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

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 PPE.

• Identify basic accounting issues for intangible assets and goodwill.

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

• Describe methods for evaluating the use of assets.

Property, Plant, and Equipment (PPE)

Definition and Characteristics

• Long-lived resources controlled by the company.

• Tangible assets (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: land, land improvements, buildings, equipment, etc.

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.

Land Improvements

• 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 (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, fixtures.

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

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

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

Leasing: Buy or Lease?

Advantages of Leasing

• Reduced risk of obsolescence.

• Cash outlays spread over time.

• 100% financing.

• Income tax advantages.

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

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 does not pass.

• 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, revenue for lessor.

Depreciation

Definition and Purpose

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

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

• 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 expense is constant each year.

• Formula:

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

Diminishing-Balance Method

• Produces a decreasing annual depreciation expense.

• Depreciation is calculated on the asset's carrying amount at the start of each year.

• Formula:

$\text{Depreciation Expense} = \text{Carrying Amount at Beginning of Year} \times \text{Depreciation Rate}$ $\text{Depreciation Rate} = \text{Straight-Line Rate} \times \text{Multiplier}$

Units-of-Production Method

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

• Formula:

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

Other Depreciation Issues

• Significant components: May be depreciated separately.

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

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

• Cost vs. revaluation model: IFRS allows revaluation to fair market value (limited use).

• Revising depreciation: Needed for capital expenditures, impairment, changes in useful life or residual value, or consumption pattern. 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 amount is called reserves.

Derecognition of Property, Plant, and Equipment

Steps in Derecognition

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.

Intangible Assets and Goodwill

Definition and Characteristics

• Lack 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 or based on contractual/legal rights; treated differently.

Accounting for Intangible Assets

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

• If finite life: cost is amortized over useful or legal life (whichever is shorter).

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

Examples of Intangible Assets

• Finite lives: Patents (20 years), copyrights (life of creator + 50 years), development costs (capitalized if associated with identifiable, feasible product).

• Indefinite lives: Trademarks, trade names, franchises, licenses.

Goodwill

• Represents future economic benefits from acquiring a business.

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

• 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/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 Asset Use

Return on Assets (ROA)

• Measures overall profitability relative to assets used.

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

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

Asset Turnover

• Measures efficiency in using 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 ROA.

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

Additional info: These notes are based on textbook slides and standard accounting principles under IFRS and ASPE. For more detailed examples and exercises, refer to the textbook or instructor-provided materials.