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Chapter 11 completes the discussion of accounting for property, plant and equipment, investment property and intangible assets by addressing the subsequent valuation and allocation of the value of these assets to the periods benefitted by their use. Expenditures subsequent to acquisition and impairment are also covered in this chapter.
Chapter 11 PROPERTY, PLAND AND EQUIPMENT,INVESTMENT PROPERTY, AND INTANGIBLE ASSETS: UTILIZATION AND IMPAIRMENT © 2013 The McGraw-Hill Companies, Inc Cost Allocation – An Overview The The matching matching principle principle requires requires that that part part of of the the acquisition acquisition cost cost of of property, property, plant plant and and equipment, equipment, investment investment property property and and intangible intangible assets assets be be expensed expensed in in periods periods when when the the future future revenues revenues are are earned earned Depreciation, Depreciation, depletion, depletion, and and amortization amortization are are cost cost allocation allocation processes processes used used to to help help meet meet the the matching matching principle principle requirements requirements Some Some of of the the cost cost is is expensed expensed each each period period Acquisition Acquisition Cost Cost 11 - (Balance Sheet) Expense Expense (Income Statement) Cost Allocation – An Overview Asset Category Debit Property, Plant & Equipment Depreciation Natural Resource Depletion Intangible Amortization Account Credited Accumulated Depreciation Natural Resource Asset Intangible Asset Caution! Depreciation, depletion, and amortization are processes of cost allocation, not valuation! 11 - Depreciation on the Statement of Financial Position Measuring Cost Allocation Cost allocation requires three pieces of information for each asset: Service Service Life Life Allocation Allocation Base Base The The estimated estimated expected expected use use from from an an asset asset Allocation Allocation Method Method The The systematic systematic approach approach used used for for allocation allocation Total Total amount amount of of cost cost to to be be allocated allocated Cost Cost Residual Residual Value Value (at (at end end of of useful useful life) life) 11 - Depreciation Time-based Time-based Methods Methods Straight-line Straight-line (SL) (SL) Accelerated Accelerated Methods Methods Sum-of-the-years’ Sum-of-the-years’ digits digits (SYD) (SYD) Declining Declining Balance Balance (DB) (DB) Activity-based Activity-based methods methods Group Group and and composite composite methods methods Tax Tax depreciation depreciation Units-of-production Units-of-production method method (UOP) (UOP) 11 - Straight-Line The The most most widely widely used used and and most most easily easily understood understood method method Results Results in in the the same same amount amount of of depreciation depreciation in in each each year year of of the the asset’s asset’s service service life life On On January January 1, 1, we we purchase purchase equipment equipment for for $50,000 $50,000 cash cash The The equipment equipment has has an an estimated estimated service service life life of of 55 years years and and estimated estimated residual residual value value of of $5,000 $5,000 What What is is the the annual annual straight-line straight-line depreciation? depreciation? 11 - Depreciation Straight-Line Year Depreciation (debit) Accumulated Depreciation (credit) Accumulated Depreciation Balance $ $ $ $ 11 - Life in Years 9,000 9,000 9,000 9,000 9,000 45,000 $ 9,000 9,000 9,000 9,000 9,000 45,000 9,000 18,000 27,000 36,000 45,000 BV = Residual Value at the end of the asset’s useful life Undepreciated Balance (book value) $ 50,000 41,000 32,000 23,000 14,000 5,000 Residual Value Accelerated Methods Accelerated methods result in more depreciation in the early years of an asset’s useful life and less depreciation in later years of an asset’s useful life Note that total depreciation over the asset’s useful life is the same as the straight-line method Sum-of-the-years’-digits (SYD) depreciation 11 - Sum-of-the-Years’ Digits (SYD) On January 1, we purchase equipment for $50,000 cash The equipment has a service life of years and an estimated residual value of $5,000 Using SYD depreciation, compute depreciation for the first two years 11 - Sum-of-the-Years’ Digits (SYD) 11 - 10 U.S GAAP vs IFRS Impairment of Value: Property, Plant, and Equipment and Finite-life Intangible Assets • • 11 - 47 Assets are tested for impairment when events or changes in indicators suggest that book value may not be recoverable An impairment loss is required when an asset’s book value exceeds the undiscounted sum of the estimated future cash flows • • Assets must be assessed for circumstances of impairment at the end of each reporting period An impairment loss is required when an asset’s book value exceeds the higher of the asset’s value-in-use (present value of estimated future cash flow) and fair value less costs to sell U.S GAAP vs IFRS Impairment of Value: Property, Plant, and Equipment and Finite-life Intangible Assets • • The impairment loss is the difference between book value and fair value Reversals of impairment losses are prohibited • • 11 - 48 The impairment loss is the difference between book value and the recoverable amount, the higher of the asset’s valuein-use and fair value less costs to sell An impairment loss is reversed if the circumstances that caused the impairment is resolved Indefinite-life Intangibles Test for impairment of value at least annually Goodwill Goodwill Allocate Allocate Goodwill Goodwill to to Cash Cash Generating Generating Units Units Determine Determine ifif impairment impairment is is indicated indicated and and calculate calculate the the amount amount of of the the impairment impairment 11 - 49 Other Other Indefinite Indefinite Life Life Intangibles Intangibles One-step One-step Process Process IfIf BV BV of of asset asset >> RV, RV, recognize recognize impairment impairment loss loss Impairment of Goodwill In 2012, the Upjane Corporation acquired Pharmacopia Corporation for $500 million Upjane recorded $100 million in goodwill related to this acquisition because the fair value of the net assets of Pharmacopia was $400 million After the acquisition, the assets of Pharmacopia are the smallest group of assets that generate cash flows that are largely independent of the cash flows from other assets or group of assets Therefore, Pharmacopia is a cash-generating unit As this cash-generating unit (Pharmacopia) includes goodwill within its carrying amount, it must be tested for impairment annually or more frequently if there is an indication that it may be impaired At the end of 2013, Pharmacopia’s net assets have a book value of $380 million and a recoverable amount of $350 million Is goodwill impaired and if so, by what amount? 11 - 50 Impairment of Goodwill For all values, ($ in millions) Determination of the carrying amount of the Cash Generating Unit Carrying amount of goodwill $ 100 Carrying amount of Blake's net assets 380 Total carrying amount $ 480 Measure of impairment loss Unit’s carrying amount Unit’s recoverable amount Impairment loss Allocation of impairment loss Carrying amount Impairment loss Carrying amount after impairment loss 11 - 51 $ 480 350 $ 130 Goodwill $ 100 (100) $ - NIA $ 380 (30) $ 350 U.S GAAP vs IFRS Impairment of Value: Indefinite-life Intangible Assets Other than Goodwill • • 11 - 52 Indefinite-life intangible assets other than goodwill are tested for impairment at least annually The impairment loss is the difference between book value and fair value • • Indefinite-life intangible assets other than goodwill are tested for impairment at least annually The impairment loss is the difference between book value and the recoverable amount, the higher of the asset’s valuein-use (present value of estimated future cash flows) and fair value less costs to sell U.S GAAP vs IFRS Impairment of Value: Indefinite-life Intangible Assets Other than Goodwill • • 11 - 53 Reversals of impairment losses are prohibited If certain criteria are met, indefinite-life intangible assets are combined for the required annual impairment test • • An impairment loss is reversed if the circumstances that caused the impairment is resolved Indefinite-life intangible assets may not be combined with other indefinite-life intangible assets for the required annual impairment test U.S GAAP vs IFRS Impairment of Value: Goodwill • • • 11 - 54 Goodwill is tested for impairment at least annually Reversals of impairment losses are prohibited The level of testing (reporting unit) is a segment or a component of an operating segment for which discrete financial information is available • • • Goodwill is tested for impairment at least annually Reversals of impairment losses are prohibited The level of testing (cashgenerating unit) is the smallest identifiable group of assets that generates cash flows that are largely independent of the cash flows from other assets U.S GAAP vs IFRS Impairment of Value: Goodwill • 11 - 55 Measurement of an impairment loss is a two-step process In step one the fair value of the reporting unit is compared to its book value A loss is indicated if the fair value is less than the book value In step two, the impairment loss is calculated as the excess of book value of goodwill over the implied fair value of goodwill • Measurement of an impairment loss is a one-step process The recoverable amount of the cash-generating unit is compared to its book value If the recoverable amount is less, goodwill is reduced before other assets are reduced Assets Held for Sale Assets held for sale include assets that management has committed to sell immediately in their present condition and for which sale within one year Is highly probable Impairment loss 11 - 56 = Book value Fair value less – cost to sell Expenditures Subsequent to Acquisition Type of Expenditure Repairs and Maintenance Definition Costs of day-to-day servicing to maintain a given level of Benefits Usual Accounting Treatment Expense in the period incurred Regular major inspections Expenditure required for continuing operation of the Asset Capitalize and amortize over the period between major Inspections Additions The addition of a new major component to an existing asset Capitalize and depreciate over the remaining useful life of the original asset or its own useful life, whichever is shorter Improvements The replacement of a major component Capitalize and depreciate over the useful life of the improved asset Rearrangements Expenditures to restructure an asset without addition, replacement, or improvement If expenditures are material and clearly increase future benefits, capitalize and depreciate over the future periods benefited 11 - 57 U.S GAAP vs IFRS Costs of Defending Intangible Rights • 11 - 58 Litigation costs to successfully defend intangible rights are capitalized and amortized over the remaining useful life of the asset • Litigation costs are expensed, except in rare situations when an expenditure increases future benefits Appendix 11A – Tax Depreciation Tax Tax rules rules allow allow taxpayers taxpayers to to compute compute depreciation depreciation for for their their tax tax returns returns based based on on the the tax tax laws laws of of the the relevant relevant jurisdictions jurisdictions The The common common differences differences in in calculation calculation pertain pertain to: to: Estimated useful lives and residual values are not used in tax depreciation 11 - 59 Firms can’t choose among various accelerated methods used for income tax purposes A half-year convention is often used in determining the tax depreciation amounts Appendix 11B – Retirement and Replacement Methods of Depreciation Used for groups of similar, low-valued assets with short service lives Retirement Method Replacement Method Acquisitions: Acquisitions: • Record initial acquisitions of assets at cost in the asset account • Record subsequent acquisitions of assets at cost in the asset account Dispositions: • Credit the asset account for cost • Debit depreciation expense for cost less the proceeds received 11 - 60 • Record initial acquisitions of assets at cost in the asset account • Record subsequent acquisitions with a debit to depreciation expense Dispositions: • Credit depreciation expense for the proceeds received End of Chapter 11 ... acquisition acquisition cost cost of of property, property, plant plant and and equipment, equipment, investment investment property property and and intangible intangible assets assets be be expensed... the asset’s asset’s cost cost and and the the proceeds proceeds 11 - 19 U.S GAAP vs IFRS Valuation of Property, Plant, and Equipment • • 11 - 20 Property, plant, and equipment is reported in the... life) life) 11 - Depreciation Time-based Time-based Methods Methods Straight-line Straight-line (SL) (SL) Accelerated Accelerated Methods Methods Sum-of-the-years’ Sum-of-the-years’ digits