CHAPTER 9

Reporting and Analyzing Long-Lived Assets

Learning Objectives

1. Explain the accounting for plant asset expenditures.

2. Apply depreciation methods to plant assets.

3. Explain how to account for the disposal of plant assets.

4. Identify the basic issues related to reporting intangible assets.

5. Discuss how long-lived assets are reported and analyzed.

*6. Compute periodic depreciation using the declining-balance method and the units-
of-activity method.

*7. Compare the accounting for long-lived assets under GAAP and IFRS.
 Chapter Outline

Learning Objective 1 — Explain the Accounting for Plant

Asset Expenditures

 Plant Assets (also called property, plant, and equipment and fixed assets) are
resources that are expected to be of use to the company for a number of years.
Except for land, plant assets decline in service potential over their useful lives.

 All plant assets have three characteristics:

1. They have physical substance (a definite size and shape).

2. They are used in the operations of the business.
3. They are not intended for sale to customers.

 It is important for companies to keep assets in good operating condition, and to

replace worn-out or outdated assets, and expand productive assets as needed.

 In determining the cost of plant assets, the historical cost principle requires
that companies record plant assets at cost.

 Cost consists of all expenditures necessary to acquire an asset and make it

ready for its intended use. Cost is measured by the cash paid in a cash
transaction or by the cash equivalent price paid when noncash assets are used
in payment.

o The cash equivalent price is equal to the fair value of the asset given up or
the fair value of the asset received, whichever is more clearly determinable.

 Once cost is established, it becomes the basis of accounting for the plant asset
over its useful life. Current fair value is not used to increase the recorded cost
after acquisition.

 Land is often used as a building site for a manufacturing plant or office building.

o The cost of land includes:

 The cash purchase price.

 Closing costs such as title and attorney fees.
 Real estate broker commissions.
 Accrued property taxes and other liens assumed by the purchaser.

o All necessary costs incurred in making land ready for its intended use are
debited (an increase) to the Land account.

 Land improvements are structural additions with limited lives that are made to
land. Examples are driveways, parking lots, fences, and underground sprinklers.
 o The cost of land improvements includes all expenditures necessary to make
the improvements ready for their intended use.

o The total of all these costs would be debited (an increase) to Land
Improvements.

o Land improvements have limited useful lives. Even when well-maintained,

they will eventually need to be replaced. As a result, companies expense
(depreciate) the cost of land improvements over their useful lives.

 Buildings are facilities used in operations, such as stores, offices, factories,

warehouses, and airplane hangars.

o All necessary expenditures related to the purchase or construction of a

building are debited (an increase) to the Buildings account.

o When a building is purchased, such costs include the purchase price, closing
costs (e.g., attorney’s fee and title insurance), and the real estate broker’s
commission.

o When a new building is constructed, its cost consists of the contract price plus
payments made by the owner for architects’ fees, building permits, and
excavation costs.

o Interest costs incurred to finance the project are included in the cost of the
building when a significant period of time is required to get the building ready
for use. The inclusion of interest costs in the cost of a constructed building is
limited to interest costs incurred during the construction period.

 Equipment includes assets used in operations, such as store check-out

counters, office furniture, factory machinery, computers, printers, and delivery
trucks.

o The cost of equipment consists of the cash purchase price, sales taxes,
freight charges, and insurance during transit paid by the purchaser. The cost
also includes expenditures required in assembling, installing, and testing the
equipment.

o Annual recurring expenditures which do not benefit future periods are treated
as expenses and not as a cost of equipment. Two criteria apply in
determining the cost of equipment:

1. The frequency of the cost (one time or recurring).

2. The benefit period (the life of the asset or one year).

 A company many incur expenditures during the useful life of a plant asset for
ordinary repairs, additions, or improvements.
  Ordinary repairs are expenditures to maintain the operating efficiency and
expected productive life of the asset. They are usually small amounts that occur
frequently. Examples are motor tune-ups and oil changes, the painting of
buildings, and the replacing of worn-out gears on machinery.

o Ordinary repairs are debited (an increase) to Maintenance and Repairs

Expense as they are incurred.

o Because ordinary repairs are immediately charged as an expense against

revenues, these costs are referred to as revenue expenditures.

 Additions and improvements are costs incurred to increase the operating

efficiency, productive capacity, or expected useful life of a plant asset. They are
usually material in amount and occur infrequently. Additions and improvements
increase the company’s investment in productive facilities.

o Additions and improvements are debited (an increase) to the plant asset
affected.

o Additions and improvements are referred to as capital expenditures.

 Oftentimes, a company has to decide whether to buy or lease a plant asset. An

alternative to purchasing an asset is leasing.

 A lease is a contractual agreement in which the owner of an asset (lessor)

allows another part (lessee) to use the asset for a period of time at an agreed
price.

o Some advantages of leasing an asset versus purchasing it are:

 Reduced risk of obsolescence because frequently, lease terms allow the

party using the asset (lessee) to exchange the asset for a more modern
one if it becomes outdated.

 Little or no down payment required, compared to purchasing an asset

which may require companies to borrow money.

 Shared tax advantages as lessees may be startup companies typically

earning little or no profit in their early years with little need for the tax
deductions available from owning an asset.

Learning Objective 2 — Apply Depreciation Methods to Plant Assets

 Depreciation is the process of allocating to expense the cost of a plant asset over
its useful (service) life in a rational and systemic manner. Such cost allocation is
designed to properly record (efforts) with associated revenues (results).
  Depreciation affects the balance sheet through accumulated depreciation, which
is reported as a deduction from plant assets. It affects the income statement
through depreciation expense.

 Depreciation is a cost allocation process, not an asset valuation process. No

attempt is made to measure the change in an asset’s fair value during ownership.

o The book value—cost less accumulated depreciation—of a plant asset may

differ significantly from its fair value. If an asset is fully depreciated, it can
have zero book value but still have a significant fair value.

 Depreciation applies to three classes of plant assets:

o Land improvements
o Buildings
o Equipment

Land is not a depreciable asset because its usefulness and revenue-producing

ability generally remain intact as long as the land is owned.

 During a depreciable asset’s useful life, its revenue-producing ability can decline
because of:

o Wear and tear.

o Obsolescence, which is the process by which an asset becomes out of date
before it physically wears out.

 Recognizing depreciation for an asset does not result in the accumulation of cash
for replacement of the asset.

o The balance in Accumulated Depreciation represents the total amount of the

asset’s cost the company has charged to expense to date; it is not a cash
fund.

 The factors in computing depreciation are:

 Cost comprises all expenditures necessary to acquire the asset and make it
ready for intended use.

 Useful life is an estimate of the expected life based on need for repair, service
life, and vulnerability to obsolescence.

 Salvage value is an estimate of the asset’s value at the end of its useful life.

 Useful Life & Salvage Value are determined internally by management.

 Depreciation is generally computed using one of three depreciation methods:

1. Straight-line
 2. Declining-balance
3. Units-of-activity

 Each of these depreciation methods is acceptable under generally accepted

accounting principles. Management selects the method it believes best measures
an asset’s contribution to revenue over its useful life.

 Once a company chooses a method, it should be applied consistently over the

useful life of the asset. Consistency enhances the ability to analyze financial
statements over multiple years.

 The straight-line method is the most widely used method. Under the straight-
line method, companies expense an equal amount of depreciation each year of
the asset’s useful life.

o To compute the annual depreciation expense, divide depreciable cost by the

estimated useful life.

 Depreciable cost represents the total amount subject to depreciation, and

is calculated as the cost of the plant asset less its salvage value.

o Alternatively, a company can compute the annual rate at which it calculates

depreciation. To compute the annual rate, divide 100% by the useful life.

o If an asset is purchased during the year, rather than on January 1, the annual
depreciation is prorated for the proportion of the year the asset is used.

Using the example in the book of the small delivery truck purchased by Bill’s Pizzas on
January 1, 2025:
Cost $ 13,000
Expected salvage value $ 1,000
Estimated useful life (in years) 5
Estimated useful life (in miles) 100,000
Computation of annual depreciation: ($13,000 - $1,000)  5 years = $2,400 per year
Annual rate: 100%  5 years = 20% per year
Depreciation Schedule Assuming Straight-Line Depreciation
Annual End of Year
Depreciable Value Depreciation Accumulated Book
Year Cost Rate Expense Depreciation Value
2025 $ 12,000 x 20% = $ 2,400 $ 2,400 $ 10,600
2026 12,000 x 20% = 2,400 4,800 8,200
2027 12,000 x 20% = 2,400 7,200 5,800
2028 12,000 x 20% = 2,400 9,600 3,400
2029 12,000 x 20% = 2,400 12,000 1,000
Total $ 12,000
__________________
  The declining-balance method computes depreciation expense using a
constant rate applied to a declining book value.

o This method is called an accelerated-depreciation method because it

results in higher depreciation in the early years of an asset’s life than does the
straight-line approach.

 Because the total amount of depreciation (depreciable cost) taken over an

asset’s life is the same no matter what approach is used, the declining-
balance method produces a decreasing annual depreciation expense over
the asset’s useful life.

 In early years, declining-balance will exceed straight-line. In later years, it

will be less than straight-line.

o Companies can apply declining-balance at different rates, which result in

varying speeds of depreciation. A common declining-balance rate is double
the straight-line rate, referred to as the double-declining-balance method.

Bill’s Pizzas on January 1, 2025, using the double-declining-balance method. The

Appendix expands the example to show that when using the declining-balance method,
the salvage value is ignored in the beginning. However, the asset cannot be
depreciated below its salvage value.

Rate = 100% ÷ 5 years = 20% x 200% (DDB) = 40% per year

Depreciation Schedule Assuming Double-Declining Balance Depreciation
Beginning Year-End Year-
of Year Annual Accumulated End
Book Depreciation Depreciation Book
Year Value Rate Expense to Date Value
2025 $ 13,000 40% $ 5,200 $ 5,200 $ 7,800
2026 7,800 40% 3,120 8,320 4,680
2027 4,680 40% 1,872 10,192 2,808
2028 2,808 40% 1,123 11,315 1,685
2029 685 40% 685 12,000 1,000
Total $ 12,000
__________________

 Under the units-of-activity method, useful life is expressed in terms of the total
units of production or the use expected from the asset.

o The units-of-activity method is ideally suited to factory machinery as

companies can measure production in terms of units of output or in terms of
machine hours used in operating the machinery. It is also possible to use the
method for such items as delivery equipment (miles driven) and airplanes
(hours in use).
 o The units-of-activity method is generally not suitable for such assets as
buildings or furniture because activity levels are difficult to measure.

o Under units-of-activity depreciation, the amount of depreciation is proportional

to the activity that took place during that period.

 Computing depreciation under units-of-activity is similar as straight line. The only

difference is that life is expressed in terms of activity rather than years. Activity
may be measured in units produced, miles driven, etc., depending on the asset.
Returning to the example of Bill’s delivery truck the units-of-activity depreciation
would be computed as follows:
Rate = ($13,000 - $1,000)  100,000 miles = $0.12 per mile
Depreciation Schedule Assuming Units-of-Activity Depreciation
Year-End Year-End
Units of Annual Accumulated Book
Activity Depreciation Depreciation Value
Year (Miles) Rate Expense to Date
2025 15,000 $ 0.12 $ 1,800 $ 1,800 $ 11,200
2026 30,000 0.12 3,600 5,400 7,600
2027 20,000 0.12 2,400 7,800 5,200
2028 25,000 0.12 3,000 10,800 2,200
2029 10,000 0.12 1,200 12,000 1,000
Total 100,000 $ 12,000
__________________

 The comparison of methods for annual and total depreciation expense is as

follows:
Double-Declining
Year Straight-Line Balance Units-of-Activity
2025 $ 2,400 $ 5,200 $ 1,800
2026 2,400 3,120 3,600
2027 2,400 1,872 2,400
2028 2,400 1,123 3,000
2029 2,400 685 1,200
Total $ 12,000 $ 12,000 $ 12,000
While annual depreciation expense varies considerably among the methods, total
depreciation expense (over the life of the asset) is the same ($12,000) for the
five-year period.

 For depreciation and income taxes, the Internal Revenue Service (IRS) allows
corporate taxpayers to deduct depreciation expense when computing taxable
income.

o However, the IRS does not require the taxpayer to use the same depreciation
method on the tax return that it uses in preparing financial statements.
 o For tax purposes, taxpayers must use on their tax returns either the straight-
line method or a special accelerated-depreciation method called the Modified
Accelerated Cost Recovery System (MACRS).

 A company’s choice of depreciation method must be disclosed in their

financial statements or in related notes that accompany the statements.

 Revising periodic depreciation should be done by management after periodically

reviewing annual depreciation expense. If wear and tear or obsolescence indicates
that annual depreciation is either inadequate or excessive, the company should
change the depreciation expense amount.

 When a change in an estimate is required, the change is made in current and

future years but not to prior periods. The company does not change previously
depreciation expense. The company revises depreciation expense for current
and future years.

o The rationale for this treatment is that continual restatement of prior periods
would adversely affect the users’ confidence in financial statements.
 Companies must disclose in the financial statements significant changes in
estimates.

 Impairment is a permanent decline in the fair value of an asset where its fair value
may materially fall below book value. This may happen because a machine has
become obsolete, or the market for the product made by the machine has dried up
or has become very competitive.

 So as not to overstate the asset on the books, the company records a write-
down, whereby the asset’s book value is reduced to its new fair value during the
year in which the decline in value occurs.

o This is recorded by debiting (an increase) a loss and crediting (an increase) in
accumulated depreciation.

 In the past some companies improperly delayed recording losses on impairments

until a year when the impact on the company’s reported results was minimized.

o The practice of timing the recognition of gains and losses to achieve certain
income results is known as earnings management. Earnings management
reduces earnings quality.

o To minimize earnings management, accounting standards now require

immediate loss recognition on impaired assets.

Learning Objective 3 — Explain How to Account for the Disposal of Plant Assets

 Companies dispose of plant assets that are no longer useful to them.

  There are three methods of plant asset disposal:

1. Sale, where the plant asset is sold to another party.

2. Retirement, where the plant asset is scrapped or discarded.
3. Exchange, where the existing plant asset is traded for a new plant asset.

 Whatever the disposal method, the company must determine the book value of
the plant asset at the time of disposal in order to determine the gain or loss.

o Recall that book value is the difference between the cost of the plant asset
and the accumulated depreciation to date.

o If disposal occurs at any time during the year, the depreciation for the fraction
of the year to the date of disposal must be recorded.

o Book value is eliminated by debiting (a decrease) Accumulated Depreciation

for the total depreciation associated with that asset to the date of disposal and
crediting (a decrease) the asset account for the cost of the asset. A gain or
loss on disposal may be needed to balance this entry.
 In a sale of plant assets, the company compares the book value of the asset with
the proceeds received from the sale.

 If the proceeds from the sale exceed the book value of the plant asset, a gain on
sale (disposal) occurs.

o The gain is reported in the “Other revenues and gains” section of the income
statement.

To illustrate a gain on sale of plant assets, assume that on July 1, 2025, Wright
Company sells office furniture for $16,000 cash. The office furniture originally cost
$60,000 and as of January 1, 2025, had accumulated depreciation of $41,000.
Depreciation for the first six months of 2025 is $8,000. Then entries to record
depreciation expense and update accumulated depreciation to July 1 and to record the
sale and the gain on sale are as follows:
July 1 Depreciation Expense............................................. 8,000
Accumulated Depreciation—Equipment....... 8,000
(To record depreciation expense for the
first six months of 2025)

July 1 Cash........................................................................ 16,000

Accumulated Depreciation—Equipment.................. 49,000
Equipment.................................................... 60,000
Gain on Disposal.......................................... 5,000
(To record sale of office furniture at a gain)
__________________

 If the proceeds from the sale are less than book value of the plant asset, a loss
on sale (disposal) occurs.
 o The loss is reported in the “Other expenses and losses” section of the income
statement.

Assume that the office furniture was sold for $9,000. There will be a loss of $2,000. To
record the loss on the sale is as follows:
July 1 Cash........................................................................ 9,000
Accumulated Depreciation—Equipment.................. 49,000
Loss on Disposal..................................................... 2,000
Equipment.................................................... 60,000
(To record sale of office furniture at a loss)
__________________

 Companies simply retire plant assets, rather than sell them at the end of their useful
lives. Companies record retirement of any asset as a special case of disposal where
no cash is received.

 The company debits (a decrease) Accumulated Depreciation for the full amount
of depreciation taken over the life of the asset and credit (a decrease) the asset
account for the original cost of the asset. The loss is equal to the asset’s book
value on the date of retirement. (A gain is not possible on a retirement.)

Learning Objective 4 — Identify the Basic Issues Related to

Reporting Intangible Assets

 Intangible assets are rights, privileges, and competitive advantages (without

physical substance) that result from ownership of long-lived assets.

 Intangibles may be evidenced by contracts, licenses, and other documents. They

may arise from the following sources:

o Government grants, such as patents, copyrights, licenses, trademarks, and

trade names.

o Acquisition of another business in which the purchase price includes a

payment for goodwill.

o Private monopolistic arrangements arising from contractual agreements, such

as franchises and leases.

 In accounting for intangible assets, they are recorded at cost. This cost consists
of all expenditures necessary for the company to acquire the right, privilege, or
competitive advantage.

 Intangibles are categorized as having either a limited life or an indefinite life.

o If an intangible asset has a limited life, the company allocates its cost over the
asset’s useful life using a process called amortization. Amortization is similar
to depreciation.
  To record amortization of an intangible asset, a company debits (an
increase) Amortization Expense and credits (a decrease) the specific
intangible asset. Alternatively, some companies choose to credit (an
increase) a contra account, such as Accumulated Amortization.

 Intangible assets are typically amortized on a straight-line basis.

 In determining useful life, a company should consider obsolescence,

inadequacy, and other factors that may cause an intangible asset to
become economically ineffective before the end of its legal life.

o The cost of intangible assets with indefinite lives should not be amortized.

 These are the types of intangible assets:

 A patent is an exclusive right issued by the U.S. Patent Office that enables the
recipient to manufacture, sell, or otherwise control an invention for a period of 20
years from the date of the grant.

o The initial cost of a patent is the cash or cash equivalent price paid to acquire
the patent.

o The owner adds the legal costs of successfully defending a patent to the
Patents account and amortizes them over the remaining life of the patent.
(Costs of unsuccessful defenses are expenses.)

 The federal government grants copyrights, which give the owner the exclusive
right to reproduce or sell an artistic or published work. Copyrights last for the life
of the creator plus 70 years.

o The cost of a copyright is the cost of acquiring and successfully defending it.

o The useful life of a copyright generally is significantly shorter than its legal life.

 A trademark or trade name is a word, phrase, jingle, or symbol that identifies a

particular enterprise or product. Trade names create immediate product
identification and generally enhance the sale of the product.

o The creator or original user may obtain exclusive legal right to the trademark
or trade name by registering it with the U.S. Patent Office. Such registration
provides 20 years of protection and may be renewed indefinitely as long as
the trademark or trade name is in use.

o If a company purchases the trademark or trade name, the cost is the

purchase price. If the company develops and maintains the trademark or
trade name, any costs related to these activities are expensed as incurred.
 o Because trademarks and trade names have indefinite lives, they are not
amortized.

 A franchise is a contractual agreement between a franchisor and a franchisee.

The franchisor grants the franchisee the right to sell certain products, to perform
specific services, or to use certain trademarks or trade names, usually within a
designated geographic area.

o Another type of franchise is a license. A license granted by a government

body, permits a company to use public property in performing its services.

o Companies record as operating expenses annual payments made under a

franchise agreement in the period in which they are incurred.

o In the case of a limited life, a company amortizes the cost of a franchise (or
license) as an operating expense over the useful life.

o If the life is indefinite or perpetual, the cost is not amortized.

 Goodwill represents the value of all favorable attributes that relate to a company
that are not attributable to any other specific asset. These include exceptional
management, desirable location, good customer relations, skilled employees,
high-quality products, and harmonious relations with labor unions.

o Goodwill is unique. Unlike assets such as investments and plant assets,

which can be sold individually in the marketplace, goodwill can be identified
only with the business as a whole.

o Companies record goodwill only when an entire business is purchased.

Goodwill is the excess of cost over the fair value of the net assets (assets
less liabilities) acquired.

o Goodwill is not amortized because it is considered to have an indefinite life.

However, goodwill must be written down if a company determines that its
value has been permanently impaired.

 Research and development costs (R&D costs) are expenditures that may lead
to patents, copyrights, new processes, and new products.

o R&D costs present accounting challenges, such as:

 It is sometimes difficult to assign the costs to specific projects.

 There are uncertainties in identifying the extent and timing of future

benefits.
 o Companies record R&D costs as an expense when incurred (instead of as an
asset), whether the research and development is successful or not.

Learning Objective 5 — Describe How Long-Lived Assets Are

Reported and Analyzed

 Usually, companies present plant assets in the financial statements under

“Property, plant, and equipment,” and they show intangibles separately under
“Intangible assets.”

 When a plant asset is fully depreciated, the plant asset and related accumulated
depreciation should continue to be reported on the balance sheet without further
depreciation or adjustment until the asset is retired.

 Intangibles do not usually use a contra asset account like the contra asset
account Accumulated Depreciation used for plant assets. Instead, companies
record amortization of intangibles as a direct credit (a decrease) to the asset
account.

 Companies should report goodwill as a separate line item.

 Either within the balance sheet or in the notes, companies should disclose the
balances of the major classes of assets, such as land, buildings, equipment, and
of accumulated depreciation by major classes or in total.

 In addition, companies should describe the depreciation and amortization

methods used and disclose the amount of depreciation and amortization expense
for the period.

 Two measures are used in the analysis of plant assets.

 Return on assets is an overall measure of profitability. Return on assets

indicates the amount of net income generated by each dollar of assets. The
higher the return on assets, the more profitable the company. This ratio is
computed as follows:

Net Income
Average Total Assets

o Average total assets are commonly calculated by adding the beginning and
ending values of assets and dividing by 2.

 Asset turnover indicates how efficiently a company uses its assets to generate
sales, that is, how many dollars of sales a company generates for each dollar
invested in assets. A higher asset turnover indicates a company is operating
more efficiently. This ratio is computed as follows:

Net Sales
Average Total Assets
  As you may recall, profit margin tells how effective a company is in turning its
sales into income, that is, how much income each dollar of sales provides. This
ratio is computed as follows:

Net Income
Net Sales

 The return on assets can also be computed from the profit margin and the asset
turnover.

Profit Margin x Asset Turnover = Return on Assets

o This relationship has very important strategic implications for management. If

a company wants to increase its return on assets, it can do so in two ways:

 Increase the margin it generates from each dollar of goods that it sells
(profit margin).

 Increase the volume of goods that it sells (asset turnover).

 In Keeping an Eye on Cash, it is interesting to examine the statement of cash flows

to determine the amount of property, plant, and equipment a company purchased
and the cash received from property, plant, and equipment sold in a given year. The
cash flows from purchases and dispositions of property, plant, and equipment are
shown in the investing activities section of the statement of cash flows.

Learning Objective *6 — Compute Periodic Depreciation Using

the Declining-Balance Method and
the Units-of-Activity Method

 The declining-balance method produces a decreasing annual depreciation expense

over the useful life of the asset.

 The method is so named because the computation of periodic depreciation is

based on the declining book value (cost less accumulated depreciation) of the
asset.

o Annual depreciation expense is computed by multiplying the book value at the

beginning of the year by the declining-balance depreciation rate.

o The depreciation rate remains constant from year to year, but the book value
to which the rate is applied declines each year.

 Book value in the first year is the cost of the asset because the balance in
accumulated depreciation at the beginning of the asset’s useful life is zero.
 In subsequent years, book value is the difference between cost and
accumulated depreciation at the beginning of the year.

o Unlike other depreciation methods, the declining-balance method ignores

salvage value in determining the amount to which the declining-balance rate
is applied.

 Salvage value, however, does limit the total depreciation that can be
taken. Depreciation stops when the asset’s book value equals its expected
salvage value.

Example – Double Declining Balance Method

Rate = 100% ÷ 5 years = 20% x 200% (DDB) = 40% per year

Depreciation Schedule Assuming Double-Declining Balance Depreciation
Beginning Year-End Year-
of Year Annual Accumulated End
Book Depreciation Depreciation Book
Year Value Rate Expense to Date Value
2025 $ 13,000 x 40% = $ 5,200 $ 5,200 $ 7,800
2026 7,800 x 40% = 3,120 8,320 4,680
2027 4,680 x 40% = 1,872 10,192 2,808
2028 2,808 x 40% = 1,123 11,315 1,685
2029 685 x 40% = 685 * 12,000 1,000
Total $ 12,000

* In 2029, the Annual Depreciation Expense is not computed by multiplying

the Book Value at Beginning of Year by the Rate because the amount
computed would cause the End of Year Accumulated Depreciation to Date
to exceed the depreciable cost. Generally, in the last year, it will be a plug.
__________________

o The declining-balance method is compatible with the expense recognition

principle.

 The declining-balance method recognizes the higher depreciation

expense in early years with the associated higher benefits received in
these years.

 Conversely, it recognizes lower depreciation expense in later years when

the asset’s contribution to revenue is likely to be lower.

o When an asset is purchased during the year, it is necessary to prorate the

declining-balance deprecation in the first year on a time basis.

 Under the units-of-activity method, useful life is expressed in terms of the total
units of production or use expected from the asset.
 To use this method, a company estimates the total units of activity for the entire
useful life and divides that amount into the depreciable cost to determine the
depreciation cost per unit.

 It then multiplies the depreciation cost per unit by the units of activity during the
year to find the annual depreciation for that year.

__________________

 When the productivity of the asset varies significantly from one period to another,
the units-of-activity method results in the best association of expenses (efforts)
with related revenues (results).

 This method is easy to apply when assets are purchased during the year. In such
a case, the productivity of the asset for the partial year is used in computing the
depreciation.
 IFRS

Learning Objective *7 — Compare the Accounting for Long-Lived

Assets Under GAAP and IFRS

IFRS follows most of the same principles as GAAP in the accounting for property, plant,
and equipment. There are, however, some significant differences in the implementation.
IFRS allows the use of revaluation of property, plant, and equipment, and it also
requires the use of component depreciation. In addition, there are some significant
differences in the accounting for both intangible assets and impairments.

 Similarities:

 The definition for plant assets for both IFRS and GAAP is essentially the same.

 Both IFRS and GAAP follow the historical cost principle when accounting for
property, plant, and equipment at date of acquisition. Cost consists of all
expenditures necessary to acquire the asset and make it ready for its intended
use.

 Under both IFRS and GAAP, interest costs incurred during construction are
capitalized. Recently, IFRS converged to GAAP requirements in this area.

 IFRS also views depreciation as an allocation of cost over an asset’s useful life.
IFRS permits the same depreciation methods (e.g., straight-line, accelerated,
and units-of-activity) as GAAP.

 Under both GAAP and IFRS, changes in the depreciation method used and
changes in useful life are handled in current and future periods. Prior periods are
not affected.

 The accounting for subsequent expenditures (such as ordinary repairs and

additions) are essentially the same under IFRS and GAAP.

 The accounting for plant asset disposals is essentially the same under IFRS and
GAAP.

 Initial costs to acquire natural resources are recorded in essentially the same
manner under IFRS and GAAP.

 The definition of intangible assets is essentially the same under IFRS and GAAP.

 The accounting for exchanges of nonmonetary assets has recently converged

between IFRS and GAAP. GAAP now requires that gains on exchanges of
nonmonetary assets be recognized if the exchange has commercial substance.
This is the same framework used in IFRS.
 Differences:
 IFRS uses the term residual value rather than salvage value to refer to an
owner’s estimate of an asset’s value at the end of its useful life for that owner.

 IFRS allows companies to revalue plant assets to fair value at the reporting date.
Companies that choose to use the revaluation framework must follow revaluation
procedures. If revaluation is used, it must be applied to all assets in a class of
assets. Assets that are experiencing rapid price changes must be revalued on an
annual basis, otherwise less frequent revaluation is acceptable.

 IFRS requires component depreciation. Component depreciation specifies that

any significant parts of a depreciable asset that have different estimated useful
lives should be separately depreciated. Component depreciation is allowed under
GAAP but is seldom used.

 As in GAAP, under IFRS the costs associated with research and development
are segregated into the two components. Costs in the research phase are always
expensed under both IFRS and GAAP. Under IFRS, however, costs in the
development phase are capitalized as Development Costs once technological
feasibility is achieved.

 IFRS permits revaluation of intangible assets (except for goodwill). GAAP

prohibits revaluation of intangible assets.
 Chapter Review

 Why are plant assets reported at historical cost? What costs are included
in the cost of plant assets?

 What is depreciation?

 Compute periodic depreciation using the straight-line method assuming a

cost of $10,000, zero salvage value, and a 5-year useful life. Contrast its
expense pattern with that of an accelerated method.

 When and how do you revise depreciation? Explain the difference

between revenue expenditures and capital expenditures.

 What are the ways in which plant assets can be disposed? Explain how to
account for the disposal of plant assets.

 Describe methods for analyzing a company’s use of plant assets.

 What are intangible assets and how are they reported?

 How are long-lived assets reported on the balance sheet?

 Explain how the declining balance method is calculated. What kind of

assets is the units-of-activity method of depreciation suited for?