kieso, weygandt ACCOUNTING IFRS EDITION Propered by: Goby Harmo! University of Califor a Sa nta Barbara na festmo! mt Coleg WILEYDepreciation, Impairments, and Depletion CHAPTER 11 LEARNING OBJECTIVES After studying this chapter, you should be able to: 1. Describe depreciation concepts and methods of depreciation. Identify other depreciation issues. Explain the accounting issues related to asset impairment. 4 Discuss the accounting procedures for depletion of mineral resources. Apply the accounting for revaluations. Demonstrate how to report and analyze property, plant, equipment, and mineral resources. 12PREVIEW OF CHAPTER 11 DEPRECIATION, IMPAIRMENTS, AND DEPLETION Other Impairments | | Depletion Presentation Depreciation | |. recognizing || Establishinga | + Recognizing | | and Analysis Cost Allocation | | issues impairments depletionbase | revaluations | |. presentation of + Factors + Component | |+ Impairment || + write-offof | |» Revaluation property, plant, involved inthe ||” depreciation illustrations resource cost ues equipment, depreciation || . Depreci + Reversal of + Estimating and mineral process and partial impairment recoverable resources periods loss reserves + Analysis of + Depreciation | |+ Cash- + Liquidating property Plant ar generating dividends and equipment replacementof | | units rien property, plant, | |. impairment of and equipment | |" assets to be + Revision of disposed of depreciation rates Intermediate Accounting IFRS 3rd Edition Kieso e Weygandt « Warfield 13LEARNING OBJECTIVE 1 Depreciation—A Method — cesztive depreciation concepts and methods of of Cost Allocation depreciation, Depreciation is the accounting process of allocating the cost of tangible assets to expense in a systematic and rational manner to those periods expected to benefit from the use of the asset. Allocating costs of long-lived assets: ¢@ Fixed assets = Depreciation expense @ Intangibles = Amortization expense @ Mineral resources = Depletion expense 14 LotDepreciation—Method of Cost Allocation Factors Involved in the Depreciation Process Three basic questions: 1. What depreciable base is to be used? 2. Whatis the asset's useful life? 3. What method of cost apportionment is best? 15 LotFactors Involved in Depreciation Process Depreciable Base for the Asset Original cost €10,000 Less: Residual value 1,000 Depreciation base € 9,000 ILLUSTRATION 11.1 Computation of Depreciation Base 11-6 LotFactors Involved in Depreciation Process Estimation of Service Lives @ Service life often differs from physical life. ¢ Companies retire assets for two reasons: 1. Physical factors (casualty or expiration of physical life). 2. Economic factors (inadequacy, supersession, and obsolescence). "7 Lot18 Depreciation—Method of Cost Allocation Methods of Depreciation The profession requires the method employed be “systematic and rational.” Methods used include: 1. Activity method (units of use or production). 2. Straight-line method. 3. Diminishing (accelerated)-charge methods: a. Sum-of-the-years’-digits. b. Declining-balance method. LotMethods of Depreciation Activity Method ILLUSTRATION 11.2 Data Used to Thustate Depreciation Methods Data for Cost of crane $500,000 Stanley Coal Estimated useful life 5 years . Estimated salvage value $ 50,000 Mines Productive life in hours 30,000 hours Illustration: If Stanley uses the crane for 4,000 hours the first year, the depreciation charge is: ILLUSTRATION 11.3 Depreciation Calcuaton, {Cost — R Activity Method—Crane Total Estimated Hours Example ($500,000 ~ $50,000) x 4.000 _ 545 99 30,000 1-9 LotMethods of Depreciation Straight-Line Method ILLUSTRATION 11.2 Data Used to tlustrato Depreciation Methods Data for Cost of crane $500,000 Stanley Coal Estimated useful life 5 years . y Estimated salvage value $ 50,000 Mines Productive life in hours 30,000 hours Illustration: Stanley computes depreciation as follows: ILLUSTRATION 11.4 Cost — Residual Value ty Stognt tive Meter So = Depreciation Charge Crane Example Estimated Service Life $500,000 — $50,000 5 = $90,000 1-10 Lot1M Methods of Depreciation Diminishing-Charge Methods ILLUSTRATION 11.2 Data Used to isate Depreciation Methods Data for Cost of crane $500,000 Stanley Coal Estimated useful life 5 years . Estimated salvage value $ 50,000 Mines Productive life in hours 30,000 hours Sum-of-the-Years’-Digits. Each fraction uses the sum of the years as a denominator (5 + 4+3+2+1= 15). Thenumerator is the number of years of estimated life remaining as of the beginning of the year. Alternate sum-of-the- _n(n+1) 5(5+1) 45 i LotMethods of Depreciation Sum-of-the-Years’ -Digits Remaining Book Depreciation Life in Depreciation Depreciation Value, End Year Base Years Fraction Expense of Year 1 $450,000 5 5/15 $150,000 $350,000 2 450,000 4 4/5 120,000 230,000 3 450,000 3 315 90,000 140,000 4 450,000 2 2ns 60,000 20,000 5 450,000 a1 15 30,000 50,000° "Residual value. ILLUSTRATION 11.6 ‘Sum-of-the-Years'-Digits Depreciation Schedule—Crane Example 112 LotMethods of Depreciation Diminishing-Charge Methods ILLUSTRATION 11.2 Data Used to isate Depreciation Methods Data for Cost of crane $500,000 Stanley Coal Estimated useful life 5 years . Estimated salvage value $ 50,000 Mines Productive life in hours 30,000 hours Declining-Balance Method. Utilizes a depreciation rate (percentage) that is some multiple of the straight-line method. ¢ Does not deduct the salvage value in computing the depreciation base. 1-413 LotMethods of Depreciation Declining-Balance Method Book Value Rate on. Balance Book of Asset First Declining Depreciation Accumulated Value, End Year of Year Balance® Expense Depreciation of Year 1 $500,000 40% $200,000 $200,000 $300,000 2 300,000 40% 120,000 320,000 180,000 a 180,000 40% 72,000 392,000 108,000 4 108,000 40% 43,200 435,200 64,800 5 64,800 40% 14,800° 450,000 50,000 ®'Based on twice the straight-line rate of 20% (§90,000/8450,000 - 20%; 20% x 2 ~ 40%), Limited to $14,800 because book value should not be less than residual value. ILLUSTRATION 11.7 Double-Deciining Depreciation Schedule—Crane Example 1.44 LotLEARNING OBJECTIVE 2 Other Depreciation Issues _ ‘entify other depreciation issues Component Depreciation IFRS requires that each part of an item of property, plant, and equipment that is significant to the total cost of the asset must be depreciated separately. 1415 Lo2Component Depreciation Illustration: EuroAsia Airlines purchases an airplane for €100,000,000 on January 1, 2020. The airplane has a useful life of 20 years and a residual value of €0. EuroAsia uses the straight- line method of depreciation for all its airplanes. EuroAsia identifies the following components, amounts, and useful lives. Components Component Amount Component Useful Life Airframe €60,000,000 20 years Engine components 32,000,000 8 years Other components 8,000,000 5 years ILLUSTRATION 11.8 Airplane Components 11-16 Lo2Component Depreciation Computation of depreciation expense for EuroAsia for 2020. ILLUSTRATION 11.9 Computation of Component Depreciation Components Component Amount + Useful Life = — Component Depreciation Airframe € 60,000,000 20 3,000,000 Engine components 2,000,000 8 4,000,000 Other components 8,000,000 5 4,600,000 Total Depreciation journal entry for 2020, Depreciation Expense 8,600,000 Accumulated Depreciation—Equipment 8,600,000 W417 Lo2Component Depreciation On the statement of financial position at the end of 2020, EuroAsia reports the airplane as a single amount. Non-current assets Airplane €100,000,000 Less: Accumulated depreciation —airplane 8,600,000 € 91,400,000 ILLUSTRATION 11.10 Presentation of Carrying Amount of Airplane 11-18 Lo21419 Other Depreciation Issues Depreciation and Partial Periods How should companies compute depreciation for partial periods? ¢ Companies determine the depreciation expense for the full year and then ¢@ prorate this depreciation expense between the two periods involved. This process should continue throughout the useful life of the asset. Lo211-20 Depreciation and Partial Periods Illustration—(Four Methods): Maserati SpA purchased a new machine for its assembly process on August 1, 2019. The cost of this machine was €150,000. The company estimated that the machine would have a salvage value of €24,000 at the end of its service life. Its life is estimated at 5 years and its working hours are estimated at 21,000 hours. Year-end is December 31. Instructions: Compute the depreciation expense under the following methods. (a) Straight-line depreciation. (c) Sum-of-the-years’-digits. (b) Activity method (d) Double-declining balance. Lo2Depreciation and Partial Periods Straight-line Method Current Depreciable Annual Partial Year Accum. Year Base Years Expense Year Expense _Deprec. 2019 € 126,000 / 5 = x = 2020 126,000 J 5 2021 126000 / 5 = 2022 126000 J 5 2023 126,000 J 5 2024 126000 / 5 = x = Journal entry: 2019 Depreciation expense Accumultated depreciation 11-21 Lo2Depreciation and Partial Periods Activity Method (Assume 800 hours used in 2019) (€126,000 / 21,000 hours = €6 per hour) (Given) Current Hours Rate per Annual_—_—Partial Year Accum. Year __Used Hours Expense Year _ Expense _Deprec. 2019 goo x $6 = € 4,800 2020 x = 2021 x = 2022 x 2023 x = 800 Journal entry: 2019 Depreciation expense Accumultated depreciation 11-22 Lo2Depreciation and Partial Periods Sum-of-the-Years’-Digits Method Current Depreciable Annual Partial Year Accum. Year Base Years Expense Year __Expense _Deprec. 2019 € 126,000 x = x 2020 126,000 x = 2021 126,000 x 2 2022 126,000 x = 2023 126,000 x = 2024 126,000 x = Journal entry: 2019 Depreciation expense Accumultated depreciation 11.23 LozDepreciation and Partial Periods Double-Declining Balance Method Current Depreciable Rate Annual Partial Year Year Base per Year Expense Year Expense 2019 x = 2020 x = 2021 x = 2022 x = 2023 x = Journal entry: 2019 11-24 Depreciation expense Accumultated depreciation Lo2Other Depreciation Issues Depreciation and Replacement of PP&E Does depreciation provide for the replacement of assets? ¢@ Does not involve a current cash outflow. @ Funds for the replacement of the assets come from the revenues (generated through use of the asset). 11-25 Lo2Other Depreciation Issues Revision of Depreciation Rates How should companies handle revisions in depreciation rates? ¢ Accounted for in the current and prospective periods ¢@ Not handled retrospectively @ Not considered errors or extraordinary items 11-26 Lo211.27 Revision of Depreciation Rates Arcadia HS, purchased equipment for $510,000 which was estimated to have a useful life of 10 years with a residual value of $10,000 at the end of that time. Depreciation has been recorded for 7 years on a straight-line basis. In 2019 (year 8), it is determined that the total estimated life should be 15 years with a residual value of $5,000 at the end of that time. Questions: e Whatis the journal entry to correct the prior years’ depreciation? e Calculate the depreciation expense for 2019, No Entry Required Lo2Revision of Depreciation Rates Equipment cost $510,000 First, establish NBV Salvage value -_ 10,000 at date of change in Depreciable base 500,000 estimate. Useful life (original) 10 years Annual depreciation $50,000 x 7 years = $350,000 Balance Sheet (Dec. 31, 2018) Equipment $510,000 Accumulated depreciation 350,000 Net book value (NBV) $160,000 11-28 Lo2Revision of Depreciation Rates Net book value $160,000 Depreciation Salvage value (new) 5,000 Expense calculation Depreciable base 155,000 for 2019. Useful life remaining 8 years Annual depreciation $ 19,375 Journal entry for 2019 Depreciation Expense 19,375 Accumulated Depreciation 19,375 11-29 Lo2LEARNING OBJECTIVE 3 Impairments Explain the accounting issues related to asset Ce (TT 11-30 Recognizing Impairments Along-lived tangible asset is impaired when a company is not able to recover the asset's carrying amount either through using it or by selling it. On an annual basis, companies review the asset for indicators of impairments—that is, a decline in the asset's cash-generating ability through use or sale. Lo31-31 Recognizing Impairments If impairment indicators are present, then an impairment test must be conducted. Recoverable Amount ILLUSTRATION 11.15 Impairment Test Lo31-32 Recognizing Impairments Example: Assume that Cruz SA performs an impairment test for its equipment. The carrying amount of Cruz’s equipment is €200,000, its fair value less costs to sell is €180,000, and its value-in-use is €205,000. ILLUSTRATION 11.15 €200,000 €205,000 I] Recoverable No eee Impairment Compared to Higher of €180,000 €205,000 Lo3Recognizing Impairments Example: Assume the same information for Cruz Company except that the value-in-use of Cruz’s equipment is €175,000 rather than €205,000. €20,000 Impairment Loss —enme— ~ ILLUSTRATION 11.15 €200,000 €180,000 Recoverable Amount Compared to Higher of €180,000 €175,000 11-33 Lo3Recognizing Impairments Example: Assume the same information for Cruz Company except that the value-in-use of Cruz's equipment is €175,000 rather than €205,000. €20,000 Impairment Loss —enme— ~ ILLUSTRATION 11.15 €200,000 €180,000 Carrying : Recoverable Amount ey Amount Cruz makes the following entry to record the impairment loss. Loss on Impairment 20,000 Accumulated Depreciation—Equipment 20,000 11-34 Lo3Impairment Illustrations Case 1 At December 31, 2020, Hanoi Ltd. has equipment with a cost of VND26,000,000, and accumulated depreciation of VND12,000,000. The equipment has a total useful life of four years with a residual value of VND2,000,000. The following information relates to this equipment. 1. The equipment’s carrying amount at December 31, 2020, is VND14,000,000 (VND26,000,000 - VND12,000,000). 2. Hanoi uses straight-line depreciation. Hanoi’s depreciation was VND6,000,000 [(VND26,000,000 - VND2,000,000) + 4] for 2020 and is recorded. 3. Hanoi has determined that the recoverable amount for this asset at December 31, 2020, is VND11,000,000. 4. The remaining useful life of the equipment after December 31, 2020, is two years. 11-35 Lo3Impairment Illustrations Case 1: Hanoi records the impairment on its equipment at December 31, 2020, as follows. VND3,000,000 Impairment Loss oT Os ILLUSTRATION 11.15 ; VND14,000,000 —____— VND 11,000,000 Recoverable Amount Carrying Amount [7] Compared to. -—#} Loss on Impairment 3,000,000 Accumulated Depreciation—Equipment 3,000,000 11-36 Lo311.37 Impairment Illustrations Equipment VND 26,000,000 Less: Accumulated Depreciation-Equipment 15,000,000 Carrying value (Dec. 31, 2020) VND 11,000,000 Hanoi Ltd. determines that the equipment's total useful life has not changed (remaining useful life is still two years). However, the estimated residual value of the equipment is now zero. Hanoi continues to use straight-line depreciation and makes the following journal entry to record depreciation for 2021. Depreciation Expense 5,500,000 Accumulated Depreciation—Equipment 5,500,000 Lo3Impairment Illustrations Case 2 At the end of 2019, Verma Company tests a machine for impairment. The machine has a carrying amount of $200,000. It has an estimated remaining useful life of five years. Because there is little market-related information on which to base a recoverable amount based on fair value, Verma determines the machine’s recoverable amount should be based on value-in-use. Verma uses a discount rate of 8 percent. Verma’s analysis indicates that its future cash flows will be $40,000 each year for five years, and it will receive a residual value of $10,000 at the end of the five years. It is assumed that all cash flows occur at the end of the year. Present value of 5 annual payments of $40,000 ($40,000 x 3.99271, Table 6-4) $159,708.40 Present value of residual value of $10,000 ($10,000 x .68058, Table 6-1) 6,805.80 Value-in-use related to machine & 4.20 ILLUSTRATION 11.16 \Value-in-Use Computation 11-38 Lo3Impairment Illustrations Case 2: Computation of the impairment loss on the machine at the end of 2019. $33,486 Impairment Loss aE #Y—-———*~ ILLUSTRATION 11.15 $200,000 $166,514 Recoverable Amount Compared to Higher of Unknown $166,514 11-39 Lo3Impairment Illustrations Case 2: Computation of the impairment loss on the machine at the end of 2019. $33,486 Impairment Loss —. ao $200,000 $166,514 eae | A conazaio | Pest Loss on Impairment 33,486 Accumulated Depreciation—Machinery 33,486 11-40 Lo3Reversal of Impairment Loss Illustration: Tan Group purchases equipment on January 1, 2019, for HK$300,000, useful life of three years, and no residual value. Year Depreciation Expense Carrying Amount 2019 HK$100,000 (HK$300,000/3) HK$200,000 2020 HK$100,000 (HK$300,000/3) HK$100,000 2021 HK$100,000 (HK$300,000/3) 0 141 At December 31, 2019, Tan records an impairment loss of HK$20,000. Loss on Impairment 20,000 Accumulated Depreciation—Equipment 20,000 Lo3Reversal of Impairment Loss Depreciation expense and related carrying amount after the impairment. Year Depreciation Expense Carrying Amount 2020 HK$90,000 (HK$180,000/2) HK$90,000 2021 HK$90,000 (HK$180,000/2) 0 11-42 At the end of 2020, Tan determines that the recoverable amount of the equipment is HK$96,000. Tan reverses the impairment loss. Accumulated Depreciation—Equipment 6,000 Recovery of Impairment Loss 6,000 Lo31-43 Impairments Cash-Generating Units When it is not possible to assess a single asset for impairment because the single asset generates cash flows only in combination with other assets, companies identify the smallest group of assets that can be identified that generate cash flows independently of the cash flows from other assets. Lo3Impairments Impairment of Assets to Be Disposed Of ¢ Report the impaired asset at the lower-of-cost-or-net realizable value (fair value less costs to sell). ¢@ No depreciation or amortization is taken on assets held for disposal during the period they are held. @ Can write up or down an asset held for disposal in future periods, as long as the carrying amount after the write up never exceeds the carrying amount of the asset before the impairment. 11-44 Lo3Measurement of Impairment Loss Impairment Test Graphic of Account Impairments ‘The higher of fair value less costs to soll or value-in-use. ILLUSTRATION 11. ing for Lo3LEARNING OBJECTIVE 4 Depletion Discuss the accounting procedures for depletion of mineral resources. Natural resources can be divided into two categories: 1. Biological assets (timberlands) » Fair value approach (chapter 9) 2. Mineral resources (oil, gas, and mineral mining). » Complete removal (consumption) of the asset. » Replacement of the asset only by an act of nature. Depletion - process of allocating the cost of mineral resources. 11-46 Lo4Depletion Establishing a Depletion Base Computation of the depletion base involves: 1. Pre-exploratory costs. 2. Exploratory and evaluation costs. 3. Development costs. 11-47 Lo4Depletion Write-off of Resource Cost Normally, companies compute depletion on a units-of- production method (activity approach). Depletion is a function of the number of units extracted during the period. Calculation: Total Cost — Residual value Total Estimated Units Available Depletion Cost Per Unit Units Extracted x Cost Per Unit Depletion 11-48 Lo4Depletion Illustration: MaClede SA acquired the right to use 1,000 acres of land in South Africa to mine for silver. The lease cost is €50,000, and the related exploration costs on the property are €100,000. Intangible development costs incurred in opening the mine are €850,000. MaClede estimates that the mine will provide approximately 100,000 ounces of gold. ILLUSTRATION 11.19 Computation of Depletion Rate Total Cost — Residual Value Total Estimated Units Available — DRONE Ea 11-49 Lo4Depletion If MaClede extracts 25,000 ounces in the first year, then the depletion for the year is €250,000 (25,000 ounces x €10). Inventory 250,000 Accumulated Depletion 250,000 ILLUSTRATION 11.20 MaClede’s statement of financial position: Statement of Financial Position Presentation of Mineral Resource Silver mine (at cost) €1,000,000 Less: Accumulated depletion 250,000 €750,000 Depletion cost related to inventory sold is part of cost of goods sold. 11-50 Lo4Depletion Estimating Recoverable Reserves ¢@ Same as accounting for changes in estimates. @ Revise the depletion rate on a prospective basis. ¢@ Divide the remaining cost by the new estimate of the recoverable reserves. 11-51 Lo41-52 Depletion Liquidating Dividends - Dividends greater than the amount of accumulated net income. Illustration: Callahan Mining had a retained earnings balance of £1,650,000, accumulated depletion on mineral properties of £2,100,000, and share premium of £5,435,493. Callahan's board declared a dividend of £3 a share on the 1,000,000 shares outstanding. It records the £3,000,000 cash dividend as follows. Retained Earnings 1,650,000 Share Premium—Ordinary 1,350,000 Cash 3,000,000 Lo4Depletion Presentation on the Financial Statements Disclosures related to E&E expenditures should include: 1. Accounting policies for exploration and evaluation expenditures, including the recognition of E&E assets. 2. Amounts of assets, liabilities, income and expense, and operating cash flow arising from the exploration for and evaluation of mineral resources. 11-53 Lo4LEARNING OBJECTIVE 5 Revaluations Apply the accounting for 1-54 revaluations. Recognizing Revaluations Companies may value long-lived tangible asset subsequent to acquisition at cost or fair value. Network Rail (GBR) elected to use fair values to account for its railroad network. » Increased long-lived tangible assets by £4,289 million. » Change in the fair value accounted for by adjusting the asset account and establishing an unrealized gain. » Unrealized gain is often referred to as revaluation surplus. LosRecognizing Revaluation Revaluation—Land Illustration: Siemens Group (DEV) purchased land for €1,000,000 on January 5, 2019. The company elects to use revaluation accounting for the land in subsequent periods. At December 31, 2019, the land’s fair value is €1,200,000. The entry to record the land at fair value is as follows. Land 200,000 Unrealized Gain on Revaluation - Land 200,000 Unrealized Gain on Revaluation—Land increases other comprehensive income in the statement of comprehensive income. 1-55 Los1-56 Recognizing Revaluation Revaluation—Depreciable Assets Illustration: Lenovo Group (CHN) purchases equipment for ¥500,000 on January 2, 2019. The equipment has a useful life of five years, is depreciated using the straight-line method of depreciation, and its residual value is zero. Lenovo chooses to revalue its equipment to fair value over the life of the equipment. Lenovo records depreciation expense of ¥100,000 (¥500,000 + 5) at December 31, 2019, as follows. Depreciation Expense 100,000 Accumulated Depreciation—Equipment 100,000 LosRecognizing Revaluation Revaluation—Depreciable Assets After this entry, Lenovo’s equipment has a carrying amount of ¥400,000 (¥500,000 - ¥100,000). Lenovo receives an independent appraisal for the fair value of equipment at December 31, 2019, which is ¥460,000. Accumulated Depreciation—Equipment 100,000 Equipment 40,000 Unrealized Gain on Revaluation—Equipment 60,000 11-57 LosRecognizing Revaluation Revaluation—Depreciable Assets Fanci Setomert Presentation—Revaluations Statement of Comprehensive Income Other comprehensive income Unrealized gain on revaluation—equipment ¥ 60,000 Statement of Financial Position Non-current assets Equipment (¥500,000 — ¥40,000) ¥460,000 Accumulated depreciation—equipment (¥100,000 — ¥100,000) S05 Carrying amount ¥460,000 Equity Accumulated other comprehensive income ¥ 60,000 Under no circumstances can the Accumulated Other Comprehensive Income account related to revaluations have a negative balance. 11-58 Los11-59 Recognizing Revaluation Revaluations Issues Company can select to value only one class of assets, say buildings, and not revalue other assets such as land or equipment. If a company selects only buildings, » revaluation applies to all assets in that class of assets. » Aclass of assets is a grouping of items that have a similar nature and use in a company’s operations. » Companies must also make every effort to keep the assets’ values up to date. LosLEARNING OBJECTIVE 6 and analyze property, plant, Presentation and Analysis 2:monstate how to report equipment, and mineral resources Presentation of Property, Plant, Equipment, and Mineral Resources Depreciating assets, use Accumulated Depreciation. Depleting assets may include use of Accumulated Depletion account, or the direct reduction of asset. 11-60 Disclosures ¢@ Basis of valuation (usually cost) @ Pledges, liens, and other commitments Lo6Presentation and Analysis Analysis of Property, Plant, and Equipment Asset Turnover Siemens Group Measures how Net sales € 79,644 | efficiently a company Total assets, 9/30/16 125,717 uses its assets to Total assets, 9/30/15 120,348 generate sales. Net income 5,584 Asset Turnover = Net Sales Average Total Assets ILLUSTRATION 11.24 Asset Turnover = 11-61 —_— Lo6Presentation and Analysis Analysis of Property, Plant, and Equipment Profit Margin on Sales Siemens Group Measure of the ability Net sales € 79,644 | to generate operating Total assets, 9/30/16 125,717 income from a A etaattey ee ieee particular level of i sales. Profit Margin on Sales = Net Income Net Sales ILLUSTRATION 11.25 a 11-62 ProftMargnonsaes LosPresentation and Analysis Analysis of Property, Plant, and Equipment Return on Assets Siemens Group Measures a firm’s Net sales € 79,644 success in using Total assets, 9/30/16 125,717 assets to generate Total assets, 9/30/15 120,348 earnings. Net income 5,584 Return on Assets = Nesincome Average Total Assets ILLUSTRATION 11.26 11-63 Return on Assets, = Lo6Presentation and Analysis By relating the profit margin on sales to the asset turnover, we can ascertain how profitably the company used assets during that period of time in a measure of the return on assets. Rate of Return = Profit Margin on x Asset Turnover on Assets Sales Net Income Net Income —NetSates— 5 —>* — Average Total Assets —NetSGates— Average Total Assets 11-64 Lo6Presentation and Analysis By relating the profit margin on sales to the asset turnover, we can ascertain how profitably the company used assets during that period of time in a measure of the return on assets. Rate of Return = Profit Margin on x Asset Turnover on Assets Sales €5,584 €5,584 €79,644 5 —>* (€125,717 + €120.348) €79,644 (€125,717 + €120.348) 12 12 [70% | «x Lo6 1-65baled of Property, Plant, and Equipment LEARNING OBJECTIVE 7 Mustrate revaluation accounting procedures. The general rules for revaluation accounting are as follows. 1. Whena company revalues its long-lived tangible assets above historical cost, it reports an unrealized gain that increases other comprehensive income. 2. Ifacompany experiences a loss on impairment (decrease of value below historical cost), the loss reduces income and retained earnings. Thus, gains on revaluation increase equity but not net income. 11-66 Lo7baled Co) ce) aA Ue Equipment 11-67 If a revaluation increase reverses a decrease that was previously reported as an impairment loss, a company credits the revaluation increase to income using the account Recovery of Impairment Loss up to the amount of the prior loss. Any additional valuation increase above historical cost increases other comprehensive income and is credited to Unrealized Gain on Revaluation. If a revaluation decrease reverses an increase that was reported as an unrealized gain, a company first reduces other comprehensive income by eliminating the unrealized gain. Any additional valuation decrease reduces net income and is reported as a loss on impairment. Lo711-68 Revaluation of Land Revaluation—2019: Valuation Increase Assume that Unilever Group (GBR and NLD) purchased land on January 1, 2019, that cost €400,000. Unilever decides to report the land at fair value in subsequent periods. At December 31, 2019, an appraisal of the land indicates that its fair value is €520,000. Unilever makes the following entry to record the increase in fair value. Land 120,000 Unrealized Gain on Revaluation—Land 120,000 (€520,000 - €400,000) Lo7Revaluation—2019: Valuation Increase ILLUSTRATION 11A1 ‘Summary of Revaluation—2019 Accumulated Retained Other Comprehensive Date Item Land Fair Value Earnings Income (AOC!) Jan. 1, 2019 Beginning balance -€400,000 €0 € 0 Dec. 31, 2019 Revaluation 120,000 0 120,000 Dec. 31, 2019 Ending balance 520,000 0 120,000 Land is now reported at its fair value of €520,000. The increase in the fair value of €120,000 is reported on the statement of comprehensive income. The ending balance in Unrealized Gain on Revaluation—Land is reported as accumulated other comprehensive income in the statement of financial position in the equity section. 11-69 Lo71-70 Revaluation—2020: Decrease below Historical Cost What happens if the land’s fair value at December 31, 2020, is €380,000, a decrease of €140,000 (€520,000 - €380,000)? In this case, the land’s fair value is below its historical cost. Unilever makes the following entry on December 31, 2020 to record the decrease in fair value of the land. Unrealized Gain on Revaluation—Land 120,000 Loss on Impairment 20,000 Land (€520,000 - €380,000) 140,000 Lo7Revaluation—2020: Decrease below Cost ILLUSTRATION 11A.2 ‘Summary of Revaluation—2020 Accumulated Retained Other Comprehensive Date Item Land Fair Value Earnings Income (AOCI) Jan. 1, 2019 Beginning balance €400,000 € 0 € 0 Dec. 31, 2019 Revaluation 120,000 0 120,000 Dec. 31, 2019 Ending balance 520,000 ° 120,000 Jan. 1, 2020 Beginning balance €520,000 € 0 € 120,000 Dec. 31, 2020 Revaluation (140,000) (20,000) (120,000) Dec. 31, 2020 Ending balance 380,000 (20,000) 0 @ The debit to Unrealized Gain on Revaluation—Land of €120,000 reduces other comprehensive income, which reduces accumulated other comprehensive income. ¢@ The debit to Loss on Impairment of €20,000 reduces net income and retained earnings. wm Lo71-72 Revaluation—2021: Recovery of Impairment Loss At December 31, 2021, Unilever's land value increases to €415,000, an increase of €35,000 (€415,000 - €380,000). In this case, the Loss on Impairment of €20,000 is reversed and the remaining increase of €15,000 is reported in other comprehensive income. Unilever makes the following entry to record this transaction. Land 35,000 Unrealized Gain on Revaluation—Land 15,000 Recovery of Impairment Loss 20,000 Lo7Revaluation—2021: Recovery of Impairment Loss ILLUSTRATION 1183 ‘Summary of Revaluation—2021 eee Retained Other Comprehensive Date Item Land Fair Value Earnings Income (AOCI) Dec. 31, 2020 Ending balance 380,000 (20,000) o Jan. 1, 2021 Beginning balance € 380,000 €(20,000) € 0 Dec. 31, 2021 Revaluation 35,000 20,000 15,000 Dec. 31, 2021 Ending balance 415,000 0 15,000 On January 2, 2022, Unilever sells the land for €415,000. Unilever makes the following entry to record this transaction. Cash 415,000 Land 415,000 11-73 Lo7Revaluation—2021: Recovery of Impairment Loss ILLUSTRATION 1183 ‘Summary of Revaliation—2021 eee Retained Other Comprehensive Date Item Land Fair Value Earnings Income (AOC!) Dec. 31,2020 Ending balance 380,000 (20,000) o Jan.1,2021 Beginning balance € 380,000 €{20,000) ar) Dec. 31,2021 Revaluation 35,000 20,000 15,000 Dec. 31,2021 __Ending balance 415,000 0 15,000 Since the land is sold, Unilever has the option to transfer Accumulated Other Comprehensive Income (AOCI) to Retained Earnings. Accumulated Other Comprehensive Income 15,000 Retained Earnings 15,000 1-741-75 Revaluation—2021: Recovery of Impairment Loss The purpose of this transfer is to eliminate the unrealized gain on the land that was sold. @ Transfers from Accumulated Other Comprehensive Income cannot increase net income. @ Even though the land has appreciated in value by €15,000, Unilever is not able to recognize this gain in net income over the periods that it held the land. Lo71-76 Revaluation of Depreciable Assets Revaluation—2019: Valuation Increase Assume that Nokia (FIN) purchases equipment for €1,000,000 on January 2, 2019. The equipment has a useful life of five years, is depreciated using the straight-line method of depreciation, and its residual value is zero. Nokia chooses to revalue its equipment to fair value over the life of equipment. On December 31, 2019, Nokia records depreciation expense of €200,000 (€1,000,000 + 5) as follows. Depreciation Expense 200,000 Accumulated Depreciation—Equipment 200,000 Lo7"77 Revaluation—2019: Valuation Increase After this entry, Nokia’s equipment has a carrying amount of €800,000 (€1,000,000 - €200,000). Nokia employs an independent appraiser, who determines that the fair value of equipment at December 31, 2019, is €950,000. To report the equipment at fair value, Nokia does the following. 1. Reduces the Accumulated Depreciation—Equipment account to zero, 2. Reduces the Equipment account by €50,000—it then is reported at its fair value of €950,000. Lo71-78 Revaluation—2019: Valuation Increase After this entry, Nokia’s equipment has a carrying amount of €800,000 (€1,000,000 - €200,000). Nokia employs an independent appraiser, who determines that the fair value of equipment at December 31, 2019, is €950,000. To report the equipment at fair value, Nokia does the following. 3. Records an Unrealized Gain on Revaluation—Equipment for the difference between the fair value and carrying amount of the equipment, or €150,000 (€950,000 - €800,000). The entry to record this revaluation at December 31, 2019, is: Accumulated Depreciation—Equipment 200,000 Equipment 50,000 Unrealized Gain on Revaluation—Equipment 150,000Revaluation—2019: Valuation Increase ILLUSTRATION 110.4 Summary of Revaluton—2019 y au Accumulated Equipment Accumulated Retained Other Comprehensive Date Item FairValue Depreciation _Eamings Income (AOC!) Jan.1,2019 Beginningbalance €1,000,000 € 0 Dec. 31,2019 Depreciation €200,000 _€(200,000) Dec. 31,2019 Revaluation (60,000) _(200,000) 150,000 Dec. 31,2019 Ending balance 950,000 © (200,000) 150,000 The carrying amount of the asset is now €950,000. Nokia reports depreciation expense of €200,000 in the income statement and Unrealized Gain on Revaluation—Equipment of €150,000 in other comprehensive income. 11-79 Lo711-80 Revaluation—2020: Decrease below Historical Cost Assuming no change in the useful life of the equipment, depreciation expense for Nokia in 2020 is €237,500 (€950,000 + 4), and the entry to record depreciation expense on December 31, 2020 as follows. Depreciation Expense 237,500 Accumulated Depreciation—Equipment 237,500 Under IFRS, Nokia may transfer from AOCI the difference between depreciation based on the revalued carrying amount of the equipment and depreciation based on the asset's original cost to retained earnings. Lo7Revaluation—2020: Decrease below Cost Depreciation based on the original cost was €200,000 (€1,000,000 + 5) and on fair value is €237,500, or a difference of €37,500 (€237,500 - €200,000). The entry to record this transfer at December 31, 2020 is as follows. Accumulated Other Comprehensive Income 37,500 Retained Earnings 37,500 Before revaluation in 2020, Nokia has the following amounts related to its equipment. Equipment €950,000 Less: Accumulated depreciation—equipment 237,500 Carrying amount €712,500 Accumulated other comprehensive income €112,500 (€150,000 — €37,500)"* 1-81 Lo7Revaluation—2020: Decrease below Cost Equipment €950,000 Less: Accumulated depreciation—equipment 237,500 Carrying amount €712,500 Accumulated other comprehensive income €112,500 (€150,000 — €37,500}"" 11-82 Nokia determines through appraisal that the equipment now has a fair value of €570,000. To report the equipment at fair value, Nokia does the following. 1. Reduces the Accumulated Depreciation—Equipment account of €237,500 to zero, 2. Reduces the Equipment account by €380,000 (€950,000 — €570,000)—it then is reported at its fair value of €570,000. Lo7Revaluation—2020: Decrease below Cost Equipment €950,000 Less: Accumulated depreciation—equipment 237,500 Carrying amount Accumulated other comprehensive income €112,500 (€150,000 — €37,500}"" 11-83 3. Reduces Unrealized Gain on Revaluation—Equipment by €112,500, to off set the balance in the unrealized gain account (related to the revaluation in 2019). 4. Records a loss on impairment of €30,000. Accumulated Depreciation—Equipment 237,500 Loss on Impairment 30,000 Unrealized Gain on Revaluation—Equipment 112,500 Equipment 380,000 Lo7ILLUSTRATION 110.5 ‘Summary of Revaluation—2020 Accumulated Equipment Retained Other Comprehensive Date Item Fair Value Earnings Income (AOC!) Dec. 31,2019 Ending balance 950,000 (200,000) 150,000 Jan. 1,2020 Beginningbalance € 950,000 €(200,000) €150,000 Dec. 31,2020 Depreciation (237,500) Dec. 31,2020 Transfer from AOCI 37,500 (37,500) Dec. 31,2020 Revaluation (380,000) (30,000) (112,500) Dec. 31,2020 Ending balance 570,000 (430,000) ° The carrying amount of the equipment is now €570,000. Nokia reports depreciation expense of €237,500 and an impairment loss of €30,000 in the income statement. ¢@ Nokia reports the reversal of the previously recorded unrealized gain by recording the transfer to retained earnings of €37,500 and the entry to Unrealized Gain on Revaluation— Equipment of €112,500. 11-84 Lo711-85 Revaluation—2021: Recovery of Impairment Loss Assuming no change in the useful life of the equipment, depreciation expense for Nokia in 2021 is €190,000 (€570,000 + 3), and the entry to record depreciation expense on December 31, 2021 as follows. Depreciation Expense 190,000 Accumulated Depreciation—Equipment 190,000 Lo7Nokia transfers the difference between depreciation based on the revalued carrying amount of the equipment and depreciation based on the asset's original cost from AOCI to retained earnings. Depreciation based on the original cost was €200,000 (€1,000,000 + 5) and on fair value is €190,000. Retained Earnings 10,000 Accumulated Other Comprehensive Income 10,000 Before revaluation in 2021, Nokia has the following amounts related to its equipment. Equipment €570,000 Less: Accumulated depreciation—equipment Carrying amount Accumulated other comprehensive income 11-86 Lo711-87 Revaluation—2021: Recovery of Loss Nokia determines through appraisal that the equipment now has a fair value of €450,000. To report the equipment at fair value, Nokia does the following. 1. Reduces the Accumulated Depreciation—Equipment account of €190,000 to zero. 2. Reduces the Equipment account by €120,000 (€570,000 - €450,000)—it then is reported at its fair value of €450,000. 3. Records an Unrealized Gain on Revaluation—Equipment for €40,000. 4. Records a Recovery of Loss on Impairment for €30,000. Lo7Revaluation—2021: Recovery of Loss Nokia determines through appraisal that the equipment now has a fair value of €450,000. To report the equipment at fair value, Nokia does the following. The entry to record this transaction is as follows. Accumulated Depreciation—Equipment 190,000 Unrealized Gain on Revaluation—Equipment 40,000 Equipment 120,000 Recovery of Loss on Impairment 30,000 11-88 Lo7ILLUSTRATION 110.6 ‘Summary of Revaluation—2024 ee Equipment Accumulated Retained Other Comprehensive Date Item FairValue Depreciation _ Earnings Income (AOC!) Dec. 31,2020 Ending balance 570,000 © (430,000) 0 Jan.1,2021 Beginningbalance € 570,000 € 0 — €(430,000) € 0 Dec. 31,2021 Depreciation 190,000 (190,000) Dec. 31,2021 Transfer from AOCI (10,000) 10,000 Dec. 31,2021 Revaluation (120,000) (190,000) 30,000 40,000 Dec. 31,2021 Ending balance 450,000 © (600,000) 50,000 On January 2, 2022, Nokia sells the equipment for €450,000. Nokia makes the following entry to record this transaction. Cash Equipment 450,000 450,000 Nokia does not record a gain or loss because the carrying amount of the equipment is the same as its fair value. 11-89 Lo7ILLUSTRATION 110.6 ‘Summary of Revaluation—2024 ee Equipment Accumulated Retained Other Comprehensive Date Item FairValue Depreciation _ Earnings Income (AOC!) Dec. 31,2020 Ending balance 570,000 © (430,000) 0 Jan.1,2021 Beginningbalance € 570,000 € 0 — €(430,000) € 0 Dec. 31,2021 Depreciation 190,000 (190,000) Dec. 31,2021 Transfer from AOCI (10,000) 10,000 Dec. 31,2021 Revaluation (120,000) (190,000) 30,000 40,000 Dec. 31,2021 Ending balance 450,000 © (600,000) 50,000 Nokia transfers the remaining balance in Accumulated Other Comprehensive Income to Retained Earnings. Accumulated Other Comprehensive Income Retained Earnings 50,000 50,000 Even though the equipment has appreciated in value by €50,000, the company does not recognize this gain in net income. 11-90 Lo7D ' GLOBAL ACCOUNTING INSIGHTS LEARNING OBJECTIVE 8 Compare accounting procedures for property, plant, and equipment under IFRS and U.S. GAAP U.S. GAAP adheres to many of the same principles as IFRS in the accounting for property, plant, and equipment. Major differences relate to use of component depreciation, impairments, and revaluations. 11-91 LosD ‘ GLOBAL ACCOUNTING INSIGHTS Relevant Facts Following are the key similarities and differences between U.S. GAAP and IFRS related to property, plant, and equipment. Similarities + The definition of property, plant, and equipment is essentially the same under U.S. GAAP and IFRS. + Under both U.S. GAAP and IFRS, changes in depreciation method and changes in useful life are treated in the current and future periods. Prior periods are not affected. + The accounting for plant asset disposals is the same under U.S. GAAP and IFRS. 11-92 Los0 * GLOBAL ACCOUNTING INSIGHTS Relevant Facts Similarities + The accounting for the initial costs to acquire natural resources is similar under U.S. GAAP and IFRS. + Under both U.S. GAAP and IFRS, interest costs incurred during construction must be capitalized. Recently, IFRS converged to U.S. GAAP. + The accounting for exchanges of non-monetary assets is essentially the same between U.S. GAAP and IFRS. U.S. GAAP requires that gains on exchanges of non-monetary assets be recognized if the exchange has commercial substance. This is the same framework used in IFRS. + U.S. GAAP and IFRS both view depreciation as allocation of cost over an asset's life. US. GAAP and IFRS permit the same depreciation methods (straight-line, diminishing-balance, units-of-production), 11-93 LosD * GLOBAL ACCOUNTING INSIGHTS Relevant Facts Differences + Under U.S. GAAP, component depreciation is permitted but is rarely used. IFRS requires component depreciation. + U.S. GAAP does not permit revaluations of property, plant, equipment, and mineral resources. Under IFRS, companies can use either the historical cost model or the revaluation model. In testing for impairments of long-lived assets, U.S. GAAP uses a different model than IFRS. Under U.S. GAAP, as long as future undiscounted cash flows exceed the carrying amount of the asset, no impairment is recorded. The IFRS impairment test is stricter. However, unlike U.S. GAAP, reversals of impairmentlosses are permitted under IFRS. 11-94 LosNV GLOBAL ACCOUNTING INSIGHTS Relevant Facts Differences + Under U.S. GAAP, all losses on non-monetary asset exchanges are recognized immediately. 11-95 LosD ' GLOBAL ACCOUNTING INSIGHTS About The Numbers As indicated, impairment testing under U.S. GAAP is a two-step process. Illustration 11.18, in the text, summarizes impairment measurement under U.S. GAAP. The key distinctions relative to IFRS relate to the use of a cash flow recovery test to determine if an impairment test should be performed. Also, U.S. GAAP does not permit reversal of impairment losses for assets held for use. 11-96 LosD ' GLOBAL ACCOUNTING INSIGHTS On the Horizon With respect to revaluations, as part of the conceptual framework project, the Boards will examine the measurement bases used in accounting. It is too early to say whether a converged conceptual framework will recommend fair value measurement (and revaluation accounting) for property, plant, and equipment. However, this is likely to be one of the more contentious issues, given the long-standing use of historical cost as a measurement basis in U.S. GAAP. 11-97 Los11-98 Copyright Copyright © 2018 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. 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