Chapter : 1

Long lived assets through U.S. GAAP

Chapter 1 component

Chapter 1

2.6.
2.7. Intangible Depreciation Accounting
Defnition Cost determinition Impairmen
assets Methods problems
t and disposal

initial Subsequent
 Introduction

There are many differences of accounting treatments between U.S GAAP and IFRS
because U.S GAAP more strictly than IFR. The aimed of this chapter is identifying
and describing the accounting treatment of the long lived assets especially
property, plant and equipment and intangible assets under U.S. GAAP and shows
the differences with international financial reports standards IFRS.

This chapter aimed to discuss

1. Definition of Property plant and equipment

2. Cost determination and measurement
2.1. Initial measurement and acquisition
2.2. Measurement Subsequent to Initial Recognition
2.3. Accounting problems associated to measurements
2.4. Property, plant and equipment depreciation
2.5. Impairment and disposal of long lived assets
2.6. Intangible assets issues
 1. Definition of the property plant and equipment

According to Gleim (2017) Property, plant, and equipment (PPE), also called fixed
assets, are tangible property expected to benefit the entity for more than 1 year.
They are held for the production or supply of goods or services, rental to others,
or administrative purposes .

Plant assets are long lived, tangible assets used in the operation of a business
such as land, building and furniture.

Also we can define property ,plant , and equipment upon its characteristics , the
major characteristics are as follows (1) they are acquired for use in operation not
for resale, An idle building is more appropriately classified separately as an
investment, land developers or sub dividers classify land as inventory. (2)they are
long term in nature and usually depreciated, companies allocate the cost of the
investment in these assets to future periods through periodic depreciation
charges , the exception is land , which is depreciated only if a material decrease in
value occurs such as loss in fertility of agricultural land. (3) they possess physical
substance.( kieso, weygandt, warfield, 2016, P490).

PPE are used in operations , so there’s must matching their cost and revenues
they generate , value of plant assets ( balance sheet effect) and then allocate their
costs to periods benefiting from their use ( income statement effect).

2. Cost determination and measurement

2.1. Initial measurement and acquisition
Under U.S GAAP, PPE are initially measured at historical cost, which consists of all
the costs necessarily incurred to bring the asset to the condition and location
necessary for its intended use.

Historical cost ( cost principle ) measures the cash or cash equivalent price of
obtaining the assets and bringing it to the location and condition necessary for its
intended use.

The historical (initial) cost includes (1) The net purchase price (minus trade
discounts and rebates, plus purchase taxes and import duties) and (2) The directly
attributable costs of bringing the asset to the location and condition needed for
its intended operation, such as architects’ and engineers’ fees, site preparation,
delivery and handling, installation, assembly, and testing. (3)Interest (borrowing
costs) attributable to the acquisition, construction, or production of a PPE asset
constructed for internal use is included in its initial cost.

2.2. Measurement Subsequent to Initial Recognition

Subsequent to acquisition, companies should nor write up property, plant and

equipment to reflect fair value when it is above cost the main reason are as
follows

(1) Historical cost involves actual not hypothetical, transactions and so is the
most reliable.
(2) Companies should not anticipate gain or losses but recognize gains or
losses only when the assets is sold.
The carrying amount of an item of PPE is the amount at which it is presented in
the balance sheet. This amount is equal to the historical cost minus accumulated
depreciation and impairment losses.

The accounting issue related to expenditures for PPE subsequent to initial

recognition is to determine whether they should be

1) Capitalized at cost and depreciated in future periods (a capital expenditure) or

2) Recognized as an expense as incurred (a revenue expenditure).

2.3. Accounting problems associated to measurements

2.3.1. self-constructed assets

Some companies construct their own assets, the companies must allocate costs
to arrive at the cost of self constructed assets.

Material and direct labor used in construction pose no problem, but the
assignment of indirect costs of manufacturing ( such as power, heat and light)
creates special problem, companies can handle with this problem in one of two
ways :

1. Assign no fixed overhead to the cost of the constructed assets

2. Assign a portion of all overhead to the construction process
2.3.2. Interest costs during construction

Under U.S GAAP capitalize only the actual interest costs incurred during
construction through debt financing

2.3.3. Exchange non monetary assets

Under U.S. GAAP companies account for the exchange of nonmonetary assets on
the basis of the fair value of the assets given up or the fair value of the assets
received , whichever is clearly more evident. Thus companies should recognize
immediately any gain or losses on the exchange.

2.4. Property, plant and equipment depreciation

Depreciation is the process of systematically and rationally allocating the

depreciable base of a tangible capital asset over its expected useful life. The
periodic depreciation expense is recognized in the income statement.
Accumulated depreciation is a contra-asset account.

The debit is to depreciation expense, and the credit is to accumulated

depreciation.

The asset’s depreciable base (the amount to be allocated) is calculated as follows:

Depreciable base = Historical cost – Salvage value – Recognized impairment loss

Estimated useful life is an estimated period over which services or economic

benefits are expected to be obtained from the use of the asset.

Salvage value (residual value) is the amount that the entity expects to obtain from
disposal of the asset at the end of the asset’s useful life. Land has an indefinite
useful life and therefore must not be depreciated. Thus, the depreciable base of
property that consists of land or a building is the depreciable base of the land or
building.
The depreciation method chosen should reflect the pattern in which economic
benefits (or services) from the assets are expected to be received. The chosen
method allocates the cost of the asset as equitably as possible to the periods
during which services (or economic benefits) are obtained from the use of the
asset.

The difference between IFRS and U.S. GAAP that each part of an item with a cost
significant to the total cost must be depreciated separately. But an entity may
separately depreciate parts that are not significant.

2.4.1. Depreciation Methods

A. Straight-line (S-L) depreciation is the simplest method because an equal

amount of depreciation is charged to each period of the asset’s useful life. The
easiest way to calculate straight-line depreciation is to divide the depreciable
base by the estimated useful life.

Periodic depreciation expense = Depreciable base ÷ Estimated useful life

B. Usage-centered activity methods calculate depreciation as a function of an

asset’s use rather than the time it has been held. The units-of-output method
allocates cost based on production. As production varies, so will the depreciation
expense.
C. Accelerated depreciation methods are time-based. They result in decreasing
depreciation charges over the life of the asset. The two major time-based
methods are declining balance and sum-of-the-years’-digits.

Declining balance determines depreciation expense by multiplying the carrying

amount (not the depreciable base equal to cost minus salvage value) at the
beginning of each period by some percentage (e.g., 200% or 150%) of the
straight-line rate of depreciation.

Period depreciation expense = Carrying amount × Declining-balance percentage

The carrying amount decreases by the depreciation recognized. The result is the
use of a constant rate against a declining balance.

Salvage value is ignored in determining the carrying amount, but the asset is not
depreciated below salvage value.

D. The sum-of-the-years’-digits (SYD) depreciation method multiplies not the

carrying amount but the constant depreciable base (cost minus salvage value) by
a declining fraction. It is a declining rate, declining-charge method.

2.4.2. Group and composite depreciation methods

Under U.S. GAAP apply straight-line accounting to a collection of assets

depreciated as if they were a single asset. The composite method applies to
groups of dissimilar assets with varying useful lives, and the group method applies
to similar assets. They provide an efficient way to account for large numbers of
depreciable assets. They also result in the offsetting of under- and overstated
depreciation estimates.

Under IFRS an entity may choose either the cost model (as under U.S. GAAP) or
the revaluation model as its accounting policy. It must apply that policy to an
entire class of PPE.

A class is a grouping of assets of similar nature and use in an entity’s operations,

for example, land, office equipment, or motor vehicles.

An item of PPE whose fair value can be reliably measured may be carried at a
revalued amount equal to fair value at the revaluation date (minus subsequent
accumulated depreciation and impairment losses).

Revaluation is needed whenever fair value and the asset’s carrying amount differ
materially. Accumulated depreciation is restated proportionately or eliminated.

A revaluation increase must be recognized in other comprehensive income and

accumulated in equity as revaluation surplus. But the increase must be recognized
in profit or loss to the extent it reverses a decrease of the same asset that was
recognized in profit or loss.

A revaluation decrease must be recognized in profit or loss. But the decrease

must be recognized in other comprehensive income to the extent of any credit in
revaluation surplus for the same asset.

Under IAS 40, Investment Property, investment property is property (land,

building, part of a building, or both) held by the owner or by the lessee under a
finance lease to earn rental income or for capital appreciation or both.
Investment property may be accounted for according to (1) the cost model and
carried at historical cost minus accumulated depreciation and impairment losses
(as under U.S. GAAP) or (2) the fair value model. If the fair value model is chosen
as the accounting policy, all of the entity’s investment property must be
measured at fair value at the end of the reporting period. A gain or loss arising
from a change in the fair value of investment property must be recognized in
profit or loss for the period in which it arises. Investment property that is
accounted for according to the fair value model is not depreciated

2.5. Impairment and disposal of long lived assets

Under US.GAAP two-step impairment test is applied to fixed assets and to

intangible assets with finite useful lives. An impairment loss is recognized
immediately in income from continuing operations.

Testing for impairment occurs when events or changes in circumstances indicate

that the carrying amount of the asset may not be recoverable, for example, when

1) The market price has decreased significantly or 2) The use or physical

condition of the asset has changed significantly and adversely.

- Recoverability test. The carrying amount of a long-lived asset to be held

and used is not recoverable if it exceeds the sum of the undiscounted
future cash flows expected from the use and disposition of the asset.
- If the carrying amount is not recoverable, an impairment loss is
recognized. It equals the excess of the carrying amount of the asset over
its fair value.
- The carrying amount of a long-lived asset adjusted for an impairment
loss is its new cost basis. A previously recognized impairment loss must
not be reversed.

Under IFRS The entity assesses at each reporting date whether an

indication of impairment exists. Given such an indication, IFRS requires a
one-step impairment test.

The recoverable amount is the greater of an asset’s (1) fair value minus cost
to sell or (2) value in use. Value in use of the asset is the present value of its
expected cash flows.

An impairment loss on an asset (besides goodwill) may be reversed in a

subsequent period if a change in the estimates used to measure the
recoverable amount has occurred. The reversal of an impairment loss is
recognized immediately in profit or loss as income from continued
operations.

When an item of PPE is sold, the gain or loss on disposal is the difference
between the net proceeds and the carrying amount of the asset.
Depreciation (if any) is recognized to the date of sale, the carrying amount
is removed from the books, the proceeds are recorded, and any gain or loss
is recognized

disposal of long lived assets: The carrying amount of an asset is compared

with its recoverable amount. An impairment loss is recognized equal to the
excess of the carrying amount over the recoverable amount.
2.6. Intangible assets issues
2.6.1 definition of intangible assets

An intangible asset is an identifiable, nonmonetary asset that lacks physical

substance. Examples of intangible assets include licenses, patents, copyrights,
franchises, and trademarks.

Initial recognition

Under U.S. GAAP externally acquired intangible assets (other than goodwill) are
initially recorded at acquisition cost plus any additional costs, such as legal fees.

Internally developed intangible assets (other than goodwill) are recorded initially
at the amount of the additional costs other than those for research and
development (e.g., legal fees).

Under U.S. GAAP Research and development (R&D) costs must be expensed as
incurred and are thus never capitalized.

Under IFRS development costs may result in recognition of an intangible asset if

the entity can demonstrate the (1) technical feasibility of completion of the asset,
(2) intent to complete, (3) ability to use or sell the asset, (4) way in which it will
generate probable future economic benefits, (5) availability of resources to
complete and use or sell the asset, and (6) ability to measure reliably
expenditures attributable to the asset.

Intangible assets may be accounted for under either the cost model (as under U.S.
GAAP) or the revaluation model. The revaluation model can be applied only if the
intangible asset is traded in an active market.
Intangible Assets with Finite Useful Lives

Under U.S. GAAP An intangible asset with a finite useful life (an amortized
intangible asset) to the reporting entity is amortized over that useful life. The
debit is to amortization expense, and the credit is to intangible asset.

The amortizable amount equals the amount of cost initially assigned minus the
residual value. Amortizable amount = Historical (initial) cost – Residual value

The carrying amount of an intangible asset with a finite useful life equals its
historical cost minus accumulated amortization and any impairment losses.

The impairment test for an intangible asset with a finite useful life (an amortized
intangible asset) is the two-step impairment test for long-lived assets.

Under IFRS an impairment loss for an asset (except goodwill) may be reversed if a
change in the estimates used to measure the recoverable amount has occurred.
The test for impairment of assets other than goodwill has one step: determine
whether an asset’s carrying amount is greater than its recoverable amount
(greater of fair value minus costs to sell or value in use).

Intangible Assets with Indefinite Useful Lives

An intangible asset with an indefinite useful life is not amortized. The carrying
amount of an intangible asset with an indefinite useful life equals its historical
cost minus any impairment losses.

Goodwill is an intangible asset with an indefinite useful life. However, the

accounting treatment of goodwill differs from that for other intangible assets.
Impairment test. An intangible asset with an indefinite useful life (a nonamortized
intangible asset) must be reviewed for impairment at least annually. It is tested
more often if events or changes in circumstances suggest that the asset may be
impaired.

1) An entity may elect to perform a qualitative assessment to determine whether

a quantitative impairment test is needed. The entity also may directly perform the
quantitative test.

a) Qualitative assessment. After the assessment of qualitative factors, the entity

may determine that it is more likely than not (probability > 50%) that an
indefinite-lived intangible asset is not impaired. In this case, the quantitative
impairment test is not required. If potential impairment is found, the quantitative
impairment test must be performed.

Determination of an Impairment Loss

1. Review for impairment

2. Impairment loss = Carrying amount – Fair value

This impairment loss is nonreversible, so the adjusted carrying amount is the new
accounting basis.

b) Quantitative impairment test. The carrying amount of an asset is compared

with its fair value. If the carrying amount exceeds the fair value, the asset is
impaired, and the excess is the recognized impairment loss.

Under IFRS A one-step quantitative impairment test is performed. No qualitative

assessment exists
Goodwill

Goodwill is recognized only in a business combination. It is “an asset representing

the future economic benefits arising from other assets acquired in a business
combination that are not individually identified and separately recognized

Impairment test. Goodwill is tested for impairment at the reporting-unit level. All
goodwill is assigned to the reporting units that will benefit from the business
combination. It is tested for impairment each year at the same time.

As in the case of an intangible asset with an indefinite useful life, an entity may
elect to perform a qualitative assessment to determine whether the quantitative
impairment test is needed.

Quantitative test. If the qualitative assessment indicates potential impairment,

the following two-step quantitative test is performed:

1) The first step compares the fair value of the reporting unit with its carrying
amount, including goodwill. If the fair value is greater than the carrying amount,
no impairment loss is recognized. However, if the fair value is less than the
carrying amount, the second step must be performed.

2) The second step compares the implied fair value of reporting-unit goodwill with
the carrying amount of that goodwill. An impairment loss is recognized for the
excess of the carrying amount of reporting-unit goodwill over its implied fair
value. This impairment loss is nonreversible.
Summary

This chapter discussed the accounting treatment of long lived assets especially
property, plant and equipment and intangible assets under US. GAAP and
mention the differences with IFRS.