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- 1. 11 - 1 Covering Initial costs Subsequent costs Cost allocations Revaluations of Non-Current Assets Impairment Loss of Non-Current Assets Treatment for Donated & Gifted Non-Current Assets Disposals: Utilization and Impairment
- 2. 11 - 2 Purchase price+ Transportation+ Handling Cost+ Borrowing cost If Self constructed, Labour Cost of own employees Includes site preparation and installation cost and professional cost. Two more special points 1.Borrowing cost during construction phase only 2.Removing and dismantling and restoration costs which qualify under IAS 37(Provisions and Contingencies), after discounting the present value. The entry through the Journal into the accounts is slightly surprising: Dr Non-current Assets Cr Provision for restoration
- 3. 11 - 3 Where it enhances the economic benefits in excess of its current standard of performance through any of: o Increase/extension of assets life o Production capacity (energy saving) o Improved quality of output
- 4. 11 - 4 Some of the cost is expensed each period. Expense Acquisition Cost (SFP) (IS) The matching principle requires that part of the acquisition cost of property, plant, and equipment and intangible assets be expensed in periods when the future revenues are earned. Depreciation, depletion, and amortization are cost allocation processes used to help meet the matching principle requirements.
- 5. 11 - 5 Asset Category Debit Intangible Amortization Intangible Asset Account Credited Accumulated Depreciation Property, Plant, & Equipment Depreciation Natural Resource Depletion Natural Resource Asset Caution! Depreciation, depletion, and amortization are processes of cost allocation, not valuation! Depreciation on the SFP
- 6. 11 - 6 Cost allocation requires three pieces of information for each asset: The estimated expected use from an asset. Total amount of cost to be allocated. Cost - Residual Value (at end of useful life) The systematic approach used for allocation. Allocation Base Service Life Allocation Method
- 7. 11 - 7 Straight-line (SL)- constant charge over the useful life. Declining Balance(DB)-decreasing charge over the useful life.
- 8. 11 - 8 The most widely used and most easily understood method. Results in the same amount of depreciation in each year of the asset’s service life. On January 1, we purchase equipment for QR.50,000 cash. The equipment has an estimated service life of 5 years and estimated residual value of QR.5,000. What is the annual straight-line depreciation?
- 9. 11 - 9 Annual 1,000 – 100 Depreciation = 180 = Straight-line 5 Accumulated Accumulated Undepreciated Depreciation Depreciation Depreciation Balance Year (debit) (credit) Balance (book value) 1,000 1 180 180 180 820 2 180 180 360 640 3 180 180 540 460 4 180 180 720 280 5 180 180 900 100 900 900 Residual Value BV = Residual Value at the end of the asset’s useful life. 0 50 100 150 200 1 2 3 4 5 Life in Years Depreciation
- 10. 11 - 10 Note that total depreciation over the asset’s useful life is the same as the straight-line method. Declining 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 as many assets are most useful when they are new.
- 11. 11 - 11 Book Value at beginning Depreciation Depreciation Accumulated Balance of the year Rate (debit) Depreciation (book value) 1,000 40% 400 400 600 600 40% 240 640 360 360 40% 144 784 216 216 40% 86 870 130 130 130-100 30 900 100 Residual Value 0 50 100 150 200 250 300 350 400 Life in Years Depreciation
- 12. 11 - 12 Each component of an item of property, plant, and equipment is depreciated separately if its cost is significant to the total cost of the item. Depreciable base is determined by subtracting estimated residual value from cost. IFRS requires a review of residual values annually. Component Depreciation, Depreciable Base, and Residual Value
- 13. 11 - 13 Property, plant, and equipment may be reported at cost less accumulated depreciation, or alternatively, at fair value (revaluation). If revaluation is chosen, all assets within a class of property, plant, and equipment must be revalued on a regular basis. Valuation of Property, Plant, and Equipment
- 14. 11 - 14 The approach is based on the units-of- production method. As natural resources are “used up,” or depleted, the cost of the natural resources must be allocated to the units extracted. Cost of Natural Resource – Residual Value Estimated Recoverable Units Depletion rate per unit = Total Depletion Cost = Unit Depletion Rate × Units Extracted
- 15. 11 - 15 ABC Mining acquired a tract of land containing ore deposits. Total costs of acquisition and development were QR.1,100,000. ABC estimated the land contained 40,000 tons of ore, and that the land will be sold for QR.100,000 after the coal is mined. What is ABC’s depletion rate? Depletion rate = 1,000,000 ÷ 40,000 Tons = QR.25 Per Ton For the year ABC mined 13,000 tons. What is the total amount of depletion for the year? Depletion = 13,000 tons × QR.25per ton = QR.325,000
- 16. 11 - 16 Biological assets are valued at fair value less estimated costs to sell. Valuation of Biological Assets
- 17. 11 - 17 The amortization process uses the straight-line method, but usually assumes residual value = 0. Amortization period is the shorter of the asset’s legal or contractual life. The amortization entry is: A contra-asset account is generally not used when recording the amortization of intangible assets. Amortization expense .................................. QR.QR.QR. Intangible asset ………………........ QR.QR.QR. To record amortization expense.
- 18. 11 - 18 Torch, Inc. has developed a new device. Patent registration costs consisted of QR.2,000 in attorney fees and QR.1,000 in federal registration fees. The device has a contractual (useful) life of 5 years. The legal life is 20 years. For year 1, what is Torch’s amortization expense? Amortization = Cost ÷ Contractual life = $3,000 ÷ 5 years = $ 600 per year Use the shorter of contractual life (5 years) or legal life (20 years). Amortization expense ................................... 600 Patent ………………........................ 600 To record amortization of patent.
- 19. 11 - 19 Not amortized. Subject to assessment for impairment of value and may be written down. Goodwill and Trademarks
- 20. 11 - 20 Intangible assets may be reported at (1) cost less accumulated amortization or (2) fair value, if fair value can be determined in an active market. If revaluation is chosen, all assets within the class of intangibles must be revalued on a regular basis. Goodwill cannot be revalued. Valuation of Intangible Assets
- 21. 11 - 21 Pro-rating the depreciation based on the date of acquisition is time-consuming and costly.
- 22. 11 - 22 Revaluation reserve arises when we revaluate the fixed assets and recognize that value of fixed assets market/fair value is greater/less than the net carried value on the balance at the same date of revaluation. Carrying value of non-current asset at revaluation date X Revaluation of non-current asset X Difference = gain or loss on revaluation X
- 23. 11 - 23 Fixed assets revaluation is not normal event. Company revaluates their fixed assets if following reasons exist. To negotiate fair price for the assets of the company before merger with or acquisition by another company To get fair market value of assets, incase of sale and lease back transaction. When the company intends to take a loan from banks/financial institutions by mortgaging its fixed assets •If revaluation gains arise it always recognizes in equity under revaluation reserve (surplus). If revaluation loss arises then first we reverse the previous surplus (reduce the revaluation reserve) and remain amount we charged to P&L as a loss. Revaluation gain or loss must be disclosed in the both statement of changes in equity and in other comprehensive statement.
- 24. 11 - 24 If Plant Cost as on 1st Jan, 2000- QR.100, 000, Life 20 Years, Revaluation Value on 1st Jan 2002-QR.120,000. Carrying value of Fixed assets at revaluation date 01st Jan,2000 (100,000-(100,000/20 years*2years) 90,000 Fixed Assets revaluation 120,000 Gain on revaluation 30,000 Plant Cost ................................... 20,000 Accum Depreciation …………………. 10,000 Revaluation Surplus……………. 30,000 To record revaluation gain.
- 25. 11 - 25 If Plant Cost as on 1st Jan, 2000- QR.100, 000, Life 20 Years, Revaluation Value on 1st Jan 2002-QR.77,000. There is revaluation reserve balance with Qr. 10,000 relating to original gain of same type of assets. Carrying value of Fixed assets at revaluation date 01st Jan,2000 (100,000-(100,000/20 years*2years) 90,000 Fixed Assets revaluation 77,000 Loss on revaluation 13,000 Revaluation Reserve ................................... 10,000 Profit & Loss A/c …………………. …………….. 3,000 Plant & Machinery Cost……………. 13,000 To record revaluation loss.
- 26. 11 - 26 As per IAS 16-revaluated amount should be depreciated over the assets remaining useful life and it should transferred to revaluation reserve to retained earnings. For example, total revaluation surplus (revaluation gain) as of 31st 2008-QR.100,000, remaining useful life-4year Revaluation Reserve ................................... 25,000 Profit & Loss A/c …………………. …………….. 25,000 Treatment of remaining portion of revaluation surplus during sale of revaluated assets As per IAS 16 during the sale of revalued fixed assets, remaining part of revaluation reserved (Surplus) is considered as ‘realized gain’ and therefore should be transferred to retained earnings
- 27. 11 - 27 ESTIMATED service life ESTIMATED residual value Changes in estimates are accounted for prospectively. The book value less any residual value at the date of change is depreciated over the remaining useful life. A disclosure note should describe the effect of a change. On January 1, equipment was purchased that cost QR.30,000, has a useful life of 10 years and no salvage value. At the beginning of the fourth year, it was decided that there were only 5 years remaining, instead of 7 years. Calculate depreciation expense for the fourth year using the straight-line method.
- 28. 11 - 28 Asset cost 30,000 $ Accumulated depreciation ($3,000 per year × 3 years) 9,000 Remaining book value 21,000 Divide by remaining life ÷ 5 Revised annual depreciation 4,200 $
- 29. 11 - 29 Accounting treatment differs. Long-term assets to be held and used Long-term assets held for sale Tangible and intangible with finite useful lives Intangible with indefinite useful lives Goodwill Test for impairment of value when considered for sale. Test for impairment of value at least annually. Test for impairment of value when it is suspected that book value may not be recoverable
- 30. 11 - 30 An asset is impaired when . . . The undiscounted sum of its estimated future cash flows Measurement – Step 1 Its book value <
- 31. 11 - 31 Impairment loss = Book value Fair value – Measurement – Step 2 QR.0 QR.250 QR.125 Case 1: QR.50 book value. No loss recognized Case 2: QR.150 book value. No loss recognized Case 3: QR.275 book value. Loss = QR.275 - QR.125 Fair Value Undiscounted future cash flows Market value, price of similar assets, or PV of future net cash inflows. Reported as part of income from continuing operations.
- 32. 11 - 32 Impairment loss = Book value Fair value less cost to sell – Assets held for sale include assets that management has committed to sell immediately in their present condition and for which sale is probable.
- 33. 11 - 33 Assets must be assessed for circumstances of impairment at the end of each reporting period. Impairment means review the performance and value of the assets when following circumstances indicate carrying value (net) exceed the estimated recoverable amount. It means fair value is higher than the cost to sell. External Sources: Market value declines Negative changes in technology. Internal Sources: Physically fully damaged Worse economic performance than expected. An impairment loss is reversed if the circumstances that caused the impairment is resolved. Impairment of Value: Property, Plant, and Equipment and Finite-life Intangible Assets(IAS-36)
- 34. 11 - 34 If any impairment loss arise, we write off the fixed assets with value of loss. Accounting treatment as follows: Let’s, total Free Hold land cost is QR. 1,500,000. Due to declines of market value impairment loss came QR.200,000. This impairment is charges I/S Impairment loss ................................... 200,000 Free Hold Land ……………………. 200,000 To record impairment loss.
- 35. 11 - 35 Step 2 Impairment loss = QR.200 million – QR.120 million = QR.80 million
- 36. 11 - 36 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. Impairment of Value: Goodwill
- 37. 11 - 37 Whenever we received any non-current assets as a gift or donation. We estimated by using the cost of similar items acquired at the same time. With Same value we debit to non-current asset accounts and credit to donation/gift reserve accounts under equity and each year we write off the donation reserve with same value of depreciation charged during the year.
- 38. 11 - 38 End of Presentation 11
Editor's Notes
- Part I. The matching principle requires that part of the acquisition cost of property, plant, and equipment and intangible assets be expensed in periods when the future revenues are earned. A portion of an asset’s cost is moved from the balance sheet to the income statement each period. Part II. Depreciation, depletion, and amortization are cost allocation processes. We allocate the cost of the asset to expense over its useful life in some rational and systematic manner. The unused portion of the asset’s cost appears on the balance sheet. We allocate a portion of the cost to expense on the income statement each accounting period. Accumulated depreciation represents the depreciation taken on the asset since its purchase, and is deducted from the asset’s cost on the balance sheet. Depreciation, depletion, or amortization of an asset used in manufacturing a product is a part of the product cost that is included in inventory. The depreciation, depletion, or amortization does not immediately become an expense, but is expensed as part of cost of goods sold when the product is sold.
- Part I. Depreciation is term used for the cost allocation process for the plant and equipment category. Land is not depreciated. Depletion is the cost allocation process for natural resources, and amortization refers to the allocation of intangible asset costs. Depreciation, depletion, and amortization are processes used for cost allocation, not valuation. We do not want to confuse asset valuation, an economic concept, with allocation of acquisition costs to periods benefited by the use of the assets. Part II. Here you see an example of the property, plant, and equipment section of a balance sheet showing the assets at cost less the accumulated depreciation. Accumulated depreciation is a contra-asset account and is subtracted from the assets’ cost to determine book value. Net property, plant, & equipment is the undepreciated cost (book value) of plant assets. Book value is not equal to market value.
- Regardless of the method used to calculate the amount of cost allocated to a period, we must have three items of information: (1) the estimated useful life of the asset; (2) the allocation base which is the cost of the asset less its estimated residual value at the end of its useful life, and (3) the allocation method.
- There are two general approaches to depreciation: time-based methods and activity based methods. The most commonly used time-based method is the straight-line method that results in an equal amount of depreciation in each period. The other time-based methods are referred to as accelerated methods because they result in a greater amount of depreciation in the earlier years of an assets life. Sum-of-the-years’ digits and declining balance are two accelerated methods. Activity-based methods use a measure of an asset’s output in a period for the depreciation computation. Units-of-production is an activity-based method. We will examine each of these methods with examples as we study depreciation. In addition to these methods, we will also cover group and composite methods, tax depreciation (Appendix 11A), and retirement and replacement methods (Appendix 11B).
- Part I. The straight-line method is the most widely used and the most easily understood method of depreciation. It results in an equal amount of depreciation in each year of an asset’s useful life. The annual depreciation is determined by dividing the asset’s cost less its estimated residual value by the asset’s estimated useful life in years. Part II. Consider the following example. On January 1, we purchase equipment for QR.50,000 cash. The equipment has an estimated service life of five years and an estimated residual value of QR.5,000. What is the annual straight-line depreciation?
- Part I. The annual depreciation is determined by dividing the asset’s cost of QR.50,000 minus its estimated residual value of QR.5,000 by the asset’s estimated useful life of five years. The result is annual depreciation of QR.9,000. Part II. Notice that depreciation is the same amount in each of the five years. The cost of the asset (QR.50,000) less accumulated depreciation at the end of any year is called book value. Book value decreases by QR.9,000 each year. The book value is equal to the estimated residual value at the end of the asset’s useful life. We want this to be true regardless of the method we use. Accumulated depreciation increases by QR.9,000 each year. In this graph you can clearly see that the amount of depreciation is the same each year, resulting in a horizontal straight line at QR.9.000.
- Part I. 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. The total amount of depreciation over the asset’s useful life is the same as the straight-line method. Part II. Sum-of-the-years’-digits depreciation is calculated by multiplying cost minus residual value times a fraction that declines each year of an asset’s useful life. The numerator of the fraction is a number equal to the remaining useful life of the asset. For an asset with a four-year life, the numerator would be four for the first year, three for the second year, two for the third year and one for the fourth year The denominator of the fraction is constant. It is the sum of the digits in the asset’s life from one to n, where n is the number of years in the asset’s life. For example, if the estimated life is four years, the sum of the digits is 1 plus 2 plus 3 plus 4, a total of 10.
- Notice that depreciation is less each succeeding year of the asset’s life. Accumulated depreciation increases by each year by the amount of the depreciation expense. At the end of the five year period the accumulated depreciation is QR.45,000, resulting in a book value of QR.5,000. The book value is equal to the estimated residual value at the end of the asset’s useful life. We want this to be true regardless of the method we use. In the graph you can clearly see that the amount of depreciation expense declines each year using the sum-of-the-years’-digits method.
- ISA No. 16 requires that each component of an item of property, plant, and equipment must be depreciated separately if its cost is significant in relation to the total cost of the item. In the U.S., component depreciation is allowed but is not often used in practice. U.S. GAAP and IFRS determine depreciable base in the same way, by subtracting estimated residual value from cost. However, IFRS requires a review of residual values at least annually.
- Under U.S. GAAP a company reports property, plant, and equipment in the balance sheet at cost less accumulated depreciation (book value). ISA No. 16 allows a company to report property, plant, and equipment at cost less accumulated depreciation, or, alternatively, at its fair value (revaluation). If a company chooses revaluation, all assets within a class of property, plant, and equipment must be revalued on a regular basis. U.S. GAAP prohibits revaluation. If the revaluation option is chosen, the way the company reports the difference between fair value and book value depends on which amount is higher: If fair value is higher than book value, the difference is reported as other comprehensive income (OCI) which then accumulates in a “revaluation surplus: (sometimes called revaluation reserve) account in equity. If book value is higher than fair value, the difference is reported as an expense in the income statement. An exception is when a revaluation surplus account relating to the same asset has a balance from a previous increase in fair value, that balance is eliminated before debiting revaluation expense.
- In general, natural resources can be thought of as anything extracted from our natural environment such as coal, oil, and iron ore. Allocation of the cost of natural resources is called depletion. Total cost, including exploration and development, is charged to depletion over the periods benefited. We use the units-of-production method to compute depletion, and report natural resources at their cost less accumulated depletion. We begin the process of calculating depletion expense by determining the depletion expense per unit of the natural resource. The numerator of the equation contains the resource cost less any estimated residual value. The denominator of the equation is our estimated total capacity of the natural resource we expected to extract. For oil we express the denominator in terms of barrels and for coal or iron ore we use tons. Once we compute the depletion rate per unit of output, we may calculate depletion for the period by multiplying the depletion rate per unit times the number of units extracted. Let’s look at an example.
- Part I. ABC Mining acquired a tract of land containing ore deposits. Total costs of acquisition and development were QR.1,100,000. ABC estimated the land contained 40,000 tons of ore, and that the land will be sold for QR.100,000 after the coal is mined. What is ABC’s depletion rate? Part II. We divide the QR.1,100,000 cost minus the QR.100,000 residual value by the number of units in the estimated service life to get the depletion rate of QR.25 per ton. For the year ABC mined 13,000 tons. What is the total amount of depletion for the year? Part III. We multiply the depletion rate of QR.25 per ton times the 13,000 mined to get QR.325,000 of total depletion. Depletion is a product cost that is included in the cost of coal inventory. The depletion is then included in cost of goods sold in the income statement when the coal is sold.
- Living animals and plants, including the trees in a timber tract or in a fruit orchard, are referred to as biological assets. Under U.S.GAAP, a timber tract is valued at cost less accumulated depletion and a fruit orchard at cost less accumulated depreciation. Under IFRS, biological assets are valued at their fair value less estimated costs to sell.
- Amortization is the process of allocating the cost of an intangible asset to the periods benefited by its use. The amortization process uses the straight-line method, but usually assumes a zero residual value. The amortization period is the shorter of the intangible asset’s legal or contractual life. The journal entry to record amortization requires a debit to amortization expense and a credit to the intangible asset account. Companies generally do not use a contra-asset account such as accumulated amortization when recording the amortization of intangible assets. Let’s look at an example.
- Part I. Torch, Inc. has developed a new device. Patent registration costs consisted of QR.2,000 in attorney fees and QR.1,000 in federal registration fees. The device has a contractual (useful) life of 5 years. The legal life is 20 years. At the end of year 1, what is Torch’s amortization expense? Part II. Since the five-year economic life is shorter than the twenty-year legal life for this patent, we will amortize the patent over five years. The amortization expense is the asset’s cost of QR.3,000 divided by its economic life of five years, resulting in annual amortization of QR.600. The journal entry to record amortization requires a debit to amortization expense for QR.600 and a credit to the patent account for QR.600. The patent will have a book value of QR.2,400 after the amortization entry is posted.
- Goodwill and trademarks have indefinite useful lives and are not amortized into the results of operations, but instead are reviewed for impairment annually, or more often if impairment indicators arise. If an impairment is determined to exist, we will reduce the asset account and recognize the loss in value.
- IAS No. 38 allows a company to value an intangible asset subsequent to initial valuation at (1) cost less accumulated amortization or (2) fair value, if fair value can be determined by reference to an active market. If revaluation is chosen, all assets within the class of intangibles must be revalued on a regular basis. Goodwill, however, cannot be revalued. U.S.GAAP prohibits revaluation of any intangible asset. The revaluation option is possible only if fair value can be determined by reference to an active market, making the option relatively uncommon. However, the option possibly could be used for intangibles such as franchises and certain license agreements. If the revaluation option is chosen, the accounting treatment is similar to the way we applied the revaluation option for property, plant, and equipment earlier. The way the company reports the difference between fair value and book value depends on which amount is higher. If fair value is higher than book value, the difference is reported as other comprehensive income (OCI) and then accumulated in a revaluation surplus account in equity. If book value is higher than fair value, the difference is expensed.
- To this point we have discussed assets that were purchased at the beginning of a year and depreciated for a full year. Relatively few assets will actually be purchased on January 1. When an operational asset is acquired during the year, depreciation is calculated for the fraction of the year the asset is owned. Pro-rating the depreciation based on the date of acquisition is time-consuming and costly. A commonly used alternative is the half-year convention. Using this convention, a company would record one-half year of depreciation in the year of acquisition, and one-half year of depreciation in the year of disposal.
- To this point we have discussed assets that were purchased at the beginning of a year and depreciated for a full year. Relatively few assets will actually be purchased on January 1. When an operational asset is acquired during the year, depreciation is calculated for the fraction of the year the asset is owned. Pro-rating the depreciation based on the date of acquisition is time-consuming and costly. A commonly used alternative is the half-year convention. Using this convention, a company would record one-half year of depreciation in the year of acquisition, and one-half year of depreciation in the year of disposal.
- To this point we have discussed assets that were purchased at the beginning of a year and depreciated for a full year. Relatively few assets will actually be purchased on January 1. When an operational asset is acquired during the year, depreciation is calculated for the fraction of the year the asset is owned. Pro-rating the depreciation based on the date of acquisition is time-consuming and costly. A commonly used alternative is the half-year convention. Using this convention, a company would record one-half year of depreciation in the year of acquisition, and one-half year of depreciation in the year of disposal.
- The service life and the residual value used in depreciation computations are both estimates. Like all estimates, new information may come to light that will cause us to revise our previous estimate. Changes in estimates are accounted for prospectively. The book value, less any residual value at the date of change, is depreciated over the remaining useful life. A disclosure note should describe the effect of a change in estimate on income before extraordinary items, net income, and related pershare amounts for the current period. Let’s look at an example of a change in useful life. On January 1, equipment was purchased that cost QR.30,000, has a useful life of ten years and no salvage value. At the beginning of the fourth year, it was decided that there were only five years remaining, instead of seven years. Calculate depreciation expense for the fourth year using the straight-line method.
- The depreciation expense for each of the first three years is QR.3,000 (QR.30,000 cost divided by the original estimated useful life of ten years). The accumulated depreciation for the first three years totals QR.9,000, computed by multiplying the QR.3,000 of depreciation each year times three years. The undepreciated cost (book value) of the equipment on the date of change is QR.21,000, computed by subtracting QR.9,000 of accumulated depreciation from the QR.30,000 cost. To calculate the amount of straight-line depreciation for each of the remaining five years of the equipment’s life, we divide the QR.21,000 book value of the equipment by five years. The resulting straight-line depreciation is QR.4,200 per year. Now, let’s see how to account for a change in depreciation method.
- Part I. Impairment is the loss of a significant portion an asset’s benefits through casualty, obsolescence, or lack of demand for the asset’s services. If an asset’s value decreases and cannot be recovered through future use or sale, the asset is considered to be impaired and it should be written down to its net realizable value. We recognize and measure impairment loss differently depending on whether the asset is being held for use or held for sale. For assets being held for use, different guidelines apply to tangible and intangible assets with finite useful lives and intangible assets with indefinite useful lives. Finally, because goodwill is a unique intangible asset with an indefinite useful life, there is yet another difference in accounting treatment. Part II. Tangible assets and finite life intangible assets are tested for impairment when events or changes in circumstances indicate that the book value may not be recoverable Intangible assets with indefinite useful lives, including goodwill are tested for impairment annually. Operational assets held for sale are tested for impairment when considered for sale.
- Determining the amount of impairment loss to record on a tangible asset or on a finite life intangible asset is a two-step process. The first step is to determine if an impairment has occurred. An asset is impaired if the undiscounted sum of its estimated future cash flows is less than its book value.
- Part I. If it is determined that an impairment loss has occurred on a tangible asset or on a finite life intangible asset in step one, the second step in the process is to determine the amount of the impairment loss. The impairment loss is the amount by which book value exceeds fair value. If fair value cannot be determined in the market place, it is estimated as the discounted sum (present value) of the estimated future cash flows from the asset. Recall that undiscounted cash flows are used in step one. An impairment is reported as part of income from continuing operations. Part II. Let’s look at an example illustrating two steps of the process. In case one, the undiscounted sum of estimated future cash flows of QR.250 is greater than the book value of QR.50, so there is no impairment (step one). In case two, the undiscounted sum of estimated future cash flows of QR.250 is greater than the book value of QR.150, so there is no impairment (step one). In case three, the undiscounted sum of estimated future cash flows of QR.250 is less than the book value of QR.275, so there is an impairment (step one). The amount of the impairment is equal to the QR.275 book value of the asset less the QR.125 fair value of the asset (step two).
- Assets held for sale include assets that management has committed to sell immediately in their present condition and for which sale is probable. The impairment loss is the amount by which book value exceeds fair value less the cost to sell.
- IFRS requires that assets must be assessed for circumstances of impairment at the end of each reporting period. Under U.S. GAAP, assets are tested for impairment only when events or changes in indicators suggest that book value may not be recoverable. IFRS indicators of impairment are similar to U.S. GAAP. Under U.S. GAAP, An impairment loss is required when an asset’s book value exceeds the undiscounted sum of the estimated future cash flows. Under IFRS, 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.
- Part I. Because Acme Auto Parts has seen its sales steadily decrease due to the decline in new car sales, Acme’s management believes that equipment that originally cost QR.350 million, with a QR.200 million book value, may not be recoverable. Management estimates that future undiscounted cash flows associated with the equipment’s remaining useful life will be only QR.140 million, and that the equipment could be sold now for QR.120 million. Has Acme suffered an impairment loss and if so, how should it be recorded? Part II. Step 1. Recoverability. The undiscounted sum of estimated future cash flows (QR.140 million) is less than book value (QR.200 Million), so an impairment is indicated.
- Part I. Since an impairment is indicated, we will proceed with step 2, measurement. The impairment loss of QR.80 million is equal to the book value of QR.200 million less the current fair value of QR.120 million. Part II. To record the loss, we debit impairment loss for QR.80 million, debit accumulated depreciation for QR.150 million, and credit equipment for QR.230 million (QR.350 million cost less QR.120 million fair value). The entry reduces the accumulated depreciation balance to zero and reduces the equipment account to its current fair value of QR.120 million.
- Under U.S. GAAP, the measurement of an impairment loss for goodwill is a two-step process. In step one the fair value of the reporting unit is compared to its book value to see if an impairment is indicated. 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. Because fair value of goodwill does not exist separately from the reporting unit, and cannot be measured directly (no separate market value or separate present value of cash flows), we imply the fair value of goodwill by subtracting the fair value of all identifiable net assets from the fair value of the entire reporting unit. The impairment loss is then equal to the amount by which the book value of goodwill exceeds the implied fair value of goodwill. Under IFRS, the 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. Recall that the recoverable amount is the higher of fair value less costs to sell and value–in-use (present value of estimated future cash flows).
- Under U.S. GAAP, the measurement of an impairment loss for goodwill is a two-step process. In step one the fair value of the reporting unit is compared to its book value to see if an impairment is indicated. 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. Because fair value of goodwill does not exist separately from the reporting unit, and cannot be measured directly (no separate market value or separate present value of cash flows), we imply the fair value of goodwill by subtracting the fair value of all identifiable net assets from the fair value of the entire reporting unit. The impairment loss is then equal to the amount by which the book value of goodwill exceeds the implied fair value of goodwill. Under IFRS, the 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. Recall that the recoverable amount is the higher of fair value less costs to sell and value–in-use (present value of estimated future cash flows).
- End of chapter 11.