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158. Describe several issues in the accounting for long-lived assets.
Long-lived assets include both tangible assets, such as land, buildings, and equipment, and intangible assets,
such as patents, brand names, trademarks, customer lists, airport landing rights, and franchise rights. Long-lived
financial assets also include investments in securities. Both U.S. GAAP and IFRS provide guidance in the
following areas of the accounting for long-lived tangible and intangible assets:
159. Discuss the treatment of expenditures as assets versus immediate expenses.
TREATMENT OF EXPENDITURES AS ASSETS VERSUS AS IMMEDIATE EXPENSES
An expenditure qualifies as an asset if it (1) meets the definition of an asset, and (2) satisfies the criteria for
asset recognition. These requirements are similar in U.S. GAAP and IFRS. FASB Statement of Financial
Accounting Concepts No. 61 states that an asset has three essential characteristics:
FASB Statement of Financial Accounting Concepts No. 52 imposes an additional recognition criterion: the item
must have a relevant attribute that a firm can measure with sufficient reliability. That relevant attribute is the
fair value of the asset at the time of initial recognition.
Thus, firms treat expenditures as assets when they
The accounting treatment of expenditures on resources with potential long-term benefits can be generalized as
follows:
160. When a firm constructs its own buildings or equipment, what costs are capitalized?
Self-Constructed Asset
161. How is the acquisition cost treated over the life of tangible and intangible assets?
TREATMENT OF ACQUISITION COST OVER LIFE OF ASSET
The cost of long-lived assets with a finite life, that is, ones for which a firm consumes the asset’s services over
time in generating revenues, is recognized as an expense each period. The balance sheet carrying value
decreases over time as the firm recognizes the cost of the asset as an expense. Management must estimate the
asset’s finite life, that is, its service life or useful life. Examples include buildings, equipment, patents,
copyrights, landing rights, and customer lists.
The cost of long-lived assets with an indefinite life, that is, ones for which a firm does not consume the asset’s
162. Discuss the concepts of depreciation and amortization.
FUNDAMENTAL CONCEPTS OF DEPRECIATION AND AMORTIZATION
Firms spread the acquisition cost of long-lived assets over their expected service lives,
allocate a joint cost. Firms select a depreciation or amortization method for a long-lived asset that allocates the
acquisition cost minus salvage value to each period of expected useful life in a systematic, predetermined
manner.
Depreciation and Amortization: Not a Measure of the Decline in Economic Value.
163. Describe the depreciation and amortization methods used in accounting.
MEASUREMENT OF DEPRECIATION AND AMORTIZATION
Calculating depreciation or amortization of long-lived assets requires management to
Depreciable or Amortizable Basis of Long-Lived Assets: Acquisition Cost Less Salvage Value
Firms base depreciation and amortization charges on the acquisition cost less the estimated salvage value of
long-lived assets. The terms salvage value and residual value refer to the estimated proceeds on the disposition
of an asset less all removal and selling costs. Firms recover salvage value through the proceeds of sale, so it is
not part of the depreciable or amortizable basis of an asset.
The second factor in calculating depreciation and amortization is the expected service life. Both physical and
functional factors limit service lives. Physical factors for tangible assets include ordinary wear and tear from
use, chemical action such as rust, and the effects of wind and rain. The most important functional factor for both
tangible and intangible assets is obsolescence. Changes in production processes, for example, might reduce the
unit cost of production to the point where a firm finds continued operation of old equipment uneconomical,
components of fixed assets to determine if those components have different service lives; if they do, firms must
use a component’s service life to depreciate the cost of that component. For example, the airframe and the
engines of an aircraft likely have different service lives, and the firm would therefore depreciate them
separately.
Pattern of Depreciation and Amortization
An asset’s acquisition cost, salvage value, and service life determine both the total of depreciation or
amortization charges and the time span over which to charge those costs. The firm must also select the pattern
for allocating those charges to the specific years of the service life.
Depreciation of tangible assets follows one of three basic patterns.
Amortization of intangible assets is usually straight line over time.
The next section describes and illustrates the depreciation and amortization patterns. When acquiring or retiring
a long-lived asset during an accounting period, a firm calculates depreciation and amortization only for that
portion of the period during which it uses the asset.
164. Discuss the factors a firm considers when choosing among the alternative depreciation and amortization
methods.
FACTORS IN CHOOSING THE DEPRECIATION AND AMORTIZATION METHOD
Depreciation and amortization affect both net income reported in the financial statements and taxable income on
tax returns. Taxing authorities in most jurisdictions specify allowable depreciation methods for tax reporting.
When permitted to do so by the taxing authority, firms often use different depreciation methods for financial
and tax reporting. When this happens, the difference between depreciation expense in the financial statements
and the depreciation deduction on the tax return leads to an issue in accounting for income taxes.
165. How are periodic depreciation and amortization accounted for?
ACCOUNTING FOR PERIODIC DEPRECIATION AND AMORTIZATION
Recording periodic depreciation and amortization results in a debit to either an expense account or a product
cost account. Depreciation of factory buildings and equipment used in manufacturing operations becomes part
of the cost of work-in-process and finished goods inventories; that is, these depreciation charges are product
costs. The amortization of a patent on a semiconductor that a firm embeds in its product is likewise a product
cost. Firms classify the amortization of a customer list as either amortization expense or selling expense,
depending on whether the firm classifies expenses by their nature or by their function. Firms classify the
depreciation of office equipment in the corporate headquarters as either depreciation expense or administrative
expense. The amortization of the customer list and depreciation of the office equipment do not relate to product
manufacturing and are, therefore, period costs.
166. What happens when the original depreciation or amortization schedule for long-lived assets requires
changing?
167. How do firms account for expenditures to maintain or improve long-lived assets?
ADDITIONAL EXPENDITURES TO MAINTAIN OR IMPROVE LONG-LIVED ASSETS
Firms often incur costs to maintain, repair, and improve their tangible assets. Distinguishing between these
purposes affects reported income because U.S. GAAP and IFRS require firms to treat expenditures for
maintenance and repairs as expenses of the period as incurred but treat expenditures for improvements as assets
(which firms subsequently depreciate or amortize).
Expenditures on maintenance and repairs have different income effects than expenditures on improvements.
Some expenditures may both repair and improve. Consider expenditures to replace a roof damaged in a
168. What happens when the fair value of long-lived assets change?
CHANGES IN THE FAIR VALUE OF LONG-LIVED ASSETS
A firm acquires assets for their future benefits. The world changes, and expected future benefits change,
sometimes increasing and sometimes decreasing. U.S. GAAP does not permit firms to increase the balance
sheet carrying values of tangible and intangible long-lived assets when the fair values of their assets increase.
This prohibition means that firms will recognize the increase in the fair value of the asset only as the firm
realizes the value increase through either sale or continuing use.
This category includes property, plant, equipment, patents, franchise rights, and similar assets. These assets
provide benefits over predictable, finite periods of time and are therefore subject to depreciation or
amortization. This category, however, also includes land, which provides benefits for an indefinite period of
time and is not depreciated.
Category 2. Intangibles, other than goodwill, not subject to amortization.
This category includes brand names, trademarks, and renewable licenses or other legal rights. Firms do not
amortize these intangibles if they provide benefits over an indefinite period of time.
In requiring that the firm use undiscounted cash flows to test for an asset impairment in Step 1, the FASB
reasoned that a loss has not occurred if the firm can recover in future cash flows an amount at least equal to or
larger than the carrying value. The use of undiscounted, instead of discounted, cash flows seems theoretically
unsound. The economic value of an asset may decline below its carrying value, but the firm would recognize no
impairment loss because the undiscounted future cash flows from the asset exceed its carrying value.
IFRS Treatment of Asset Impairment for Long-Lived Assets Other Than Nonamortized Intangibles and
Goodwill (Category 1)
The test for an impairment loss for assets in this category compares the balance sheet carrying value with the
asset’s recoverable amount, defined as the higher of (1) fair value less cost to sell, and (2) value in use, defined
as the present value of future cash flows of the asset in its current use by the firm. The impairment loss is the
excess of the carrying value over the assets’ recoverable amount. The IASB requirements differ from those of
U.S. GAAP in two ways:
U.S. GAAP Treatment of Asset Impairment on Nonamortized Intangibles, Other Than Goodwill (Category 2)
Because these assets have an indefinite life, firms cannot feasibly apply the undiscounted cash flow test for
asset impairment. That is, the indefinite life precludes estimation of total future cash flows. U.S. GAAP requires
firms to recognize an impairment loss on a nonamortized intangible other than goodwill whenever the carrying
value of the asset exceeds its fair value.
Asset Impairment for Goodwill (Category 3)
Firms do not amortize goodwill under either U.S. GAAP or IFRS. Both standard-setting bodies require firms to
test annually for impairment losses on goodwill, as well as whenever there is an indication of impairment due,
for example, to changes in the legal or economic climate, adverse regulatory conditions, unanticipated
competition, and loss of key personnel.
Goodwill is not a separable asset, so it is evaluated for impairment as part of a reporting unit (U.S. GAAP) or a
cash generating unit (IFRS). These units are identifiable groups of assets that generate identifiable cash
flows,which firms use to measure fair value (U.S. GAAP) or recoverable amount (IFRS).
Step 1. Test for Impairment of Goodwill.
Ascertain the current fair value of a reporting unit that includes goodwill. Fair value is an exit value, the price a
firm would receive if it sold the reporting unit in an orderly transaction at the measurement date. If the fair
value of a reporting unit that includes goodwill is less than the carrying value of its assets (including goodwill)
less liabilities, then an impairment loss on goodwill may have occurred and the firm proceeds to Step 2.
Step 2. Measure the Amount of the Goodwill Impairment Loss. Measuring the amount of the impairment loss of
goodwill involves the following:
IFRS Treatment of Goodwill
The impairment test under IFRS is applied at the level of a cash generating unit, defined as the smallest
identifiable group of assets that generates cash flows that are largely independent of the cash flows of other
assets. If the recoverable amount of the unit is less than the balance sheet carrying value, the firm recognizes an
impairment loss. The credit to offset the debit for the impairment loss is allocated first to goodwill and second
to the other assets, the latter prorated based on their carrying amounts. In each instance, the asset (whether
goodwill or a separately identifiable asset) is written down to its recoverable amount or zero, whichever is
larger.
169. How does disposal of an asset through sale, abandonment, or trade-in on another asset affect net income?
DISPOSAL OF ASSETS
Firms will sometimes abandon assets if there is no market for the asset. Examples include an automobile
severely damaged in an accident or a machine requiring an overhaul that is not cost effective. The firm
eliminates the carrying value of the asset and recognizes a loss in an amount equal to the carrying value.
170. Discusses the presentation of long-lived assets in the balance sheet and income statement.
FINANCIAL STATEMENT PRESENTATION
This section discusses the presentation of long-lived assets in the balance sheet and income statement.
BALANCE SHEET
The balance sheet separates noncurrent from current assets. Tangible long-lived assets typically appear under
the title Property, Plant, and Equipment, among the noncurrent assets. Firms generally disclose the assets’
acquisition cost and accumulated depreciation in one of three ways:
171. How are long-lived assets analyzed?
PROPERTY, PLANT, AND EQUIPMENT
The financial statements and notes provide information for analyzing changes in property, plant, and equipment.
The analysis of intangible assets is more challenging than the analysis of tangible long-lived assets for the
following reasons:
