IFRS for Longlived Assets

1
IFRS for Long-lived Assets RD

• With comparison to US GAAP

2
IFRS for long-lived assets including intangibles

• Relevant IFRS
• IAS 16, Property, Plant and Equipment
• IAS 38, Intangible Assets,
• IAS 36, Impairment of Assets
• IFRS 5, Non-current Assets Held for Sale and
  Discontinued Operations)

3
Plant, Property Equipment

• IFRS
• PPE can be carried at historical cost or
  revalued amount less accumulated depreciation
  impairment
• Interest costs are capitalized if criteria of
  IAS23 are met
• No inclusion of ARO in cost of asset when used
  for production of inventories

• US GAAP
• PPE must be carried at historical cost less
  accumulated depreciation
• Interest costs must be capitalized if FAS34
  requirements are met
• AROs are recognized where there is a obligation
  to be met at retirement (no exception)

4
Plant, Property Equipment

• Revaluation under IFRS
• Entity must choose cost model or revaluation
  model for an entire class of property, plant
  equipment IAS16, para. 29
• If revaluation model is chosen, fair values that
  can be reliably determined must be done with
  sufficient regularity to ensure that the carrying
  amount does not differ materially from that which
  would be determined using fair value at the end
  of the reporting period IAS16, para. 31

5
Revaluation under IFRS

• Increase in value
• Debit asset and report comprehensive income
• The associated AOCI is called revaluation
  surplus
• Decrease in value
• Credit asst and
• First, debit revaluation surplus to the extent it
  exists (for the specific asset) and report that
  portion of the loss in comprehensive income
• Any remaining loss reduces profit loss for the
  period

6
Class Discussion - Brainstorm

• What is it about American culture and history
  that makes upward revaluation unacceptable?
• If you are not an American, what is it about your
  culture (or others) that make upward revaluation
  acceptable?

7
Research Development

• IFRS
• Development costs must be capitalized and
  amortize if criteria are met
• Cost to develop websites must be capitalized if
  criteria are met, including probably future
  economic benefit
• In-process RD acquired as part of business
  combination is capitalized
• Revaluation is allowed although rare

• US GAAP
• Expense RD as incurred
• Website cost capitalization depends on phase of
  spending based on SOP 98-1 and/or FAS86
• IPRD acquired as part of business combination is
  expensed immediately
• Revaluation is not allowed

8
Research vs. Development under IFRS (IAS38, para.
54-57)

• First step classify internally generated
  intangible assets as being in either (1) a
  research phase or (2) a development phase
• Research is expensed as incurred
• Development costs are capitalized only when the
  entity can demonstrate all of the following
• Next slide 6 criteria

9
Capitalization Criteria IAS38 57

• The technical feasibility of completing the
  intangible
• Its intention to complete the intangible asset
• Its ability to use or sell the intangible asset
• How the intangible asset will generate probable
  future economic benefits
• The availability of adequate technical, financial
  and other resources to complete
• Reliable measurement of related expenditures

10
Caveats in IAS 38

• Internally generated brands, mastheads,
  publishing titles, customer lists and items
  similar in substance shall not be recognized as
  intangible assets.
• Past expenses cannot not later be recognized as
  part of an intangible asset

11
Compare to FAS 86
Deferred Costs (Intangible Assets)
R D Costs (Expense)
Inventory Costs
Technological feasibility established
Software available for commercial production
Software sold
Software project initiated
12
IFRS amortization rules basically similar to US
GAAP

• Intangible assets with indefinite life are not
  amortized but are tested for impairment
• Intangible assets with finite useful lives
• Allocated on a systematic basis over the useful
  life to reflect pattern of the economic benefits
  expected
• Cease amortization at date asset is classified as
  held for sale

13
Review of uS GAAP

• FAS 86 accounting for software

14
FASB 86 - review

• Applies to
• Computer software to be sold, leased or otherwise
  marketed.

15
FASB 86 - review

• Expense
• all costs incurred to establish the technological
  feasibility of a computer software product
• Classify as R D
• Capitalize
• costs incurred between time technological
  feasibility is established up until the product
  is ready for sale

16
FAS 86Technological feasibility is established
when

• All planning, designing, coding testing
  activities have been completed.
• A working model has been completed tested.

I could find no IFRS definition of technical
feasibility
17
FAS86 Amortization of Computer Software

• Amortization expense is the greater of
• a. SL over estimated remaining economic life,
  or
• b. Book Current Gross
  Revenues Value Current and Future
  Gross Revenues

• Evaluate Capitalized Software Costs
• At each balance sheet date.
• Write down to net realizable value if necessary.

18
Impairment of Assets IAS 36

• US GAAP
• FAS 144 PPE
• FAS 142 Intangibles Goodwill

19
Impairment of long-lived assets

• IFRS 1-step process
• Recoverable amount is higher of
• Fair value less cost to sell
• Value in use
• Discounting required in evaluation stage
• Impairment losses must be reversed if
  circumstances change (except goodwill)

• FASB 2-step process
• FAS 144for an asset in use, undiscounted future
  cash flows from use establish recoverability used
  for the impairment calculation
• Not considered impaired unless undiscounted cash
  flows are less than carrying value
• Discounting occurs only for the step 2 valuation
  stage
• Impairment losses cannot be reversed

20
IFRS 1-step test

• Impaired if recoverable amount gt carrying value
• At end of each reporting period, look for
  indications of impairment
• Impairment tests need not be done if there are
  no indications of impairment
• EXCEPTION
• Intangible assets with indefinite useful life
  (including goodwill) and intangible asset not
  yet available for use
• For these assets, impairment test is at end of
  reporting period

Similar to US GAAP which requires annual
impairment tests for intangibles with indefinite
lives but not for other long-lived assets
21
When there is an indication of possible
impairment
IAS 36
22

• Step 2

• Step 1

23
IAS36 Indicators of impairment

• Decline in market value greater than expected as
  a result of normal use or passage of time
• Significant adverse changes affecting entity
  including economic, technological, legal
  environment
• Higher interest rates which would make future
  cash flows less valuable
• Evidence of physical damage or obsolescence
• Plans to discontinue use, dispose of asset, etc.

24
FAS 144 Indicators of impairment

• Events or changes in circumstances that could
  indicate that the carrying amount may not be
  recoverable
• Decline in market value
• Change in way asset is used or physical change in
  asset
• Adverse changes in legal factors or business
  climate
• Probable sale of asset before end of useful life
• Current period losses with history of operating
  or cash flow losses associated with asset

25
Timing of impairment tests
Very Similar

• IFRS
• When an indication of impairment is observed
  (look for them at least annually)
• Land, buildings, equipment
• Intangible assets with finite life
• At least annually
• (at same time of year but not necessarily at year
  end)
• Intangibles with indefinite life including
  goodwill
• Intangibles not yet in use (development costs)

• US GAAP
• When indication of impairment exists (FAS 144)
  long-lived assets intangibles subject to
  amortization (FAS142, para. 15)
• At least annual tests for intangibles with
  indefinite life including goodwill
• GW tested at reporting unit level related to
  segment reporting rules FAS131
• Detailed evaluation of fair value may not be
  required every year

26
Timing of impairment tests
Very Similar

• IFRS
• When an indication of impairment is observed
  (look for them at least annually)
• Land, buildings, equipment
• Intangible assets with finite life
• At least annually
• (at same time of year but not necessarily at year
  end)
• Intangibles with indefinite life including
  goodwill
• Intangibles not yet in use (development costs)

• US GAAP
• When indication of impairment exists (FAS 144)
  long-lived assets intangibles subject to
  amortization (FAS142, para. 15)
• At least annual tests for intangibles with
  indefinite life including goodwill
• GW tested at reporting unit level related to
  segment reporting rules FAS131

Detailed re-evaluation each year can be waived if
previous impairment test showed significant
headroom IAS 36, 15 and FAS142 27)
27
IAS36 Measuring recoverable amount (1)

• Recoverable amount can be for an individual asset
  unless the asset does not generate cash flows
  that are largely independent of other assets
• In this case, use a cash-generating unit (CGI) to
  which the asset belongs
• This is the usual case

28
IAS36 Measuring recoverable amount (2)

• Value in Use based on calculations that
  include
• Estimate of future cash flows related to asset
• Expectations about possible variations in amount
  or timing of future cash flows
• The time value of money
• Price for bearing uncertainty inherent in the
  asset
• Other factors such as illiquidity

29
IAS36 VIU (3)

• Discount rate to use Discount rate
• The discount rate (rates) shall be a pre-tax rate
  (rates) that reflect(s) current market
  assessments of
• the time value of money
• the risks specific to the asset for which the
  future cash flow estimates have not been adjusted

30
IAS36 Compare recoverable amounts (4)

• Value in Use (discounted cash flows)
• Discount the future cash inflows and outflows to
  be derived from continuing use of the asset and
  from its ultimate disposal using appropriate
  discount rate
• Fair Value less costs to sell (market-based)
• Best FV would be a binding sales agreement in an
  arms length transaction
• Next best would be based on identical or similar
  assets traded in an active market
• Never actually recommends discounted expected
  cash flow analysis

31
Impairment Example

• Johnson Company purchased equipment 8 years ago
  for 1,000,000. The equipment has been
  depreciated using the straight-line method with a
  20-year useful life and 10 residual value.
• Johnson's operations have experienced significant
  losses for the past 2 years and, as a result, the
  company has decided that the equipment should be
  evaluated for possible impairment.

32
Impairment Example (cont)

• The management of Johnson Company estimates that
  the equipment has a remaining useful life of 7
  years. Net cash inflow from the equipment will be
  80,000 per year. The fair value of the equipment
  is 240,000 (based on market values of similar
  equipment). No goodwill was associated with the
  purchase of the equipment.

33
FAS 144 solution (slide a)

• Determine if an impairment loss should be
  recognized.
• Annual depreciation for the equipment has been
  45,000 (1,000,000 - 100,000)/20 years. Current
  book value of the equipment is
• Original cost
  1,000,000
• Accumulated depreciation 360,000
  (45,000 8 years)
• Book value
  640,000

34
FAS 144 solution (slide b)

• Determine if an impairment loss should be
  recognized.
• Anticipated future cash flows 560,000 
• (7 years 80,000 per year)
• Look at the flow chart should we recognize an
  impairment?

• The fair value is lower, so an impairment loss
  should be recognized.  

35
FAS 144 solution (slide c)

• The step 2 phase Determine the amount of the
  loss and prepare the journal entry to record the
  loss.
• The impairment loss is equal to 400,000
  (640,000 - 240,000) -- the difference between
  the book value of the equipment and its fair
  value. The impairment loss would be recorded as
  follows
•  
• Accd Depreciation 360,000
•  Loss on Impairment 400,000
•    Equipment 760,000 

36
VARIATION of Example(FAS144 solution, slide d)

• What journal entry should Johnson Company make if
  future cash flows related to the equipment were
  980,000 in total?
• Since the future cash flows (undiscounted) equal
  980,000 and this amount is greater than the book
  value of 640,000, Johnson Company will not do
  anything.
• No impairment is recognized and no upward
  revaluation is recorded.
• No journal entry needed.

37
IFRS solution to the impairment example (slide 1)

• Synopsis of facts
• Carrying value 640,000
• Future cash flows from use 80,000 per year
  for 7 years
• Market-based fair value less cost to sell
  240,000
• Determine VIU using 5 rate

38
IFRS solution to the impairment example (slide 2)

• Determine VIU
• N7, i5, FV0, PMT80,000.PV 462,910
• Recoverable amount higher of FV (240,000) and
  VIE (462,910)
• Therefore, loss is 177,090(BV 640,000 VIE
  462,910)

39
IFRS solution to the impairment example
(VARIATION)

• Synopsis of facts
• Carrying value 640,000
• Future cash flows from use 140,000 per year
  for 7 years
• Market-based fair value less cost to sell
  240,000
• Determine VIU using 5 rate

40
Your IAS36 Solution to Variation of Example

• Fair value less cost to sell 240,000
• Carrying value 640,000
• Determine VIU (n7, i5, FV0, PMT140,000)

41
IAS36 Solution to Variation of Example

• Determine VIU
• N7, i5, FV0, PMT140,000.PV 810,092
• Recoverable amount higher of FV (240,000) and
  VIE (810,092)
• Therefore, no loss is recognized (BV 640,000 lt
  VIE 810,092)

Not for student version
42
Comparing the solutions

• Under FAS144

• Under IAS36

• Original facts
• Loss 177,090
• VARIATION
• No loss recognized

• Original facts
• Loss 400,000
• VARIATION
• No loss recognized

43
US GAAP Goodwill Impairment Test is not quite the
same as the FAS 144 test

• We test goodwill for impairment at least annually
  (see hidden review slides)
• This is 2-step test similar to the FAS144 test we
  just examined

44
Impairment Overall comparison

• Similar rules overall but impairment test is
  different which can cause large differences in
  reported earnings
• VIU is discounted version of discounted cash flow
  approach to estimating fair value that is used in
  US only if no market-based fair value is
  available
• Big differences
• IFRS requires that impairment losses be restored
  (except for goodwill) while FASB does not permit
  restoration

45
Review of us gaap

• Impairment tests FAS 142 144

46
Impairment or Disposal of Long-lived Assets -
FASB 144

• For assets to be held and used
• Carrying value is written down to fair value when
  projected future cash flows (undiscounted) are
  less than carrying value
• Scope
• Land, Buildings and Equipment
• Natural resources
• Intangible assets
• FASB 147 says FAS144 covers long-term
  customer-relation intangible assets in the
  banking industry

47
Assets held for use

• See flow chart

• Note that FASB 144 has different rules for assets
  to be sold or abandoned that are NOT on this flow
  chart

48
FAS 144 Assets held for use

• When should impairment be recognized?
• Testing each asset each period would be too
  costly
• We wait for a triggering event

49
FAS 144 Impairment test when

• Events or changes in circumstances indicate that
  the carrying amount may not be recoverable
• Decline in market value
• Change in way asset is used or physical change in
  asset
• Adverse changes in legal factors or business
  climate
• Probable sale of asset before end of useful life
• Current period losses with history of operating
  or cash flow losses associated with asset

50
To apply FAS144 impairment tests

• A long-lived asset shall be grouped with other
  assets and liabilities at the lowest level for
  which identifiable cash flows are largely
  independent of the cash flows of other assets and
  liabilities.

• This is referred to as a primary asset approach
  because we need to have a group of assets that
  generates cash flows

51
A FAS144 impairment loss is recognized if

• Carrying amount of asset (book value) is greater
  than undiscounted future cash flows related to
  use and disposal of asset
• The asset is written down to fair value
• The fair value becomes the new carrying value
  (book value) and depreciation is recorded over
  remaining useful life
• Restoration of a previously recognized impairment
  loss is prohibited. 

52
Triggering Event
53
Determining fair value

• FASB 144 describes a probability-weighted cash
  flow estimation approach to deal with situations
  in which
• alternative courses of action to recover the
  carrying amount of a long-lived asset are under
  consideration, or
• a range is estimated for the amount of possible
  future cash flows

54
Long-lived assets to be disposed of and NOT held
for use

• FAS 144 -- These rules are NOT covered on the
  earlier flow chart

55
FAS144 - Long-lived assets to be disposed of by
sale

• Classified as held for sale in period in which
  all of the following 6 criteria are met
• Management commits to a plan to sell the asset
• Asset is available for immediate sale in its
  present condition
• Active program to locate a buyer has been
  initiated

56
Long-lived assets to be disposed of by sale (FAS
144)

• Continued from previous slide - Classified as
  held for sale in period in which all of the
  following 6 criteria are met
• Sale is probable within one year
• Asset is being actively marketed for a reasonable
  price
• It is unlikely that the plan to sell will be
  changed 

57
Measurement under FAS144(Assets to be disposed
of)

• Write asset down to the LOWER of
• Carrying amount
• Fair value less cost to sell
• Depreciation
• If asset will be sold, stop depreciation
• If asset will be abandoned, exchanged, etc,
• Depreciation continues but reduced life should be
  reflected in amounts charged to expense 

58
FAS144 - Assets to be disposed of other means

• Asset stays in PPE
• Depreciation estimates should be revised to
  reflect shortened life
• Depreciation ends and a gain or loss is recorded
  when the property is disposed of

59
FAS144The disposed of date

• Abandoned
• The date it ceases to be used

• Exchanged or distributed to owners through a
  spinoff
• The date when it is exchanged or distributed

60
Review of goodwill accounting

• FAS 142 Impairment test for goodwill

61
Under FASB 142

• Goodwill is not amortized because it has an
  indefinite life.
• Instead, a two-stage impairment test is performed
  at least annually
• Impairment losses on goodwill
• Presented in aggregate on income statement as
  separate line item
• Presented before income from continuing
  operations

62
2-step impairment test for GW

• 1. Determine fair values of all identifiable
  tangible and intangible assets (other than
  goodwill) and the fair values of all liabilities
• If fair value is greater than carrying value, no
  impairment loss is recorded
• If fair value is LESS than carrying value,
  perform step two

63
2-step impairment test for GW

• Implied goodwill is the difference between the
  fair values as determined in step 1 and the
  carrying value without goodwill
• 2. If implied goodwill is less than the carrying
  value of goodwill, recognize an impairment loss
  for the difference

64
2-step impairment test

• Detailed evaluation can be carried forward to the
  next year without change if
• No significant changes in assets and liabilities
  in the reporting unit
• Most recent evaluation indicated substantial
  margin of implied goodwill over the carrying
  value of goodwill
• The likelihood that a current fair value
  determination would be less than the current
  carrying value is considered remote

65
Interim impairment tests

• If events and circumstances indicate that
  impairment is more likely than not, an interim
  impairment test must be conducted
• Adverse change in business climate
• Unanticipated competition
• Loss of key personnel
• Adverse action or assessment by a regulator

66
Asset Retirement Obligations

• FIN 47 - Accounting for Conditional Asset
  Retirement Obligations an interpretation of FASB
  Statement No. 143

67
Do we need to review FAS 143?

• There are lecture notes on the notes page at
  the course web site
• Im not sure if there will be time to fit this
  topic in this semester but some of you have done
  a research case on AROs (in Acct 414 or 315)
• If you know nothing about this topic and want to
  do something for extra credit, ask about this case

68
Asset retirement obligations

• FIN 47 (March 2005) would clarifies that a legal
  obligation to perform an asset retirement
  activity that is conditional on a future event is
  within the scope of FASB Statement No. 143
• Uncertainty surrounding the timing and method of
  settlement that may be conditional on events
  occurring in the future would be factored into
  the measurement of the liability rather than the
  recognition of the liability.
• If there is insufficient information to estimate
  the fair value, the liability would be initially
  recognized in the period in which sufficient
  information is available for an entity to make a
  reasonable estimate of the liabilitys fair
  value.

69
ARO Examples

• Telephone company uses wood poles that are
  chemically treated
• No legal requirement to remove poles from ground
• However, if and when poles are removed from the
  ground, special disposal procedures are mandated
  by law
• An asset retirement obligation should be
  estimated at date of purchase

70
ARO Example

• Facility currently owned contains asbestos
• Since acquisition, regulations are put into place
  that require special handling if building is
  renovated or demolished
• ARO should be recognized when regulations go into
  effect, if entity can reasonably estimate fair
  value of the liability