Understanding

Financial Accounting
Third Canadian Edition
By Christopher D. Burnley
Prepared by Debbie Musil, FCPA, FCMA

Chapter 4

Long-Term Assets

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Learning Objectives (1 of 4)
L01 – Identify and distinguish between various types of
long-term assets.
L02 – Describe the valuation methods for property,
plant, and equipment, including identifying costs
that are usually capitalized.
L03 – Explain why property, plant, and equipment assets
are depreciated.

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Learning Objectives (2 of 4)
L04 – Identify the factors that influence the choice of
depreciation method and implement the most
common methods of depreciation.
L05 – Describe and implement changes in depreciation
estimates and methods.
L06 – Explain what it means if property, plant, and
equipment assets are impaired.

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Learning Objectives (3 of 4)
L07 – Account for the disposal of property, plant, and
equipment.
L08 – Explain the accounting treatment for intangible
assets, including amortization.
L09 – Explain the accounting treatment for goodwill,
including impairment

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Learning Objectives (4 of 4)
L010 – Explain the accounting treatment for right-of-use
and biological assets.
L011 – Assess the average age of property, plant, and
equipment; calculate the fixed assets turnover
ratio; and assess the results.

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Various Types of Long-Term Assets
• Different types of of long-term or long-lived assets:
o Property, plant and equipment (PP&E) – tangible
assets that have physical presence and include land,
building and machinery
o Right-of-use assets – tangible assets that are leased
rather than purchased for periods of one year or more
o Intangible assets – intangible assets without physical
presence and include trademarks, patents and
copyrights

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Various Types of Long-Term Assets -
continued
• Goodwill – the established reputation of a business
regarded as a quantifiable asset as represented by
the excess of the price paid at a takeover for a
company over its fair market value.
• Biological Assets – assets that are living – for
example, trees, animals, or cannabis

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The Significance of Long-Term Assets
• Companies invest in long-term assets to generate
future revenues
• The purchase and sale of long-term assets are often
the most significant investing activities of a company
o An asset purchase represents a cash outflow
o An asset sale represents a cash inflow
• Most long-term assets are subject to depreciation
and amortization

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Investing Activities: Common
Transactions

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Valuation of Property, Plant, and
Equipment
• An asset represents future economic benefits:
o Used to generate future revenue through sales of
products or services
o Can be sold in the future when it is no longer of use to
company
• Under IFRS there are two valuation models
o Cost Model – only model allowed under ASPE
o Revaluation Model

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The Cost Model
• Assets are reflected at their carrying amount on the
statement of financial position
• Expensed (depreciated) over the asset’s useful life
• Carrying Amount
o Original cost less accumulated depreciation and
accumulated impairment losses
o This does not represent what the asset is worth
o Accumulated depreciation is a contra-asset account

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Carrying Amount

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What is included in “Cost”?
• Costs to be capitalized include:
o Purchase price less any rebates or discounts
o Non-refundable taxes and import duties on the
purchase price
o Legal costs associated with the purchase
o Shipping or transportation costs
o Site preparation, installation and set-up costs

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Purchase of Multiple Assets for a Single
Price (Lump Sum Purchase)
Example:
• Assume that a company purchased a new warehouse
for $2.4 million.
• As part of the purchase, it acquired the land that the
warehouse was situated on, the warehouse building,
some fencing around the property, and some storage
racks.

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Lump Sum Purchase example continued
Example (continued):
• The company had an appraisal completed at the time
of purchase that valued all components of the
warehouse at $2.6 million.
• The buyer was able to negotiate a lower purchase
price because the seller was in financial distress and
was very motivated to sell.

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Purchase Price Allocation
Example (continued):
The appraisal provided the following values:
Purchase
Fair Value Percentage Price Allocated Cost
Land $1,300,000 50% $2,400,000 $1,200,000
Building $910,000 35% $2,400,000 $840,000
Storage racks $260,000 10% $2,400,000 $240,000
Fencing $130,000 5% $2,400,000 $120,000
$2,600,000 100% $2,400,000

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Costs Subsequent to Purchase
• Costs incurred after an asset’s purchase will be
treated in one of two ways:
o Capitalized – added to the cost of the asset
o Expensed – treated as a period cost

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The Revaluation Model
• Under this model, PP&E assets are carried at fair
value less any subsequent accumulated depreciation
and subsequent impairment losses
• Revaluation dates may be annual or every three or
four years
• If a company is using this model for a class of assets,
then all assets must be revalued

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Depreciation
• If costs are capitalized they will be expensed in future
periods through the depreciation process
• In order to depreciate PP&E must know the following:
o Cost
o Estimated residual value
o Estimated useful life

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Information Required to Determine
Depreciation
1. Cost Discussed in the previous section.
2. Estimated This is a management estimate and is the net amount that the
residual company expects it would receive if the asset were sold in the
value condition it is expected to be in at the end of its useful life. This is the
portion of the asset’s cost that will never be an expense to the
company because it expects to recover that cost when it is finished
with the asset.
3. Estimated This is a management estimate and can be determined by time (such
useful life as years) or usage (such as units, hours, or kilometres). If time is used,
then this is the period over which the asset is expected to be used by
the company to help generate revenue. If usage is used, then this is
the total number of units that are expected to be obtained from the
asset. Note that, just because an asset has reached the end of its
useful life for one company, it does not mean it can’t be useful to
another.

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Determining an Asset’s Depreciable
Amount
• Depreciable amount = Cost – Estimated Residual
Value

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Depreciation Methods
• The three most common deprecation methods
include:
o Straight-line depreciation method – the simplest and
most commonly used method
o Units-of-production method(units-of-activity) method
o Diminishing-balance method (declining-balance)
method

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Comparison of Depreciation Methods
Annual Depreciation Expense

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Comparison of Depreciation Methods
continued

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Data for Example Depreciation
Calculations
On January 1, 2024, a company buys equipment for
$50,000. Management determines that the equipment
has an estimated useful life of five years and an
estimated residual value of $5,000. The company has a
December 31 year end.

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Straight-Line Method
• Assumption
o Economic benefits embodied in asset will be used up
evenly over its useful life
o Asset’s cost should be allocated evenly over same
time frame

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Straight-Line Method Calculations

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Units of Production Method
• Assumption
o Economic benefits embodied in asset is related to the
output or use of an asset
o Requires that the useful life can be expressed as units
of output

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Units of Production Method
Calculations

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Diminishing-Balance Method -
Accelerated Depreciation Method
• Assumption
o Greater proportion of the asset’s economic benefit
will be consumed early in its useful life and less as
time goes by

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Accelerated Depreciation Method
Concepts
• Depreciation calculation steps:
o Determine depreciation rate (1/estimated useful life)
o Multiply the asset’s carrying amount by the
depreciation rate
• Carrying amount decreases each year
• Depreciation expense decreases each year
• Depreciation rates
o Lower when asset has longer life

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Common Accelerated Depreciation
Method
• Double-diminishing-balance method
o Percentage is double the straight-line rate
o Residual value
• Not used for calculations
• Serves as a constraint – asset must not be depreciated below
the estimated residual value
• Formula
o Carrying Amount × Depreciation Rate = Depreciation
Expense
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Three Steps to Calculating Double-
Diminishing-Balance
Step 1: Determine the depreciation rate (1/Estimated Useful Life).
Step 2: Apply the rate to the asset’s carrying amount.
Step 3: Ensure that the asset’s ending carrying amount is greater than
or equal to the asset’s estimated residual value. If not, then go
back to Step 2 and the depreciation expense for that period will
be equal to the difference between the opening carrying
amount and the estimated residual value.

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Double Diminishing Balance Method
Calculations

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Recording Depreciation Expense
• The same journal entry is used for all depreciation
methods:
Depreciation Expense XX
Accumulated Depreciation XX
o Use contra-asset account, Accumulated Depreciation -
More informative than reducing the asset directly.
o Depreciation is a non cash expense – it does not
involve cash

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Determining Depreciation for Partial
Periods
• Prorate annual depreciation by using the “nearest
whole month” rule or “15 day rule”
• Take a half a year’s depreciation on the net
acquisitions for the year, no matter when the assets
were acquired by using the “half-year” rule

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Depreciation and Income Taxes
• Canada Revenue Agency (CRA)
o Depreciation expense is not allowed to be deducted
to calculate accounting income
o Capital cost allowance (CCA) instead must be used to
calculate taxable income
• Similar to depreciation

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Corporate Income Taxes
• There are a few important differences between
depreciation and (CCA):
o The Income tax act specifies the method of depreciation
that must be used, it is similar to the diminishing-balance-
method
o The tax act also specifies the CCA Rate that must be used
o Residual values are ignored
o The tax act determines the maximum depreciation that a
company may claim on its income tax return

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Changes in Depreciation Methods
• Companies are required to annually review estimated
residual values, estimated useful lives and
depreciation methods used.

• Changes are treated prospectively and not

retrospectively
o Known as a change in accounting estimate

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Changes in Depreciation Estimates

Example of Changes in
Estimates of Useful Life
and Residual Value under
the Straight-Line Method

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Impairment
When indications of impairment are present, management then
determines:
• The total of all the future cash flows that are expected to be
generated from the asset’s use
and
• The asset’s fair value less any selling costs incurred to sell it
The Recoverable Amount is the greater of these two amounts.
Impairment Loss is the excess of the recoverable amount over
the asset carrying amount

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Calculation of Impairment Loss

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Impairment Loss Example
• At the end of 2026, the carrying amount of an asset is
$23,000. Management determines that as a result of
damage to the equipment the recoverable from its
future use is only $20,000.
• The following entry would be made to record the
impairment loss:
Dr. Loss on Impairment $3,000
Cr. Accumulated Impairment Losses, Equipment $3,000

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Determination of Carrying Amount after
Recording Impairment Loss

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Disposal of Property, Plant, and
Equipment
• When PP&E is disposed of or scrapped it is
derecognized. There are two steps necessary
whenever this occurs:
o The asset should be depreciated up to the date of
derecognition
o The asset and related accumulated depreciation
account should be removed from the books and any
resulting gain or loss should be determined.

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Determining the Gain/Loss on Asset
Disposal

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Intangible Assets
• Intangible assets have probable future benefit but are
without physical form
• Guidelines:
o If developed internally, research costs must be
expensed but development costs can be capitalized
provided six specific criteria have been met
o If purchased, acquisition costs can be capitalized

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How Intangible Assets are Reflected on
Statement of Financial Position
• Initially recorded at cost, IFRS allows for either the
cost model or revaluation model to be used
• Management must determine whether or not the
asset has an indefinite useful life or a finite useful life
• Often the legal life exceeds an asset’s useful life

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Types of Intangible Assets
• Patents, Trademarks, Copyrights
o Legal life is the maximum for amortizing
o Useful, or economic life, is generally used for
calculating amortization
• Trade secrets – no legal registration system in Canada

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Additional Types of Intangible Assets
• Licences, Customer lists, and Franchise rights
• Computer software – includes web development
costs provided site is used to generate revenues
• Development costs – can be capitalized provided
specific criteria are met. Research costs CANNOT be
capitalized

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Intangible Assets - Amortization
• Estimate useful life and residual value (if any)
• Straight-line method is most commonly used
• Journal entry is very similar to depreciation of PP&E
assets
Amortization Expense XX
Accumulated Amortization, Patents XX

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Goodwill
• Goodwill is a long-term asset that arises when two
businesses are combined
• It is the premium or excess paid by one business
when it is acquiring another
o Related to factors such as management expertise,
corporate reputation, customer loyalty
• Will contribute to the generation of revenues in
future periods
• Internally generated goodwill cannot be recognized
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Determining Goodwill

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Determining the Carrying Amount of
Goodwill
Goodwill is carried on the statement of financial position
at cost less any accumulated impairment losses

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Treatment of Goodwill
• Goodwill is not amortized (considered to have an
indefinite useful life)
• Must be reviewed annually to determine whether
there is evidence that it has been impaired

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Right-Of-Use Assets
• Assets that are being leased or rented by a company
o Examples are equipment, vehicles, retail or store locations
• Lease or rental agreements give the company renting the
asset the right to use the asset for the duration of lease
term
• Viewed as another way of financing acquisition of an
asset
• Reported at their carrying amount and presented
separately from PP&E

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Biological Assets
• Living plants and animals whose biological
transformation or growth is being managed
o Examples are cannabis plants, trees, grape vines, fish,
cows, hogs and poultry
• Once harvested, biological assets become agricultural
produce and eventually inventory
• Reported at fair value less any estimated selling costs

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Financial Statement Analysis - Average
Age of Assets
• Measuring the age of assets:

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Financial Statement Analysis – Fixed
Asset Turnover
• Effective company use of its long-term assets:

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