What we have seen so far is the cost model of accounting where an asset is recorded originally at cost. This value is then depreciated every year. An alternative to cost model is the revaluation model. Under the revaluation model, assets are revalued periodically. The carrying value of an asset after revaluation becomes the fair value. The method is used when the fair value of an asset can be easily determined and is subject to judgment.
IFRS permits the use of either the cost model or the revaluation model for the valuation and reporting of long-lived assets, but the revaluation model is not allowed under US GAAP.
Impact of revaluation on financial statements
The impact of revaluation on financial statements depends on whether the revaluation initially increased or decreased the asset class’ carrying amount. Let us consider both the cases.
When a revaluation initially decreases the carrying amount of an asset:
When a revaluation initially increases the carrying amount of the asset class:
Upward Corp, a hypothetical manufacturing company, has elected to use the revaluation model for its machinery. Assume for simplicity that the company owns a single machine, which it purchased for $20,000 on the first day of its fiscal period, and that the measurement date occurs simultaneously with the company’s fiscal period end.
At the end of the first fiscal period, the company’s balance sheet will show the asset at a value of $22,000. The $2,000 increase in the value of the asset will appear in other comprehensive income and be accumulated in equity under the heading of revaluation surplus.
Note: Gains do not go through income statement and instead go directly to equity under revaluation surplus. In case of loss, part of the decrease is shown as loss in income statement.
At the end of the second fiscal period, the company’s balance sheet will show the asset at a value of $15,000. The total decrease in the carrying amount of the asset is $7,000 ($22,000 – $15,000). Of the $7,000 decrease in the carrying amount, $2,000 will reduce the amount previously accumulated in equity under the heading of revaluation surplus. This does not go through the income statement. The other $5,000 will be shown as a loss on the income statement.
Downward Corp, a hypothetical manufacturing company, has elected to use the revaluation model for its machinery. Assume for simplicity that the company owns a single machine, which it purchased for $20,000 on the first day of its fiscal period, and that the measurement date occurs simultaneously with the company’s fiscal period end.
At the end of the first fiscal period, the company’s balance sheet will show the asset at a value of $15,000. The $5,000 decrease in the value of the asset will appear as a loss on the company’s income statement.
At the end of the second fiscal period, the company’s balance sheet will show the asset at a value of $22,000. The total increase in the carrying amount of the asset is an increase of $7,000 ($22,000 – $15,000). Of the $7,000 increase, $5,000 goes towards reversal of a previously reported loss and will be reported as a gain on the income statement. The other $2,000 will bypass profit or loss and be reported as other comprehensive income and be accumulated in equity under the heading of revaluation surplus.
Impairment charges reflect an unexpected decline in the fair value of an asset to an amount lower than its carrying amount (Whereas depreciation and amortization charges allocate the cost of a long-lived asset over its useful life.)
Under US GAAP,
Impact of Financial Statements
When an asset is impaired the impact in that period is:
The impact in subsequent periods is:
Given the following data, what is the reported value under IFRS and US GAAP:
IFRS: Recoverable amount = greater of ($7,000 – $200, $ 6,000) = $6,800
Impairment loss = $8,000- $6,800 = $1,200
Write down the value of asset from $8,000 to $6,800 in the balance sheet and record a loss of $1,200 in the income statement.
US GAAP: Is the asset impaired? No, since the carrying amount of $8,000 is less than the undiscounted future cash flows of $9,000.
Other Impairment Scenarios
Impairment of Intangible Assets with Indefinite Lives: Intangible assets with infinite lives such as goodwill are not amortized. They are carried on the balance sheet at historical cost, but they are tested annually for impairment.
Impairment of Long–Lived Assets Held for Sale: A long-lived asset is reclassified as held for sale, if the management’s intent is to sell it and its sale is highly probable. For example, if a company owns a machine with the intent of using it but now intends to sell it, then it should be reclassified as held for sale. Held-for-sale assets are not depreciated or amortized. At the time of reclassification, the asset should be tested for impairment and any impairment loss should be recognized.
The impairment loss can be reversed under IFRS and US. GAAP if the value of the asset recovers in the future. However, this reversal is limited to the original impairment loss. Therefore, the carrying value of the asset after reversal cannot exceed the carrying value before the impairment was recognized.
A company derecognizes an asset (i.e., removes it from the financial statements) when the asset is disposed of or is expected to provide no future benefits from either use or disposal.
The three ways in which an asset can be derecognized (removed from a company’s financial statements) are as follows:
Impact on Financial Statements
A derecognition can result in either a gain or loss on the income statement.
Under IFRS, for each class of property, plant, and equipment, a company must disclose the measurement bases, the depreciation method, the useful lives (or, equivalently, the depreciation rate) used, the gross carrying amount, the accumulated depreciation at the beginning and end of the period, and a reconciliation of the carrying amount at the beginning and end of the period.
Under U.S. GAAP, the requirements are less exhaustive. A company must disclose the depreciation expense for the period, the balances of major classes of depreciable assets, accumulated depreciation by major classes or in total, and a general description of the depreciation method(s) used in computing depreciation expense with respect to the major classes of depreciable assets.
The disclosures related to impairment losses also differ under IFRS and US GAAP. Under IFRS, a company must disclose for each class of assets the following:
Under US GAAP, reversal of impairment losses for assets held for use is not permitted. The company must disclose the following:
Assuming straight-line depreciation and no salvage value, we can state the following relationships:
Estimated total useful life = Time elapsed since purchase (Age) + Estimated remaining life
Estimated total useful life = Historical cost ÷ annual depreciation expense
Historical cost = Accumulated depreciation + Net PPE
The information presented in a company’s disclosures and these relationships can be used to conduct an analysis on the company’s long-lived assets.
Investment property is defined as property that is owned (or, in some cases, leased under a finance lease) for the purpose of earning rentals, capital appreciation, or both.
Under IFRS, companies are allowed to value investment properties using either a cost model or a fair value model. The cost model is identical to the cost model used for property, plant, and equipment, but the fair value model differs from the revaluation model used for property, plant, and equipment. Under the fair value model, all changes in the fair value of investment property affect net income.
Under U.S. GAAP, investment properties are generally measured using the cost model.