Long-lived assets

In depth

What goes into the cost of an asset

Under the historical cost principle an asset is recorded at everything it took to acquire it and get it ready for its intended use. IAS 16 spells this out: cost is the purchase price, including import duties and non-refundable purchase taxes, after trade discounts and rebates, plus the costs directly attributable to bringing the asset to the location and condition needed for it to operate as intended, such as site preparation, delivery and handling, installation and assembly, and testing (IAS 16, paragraphs 16–17). US GAAP (ASC 360) applies the same idea. Costs that would be incurred whether or not the asset was bought do not qualify: opening a new facility, advertising a new product, training staff, and administration and general overheads are expenses (IAS 16, paragraph 19).

• Capitalise: purchase price less trade discounts; non-refundable sales tax and import duties; freight and insurance in transit; installation, assembly and testing; professional fees such as an architect’s or engineer’s; for land, legal fees, title costs and the cost of clearing it.
• Expense: staff training; day-to-day servicing and repairs; repairs of damage caused in delivery or installation; advertising; general overheads; interest on money borrowed to buy a finished asset.

Land, land improvements and buildings are kept in separate accounts because they are treated differently. Land has an unlimited life and is not depreciated. Land improvements, such as a car park, fences and outdoor lighting, wear out and are depreciated. A building is depreciated over its own life. When a business buys land with an old building that it demolishes, the cost of demolition (less anything recovered from the materials) is part of the cost of the land, because it was needed to make the land ready for use.

Spending after an asset is in use follows the same test. Day-to-day servicing (oil changes, descaling the espresso machine, new tyres when they wear out) keeps the asset working as expected and is expensed (IAS 16, paragraph 12). Spending that extends the useful life, increases capacity or improves quality, such as a new engine or a second grinder head, is capitalised and depreciated over the remaining life. Many businesses set a capitalisation threshold, expensing small purchases such as a $40 kettle even though it will last for years; this applies the idea of materiality and is a policy, not a rule of the standards.

Three depreciation methods

Every method allocates the same total, the depreciable amount (cost minus residual value), over the same useful life; they differ only in timing. IAS 16 requires the depreciable amount to be allocated on a systematic basis (paragraph 50) by a method that reflects the pattern in which the asset’s benefits are consumed (paragraph 60), and names three: the straight-line method, the diminishing balance method and the units of production method (paragraph 62). It forbids methods based on the revenue an asset generates (paragraph 62A). US companies use the same three methods.

The straight-line method of F01 charges the same amount every full year. The double-declining-balance method, the commonest diminishing balance method, charges twice the straight-line rate on the asset’s book value at the start of each year: for a five-year asset, 2 × 20% = 40% (a 150% declining-balance method uses 1.5 times the straight-line rate, 30%). Residual value is not subtracted from the base, but depreciation stops when book value reaches it. The method front-loads the expense, which suits assets that lose most of their usefulness early, such as computers. The units-of-production method ties depreciation to use: divide the depreciable amount by the total expected output (miles, hours, units), and charge that rate for each unit used.

Double-declining balance: 2026 is 30,000 × 40% × 7/12 = 7,000; 2027 is 23,000 × 40% = 9,200; 2028 is 13,800 × 40% = 5,520; in 2029 40% of 8,280 would be 3,312, which would take book value below the $6,000 residual value, so only 2,280 is charged.

The table shows the pattern. Both methods charge $24,000 in total and end at the $6,000 residual value, but double-declining balance charges $7,000 in 2026 against $2,800 for the straight line, and nothing at all in 2030 and 2031. Suppose instead that Ana expected the van to cover 120,000 miles in its life, and that it covered 16,500 miles from June to December. Units of production would charge $(30{,}000 - 6{,}000) \div 120{,}000 = 0.20$ a mile, $16{,}500 \times 0.20 = 3{,}300$ for 2026, and more in a busy year than in a quiet one.

Lantern’s depreciation for 2026

Both of Lantern’s adjustments use the straight-line method and the full-month convention. The equipment was bought in March, so it bears ten months; the van, bought in June, bears seven.

After the two entries, the equipment’s book value is $12{,}000 - 2{,}000 = 10{,}000$ and the van’s is $30{,}000 - 2{,}800 = 27{,}200$, so property and equipment are shown at $37{,}200$. Depreciation expense for the year is $2{,}000 + 2{,}800 = 4{,}800$, the amount added back to operating income to give EBITDA.

When an estimate changes

Useful lives and residual values are estimates, and IAS 16 requires them to be reviewed at least at each financial year-end (paragraph 51). When new information changes an estimate, the change is a change in accounting estimate: it is applied from the period of the change onward, and earlier statements are not restated (ASC 250; IAS 8, paragraph 36). The new charge spreads the book value that remains, less the new residual value, over the remaining life. Suppose that on 1 January 2028 Ana decides to replace the espresso machine at the end of 2029 and expects to sell it then for $1,600. Its book value at 31 December 2027 is $12{,}000 - 2{,}000 - 2{,}400 = 7{,}600$, so depreciation for 2028 and 2029 becomes $(7{,}600 - 1{,}600) \div 2 = 3{,}000$ a year instead of $2,400; the 2026 and 2027 figures stand, because they were the best estimates at the time.

A change of depreciation method is treated the same way, prospectively. US GAAP calls it a change in estimate effected by a change in accounting principle and allows it only if the new method is preferable; IAS 16 requires the method itself to be reviewed each year (paragraph 61). A method is not something to switch to improve a year’s profit.

Disposals: gains and losses

When an asset is sold, scrapped or traded in, three steps take it off the books. First, record depreciation up to the date of disposal, so the book value is current (by whole months under Lantern’s convention: an asset sold on 31 May bears May’s depreciation, one sold on 1 June does not). Second, remove the asset’s cost and its accumulated depreciation: credit the asset account, debit the contra account. Third, record what was received and the difference: proceeds above book value are a gain on disposal; proceeds below it, a loss. An asset scrapped for nothing produces a loss equal to its book value.

A gain on disposal is not revenue, because selling used equipment is not what the business exists to do (IAS 16 says so in paragraph 68). Under US GAAP the gain or loss belongs in income from continuing operations, and if the income statement shows an operating income subtotal, it is included in that subtotal (ASC 360-10-45-5). Many introductory textbooks show them under other income instead, but a US GAAP income statement that reports operating income must include them in it, as Lantern’s chart does. Either way they are kept apart from revenue and from the depreciation charge. A gain or loss is partly a correction of the depreciation charged earlier: had the estimates been perfect, the book value would have equalled the proceeds and there would have been neither.

Intangible assets

An intangible asset is recognised when it is bought, or acquired as part of a business, and can be identified separately: a patent, a copyright, a trademark, a licence, customer lists or software. A patent gives its owner the exclusive right to an invention; a US utility patent filed on or after 8 June 1995 runs for 20 years from the filing date. Intangibles with a finite useful life are amortised, usually by the straight-line method and with no residual value, over the shorter of their legal life and the period the business expects to benefit. Those with an indefinite life, such as a trademark the owner can renew indefinitely and intends to keep, are not amortised but are tested for impairment every year. Lantern’s chart records amortisation in a contra account, Accumulated Amortisation—Patents; some companies credit the patent account directly.

Intangibles a business creates itself are a different matter. US GAAP expenses research and development as it is incurred (ASC 730-10), so a patent developed in-house carries only its legal and registration costs. IAS 38 also expenses research but capitalises development costs once specified criteria are met. The GAAP and IFRS lesson compares the two.

Goodwill

Goodwill arises only when one business buys another. It is the amount by which the price paid exceeds the fair value of the identifiable assets acquired less the liabilities assumed, and it stands for things that can’t be recognised separately: reputation, an assembled workforce, expected savings from combining the two. Suppose Aster Hotel Group, a fictional chain, pays $2,600,000 for a guesthouse business whose identifiable assets are worth $2,450,000 and whose liabilities are $350,000. Goodwill is $2{,}600{,}000 - (2{,}450{,}000 - 350{,}000) = 500{,}000$. A business can’t record goodwill it builds for itself, however valuable its name.

What happens next depends on who reports. A public company under US GAAP does not amortise goodwill; it tests it for impairment at least annually (ASC 350-20-35-28) and writes it down if it is impaired. A private company may elect an accounting alternative, introduced by ASU 2014-02 and extended to not-for-profits by ASU 2019-06, that amortises goodwill on a straight-line basis over ten years, or less if another life is more appropriate, and tests it for impairment only when an event suggests it may be impaired; Aster, if private, could amortise $500{,}000 \div 10 = 50{,}000$ a year. Full IFRS does not amortise goodwill either (the separate IFRS for SMEs Accounting Standard does): IAS 36 tests it every year, and an impairment loss on goodwill is never reversed. The FASB considered requiring public companies to amortise goodwill but removed that project from its agenda in June 2022; in July 2026 it added a project on the level and frequency of goodwill impairment testing, so check the current rule before relying on this paragraph.

Impairment in outline

An asset is impaired when it can no longer earn back its carrying amount, perhaps because demand has fallen, the asset is damaged or technology has moved on. The two frameworks test this differently. US GAAP (ASC 360) uses two steps when events suggest a problem: if the undiscounted future cash flows from the asset are less than its carrying amount, the asset is written down to fair value, and an impairment loss on an asset held and used is never reversed. IAS 36 uses one step: the carrying amount is compared with the recoverable amount, the higher of fair value less costs of disposal and value in use (the present value of the future cash flows). If conditions improve, an impairment loss on an asset other than goodwill is reversed, up to the carrying amount the asset would have had without it.

Value in use (discounted cash flows) is 440,000; fair value less costs of disposal is 410,000 − 10,000 = 400,000; the recoverable amount is the higher. Under US GAAP the loss, had the test been failed, would have been carrying amount minus fair value.