Long-Lived Assets

(or Non-Current Assets)

Revsine/Collins/Johnson/Mittelstaedt/Soffer: Chapter 10
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 Learning Objectives
After studying this chapter, you will understand:

1. What measurement base is used in accounting for long-lived assets.

2. What specific costs can be capitalized and how joint costs are allocated among
assets.
3. Why balance sheet carrying values for internally developed intangibles usually
differ from their real values.
4. When long-lived asset impairment exists and how it is recorded.
5. Assets held for sale.
6. How different depreciation methods are computed.
7. How analysts can adjust for different depreciation assumptions and improve
interfirm comparisons.

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 Accounting Standard AASB 116
Property, Plant and Equipment
 The standard prescribes the accounting treatment for property, plant and
equipment so that users of the financial statements can discern information
about an entity’s investment in its property, plant and equipment and the
changes in such investment.

 The principal issues in accounting for property, plant and equipment are the
recognition of the assets, the determination of their carrying amounts and the
depreciation charges and impairment losses to be recognised in relation to
them.

 The hypothetical range of long-lived asset carrying amounts as measured under

each approach—expected benefit versus economic sacrifice.

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 Accounting Standard AASB 116 Property,
Plant and Equipment

This Standard does not apply to:

 (a) property, plant and equipment classified as held for sale in accordance with
AASB 5 Non-current Assets Held for Sale and Discontinued Operations.
 (b) biological assets related to agricultural activity other than bearer plants (see
AASB 141 Agriculture). This Standard applies to bearer plants but it does not
apply to the produce on bearer plants.
 (c) the recognition and measurement of exploration and evaluation assets (see
AASB 6 Exploration for and Evaluation of Mineral Resources).
 (d) mineral rights and mineral reserves such as oil, natural gas and similar non-
regenerative resources.

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 Cost of Property, Plant and Equipment

The cost of an item of property, plant and equipment shall be recognised as an

asset if, and only if:
 (a) it is probable that future economic benefits associated with the item will flow
to the entity; and
 (b) the cost of the item can be measured reliably.

The cost of an item of property, plant and equipment comprises:

 (a) its purchase price, including import duties and non-refundable purchase
taxes, after deducting trade discounts and rebates.
 (b) any costs directly attributable to bringing the asset to the location and
condition necessary for it to be capable of operating in the manner intended by
management.
 (c) the initial estimate of the costs of dismantling and removing the item and
restoring the site on which it is located, the obligation for which an entity incurs
either when the item is acquired or as a consequence of having used the item
during a particular period for purposes other than to produce inventories during
that period.

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 Cost of Property, Plant and Equipment

Cost model
 After recognition as an asset, an item of property, plant and equipment shall be
carried at its cost less any accumulated depreciation and any accumulated
impairment losses.

Revaluation model
 After recognition as an asset, an item of property, plant and equipment 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 end of the reporting period

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 Non-current Assets/Long-Lived
Assets
Operating assets expected to yield their economic benefits (or
service potential) over a period longer than one year are called
long-lived assets.

Long-lived assets comprise 74.7%

of ExxonMobil’s total assets.

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 Measurement of the Carrying
Amount of Long-Lived Assets

 There are two ways that long-lived assets could be measured on balance sheets:

Expected Benefit Approach Economic Sacrifice Approach

Discounted
present value Historical cost
$$ $$
Net realizable Replacement cost
value

Estimated value in an Estimated value in an input

output market where market where the asset is
the asset is sold purchased

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 Expected Benefit &
Economic Sacrifice Approaches
 Assume a truck originally costing $100,000, is two years old, has a remaining
life of 8 years, is being depreciated on a straight-line basis, and is expected to
have no salvage value.
 The hypothetical range of long-lived asset carrying amounts as measured under
each approach—expected benefit versus economic sacrifice—is as follows:

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10-9
 Long-Lived Asset Measurement Rules

 The initial balance sheet carrying amount of a long-lived asset is governed by two
rules:

1. All costs necessary to acquire the asset and make it ready for use are
included in the asset account; that is, they are capitalized costs. (Expenditures
excluded from asset categories are “expensed” to income.)

Capitalized Expensed

$$ Price paid for land $$ Monthly equipment rental

Cost to repair damaged
$$ Cost of clearing land $$
equipment
2. Joint costs incurred in acquiring more than one asset are apportioned among
the acquired assets on a relative fair value basis or some other rational basis.

$100 Equipment A
$200 delivery
and installation fee
$100 Equipment B

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 Long-Lived Asset Measurement Rules

Purchase price

Preparation
costs
Joint cost

Construction
costs
Joint cost

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 Computing Avoidable Interest

 GAAP requires capitalizing what are called avoidable interest payments on self-
constructed assets; this interest is defined as that “could have been avoided . . .
if expenditures for the assets had not been made.”
 Avoidable interest = Cumulative weighted average expenditures on the
constructed asset x I interest rate
 Canyon’s calculation of avoidable interest:

Construction
expenditures

Avoidable interest = $7,150,000 x 10% = 715,000

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 Limits on the Amount of Interest Capitalized
GAAP limits the amount of interest that can be capitalized to the lower of (1)
interest actually incurred or (2) avoidable interest.
Case 1: Case 2:
Avoidable interest Avoidable interest

$715,000 $715,000

Actual interest Actual interest

Actual interest is
$800,000 $600,000 less in this case

Interest capitalized Interest capitalized

Therefore only
$715,000 $600,000 $600,000 would
be capitalized

Capitalization is restricted to interest arising from actual borrowings from

outsiders.

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 Tax v Financial Reporting Incentives
 How costs are allocated between land and building affects the amount of income that will be
reported in future periods.

Allocation 1: Allocation 2:
Higher Lower
depreciation depreciation

$500 Lower net $500 Higher net

income income
$100 Lower $100 Higher
taxes taxes
Land Building Land Building

 For tax purposes, the incentives for allocating costs between land and building asset
categories are completely different because the objective of most firms is to minimize tax
payments, not to “correctly” allocate costs.
 The higher the costs allocated to land for tax purposes, the higher the future taxable
income becomes because land cannot be depreciated.

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10-14
 Capitalization criteria:
Costs incurred after initial use

Suppose that in January 2020, Winger spends an additional $8,000.

$6,000 for the installation of a new component that Capitalized in 2020 and
allowed the machine to consume less raw material added to the carrying
and operate more efficiently amount of the machine
Treated as a period
$2,000 for ordinary repairs and maintenance expense

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 Intangible Assets
 Intangible assets are long-lived assets that do not have physical
substance.
 The category includes the following types of assets.
 Patents  Licenses
 Copyrights  Technology
 Trademarks  Franchises
 Brand names  Employment contracts
 Customer lists

 The accounting for acquired intangible assets is straight-forward:

 The acquired intangible asset is first recorded at the arm’s length transaction

price.
 Most acquired intangible assets are amortized (depreciated) on a straight-line

basis over their expected useful economic lives and reviewed for impairment.
 Some intangible assets, known as indefinite-lived intangible assets, have

indefinite lives and are not amortized. Instead, they are evaluated annually
for impairment.

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 Research and Development (R&D)

 Difficult financial reporting issues exist when the intangible asset is developed
internally instead of being purchased from another company.
 These difficulties arise because it is uncertain whether current expenditures will
ultimately lead to valuable patents or trademarks.

 The recoverability of research and development (R&D) expenditures is highly

uncertain at the start of a project.
 Consequently, the GAAP requires that virtually all R&D expenditures be charged to
expense immediately.

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 Computer Software Products

 Prior to establishing the technological feasibility of a computer software product,

companies are required to expense all R&D costs incurred to develop it.

 After technological feasibility is established, additional costs incurred to ready

the product for general release to customers are supposed to be capitalized.
 The capitalization of additional costs ceases when the final product is
available for sale.

Technological feasibility established

Expensed as Capitalized
incurred and amortized
Development Development
expenditures $$ expenditures $$

Before After
Software project time line

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10-18
 Asset Impairment

• To record the loss, the following entry:

• The impairment loss decreases both assets and net income.

• Though it does not affect current cash from operations, the loss
has negative implications for future revenue and cash flow.

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10-19
 Assets Held for Sale
 When firms actively try to sell assets they own, the asset groups should
be classified on the balance sheet as “held for sale”.
Table from middle
 When assets are held for sale, they
of page 531are reported at the lower of book
value or fair market value minus costs to sell.
$2,304,000

$2,500,000
$2,350,000
$46,000

Book value Fair value Expected

cost to sell

 So, these assets would be shown on the balance sheet at $2,304,000.

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10-20
 Depreciation: Straight-Line
Depreciation Method - recap
The straight-line (SL) depreciation method simply allocates cost
minus salvage value evenly over the asset’s expected useful life.

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10-21
 Depreciation: Units of Production Method

The units-of-production (UP) depreciation method allocates cost

minus salvage over the expected units to be produced instead of
the expected useful life.

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10-22
 Depreciation: Double-Declining
Balance Method
• The depreciation rate for the double-declining balance (DDB) method is
double the straight-line rate. Applying a constant DDB depreciation
percentage to a declining balance will produce a book value at the end of the
asset’s economic life that is above or below the salvage value.
• Apply twice the SL rate to the book value of the assets without subtracting the
salvage value.
• Once the DDB depreciation amount falls below what it would be with SL, a firm
might use the straight-line method for the remaining years.

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 Depreciation: Sum-of-the-Years’ Digits Method

The sum-of-the-years’ digits (SYD) method is another accelerated depreciation

method. It depreciates an asset to precisely its salvage value.

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 Depreciation: Alternative Depreciation
Methods
Figure 10.2 Alternative
depreciation methods
Annual depreciation charges
Total depreciation expenses is
the same under all methods

Net book value

Ending book values are the
same under all methods

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10-25
 Disposition of Long-Lived Assets

When individual long-lived assets are disposed of before their useful lives
are completed, any difference between the net book value of the asset and
the disposition proceeds is treated as a gain or loss.
Gain (loss) = Disposition proceeds – Book Value
Gain (loss) = Disposition proceeds – (Cost – Accumulated Depreciation)

 The entry to record the disposition removes the asset and its
accumulated deprecation from the books:

Gain (loss) = $5,000 – ($10,500 – $6,720 = $1,220

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 Summary

 The need for unbiased, accurate, cost-effective, and verifiable numbers causes
these assets to be measured in terms of the economic sacrifice incurred to obtain
them—their historical cost—rather than in terms of their current expected benefit—
or economic worth—to the firm.
 Because it is uncertain whether future benefits result from research and brand
development costs, these costs are generally expensed in the period incurred.
Consequently, balance sheet carrying amounts for intangible assets often differ
from their real value to the firm. Analysts must scrutinize disclosures of R&D
expenses to undo the overly conservative accounting.
 When comparing return on assets (ROA) ratios across firms, one must remember that
historical cost leads to an upward drift in reported ROA as assets age. So, analysts must
determine whether the average age of the long-lived assets for firms being analyzed is stable
or rising. Inflation also injects an upward bias into reported ROA.
 Asset impairment write-downs depend on subjective forecasts and could be used to manage
earnings.
 An understanding of differences in depreciation choices across firms permits better interfirm
comparisons. When making interfirm comparisons, analysts should use note disclosures to
overcome differences in the long-lived asset useful lives chosen by each firm and, when
possible, in their depreciation patterns.

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10-27
 Workshop Discussion

Week 10 Workshop Questions

 Revsine Textbook Chapter 10
 Exercises: E10-4 (ice-breaker); E10-8; E10-10; [E10-14; E10-15];
E10-18
 Problems: P10-4; P10-6; P10-9; P10-10
 [P10-12 and P10-15 are additional questions provided for student’s self-study]