Chapter 7

Long-Lived
Nonmonetary
Assets and Their
Amortization

McGraw-Hill/Irwin Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.

 Nature of Long-Lived Assets

• Benefits obtained from expenditures on

goods or services acquired.
– Expense when benefits are obtained in current
period.
– Capitalize when benefits expected to be
obtained in future periods (i.e., capital asset).
• Similar to a prepaid expense.
• Amortization is process of matching capitalized
costs with revenues obtained from their use.
7-2
 Types of Long-Lived Assets
 Tangible asset.
 Asset with physical substance.
 Property, plant, and equipment.
 Also known as fixed assets.
 Intangible asset.
 Intellectual property.
 No physical substance.
 E.g., patent rights, copyrights.
7-3
 Types of Amortization

Tangible assets:
Land → Not amortized
Plant and equipment → Depreciation expense
Natural resources → Depletion expense

7-4
 Types of Amortization
Intangible assets:
Goodwill → Not amortized
Other intangible assets,
(limited life) → Amortization expense
Other intangible assets,
(indefinite life) → Not amortized
Leasehold improvements → Amortization expense
Deferred charges → Amortization expense
Research and
development costs → Not capitalized
7-5
 Asset vs. Expense?
 Determination not clear-cut.
 Capitalize:
 Betterments (i.e., improves or extends useful
life).
 Replacement of entire asset.
 Expense:
 Long-lived low-cost items (materiality concept).
 Repairs and maintenance.
 Replacement of component part (e.g., elevator
in a building).
7-6
 What Should be Capitalized?
 All expenditures necessary to make asset
ready for its intended use.
 E.g., purchase price, sales tax, commissions paid,
legal fees, delivery charges, site preparation.
 Self constructed assets:
 All construction costs (i.e., materials, labor,
overhead).
 Noncash acquisitions:
 E.g., stock for asset, donated asset.
 Record at fair market value of consideration given
or received.
7-7
 What Should be Capitalized?
 Basket purchase:
 Lump sum purchase of different assets.
 Allocate cost based on FMV of acquired assets.
 IFRS differences:
 Cost model (i.e., similar to GAAP).
 Revaluation model.
 Continually revalue carrying value to fair value.
 Relevance over objectivity.

7-8
 Depreciation Expense
 Gradual conversion of capitalized cost
into expense.
 Book value of asset equals the original
cost minus the depreciation
accumulated to date.
 Calculating depreciation.
 GAAP: “systematic and rational” method.
 IFRS: reflect pattern of usage.

7-9
 Judgments Required

 Service life of asset.

– Deterioration (i.e., physical process of wearing out).
– Obsolescence (i.e., loss of usefulness because of
change in technology or tastes).
– Service life usually shorter than physical life.
 Residual value at the end of its service life.
 Often an immaterial amount.
 Method of depreciation used to allocate cost
over useful life of asset.
7-10
 Depreciation Methods
 Straight-line method.
 (Original cost - residual value) ÷ Service life.
 Equal expense for all years.
 Can be shown as a rate (e.g., 5 year asset is same
as 20% depreciation rate).
 Accelerated methods.
 Higher expense in early years.
 Declining-balance method.
 Sum of the years’ (or years’ digits) method.
7-11
 Declining Balance Method
 Declining-balance rate is % of straight-line
rate (e.g., 200% of 20% equals 40%).
 Depreciation expense.
 Book value x Declining-balance rate.
 Expense continually goes down because book
value is continually decreasing.

7-12
 Years Digits Method
 Sum years of useful life (i.e., 1 + 2 + 3 + 4 + etc.).
 Depreciation expense:
 (Original cost - residual value) x Fraction

 Example using 5-year asset:

 Sum of years digits = 1 + 2 + 3 + 4 + 5 = 15.
 Depreciation expense:
 Year 1: (Original cost - residual value) x 5/15.
 Year 2: (Original cost - residual value) x 4/15.
 Year 3: (Original cost - residual value) x 3/15, etc.
7-13
 Units of Production Method
 Depreciation based on units of service rather
than time (e.g., miles traveled).
 Depreciation rate:
 (Original cost - residual value) ÷ Total service units.
 Depreciation expense:
 Rate x Units of service consumed.

7-14
 Accounting for Depreciation
 Changes in estimates (i.e., service life, residual value)?
 Charge off book value over remaining service life.
 Fully depreciated assets?
 Show in financial statements until disposal.
 Partial year acquisition?
 Half year convention commonly used (i.e., record half year’s
depreciation in year of acquisition and disposition).
 Required disclosure?
 Depreciation expense for period, original cost,
accumulated depreciation, method used.

7-15
 Plant and Equipment:
Disposal
• Recording the sale of depreciable asset:
– Record asset (e.g., cash) received.
– Remove original cost.
– Remove accumulated depreciation.
– Record gain or loss.
• Gain = Cash received > Book value of asset.
• Loss = Cash received < Book value of asset.
• Gain/loss shown in current period income
statement.
7-16
 Impaired Assets
 Impaired if remaining benefits (i.e., as measured by
sum of future cash flows generated by use of asset)
is less than book value.
 GAAP:
 If entity expects to hold asset, write down to fair value.
 If entity expects to sell asset write down to lower of cost
or fair value less cost of disposal.
 IFRS (i.e., when using cost model):
 Reduce asset to recoverable amount.
 Recoverable amount = higher of fair value (less disposal
cost) or value in use (i.e., present value of future cash
flows). 7-17
 Exchange and Trade-Ins
 Similar assets:
 Same general type or performing same
function.
 New asset value is additional amount paid
plus book value of old asset.
 No gain or loss is recorded.
 Dissimilar assets:
 Record asset received at fair value.
 Recognize gain or loss on disposal of old
asset. 7-18
 Group Depreciation

• Time saver over unit (item) depreciation.

• Treats all similar assets as a “pool” or
group.
• No gain/loss on disposal.
– Reduce Accumulated Depreciation for
difference between cost and proceeds
received.

7-19
 Depreciation Clarification
• Process of allocation, not valuation (i.e., book
value is not market value).
• Does not represent accumulation of any
tangible thing (is not money).
• Simply amount of original cost that has been
expensed.
• Funding depreciation is a financing
transaction (unrelated to recording
depreciation).
7-20
 Income Tax Considerations
• Modified accelerated cost recovery system
(MACRS).
• Acts as incentive to invest in capital assets
(Why? lower taxes through faster write off).
• Combination of declining-balance method,
half-year convention, switch to straight-line
depreciation in latter years, ignores residual
values.
• Investment tax credit (ITC).
 Encourages investment by granting a tax credit as
a percent of capital asset cost.
 Currently not in tax code.
7-21
 Natural Resources

 Measure cost same as other assets.

 Exploration costs?
 Full cost method (i.e., capitalize costs of
both successful and unsuccessful efforts).
 Successful efforts method (i.e., only
capitalize costs involved with successful
efforts.
 Both allowed under GAAP.
7-22
 Depletion
 Amortizing costs of natural resources.
 Units of production method ordinarily used.
 Depletion rate:
 (Cost of reserve) ÷ Total units in reserve.
 Depletion expense:
 Rate x Units of reserve extracted.
 Accretion.
 Increase in value arising from natural growth.
 Not recognized in accounts until sold.
 But costs incurred are capitalized.
7-23
 Intangible Assets
 Cost of intangible assets.
 Internally developed → expensed as incurred.
 Acquired → capitalized.
• Intangible assets with limited life.
• E.g., patents, copyrights.
• Amortized over useful life (may be shorter than
legal life).
• Amortization should reflect the pattern in which
economic benefits are consumed (use straight-
line if cannot be determined).
7-24
 Intangible Assets
• Intangible assets with indefinite lives.
• E.g., renewable broadcast license.
• Considered indefinite if no legal, regulatory,
contractual, competitive or other limiting factors.
• Not amortized, but tested for impairment.
• If impaired, written down to realizable value and
charged against income.

7-25
 Intangible Assets
• Goodwill.
• Occurs when one company buys another.
• Created when purchase price exceeds fair value
of net assets.
• Not amortized, but annual impairment test.
• Any write-down is charged against income.

7-26
 Intangible Assets
• Leasehold improvements.
 Improvements made to leased property.
 Revert to property owner at end of lease.
 Amortized over the shorter of useful life or length
of lease.
 But if renewal likely, amortize through renewed
period.
• Deferred charges.
 Usually start-up costs in pre-operating period.
 Can expense or capitalize and amortize over a
short period (i.e., one to five years).
7-27
 Research & Development
(R&D) Costs
 Costs incurred to develop new knowledge/
products or improve existing goods, processes,
or services.
 GAAP:
 Expense all since future benefits uncertain.
 Follows conservatism and objectivity concepts, but
violates matching concept.
 IFRS:
 Expense in research phase.
 Capitalize development costs if expected to be
recovered from future sales.
7-28
 Research & Development
(R&D) Costs
 Software development:
 Costs are expensed until technological feasibility
of product has been established (i.e., detailed
design, working prototype).
 After technological feasibility, capitalize costs up
to point where product is available for release to
customer.
 Amortization based on greater of straight-line
amount or ratio of year’s revenues to total
anticipated revenues.
 Internal use → use commitment to develop as
capitalization point. 7-29
 Analysis of Nonmonetary
Assets
• Average age of depreciable assets.
• (Accumulated depreciation) ÷ (Annual
depreciation expense).
• Asset’s depreciation period.
• (Original cost) ÷ (Annual depreciation expense).
• Annual expenditure for an intangible asset
category.
• (Annual amortization expense) plus (minus)
increase (decrease) in asset’s balance.

7-30