Reporting and Analyzing Long-Lived Assets (Chapter 9) – Study Notes

Reporting and Analyzing Long-Lived 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 PPE

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.

• 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 purchase or construction of a building (e.g., stores, offices, factories, warehouses).

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

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

Equipment

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

• 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.

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 (e.g., landlord).

• Lessee: Party leasing asset from owner (e.g., tenant).

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 asset is expected to be available for use, or number of 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:

$\text{Depreciable Amount} = 33,000 - 3,000 = 30,000$ $\text{Depreciation Expense} = \frac{30,000}{5} = 6,000$ per year

Diminishing-Balance Method

• Produces decreasing annual depreciation expense.

• Depreciation is calculated on the asset’s carrying amount (cost minus accumulated depreciation).

• Formula:

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

Example: For a van, straight-line rate is 20%, double-diminishing-balance rate is 40%.

Units-of-Production Method

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

• Formula:

$\text{Depreciation Expense} = \text{Depreciation Rate per Unit} \times \text{Units of Activity During the Year}$ $\text{Depreciation Rate per Unit} = \frac{\text{Cost} - \text{Residual Value}}{\text{Estimated Total Units of Activity}}$

Example: For a van, $30,000/100,000$ km = $0.30$ per km. If 15,000 km used in a year, depreciation is $0.30 \times 15,000 = 4,500$.

• 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 (rarely used).

• Revising depreciation: Needed if capital expenditures, impairment, or changes in useful life/residual value 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.