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FRA > Long-lived assets > Flashcards

Long-lived assets Flashcards

1
Q

What are long-lived assets?

A

They are expected to provide economic benefits to a company over an extended period of time, typically longer than one year.

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2
Q

What are the 2 types of long-lived assets whose costs are not expensed over time?

A
  • Land
  • Intangible assets with indefinite useful lives
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3
Q

What is a capitalized item?

A

It is an item that provides benefits to the company for a period longer than one year.

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4
Q

What is an expensed item?

A

It provides economic benefits in only the current period; its cost is expensed.

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5
Q

What is the accounting treatment of capitalized cost?

A
  • It is recognized as a noncurrent asset on the BS,
  • The associated CF outflow is listed under investing activities on the CF statement.
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6
Q

What happens to items that are capitalized on other subsequent periods?

A

The capitalized amount is depreciation or amortization expense on the IS.

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7
Q

What is the accounting treatment of expensed costs?

A
  • A cost that is immediately expensed reduces net income for the current period by its entire tax amounts
  • The associated cash outflow is classified under operating activities on the CF statement.
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8
Q

What happens if an asset is acquired in a nonmonetary exchange?

A

The amount recognized on the balance sheet typically equals the fair value of the asset acquired.

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9
Q

What happens if the fair value of the asset acquired is greater than the value of the asset given up?

A

A gain is recorded on the income statement. If the fair value of the asset acquired is lower than that of the asset given up, a loss is recorded.

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10
Q

What happens if the fair value of the acquired asset cannot be determined?

A

The amount recognized on the BS equals the carrying amount of the asset given up.

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11
Q

What does expensing allow the company to do regarding taxes?

A

It allows companies to report lower taxable income in the current period and pay lower taxes.

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12
Q

What is the benefit of capitalization on cash flow?

A

It allows companies to report higher operating CF.

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13
Q

Where do interest costs appear with the accounting treatment?

A
  • When capitalized: it appears on the BS.
  • When expensed: it appears on the IS.
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14
Q

What is the interest payments treatment if the construction and sale of buildings is the core business activity of the firm?

A
  • Interest payments made prior to completion of construction that are capitalized are classified under CFI.
  • Interest payments that are expensed may be classified as CFO or CFF outflows under IFRS and CFO outflows under US GAAP.
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15
Q

What should be included in the interest coverage ratio to provide a true picture of a company’s interest coverage ratio?

A
  • The entire amount of interest expense for the period, whether capitalized or expensed, should be used in the denominator.
  • If the company is depreciating interest that was capitalized in previous years, EBIT should be adjusted to remove the effect of the depreciation of capitalized interest.
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16
Q

How are intangible assets of finite and indefinite life amortized?

A
  • For finite life: it is amortized over its useful life.
  • For indefinite life: it is not amortized; instead, the asset is tested for impairment at least annually.
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17
Q

What are the 5 criteria for recognizing intangible assets as identifiable under IFRS?

A
  • They must be identifiable (they either should be separable from the entity or must arise from legal rights).
  • They must be under the company’s control.
  • They must be expected to earn future economic benefits.
  • It is probable that expected future economic benefits will flow to the entity.
  • The cost of the asset can be reliably measured.
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18
Q

What is an unidentifiable intangible asset?

A

It is one that cannot be purchased separately and may have an indefinite life.

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19
Q

What is the accounting treatment of intangible assets acquired in situations than business combinations?

A
  • They are recorded at their fair value when acquired, where the fair value is assumed to equal the purchase price.
  • They are recognized on the BS, and costs of acquisition are classified as investing activities on the CF statement.
  • If several intangible assets are acquired as a group, the purchase price is allocated to each individual asset based on its fair value.
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20
Q

What is the accounting treatment of intangible assets developed internally?

A

They are generally expensed when incurred but may be capitalized in certain situations.
- A company that develops intangible assets internally will expense costs of development and recognize no related assets, whereas a firm that acquires intangible assets will recognize them as assets.
- A company that develops intangible assets internally will classify development-related cash outflows under operating activities on the CF statement, whereas an acquiring firm will classify these costs under investing activities.

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21
Q

How is research defined under IFRS?

A

It is an original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding.

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22
Q

How is development defined under IFRS?

A

It is the application of research findings or other knowledge to a plan or design of products, processes, systems, or services before the start of commercial production or use.

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23
Q

What is the accounting treatment of R&D under IFRS and US GAAP?

A
  • IFRS: it requires that expenditures on R&D be expensed.
  • US GAAP: It requires that R&D costs are expensed when incurred. The exception is for software development, where it needs to be capitalized.
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24
Q

What happens when a company acquires another company with a price that exceeds the fair value of its net assets?

A

The excess cash is recorded as goodwill.

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25
Q

What is goodwill?

A

It is an intangible asset that cannot be identified separately from the business as a whole.

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26
Q

When should an item acquired in a business combination be recognized separately from goodwill?

A
  • If the asset arises from legal or contractual rights.
  • The item can be separated from the acquired company.
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27
Q

What is the adjustment for a company that capitalizes on development costs?

A
  • IS for the current period should include related software development costs as an expense and exclude amortization of development costs capitalized in prior periods.
  • Capitalized assets should be removed.
  • CFO should be reduced, and CFI should be increased by the amount of development costs capitalized in the current period.
  • Ratios that include income, long-lived assets, or cash flow from operations should be recalculated using adjustment values.
28
Q

What are the 2 models for reporting long-lived assets?

A
  • The cost model
  • The revaluation model
29
Q

Describe the cost model.

A
  • It is required under US GAAP and permitted under IFRS.
  • The cost of long-lived tangible assets and intangible assets with finite useful lives is allocated over their useful lives.
  • Reported at carrying value
30
Q

Describe the revaluation model.

A
  • Permitted under IFRS, but not under US GAAP.
  • Reported at fair value.
31
Q

What is the straight-line depreciation method?

A

The cost of the asset is allocated evenly across its estimated useful life.

32
Q

What is accelerated depreciation?

A
  • The allocation of depreciable cost is greater in the early years of the asset’s use.
  • Salvage value is not used to calculate depreciation expense, but the carrying amount should not be reduced below the salvage value.
33
Q

What is the units-of-production depreciation method?

A

The amount of depreciation expense for a period is based on the proportion of the asset’s production during the period compared with the total estimated productive capacity of the asset over its useful life.

34
Q

What are the consequences of using the straight-line method to depreciate its assets?

A
  • A lower asset turnover ratio during the early years of the asset’s use.
  • Higher operating profit margin in the early years of the asset’s use.
  • Higher operating return on assets in the early years of the asset’s use.
35
Q

What are the 2 main subjective assumptions that the company’s management can make?

A
  • They can significantly write down the value of long-lived assets and recognize a hefty charge against NI in the current period. While this would depress earnings in the current year, it would allow management to recognize lower annual depreciation expenses going forward, inflate profits, and report impressive growth in profitability.
  • They can overstate the useful life and the salvage value of an asset to show impressive profits over the near term and recognize a significant loss at a later point in time when the asset is retired.
36
Q

What is the component method?

A

Companies depreciate different components of assets separately.

37
Q

What are the estimates required to calculate yearly amortization expense for an intangible fixed asset with a finite life?

A
  • The original value of the intangible asset.
  • The residual value at the end of its useful life.
  • The length of its useful life.
38
Q

What is the condition for using the revaluation model or the cost model?

A
  • The company applies the same model to assets in a particular class.
  • Whenever a revaluation is performed, all assets in the particular class are revalued.
39
Q

What happens to the carrying amount of an asset if a revaluation initially decreases?

A
  • The decrease in value is recognized as a loss on the IS.
  • The increase is recognized as a gain on the IS.
  • Any increase in value beyond the reversal amount will be adjusted directly to equity through the revaluation surplus account.
40
Q

What happens to the carrying amount of an asset if a revaluation initially increases?

A
  • The increase in value bypasses the IS and goes directly to equity through the evaluation surplus account.
  • The decrease reduces the revaluation surplus.
  • Any decrease in value beyond the reversal amount will be recognized as a loss on the IS.
41
Q

What happens when the asset revaluation increases?

A
  • An increase in the carrying value of depreciable long-lived assets increases total assets and shareholders’ equity.
  • If a company is seeking new capital of approaching leverage limitations set by financial covenants, it may choose to revalue its assets upward to present more favorable solvency levels.
42
Q

What happens when the asset revaluation decreases?

A
  • Asset revaluations that decrease the value of an asset also decrease net income in the year of revaluation.
  • Managers can then opportunistically time the reversals to manage earnings and increase income.
43
Q

What is an impairment?

A

It is made to reflect the unexpected decline in the fair value of an asset.

44
Q

What is the effect of impairment recognition on a company’s financial statements?

A
  • The carrying value of the asset decreases.
  • The impairment charge reduces NI.
  • Impairment does not affect CF because it is a non-cash charge.
45
Q

What are examples of indications of impairment?

A

It includes evidence of obsolescence, a decrease in demand for the asset’s output, and technological advancements.

46
Q

When does a company need to recognize an impairment loss?

A

When the asset’s carrying value (CV) is higher than its recoverable amount.

47
Q

What is the accounting treatment for the impairment of PP&E under IFRS?

A
  • An asset is considered impaired when its CV exceeds its recoverable amount.
  • The recoverable amount equals the higher NRV and DCF of the asset.
  • The impairment loss that must be recognized equals the carrying amount minus the recoverable amount.
48
Q

What is the accounting treatment for the impairment of PP&E under US GAAP?

A
  • Determining whether an asset is impaired is different from measuring the impairment loss.
  • An asset is considered impaired when its CV exceeds the total of its undiscounted expected future CF.
  • The impairment loss is measured as the difference between the asset’s carrying amount and its fair value.
49
Q

When does the impairment of intangible assets with a finite life is tested?

A

They are not tested for impairment annually; they are tested for impairment only upon the occurrence of significant adverse events.

50
Q

What is the impairment treatment of intangible assets with an indefinite life?

A

They are carried on the BS at historical cost and tested at least annually for impairment. Impairment must be recognized when the CV exceeds its fair value.

51
Q

When are long-lived assets reclassified between being an asset “held-for-use” to an asset “held-for-sale”?

A

They are reclassified when it is no longer in use and management intends to sell them. These assets are tested for impairment when they are categorized as held for sale.

52
Q

What are the reversals of the impairment process under US GAAP?

A
  • Once an impairment loss is recorded for assets held for use, it cannot be reversed.
  • For asset held-for-sale, if the fair value of the asset increases subsequent to impairment recognition, the loss can be reversed, and the asset’s value can be revised upward.
53
Q

What are the reversals of the impairment process under IFRS??

A

It allows reversal of impairment losses if the value of the asset increases regardless of classification of the asset. IFRS only allows reversals for impairment losses.

54
Q

What is the process of derecognition?

A

A company derecognizes or removes an asset from its financial statement when the asset is deposed of or is not expected to provide any future economic benefits from use or disposal.

55
Q

How is the gain or loss on asset disposal calculated?

A

By subtracting the selling price (cash inflow from investing) by the carrying or book value of asset

56
Q

How is the carrying (book value) calculated?

A

By subtracting the historical cost and the accumulated depreciation updated to the time of sale.

57
Q

What is the accounting treatment of long-lived assets intended to be disposed of other than by a sale?

A

It is classified as held for use until disposal or until they meet the criteria to be classified as held for sale or held for distribution.

58
Q

What happens when an asset is retired or abandoned?

A
  • The company does not receive any cash for it.
  • The assets are reduced by the CV of the asset at the time of retirement of abandonment, and a loss equal to the asset’s carrying amount is recorded on the IS.
59
Q

What happens when an asset is exchanged for another asset?

A
  • The carrying amount of the asset given up is removed from the company’s BS and replaced by the fair value for the asset acquired.
  • The fair value used is the fair value of the asset given up unless the fair value of the asset acquired is more clearly evident.
60
Q

What are the disclosures about long-lived assets throughout the financial statement?

A
  • The BS reports the CV of the asset.
  • On the IS, depreciation expense may or may not appear as a separate line item.
  • On the CF statement, acquisition and disposals of fixed assets are found in the investing section.
  • The notes to the financial statement describe the company’s accounting methods, estimated useful lives, and historical cost by categories of fixed asset accumulated depreciation and annual depreciation expense.
61
Q

What is the fixed asset turnover ratio? Describe its meaning.

A
  • It is the total revenue divided by the average net fixed assets.
  • The higher the ratio, the higher the number of sales a company is able to generate with a given amount of investment in fixed assets, which suggests that the company is operating more efficiently.
62
Q

What is the assumption of the asset age ratios?

A

It assumes that the cost model is used and that straight-line depreciation is used.

63
Q

Why are the calculations of estimated useful life, average life, and remaining useful life important?

A
  • They help identify older, obsolete assets that might make the firm’s operations less efficient.
  • They help forecast future cash flows from investing activities and identify major capex that the company might need to raise cash for in the future.
64
Q

What can affect the comparisons across companies?

A
  • Differences in the composition of the companies’ operations and differences in acquisition and divesture activity.
  • Use of different accounting standards.
  • Use of different depreciation methods.
  • Differences in the grouping of assets in fixed asset disclosures.
65
Q

What is investment property under IFRS?

A
  • It is a property that is owned for the purpose of earning rentals or capital appreciation or both.
  • Long-lived tangible assets that are held for sale in a company’s normal course of business are also not classified as investment property.
66
Q

What are the 2 methods under IFRS to value investment properties?

A
  • Cost model: this is identical to the cost model used for PP&E.
  • The fair value model: it differs from the revaluation model used for PP&E in the way NI is affected.
67
Q

How does US GAAP account for investment property?

A
  • It does not specifically define investment property.
  • It does not distinguish between investment property and other types of long-lived assets.

FRA (18 decks)

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