Long-Lived Assets

Revsine/Collins/Johnson/Mittelstaedt: Chapter 10

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
 Learning objectives
1. What measurement base is used for long-lived assets.

2. What kinds of costs are capitalized and how joint costs are
allocated among assets.

3. How GAAP measurement rules complicate trend analysis and

comparisons across companies.

4. Why the carrying values of internally developed intangibles often

differ from their real values.

5. What asset “impairment” means and how it is recorded.

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 Learning objectives concluded
6. How to account for asset retirement obligations and assets held
for sale.

7. How different depreciation methods are computed.

8. How analysts can adjust for different depreciation assumptions

and improve comparisons across companies.

9. How to account for exchanges of long-lived assets.

10. The key differences between GAAP and IFRS requirements for
long-lived asset accounting.

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 Long-lived operating assets
 An asset generates future economic benefits and is under the
exclusive control of a single entity.

 This chapter concentrates on operating assets expected to yield their

economic benefits (service potential) over a period longer than one
year.

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 Initial 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 to use are
included in the asset account (meaning they are capitalized costs). Other
costs 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.

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

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 Initial asset measurement rules:
Interest capitalization
 Authoritative accounting literature requires capitalization of
avoidable interest payments on self-constructed assets.
 Interest paid to lenders during the construction period is
considered to be a cost necessary to prepare the asset for its
intended use. Follows from initial asset
measurement rule 1.

 Here is Canyon’s calculation of avoidable interest:

Construction
expenditures

If the interest rate is 10%, then Canyon’s avoidable interest is $715,000.

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 Capitalization criteria:
Costs incurred after initial use

 GAAP capitalizes costs incurred after the asset has been placed
in use as long as the expenditure:

 Extends the asset’s useful life

 Increases its productive capacity (e.g. attainable production units)
 Increases its production efficiency (e.g., fewer raw materials)
 Or, increases the asset’s other economic benefits

 If there is no increase in economic benefits (or future service

potential), the expenditure is charged to income as an expense.

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 Financial analysis and fixed assets:

Assume:
 No new capital expenditures.
 Prices rise at 3% per year.

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Financial analysis and fixed assets
Why ROA appears to increase

Increase 3% Asset base declines

each year each year

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 Intangible assets:
Overview
 The accounting for acquired
 Intangible assets are intangible assets is straight-
long-lived assets that do forward:
 The asset is first recorded
not have physical
at the arm’s length
substance. They include: transaction price.
 Patents  Then amortized (think
 Copyrights “depreciation”) over its
 Trademarks expected useful life.
 Brand names  Difficult financial reporting
 Customer lists issues arise when the
 Licenses intangible asset is developed
internally instead of being
 Technology purchased.
 Franchises
 Employment contracts
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 Intangible assets:
Research and development (R&D)

 Recoverability of R&D expenditures (i.e., the future benefit) is

highly uncertain at the start of a project.

 So, GAAP requires virtually all R&D expenditures to be expensed

as incurred.

 In the pre-Codification document for research and development

costs, the FASB justified expensing all R&D for three reasons:
1. The future benefits are highly uncertain and difficult to predict.
2. A causal relationship between current R&D and future revenue (the
benefit) has not been demonstrated.
3. Whatever benefits may arise cannot be objectively measured.

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Asset impairment:
Long-lived Asset Impairment Guidelines

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 Depreciation:
Basic concepts
 The costs of productive assets must be apportioned to the periods
in which they provide benefits (matching principle).

• Buildings
Depreciation • Equipment

Amortization • Intangibles
• Mineral deposits
Depletion • Wasting assets

 The cost to be allocated to periods is the asset’s original historical

cost minus its expected salvage value.

 Depreciation is not intended to track the asset’s declining market

value.

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 Exchanges of Nonmonetary assets
 Sometimes firms exchange one nonmonetary asset like inventory or
equipment for another nonmonetary asset.

 Unless certain exceptions apply, the recorded cost of the acquired

asset is the fair market value of the asset given up.

FMV of truck
plus cash
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 Global Vantage Point
Comparison of IRFS and GAAP Long-Lived Asset
Accounting
Tangible Long-Lived Assets
IAS 16 allows two different models
Cost Method – same as U.S. GAAP
Revaluation Method – asset is carried at a revalued amount
reflecting fair market value at the revaluation date. Subsequent
depreciation is based on fair value, not original cost. The amount of
the write-up is credited to an owners’ equity account called
Revaluation Surplus (equivalent to Accumulated other
comprehensive income).

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 Global Vantage Point
Comparison of IRFS and GAAP Long-Lived Asset
Accounting
 Intangible Long-Lived Assets
 Similar to U.S. GAAP except that a revaluation method is allowed,
but an active market must be available for the intangible.
 IAS 38 distinguishes between research and development
 Research is expensed
 Development may be capitalized if certain criteria is met.

 Impairment of Assets
 Similar to U.S. GAAP unless the impairment loss occurs if the
carrying value exceeds the recoverable amount

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 Summary
 The need for reliable and verifiable numbers causes long-lived
assets to be measured using historical cost.

 The balance sheet amounts for intangible assets often differ from
their real value.

 Changes in the amount of capitalized interest from one period to

another can distort earnings trends.

 When comparing return on assets (ROA) ratios across firms,

remember that ROA drifts upward as assets age.

 Asset impairment write-downs depend on subjective forecasts

and could be used to manage earnings.

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 Summary concluded
 Depreciation differences can complicate comparisons across
firms. Footnote details can be used to improve these
comparisons.

 International practices for long-lived assets are sometimes very

different from those in the United States.

 Some of the key differences between IFRS and GAAP relate to

the revaluation of tangible assets, investment property,
capitalization of intangible development costs, and impairments
losses.

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