22,000 2,000
Salvage Value
Example: Double Declining Method

Annual Depreciation = Beginning Book Value * Depreciation Rate

2
Depreciation Rate =
Useful Life (4 Years)

Double Declining
Year Calculation Depreciation Acc. Depn. Book Value
Y1 24,000 x (2/4) 12,000 12,000 12,000
Y2 12,000 x (2/4) 6,000 18,000 6,000
Y3 6,000 x (2/4) 3,000 21,000 3,000
Y4 ? 2,000
Salvage Value
Example: Double Declining Method

Annual Depreciation = Beginning Book Value * Depreciation Rate

2
Depreciation Rate =
Useful Life (4 Years)

Double Declining
Year Calculation Depreciation Acc. Depn. Book Value
Y1 24,000 x (2/4) 12,000 12,000 12,000
Y2 12,000 x (2/4) 6,000 18,000 6,000
Y3 6,000 x (2/4) 3,000 21,000 3,000
Y4 3,000 - 2,000 1,000 22,000 2,000
Salvage Value

The final year’s depreciation is

a “plug” amount needed to reduce
book value to residual value
Example: Double Declining Method
Journal Entries

Y1: Depreciation Expense (+E, -SE) 12,000

Accumulated Depreciation (+XA, -A) 12,000
Accumulated Depreciation
Depreciation Expense (+E, -SE) 6,000
12,000 Y1
Y2: Accumulated Depreciation (+XA, -A) 6,000 6,000 Y2
Y3: Depreciation Expense (+E, -SE) 3,000 3,000 Y3
Accumulated Depreciation (+XA, -A) 3,000
1,000 Y4
Y4: Depreciation Expense (+E, -SE) 1,000 22,000
Accumulated Depreciation (+XA, -A) 1,000

Double Declining
Year Calculation Depreciation Acc. Depn. Book Value
Y1 24,000 x (2/4) 12,000 12,000 12,000
Y2 12,000 x (2/4) 6,000 18,000 6,000
Y3 6,000 x (2/4) 3,000 21,000 3,000
Y4 3,000 - 2,000 1,000 22,000 2,000
Salvage Value
Depreciation Example
12000

10000
Annual Depn Exp

8000

Y1
6000
Y2
Y3
4000
Y4

2000

0
SL Units DDM Sum
Depreciation Methods
Choose a Depreciation Method

Straight-line Units-of-production Double-declining-

• Best for assets • Best for assets balance
that generate whose contribution • Best for assets
revenue evenly to revenue is that generate
proportionate to more revenue
actual use early in useful life
Tax-Effects of Depreciation
Most companies use an accelerated depreciation method
for tax purposes (when allowed) because
It provides the most depreciation expense as early as
possible and reduces the tax liability, resulting in better
cash flows
Choosing Depreciation Methods: tax
purpose

Accelerated depreciation provides fastest tax deductions

Tax deductions decrease tax payments

Tax savings can be reinvested in business

 Exercise
Pulley-Bone Fried Chicken bought equipment on January 2, 2007, for $42,000.
The equipment was expected to remain in service 4 years and to perform 3,000 fry
jobs. At the end of the equipment’s useful life, Pulley-Bone estimates that its
residual value will be $3,000. The equipment performed 300 jobs the first year, 900
the second year, 1,200 the third, and 600 the fourth year.

Required: Calculate the depreciation expenses for Y1 to Y4 using all three

methods and the book value over the four years
Changes in Estimates
• When occurs, recalculate depreciation for the remaining years
based on CURRENT book value

• Example: After using its equipment for 3 years, DVC’s equipment

(originally purchased at $24,000 with a $2,000 salvage value, with a
4-year useful life, straight-line method), better information reveals
the equipment has a 6-year useful life (in total) and a $3,000
salvage value. Calculate the new depreciation expense for the next
three years.
Change in Depreciation Method
• Change in pattern of economic benefits.
• Existing depreciation will change based on new accounting method
& No retrospective adjustment required (similar to a change in
estimates).

• Example: On January 1, 2011, Matrix, Inc., purchased equipment for

$400,000. Matrix expected a residual value $40,000, and a service
life of 5 years. Matrix uses the double-declining-balance method to
depreciate this type of asset. In the beginning of 2013, the company
switched from double-declining balance to straight-line depreciation.
The residual value remained at $40,000. Determine the amount of
depreciation to be recorded at the end of 2013.
Component Method of Depreciation
• Companies separately depreciate the significant
components of an asset
– Separate depreciation for different parts of an item with a
cost that is significant in relation to the total cost and/or
with different useful lives
– E.g., the engine, frame, and interior furnishing of an
aircraft.
– Additional estimates for the various components are
necessary.

• Required under IFRS, whereas allowed under US GAAP

Using Fully Depreciated Assets
• A fully depreciated asset is
– An asset that has reached the end of its estimated useful
life
– An asset on which no more depreciation is recorded

• The asset and its depreciation account may remain in the

ledger with no additional depreciation entries
– Book value of zero (or sometimes for asset register
purposes, left at $1)

• Doesn’t mean that the asset is worthless; it can still be used

after it is fully depreciated
 Impairment of PPE
• An asset is impaired when its carrying value is higher
than its recoverable amount.

• Impairment charges reflect an unanticipated decline in

the value of an asset.
– For example, PPE is impaired when the demand for the product
has declined substantially since the introduction of a competing
product.
– In contrast with depreciation charges, which serve to allocate the
depreciable cost of a long-lived asset over its useful life.

• Journal entry
– Debit impairment losses
– Credit accumulated impairment losses (contra-asset)
How to Record Impairment Losses
When an asset’s carrying amount is considered not recoverable (i.e., carrying
value > recoverable amount), both IFRS and US GAAP require companies to
write down the carrying amount of impaired assets.

• Under IFRS
– Recoverable amount is the higher of (1) fair value less cost to sell and (2) value
in use (i.e., is a discounted measure of expected future cash flows)
– If carrying amount > recoverable amount, then the impairment loss is measured
as the difference between the asset’s recoverable amount and carrying amount.
– Impairment reversals are permitted.

• Under US GAAP
– Recoverable amount is the undiscounted expected future cash flows.
– If carrying amount > recoverable amount, the impairment loss is measured as
the difference between the asset’s fair value and carrying amount.
– Assessing recoverability is separate from measuring the impairment loss
– Impairment reversals are NOT permitted.
Exercise
Sussex, a hypothetical company, has a machine it uses to produce a
single product. The demand for the product has declined substantially
since the introduction of a competing product. The company has
assembled the following information with respect 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

1. Under IFRS, what would the company report for the machine?

2. Under US GAAP, what would the company report for the machine?
Exercise
Essex, a hypothetical company, has a machine it uses to produce a
single product. The demand for the product has declined substantially
since the introduction of a competing product. The company has
assembled the following information with respect to the machine:

Carrying amount $ 18,000

Undiscounted expected future cash flows $ 16,000
Present value of expected future cash flows $ 14,000
Fair value if sold $ 10,000
Costs to sell $ 2,000

1. Under IFRS, what would the company report for the machine?

2. Under US GAAP, what would the company report for the machine?
Disposal of PPE
• Means of disposal: sell, exchange, or junk

• How to record the transaction?

– First bring depreciation up to date (to measure the asset’s
final book value)
– Then compare the assets received (e.g., cash, A/R, or
other assets) with the book value of the asset being
disposed of to determine if there is a gain or loss
– Finally, record journal entry to remove asset and related
accumulated depreciation account from books
Example: Disposal of PPE
Equipment costing $10,000 was purchased Jan 1, 2009 with a 10-year useful life and no
residual value (straight line depreciation). Sold on Sep 30, 2012 for $7,300 cash.

– Step1: Update depreciation expense

• Annual depreciation = (10,000 – 0) / 10 = $1,000
• Accumu. Dep. (3 yr. 9 mo.) = 1,000 * 3 + 1,000 * 9/12 = 3,750
• Net Book Value = 10,000 – 3,750 = 6,250

– Step 2: Calculate gain or loss

• Proceeds – Book Value = 7,300 – 6,250 = 1,050 (Gain)

– Step 3: Journal Entry

Depreciation Expense (+E, -SE) 750

Accumulated Depreciation (+XA, -A) 750

Cash (+A) 7,300

Accumulated Depreciation - Equipment (-XA, +A) 3,750
Equipment (-A) 10,000
Gain on Sale of Equipment (+G, +SE) 1,050
Gain or Loss on Disposal
• If asset is sold or exchanged
– Proceeds received on disposal is > NBV = gain (I/S)
– Proceeds received on disposal is < NBV = loss (I/S)
– Proceeds received on disposal is = NBV = no gain/ no loss

• If asset is junked:
– Fully-depreciated and no residual value
• No gain or loss
– If not full-depreciated and/or has a residual value
• Loss equals ending book value
 Exercise
On January 2, 2006, Ditto Clothing Consignments purchased showroom
fixtures for $10,000 cash, expecting the fixtures to remain in service 5
years. Ditto has depreciated the fixtures on a double-declining-balance
basis, with zero residual value. On September 30, 2007, Ditto sold the
fixtures for $6,200 cash. Determine the amount of gains or losses resulting
from this transaction.
Exercise
A company reported following balance sheet accounts:

On Dec. 31. 2008:

PP&E (Gross): $210,000
Accumulated Depreciation – PP&E: $60,000

On Dec. 31. 2009:

PP&E (Gross): $50,000
Accumulated Depreciation – PP&E: $10,000

In 2009, this company purchased additional PP&E for $300,000.

What was the original cost of PP&E sold (disposed of) during
2009?
Exercise
A company reported following balance sheet accounts:

On Dec. 31. 2008:

Equipment (Gross): $150,000
Accumulated Depreciation – Equipment : $80,000

On Dec. 31. 2009:

Equipment (Gross): $200,000
Accumulated Depreciation – Equipment : $100,000

In 2009, this company disposed of equipment whose historical cost was

$200,000 with accumulated depreciation of $30,000.

How much of depreciation expense was recorded in 2009?

Choice of Cost vs Revaluation Model
Under IFRS, an entity elects one out of two measurement models for each
class of PPE, which is defined as a grouping of assets of similar nature
and use in an entity’s operations
– Cost model: an item of PPE shall be carried at its cost less any
accumulated depreciation and any accumulated impairment losses.
This is similar to what we have discussed in this chapter thus far.
– Revaluation model: an item of PPE whose fair value can be
measured reliably shall be carried at a revalued amount, being its
fair value at the date of the revaluation less any subsequent
accumulated depreciation and subsequent accumulated impairment
losses. Revaluations shall be made with sufficient regularity to
ensure that the carrying amount does not differ materially from that
which would be determined using fair value at the balance sheet
dates.
Revaluation Model
If PPE is revalued at year-end, the asset’s carrying amount can either
increase or decrease due to revaluation.

In case of an initial change in the carrying amount:

- if asset’s carrying amount increases (that is, surplus on revaluation):

Dr. Asset (+A)

Cr. Revaluation Surplus (equity account on B/S)
- if asset’s carrying amount decreases (that is, deficit on revaluation):
Dr. Revaluation Loss (Income Statement)
Cr. Asset (-A)
Revaluation Model
If PPE is revalued at year-end, the asset’s carrying amount can either
increase or decrease due to revaluation.

In case of subsequent changes in the carrying amount:

- if asset’s carrying amount increases (that is, surplus on revaluation):

Dr. Asset (+A on B/S)
Cr. Revaluation Gain (+Gain on I/S)
Cr. Revaluation Surplus (+SE on B/S)
Gain recognized only up to the
amount that reverses a
revaluation decrease of the
same asset class previously
recognized in I/S.

- if asset’s carrying amount decreases (that is, deficit on revaluation):

Dr. Revaluation Surplus (-SE on B/S) If there is a positive balance of

the revaluation surplus, it is
Dr. Revaluation Loss(+Loss on I/S)
first decreased.
Cr. Asset (-A on B/S)
Example: Revaluation Model
UPFIRST, a hypothetical company, has elected to use the revaluation model for its
machinery. Assume for simplicity that the company owns a single machine, which it
purchased for $10,000 on the first day of its fiscal period, and that the
measurement date occurs simultaneously with the company’s fiscal period end.
Ignore depreciation.

1. 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 asset?
Machine Dr. Asset (+A) 1,000
Beg. 10,000 Cr. Revaluation Surplus (+SE on B/S) 1,000
1,000
End. 11,000

2. 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
statement reflect the machine?
Machine
Dr. Revaluation Surplus (-SE on B/S) 1,000
Beg. 11,000 Dr. Revaluation Loss (+L on I/S) 2,500
3,500 Cr. Asset (-A) 3,500
End. 7,500
Example: Revaluation Model
DOWNFIRST, a hypothetical company, has elected to use the revaluation model for
its machinery. Assume for simplicity that the company owns a single machine,
which it purchased for $10,000 on the first day of its fiscal period, and that the
measurement date occurs simultaneously with the company’s fiscal period end.
Ignore depreciation.

1. 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 asset?
Machine
Beg. 10,000 Dr. Revaluation Loss (+Loss on I/S) 2,500
2,500 Cr. Asset (-A) 2,500
End. 7,500

2. 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
statement reflect the machine?
Machine
Beg. 7,500 Dr. Asset (+A) 3,500
3,500 Dr. Revaluation Gain (+Gain on I/S) 2,500
Cr. Revaluation Surplus (+SE on B/S) 1,000
End. 11,000
Depreciation under Revaluation Model
• When an asset is being depreciated, a company needs to recognize the
depreciation for the current financial year before it recognizes any
revaluation surplus or deficit.

• In revaluing an asset, the accumulated depreciation relating to the same

asset can be treated in one of the following two ways:
– Elimination Method:
• Eliminate the accumulated depreciation balance against the gross amount of
the asset and restate the net amount to the revalued amount of the asset.
• This method treats the revalued asset as a “new” asset and is commonly
used for buildings.

– Proportionate Method.
• Restate proportionately both the accumulated depreciation balance and
gross amount of the asset so that the difference between the restated
accumulated depreciation balance and the restated gross amount is equal to
the revalued amount of the asset.
Example: Elimination Method
At the beginning of its 2013 financial year, Candless Corporation purchased
equipment for $100,000. The equipment is expected to have a five-year useful
life with no residual value, so depreciation for 2013 is $20,000 (i.e., straight-line
method). At the end of the year, Candless chooses to revalue the equipment.
The fair value of the equipment at year-end is $84,000.

Recognition of Depreciation Expense

Depreciation expense (+E, -SE) 20,000

Accumulated depreciation (+XA, -A) 20,000

After this entry, the net book value of the equipment is $80,000; its fair value is
$84,000

Accumulated depreciation (-XA, +A) 20,000

Equipment (+A) 20,000

Equipment (+A) 4,000

Revaluation surplus (+SE on B/S) 4,000
Example: Proportionate Method
At the beginning of its 2013 financial year, Candless Corporation purchased
equipment for $100,000. The equipment is expected to have a five-year useful
life with no residual value, so depreciation for 2013 is $20,000 (i.e., straight-line
method). At the end of the year, Candless chooses to revalue the equipment.
The fair value of the equipment at year-end is $84,000.

Recognition of Depreciation Expense

Depreciation expense (+E, -SE) 20,000
Accumulated depreciation (+XA, -A) 20,000

After this entry, the net book value of the equipment is $80,000; its fair value is
$84,000
Dec. 31, 2013 Before Revaluation After Revaluation
Equipment (Gross) 100,000 84/80 105,000
Accumulated depreciation (20,000) 84/80 (21,000)
Book value 80,000 84/80 84,000

Equipment (+A) 5,000

Accumulated depreciation (+XA, -A) 1,000
Revaluation surplus (+SE on B/S) 4,000
Exercise
Refer to the same company (i.e., Candless Corporation) illustrated in
the previous slide. Now, the fair value of the equipment at year-end is
$57,000 in 2014.

1. How much of depreciation expense is reported for this equipment for

2014?

2. How much of revaluation surplus is reported at the end of 2014?

3. How much of revaluation loss is reported for 2014?

Exercise
Synthetic Fuels Corporation prepares its financial statements according to
IFRS. On June 30, 2013, the company purchased equipment for $350,000. The
equipment is expected to have a seven-year useful life with no residual value.
Synthetic uses the straight-line depreciation method for all depreciable assets.
On December 31, 2013, the end of the company's fiscal year, Synthetic
chooses to revalue the machinery to its fair value of $299,000.

1. How much of depreciation expense is reported for this equipment for 2013?

2. How much of revaluation loss or revaluation surplus is reported at the end

of 2013?

3. How much of depreciation expense is reported for this equipment for 2014?

4. Assume that the fair value of the equipment at the end of 2013 is $338,000.
How much of revaluation loss or revaluation surplus is reported at the end
of 2013?
Investment Property
• Under IFRS, investment property is defined as property owned for
the purpose of earning rentals or capital appreciation or both.
– Example:
• A building owned by a company and leased out to tenants – Investment
Property.
• A building owned by a company for producing its goods and services –
PP&E
• Houses owned by a housing construction company for sale – Inventory
– Valued using either a cost model or a fair value model, which differs from the
revaluation model.
• Under the fair value model, all changes in the fair value of the asset affect
net income

• Under US GAAP, no specific definition of investment properties are

provided (Most firms use a cost model).
Subsequent Change in Fair Value
under IFRS
Revaluation Fair Value
Cost Model
Model Model

PP&E
PP&E Investment
Investment Property
Intangible Assets Property only
Intangible Assets
 Intangible Assets
• Intangibles are rights and privileges that
– Are long-lived (non-current),
– Are not held for resale,
– Have no physical substance,
– Usually provide owner with some form of competitive advantage

• Examples
– Patent: An exclusive right granted to manufacture and sell an invention
– Franchise and license : An entity that has been licensed to sell the product of
a manufacturer or to offer a particular service or activity in a given area
– Copyright: exclusive rights to reproduce and sell a book, musical
composition, film, or other work of art
– Trademarks and trade names: distinctive identifications of products or
services
– Goodwill: the excess of the cost of purchasing another company over the
sum of the fair values of the acquired company’s net assets (assets minus
liabilities)
Intangible Assets – Recognition
An asset is a resource controlled by the enterprise as a result of past events
and from which future economic benefits are expected to flow to the enterprise.
(FRS Framework para 45)

Some items are not recognized as assets even though we expect to have
future economic benefits generated from them.

For example, even when the company claims “our employees are our greatest
assets”, you will never see employees on the balance sheet. Other examples
include management competency, brand power and so on.

Why are these usually not recognized as assets in the B/S ?

Are they relevant (in terms of the value of the firm)? Yes!
Are they reliable? Usually not reliable…
Rule of thumb: only recognize when the numbers are reliable
Amortization and Impairment
• Intangibles with Finite Lives
– Amortized over the life of the intangible asset
– Use straight-line method
– Zero residual value
– Write off intangible assets directly (no use of contra asset
account)
– Subject to impairment test

• Intangibles with Indefinite Lives (e.g., goodwill)

– Not amortized
– Subject to impairment test
Example: Amortization and Impairment

A patent valued at $200,000, lasting 8 years

• Amortized at 25,000 per year over its life (straight-line

method)
Dr. Amortization Expense (+E, -SE) 25,000
Cr. Patent (-A) 25,000

• If impairment test indicates $10,000 of impairment

Dr. Impairment loss on Patent (+Loss, -SE) 10,000
Cr. Patent (-A) 10,000
Exercise
1. Morris Printers purchased for $900,000 a patent for a new laser
printer. Although the patent gives legal protection for 20 years, it is
expected to provide Morris Printers with a competitive advantage
for only 10 years. Assuming the straight-line method of
amortization, make journal entries to record (a) the purchase of the
patent and (b) amortization for year 1.

2. After using the patent for five years, Morris Printers learns at a
industry trade show that Super Printers is designing a more
efficient printer. On the basis of this new information, Morris
Printers determines that the patent’s total useful life is only seven
years. Record amortization for year 6.
Research & Development
• Under IFRS, costs associated with the creation of
intangible assets are classified into research phase costs
and development phase costs.
– Costs in the research phase are always expensed.
– Costs in the development phase are capitalized if the company
can demonstrate the technological feasibility of completing the
intangible asset and the intent to use or sell the asset.,
• Like many accounting standards, the separation between research and
development phase is one that requires judgment, supported by objective
evidence.

• Under US GAAP, all R&D costs are expensed in the

period incurred.
– The only exemption is when it involves “software development”.
Goodwill
• Defined as the excess of the purchase price of the company
over the market value of its net assets

• Recorded only when it is purchased in the acquisition of another

company.
– A purchase transaction provides objective evidence of the
value of goodwill as the excess of purchase consideration
over the net fair value of identifiable assets and liabilities.
• Companies never record goodwill that they create for their own
business.

• Goodwill is not amortized, and is subjected to strict impairment

tests.
Example: Goodwill
PepsiCo, Inc., has acquired several other companies. Assume that
PepsiCo purchased Kettle Chips Co. for $8 million cash. The book
value of Kettle Chips’ assets is $12 million (market value, $15
million), and it has liabilities of $10 million.

Purchase Price : 8,000,000

MV of Net Asset: (5,000,000)
Cost of Goodwill Purchased: 3,000,000

Journal Entry:
Assets (+A) 15,000,000
Goodwill (+A) 3,000,000
Liabilities (+L) 10,000,000
Cash (-A) 8,000,000
Exercise
Assume Haledan paid $16 million to purchase Northshore.com.
Assume further that Northshore had the following summarized
data at the time of the Haledan acquisition (amounts in million).

Assets Liabilities and Equity

Current assets $ 13 Total liabilities $ 25
Long-term assets 23 Shareholders' equity 11
36 36

Northshore’s long-term asset had a current market value of only

$18 million. Compute the cost of goodwill purchased by Haledan.