IFRS for Long-lived Assets & R&D

1. IFRS for Long-lived Assets & R&D With comparison to US GAAP

2. IFRS for long-lived assets including intangibles Relevant IFRS: • IAS 16, Property, Plant and Equipment • IAS 38, Intangible Assets, • IAS 36, Impairment of Assets • IFRS 5, Non-current Assets Held for Sale and Discontinued Operations)

3. Plant, Property & Equipment • IFRS • PP&E can be carried at historical cost or revalued amount less accumulated depreciation & impairment • Interest costs are capitalized if criteria of IAS23 are met • No inclusion of ARO in cost of asset when used for production of inventories • US GAAP • PP&E must be carried at historical cost less accumulated depreciation • Interest costs must be capitalized if FAS34 requirements are met • AROs are recognized where there is a obligation to be met at retirement (no exception)

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

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

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

7. Research & Development • IFRS • Development costs must be capitalized and amortize if criteria are met • Cost to develop websites must be capitalized if criteria are met, including probably future economic benefit • In-process R&D acquired as part of business combination is capitalized • Revaluation is allowed although rare • US GAAP • Expense R&D as incurred • Website cost capitalization depends on phase of spending based on SOP 98-1 and/or FAS86 • IPR&D acquired as part of business combination is expensed immediately • Revaluation is not allowed

8. Research vs. Development under IFRS (IAS38, para. 54-57) First step – classify internally generated intangible assets as being in either (1) a research phase or (2) a development phase • Research is expensed as incurred • Development costs are capitalized only when the entity can demonstrate all of the following: • Next slide – 6 criteria

9. Capitalization Criteria [IAS38 ¶57] The technical feasibility of completing the intangible Its intention to complete the intangible asset Its ability to use or sell the intangible asset How the intangible asset will generate probable future economic benefits The availability of adequate technical, financial and other resources to complete Reliable measurement of related expenditures

10. Caveats in IAS 38 Internally generated brands, mastheads, publishing titles, customer lists and items similar in substance shall not be recognized as intangible assets. Past expenses cannot not later be recognized as part of an intangible asset

11. Compare to FAS 86 Deferred Costs (Intangible Assets) R & D Costs (Expense) Inventory Costs Technological feasibility established Software available for commercial production Software sold Software project initiated

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

13. Impairment of Assets – IAS 36 US GAAP FAS 144 PP&E FAS 142 Intangibles & Goodwill

14. Impairment of long-lived assets • IFRS: 1-step process • Recoverable amount is higher of • Fair value less cost to sell • Value in use • Discounting required in evaluation stage • Impairment losses must be reversed if circumstances change (except goodwill) • FASB: 2-step process • FAS 144—for an asset in use, undiscounted future cash flows from use establish recoverability used for the impairment calculation • Not considered impaired unless undiscounted cash flows are less than carrying value • Discounting occurs only for the step 2 valuation stage • Impairment losses cannot be reversed

15. IFRS 1-step test Similar to US GAAP which requires annual impairment tests for intangibles with indefinite lives but not for other long-lived assets Impaired if recoverable amount > carrying value • At end of each reporting period, look for indications of impairment • Impairment tests need not be done if there are no indications of impairment • EXCEPTION • Intangible assets with indefinite useful life (including goodwill) and intangible asset not yet available for use • For these assets, impairment test is at end of reporting period

16. When there is an indication of possible impairment: IAS 36

17. Step 2 Step 1

18. IAS36 – Indicators of impairment Decline in market value greater than expected as a result of normal use or passage of time Significant adverse changes affecting entity including economic, technological, legal environment Higher interest rates which would make future cash flows less valuable Evidence of physical damage or obsolescence Plans to discontinue use, dispose of asset, etc.

19. FAS 144 Indicators of impairment • Events or changes in circumstances that could indicate that the carrying amount may not be recoverable • Decline in market value • Change in way asset is used or physical change in asset • Adverse changes in legal factors or business climate • Probable sale of asset before end of useful life • Current period losses with history of operating or cash flow losses associated with asset

20. Timing of impairment tests Very Similar • IFRS • When an indication of impairment is observed (look for them at least annually) • Land, buildings, equipment • Intangible assets with finite life • At least annually • (at same time of year but not necessarily at year end) • Intangibles with indefinite life including goodwill • Intangibles not yet in use (development costs) • US GAAP • When indication of impairment exists (FAS 144) long-lived assets intangibles subject to amortization (FAS142, para. 15) • At least annual tests for intangibles with indefinite life including goodwill • GW tested at reporting unit level – related to segment reporting rules FAS131 • Detailed evaluation of fair value may not be required every year

21. Timing of impairment tests Very Similar • IFRS • When an indication of impairment is observed (look for them at least annually) • Land, buildings, equipment • Intangible assets with finite life • At least annually • (at same time of year but not necessarily at year end) • Intangibles with indefinite life including goodwill • Intangibles not yet in use (development costs) • US GAAP • When indication of impairment exists (FAS 144) long-lived assets intangibles subject to amortization (FAS142, para. 15) • At least annual tests for intangibles with indefinite life including goodwill • GW tested at reporting unit level – related to segment reporting rules FAS131 Detailed re-evaluation each year can be waived if previous impairment test showed significant “headroom” IAS 36, ¶15 and FAS142 ¶27)

22. IAS36 – Measuring recoverable amount (1) Recoverable amount can be for an individual asset unless the asset does not generate cash flows that are largely independent of other assets • In this case, use a cash-generating unit (CGI) to which the asset belongs • This is the usual case

23. IAS36 – Measuring recoverable amount (2) Value in Use – based on calculations that include: • Estimate of future cash flows related to asset • Expectations about possible variations in amount or timing of future cash flows • The time value of money • Price for bearing uncertainty inherent in the asset • Other factors such as illiquidity

24. IAS36 – VIU (3) Discount rate to use Discount rate The discount rate (rates) shall be a pre-tax rate (rates) that reflect(s) current market assessments of: • the time value of money • the risks specific to the asset for which the future cash flow estimates have not been adjusted

25. IAS36 – Compare recoverable amounts (4) Value in Use (discounted cash flows) • Discount the future cash inflows and outflows to be derived from continuing use of the asset and from its ultimate disposal using appropriate discount rate Fair Value less costs to sell (market-based) • Best FV would be a binding sales agreement in an arm’s length transaction • Next best would be based on identical or similar assets traded in an active market • Never actually recommends discounted expected cash flow analysis

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

27. Impairment Example (con’t) • The management of Johnson Company estimates that the equipment has a remaining useful life of 7 years. Net cash inflow from the equipment will be $80,000 per year. The fair value of the equipment is $240,000 (based on market values of similar equipment). No goodwill was associated with the purchase of the equipment.

28. FAS 144 solution (slide a) • Determine if an impairment loss should be recognized. • Annual depreciation for the equipment has been $45,000 ($1,000,000 - $100,000)/20 years. Current book value of the equipment is: • Original cost $1,000,000 • Accumulated depreciation 360,000 ($45,000 * 8 years) • Book value $ 640,000

29. FAS 144 solution (slide b) • Determine if an impairment loss should be recognized. • Anticipated future cash flows $ 560,000  • (7 years * $80,000 per year) • Look at the flow chart – should we recognize an impairment? The fair value is lower, so an impairment loss should be recognized.  

30. FAS 144 solution (slide c) • The “step 2” phase: Determine the amount of the loss and prepare the journal entry to record the loss. • The impairment loss is equal to $400,000 ($640,000 - $240,000) -- the difference between the book value of the equipment and its fair value. The impairment loss would be recorded as follows: • Acc’d Depreciation 360,000 •  Loss on Impairment 400,000 •    Equipment 760,000 

31. VARIATION of Example(FAS144 solution, slide d) • What journal entry should Johnson Company make if future cash flows related to the equipment were $980,000 in total? • Since the future cash flows (undiscounted) equal $980,000 and this amount is greater than the book value of $640,000, Johnson Company will not do anything. • No impairment is recognized and no upward revaluation is recorded. • No journal entry needed.

32. IFRS solution to the impairment example (slide 1) Synopsis of facts: Carrying value = $640,000 Future cash flows from use = $80,000 per year for 7 years Market-based fair value less cost to sell = $240,000 Determine VIU using 5% rate

33. IFRS solution to the impairment example (slide 2) Determine VIU: N=7, i=5%, FV=0, PMT=$80,000.PV = $462,910 Recoverable amount = higher of FV ($240,000) and VIE ($462,910) Therefore, loss is $177,090(BV 640,000 – VIE 462,910)

34. IFRS solution to the impairment example (VARIATION) Synopsis of facts: Carrying value = $640,000 Future cash flows from use = $140,000 per year for 7 years Market-based fair value less cost to sell = $240,000 Determine VIU using 5% rate

35. Your IAS36 Solution to Variation of Example: Fair value less cost to sell = $240,000 Carrying value = $640,000 Determine VIU: (n=7, i=5%, FV=0, PMT=$140,000)

36. Comparing the solutions Under FAS144 Under IAS36 Original facts Loss = $400,000 VARIATION No loss recognized • Original facts • Loss = $177,090 • VARIATION • No loss recognized