Long Lived Assets

Question 1

Purchased vs. Developed vs. Acquired Intangibles

Answer 1

Purchased = on books at cost or FMV

• If definite lived -> amortize over useful life
• If indefinite - test for impairment at least annually

Developed = expensed, but depends

• IFRS allows for development costs to be capitalized
• GAAP all R&D is expensed unless it is software related

Acquired = acquisition method
- Purchase price > acquired firms net assets then goodwill is created

Question 2

Capitalization vs. Expensing

Answer 2

Compared to expensing capitalization results in

• Lower expense and higher NI in the early years
• Higher assets and equity
• Lower (more negative) CFI and higher CFO
• Higher ROE and ROA in early period
• Lower debt to assets and debt to equity

Question 3

Straight-line depreciation

Answer 3

D expense = (Cost - Salvage) / Depreciable Life

Cost - Salvage = Max AD over the life of the asset

Question 4

Accelerated depreciation -> Double declining balance (DDB)

Answer 4

D expense = (2/useful life) X Book value at beginning of year

Results in lower NI, ROA, ROE in the early years relative to SL approach…cash flow is not impacted b/c D exp is non-cash

Question 5

Units of Production Method

Answer 5

D expense = ((Cost - Salvage)/Life in output)) x output units used in the period

Question 6

Revaluation Model

Answer 6

IFRS firms have the option to revalue assets based on fair value – GAAP does not allow for it

Initial gain = straight to equity as part of OCI (revaluation surplus)

• Subsequent loss reduces the revaluation surplus
• Excess loss beyond that is recorded as a loss on the I/S

Initial loss = recorded on I/S

• Subsequent gains recorded as gain on I/S to extent of loss
• Excess gains beyond that recorded as OCI (revaluation surplus) as part of equity

Question 7

IFRS Impairment Rules

Answer 7

Impairment occurs when carrying value > recoverable amount

Where recoverable amount is the higher of

1) NRV = SP - Selling costs
2) Value in use (PV expected cash flows

If impaired the asset is written down to recoverable amount

Question 8

GAAP Impairment Rules

Answer 8

Impairment occurs when carrying value > undiscounted future cash flows

If impaired the asset is written down to the fair market value

Question 9

Sale of a Long-Lived Asset

Answer 9

Gain (Loss) = Selling price - NBV

Reported on the I/S

Selling price reported as a CFI inflow

Gain (Loss) adjustment in CFO

Question 10

Abandonment of Long-Lived Asset

Answer 10

Carrying value is removed from B/S and a loss is recognized in that amount

Question 11

Exchanged Long-Lived Asset

Answer 11

Carrying Value of Old - Carrying Value of New Asset results in a gain or loss

Question 12

Impairment implications

Answer 12

Lower NI, assets and equity

Lower ROA, ROE and higher debt to equity and debt to assets

Question 13

Average age of assets

Answer 13

= Accumulated D / Annual D expense

Question 14

Total useful life

Answer 14

= Historical cost / Annual D expense

Question 15

Remaining useful life

Answer 15

= Ending net PP&E / Annual D expense

Question 16

Investment property

Answer 16

Only IFRS and is property that earns rent or owned for capital appreciation purposes

IFRS allows for either cost or fair value model

Under fair value model, gains are reported on the income statement rather than direct to equity

Question 17

Capitalization of interest

Answer 17

Only allowed for debt to finance the construction period

Need to adjust financial statements for comparability

Adj EBIT = EBIT + Depreciation of capitalized interest

Adj Interest exp = Interest exp + capitalized interest

B/S -> Lower PP&E by interest amount

C/F -> CFO declines due to higher interest expense and CFI becomes less negative due to the decapitalization of the interest

Question 18

Operating Lease

Answer 18

No asset, no liability, no depreciation, no interest - just 100% operating expense

More profitable in early years b/c rent < sum (deprecation and interest) on capital lease

Higher taxes in early years b/c of higher taxable income

Lower CFO because rent is 100% operating outflow

Makes ratios appear better

Question 19

Capital Lease

Answer 19

Lessee essentially purchases the asset from the lessor on credit

Increases non-current asset (subject to depreciation) and a liability so equity remains flat

Each PMT is comprised of interest (CFO outflow) and principal reduction (CFI outflow)

In the early years of the lease expenses will be higher than an operating lease which results in lower taxes paid

CFO is also higher in early years due b/c PMT is split between CFO and CFI

Question 20

GAAP Capitalization Requirements

Answer 20

SNOB (1 out of 4) 
S - term lease >= to 75% of asset life 
N - PV PMTs >= 90% of FMV
O - Owner ship at end of lease
B - bargain purchase option at end of lease 

IFRS has similar guidelines, but is more flexible around the % requirements

For the lessor to capitalize LUC
L - Lessee is a SNOB
U - No cost uncertainties
C - PMTs reasonably collectable

Question 21

Operating Lease –> Capital Lease Adjustments

Answer 21

B/S = PV of lease PMT where the PV = DCF/UDCF x Sum of PMTs

I/S = EBIT + Rent expense - Depreciation