Long-lived assets refer to the long term assets that include property, plant and equipment (PPE), natural resources, intangible assets, and financial assets.

Long-lived Assets

Management typically has some discretion in determining if the cost of an item should be capitalized to the balance sheet and depreciated (or amortized if it is an intangible asset) to the income statement over time or if the cost of the item should be fully expensed to the income statement in the current period. In general, any expenditure that is expected to provide economic benefits for multiple accounting periods should be capitalized.

When a cost is capitalized, it is reported in the balance sheet as an asset. The cost is then allocated to the income statement over multiple periods as depreciation expense for tangible assets and amortization expense for intangible assets.

On the other hand, if a cost is expensed in the current period, it reduces the pre-tax income by that amount.

Once an asset has been capitalized, any more expenditure related to the asset that will increase its useful life will also be capitalized. However, any expenditure that helps the company maintain the asset will be expensed to the income statement.
<h5>Example</h5>
Let’s take an example. Suppose a firm purchased new machinery for $100,000. This amount includes the freight and taxes. After that the company spent $5,000 to install the machinery and another $2,000 was spent on training the staff. Every year the company spent $3,000 for maintenance of the machinery. After 5 years, the company spent $25,000 on the machinery that helped the company in extending the life of the equipment. The following table summarizes which costs are capitalized and which ones are expensed.
<table>
<tbody>
<tr>
<td width="262"><strong>Cost</strong></td>
<td width="170"><strong>Capitalized</strong></td>
<td width="132"><strong>Expensed</strong></td>
</tr>
<tr>
<td width="262"><strong>Purchase cost - $100,000</strong></td>
<td width="170">Yes</td>
<td width="132"></td>
</tr>
<tr>
<td width="262"><strong>Installation - $5,000</strong></td>
<td width="170">Yes</td>
<td width="132"></td>
</tr>
<tr>
<td width="262"><strong>Training - $2,000</strong></td>
<td width="170"></td>
<td width="132">Yes</td>
</tr>
<tr>
<td width="262"><strong>Maintenance - $3,000</strong></td>
<td width="170"></td>
<td width="132">Yes</td>
</tr>
<tr>
<td width="262"><strong>Rebuilding - $25,000</strong></td>
<td width="170">yes</td>
<td width="132"></td>
</tr>
</tbody>
</table>
<h5>Impact on Financial Statements</h5>
The following table provides examples of the effects on a company’s financial statements and ratios when expensing in-year versus capitalizing in-year.
<table width="616">
<tbody>
<tr>
<td><strong>IMPACTED ITEM</strong></td>
<td><strong>EXPENSING</strong></td>
<td><strong>CAPITALIZING</strong></td>
<td><strong>Remarks</strong></td>
</tr>
<tr>
<td><strong>Net Income, Profit Margins, Equity</strong></td>
<td>Lower</td>
<td>Higher</td>
<td>Capitalizing delays expense recognition. Over the life of the asset, the total net income in both cases will be same.</td>
</tr>
<tr>
<td><strong>Asset Turnover</strong></td>
<td>Higher</td>
<td>Lower</td>
<td>Under capitalization, net income is higher, and therefore shareholder’s equity is higher.</td>
</tr>
<tr>
<td><strong>Debt to Equity Ratio</strong></td>
<td>Higher (Equity is Lower)</td>
<td>Lower (Equity is Higher)</td>
<td></td>
</tr>
<tr>
<td><strong>ROA and ROE</strong></td>
<td>Lower</td>
<td>Higher</td>
<td></td>
</tr>
</tbody>
</table>
<h5>Cash Flows and Expensing vs. Capitalizing of Purchases</h5>
On a total cash flow basis, the decision to expense or capitalize has no impact because depreciation is a non-cash expense.  However, when Cash Flows are separated by: Operating Activities, Investing Activities, and Financing Activities, the decision to expense or capitalize takes on more meaning.

<strong>Cash Generated by Operating Activities</strong> – when a company expenses an item paid with cash, instead of capitalizing it, the firm will show lower operating cash flows.

<strong>Cash Generated by Investing </strong><strong>Activities</strong> – when a company expenses an item paid with cash, instead of capitalizing it, there will be NO CHANGE to investing cash flows.  However, if the company capitalizes the item as a physical investment in PPE, investing cash flows will be lower.
<h5>Capitalization of Interest Expenses</h5>
US GAAP and IFRS-IAS provide treatment of the capitalization of interest expenses associated with the construction of long-lived assets. When a firm is constructing a long-lived asset, the interest accrued during the period of construction is capitalized as a part of the cost of the asset. The interest is capitalized in order to accurately measure the cost of the asset. Only interest up to the construction cost can be capitalized.

If the firm has borrowed funds for construction and has earned income by temporarily investing these funds, then the interest to be capitalized is reduced by the amount of income under IFRS. No such offsetting is allowed under US GAAP.

When interest is capitalized, it’s added to the asset cost in the balance sheet and does not show as interest expense on the income statement. If the asset is for the firm’s own use, then it is allocated to income statement as depreciation expense. If the asset is held for sale, then it is allocated to income statement as COGS.

In the cash flow statement, the capitalized interest is shown as outflow under investing activities.

Since capitalizing interest, reduces the interest expense, it increases the interest coverage ratio (EBIT/interest expense).

Capitalizing Vs. Expensing Costs

Intangible assets are those assets that have no physical substance such as patents, trademarks, franchises, and copyrights.

Intangible assets can have finite lives or indefinite lives. For assets with finite lives, the cost is amortized over the life of the asset. For assets with indefinite lives, there is no amortization. Instead a test of impairment is conducted at least once a year to check if the assets are impaired. If there is impairment, then the value of the asset is reduced and the reduction is recognized as a loss in income statement.

<a title="Introduction to International Financial Reporting Standards (IFRS)" href="https://financetrain.com/introduction-to-international-financial-reporting-standards-ifrs/">IFRS</a> defines intangible assets as 'identifiable non-monetary assets without physical substance'. In order to be an identifiable intangible asset, an asset must meet the following three criteria:
<ol>
	<li>Asset must be identifiable (Capable of being separated from the firm or arise from a contractual or legal right)</li>
	<li>Asset is controlled by the firm.</li>
	<li>Asset is capable of generating future economic benefit.</li>
</ol>
In addition, there are two recognition criteria: 1) It is probable that the expected future economic benefits of the assets will flow to the company. 1) The cost of the asset can be reliably measured.

The intangible assets are accounted for depending on how they are acquired. Intangible assets can be:
<ul>
	<li>Purchased</li>
	<li>Internally developed</li>
	<li>Acquired in a business combination</li>
</ul>
<h3>Internally Developed Assets</h3>
All costs to create intangible assets are expensed as incurred. A few exceptions are research and development costs and software development costs. The treatment of these exceptions is summarized below:
<table>
<tbody>
<tr>
<td width="205"><strong> </strong></td>
<td width="205"><strong>IFRS</strong></td>
<td width="205"><strong>US GAAP</strong></td>
</tr>
<tr>
<td width="205"><strong>Research Costs</strong></td>
<td width="205">Expensed</td>
<td width="205">Expensed</td>
</tr>
<tr>
<td width="205"><strong>Development Costs</strong></td>
<td width="205">Capitalized</td>
<td width="205">Expensed

<em>Exception: Software development costs</em></td>
</tr>
<tr>
<td width="205"><strong>Software Development (Own Use)</strong></td>
<td width="205">Costs expensed till technical feasibility is established. (Capitalization criteria)

Capitalized thereon.</td>
<td width="205">Capitalized</td>
</tr>
<tr>
<td width="205"><strong>Software Development (For sale)</strong></td>
<td width="205">Costs expensed till technical feasibility is established.

Capitalized thereon.</td>
<td width="205">Costs expensed till technical feasibility is established.

Capitalized thereon.</td>
</tr>
</tbody>
</table>
Let’s take an example to understand the accounting of software development cost. A firm is developing software for its own use. Initially it spends $5,000 on software development. However, till then the firm could not estimate the expected future economic benefits of the assets. After that the company is able to estimate the expected future economic benefits from the intangible asset and then spends $20,000 more to develop the software.

Under IFRS, the initial $5,000 will be expensed, and the rest $20,000 will be capitalized. Under US GAAP, the entire $25,000 will be capitalized.
<h3>Purchased Intangible Assets</h3>
If an intangible asset is purchased, it will be treated in the same way as capitalization of any other tangible asset. The cost of acquiring the intangible asset (fair value at acquisition) is recorded on the balance sheet.

The capitalization results in higher net income, higher equity, higher assets and higher operating cash flows.

An analyst will be more interested in the type of asset purchased. For example, if the firm has purchased a franchise, the analyst will have some insight into the future earning capacity of the business.
<h3>Intangible Assets Acquired in a Business Combination</h3>
When a company acquires another company, the acquisition method is used to account for the transaction. Under this method:
<ul>
	<li>The acquirer allocates the purchase price to each asset acquired on a fair value basis.</li>
	<li>If the total purchase price exceeds the sum of fair value amounts allocated, then the excess is recorded as goodwill.</li>
</ul>
The goodwill generated in business combination is the only asset recorded in the balance sheet. Note that goodwill is an unidentifiable indefinite asset and cannot be separated from the entity. Also note that any internally created goodwill will be expensed in the period in which it is incurred.

Under IFRS, the acquired intangible assets include assets that meet all the definitional and recognition criteria discussed earlier. Any intangible asset not meeting these criteria is recognized as goodwill.

Under US GAAP, an intangible asset acquired in a business combination is recognized separately from goodwill if it is capable of being separated from the firm or arise from a contractual or legal right.

Financial Reporting of Intangible Assets

Depreciation is defined as the ‘allocation of the depreciable amount of an asset over its estimated life’. According to the matching concept, revenues should be matched with expenses in order to determine the accounting profit. The cost of the asset purchased should be spread over the periods in which the asset will benefit a company.

We will study the following methods of depreciation:
<ul>
	<li>Straight-line Method</li>
	<li>Accelerated Depreciation Methods
<ul>
	<li>Sum-of-the-Years Digits (SYD)</li>
	<li>Double-declining Balance (DDB)</li>
</ul>
</li>
	<li>Units-of-production Method</li>
</ul>
<h3>Straight-line Method</h3>
The straight-line method associates the long-lived asset’s usefulness with its age. Under this method, depreciation is computed by dividing the depreciable amount of the asset by the expected number of accounting periods of its useful life.

<img class="aligncenter size-full wp-image-21472" src="https://financetrain.com/wp-content/uploads/de11.gif" alt="de1" width="562" height="59" />

Note that useful economic life is not equal to physical life. It is the period over which the firm intends to use the asset.

Residual amount is the amount received after disposal of the asset.

<strong>Example</strong>

Cost of Asset = $1,000

Residual/Salvage value = $200

Estimated Useful life = 4 years

<em>Annual charge for depreciation = (1,000 – 200)/4 = $200</em>
<h3>Accelerated Depreciation Methods</h3>
Accelerated depreciation methods allow higher depreciation to be charged in the early years, and lower depreciation in the later periods.

The two common accelerated depreciation methods are: Sum-of-the-Years Digits (SYD) expensing and Double Declining Balance (DDB) expensing.
<h3>Sum-of-the-Years Digits (SYD)</h3>
SYD method treats an asset as more useful in its early life by raising the depreciation expense for the early years.

<strong>SYD Example:</strong> If a company’s factory has a new conveyor belt with a useful life of 5 years, then SYD = 1+2+3+4+5 = 15.  This conveyor belt cost $100,000 and has a salvage value = $0.  The year two depreciation expense under the SYD method for the company will be calculated as follows:

<strong>($100,000 – $0) * (5 – 2 +1)/15 = $100,000*(4/15) = $26,667</strong>

<strong>SYD Depreciation Expense for Year “i” = (Cost – Salvage Value) * ((n – “# of the i<sup>th</sup> year” +1))/SYD</strong>
<h3>DDB Methods</h3>
DDB method accelerates the depreciation rate of the straight line method.

<strong>DDB Expense = (Cost – Accumulated Depreciation) * (2/n)</strong>

<strong>Example</strong>

Cost of Asset = $1,000

Estimated Useful life = 4 years

<em>DDB depreciation in year 1 = 1,000*2/4 = 500</em>

<em>DDB depreciation in year 2 = (1,000 – 500)*2/4 = $250</em>

<em>And so on…</em>

Note that the DDB depreciation calculation does not include salvage/residual value. When the book value of the asset reaches its salvage value, no more depreciation expense will be recognized.
<h5>Units-of-production Method</h5>
Unlike the time based methods of straight line and accelerated depreciation, the Units-of-Production (U-O-P) depreciation method is activity based.  A year’s depreciation expense on an annual income statement will include that year’s production as a fraction of total estimated lifetime production from the asset.

<strong><img class="aligncenter size-full wp-image-21473" src="https://financetrain.com/wp-content/uploads/de21.gif" alt="de2" width="627" height="39" /></strong>

<strong>Example</strong>

A company bought a machine at $10,000 and expects that the machine would run for 2,000 hours during its life.  It is expected to have no scrap value. The machine was run 800 hours in year 1, 600 hours in year 2, 350 hours in year 3, and 250 hours in year 4. Assuming no salvage value, the depreciation charge will be calculated as follows:

Year 1: $10,000 * 800/2,000 = $4,000

Year 2: $10,000 * 600/2,000 = $3,000

Year 3: $10,000 * 350/2,000 = $1,750

Year 4: $10,000 * 250/2,000 = $1,250

Once a company has invested in a long-lived asset, it must:
<ul>
	<li>Choose a depreciation method;</li>
	<li>Estimate the useful life of the asset over which the depreciation will take place; and</li>
	<li>Determine if the asset will have a salvage value at the end of its depreciable life.</li>
</ul>

Depreciation Methods for Property, Plant, and Equipment (PPE)

The table below summarizes the early year impacts on selected financial reporting items by choosing the straight-line method versus an accelerated depreciation method.
<table width="610">
<tbody>
<tr>
<td><strong>ITEM IMPACTED</strong></td>
<td><strong>STRAIGHT-LINE</strong></td>
<td><strong>ACCELERATED</strong></td>
</tr>
<tr>
<td><strong>Earnings, Equity, Profit Margins</strong></td>
<td>Higher, as depreciation expense is lower in early years.</td>
<td>Lower, as depreciation expense is higher in early years.</td>
</tr>
<tr>
<td><strong>Current Ratio</strong></td>
<td>No impact because the current ratio relates to short-term assets.</td>
<td>No impact because the current ratio relates to short-term assets.</td>
</tr>
<tr>
<td><strong>Total Pre-Tax Cash Flow</strong></td>
<td>No change.</td>
<td>No change.</td>
</tr>
<tr>
<td><strong>Asset Turnover</strong></td>
<td>Lower, as asset values are higher in the early years.</td>
<td>Higher, as asset values are depreciated up front.</td>
</tr>
<tr>
<td><strong>Debt-to-Equity Ratio</strong></td>
<td>Lower, as equity is higher driven by higher earnings in the early years.</td>
<td>Higher, as equity is lowered in the early years with an elevated depreciation expense.</td>
</tr>
</tbody>
</table>

Impact of Depreciation Methods on Financial Statements

<ul>
	<li><strong>Choosing a Useful Life</strong>– In isolation, the shorter the useful life, the higher the depreciation expense.  A company’s management may attempt to show higher earnings in the near-term by increasing the useful life estimates for its long lived assets.</li>
	<li><strong>Estimating Salvage Value</strong>– A high salvage value lowers depreciation expense, raising income and equity value.  A company’s management may decide to assign a $0 salvage value to its long-lived assets in order to show higher profitability.</li>
	<li>A company’s management may decide to change its depreciation method.  The reason could be legitimate or it may signal an attempt to “window dress” (present an artificially optimistic financial report).
<ul>
	<li>An analyst is expected to be able to read the financial statement footnotes to understand the company’s choice of depreciation method.</li>
	<li>The disclosure by management of a change in depreciation method should serve as a red flag to a skilled financial analyst and he or she must calculate the impacts of the depreciation method change on key financial ratios.</li>
</ul>
</li>
	<li><strong>Depreciation Accounting and Inflation</strong>– When a company depreciates PPE at historical cost during a period of rising prices, the true depreciation expense is likely understated. If the historical cost basis for a firm’s depreciation expense is lower than its replacement cost, then an analyst may believe that the company is over reporting net income.</li>
	<li><strong>Component Depreciation </strong>– Under IFRS, each component of an asset is required to be depreciated separately. For example, in a building, the roof, walls, electrical fittings, plumbing, etc. are different components and for each component the useful life is estimated separately and depreciation expense computed separately. US GAAP also allows component depreciation but is hardly used.</li>
</ul>

Depreciation – Important Points

As we learned earlier, the intangible assets can have finite lives or indefinite lives. For assets with finite lives, the cost is amortized over the life of the asset. The procedure and methods of amortization are the same as for depreciation, i.e., straight-line method, accelerated depreciation methods, and units-of-production method. Just like tangible assets we estimate the useful life and salvage value of the intangible assets also. Their impact on financial statements is also the same.

For assets with indefinite lives, there is no amortization. Instead a test of impairment is conducted at least once a year to check if the assets are impaired. If there is impairment, then the value of the asset is reduced and the reduction is recognized as a loss in income statement. An example of an unidentifiable intangible asset with indefinite life is goodwill created as a result of business combination.
<h3>Example</h3>
A company acquired another company and as a result of the business combination, it acquired the following intangible assets:

Copyright = $200,000

Trademark = $500,000

Franchise = $200,000

Goodwill = $300,000

<strong>Total intangible assets = $1,200,000</strong>

The company expects to sell the copyright after 5 years for $50,000

The trademark will expire in 10 years.

The franchise agreement will expire in 5 years which the company can renew at a small fee.

We can use any depreciation method to calculate the depreciation. Using the straight-line method, the depreciation of each intangible asset will be calculated as follows:

Copyright = (200,000 – 50,000)/5 = $30,000

Trademark = 500,000/10 = $50,000

Franchise is an indefinite asset as it can be renewed for a small fee. So, it will not be amortized. Goodwill also is an indefinite asset and will not be amortized.

Total amortization expense = $30,000 + $50,000 = $80,000

At the end of the first year, the carrying value (book value) of intangible assets will be:

Intangible assets: $1,200,000

<em>Less Accumulated amortization: -80,000</em>

<strong>Net intangible assets: 1,120,000</strong>

Amortization of Intangible Assets

US GAAP does not permit firms to revalue the fixed assets on their balance sheets. Assets are reported on the balance sheet after deducting accumulated depreciation and impairment charges.

IFRS allows for revaluation if certain conditions are met or guidelines are followed, but the analyst may face challenges if companies regulated by different standards apply different techniques to revalue assets.

Under revaluation model long-lived assets can be reported at their fair values. A few important points about revaluation model are discussed below:
<ul>
	<li>If a company chooses to use revaluation model, it must use it for all similar assets and not apply it selectively to specific assets.</li>
	<li>To be able to use the revaluation, a firm must have a reliable way to estimate the fair value such as existence of active markets.</li>
	<li>Revaluation can result in increase or a decrease in fair value.</li>
	<li>When the company moves from historical cost to revaluation model, if fair value is less than historical cost, a loss is reported in income statement.</li>
	<li>If fair value is more than historical cost (regardless of prior revaluation), no gain is reported in income statement. Instead the amount is reported as a part of shareholder’s equity in an account called revaluation surplus.</li>
	<li>In the subsequent years, if revaluation results in a loss, the loss is first deducted from the revaluation surplus and once the surplus is exhausted, a loss is reported in income statement.</li>
</ul>
A financial analyst may need to revalue a company’s reported asset base in order to perform proper due-diligence when analyzing the firm for debt and/or equity valuation purposes.

If the analyst revises a company’s balance sheet asset values in an upward manner, then the analyst’s near term financial forecast for the company should show a decline in profit and asset turnover, as the firm is believed to be publicly reporting an insufficient depreciation expense.  The higher asset base will drive a lower ROA.

Revaluation Model for Fixed Assets

A long-lived asset has become impaired when the book value of the asset as recorded on the <a href="https://financetrain.com/understanding-balance-sheets/">balance sheet</a> is not expected to be recovered during future operations.

<strong>Example</strong>

A call center operator recently capitalized a $2 million investment in production fixtures at a leased building.  The call center company’s primary client in this site cancels the existing business contract two months after the investment is made.  The call center firm’s capitalized assets associated with this building may have become impaired, if the company feels that it cannot place new business in this site and must cease operations there.

Events that may cause a “lack of asset value recoverability” could be:
<ul>
	<li>A decrease in the asset’s market value.</li>
	<li>Adverse changes in the law.</li>
	<li>Adverse changes in the business climate involving the asset.</li>
	<li>Cost overruns on a project associated with the asset.</li>
	<li>The experience or anticipation ofincome statement or cash flow losses associated with the asset.</li>
</ul>
Both <a title="Differences in IFRS and US GAAP Frameworks" href="https://financetrain.com/differences-in-ifrs-and-us-gaap-frameworks/">IFRS and US GAAP</a> require impaired assets to be written down and losses recognized in the income statement. However, there are some differences.
<table>
<tbody>
<tr>
<td width="111"><strong> </strong></td>
<td width="198"><strong>IFRS</strong></td>
<td width="307"><strong>US GAAP</strong></td>
</tr>
<tr>
<td width="111"><strong>Criteria</strong></td>
<td width="198">Must annually assess for circumstances indicating impairment and then test for impairment</td>
<td width="307">Test for impairment only if events and circumstances indicate so.</td>
</tr>
<tr>
<td width="111"><strong>Impairment condition</strong></td>
<td width="198">Carrying value &gt; Recoverable amount

&nbsp;

Recoverable amount = Fair value (less selling cost) or value in use, whichever is higher.

&nbsp;

The value in use is the present value of its future cash flow stream from continued use.</td>
<td width="307">US GAAP has a two-step process for determining if an asset impairment charge is required:
<ul>
	<li><strong>Recoverability Test</strong>– An asset impairment must be recognized once the UNDISCOUNTED future cash flows from an asset fall below the book value of the asset on the balance sheet.</li>
	<li><strong>Loss Measurement</strong>– The amount by which an impaired asset it to be reduced equals the difference between its book value and its fair market value (this can be called “mark to market accounting”).</li>
</ul>
&nbsp;</td>
</tr>
<tr>
<td width="111"><strong>Impact on Balance Sheet</strong></td>
<td width="198">Asset is written down on the balance sheet to the recoverable amount</td>
<td width="307">Asset value is written down to fair value.</td>
</tr>
<tr>
<td width="111"><strong>Impact on Income Statement</strong></td>
<td width="198">An impairment losses is recorded on the income statement equal to Carrying value – Recoverable amount</td>
<td width="307">A loss charge is taken on the income statement equal to the reduction in asset value on the balance sheet.

If fair value is not known, discount value of future cash flows is used.</td>
</tr>
<tr>
<td width="111"><strong>Loss reversal</strong></td>
<td width="198">Loss can be reversed if value of impaired assets recovers in the future. Loss reversal is limited to original impairment loss.</td>
<td width="307">Loss reversal is not permitted.</td>
</tr>
</tbody>
</table>
<h3> Types of Asset Impairment</h3>
<ul>
	<li><strong>Write-downs</strong>– Asset values have changed as a result of changing market conditions.</li>
	<li><strong>Restructurings </strong>– Asset value declines associated with the re-organization of business operations.</li>
</ul>
The US approach to impairment of long-lived assets has flaws because company management retains the ability to determine the assumptions, which go into performing a recoverability test.

In a period of economic recession, an analyst should be suspicious of a firm that does not experience any asset impairment, as management may be sticking to older, more optimistic assumptions about the expected future cash flows generated by its assets.
<h3>Intangible Assets with Indefinite Lives</h3>
These assets are not amortized but tested for impairment at least annually.

If carrying value exceeds fair value, assets are written down in balance sheet and a loss is recognized in income statement.
<h3>Long-lived Assets Held for Sale</h3>
The assets held-for-sale are impaired if their carrying value exceeds net realizable value. If carrying value exceeds net realizable value, assets are written down in balance sheet and a loss is recognized in income statement.

Under both IFRS and US GAAP, loss can be reversed if asset value recovers. Loss reversal is limited to original impairment loss.

Impairment of Long-lived Assets


In the initial period following an asset impairment, a firm’s:
<ul>
	<li><a title="Fixed Asset and Total Asset Turnover Ratio" href="https://financetrain.com/fixed-asset-and-total-asset-turnover-ratio/">Asset turnover ratios</a> will rise because the asset base is lower.</li>
	<li>Debt-to-Equity ratio will rise because the impairment has lowered the value of equity.</li>
	<li>Profit margins will show a one-time dip due to the write-down expense (assuming all needed write-downs have taken place).</li>
	<li>Book value of equity will drop.</li>
</ul>
In the future accounting periods, after the asset impairment has been recognized, a firm’s:
<ul>
	<li>Future <a title="Depreciation Methods for Property, Plant, and Equipment (PPE)" href="https://financetrain.com/depreciation-methods-for-property-plant-and-equipment-ppe/">depreciation</a> expense will decline because the book value of the depreciable asset base is now lower.</li>
	<li>Future profitability should rise because depreciation expense is lower.</li>
	<li>Return on Assets (ROA) and Return on Equity (ROE) should rise because the firm is more profitable and has a lower asset base.</li>
</ul>
 

Impact of Asset Impairment

Derecognition happens when an asset is sold, exchanged or abandoned and therefore removed from the balance sheet.
<table>
<tbody>
<tr>
<td width="205"><strong> </strong></td>
<td width="205"><strong>Balance Sheet</strong></td>
<td width="205"><strong>Income Statement</strong></td>
</tr>
<tr>
<td width="205"><strong>Asset is sold</strong></td>
<td width="205"><a title="Financial Reporting of Intangible Assets" href="https://financetrain.com/financial-reporting-intangible-assets/">Asset</a> is removed from balance sheet.</td>
<td width="205">A loss/gain equal to carrying value <em>less</em> sale proceeds is reported on <a title="Income Statement" href="https://financetrain.com/income-statement/">income statement</a>.</td>
</tr>
<tr>
<td width="205"><strong>Asset is exchanged</strong></td>
<td width="205">The old asset is removed from balance sheet.

The new asset is added to balance sheet at fair value.</td>
<td width="205">A loss/gain is reported in income statement equal to difference between:
<ul>
	<li>Carrying value of old asset and fair value of old asset</li>
	<li>Carrying value of old asset and fair value of new asset (if reliable estimated)</li>
</ul>
</td>
</tr>
<tr>
<td width="205"><strong>Asset is abandoned</strong></td>
<td width="205">Asset is removed from balance sheet.</td>
<td width="205">A loss/gain is reported in income statement equal to the carrying value of the asset.</td>
</tr>
</tbody>
</table>
&nbsp;

Derecognition of PPE and Intangible Assets

<h3>Disclosures under <a title="Calculation of EBITDA Under IFRS" href="https://financetrain.com/calculation-of-ebitda-under-ifrs/">IFRS</a></h3>
<strong>Disclosures for PPE</strong>
<ul>
	<li>Measurement basis</li>
	<li>Depreciation method</li>
	<li>Estimated useful lives or equivalent depreciation rate</li>
	<li>Gross carrying amount and accumulated depreciation</li>
	<li>Reconciliation of carrying amounts at beginning and end</li>
</ul>
The following additional disclosures are required:
<ul>
	<li>Restriction on title and pledges as collateral of property</li>
	<li>Equipment and contractual agreements to acquire <a title="Depreciation Methods for Property, Plant, and Equipment (PPE)" href="https://financetrain.com/depreciation-methods-property-plant-equipment-ppe/">PPE</a></li>
</ul>
If <a title="Revaluation Model for Fixed Assets" href="https://financetrain.com/revaluation-model-fixed-assets/">revaluation mode</a>l is used, the firm is required to disclose:
<ul>
	<li>Date of revaluation</li>
	<li>How fair value was determined</li>
	<li>Carrying amount under cost method</li>
	<li>Revaluation surplus</li>
</ul>
<strong>Disclosures for Intangible Assets</strong>
<ul>
	<li>Whether indefinite or finite</li>
	<li>If finite life:
<ul>
	<li>Useful life of each intangible asset</li>
	<li>Amortization method used</li>
	<li>Gross carrying amount and accumulated<a title="Amortization of Intangible Assets" href="https://financetrain.com/amortization-intangible-assets/"> amortization</a></li>
	<li>Reconciliation of carrying amounts at beginning and end</li>
</ul>
</li>
	<li>If indefinite asset:
<ul>
	<li>Disclose carrying amount of asset and why it is considered indefinite</li>
</ul>
</li>
	<li>Restriction on title and pledges as collateral of intangible assets</li>
	<li>Equipment and contractual agreements to acquire intangible assets</li>
</ul>
<strong>Disclosures for Impaired Assets</strong>
<ul>
	<li>For each<a title="Efficiency, Assets, and Time" href="https://financetrain.com/efficiency-assets-and-time/"> asset class</a>, the amount of impairment losses</li>
	<li>Reversal of impairment losses recognized in the period</li>
	<li>Where impairment losses and loss reversals are recognized in the income statement</li>
	<li>Main events and circumstances leading to recognition of impairment losses</li>
</ul>
<h3>Disclosures under US <a title="Differences in IFRS and US GAAP Frameworks" href="https://financetrain.com/differences-in-ifrs-and-us-gaap-frameworks/">GAAP</a></h3>
<strong>Disclosures for PPE and Intangible Assets are same</strong>
<ul>
	<li>Gross carrying amount and accumulated depreciation for major asset classed or in total</li>
	<li>General description of depreciation methods used</li>
	<li>Aggregate amortization expense</li>
	<li>Estimated amortization expense next 5 years</li>
</ul>
<strong>Disclosures for Impaired Assets</strong>

There is no reversal of impairment losses, so no related disclosures. The firm must disclose:
<ul>
	<li>Description of impaired asset</li>
	<li>Reason for impairment</li>
	<li>Method for determining fair value</li>
	<li>Amount of impairment loss</li>
	<li>Where impairment losses are recognized in the income statement</li>
</ul>

Disclosures Related to PPE and Intangible Assets

Under US GAAP, there is no distinction between investment property and other long-lived assets.

Under IFRS, investment property is distinguished from other long-lived asset. An investment property is the property that the firm owns for earning rental income, earning <a title="Understaning Economic Capital" href="https://financetrain.com/understaning-economic-capital/">capital gains</a> or both.
<h3>Valuation of Investment Property</h3>
The firm has the choice to use historical cost or fair value method. However, whichever method the company chooses, it must use the same method for all investment properties.
<ul>
	<li>Cost Mode<strong>l:</strong> Same as the cost model for valuing PPE</li>
	<li><a title="Revaluation Model for Fixed Assets" href="https://financetrain.com/revaluation-model-fixed-assets/">Fair value mode</a>l<strong>:</strong> Different from revaluation model used for PPE. In revaluation model, if fair value is more than historical cost, no gain is reported in income statement. Instead the amount is reported as a part of shareholder’s equity in an account called revaluation surplus. For investment property, the gain is recorded in the income statement and there is no revaluation surplus account.</li>
	<li><a title="How Do Analysts Select an Equity Valuation Model?" href="https://financetrain.com/how-do-analysts-select-an-equity-valuation-model/">Valuation mode</a>l used</li>
	<li>How fair value is determined</li>
	<li>Reconciliation of carrying amounts at beginning and end</li>
	<li>If cost model is used, disclose the fair value and other disclosures required for other long-lived assets</li>
</ul>
<h3>Disclosures Required</h3>
<h4>Transfers Into and Out of Investment Property</h4>
Sometimes the firm may change how it uses its property. For example, it may change a self-occupied property to investment property and vice versa. If cost model is used to value such a property, then there is no change in carrying value, however, if fair value model is used, financial statement treatment is as described below:
<table>
<tbody>
<tr>
<td width="205"><strong>Transfer From</strong></td>
<td width="205"><strong>Transfer To</strong></td>
<td width="205"><strong>Treatment</strong></td>
</tr>
<tr>
<td width="205">Own occupied property</td>
<td width="205">Investment property</td>
<td width="205">Treat as revaluation.Gain is recognized only if it reverses previously recognized loss.</td>
</tr>
<tr>
<td width="205">Inventory</td>
<td width="205">Investment property</td>
<td width="205">Record gain/loss in income statement based on the difference between fair value and carrying value.</td>
</tr>
<tr>
<td width="205">Investment property</td>
<td width="205">Own occupied property or Inventory</td>
<td width="205">Record fair value of the asset on transfer date as its cost.</td>
</tr>
</tbody>
</table>
&nbsp;

Financial Reporting of Investment Property Vs. PPE

This quiz is a part of the CFA Level 1 reading 'Long-lived Assets'. 

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Long-lived Assets

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