Long Lived Assets: Acquisition and Disposition
...
Current assets
Assets a company expects to convert into cash, or
consume either in one year or in the operating cycle, whichever is
longer.
-->Cash and A/R
-->Inventory
-->Prepaid expense, short-term investment
Long-lived assets
Expected to provide economic benefits beyond the next year or operating cycle
-->Property, plant and equipment (PP&E)
-->Intangible assets
-->Long-term Investments
Because long-lived assets are going to provide economic benefits for more than a year, we need to...
match the benefit they provide andthe cost
Two types of Long-lived assets
-Tangible Assets
-Intangible Asset
Tangible Assets
� Land: Indefinite useful life, so never consumed (therefore, not
depreciated or amortized).
� Plant and Equipment: Definite life, so depreciated over that life.
� Natural resources: depletion
Intangible asset
Lacks physical substance
-Patents, Trademarks, Copyrights, etc.: Definite life, so
amortized over that life.
� Goodwill: Indefinite life, so not amortized or depreciated.
GAAP for Long Lived Assets--> Key question: To capitalize or to expense
-For both tangible and intangible long lived assets, we say we "capitalize" their costs because we place the amount we paid for these assets on the
Balance Sheet.
- We do not capitalize costs of short lived assets (life is less than one year),
we expense
Case A:
1) Company A buys a
computer for $1000 as inventory for sale
2) When the inventory gets sold
1)
Inventory 1000
Cash 1000
2)
Cash (or A/R) 1200
Sales Revenue 1200
COGS 1000
Inventory 1000
Case B:
1) Company B buys a computer for $1000
to use in operations
2) Let's assume the company plans to use the
computer for 5 years, then the company
depreciates the $1000 over the 5-year period.
1) Equipment (computer) 1000
Cash 1000
2) Depreciation expense 200
Accum depreciation 200
Long lived assets are______ _____, and are recorded at their _______ _____ on the Balance Sheet
non-current assets, acquisition cost
PP&E are reported as...
net of accumulated depreciation
Accumulated Depreciation is the...
contra-asset to the depreciable
asset. As a contra asset, it has a credit balance.
Net depreciable assets =
Gross depreciable assets less the accumulated depreciation
Intangible assets are
Intangible assets are amortized
Investment=
gains and losses need to be evaluated (will be discussed in session 11)
General rule of cost capitalization:
The initial cost of an
asset includes the purchase price and all expenditures
necessary to bring the asset to its desired condition and
location for use.
-Purchase price
-taxes (sale tax vs. property tax)
-Fees
-Delivery
-Costs to adapt to intended use
-I
Cost of Equipment
� Purchase price + sales tax
� Transportation costs
� Installation costs
� Testing and trial runs
� Legal fees to establish title
� Any other costs of bringing the asset to its condition and
location for use
Equipment Example: Beaverton Lumber purchased a milling machine for $30,000. In addition to the purchase price, Beaverton made the following expenditures:
-Sale tax, $5,000
-Freight, $1,500
-Installation, $3,000
-Testing, $2,000
-Personal property tax on
Purchase price= 30,000 +
Sales tax= 5,000 +
Freight= 1,500 +
Installation= 3,000 +
Testing= 2,000
________________
Total Cost= $41,500
Cost of land
-Purchase price
-Closing costs
--> Attorney fees and real estate agent fees
--> Title fees
--> Mortgage and other fees
-Cost incurred to prepare the site are also capitalized
--> Remove old buildings
--> Clearing, draining, etc.
-Land is assumed to have a
Cost of buildings
� Purchase price:
- Plus other purchase cost: legal fees; realtor commission fees
- Plus remodel costs that bring the building to desired condition of
the new owner
� Self constructed building:
- Building cost: labor, material, etc.
- Architectural fees
-
Example: Purchased Building--> Fullerton Waste Management purchased land and a warehouse for
$600,000. In addition to the purchase price, Fullerton made the
following expenditures related to the acquisition:
- broker's commission, $30,000;
- title insuran
Purchase price= 600,000
Broker's commission= 30,000
Title Insurance= 3,000
Miscellaneous closing costs= 6,000
Demolition of old building= $18,000
____________________________
Total cost of land: $657,000
When assets are purchased together (a basket
purchase) for a lump sum:
-->The purchase price must be allocated among the assets.
Lump sum purchase example:
--> Assume that fullerton decides to use the warehouse rather than demolishing it
--> An independent appraisal estimates the market values of the land and warehouse at $420,000 and $280,000, respectively.
The building will be allocated $255,600 of the total purchase price of $639,000
Land 383,400
Building 255,600
Cash 639,000
What is the difference between long-lived assets and current assets?
Provide FUTURE economic benefit
Spend $1000 to lease a computer for one year.
--> Is this a capitalize or expense?
--> Record it
Operating expense 1000
Cash 1000
A computer is designed to work for 5 years?
Is this a capitalize or expense?
How much to capitalize?
Operating expense 1000
Cash 1000
Depr expense 200
Accum Depr 200
-Purchase price and all expenditures necessary to bring the asset to its desired condition and location for use
Lump-sum acquisition exercise: Semtech Manufacturing purchased land and building for $4 million. In addition to the purchase price, Semtech made the following expenditures in connection with the purchase of the land and building:
-Title insurance $16,000
Total lump-sum payment: 4m+16k+5K+4k = 4,025,000
Land: 75% x 4,025,000 = 3,018,750
Building: 25% x 4,025,000 = 1,006,250
Land improvement: 122,000
Cost of Natural Resources: Capitalize costs of...
-Acquisition, Exploration, Development, Restoration
Acquisiton
cost paid to acquire the rights to explore for
undiscovered natural resources or to extract proven natural
resources
� For example, the auction of Gulf drilling rights at New Orleans
Exploration
(e.g.: drilling a well in order to produce oil)
Development
(after the resource has been discovered but before
production begins)
Restoration
(occurs after the production begins)
� Since this may happen in the future, restoration costs may need to be
estimated
� Restoration costs are one example of asset
retirement obligation (ARO)
Asset Retirement Obligaitons
-Often encountered with natural resource extraction when the land must be restored to a useable condition.
-Recognize the restoration costs as a liability and a corresponding increase in the related asset.
-Record at fair value, usually the present value
Intangible Assets
-Lack physical substance.
-Exclusive Rights
-Future benefits less certain than tangible assets
Intangible Assets
1) Valuation:
2) General rule:
1) Record at cost
2)
-Capitalize all acquisition costs and
- Expenditures necessary to make the intangible ready
for use.
- Just like the rule for tangible assets, but there's the
issue of R&D costs (will be discussed later)
Patents
� Patent - exclusive legal right to use, manufacture, or sell a
product or process
- Legal life is 20 years
If a patent is purchased, ______ the purchase price...
The cost might also include such other costs as legal and filing fees
to secure the patent.
- Attorney fees to defend the patent can also be capitalized
If a patient is developed internally, you can capitalize legal and filing fees
-R&D costs are expensed
Torch Inc. has developed a new device. Research and development
costs totaled $30,000. Patent registration costs consisted of $2,000
in attorney fees and $1,000 in federal registration fees. What is
Torch's patent cost?
Torch's cost for the new patent is
-Torch's cost for the new patent is $3,000. The $
Copyrights
Exclusive right to publish, sell, license or
otherwise control the use of art, literature or
music
� Capitalized costs
- Acquisition cost if purchased
- Application and legal fees
� Legal life is life of creator plus 70 years
- Useful life is often much s
Trademarks
� Symbols and names commonly used to identify a business
-Their value might be more valuable than it shows on their balance sheet
Capitalized costs of trademarkes...
-Purchase cost if acquired
- Registration and legal fees
- Registration with the U.S. Patent Office is good for 10 years and registration is renewable for an indefinite number of 10-year periods
- Why Microsoft only has $744 million intangible asset? On t
Franchises and Licenses
-Exclusive rights to perform certain functions or use certain
products or services
-Capitalized costs
--> Any lump-sum advance payment to secure the franchise
-->Legal fees
-Periodic payments to the franchisor are expensed
-->Service fee (usually a percen
Goodwill
-Goodwill is the excess of the purchase price of an
enterprise over the fair market value (FMV) of the
net assets acquired
-->Goodwill can only be purchased through the acquisition of another company.
How to calculate goodwill:
- Fair value of consideration exchange (purchase price)
- Fair value of net assets of the company
Goodwill Calculation: Eddy Company paid $1,000,000 to purchase all of
James Company's assets and assumed James
Company's liabilities of $200,000. James
Company's assets were appraised at a fair value of
$900,000. What amount of goodwill should Eddy
compan
Consideration Given: 1,000,000
Fair value of net assets:
FV of assets 900,000
Less FV of liabilities assumed 200,000
-->Therefore 1,000,000-700,000= 300,000 of Goodwill
Refer to Goodwill Exercise (Slide 16)
...
Noncash Acquistions
-Deferred payments
-Issuance of equity securities
-Donated assets
The asset acquired is recorded at the _____ ______ of the consideration given or the _____ _____ of the asset acquired, whichever is more clearly evident
Fair value, fair value
Deferred Payments:
-Happy Hal's Pizza Parlor purchased a delivery vehicle by
agreeing to pay $5,000 down and signing a note payable
of $15,000.
-What is the entry to record this transaction?
Truck 20,000
Cash 5,000
N/P 15,000
Stock exchanged for productive assets--> How to value it
-Value the asset at the FMV of the securities given or the FMV of the
assets acquired
-->Use the most objective and reliable measure
Issuance of Equity Securities:
On March 31, 2013, the Elcorn Company issued 10,000 shares of its nopar common stock in exchange for land. One the date of the transaction, the fair value of the common stock, evidence by its market price, was $20 per share.
Land 200,000
Common Stock (10,000 x $20) 200,000
The receiving company of donated assets are required to record...
-->The donated asset at fair value.
-->Revenue equal to the fair value of the donated asset.
Donated Assets example:
Elcorn Enterprises decided to relocated its office headquarters to the city of Westmont. The city agreed to pay 20% of the $20 million cost of building the headquarters in order to entice Elcorn to relocate. The building was comple
Building 20,000,000
Cash 16,000,000
Revene-donation of asset (20 x 20 million) 4,000,000
3 Steps of Dispositions
1) Update depreciation or amortization to date of disposal.
2) Remove original cost of asset and accumulated depreciation or
amortization from the books.
3) The difference between book value of the asset and the amount
received is recorded as a gain or lo
Disposition example: equipment with an historical cost of $70,000 and accumulated depreciation of $40,000 was sold for $25,000.
Since an asset with a book value of $30,000 ($70,000 cost - 40,000 accumulated depreciation) was exchanged for $25,000, the com
Cash 25,000
Accum Depr. 40,000
Loss on sale 5,000
Equipment 70,0000
Exchanges
-Exchanges of productive assets are accounted for
based on the fair market value of the assets
exchanged.
-->Might be fair value of the asset given up or the fair value of the asset received plus (minus) any cash exchanged.
-->The difference is balanced w
Exchanges example: Company A has a land in Ohio with a cost of $1 million and a fair market value of $3 million. Company A exchanges its land plus $500,000 for a land Company B owns in Illinois. The fair market value of Company B's land is $3.5 million.
Land (Illinois) 3,500,000
Cash 500,000
Land (Ohio) 1,000,000
Gain on exchange 2,000,000
Exchange Exercise: Calaveras Tire exchanged machinery for two pickup trucks. The book
value and fair value of the machinery were $20,000 (original cost of
$65,000 less accumulated depreciation of $45,000) and $17,000, respectively. To equalize fair values
Fair value of pickup trucks= 17,000 + 8,000 = 25,000
Loss= 20,000 - 17,000 = 3,000
Pickup Trucks 25,000
Accum Depr. 45,000
Loss 3,000
Cash 8,000
Machinery 65,000
Fair value not determinable
- When fair value cannot be determined or the exchange
lacks commercial substance, the asset(s) acquired are
valued at the book value of the asset(s) given up, plus (or
minus) any cash exchanged. No gain or loss is recognized.
In the previous example, assuming the fair value of
machinery is not determinable. How will you write the
journal entries?
Pickup trucks = 20,000 + 8,000 = 28,000
Pickup trucks 28,000
Accum Depr. 45,000
Cash 8,000
Machinery 65,000
Self-constructed assets--> Capitalize costs include
Capitalized costs include:
- Direct materials
- Direct labor
- Overhead
-->Incremental overhead only
-->Full-cost approach
- Interest (special rules apply)
Interest Capitalization:
Basic Principle
-Interest cost incurred during construction of fixed
assets is part of the cost of acquiring the assets
and preparing them for intended use.
-The interest cost should be capitalized as part of
the cost of the asset.
-->The cost will be allocated to expens
Overall steps in capitalization of interest
-The big picture: We will be preparing an adjusting entry at year-end
--> A company incurs construction costs
--> The company also borrows money and incurs interest costs
--> At year-end, a portion of the interest costs can be capitalized as part of the c
Step 1: Determine which assets qualify
� Qualifying assets
- Assets built for company's own use (e.g. a building)
- or discrete projects for sale or lease (e.g. ship, real
estate construction);
� Non-qualifying assets include inventories and
assets in use or ready for use
Step 2: Determine Capitalization Period
� A company can begin to capitalize interest when:
- Construction expenditures have been made
- Activities to make the asset ready for use are in
process,
- AND, interest cost of some kind is being incurred.
� Capitalization of interest ends when the asse
Step 3: Compute Average
Accumulated Expenditures (AAE)
� What is the average amount of funds that have
been tied up in the construction during the year?
� Expenditures are "weighted" by the amount of
time they were committed to the project.
AAE Calculation example:
� What is the average amount of funds that have
been tied up in the construction during the year?
� Expenditures are "weighted" by the amount of
time they were committed to the project.
REFER TO PAGE 49
...
Compute avoidable interest
� Avoidable Interest =
- Average Accumulated Expenditures x Rate
� There are special rules to determine the appropriate
interest rate
The Delmar Example: Delmar borrowed $300,000 at 12% from State Bank on Jan. 1 for the specific purpose of constructing special purpose equipment.
1) Why do we use 12%?
2) What will happen if Delmar only borrowed $200,000 for the specific purpose of constr
1) Because the loan was borrowed specifically for the construction and was sufficient to cover the AAE
2)
-Can capitalize: 200,000 * .12
-But can also capitalize interest on anouther $50,000 (interest = ?)
If AAE Exceed the Specific Debt
� Calculate the weighted average interest rate on all
other general corporate debt.
- Multiply that rate times the amount of the average
accumulated expenditures in excess of the specific debt.
� Or, if the company has no specific construction
loans:
- Us
Capitalization of Interest Example (PAGE 53)
...
Long Lived Assets: Utilization and Impairment
...
Q: The computer will provide economic benefits for five years. How to match the benefits with the costs over the five year
period?
� The matching principle requires that part of the acquisition
cost of PP&E and intangible assets be expensed in periods
when the future revenues are earned.
� Depreciation, depletion, and amortization are cost
allocation processes used to help meet the m
For PP&E what do you debit and credit?
Debit: Depreciation
Credit: Accumulated Depreciation
For Natural Resource what do you debit and credit?
Debit: Depletion
Credit: Natural Resource
For Intangible asset what do you debit and credit?
Debit: Amortization
Credit: Intangible Asset
Cost allocation requires three pieces of information for each asset
Service Life (How Long), Allocation Base (How Much), Allocation Method (How)
Service Life
The estimated expected use from an asset
Allocation Base
Total amount of cost to be allocated--> Cost - Residual value (at end of useful life)
Allocation Method
Systematic approach used for allocation
Depreciation Methods
Time-based methods, activity-based methods, Group and composite methods
Time-based methods
- Straight-line (SL)
- Accelerated Methods
--> Sum-of-the-years'-digits (SYD)
--> Declining Balance (DB)
Activity-based methods
- Units-of-production method (UOP)
Group and composite methods
...
Straight-line
-(Acquisition cost - Residual value) / (Estimated Service Life in Years)
-The most widely used and most easily understood method
-Results in the same amount of depreciation in each year of the asset's service life
Straight-line example: On January 1 2014, Lowe's purchased an equipment for $50,000 cash.
The equipment has an estimated service life of 5 years and
estimated residual value of $5,000.
(50,000 - 5,000) / 5 = 9,000
Accelerated methods result in ______ depreciation in the early years of an asset's useful and _______ depreciation in later years of an asset's useful life.
- more, less
-Note: that total depreciation over the asset's useful
life is the same as the straight-line method.
Sum-of-the-year'-digits
SYD = [Usefullife <--> (UsefulLife + 1)] / 2
SYD Deprec. = (Cost - Residual Value) x Remaining Years of Useful Life as of the beginning of the year / Sum-of-the-Years' Digits
SYD Example: On January 1 2014, Lowe's purchased an equipment for $50,000 cash. The equipment has a service life of 5 years
and an estimated residual value of $5,000. Using SYD depreciation, compute depreciation expense for
the first two years.
SYD = (5 x 6) / 2 = 15
Year 1: (50,000 - 5,000) x (5/15) = 15,000
Year 2: (50,000 - 5,000) x (4/15) = 12,000
Declining-Balance (DB) Methods
� Based on the straight-line rate multiplied by an
acceleration factor (most common one is 2).
� Computations initially ignore residual value.
- Double-Declining-Balance (DDB) depreciation
is computed as follows:
DDB =Book Value � ( 2 � Straight-line Rate
DDB = On January 1 2014, Lowe's purchased an equipment for $50,000 cash. The equipment has a service life of 5 years and an estimated residual
value of $5,000. Using DDB depreciation, compute depreciation expense for the first two years.
Straight-line rate = 1/5 = 20%
Year 1: Book value x 40% = 50,000 x 40% = 20,000
Year 2: Book value x 40% = (50,000-20,000) x 40% = 12,000
Year 3: (50,000 -20,000 - 12,000) x 40% = 7200
Year 4: (50,000 - 20,000 - 12,000- 7200) x 40% = 4320
Year 5: Force en
Activity-Based Depreciation: Units-of-Production
-Depreciation =Depreciation
rate per unit of activity �
Units of activity
- Depreciation rate per unit of activity = (Acquisition cost - Residual value) / (Estimated unites to be produced)
Units-of-Production example: On January 1 2014, Lowe's purchased an equipment for $50,000 cash. The equipment is expected to produce
100,000 units during its life and has an estimated residual value of $5,000.
If 22,000 units were produced this year, what
-Depreciation rate per unit = (50,000?5,000) / (100,000) =0.45
Deprec = 0.45 x 22000 = 9900
Group and Composite Methods
� Depreciation can be costly and time consuming
� Assets are grouped by common characteristics.
� An average depreciation rate is used.
� Annual depreciation is the average rate � the total group
acquisition cost.
� Accumulated depreciation records are no
Different Depreciation Method Exercise = On January 1 2013, Canseco Plumbing Fixtures purchased equipment
for $30,000. Residual value at the end of an estimated four-year service life is expected to be $2,000. The company expects the
machine to operate fo
a) (30,000 -2000)/4 = $7,000 for both 2013 and 2014
b) SYD
SYD = 10
2013: (30,000 - 2000) x 4/10 = 11,200
2014: (30,000 - 2000) x 3/10 = 8400
c) DDB
Straight-line rate = 25% --> DDB rate = 50%
2013: 30,000 x 50% = 15,000
2014: (30,000 - 15000) x 50% = 750
Depletion of Natural Resources: As natural resources are "used up," or depleted, the cost of the natural resources must be...
allocated to the units extracted. --> The approach is based
on the units-ofproduction
method.
Depletion Rate per Unit = (Cost of Natural Resource - Residual Value) / (Estimated Recoverable Units)
Total Depletion Cost = Unit Depletion Rate x Units Extracte
Example of Depletion of Natural Resources: ABC Mining acquired a tract of land containing ore deposits. Total costs of acquisition and development were $1,100,000. ABC estimated the land contained 40,000 tons of ore, and that the land will be sold for $10
� Depletion rate = 1,000,000 � 40,000 tons = $25 per ton
� Depletion = 13,000 tons � $25per ton = $325,000
Journal Entry:
Dr. Depletion expense 325,000
Cr. Ore Mine 325,000
A contra-asset account is generally not used.
An intangible asset's useful life may be limited by
legal, regulatory, or contractual provisions
For an intangible asset with a finite useful life, we allocate capitalized costs over...
the asset's useful life using the
straight-line method, normally with a zero residual value.
The amortization entry is...
Debit Amortization expense .................................. $$$
Credit Intangible asset .......................... $$$
Amortization of Intangible Assets at Facebook Example (PAGE 29)
...
Intangible Assets Not Subject to Amortization
� Goodwill and trademarks are often are considered to have
indefinite useful lives.
- There are no foreseeable limits on the period of time over which
these assets provide future economic benefits.
� However, if the management plans to phase the
trademark
Partial-Period Depreciation: What happens if PP&E and intangible assets are not
purchased on January 1st? Pro-rating the depreciation based on the date of acquisition is time-consuming and costly. A commonly used alternative is the . . .
Half-year convention
Half-year convention
Take � of a year of depreciation in the year of acquisition, and the other � in the year of
disposal.
Changes in estimates
Changes in estimates are accounted for prospectively.
The book value less any residual value at the date of
change is depreciated over the remaining useful life. A
disclosure note should describe the effect of a change.
Changes in Estimates example:
� On January 1, a car was purchased that cost $30,000, has a useful life of 10 years, and no residual value. At the
beginning of the fourth year, it was decided that there were only 5 years remaining, instead of 7 years.
� Ca
Book value after three years = 30,000 - 3000 x 3 = 21,000
Revised annual depreciation 21,000 /5 = 4200
A change in depreciation, amortization, or depletion
method is considered a change in...
-Accounting estimate that
is achieved by a change in accounting principle.
-We account for these changes prospectively, exactly as we
would any other change in estimate.
Change in Depreciation Method Example: (PAGE 36)
...
Errors found in a subsequent accounting period are
corrected by . . .
- Entries that restate the incorrect account balances to the correct amount
- Restating the prior period's financial statements
- Reporting the correction as a prior period adjustment to Beginning R/E
� In addition, a disclosure note is needed to describe
Value Impairment example: Many analysts and investors are concerned about the $15 billion goodwill from WhatsApp acquisition
Goodwill hunting (read this article about facebook goodwill if you
are interest: bit.ly/fbgoodwill)
- Risk of value reduction so that the asset does not provide as much
future economic benefit
- May also apply to other tangible and intangible assets
� The
Impairment of value for Long-term assets to be held and used
1) PP&E and intangible with finite useful lives (Test for impairment of value
when it is suspected that book
value may not be recoverable.)
2) Intangibles with indefinite useful lives
3) Goodwill (Test for
impairment of
value when it is
likely that the fa
Impairment of Value for Long-term assets held for sale
Test for impairment of value when considered for sale.
Impairment: Finite-Life
Assets to Be Held and Used 2 steps
1) Determine whether the asset is impaired
2) Calculate the impairment loss
How to determine whether the asset is impaired
The undiscounted sum of
its estimated future cash
flows < its book value
How to calculate the impairment loss:
Impairment loss = Book value - Fair value
Where is impairment loss recorded in the income statement?
-As a separate component of operating expense
What is fair value?
-Market value, price of similar assets, or PV of future net cash flows
Impairment Loss for Finite Life Assets Example: Because Acme Auto Parts has seen its sales steadily decrease due to
the decline in new car sales, Acme's management believes that
equipment that originally cost $350 million, with a $200 million book
value,
1) $140 million < $200 million
Impairment loss is indicated.
2) Impairment loss = $200 million - $120 million = $80 million
3)
Impairment loss= 80,000,000
Accum Deprec= 150,000,000
Equip 230,000,000
Impairment: IndefiniteLife
Intangibles--> Goodwill (2 steps)
Step 1) If BV of reporting unit >
FV of the unit, impairment
indicated.
Step 2) Loss = BV of goodwill
less implied value of goodwill.
Impairment: IndefiniteLife
Intangibles--> Other Indefinite life intangibles
One-Step Process
If BV of asset > FV, recognize impairment loss
Impairment of Goodwill Example: Simmons Company recorded $150 million of goodwill when it acquired Blake Company. Blake continues to operate as a separate company
and is considered to be a reporting unit. At the end of the current year Simmons noted the f
� Step 1: Impairment or Not?
$500 million > $400 million Impairment loss is indicated
� Step 2: Calculate impairment loss
Implied value of goodwill = 400-350 = 50 million
Goodwill impairment = 150 - 50 = 100 million
Goodwill Impairment exercise: WebHelper Inc. acquired 100% of the outstanding stock of Silicon Chips Corporation (SCC) for $45 million, of which $15 was allocated to
goodwill. At the end of the current fiscal year, an impairment test reveals the following
� Step 1: Impairment or not?
BV of reporting unit ($42 million) vs. FV of reporting unit ($40 million)
� Step 2: Calculate impairment if necessary.
BV of goodwill: 15 million
FV of goodwill: 9 million (40-31)
Impairment = 15 million -9 million = 6 million
Real World Example: HP recorded a non-cash charge for the impairment of goodwill and
intangible assets within its Software segment of approximately $8.8 billion
in the fourth quarter of its 2012 fiscal year. The majority of this
impairment charge is linke
...
Assets held for sale
-Assets held for sale
include assets that management
has committed to sell immediately in their present condition and for which sale is probable.
Impairment loss =Book value - Fair value less
cost to sell
Impairments at HP Example (PAGE 45)
...
INVESTMENTS
...
Investment (marketable securities):
debt and equity securities issued by other companies (e.g.: stock; corporate bond) or the government
(e.g.: treasury bills)
-->Classified as part of current assets (unless firm is holding them for long term purposes). Other names: Short term investments;
Why do firms invest?
- Make money by using securities as revenue sources (e.g.: Warren Buffet's
Berkshire Hathaway makes money from investing)
- Make money by obtaining a favorable business relationship (e.g.: Coca-Cola invests in its bottler companies)
- Hedge risk (e.g.: So
Two key criteria for capturing economics of the investment in securities:
- How much influence do you have over the firm you own?
� Less than 20% (little influence)
� Between 20% and 50% (significant influence)
� More than 50% (controlling influence)
- What is your intent of time horizon for "cashing out"?
� Generate income bas
Book value:
the value that the accountant records on the books.
- For example, PP&E's book value is historical cost, adjusted for depreciation
- Some investments are reported at book value. For example, Held-to-maturity
securities are recorded at amortized cost
Market value:
-price at which the item could be sold in the market (i.e.,
market price).
-->For example, market value for $100 shares of IBM stocks can be calculated using the current market price
Fair value:
-an arm's length price at which the buyer and seller would be
willing to transact.
- If there is a well-established market, then FV = MV.
- Sometimes this amount is not observed but estimated. For example, to
determine the value of investments that are no
1) Securities to Be Held to
Maturity (HTM)
2) They are reported on the balance sheet at
1) � Debt securities usually have a specific maturity date. The
investor may have the "positive intent and ability" to hold
the securities to maturity (HTM).
- Not all debt securities are HTM
� The firm (investor) will receive principal on the maturity da
Time Value of Money
� $1 tomorrow is worth less than $1 today
� Bonds with a face value (principal) and coupon interest
rate might be issued at discount or premium
HTM Example: On January 1, 2013, Matrix Inc. purchased a 10-year bond with $1,000,000 face value and 10% interest paid semi-annually. The market rate for similar bonds is 12%. Matrix paid 885,301 for this investment. (The present value of future payments
1) Investment in bonds (face amount) 1,000,000
Discount on bond investment (to balance) 114,699
Cash (present value, cash paid) 885,301
Book Value on 1/1/13: 885,301
2) June 30, 2013 (to record interest revenue)
Cash (face value x coupon rate x fraction o
HTM: At the Time of Selling Example: On December 31, 2013, after interest is received by Matrix, all the bonds are sold for $900,000 cash.
1) Record interest revenue
2) Record sale of bond
12/31/13
Cash 50,000
Discount on bond investment 3,305
Investment revenue 53,305*
53305 = 888,419
12% x 6/12
12/31/13
Cash (cash receipt) 900,000
Discount on bond investment (unamortized discount) 108,276
Investment in bonds (face amount) 1,000,000
Gain o
Financial Statement Presentaiton PAGE 13
...
Trading Securities (TS)
� Investments in debt or equity securities acquired principally
for the purpose of selling them in the near term.
- Common for financial service firms (Investment banks such as
Goldman Sachs; AIG)
Unrealized gains or losses are record of TS
1. in a valuation account called fair value adjustment, or as a direct
adjustment to the investment account.
2. as a net unrealized holding gain/loss on the income statement.
TS Example: PAGE 15
...
Financial Statement Presentation for TS in Income Statement
Fair value changes are included in the income statement in
the periods in which they occur, regardless of whether they are
realized or unrealized. Investments in trading securities do not affect
other comprehensive income
Financial Statement Presentation for TS in Balance Sheet
Securities are reported at fair value, typically as
current assets, and do not affect accumulated other comprehensive
income in shareholders' equity.
Financial Statement Presentation for TS in Cash Flow Statement
Cash flows from buying and selling trading securities typically are classified as operating activities, because the investors that hold trading securities consider them as
part of their normal operations.
Investments in debt or equity securities that are not for active trading and not to be held to maturity are classified as
available-for-sale (AFS).
--> AFS is between HTM and TS.
Unrealized gains or losses are recorded (2 ways)
1. in a valuation account called fair value adjustment, or as a direct adjustment to the investment account.
2. as a net unrealized holding gain/loss in other comprehensive income (OCI), which accumulates in accumulated other
comprehensive income (ACOI).
When we add other comprehensive income to net income we refer to the result as
comprehensive income.
Accumulated Other
Comprehensive Income
Unrealized holding gains and losses on available-forsale
securities are accumulated in the shareholders' equity section of the balance sheet. Specifically, the
account is included in accumulated other comprehensive income (AOCI).
AFS Example PAGE 22
...
AFS are presented in Income Statement as
Realized gains and losses are shown in net income in the period in which securities are sold. Unrealized gains and losses are shown in OCI in the periods in which changes in fair value occur, and reclassified out of OCI in the periods in which securities
Balance Sheet
Investments in AFS securities are reported at fair value. Unrealized gains and losses affect AOCI in shareholders' equity, and are reclassified out of AOCI in the periods in which securities are sold.
Cash Flow Statement
Cash flows from buying and selling AFS securities typically are classified as investing activities.
Exercise: HTM, AFS, and TS PAGE 28
...
At each reporting date, the appropriateness of the
classification is
� At each reporting date, the appropriateness of the
classification is reassessed and reclassifications may occur.
Any unrealized holding gain or loss at reclassification should
be accounted for in a manner consistent with the
classification into which th
Occasionally, an
investment's value will
decline for reasons that
are other-than- temporary
(OTT).-->
Impairment in Value
For HTM and AFS investments, a company recognizes an OTT impairment loss in...
earnings
Determining an "other
than temporary" decline for debt securities can be quite
complex. For both equity and debt investments, after an
OTT impairment is recognized,
the ordinary treatment of
unrealized gains and losses is resumed.
US GAAP
� U.S. GAAP permits
classification as HTM, AFS, and
TS.
� No significant tests are
required to classify a debt
investment.
� There is no comparable FVTPL
or FVTOCI classification.
IFRS
Investments in debt securities are
classified as either "Amortized
Cost" (similar to HTM) or FVTPL.
� To be classified as amortized cost
category, two important tests must
be met. The past financial crisis
qualified as one of those
circumstances.
� Invest
Significant influence:
If an investor owns more than 20% of the voting stock of an investee, it is presumed that the investor has significant influence over the financial and operating policies of the investee.
Lack of significance and reporting method
(usually < 20% equity ownership)
Varies depending on classification as previously discussed
Significant influence and reporting method
-(usually 20-50% equity ownership)
- Equity method
Has control
(Usually > 50% equity ownership)
-Consolidation
What is Equity Method?
The investor recognizes investment income equal to its
percentage share (based on stock ownership) of the net
income earned by the investee rather than the portion
of that net income received as cash dividends.
-Initially, the investment is recorded at co
Equity Method Example ON PAGE 36
...
Fair value option
GAAP allows companies to use a "fair value option" for
HTM, AFS, and equity method investments.
- The investment is carried at fair value.
- Unrealized gains and losses are included in net income.
� For HTM and AFS investments, this amounts to classifying
Consolidation
When one company (A) owns more than 50% shares in
another company (B), it has the controlling right (i.e.:
company B becomes a subsidiary of company A)
- E.g.: After Berkshire acquired Duracell, Duracell will become a
subsidiary of Berkshire
Accounting treatment of consolidation
Consolidated financial statements combine the financial statements
of the parent and the subsidiary each period into a single
aggregate set of financial statement as if there were only one company
- Economic entity assumption