Chapter 9: Reporting and Analyzing Long-Lived Assets

Reporting and Analyzing Long-Lived Assets

Learning Objectives

• Determine the cost of property, plant, and equipment (PPE).

• Explain and calculate depreciation.

• Account for derecognition of property, plant, and equipment.

• Identify the basic accounting issues for intangible assets and goodwill.

• Illustrate how long-lived assets are reported in the financial statements.

• Describe the methods for evaluating the use of assets.

Property, Plant, and Equipment (PPE)

Definition and Characteristics

• Long-lived resources controlled by the company.

• Tangible (have physical substance).

• Used in the operation of a business, not intended for sale to customers.

• Provide economic benefits over many years.

Determining the Cost of Property, Plant, and Equipment

PPE is recorded at cost, which includes:

1. Purchase price (including non-refundable taxes and duties, less discounts or rebates).

2. Expenditures necessary to bring the asset to its intended location and make it ready for use.

3. Estimated cost of future obligations to dismantle, remove, or restore the asset at the end of its useful life.

PPE is usually subdivided into classes such as land, land improvements, buildings, and equipment.

Land

• Cost includes purchase price, closing costs (title search, surveying, legal fees), and additional costs to prepare land for use (less any proceeds from salvage).

• Land has an unlimited life and is not depreciated.

Example: Building Site Cost Calculation

Item	Amount
Cash price of property	$1,200,000
Net cost of removing warehouse ($50,000 - $10,000)	$40,000
Legal fees	$5,000
Total Cost of Land	$1,245,000

Land Improvements

• Costs of structural additions (e.g., parking lots, fencing, driveways, sidewalks).

• Recorded separately from land and depreciated over their useful lives.

• Do not include costs of getting the land ready for use.

Buildings

• All expenditures related to the purchase or construction of a building (e.g., stores, offices, factories, warehouses).

• When purchased: purchase price, closing costs, costs to make ready for use.

• When constructed: contract price, architect's fees, building permits, excavation cost, interest during construction.

Equipment

• Includes office equipment, machinery, vehicles, furniture, and fixtures.

• Costs include purchase price, freight and insurance during transit, assembling, installing, and testing.

Example: Capitalization of Equipment Costs

Expenditure	Benefit Future Periods?	Required to Put Asset Ready for Intended Use?	Capitalize as Non-current Asset?	Capitalize as Prepaid Insurance?	Expense Immediately?
Price paid for van	Yes	Yes	$32,500
Painting and lettering	Yes	Yes	$500
Cost of oil change	No	No			$30
One-year insurance policy	Yes	No		$1,000

Expenditures During Useful Life

• Operating expenditures: Benefit only the current period; required to maintain asset in normal operating condition.

• Capital expenditures: Capitalized as an asset (increase the cost of the asset); increase life, productivity, or efficiency of the asset.

Leasing: Buy or Lease?

Advantages of Leasing

• Reduced risk of obsolescence.

• Cash outlays for asset are spread over time.

• 100% financing.

• Income tax advantages.

Terminology: Lessor (owner of asset for lease), Lessee (party leasing asset from owner).

IFRS Lease Rules

• Lease is considered an asset purchase financed with a loan from the lessor.

• Risks and rewards of ownership transfer to lessee even if legal title has not passed.

• Lessee must report leased asset (as a right-of-use asset) and related liability.

• Exceptions: leases under 12 months or for low-value assets are treated as period expenses.

ASPE Lease Rules

• Capital lease: Substantially all benefits and risks of ownership transfer to lessee; lessee records asset and liability at present value of minimum lease payments.

• Operating lease: Benefits and risks of ownership do not transfer; lease payments are expenses for lessee and revenue for lessor.

Depreciation

Definition and Purpose

• Systematic allocation of the cost of PPE over the asset’s useful life.

• It is a process of cost allocation, not valuation.

• Does not use or provide cash to replace the asset.

Factors in Calculating Depreciation

1. Cost: Purchase price plus costs to get asset ready for use, plus estimated retirement costs.

2. Useful life: Period of expected use or total units expected to be produced.

3. Residual value: Estimated amount to be received from disposal at end of useful life.

Depreciation Methods

• Straight-line

• Diminishing-balance

• Units-of-production

Management selects the method that best reflects the pattern of economic benefit consumption.

Straight-Line Method

• Depreciation is constant each year.

• Formula:

$\text{Depreciation Expense} = \frac{\text{Cost} - \text{Residual Value}}{\text{Useful Life}}$

Example: For a van costing $33,000, residual value $3,000, useful life 5 years:

$\text{Depreciation Expense} = \frac{33,000 - 3,000}{5} = 6,000$ per year

Diminishing-Balance Method

• Produces a decreasing annual depreciation expense.

• Depreciation is calculated on the asset’s carrying amount at the beginning of each year.

• Residual value is not included in the calculation.

• Formula:

$\text{Depreciation Expense} = (\text{Cost} - \text{Accumulated Depreciation}) \times \text{Depreciation Rate}$

Depreciation Rate = Straight-line rate × multiplier (e.g., double-diminishing balance uses multiplier 2).

Units-of-Production Method

• Useful life is expressed in terms of total units of production or activity.

• Formula:

$\text{Depreciation Expense} = \frac{\text{Cost} - \text{Residual Value}}{\text{Total Estimated Units of Activity}} \times \text{Actual Units of Activity During Period}$

Example: For a van with $30,000 depreciable amount and 100,000 km estimated life, depreciation rate per km is $0.30. If 15,000 km used in a year, depreciation is $4,500.

Comparison of Depreciation Methods

Year	Straight-Line Depreciation Expense	Straight-Line Carrying Amount	Diminishing-Balance Depreciation Expense	Diminishing-Balance Carrying Amount	Units-of-Production Depreciation Expense	Units-of-Production Carrying Amount
2021	$6,000	$27,000	$13,200	$19,800	$4,500	$28,500
2022	$6,000	$21,000	$7,920	$11,880	$6,000	$22,500
2023	$6,000	$15,000	$4,752	$7,128	$7,500	$15,000
2024	$6,000	$9,000	$2,851	$4,277	$6,000	$9,000
2025	$6,000	$3,000	$1,277	$3,000	$6,000	$3,000
Total	$30,000		$30,000		$30,000

Other Depreciation Issues

• Significant components: May be depreciated separately.

• Income tax: Capital Cost Allowance (CCA) is used for tax filing.

• Impairments: Occur when carrying amount exceeds fair value; impairment loss is recorded as:

$\text{Impairment Loss} = \text{Carrying Amount} - \text{Fair Value}$

• Cost vs. revaluation model: Under IFRS, assets may be revalued to fair market value (limited use).

• Revising periodic depreciation: Needed if capital expenditures, impairment, or changes in estimates occur. Changes are prospective (current and future years only).

• Natural resources: Long-lived tangible assets consumed physically ("wasting assets"). Depreciation is called depletion, usually using units-of-production method. Remaining asset is called reserves.

Derecognition of Property, Plant, and Equipment

1. Update depreciation to the date of disposal.

2. Calculate carrying amount: $\text{Carrying Amount} = \text{Cost} - \text{Accumulated Depreciation}$

3. Calculate gain or loss on disposal: $\text{Gain (Loss)} = \text{Proceeds} - \text{Carrying Amount}$

   • If Proceeds > Carrying Amount: Gain (Credit)

   • If Proceeds < Carrying Amount: Loss (Debit)

4. Record disposal: Remove cost and accumulated depreciation; record proceeds and gain/loss.

Example Journal Entry for Disposal:

Account	Debit	Credit
Cash (or receivable)	xx
Accumulated Depreciation	xx
Loss on Disposal (or Gain on Disposal)	xx	or xx
Specific PPE account		xx

Retirement of an asset is similar, except there may be little or no proceeds.

Intangible Assets and Goodwill

Definition and Characteristics

• Do not have physical substance.

• Provide rights, privileges, or competitive advantages (e.g., intellectual property).

• Must be identifiable (separable or based on contractual/legal rights).

• Goodwill is not separable and is treated differently.

Accounting for Intangible Assets

• Recorded at cost, including all costs to make asset ready for use.

• If finite life: systematically allocated over useful life (amortization).

• Amortize over lesser of estimated useful life and legal life.

• Test for impairment and write down if necessary.

• If indefinite life: not amortized, but tested for impairment annually.

Types of Intangible Assets

• Finite lives:

  • Patents (exclusive right for 20 years)

  • Research and development costs (research expensed, development capitalized if feasible)

  • Copyrights (life of creator + 50 years)

• Indefinite lives:

  • Trademarks and trade names

  • Franchises

  • Licenses

Goodwill

• Represents future economic benefits from the purchase of a business.

• Calculated as excess of purchase price over fair market value of net identifiable assets acquired.

• Only recognized when a business is purchased.

• Not amortized; subject to annual impairment test.

$\text{Goodwill} = \text{Purchase Price} - \text{Fair Value of Net Identifiable Assets}$

Presentation of Long-Lived Assets in Financial Statements

Statement of Financial Position

• Reported as non-current assets: PPE, Intangible Assets, Goodwill.

• Disclose cost and accumulated depreciation/amortization for each major class of assets (in statement or notes).

• Disclose depreciation/amortization methods and useful lives or rates.

• IFRS requires additional disclosures.

Statement of Income

• Depreciation expense, amortization expense, gains/losses on disposal, and impairment losses are included in operating expenses.

Statement of Cash Flows

• Cash flows from purchase and sale of long-lived assets are reported in the investing section.

Analyzing Assets

Return on Assets (ROA)

• Measures overall profitability.

$\text{Return on Assets} = \frac{\text{Net Income}}{\text{Average Total Assets}}$

Higher ROA indicates more net income generated per dollar invested in assets.

Asset Turnover

• Measures how efficiently a company uses its assets to generate sales.

$\text{Asset Turnover} = \frac{\text{Net Sales}}{\text{Average Total Assets}}$

Higher asset turnover indicates more sales generated per dollar invested in assets.

Profit Margin and ROA

• Profit margin and asset turnover together explain the return on assets ratio.

$\text{Return on Assets} = \text{Profit Margin} \times \text{Asset Turnover}$

Additional info: These notes are based on textbook slides and include expanded academic context, formulas, and examples for clarity and exam preparation.