Non-current assets

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Property, plant and equipment
Stand-alone asset
1/1/X1, XYZ bought a production machine #123 for 60,000.
For simplicity, this example does not discuss any additional costs such as agent's fees, transportation, installation, break-in, development, disposal, interest, etc.
The following (self-manufactured asset) example does.
It estimated the machine would be useful for 12 years and could be sold for 9,000.
It elected to depreciate the machine using a straight-line method.
An asset's "useful life" is the time over which it is expected to serve its purpose (a purpose).
Assets acquired for a particular purpose may or may not be reassigned to a different purpose.
For example, if a company acquired a machine to manufacture a particular product for a three-year production run, the machine's useful life would be 3 years.
If, on the other hand, the company intended to transition the machine to successive products, the machine's useful life would be longer.
As US GAAP does not specify how to determine useful life, entities may use judgment or refer to IFRS.
While ASC 360-10-35-4 requires entities to depreciate assets over their useful life, ASC 360-10 fails to specify how useful life should be determined leaving companies free to exercise judgment in setting depreciation periods.
Being able to use judgment does not, however, imply that companies are free to use any depreciation period they like.
If a period proves to be materially inaccurate, as this is generally apparent only at or near its end, it will trigger a restatement as outlined in ASC 250-10-50-12.
Caveat: intentionally failing to establishing realistic depreciation periods can have serious consequences because this is a method occasionally used to manage earnings, something the SEC takes especially seriously.
ASC 250-10-S99-1: "...the staff believes that a registrant and the auditors of its financial statements should not assume that even small intentional misstatements in financial statements, for example those pursuant to actions to "manage" earnings, are immaterial."
Note: the only way to correct errors is retrospectively, in this case going back to the period the asset was acquired.
Also note: even if the correction of an intentional error is not sufficiently material to warrant a restatement of the financial statements, the error would still need to be disclosed and reported to the SEC.
While both ASC 360-10-35-4 and IAS 16.50 require useful life, only IAS 16.56 outlines criteria.
IAS 16.56 outlines four criteria ("factors") for determining useful life.
The first should be used if possible, while the remaining three should be applied as appropriate.
a. expected usage (a.k.a. units of production)
b. physical wear and tear
c. technical or commercial obsolescence
d. legal or similar limits
Units or production not only yields better results, it can also reduce accounting complexity.
IAS 16.55 (edited emphasis added) states: ...depreciation does not cease when the asset becomes idle or is retired from active use unless the asset is fully depreciated. However, under usage methods of depreciation the depreciation charge can be zero while there is no production.
While the difference between depreciation that has ceased and a zero depreciation charge is minimal (the former implies depreciation will not be restarted in the future), being able to stop/start depreciation can bring practical benefits.
For example, assume a company estimates it will be able to manufacture and sell 10,000 units of a product per year for 10 years. To manufacture the product, it purchases a machine for 10,000.
To save effort, it assigns a fixed 10-year useful life to the asset and elects straight-line depreciation (and ignores residual value).
If production hits the target, a depreciation charge of 0.10 will accrue to year unit. However, if production falls short, say 5,000 units, a depreciation charge of 0.20 would accrue to year unit, increasing cost of sales (relative to production volume) and decreasing gross profit.
While it is possible to adjust depreciation periods on the basis of an annual review (IAS 16.51), if a units of production method is used, the adjustment occurs automatically.
For example, a production die can have a 10,000 unit limit until exceeds engineering tolerance.
Each time a unit is product, a depreciation charge of 1/10,000 would be recognized.
The drawback of this method: relatively few assets have precisely definable usage parameters.
The disadvantage of this method: the asset will need to be disposed of when the limit is reached.
This criterion is similar expected usage because it reflects the physical attributes of an asset.
It would be used in situations where units of production cannot be determined.
For example, a press utilizing a production die would most likely not, unlike the die, have a precise technical limit on the number of units it could produce.
Nevertheless, the press would eventually deteriorate physically, so would eventually need to be replaced for this reason.
In contrast to the previous two, this criterion is external.
Instead of examining how the entity uses the asset, it looks at how the asset deteriorates due to changes in technology or market conditions, both of which are generally external to the entity (and often beyond its control).
For example, an entity acquires a machine that can print 12nm circuits. Subsequently, a competitor develops a machine that can print 8nm circuits. This change in technological means the 12nm machine is now (at least partially) technologically obsolete.
Commercial obsolescence is the other side of the same coin.
Before 8nm chips were available, 12nm chips (almost certainly) sold for more than after 8nm chips became available.
Note: while commercial obsolescence can be used to determine depreciation periods, IAS 16.62A prohibits a "depreciation method that is based on revenue that is generated by an activity that includes the use of an asset" in effect disallowing its use in determining deprecation methods.
Also note: as US GAAP does not provide similarly detained guidance, "contribution to earnings" can be used to determine both depreciation periods and depreciation methods.
In practice, this criteria usually applies to intangible assets such as patents or licensing agreements.
It would also apply to right of use assets under IFRS 16, though these are also (technically) intangible assets.
When it comes to property plant and equipment, this criterion would most often apply to assets like leasehold improvements, if the lease term is shorter than the useful life of the improvement.
As no authoritative generally accepted accounting principles (ASC 105-10-05-1) specifically address useful life, nonauthoritative accounting guidance such as IFRS (ASC 105-10-05-3.d) may be considered (ASC 105-10-05-2), implying the criteria outlined in IAS 16.56 could be used to determine accounting policy in a US GAAP context.
Most items of property, plant and equipment have some remaining value at the end of their useful lives.
If this residual | salvage value is material, the asset should be depreciated to it, not zero.
IAS 16.6 defines residual value while ASC 360-10-35-4 refers to salvage value.
Since both reflect an estimate of the value an asset will have at the end of its useful life, the terms are interchangeable.
To establish residual | salvage value in practice, a company will generally use its historical experience.
For example, if it commonly sells class A machines for an average of 10% or their acquisition cost and class B machines for 20%, it would set residual | salvage values of 10% and 20% respectively.
It is also possible to estimate using observable inputs in a manner consistent with IFRS 13.67 | ASC 820-10-35-36.
For example, a company could determine the average price comparable assets bring at auction (although a quick and dirty internet search is often good enough).
However, in practice, sticking to the 10% to 20% rule of thumb is often the best option.
Depreciating PP&E to zero is common practice under many national GAAPs.
However, under IFRS | US GAAP, if the asset has residual | salvage value, not recognizing it would be an error.
Although not setting a residual | salvage for assets that are eventually sold (demonstrating that they had residual | salvage value) would be an error, if would rarely be sufficiently material to trigger a restatement as outlined in IAS 8.42 | ASC 250-10-50-12.
Caveat: intentionally failing to establish residual | salvage in situations where residual | salvage demonstrably exists to achieve a particular end would always be material as outlined in IAS 8.41 | ASC 250-10-S99-1.2
Note: the only way to correct errors is retrospectively, in this case going back to the period the asset was acquired.
Also note: even if the correction of an intentional error is not sufficiently material to warrant a restatement of the financial statements, the error would still need to be disclosed and reported to the pertinent market regulator.
This example uses a straight-line depreciation method because it is both simple and commonly used.
This should not be taken as a suggestion to use this method in all circumstances.
Instead, companies should elect a method suitable to the circumstances.
IFRS and US GAAP provide additional guidance including both suggested and prohibited methods.
A discussion of depreciation methods is provided as a standalone section of this page.
IAS 16.62A prohibits methods based on revenue (a.k.a. contribution to earnings).
ASC 360-10-35-9 prohibits tax deprecation (specifically ACRS) unless it reflects a reasonable range of the asset's useful life and ASC 360-10-35-10 prohibits the annuity method (a.k.a. decelerated depreciation).
It sold the machine for 9,500 on 12/31/X12.
1/1/X1 | 1.1.X1
Machine #123 60,000
Accounts payable 60,000

12/31/X1 to X12 | 31.12.X1 to X12
Depreciation expense 4,250
Accumulated depreciation: Machine #123 4,250
12/31/X12 | 31.12.X12
Accumulated depreciation: Machine #123 51,000
Cash 9,500
Machine #123 60,000
Gain on asset disposal 500

When a company disposes of an item of PP&E, it recognizes the difference between its net book value (carrying amount) and the sales price (if any) as a gain/loss.
Both IFRS and US GAAP prohibit recognizing revenue/expense, common practice in many national GAAPs.
IAS 16.68 (edited, emphasis added): The gain or loss arising from the derecognition of an item of property, plant and equipment shall be included in profit or loss... Gains shall not be classified as revenue.
While the paragraph is not similarly explicit with respect to losses, this is not because the guidance is asymmetrical. Instead, it is because in IFRS Expenses (the aggregated item) comprise expenses and losses (the disaggregated items).
An additional discussion of revenue vs gains and expenses vs losses is provided on the accounting elements page.
As outlined in ASC 610-20-32-2, when a company derecognizes a non-financial asset, it recognizes a gain or loss equal to the difference between amount received for the asset (ASC 610-20-32-3 to 6) and the asset's carrying amount.
Many national GAAPs do not distinguish between revenue/expenses gains/losses. The result is that when a company applying such a GAAP derecognizes an asset, it recognizes revenue/expense, which can have a dramatic impact on its reported results.
For example, some time ago a Czech company decided to list on a US exchange.
After retaining an underwriter, the underwriter retained us to draft a report consistent with US GAAP.
As, unlike CZ GAAP, US GAAP distinguishes revenue/gains and expenses/losses, this was one the first adjustments.
After reviewing our preliminary results, the underwater decided against pursuing a listing.
Our first step was to eliminate the major differences and draft a preliminary report.
Up to then, the company had only applied CZ GAAP.
As CZ GAAP does not distinguish between revenue and gains, when a company disposes of its fixed assets, it recognizes revenue in the amount received and an expense in the asset's book value.
Eliminating this difference caused a significant portion of its previously reported revenue to disappear.
In and of itself, this may have been enough to dissuade a listing, but there was more:
" As the sale of receivables is recognized similarly by CZ GAAP, a similar adjustment had to be made to factored receivables.
" As CZ GAAP (at the time) required increases in inventory and self-manufactured asset costs to be capitalized with a credit to revenue, this also had to be adjusted.
Eliminating the differences caused over half of the company's previously reported revenue to disappear.
But there was more:
" The company did not recognize the full value of its lease assets nor any associated liabilities because CZ GAAP does not require leased assets to capitalized nor liabilities to be recognized. It only requires the capitalization of advance payments, which are amortized over the lease term.
" The company also did not recognize all of its leased assets because CZ GAAP does not require capitalization of operating leases even if their term is for substantially all the underlying asset's economic life.
" The company also did not recognize all its contingent liabilities because CZ GAAP does not generally require recognition of constructive obligations.
" The company also failed to distinguish between cost of sales, selling and administrative expenses as this distinction is not required by CZ GAAP.
" The company also capitalized both development and some research as well as employee training which, at the time, was consistent with CZ GAAP.
" The company also misapplied CZ GAAP guidance, for example by using tax depreciation periods for financial reporting purposes, but an examination of these issues was beyond the scope of our engagement.
What a mess.
A second step was not necessary.
After reviewing our preliminary report, the underwater decided to terminate its relationship with the company, which eventually wound up in receivership.
Loss on disposal
Same facts as above, except XYZ sold the machine for 8,500.
12/31/X12 | 31.12.X12
Accumulated depreciation: Machine #123 51,000
Cash 8,500
Loss 500
Machine #123 60,000
Self-manufactured asset
IFRS vs US GAAP
While similar, IFRS and US GAAP provide different guidance. This example outlines the similarities and differences.
1/1/X4, XYZ began acquiring a production line to manufacture a newly designed product, which it finished 30/6/X5.
Developed technology
12/31/X3, after three years of work, XYZ's received patent #323 covering a new product. Over that time, it incurred salaries of 175,000, purchased equipment for 100,000 and acquired two supplementary patents for 12,500 each. Of the salaries, 90,000 was associated with obtaining new knowledge and 85,000 with developing, constructing and testing pre-production prototypes. Although the equipment was purchased to develop and test those prototypes, XYZ intended to continue to use it for other testing. The patents were acquired because they covered aspects of product's functionality. Acquiring them allowed XYZ to avoid paying royalties but they did not have any other, alternative use. Legal fees associated with patent #323, paid to EFG Legal, were 6,000.
IFRS / US GAAP / IFRS and US GAAP
1/1/X1 to 12/31/X3 | 1.1.X1 to 31.12.X3
Expenses: Research 90,000
Intangible assets: Patent #323 85,000
PP&E: Research equipment 100,000
Intangible assets: Patent #321 12,500
Intangible assets: Patent #322 12,500
Wages and salaries payable 175,000
Payables: Various suppliers 125,000
1/1/X1 to 12/31/X1 | 1.1.X1 to 31.12.X3
Expenses: Research and development 200,000
PP&E: Research equipment 100,000
Wages and salaries payable 175,000
Payables: Various suppliers 125,000
12/31/X1 | 31.12.X3
Intangible assets: Patent #323 6,000
Payable: EFG 6,000
Acquired technology
1/31/X4, XYZ purchased patent #324 from DEF for 20,000. In addition, XYZ purchased an unpatented prototype machine for 30,000. With the machine, XYZ received blueprints, a parts list, production, repair and training manuals, and a list of vendors. While XYZ acquired the prototype solely to help develop the production line, it intended to use the patent in several additional projects.
IFRS / US GAAP
IFRS: 1/1/X4 | 1.1.X4
Intangible assets: Patent #324 20,000
Intangible assets: Unpatented technology 30,000
Payable: DEF 50,000
US GAAP: 1/1/X4 | 1.1.X4
Intangible assets: Patent #324 20,000
Expenses: Research and development 30,000
Payable: DEF 50,000
Preliminary planning and design
From 1/1/X4 to 1/31/X4, XYZ formulated, designed, evaluated and finally selected the processes the production line would perform incurring salary costs of 10,000. It had also hired ABC to design and produce specialized tooling used in the evaluation process. ABC delivered to tools on January 1, X4, charging 20,000.
IFRS and US GAAP
1/1/X4 - 1/31/X4 | 1.1.X4 - 31.1.X4
Expenses: Research and development 30,000
Wages and salaries payable 10,000
Payable: ABC 20,000
Development and design
From 2/1/X4 to 3/31/X4, XYZ paid ABC 75,000 to help finalize the production line's design. The fee included drafting blueprints, writing construction, usage, training and repair manuals, and compiling a parts and vendors list. XYZ also incurred 15,000 (salaries) searching for and testing various tools, jigs, molds and dies from various venders and 50,000 (30,000 in salaries and 20,000 in parts, materials and consumables) developing and producing its own tools, jigs, molds and dies. Finally, it paid 19,000 to various contractors to physically prepare the production line's site for installation and incurred a cost of 6,000 related to construction and zoning permits.
IFRS / US GAAP
2/1/X4 to 3/31/X4 | 1.2.X1 to 31.3.X4
Acquisition in process: Production line #123 150,000
Expenses: Research and development 15,000
Payable: ABC 75,000
Payable: DEF 19,000
Wages and salaries 45,000
Inventory: Supplies and consumables 20,000
Cash in bank 6,000
2/1/X4 to 3/31/X4 | 1.2.X1 to 31.3.X4
Acquisition in process: Production line #123 25,000
Expenses: Research and development 140,000
Payable: ABC 75,000
Payable: DEF 19,000
Wages and salaries 45,000
Inventory: Supplies and consumables 20,000
Cash in bank 6,000
VAT/GST, customs tariff, shipping costs and agent's fees
3/5/X4, XYZ purchased equipment for 10,000 from FGI and for 20,000 from GHI. FGI was a local vendor that invoiced VAT/GST of 20%. GHI was an international vendor subject to a 3% customs tariff. XYZ hired KLM to deliver the equipment for 1,400 (including customs clearance). Both vendors sold the goods ex-works/FOB shipping point (will-call). They were picked up by KLM on 4/5/X4 and delivered to XYZ on 4/10/X5. XYZ also paid 2,000 to HIJ, the agent who arranged both purchases.
IFRS and US GAAP
5/10/X4 | 10.5.X4
Acquisition in process: Production line #123 34,000
Tax other than income: VAT/GST 2,000
Payable: FGI 10,000
VAT/GST due: FGI 2,000
Payable: GIH 20,000
Payable: KLM 2,000
Cash in bank 2,000
Components
5/15/X4 XYZ purchased 4 robots for 50,000, 55,000, 65,000, and 70,000 respectively. If used independently, each robot would be useful for at least 15 years. However, XYZ intended to dispose of the line as a whole, including these robots, in 10 years.
IFRS and US GAAP
5/15/X4 | 15.5.X4
Acquisition in process: Production line #123 a 50,000
Acquisition in process: Production line #123 b 55,000
Acquisition in process: Production line #123 c 65,000
Acquisition in process: Production line #123 d 70,000
Accounts Payable: DEF 240,000

Or simply
While the robots had significant values and so could have been recognized as components, as their useful lives were no different than the useful life of the asset as a whole, recognizing them as components is not necessary.
5/15/X4 | 15.5.X4
Acquisition in process: Production line #123 240,000
Accounts Payable: DEF 240,000
Professional services
During May, XYZ paid ABC Development 15,000 for help overcoming an unforeseen technical problem integrating equipment into the production line. It also paid 20,000 to GHI Mediation for help resolving a labor dispute. Finally, it paid 30,000 to EFG Legal for successfully defending patent #323 and 50,000 for successfully resolving a dispute involving a competitor alleging that the line would infringe on its patents.
IFRS / US GAAP
5/1/X1 to 5/31/X4 | 1.5.X1 to 31.5.X4
Acquisition in process: Production line #123 65,000
Administrative expenses: Professional services 50,000
Payable: ABC 15,000
Payable: GHI 20,000
Payable: EFG 80,000
5/1/X1 to 5/31/X4 | 1.5.X1 to 31.5.X4
Acquisition in process: Production line #123 85,000
Intangible assets: Patent #323 30,000
Payable: ABC 15,000
Payable: GHI 20,000
Payable: EFG 80,000
Exchange rate difference
May 20, X4, XYZ bought equipment JKL to be paid in a foreign currency for FC A 10,000. Payment was due in 30 days and FC A exchange rates were 1.25 on May 20 and 1.30 on June 20. On May 25, X4, XYZ also bought equipment from MNO for FC B 10,000. It paid a 50% deposit, took delivery of the equipment on June 15, X4 and paid the remaining balance on July 15, X4. FC B exchange rates were 1.70, 1.75 and 1.6.
IFRS and US GAAP
5/20/X4 | 20.5.X4
Acquisition in process: Production line #123 12,500
FC Payable: JKL in FC A 12,500

5/25/X4 | 25.5.X4
Acquisition in process: Production line #123: Advance paid 8,500
Cash in bank 8,500

6/15/X4 | 15.6.X4
Acquisition in process: Production line #123 17,250
Acquisition in process: Production line #123: Advance paid 8,500
FC Payable: MNO in FC B 8,750

6/20/X4 | 20.6.X4
FC Payable: JKL in FC A 12,500
Gains and losses: Forex loss 500
Cash in bank 13,000

7/15/X4 | 15.7.X4
FC Payable: MNO in FC B 8,750
Gains and losses: Forex gain 750
Cash in bank 8,000
Relocation and reinstallation
June 1, X4, XYZ purchased conveyer belts and related items for 30,000. It also spent 10,000 relocating conveyers that had been acquired at a different site but never brought online. Those conveyers had cost 60,000 and had been recognized as asset #105. June 2, X4, XYZ also determined that the performance parameters of equipment A12, which had originally been purchased for 50,000 and installed as part of asset #25 at another site, were too high for that application. Consequently, it replaced it with equipment B24, which cost 10,000, and spent another 5,000 relocating equipment A12.
IFRS and US GAAP
6/1/X4 | 1.6.X4
Acquisition in process: Production line #123 90,000
Administrative expenses: Relocation 10,000
Cash in bank 40,000
Asset #105 60,000

6/2/X4 | 2.6.X4
Acquisition in process: Production line #123 42,500
Administrative expenses: Reinstallation 5,000
Asset #25 10,000
Asset #25: Accumulated depreciation 7,500
Acquisition in process: Production line #123 42,500
Asset #25 50,000
Cash 15,000
Excessive wastage
June 15, X4, XYZ determined that, due to lack of proper supervision, production workers spent several days installing equipment incorrectly causing irreparable damage. The damaged equipment had originally cost 10,000. June 20, X4, it was replaced with an identical piece of equipment that also cost 10,000. The new equipment was installed on June 20, X4, and an additional 5,000 was spent on removing the damaged equipment and installing the replacement.
IFRS and US GAAP
6/15/X4 | 15.6.X4
Administrative expenses: Excessive spoilage 10,000
Acquisition in process: Production line #123 10,000

6/20/X4 | 20.6.XX4
Acquisition in process: Production line #123 10,000
Administrative expenses: Excessive spoilage 5,000
Cash 10,000
Wages and salaries 5,000

Or simply
6/20/X4 | 20.6.XX4
Administrative expenses: Excessive spoilage 15,000
Cash 10,000
Wages and salaries 5,000
Delivery, rebate
During the third quarter, XYZ will-called additional equipment, parts, material and supplies (for 337,000 in total) incurring direct driver wages of 6,000. It also recognized: fuel (900), repairs and maintenance (400), rent (2,400), depreciation (3,300). September 30, X4, it received a rebate of 10,000 from DEF. DEF credited the rebate to XYZ's account and issued a credit note.
IFRS and US GAAP
7/1/X4 - 9/30/X4 | 1.7.X4 - 30.9.XX4
Acquisition in process: Production line #123 350,000
Payables: DEF 10,000
Cash in bank, payables, etc. 337,000
Distribution expense: Delivery: Direct wages 6,000
Distribution expense: Delivery: Fuel 900
Distribution expense: Delivery: Repairs and maintenance 400
Distribution expense: Delivery: Rent 2,400
Distribution expense: Delivery: Depreciation 3,300
Acquisition in process: Production line #123 10,000
Installation
During the fourth quarter, XYZ installed parts and equipment, incurring costs: services provided by ABC (20,000), services provided by its own R&D department (50,000, including travel and lodging of 5,000), material and consumables (30,000), wages (65,000) and supervisor salaries (20,000). It also allocated fixed costs (primarily rent and depreciation) of 40,000.
IFRS and US GAAP
10/1/X5 - 12/31/X4 | 1.10.X5 - 31.12.X4
Acquisition in process: Production line #123 225,000
Payable: ABC 20,000
Expenses: R&D 50,000
Cost of sales: Direct material, Consumables 30,000
Cost of sales: Direct wages 65,000
Cost of sales: Supervisor salaries 20,000
Cost of sales: Rent, Depreciation 40,000
Break-in
In the first quarter of X5, XYZ tested and broke in the line incurring wages and salaries of 75,000 and consuming material, supplies and consumables that had been purchased for 20,000. It sold the used material as scrap for 5,000. XYZ also hired KLM to developed control software. In total, KLM invoiced 100,000 comprising: programming (50,000), debugging (20,000), systems integration (28,000) and staff training (2,000). XYZ determined that, had the training been acquired separately from a third party (LNM), it would have cost 10,000. Acquiring the offer cost 50.
IFRS and US GAAP
1/1/X5 - 3/31/X5 | 1.1.X5 - 31.3.X5
Acquisition in process: Production line #123 180,000
Expenses: Staff training 10,000
Expenses: Professional services: Valuation 50
Cash 5,000
Wages and salaries 75,000
Raw material, Supplies, Consumables 20,000
Cash, Payables 100,050
Finalizing the acquisition
5/31/X5, XYZ's quality assurance department evaluated the installation and determined that the production line was ready for its intended use. The cost of the evaluation was 450.
IFRS / US GAAP
IFRS: 3/31/X5 | 31.3.X5
Production line #123 1,414,750
Acquisition in process: Production line #123 1,414,300
Wages and salaries 450
US GAAP: 3/31/X5 | 31.3.X5
Production line #123 1,324,750
Acquisition in process: Production line #123 1,324,300
Wages and salaries 450
Capitalized interest
March 31, X5, the project manager performed a final inspection and determined that the production line was physically ready for its intended use. As the asset took a substantial period of time, was constructed as a discrete project and entailed substantial expenditures that were separately accumulated, XYZ capitalized interest.
IAS 23.8: An entity shall capitalise borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset as part of the cost of that asset.
IAS 23.5: A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale.
ASC 835-20-15-3: Interest capitalization is required only when ... an asset is constructed or produced as a discrete project for which costs are separately accumulated and where construction of the asset takes considerable time, entails substantial expenditures, and is likely to involve a significant amount of interest cost.
IFRS / US GAAP
3/31/X5 | 31.03.X5
Production line #123 46,756
Interest expense 46,756

The different capitalized interest per US GAAP is due to different acquisition costs.
P Beg. cum. cost Period cost End. cum. cost Ave. cum. cost Cap. rate Capitalized interest
A=A+A(B+1) B=cost+F(F+1) C=B+B(B+1) D=(A+C)÷2 E=(1+5%)1÷4- 1 F=DxE
X1 Q1 0 150,000 150,000 75,000 1.23% 920
X1 Q2 150,000 520,670 670,670 410,335 1.23% 5,036
X1 Q3 670,670 345,036 1,015,706 843,188 1.23% 10,348
X1 Q4 1,015,706 235,348 1,251,054 1,133,380 1.23% 13,909
X2 Q1 1,251,054 193,909 1,444,963 1,348,009 1.23% 16,543
46,756

A more through discussion of borrowings capitalization is provided in a separate section (see above).
For simplicity's sake, this example assumes XYZ expensed all borrowing costs as they were paid. To capitalize the amount related to the asset, it simply reversed that expense.
To further simplify the example, this was done in the period the asset was completed, instead of throughout its construction (as should be done in practice).
3/31/X5 | 31.03.X5
Production line #123 41,255
Interest expense 41,255

The different capitalized borrowings per IFRS are due to different acquisition costs.
P Beg. cum. cost Period cost End. cum. cost Ave. cum. cost Cap. rate Capitalized interest
A=A+A(B+1) B=cost+F(F+1) C=B+B(B+1) D=(A+C)÷2 E=(1+5%)1÷4- 1 F=DxE
X1 Q1 0 25,000 25,000 12,500 1.23% 153
X1 Q2 25,000 554,903 579,903 302,452 1.23% 3,712
X1 Q3 579,903 343,712 923,615 751,759 1.23% 9,226
X1 Q4 923,615 234,226 1,157,841 1,040,728 1.23% 12,772
X2 Q1 1,157,841 192,772 1,350,613 1,254,227 1.23% 15,392
41,255

A more through discussion of interest capitalization is provided in a separate section (see above).
For simplicity's sake, this example assumes XYZ expensed all interest as it was paid. To capitalize the amount related to the asset, it simply reversed that expense.
To further simplify the example, this was done in the period the asset was completed, instead of throughout its construction (as should be done in practice).
Removal costs and disposal obligations
March 31, X5, XYZ estimated it would incur a cost of 100,000 to dispose of the production line in 10 years. The March 31, X5 risk free rate was 2% and the premium reflecting XYZ's credit standing 2.5%.
An additional discussion including how to account for changes is provided in the asset retirement section (above).

Scenario Amount & probability Risk weighted estimate
Waste removal: worst case 55,000 x 25% = 16,025
Waste removal: most likely case 40,000 x 50% = 25,000
Waste removal: best case 25,000 x 25% = 9,225
Waste removal: risk adjusted estimate 40,000

Own labor: worst case 50,000 x 35% = 15,000
Own labor: most likely case 40,000 x 40% = 16,000
Own labor: best case 30,000 x 30% = 9,000
Own labor: risk adjusted estimate 40,000

Allocated overhead 40,000 x 50% = 20,000
100,000

IFRS / US GAAP
IFRS: 3/31/X5 | 31.3.X5
Production line #123 82,035
Disposal provision 82,035

82,035 = 100,000 ÷ (1 + 2%)10
IFRIC-items-not-taken-onto-the-agenda-IAS-January-2015.pdf: The Committee observed that paragraph 47 of IAS 37 states that 'risks specific to the liability' should be taken into account in measuring the liability. The Committee noted that IAS 37 does not explicitly state whether or not own credit risk should be included. The Committee understood that the predominant practice today is to exclude own credit risk, which is generally viewed in practice as a risk of the entity rather than a risk specific to the liability.
US GAAP: 3/31/X5 | 31.3.X5
Production line #123 64,393
Disposal provision 64,393

64,393 = 100,000 ÷ (1 + 4.5%)10
ASC 410-20-30-1: An expected present value technique will usually be the only appropriate technique with which to estimate the fair value of a liability for an asset retirement obligation. An entity, when using that technique, shall discount the expected cash flows using a credit-adjusted risk-free rate. Thus, the effect of an entity's credit standing is reflected in the discount rate rather than in the expected cash flows. ...
Consumables (small, low value assets)
XYZ is a local subsidiary of an international company.
It applies IFRS / US GAAP for reporting purposes and national GAAP for statutory accounting and tax purposes.
IAS 16.9 states: … It may be appropriate to aggregate individually insignificant items, such as moulds, tools and dies, and to apply the [capitalisation] criteria to the aggregate value. This would be appropriate when the aggregate value is material.
Although not discussed in ASC 360, US GAAP practice is comparable.
Many national GAAPs define minimum capitalization values on an individual asset level. While some also require an aggregate value test, many others do not.
As a result, many companies capitalize consumables under IFRS / US GAAP, but expense them for national GAAP / tax purposes.
For reporting purposes, it tests consumables (small assets) using an individual threshold of reporting currency (RC) 500 and an aggregate threshold of RC 5,000. For statutory accounting and tax purposes, since its national GAAP does not mandate an aggregate test, it only applies an individual threshold of local currency (LC) 40,000. The foreign exchange and income tax rates are 1:25 and 20% respectively.
Traditionally, individual assets expensed due to their low value have been referred to as consumables. Many national GAAPs, however, refer to these items as "small assets".
Since this term confuses size with value, during the IASB's 18-20 February 2015 meeting "One Board member asked whether the meaning of small assets was related to physically small or small in terms of monetary value. He said that it should be clarified in the Basis of Conclusions. The staff responded that the term 'small' meant low value." (link: IASplus.com).
This implies that the term "small assets" is now an acceptable way to refer to individual assets expensed due to their low value even though, semantically speaking, it is far from accurate.
XYZ's policy is to expenses all items with an individual cost of less than RC 500. At the end of the period it evaluates the aggregate expenses by class of item. If the total expense exceeds RC 5,000 it capitalizes the highest cost items until the total expense falls below RC 5,000.
Different policies are also applicable.
ABC also expenses all items with an individual cost of less than RC 500. In contrast to XYZ, it only performs a single aggregate test in that it capitalizes expensed items only if the aggregate expense (regardless of class) exceeds RC 50,000.
DEF's takes a different approach altogether. Its first step is to establish consumable classes based on useful life. Next multiplies the aggregate period purchases in each class by that useful life. If this aggregate value falls below 0.1% of total assets, the class is expensed, otherwise it is capitalized. XYZ also tests all the expensed classes in the period. If the total expense exceeds 1% of total assets, it capitalizes the most valuable classes. Additions to previously capitalized classes continue to be capitalized as long as the aggregate value of the class continues to exceed 0.1% of total assets. When this value falls below 0.1%, the class is expensed and derecognized.
Obviously, different policy choices can also be made.
The aim, however, is always the same: ensure that the aggregate value of expensed assets never becomes material.
1/1/X1, XYZ acquired its first consumables: a hammer for LC 275 in cash and two sets of spanners for LC 5,000 by credit card. During X1, aggregate consumable purchases were LC 237,500. The consumables were heterogenous so a composite method was applied. The weighted average life of the consumables was 7.25 years.
Dr/Cr
1/1/X1 | 1.1.X1: IFRS | US GAAP book RC RC
Consumables: X1 purchases 211
Cash 11
Credit cards payable 200
1/1/X1 | 1.1.X1: national GAAP book LC LC
501 (Expenses: Materials consumed) 275
211 (Cash) 275
501 (Expenses: Materials consumed) 5,000
231 (Short-term debts to credit institutions) 5,000

12/31/X1 | 31.12.X1: IFRS | US GAAP book RC RC
PP&E: Miscellaneous items: Small assets: X1 hand tools 9,500
Consumables: X1 purchases 9,500
Income tax expense 1,900
Deferred income tax liability 1,900

12/31/X2 | 31.12.X2: IFRS | US GAAP book RC RC
Depreciation expense: X1 hand tools 1,310
Accumulated depreciation: X1 hand tools 1,310
Deferred income tax liability 262
Income tax expense 262

3/31/X9 | 31.3.X9: IFRS | US GAAP book RC RC
Depreciation expense: X1 hand tools 328
Accumulated depreciation: X1 hand tools 328
Deferred income tax liability 66
Income tax expense 66
Accumulated depreciation: X1 hand tools 9,500
PP&E: Miscellaneous items: Small assets: X1 hand tools 9,500
Same facts except XYZ used the group method and 8-year, simple average life.
Dr/Cr
12/31/X2 | 31.12.X2: IFRS | US GAAP book RC RC
Depreciation: X1 hand tools 1,188
Consumables: X1 purchases 1,188
Accumulated depreciation: X1 hand tools 238
Income tax expense 238

12/31/X9 | 31.12.X9: IFRS | US GAAP book RC RC
Depreciation: X1 hand tools 1,188
Accumulated depreciation: X1 hand tools 1,188
Deferred income tax liability 238
Income tax expense 238
Accumulated depreciation: X1 hand tools 9,500
PP&E: Miscellaneous items: Small assets: X1 hand tools 9,500
Intangible assets
Stand-alone asset
1/1/X1, XYZ bought a patent for 10,000.
The patent was acquired on its grant date in an orderly transaction. Its term of 20 years was nonrenewable.
1/1/X1 | 1.1.X1
Patent 10,000
Cash 10,000

12/31/X1 | 31.12.X1
Amortization expense 500
Accumulated amortization: Patent 500

Unlike PP&E, a "rebuttable presumption" of zero residual | salvage value applies to intangible assets.
As outlined in IFRS 38.100 | ASC 350-30-35-8, companies should assume intangible assets will have no value at the end of their useful lives unless (a) a third party has committed to buy them or (b) there is an active | existing market, which is expected to still exist, for them.
Useful life ? legal life
Same facts except XYZ planned to use the patent to manufacture a product it expected sell for 10 years.
1/1/X1 | 1.1.X1
Patent 10,000
Cash 10,000

12/31/X1 | 31.12.X1
Amortization expense 1,000
Accumulated amortization: Patent 1,000
Developed asset
Same facts except XYZ spent 9,500 from 1/1/X1 to 12/31/X1 to develop the patent and 500 to register the patent.
1/1/X1 to 12/31/X1 | 1.1.X1 to 31/12/X1
Research and development expense 9,500
Patent (intangible asset) 500
Cash, Payables, Employee benefits, etc. 10,000

As outlined in ASC 730-10-25-1, no research or development costs may ever be capitalized.
While not as categorical as US GAAP, the criteria outlined in IAS 38 practically eliminate any possibility of capitalizing the costs of internally generating a patent unless it will be used in existing operations.
As outlined in IAS 38.54, research costs may never be capitalized.
As outlined in IAS 38.57, development may be capitalized but only if the resulting asset can be sold or used.
IAS 38.57 (edited, emphasis added): An intangible asset arising from development ... shall be recognised if, and only if, an entity can demonstrate ...:
(c) its ability to use or sell the intangible asset.
(d) how the intangible asset will generate probable future economic benefits. Among other things,
the entity can demonstrate the existence of a market for the output of the intangible asset or
the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset...
As patents are unique, it is difficult to demonstrate that a market for the patent or the output of the patent (the product or service) exists.
It is also risky.
If a company capitalizes development of a patent for a new product or service which it later cannot sell, this inability demonstrates it misapplied IAS 38.57.c and d, so it will most likely need to correct its error as outlined in IAS 8.42 (by restating its previously issued financial reports).
In contrast, if the patent covers improved technology for an existing product or service (or some other useful internal purpose), capitalizing its development is fairly straightforward.
As outlined in IAS 38.59, development comprises (a) designing, producing and testing pre-production prototypes, (b) designing new tools, (c) designing, constructing and operating pilot plants and (d) designing, producing and testing alternative materials, devices or processes.
IAS 38 does not specify what a pilot plant is, only that it is "not of a scale economically feasible for commercial production."
In practice, to be safe, this is generally interpreted to mean a production facility whose potential production volume will never be sufficient to cover its overhead (fixed and variable).
Note: if a pilot plant is later used for commercial production, the previously recognized development costs would be reversed and financial statements restated as outlined in IAS 8.42.
Also note: as US GAAP does not allow R&D to be capitalized, it does not refer to pilot plants. Instead, it requires any costs associated with facilities without an alternative use (apart from the particular research project) to be expensed as incurred.
The most effective development focuses on improving existing processes, not creating new products or services.
At the risk of stating the obvious, the downside of effective R&D is that innovation suffers.
This is one reason why older, well-established companies with well-developed internal cost control systems generally lag behind younger companies willing to take a risk on an unproven idea.
The flip side of the coin, well established companies with well-developed internal cost control systems generally go bankrupt less often than younger companies willing to take a risk on an unproven idea.
If a company is already selling a product or service, developing technology to improve its quality / reduce production costs not only involves less risk, but makes jumping the IAS 38.57.(c) and (d) hurdle much easier.
As outlined in IFRS 38.66, costs to develop an intangible asset may be capitalized once the asset meets the capitalization criteria outlined in paragraphs 21, 22 and (especially) 57.
These include (subparagraph c) fees to register the legal right.
In this example, as the costs to develop the patent did not meet IAS 38.57 criteria, XYZ only capitalized the costs to register.
While US GAAP does not provide similarly detailed guidance, ASC 350-30-25-3 does specify that costs of internally developing, maintaining, or restoring intangible assets that are not specifically identifiable, that have indeterminate lives, or that are inherent in a continuing business are expensed as incurred.
In general, this guidance is interpreted to mean that only registration costs and fees associated with developed patents are capitalized.
Note, it has been common practice in US GAAP to capitalize costs associated with a legal defense of a intangible asset such as a patent.
However, this practice was based on CON 6, which has since been superseded, and not standard level guidance. As the AICPA still considers this approach to be acceptable, one should consult with one's CPA regarding this issue before making a decision.
For its part, IFRS (IAS 38.20) does not allow costs to defend an intangible asset such as a patent to be capitalized, as these costs maintain the asset instead of being part of its acquisition.
Indefinite useful life
1/1/X1, XYZ bought a customer list for 10,000. It could not determine how long the list would be useful.
1/1/X1 | 1.1.X1
Customer list 10,000
Cash 10,000

12/31/X1 | 31.12.X1
Amortization expense N/A
Accumulated amortization: Customer list N/A

As outlined in IAS 38.107 | ASC 350-30-35-15, intangible assets with indefinite lives are not amortized.
As outlined in IAS 38.107 | ASC 350-30-35-15, intangible assets with indefinite lives are not amortized.
Because indefinite is transitory, indefinite should not be confused with infinite, unlimited, indeterminate or undeterminable (IAS 38.91 | ASC 350-30-35-4).
From a practical, accounting perspective this means assets with indefinite lives, while not amortized or depreciated, are tested for impairment at least every period.
In contrast, assets with unlimited lives, for example land, while also not depreciated or amortized, do not need to be regularly tested for impairment (IAS 38.108 | ASC 350-30-35-16).
Instead, they are tested for impairment (at minimum annually).
Both IAS 38.108 and provide ASC 350-30-35-16 relatively straight forward guidance, requiring assets with indefinite lives (not being amortized) to be tested for impairment annually (sooner if there is an indication they are impaired).
In a minor difference, ASC 350-30-35-17A prohibits acquired in-process R&D from being amortized until the project is completed (and useful life is determined) or the project is abandoned (and the asset is written off). Neither IFRS 3 nor IAS 38 provides similar guidance.
Additional guidance (IAS 38.108 | ASC 350-30-35-18A) stipulates that a review | qualitative assessment should be performed.
Note: the qualitative assessment in US GAAP is relatively involved. Paragraphs 350-30-35-18B through 35-18F outline how exactly it should be performed.
For its part, IAS 38 does not provide similarly detailed guidance. IAS 38.110 simply refers to IAS 36.
Software
Purchased
1/1/X1 XYZ bought a license for an information system for 120,000.
In contrast to US GAAP, IFRS does not specifically address software.
US GAAP not only provides stand-alone guidance for software, but separate guidance for SW developed for internal use (ASC 350-40) and SW developed for re-sale (ASC 985-20-25).
Instead, software is lumped in with all other intangible assets.
While, in the past (link: amazon.com), this fact had spawned the idea that capitalizing internally generated software was not consistent with IAS 38, this interpretation of IFRS is no longer widespread.
IFRS 38.9 (edited, emphasis added): Entities frequently [acquire] ... intangible resources such as scientific or technical knowledge, design and implementation of new processes or systems, licences, intellectual property, market knowledge and trademarks (including brand names and publishing titles). Common examples of items encompassed by these broad headings are computer software, patents, copyrights, motion picture films, customer lists, mortgage servicing rights, fishing licences, import quotas, franchises, customer or supplier relationships, ...
This implies, US GAAP is often considered when applying IFRS to software, leading to comparable results.
IAS 8.12 states (edited, emphasis added): In making the judgement [In the absence of an IFRS that specifically applies to a transaction], management may also consider the most recent pronouncements of other standard-setting bodies that use a similar conceptual framework to develop accounting standards ... to the extent that these do not conflict with [IFRSs dealing with a similar or related issue, or the Conceptual Framework].
Since no other IFRSs deal with software and the conceptual framework is moot on the subject, considering US GAAP (which is developed using a similar conceptual framework) when applying IFRS to software is common practice.
When considering US GAAP, it is important to keep in mind that US GAAP includes separate guidance SW acquired for internal use (ASC 350-40) and SW developed for re-sale (ASC 985-20-25) in that the former is more consistent with general guidance in IAS 38 than the latter.
Also see the SW developed for re-sale example below.
For simplicity, this example assumes no costs implementing the system were incurred.
Although, it planned to use the software indefinitely, the license was for a fixed, 2-year term.
Updates throughout this term were provided at no additional cost. The timing and content of the updates was at the discretion of the SW publisher.
1/1/X1 | 1.1.X1
Management information system 120,000
Cash 120,000

1/31/X1 | 31.1.X1
Amortization: MIS 5,000 (zero)
Management information system | Accumulated amortisation 5,000 (zero)

As outlined in IAS 38.107 | ASC 350-30-35-15, intangible assets with indefinite lives are not amortized.
Because indefinite is transitory, indefinite should not be confused with infinite, unlimited, indeterminate or undeterminable (IAS 38.91 | ASC 350-30-35-4).
From a practical, accounting perspective this means assets with indefinite lives, while not amortized or depreciated, are tested for impairment at least every period.
In contrast, assets with unlimited lives, for example land, while also not depreciated or amortized, do not need to be regularly tested for impairment (IAS 38.108 | ASC 350-30-35-16).
Instead, they are tested for impairment (at minimum annually).
Both IAS 38.108 and provide ASC 350-30-35-16 relatively straight forward guidance, requiring assets with indefinite lives (not being amortized) to be tested for impairment annually (sooner if there is an indication they are impaired).
In a minor difference, ASC 350-30-35-17A prohibits acquired in-process R&D from being amortized until the project is completed (and useful life is determined) or the project is abandoned (and the asset is written off). Neither IFRS 3 nor IAS 38 provides similar guidance.
Additional guidance (IAS 38.108 | ASC 350-30-35-18A) stipulates that a review | qualitative assessment should be performed.
Note: the qualitative assessment in US GAAP is relatively involved. Paragraphs 350-30-35-18B through 35-18F outline how exactly it should be performed.
For its part, IAS 38 does not provide similarly detailed guidance. IAS 38.110 simply refers to IAS 36.
1/1/X3 XYZ bought a license for two additional years for 120,000.
1/1/X3 | 1.1.X3
MIS (administrative expense) 120,000
Cash 120,000

1/1/X5 XYZ bought a license for two additional years for 150,000.
The license included a new module with additional functionality.
As outlined in ASC 350-40-25-7 to 11, costs related to upgrades or updates that add new functionality are capitalized while those that merely maintain existing functionality are expensed.
As this update clearly brought additional functionality, it was capitalized.
Although IAS 38.20 states (edited) "only rarely will subsequent expenditure ... be recognised in the carrying amount of an asset" it also states (edited, emphasis added) "The nature of intangible assets is such that, in many cases, there are no additions to such an asset or replacements of part of it. Accordingly, most subsequent expenditures are likely to maintain the expected future economic benefits embodied in an existing intangible asset rather than meet the definition of an intangible asset and the recognition criteria in this Standard...
As this situation, the update clearly did more than merely maintain expected future economic benefits, it is capitalized.
1/31/X3 | 31.1.X3
Management information system 30,000
MIS (administrative expense) 120,000
Cash 150,000
Unlike IFRS, US GAAP does not require an accumulated amortization account to be used with intangible assets.
Consequently, companies prefer to amortize intangible assets directly, saving the step of having to derecognize them.
Nevertheless, since it is not disallowed, a company may use an accumulated amortization account if it chooses.
Unlike US GAAP, IFRS requires an accumulated amortization account to be used with intangible assets.
Specifically, IAS 38.118 states (edited): An entity shall disclose ... (c) the gross carrying amount and any accumulated amortisation ... at the beginning and end of the period...
This guidance implies that IAS 38 assumes an accumulated amortisation is used.
Since ASC 350-30-50-1 does not specifically require accumulated amortization to be disclosed, an accumulated amortization account can be considered optional under US GAAP.
12/31/X2 | 31.12.X2
Accumulated amortisation 120,000
Management information system 120,000

1/1/X3 | 1.1.X3
Management information system 120,000
Cash 120,000
Developed for own use
From 1/1/X1 to 6/30/X1, XYZ spent 125,000 to develop an information system.
In contrast to US GAAP, IFRS does not specifically address software.
US GAAP not only provides stand-alone guidance for software, but separate guidance for SW developed for internal use (ASC 350-40) and SW developed for re-sale (ASC 985-20-25).
Instead, software is lumped in with all other intangible assets.
While, in the past (link: amazon.com), this fact had spawned the idea that capitalizing internally generated software was not consistent with IAS 38, this interpretation of IFRS is no longer widespread.
IFRS 38.9 (edited, emphasis added): Entities frequently [acquire] ... intangible resources such as scientific or technical knowledge, design and implementation of new processes or systems, licences, intellectual property, market knowledge and trademarks (including brand names and publishing titles). Common examples of items encompassed by these broad headings are computer software, patents, copyrights, motion picture films, customer lists, mortgage servicing rights, fishing licences, import quotas, franchises, customer or supplier relationships, ...
This implies, US GAAP is often considered when applying IFRS to software, leading to comparable results.
IAS 8.12 states (edited, emphasis added): In making the judgement [In the absence of an IFRS that specifically applies to a transaction], management may also consider the most recent pronouncements of other standard-setting bodies that use a similar conceptual framework to develop accounting standards ... to the extent that these do not conflict with [IFRSs dealing with a similar or related issue, or the Conceptual Framework].
Since no other IFRSs deal with software and the conceptual framework is moot on the subject, considering US GAAP (which is developed using a similar conceptual framework) when applying IFRS to software is common practice.
When considering US GAAP, it is important to keep in mind that US GAAP includes separate guidance SW acquired for internal use (ASC 350-40) and SW developed for re-sale (ASC 985-20-25) in that the former is more consistent with general guidance in IAS 38 than the latter.
Also see the SW developed for re-sale example below.
It planned to use the system indefinitely and expected to maintain its functionality by updating it periodically.
On 3/31/X2, it paid ABC 2,500 to install a security update.
1/1/X1 to 6/30/X1 | 1.1.X1 to 30.6.X1
Management information system 120,000
Development expenses 5,000
Cash, Accounts payable, Payroll, etc. 125,000

As outlined in ASC 350-40-25-12, once the preliminary project stage has been completed and management has committed to the acquisition, development costs, including payroll, consultants, contractors, etc., may be capitalized.
The capitalization threshold for internal use SW differs from the threshold for SW developed for sale.
ASC 350-40-25-1 (definition): When a computer software project is in the preliminary project stage, entities will likely do the following:
a. Make strategic decisions to allocate resources between alternative projects at a given point in time. For example, should programmers develop a new payroll system or direct their efforts toward correcting existing problems in an operating payroll system?
b. Determine the performance requirements (that is, what it is that they need the software to do) and systems requirements for the computer software project it has proposed to undertake.
c. Invite vendors to perform demonstrations of how their software will fulfill an entity's needs.
d. Explore alternative means of achieving specified performance requirements. For example, should an entity make or buy the software? Should the software run on a mainframe or a client server system?
e. Determine that the technology needed to achieve performance requirements exists.
f. Select a vendor if an entity chooses to obtain software.
g. Select a consultant to assist in the development or installation of the software.
An discussion of technological feasibility is provided in the introduction and next example.
ASC 350-40-30-1 provides an exclusive list of costs that may be capitalized:
" External direct materials and services, i.e.: fees paid to consultants or contractors, licenses or code purchased from third parties, travel expenses if directly associated with developing the software
" Payroll and payroll-related costs related to work (i.e. coding and debugging) spent on project
" Interest (if capitalizable as outlined in ASC 835-20)
Note: while costs of acquiring additional software to convert old data may be capitalized (ASC 350-40-25-3), the costs of actually converting that data are expensed (ASC 350-40-25-5).
Applying this guidance generally leads to most costs of developing SW for internal use being capitalized.
As outlined in ASC 350-40-25-1, costs related to the preliminary project stage are expensed as incurred.
These costs generally comprises: evaluating whether to develop the software in house or purchase already existing software, determining the performance requirements of the software, evaluating technical requirements (i.e. cloud vs. own servers), determining the technology needed to achieve the desired results, and finding, evaluating and selecting external service provides, vendors or consultants.
As outlined in ASC 350-40-25-12, the preliminary project stage ends (capitalization begins) when management decides to go ahead with the project.
Important: ASC 350-40-25-4 prohibits capitalization of employee training costs.
Interestingly, while costs of acquiring additional software that can convert old data may be capitalized (ASC 350-40-25-3), the costs of actually converting that data may not (ASC 350-40-25-5).
12/31/X1 | 31.12.X1
Amortization expense: MIS N/A
Accumulated amortization: MIS N/A

Neither IFRS nor US GAAP disallows software to have an indefinite useful life.
In contrast to US GAAP, IFRS is straightforward.
As IAS 38 does not provide specific guidance for software, its general amortisation guidance applies.
As outlined in IAS 38.107, an intangible asset with an indefinite useful life is not amortized (though it is tested for impairment).
Unfortunately, US GAAP's guidance is not similarly clear.
ASC 350-40-35-4 states (emphasis added): The costs of computer software developed or obtained for internal use shall be amortized on a straight-line basis unless another systematic and rational basis is more representative of the software's use.
This paragraph seems to imply that software, whether purchased or developed, is always amortized.
However, this guidance addresses amortization method not period.
Instead, ASC 350-40-35-5 specifies the period will be the asset's useful life.
While it does state "given the history of rapid changes in technology, software often has had a relatively short useful life", it does not state that useful life must be finite.
Another factor to consider is that this guidance was written when software was sold on diskettes packaged in boxes.
This implies that the more contemporary guidance introduced by ASU 2018-15 should be considered even when dealing software distributed in the traditional manner, not just software as a service.
ASC 350-40-35-14 (introduced by ASU 2018-15) states: An entity (customer) shall determine the term of the hosting arrangement that is a service contract as the fixed noncancellable term of the hosting arrangement plus all of the following:
a. Periods covered by an option to extend the hosting arrangement if the entity (customer) is reasonably certain to exercise that option
b. Periods covered by an option to terminate the hosting arrangement if the entity (customer) is reasonably certain not to exercise that option
c. Periods covered by an option to extend (or not to terminate) the hosting arrangement in which exercise of the option is controlled by the vendor.
This implies, if a company acquires software with an option to extend (i.e. renew the license annually) and expects to exercise that option indefinably (i.e. renew the license annually), the period covered that option to extend is indefinite and so is the software's useful life.
In contrast to purchased software, where indefinite useful lives are rarely used, with developed software they are a reasonable policy if the company intends to maintain the software's functionality indefinitely by regularly updating it.
As outlined in IAS 38.107 | ASC 350-30-35-15, intangible assets with indefinite lives are not amortized.
As outlined in IAS 38.107 | ASC 350-30-35-15, intangible assets with indefinite lives are not amortized.
Because indefinite is transitory, indefinite should not be confused with infinite, unlimited, indeterminate or undeterminable (IAS 38.91 | ASC 350-30-35-4).
From a practical, accounting perspective this means assets with indefinite lives, while not amortized or depreciated, are tested for impairment at least every period.
In contrast, assets with unlimited lives, for example land, while also not depreciated or amortized, do not need to be regularly tested for impairment (IAS 38.108 | ASC 350-30-35-16).
Instead, they are tested for impairment (at minimum annually).
Both IAS 38.108 and provide ASC 350-30-35-16 relatively straight forward guidance, requiring assets with indefinite lives (not being amortized) to be tested for impairment annually (sooner if there is an indication they are impaired).
In a minor difference, ASC 350-30-35-17A prohibits acquired in-process R&D from being amortized until the project is completed (and useful life is determined) or the project is abandoned (and the asset is written off). Neither IFRS 3 nor IAS 38 provides similar guidance.
Additional guidance (IAS 38.108 | ASC 350-30-35-18A) stipulates that a review | qualitative assessment should be performed.
Note: the qualitative assessment in US GAAP is relatively involved. Paragraphs 350-30-35-18B through 35-18F outline how exactly it should be performed.
For its part, IAS 38 does not provide similarly detailed guidance. IAS 38.110 simply refers to IAS 36.
7/31/X1 | 31.7.X1
MIS maintenance expense 2,500
Cash 2,500

As outlined in ASC 350-40-25-7 to 11, costs related to upgrades or updates that add new functionality are capitalized while those that merely maintain existing functionality are expensed.
As this update clearly brought no additional functionality, it was expensed.
For its part, IAS 38.21 states: An intangible asset shall be recognised if, and only if:
a. it is probable that the expected future economic benefits that are attributable to the asset will flow to the entity; and
b. the cost of the asset can be measured reliably.
Since a security update seems to bring future economic benefits (security) and clearly has an easy to determine cost, this guidance seems to suggest it should be capitalised.
However, IAS 38.20 states (edited, emphasis added): ... most subsequent expenditures are likely to maintain the expected future economic benefits embodied in an existing intangible asset rather than meet the definition of an intangible asset and the recognition criteria in this Standard...
Carefully examining this update reveals that it in fact only maintains expected future economic benefits by perpetuating the security that already exists.
As such, the cost of the update is expensed as incurred.
Developed for sale
From 1/1/X1 to 6/30/X1, XYZ spent 125,000 to develop an information system for sale.
It planned to release a new, paid version in every 2 years.
1/1/X1 to 6/30/X1 | 1.1.X1 to 30.6.X1
Research and development expenses 120,000
Inventory (software developed for sale) 5,000
Cash, Accounts payable, Payroll, etc. 125,000

While IFRS does not provide stand-alone guidance for software, the result of applying its general intangible asset guidance (IAS 38) is often comparable to US GAAP's specific software guidance ASC 985-20-25.
When considering US GAAP guidance, it is important to keep in mind that US GAAP offers substantially different guidance for SW developed for re-sale (ASC 985-20-25) and internal use SW (ASC 350-40).
While the letter generally leads to most costs being capitalized, the former has the opposite effect.
The main reason is that the general prohibition on capitalizing research and development (ASC 730-10-25-1) is carried over to industry specific ASC 985-20-25 (even if in a somewhat milder form).
ASC 985-20-25-1 states (emphasis added): All costs incurred to establish the technological feasibility of a computer software product to be sold, leased, or otherwise marketed are research and development costs...
However, the way technological feasibility is defined leaves some room for development (in the form of additional coding and testing) to be capitalized.
ASC 985-20-25-2 (emphasis added): For purposes of this Subtopic, the technological feasibility of a computer software product is established when the entity has completed all planning, designing, coding, and testing activities that are necessary to establish that the product can be produced to meet its design specifications including functions, features, and technical performance requirements. At a minimum, the entity shall have performed the activities in either (a) or (b) as evidence that technological feasibility has been established:

For example, a video game developer used this guidance to justify substantial additional costs including coding and testing.
Specifically, the game required characters to drive cars and shoot one another. These functions and features were proven as the previous version of the game required characters drive cars and shoot one another.
The updated version of the game however dramatically improved the lifelike nature of this driving and shooting, even though this required considerable additional coding and testing.
Nevertheless, the company's eternal auditor accepted the argument that these functions and features were not novel, unique or unproven, and did not disagree with the policy of capitalization the associated costs.
a. If the process of creating the computer software product includes a detail program design, all of the following:
1. The product design and the detail program design have been completed, and the entity has established that the necessary skills, hardware, and software technology are available to the entity to produce the product.
2. The completeness of the detail program design and its consistency with the product design have been confirmed by documenting and tracing the detail program design to product specifications.
3. The detail program design has been reviewed for high-risk development issues (for example, novel, unique, unproven functions and features or technological innovations), and any uncertainties related to identified high-risk development issues have been resolved through coding and testing.
b. If the process of creating the computer software product does not include a detail program design with the features identified in (a), both of the following:
1. A product design and a working model of the software product have been completed.
2. The completeness of the working model and its consistency with the product design have been confirmed by testing.
This interpretation of ASC 985-20-25-1 and 2 is confirmed by ASC 985-20-25-3 which states (emphasis added): Costs of producing product masters incurred subsequent to establishing technological feasibility shall be capitalized. Those costs include coding and testing performed subsequent to establishing technological feasibility.
Nevertheless, as IAS 38 is more flexible with development costs, the capitalized amounts may differ substantially.
In practice, these costs need to be carefully evaluated on a case-by-case basis. Consequently, the assumption made in this example, same amounts were capitalized under both standards, is not particularly plausible.
As SW developed for sale is developed for sale, the costs of acquiring SW for sale, like any other asset acquired for sale, should be classified as inventory (or perhaps long-term inventory).
However, as some companies consider "inventory" to comprise only physical items, they classify these costs differently.
Neither IFRS nor US GAAP expressly specify how capitalized software development costs should be classified.
As IAS 38 is more flexible with development costs, the capitalized amounts under IFRS and US GAAP may differ substantially.
In practice, these costs need to be carefully evaluated on a case-by-case basis. Consequently, the assumption made in this example, same amounts were capitalized under both standards, is not particularly plausible.
3/31/X2 | 31.3.X2
Cost of sales 208
Inventory (software developed for sale) 208
SAS
From 1/1/X1 to 6/30/X1, XYZ spent 12,000 on additional coding associated with | implementing an information system sold as a service.
While IFRS does not provide any specific guidance for SAS, the IFRIC did addressed the issue.
While it did not issue an interpretation, it did decide that "In some circumstances, however, the arrangement may result in, for example, additional code from which the customer has the power to obtain the future economic benefits and to restrict others' access to those benefits. In that case, in determining whether to recognise the additional code as an intangible asset, the customer assesses whether the additional code is identifiable and meets the recognition criteria in IAS 38." (link: ifrs.org).
At its April 2021 meeting, the IASB did not object to this agenda decision (link: ifrs.org).
This implies that, in contrast to US GAAP which does not specifically discuss coding, to capitalize SAS related costs under IFRS, some coding should have occurred.
The EITF addressed this issue, which led to the publication of ASU 2018-15. However, this update simply applies the same guidance to SAS as any other software developed for own use.
Specifically, ASC 350-40-30-5 (one of the paragraphs introduced by ASU 2018-15) states: An entity shall apply the General Subsection of this Section as though the hosting arrangement that is a service contract were an internal-use computer software project to determine when implementation costs of a hosting arrangement that is a service contract are and are not capitalized.
The difference is that the costs associated with implementing an SAS are generally considerably lower than developing own software.
From 7/31/X1 onward, it agreed to pay the service provider 5,000 per month. It planned to use the system for an indefinite period of time.
1/1/X1 to 6/30/X1 | 1.1.X1 to 30.6.X1
Management information system 12,000
Cash, Accounts payable, Payroll, etc. 12,000

7/1/X1 | 1.7.X1
MIS (administrative expense) 5,000
Cash 5,000

Note: as neither IFRS nor US GAAP provide specific guidance for SAS developers, they would apply the same guidance as any other developer to software developed for sale (previous example).
Acquired in business combination
This illustration addresses assets acquired in a business combination.
This illustration focuses on assets.
The following, Goodwill, illustration addresses:
" Consideration transferred
" Liabilities assumed
" Badwill (negative goodwill)
In contrast to other illustrations, it does not show accounting entries but line items.
1/1/X1, XYZ acquired ABC by transferring 10,000,000 to ABC's previous owners.
Businesses are generally acquired for cash, shares or a combination (a.k.a. consideration).
Interestingly, while both US GAAP and IFRS use the term consideration, neither define it.
This is not because its general meaning is unclear: it is the cash (or something of value like shares) paid in a transaction for something else of value (a product, service or, in this case, a company).
It is because its precise meaning is surprisingly difficult to pin down.
For example, entering "consideration" into Black's online law dictionary (link: thelawdictionary.org) brings up a blank page while Britannica (link: britannica.com), although it does define it, quickly goes off on a tangent about, among other things, love and affection.
... This definition, however, leaves unanswered the question of what is sufficient consideration. During certain periods of history, nominal consideration was held to be sufficient-even a cent or a peppercorn. Gradually, the courts came to require that the consideration be valuable, although not necessarily equal in value to what is received. The courts have had to decide specifically whether acts of forbearance on the faith of a promise, the giving of a counterpromise, money payments, preexisting duties to the promisor, preexisting duties to third parties, moral obligations, love and affection, surrender of another legal claim, or performance of a legal duty were sufficient, and the answer has varied considerably over time...
Fortunately, a quick google search (link: google.com) quickly brings up perhaps the best definition (link: law.cornell.edu).
IFRS 3.37 to 40 discuss | ASC 805-30-30-7 lists the various forms of consideration.
The following illustration, Goodwill, addresses the issue in more detail.
Previously recognized assets at pre-acquisition carrying amounts
XYZ found the following assets in ABC's G/L.
Consideration less previously recognized assets at unadjusted carrying amounts (net book value).
Consideration paid to (previous) owners of ABC
10,000,000
- Cash, receivables, inventory, accruals
(250,000)
- Office building (net of 900,000 accumulated depreciation)
(100,000)
- Production facility (net of 1,800,000 accumulated depreciation)
(200,000)
- Warehouse (net of 100,000 accumulated depreciation)
(1,000,000)
- Production machinery (net of 400,000 accumulated depreciation)
(600,000)
- Equipment (net of 250,000 accumulated depreciation)
(350,000)
- Furniture and fixtures (net of 150,000 accumulated depreciation)
(200,000)
Difference (not goodwill)
7,300,000

For simplicity, this example does not present land separately from buildings and structures.
Among other things, as outlined in IFRS 3.18 | ASC 805-20-30-1, an acquirer measures all assets at fair value.
Except for cash and most financial instruments (or investment properties at fair value under IAS 40), the carrying amount (net book value) of most assets is nowhere near fair value.
This is especially true with land, buildings, structures and other assets that are depreciated while their market value steadily increases.
Measuring goodwill as the difference between purchase price and net book value is, as a result, the worst possible error an accountant can ever make.
OK, it is not as bad as fabricating revenue, hiding corruption or failing to recognize SBC, but it's pretty bad.
Previously recognized assets at fair value
XYZ remeasured previously recognized assets to fair value.
Consideration less previously recognized assets at fair value
As outlined in IFRS 3.18 | ASC 805-20-30-1, assets acquired in a business combination are measured at acquisition-date fair value.
Fair value is determined using the guidance in IFRS 13 | ASC 820 (with some exceptions).
While IFRS 3 | ASC 805 does not specify how to determine fair value, IFRS 3.21 to 31A | ASC 805-20-30-10 to 23 do outline exceptions. These exceptions are updated regularly and include:
" Income taxes
" Employee benefits
" Indemnification assets
" Assets held for sale
" Leases
A discussion of these exceptions is beyond the scope of this illustration.
Please refer to the original guidance for details.
IFRS 13 | ASC 820 is discussed in more detail on a separate page.Consideration paid to (previous) owners of ABC
10,000,000
- Cash, receivables, inventory, accruals
(250,000)
- Office building (adjusted cost basis)
(2,500,000)
- Production facility (adjusted cost basis)
(1,000,000)
- Warehouse (adjusted cost basis)
(100,000)
- Production machinery
(600,000)
- Equipment
(350,000)
- Furniture and fixtures
(200,000)
Excessive goodwill 5,000,000

In determining the fair value of current assets, XYZ considered that:
" cash and cash equivalents are not remeasured as their nominal generally equals market price (level 1 inputs)
" ABC had recognized an allowance for doubtful accounts which appeared to reflect the assumptions that market participants would use when pricing these receivables, including assumptions about risk (level 3 inputs)
" ABC had acquired raw material and production supplies recently (level 2.b inputs). It also sold its finished goods for well over production cost (also level 2.b inputs)
" there is no reason to remeasure pre-paid expenses as they reflect historical cost. Similarly, to receivables, the accrued revenue recognized by ABC also appeared to reflect the assumptions that market participants would use when pricing these assets.
Based on these considerations, XYZ concluded that the carrying amount (net book value) of the previously recognized current asset reflected their post-acquisition fair value.
A summary of fair value approaches and input levels is provided on the fair value page.
In determining the fair value of the office building, XYZ considered that ABC carried it at residual | salvage value which did not reflect this value.
Consequently, as outlined in IFRS 13.62 | ASC 820-10-35-24A, XYZ remeasured it to fair value.
As it was possible to determine the prices for which similar assets (comparable buildings in comparable locations) were being sold, XYZ determined fair value using a market approach (IFRS 13.B5 to B7 | ASC820-10-55-3A to 3C) with level 2b inputs (IFRS 13.82.b | ASC 820-10-35-48.b).
In determining the fair value of the production facility, XYZ considered that ABC carried it at residual | salvage value which did not reflect this value.
Consequently, as outlined in IFRS 13.62 | ASC 820-10-35-24A, XYZ remeasured it to fair value.
As the production facility was unique, it was not possible to determine the prices for which similar assets (comparable buildings in comparable locations) were being sold.
Consequently, XYZ elected to use a cost approach (as outlined in IFRS 13.B8 and B9 | ASC 820-10-55-3D and 3E).
As a first step, XYZ considered if the building was obsolete. It concluded, as it did not have any special technological features, it was not.
Next XYZ considered if its carrying value reflected its current value. As the building was carried at its residual | salvage value of 200,000, XYZ concluded it did not.
Next XYZ evaluated the building and determined that it was reconstructed using the same technology and methods (hand laid bricks and mortar), replacing it would cost 4,000,000 at current prices.
Next XYZ considered that if the building's the service capacity was replicated using the best possible contemporary technology and methods (prefabricated concrete slabs), replacing that capacity would cost 1,000,000.
Finally, XYZ considered whether it would be more advantages to liquidate the building instead of continuing to use it.
It concluded, although it is occasionally possible to repurpose factory buildings to capture their historical value, this particular building's location made this infeasible.
In determining the fair value of the warehouse facility, XYZ considered that ABC had acquired it recently and, as a result, its net book value accurately reflected its cost (IFRS 13.B8 and B9 | ASC 820-10-55-3D and 3E).
However, XYZ also considered that, during the short time ABC used the warehouse, it established an adjacent surface impoundment to contain toxic waste would need to be recultivated at a cost of 900,000.
To estimate this cost, XYZ averaged quotes from three independent waste management contractors.
Note: while IFRS 13.B8 and B9 | ASC 820-10-55-3D and 3E do not specifically address recultivation and similar costs, they do state "From the perspective of a market participant seller, the price that would be received for the asset is based on the cost to a market participant buyer to acquire or construct a substitute asset of comparable utility, adjusted for obsolescence."
This implies, from XYZ's (the market participant seller) perspective, the price that would be received if it were to sell the warehouse (to a market participant buyer) would need to reflect, in this case not obsolescence, but the cost of the waste removal (assuming XYZ would have trouble finding a buyer interested in toxic waste).
XYZ decided to skip estimating the fair value of machinery because the items were individually immaterial and the difference was unlikely to be cumulatively material (and because it would have because too much work).
It planned to revisited this issue if necessary.
XYZ decided to skip estimating the fair value of equipment because the items were individually immaterial and the difference was unlikely to be cumulatively material (and because it would have been too much work).
It planned to revisited this issue if necessary.
XYZ decided to skip estimating the fair value of furniture and fixtures because the items were individually immaterial and the difference was unlikely to be cumulatively material (and because it would have been too much work).
It planned to revisited this issue if necessary.
Because XYZ skipped determining the fair value of all acquired assets, goodwill was excessive.
With respect to goodwill, in addition to the guidance, practical issues should also be considered.
This guidance is covered in the next, Goodwill, illustration.
Firstly, the market often interprets goodwill as the amount by which management overpaid for an acquisition.
As the market tends to punish companies it thinks overpaid for acquisitions, keeping goodwill to a minimum should reduce the scale of the punishment.
Secondly, goodwill may not be amortized but must be tested for impairment every period.
The task of testing goodwill is difficult, time consuming and costly.
Since materiality plays a role in how rigorously accounting guidance applies, the more goodwill the more difficult, time consuming and costly the test.
Thirdly, because goodwill may not be amortized, the only way to derecognize it is with an impairment charge.
Like diamonds, goodwill can last forever. Unlike diamonds, it rarely does.
When the day to impair goodwill arrives, the market generally interprets this as proof management overpaid.
Obviously, some managers hope to kick the can and be elsewhere when that day arrives.
Other managers prefer to avoid the problem by realizing, unlike goodwill, other intangible assets can be amortized.
Goodwill is the only intangible asset that may not be amortized.
All other intangible assets are either amortized (if their useful lives and finite) or not amortized (if their useful lives are indefinite).
Obviously, goodwill cannot be zero.
Some valuable things cannot be recognized.
For example, an assembled workforce, a good reputation or the synergies a business combination should bring.
An acquisition with no goodwill thus begs the question: why did management bother?
IFRS 3.B37 to 40 ASC 805-20-55-6 to 10 provide additional guidance on items that cannot be recognized as assets and so comprise goodwill.
However, keeping it reasonable (5% to 10% of the accusation price is a good rule of thumb) not only helps management avoid having to explain why they overpaid for the acquisition, not only simplifies the annual impairment test, but also makes the eventual impairment charge, while never painless, less painful.
Previously recognized and unrecognized assets at fair value
XYZ recognized and measured the previously unrecognized technology it acquired with ABC.
Consideration less previously recognized and unrecognized assets at fair value
As outlined in IFRS 3.10 | ASC 805-20-25-1, an acquirer recognizes all the acquiree's identifiable assets including those it did not previously recognize.
While identifying and valuing previously unrecognized assets is generally part of any pre-acquisition due diligence, recognizing and measuring them post acquisition in accordance to the guidance outlined in IFRS or US GAAP falls to the acquiring company's accounting department which must, at minimum, confirm that the work performed pre-acquisition conforms to this guidance.
IFRS and US GAAP implicitly emphasize this point by mentioning "independent consultants" only once, only in an example, and only in the very limited context of measuring the value of a non-controlling interest (IFRS 3.IE46 | ASC 805-30-55-15).
With respect to assets, relying on the accounting department's own expertise is not generally problematic.
However, the same cannot be said for liabilities, which are discussed in the next (Goodwill) illustration.
IFRS 3 | ASC 805 definitions: An asset is identifiable if it meets either of the following criteria:
It is separable, that is, capable of being separated or divided from the entity and sold, transferred, licensed, rented, or exchanged, either individually or together with a related contract, identifiable asset, or liability, regardless of whether the entity intends to do so.
It arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations.
As outlined in IFRS 3.13 | ASC 805-20-25-4, an acquisition may result in recognizing assets and liabilities the acquiree had not previously recognized.
While this guidance (theoretically) applies to all assets, practically it only leads to new intangible assets.
While it is theoretically possible for an acquiree to not have recognized financial instruments or PP&E, in practice this never happens. Likewise, unless the acquiree previously used some other GAAP, leases (right of use assets) are also recognized.
Many national GAAPs are legalistic in that, as long as a lease fulfills the legal definition of operating lease, no asset or liability is recognized.
Consequently, when the acquiree previously applied a national GAAP, all its rent and lease agreement must be examined and reclassified.
Note: US GAAP still allows "operating leases" to be recognized. However, as outlined in ASC 842-20-25-6.a, the only difference between this and a financial lease is the way interest is treated. Instead of it being front loaded (the result when applying an effective interest method), it is recognized on a straight-line basis.
For this reason, the supplemental guidance in IFRS 3.IE16 to IE44 | ASC 805-20-55-11 to 55-51 focuses on intangible assets, including an extensive (though not exhaustive) list.
For example, just the marketing-related asset section comprises trademarks, trade names, service marks, collective marks, certification marks, trade dress (unique color, shape, package design), newspaper mastheads, internet domain names and noncompetition agreements.
While the following list is also not exhaustive, for the sake or orderliness, it subdivides intangible assets into those recognized separately because they are legal (based in law), because they are contractual (based in contract) or because they are separable (not based in law or contract, but transferable nonetheless).

Legal

Patents: scientific discoveries, technology, manufacturing processes, business methods, software, etc.
Copyrights: literary works (books, magazines, newspapers, etc.), musical and theatrical works (plays, operas, ballets, song lyrics, etc.), audiovisual material (motion pictures, music videos, television programs, etc.), pictures, photographs, software developed for sale, etc.
Trademarks, trade names, brands and brand names: logos, advertising jingles, tag lines, endorsements, service marks, collective marks, certification marks, trade dress, package design, mastheads, Internet domain names, etc.

Contractual

Contracts and agreements: employment, customer, manufacturing, construction, development, distribution, shelf-space, listing (slotting) agreements, supply, service agreements (consulting, management, advertising), franchising, standstill, non-compete, capital (financial) leases, etc.
Licenses: broadcast (radio, television, mobile phone, etc.), operating, royalty, purchased software, etc.
Rights and permits: construction or development, landing (i.e. airport slots), mining, drilling, exploration, logging, water use, air use, pollution, CO2 emissions, route authority, toll taking, etc.
Commitments: servicing agreements (mortgage, debt, insurance, maintenance, service, etc.), order backlogs, production backlogs, bank accounts, lines of credit, guarantees, insurance agreements, etc.

Separable

Lists: customer, advertising, mailing, dealer, supplier, subscription, etc.
Relationships: distribution channels, freight forwarding, non-contractual customer relationships, lender relationships, advertising relationships, supplier relationships, etc.
Systems and services: a delivery system (market presence), customer service network, product service system, etc.
Records: legal, medical, credit, service, client history, etc.
Documentation: databases, blueprints, drawings, training manuals, procedural manuals, repair manuals, etc.
Unpatented technology: manufacturing processes, production lines, custom made machines, trade secrets, secret formulas and recipes, software developed for own use, etc.
In an interesting side note, many national GAAPs do not allow new assets to be recognized in a business combination.
For this reason, companies applying such a GAAP often report significantly more goodwill than companies applying IFRS or US GAAP.
Interestingly, while an assembled workforce may not be an asset (IFRS 3.B37 | ASC 805-20-55-6), an employment contract may (IFRS 3.IE34 | ASC 805-20-55-31.h).
As outlined in IFRS 3.18 | ASC 805-20-30-1, assets acquired in a business combination are measured at acquisition-date fair value.
Fair value is determined using the guidance in IFRS 13 | ASC 820 (with some exceptions).
While IFRS 3 | ASC 805 does not specify how to determine fair value, IFRS 3.21 to 31A | ASC 805-20-30-10 to 23 do outline exceptions. These exceptions are updated regularly and include:
" Income taxes
" Employee benefits
" Indemnification assets
" Assets held for sale
" Leases
A discussion of these exceptions is beyond the scope of this illustration.
Please refer to the original guidance for details.
IFRS 13 | ASC 820 is discussed in more detail on a separate page.Consideration paid to (previous) owners of ABC
10,000,000
- Cash, receivables, inventory, accruals
(250,000)
- Office building (adjusted cost basis)
(2.500,000)
- Production facility (adjusted cost basis)
(1,000,000)
- Warehouse (adjusted cost basis)
(100,000)
- Production machinery
(600,000)
- Equipment
(350,000)
- Furniture and fixtures
(200,000)
- Prototypes (intangible assets)
(500,000)
- Unpatented technology
(1,000,000)
Still excessive goodwill
3,500,000

For simplicity, this illustration does not adjust the book value of the machinery to reflect the machines reclassified as prototypes.
Included among the production machinery, were two machines ABC had developed, which were unique.
As it would destroy them, XYZ had no plan to ever use them in production. Instead, it planned to replicate them.
As such, it recognized them as prototypes which, at end their useful lives, it would keep as showpieces for its museum.
Note: this example recognizes the prototypes separately from the remaining unpatented technology primarily to allow it to discuss the nature of intangible assets which take physical form.
While it would be possible to use this procedure (the prototypes can be separated from the unpatented tech), from a practical perspective, it would make little sense.
Although the machines had physical substance, XYZ did not recognize them as PP&E but as intangible assets.
As outlined in IAS 16.6, property, plant and equipment is "held for use in the production or supply of goods or services, for rental to others, or for administrative purposes."
Similarly, ASC 360-10-05-3 specifies that property, plant, and equipment is "used to create and distribute an entity's products and services."
As XYZ would never use these machines to produce, create, distribute or supply products, merchandise or services, rent to others or for administrative purposes, it could not classify them as PP&E.
IAS 38.8 states: "An intangible asset is an identifiable non-monetary asset without physical substance."
Similarly ASC 350-10-20 (edited) states: "Intangible Assets [are] assets (not including financial assets) that lack physical substance..."
Obviously, these prototype machines neither lack nor are without physical substance, so do not meet the definition of intangible asset.
Nevertheless, they will never be used in production, so cannot be classified as PP&E either.
Rather than concluding the IASB and FASB may have been sloppy with their definitions, after further consideration, it concluded the prototypes' physical form merely represented the vessel containing their economic substance: the know-how they represented.
For the sake or thoroughness, XYZ also considered IFRS 3 IE16 to IE 44 | ASC 805-20-55-11 to 51 (examples of identifiable intangible assets) where it found (IFRS 3.IE 39 | ASC 805-20-55-38) patented technology, computer software and mask works, unpatented technology, databases (including title plants) and trade secrets (such as secret formulas, processes, recipes).
Unfortunately, prototypes did not make the list.
As outlined in IAS 38.4, if an asset has intangible and tangible elements, the entity uses judgement to assess which element is more significant.
While the paragraph uses software as an example, the same logic can be applied to the know-how represented by the machines versus the machines themselves.
Although ASC 350-30-25 does not go into similar detail, nothing in its guidance precludes using the outlined procedure.
So, rather than confusing a glass with the water it contains, XYZ classified the prototypes as intangible assets.
Note: it would be unusual for prototypes to be recognized separately from the remaining unpatented technology.
However, if the example did not do this, it would not have been able to discuss the economic substance these assets.
As outlined in IFRS 13.B11.c | ASC 820-10-55-3G.c, the multi-period excess earnings method is used to measure the fair value of some intangible assets.
Obviously, the intangible assets referred to in this sub-paragraph are those that cannot be valued in any other way (like prototypes of unique machines where a market price of comparable machines cannot, by definition, exist).
From a practical perspective, using the multiperiod excess earnings method is perhaps the most difficult task an accountant can ever the face.
Most difficult from a technical perspective. From a practical perspective, the most difficult task is recognizing a goodwill impairment (or, for that matter, an material impairment of any asset or assets).
The reason multi-period excess earnings is so difficult technically is because it requires estimating probability weighted future earnings solely on the basis of plans and forecasts (hopes and dreams).
In contrast, impairment testing general requires estimating probability weighted future cash flows which, while they also require considering plans and forecasts, begin with objectively verifiable past transactions, events and circumstances.
What makes impairments so difficult is not the estimate itself, but the repercussions of having to present that estimate to a management who would often rather lose an eye than report an impairment (especially a goodwill impairment) to the market.
This also implies, any accountant tasked with determining impairment charges should be prepared to have their work scrutinized and perhaps their professional abilities, not to mention tenure with the company, questioned.
Both the IASB and FASB acknowledge this indirectly by skirting the nitty-gritty of the issue.
While both IFRS and US GAAP mention multi-period excess earnings, neither IFRS 13 nor ASC 820 provides a discussion of how to calculate it.
The only helpful hint, a reminder (IFRS 13.B3.d | ASC 820-10-55-3.d) to measure intangible assets taking into account the contribution of any complementary assets and associated liabilities.
At least they give some examples (machine and software) of when to calculate it.
IAS 13.IE11 to IE14 (example 4) | ASC 820-10-55-36 to 38A examines a machine acquired in a business combination.
As XYZ acquired machines, it considered this example.
While the example suggests that only the market and cost (not income) approaches would be appropriate, it also becomes a bit confusing.
Specifically, IFRS 13.IE14 | ASC 820-10-55-38A state (edited, emphasis added): The cost approach assumes the sale of the machine to a market participant buyer with the complementary assets and the associated liabilities. The price received for the sale of the machine (that is, an exit price) would not be more than either of the following:
a. The cost that a market participant buyer would incur to acquire or construct a substitute machine of comparable utility

b. The economic benefit that a market participant buyer would derive from the use of the machine."
To the untrained eye, if a valuation "assumes the sale of the machine" to a market participant, it appears to be a market approach, not a cost approach ¯\_(?)_/¯.
Fortunately, neither a market nor "cost" approach would be applicable to this situation.
While it would be theoretically possible to use a market approach, it would involve selling the machines to a potential buyer who would need to be informed about their unique, secret and previously unpatented features.
Possible, but not a particularly sound business decision.
It would also be possible to determine how much it would cost to reproduce the machines (how most practitioners interpret the term "cost") but, as the machines would not be used in production, their reproduction cost and economic value are unrelated (just like the software in the next example).
IAS 13.IE15 to IE17 (example 5) | ASC 820-10-55-39 to 41 examines software.
Here, the company acquired internally developed, income producing software.
The example considers that it would be possible to use both a cost and income approach but concludes as "some characteristics of the software asset are unique, having been developed using proprietary information, and cannot be readily replicated" the a cost approach to be inappropriate.
XYZ decided the same logic applies to prototype machines that have unique characteristics developed using proprietary information which cannot be readily replicated.
If it was easy, they would include an example.
Since IFRS and US GAAP do not provide any (useful) guidance on how to calculate fair value using the multi-period excess earnings method, XYZ considered other guidance.
As outlined in IAS 8.10, since no IFRS specifically addresses this issue, XYZ elected to use its judgment and approach the issue as outlined in the International Valuation Standards published by the IVSC.
As outlined by ASC 105-10-05-3.e, XYZ considered standards issued by the IVSC, a professional association.
As outside in IVS 60.6 to 18, the key steps in applying a multi-period excess earnings method are:
a. forecasting the amount and timing of future income
b. forecasting the amount and timing of expenses required to generate that income
c. adjusting the expenses to exclude those related to new intangible assets (and especially research and development, and marketing)
d. identifying the contributory assets
e. determining the appropriate rates of return on the contributory assets
f. deducting the required returns on contributory assets
g. determining the appropriate discount rate
h. adding a tax amortisation benefit if appropriate
Or, to put it simply, estimating and discounting the extra future earnings the asset(s) will bring.
Obviously, easier said than done.
It estimated the prototypes would help it create machines that would generate excess earnings of 44,000 or 55,000 or 69,000 with probabilities of 21%, 55%, and 24% over 10 years. It then discounted the risk adjusted estimated excess earnings with a risk free rate of 2.19%.
This rate was selected specifically to make this simplified example unrealistic, hence the round number result.
The purpose of this example is merely to outline that multiperiod excess earnings should be calculated using the expected present value technique (a.k.a. risk adjusted cash flow method) not the discount rate adjustment technique (a.k.a. risk adjusted discount rate method).
The former should not only be used because it yields more accurate results, but also (since the risk is incorporated into the cash flow {earnings} estimate) it obviates the need to estimate a risk adjusted discount rate, alleviating some of the pain.
P EE 1 x Pr. + EE 2 x Pr. + EE 3 x Pr. = RAE PV *
1 44,000 21% 55,000 55% 69,000 24% 56,050 54,880
2 44,000 21% 55,000 55% 69,000 24% 56,050 53,734
3 44,000 21% 55,000 55% 69,000 24% 56,050 52,612
4 44,000 21% 55,000 55% 69,000 24% 56,050 51,513
5 44,000 21% 55,000 55% 69,000 24% 56,050 50,438
6 44,000 21% 55,000 55% 69,000 24% 56,050 49,384
7 44,000 21% 55,000 55% 69,000 24% 56,050 48,353
8 44,000 21% 55,000 55% 69,000 24% 56,050 47,344
9 44,000 21% 55,000 55% 69,000 24% 56,050 46,355
10 44,000 21% 55,000 55% 69,000 24% 56,050 45,387
500,000
* (PV = RAE / (1 + i)^n where RAE = risk adjusted earnings, i = risk free rate, n = period)
With the prototypes recognized separately above, XYZ also acquired:
" blueprints
" construction manuals
" repair manuals
" training manuals
" parts lists
" a parts supplier list
As these items were not separable, XYZ recognized them as a single unit of account.
Note: in practice the prototypes would also be aggregated with the remaining unpatented tech.
While patents have advantages, they also expire.
Worse, to receive a patent, the application is reviewed. As the process involves a comment period, the applicant risks exposing the know-how and it being replicated, especially by entities domiciled in jurisdictions where respect for intellectual property is under-developed or perhaps altogether absent.
Consequently, IFRS 3.IE 39 | ASC 805-20-55-38 considers both unpatented technology and trade secrets (such as secret formulas, processes, recipes), to be recognizable intangible assets.
This illustration disaggregates them simply so it can discuss intangible assets that take physical form.
As outlined in IFRS 13.B11.c | ASC 820-10-55-3G.c, multi-period excess earnings should be used to measure some intangible assets, especially assets like unpatented technology, that are practically impossible to value in another way.
Please click Protypes: 500,000 for an additional discussion of this issue.
XYZ recognized and measured additional technology related assets.
Consideration less previously recognized and unrecognized assets at fair value (version II)
Consideration paid to (previous) owners of ABC
10,000,000
- Cash, receivables, inventory, accruals
(250,000)
- Office building (adjusted cost basis)
(2.500,000)
- Production facility (adjusted cost basis)
(1,000,000)
- Warehouse (adjusted cost basis)
(100,000)
- Production machinery
(600,000)
- Equipment
(350,000)
- Furniture and fixtures
(200,000)
- Prototypes (intangible assets)
(500,000)
- Unpatented technology
(1,000,000)
- In-process R&D
(750,000)
- Contracts with key employees
(250,000)
Still excessive goodwill
2,500,000

As outlined in ASC 730-10-15-4, research and development assets acquired in a business combination (a.k.a. in-process R&D) is capitalized rather than (as all other R&D) expensed.
Likewise ASC 805-10-55-5C.a specifies that in-process research and development should be treated as a different major intangible asset class.
For its part, IAS 38.34 provides marginally more detailed guidance specifying that an acquirer will recognize in-process research and development if it (a) meets the definition of an asset and (b) is identifiable (separable, contractual or legal like other intangible assets).
As outlined in IFRS 13.B11.c | ASC 820-10-55-3G.c, multi-period excess earnings should be used to measure some intangible assets, especially assets like in-process R&D, that are practically impossible to value in another way.
Please click Protypes: 500,000 above for an additional discussion of this issue.
As outlined in IFRS 3.IE34 and IE37 | ASC 805-20-55-31.h and 37, unlike an assembled workforce (IFRS 3.B37 | ASC 805-20-55-6), employment contract may be recognized as an asset.
Applying this guidance, XYZ capitalized contracts with several R&D employees who were key to completing the ongoing research project.
To retain and incentivize them, it granted the employees stock options vesting in tranches (5%, 6%, 6%, 7%, 9%, 10%, 11%, 13%, 15%, 17%) over 10 years.
As outlined in IFRS 13.B11.c | ASC 820-10-55-3G.c, multi-period excess earnings should be used to measure some intangible assets, especially assets like employment contracts, that are practically impossible to value in another way.
Please click Protypes: 500,000 above for an additional discussion of this issue.
XYZ identified and measured additional assets not previously recognized by ABC.
Consideration less previously recognized and unrecognized assets at fair value (version III)
xxxxxxxxxx xxxxxxxxxx
As outlined in IFRS 3.10 | ASC 805-20-25-1, an acquirer recognizes all the acquiree's identifiable assets including those it did not previously recognize.
IFRS 3 | ASC 805 definitions: An asset is identifiable if it meets either of the following criteria:
It is separable, that is, capable of being separated or divided from the entity and sold, transferred, licensed, rented, or exchanged, either individually or together with a related contract, identifiable asset, or liability, regardless of whether the entity intends to do so.
It arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations.
As outlined in IFRS 3.13 | ASC 805-20-25-4, an acquisition may result in recognizing assets and liabilities the acquiree had not previously recognized.
While this guidance (theoretically) applies to all assets, practically it only leads to new intangible assets.
While it is theoretically possible for an acquiree to not have recognized financial instruments or PP&E, in practice this never happens. Likewise, unless the acquiree previously used some other GAAP, leases (right of use assets) are also recognized.
Many national GAAPs are legalistic in that, as long as a lease fulfills the legal definition of operating lease, no asset or liability is recognized.
Consequently, when the acquiree previously applied a national GAAP, all its rent and lease agreement must be examined and reclassified.
Note: US GAAP still allows "operating leases" to be recognized. However, as outlined in ASC 842-20-25-6.a, the only difference between this and a financial lease is the way interest is treated. Instead of it being front loaded (the result when applying an effective interest method), it is recognized on a straight-line basis.
For this reason, the supplemental guidance in IFRS 3.IE16 to IE44 | ASC 805-20-55-11 to 55-51 focuses on intangible assets, including an extensive (though not exhaustive) list.
For example, just the marketing-related asset section comprises trademarks, trade names, service marks, collective marks, certification marks, trade dress (unique color, shape, package design), newspaper mastheads, internet domain names and noncompetition agreements.
While the following list is also not exhaustive, for the sake or orderliness, it subdivides intangible assets into those recognized separately because they are legal (based in law), because they are contractual (based in contract) or because they are separable (not based in law or contract, but transferable nonetheless).

Legal

Contractual

Separable

Lists: customer, advertising, mailing, dealer, supplier, subscription, etc.
Relationships: distribution channels, freight forwarding, non-contractual customer relationships, lender relationships, advertising relationships, supplier relationships, etc.
Systems and services: a delivery system (market presence), customer service network, product service system, etc.
Records: legal, medical, credit, service, client history, etc.
Documentation: databases, blueprints, drawings, training manuals, procedural manuals, repair manuals, etc.
Unpatented technology: manufacturing processes, production lines, custom made machines, trade secrets, secret formulas and recipes, software developed for own use, etc.
In an interesting side note, many national GAAPs do not allow new assets to be recognized in a business combination.
For this reason, companies applying such a GAAP often report significantly more goodwill than companies applying IFRS or US GAAP.
Interestingly, while an assembled workforce may not be an asset (IFRS 3.B37 | ASC 805-20-55-6), an employment contract may (IFRS 3.IE34 | ASC 805-20-55-31.h).
As outlined in IFRS 3.18 | ASC 805-20-30-1, assets acquired in a business combination are measured at acquisition-date fair value. As IFRS 3 | ASC 805 does not specify how to determine fair value, the general guidance IFRS 13 | ASC 820 is applied (with exceptions).
While IFRS 3 | ASC 805 does not specify how to determine fair value, IFRS 3.21 to 31A | ASC 805-20-30-10 to 23 do outline exceptions. These exceptions are updated regularly and include:
" Income taxes
" Employee benefits
" Indemnification assets
" Assets held for sale
" Leases
A discussion of these exceptions is beyond the scope of this illustration.
Please refer to the original guidance for details.
IFRS 13 | ASC 820 is discussed in more detail on a separate page.Consideration paid to (previous) owners of ABC
10,000,000
- Cash, receivables, inventory, accruals
(250,000)
- Office building (adjusted cost basis)
(2.500,000)
- Production facility (adjusted cost basis)
(1,000,000)
- Warehouse (adjusted cost basis)
(100,000)
- Production machinery
(600,000)
- Equipment
(350,000)
- Furniture and fixtures
(200,000)
- Prototypes (intangible assets)
(500,000)
- Unpatented technology
(1,000,000)
- In-process R&D
(750,000)
- Contracts with key employees
(250,000)
- Masthead and brandname
(500,000)
- Customer database
(100,000)
- Distribution system
(900,000)
Goodwill
1,000,000

As outlined in IFRS 13.B11.c | ASC 820-10-55-3G.c, multi-period excess earnings should be used to measure some intangible assets, especially assets like mastheads and brandnames, that are practically impossible to value in another way.
Please click Protypes: 500,000 above for an additional discussion of this issue.
As outlined in IFRS 13.B11.c | ASC 820-10-55-3G.c, multi-period excess earnings should be used to measure some intangible assets, especially assets like customer databases, that are practically impossible to value in another way.
Please click Protypes: 500,000 above for an additional discussion of this issue.
As outlined in IFRS 13.B11.c | ASC 820-10-55-3G.c, multi-period excess earnings should be used to measure some intangible assets, especially assets like distribution systems, that are practically impossible to value in another way.
Please click Protypes: 500,000 above for an additional discussion of this issue.
As a rule of thumb, goodwill should be kept down to around 10% of the acquisition price.
With respect to goodwill, in addition to the guidance, practical issues should also be considered.
This guidance is covered in the next, Goodwill, illustration.
Firstly, the market often interprets goodwill as the amount by which management overpaid for an acquisition.
As the market tends to punish companies it thinks overpaid for acquisitions, keeping goodwill to a minimum should reduce the scale of the punishment.
Secondly, goodwill may not be amortized but must be tested for impairment every period.
The task of testing goodwill is difficult, time consuming and costly.
Since materiality plays a role in how rigorously accounting guidance applies, the more goodwill the more difficult, time consuming and costly the test.
Thirdly, because goodwill may not be amortized, the only way to derecognize it is with an impairment charge.
Like diamonds, goodwill can last forever. Unlike diamonds, it rarely does.
When the day to impair goodwill arrives, the market generally interprets this as proof management overpaid.
Obviously, some managers hope to kick the can and be elsewhere when that day arrives.
Other managers prefer to avoid the problem by realizing, unlike goodwill, other intangible assets can be amortized.
Goodwill is the only intangible asset that may not be amortized.
All other intangible assets are either amortized (if their useful lives and finite) or not amortized (if their useful lives are indefinite).
Obviously, goodwill cannot be zero.
Some valuable things cannot be recognized.
For example, an assembled workforce, a good reputation or the synergies a business combination should bring.
An acquisition with no goodwill thus begs the question: why did management bother?
IFRS 3.B37 to 40 ASC 805-20-55-6 to 10 provide additional guidance on items that cannot be recognized as assets and so comprise goodwill.
However, keeping it reasonable (5% to 10% of the accusation price is a good rule of thumb) not only helps management avoid having to explain why they overpaid for the acquisition, not only simplifies the annual impairment test, but also makes the eventual impairment charge, while never painless, less painful.
Keeping this in mind, XYZ was satisfied it had identified all previously unrecognized assets and measured these (plus all material previously recognized assets) at fair value.
XYZ adjusted the remaining, individually immaterial assets to their acquisition date fair values.
Up to this point, XYZ had avoided remeasuring individually immaterial items to fair value due to cost/benefit considerations.
While no standard specifically addresses cost vs. benefit, it is discussed in CF 6.63 to 68 | CON QC35 to QC38.
This implies "... reporting financial information imposes costs, and it is important that those costs are justified by the benefits of reporting that information" should always be kept in mind when applying the standards.
However, after evaluating the situation, XYZ's independent auditor had reservations, deeming the goodwill excessive.
Rather than press the issue, XYZ decided to accommodate its auditor and address these reservations.
Since XYZ had proceeded rigorously, it would have been pointless to revisit the assets it had already remeasured. Instead, it elected to revisit those items of machinery, equipment and furniture and fixtures it had originally deemed individually immaterial.
Note: goodwill should, never be zero as some assets (for example an assembled workforce or reputation) cannot be measured even if they exist.
The goodwill presented on the balanced sheet comprises these items.
Consideration less previously recognized and unrecognized assets at fair value (version IV)
Consideration paid to (previous) owners of ABC
10,000,000
- Cash, receivables, inventory, accruals
(250,000)
- Office building (adjusted cost basis)
(2.500,000)
- Production facility (adjusted cost basis)
(1,000,000)
- Warehouse (adjusted cost basis)
(100,000)
- Production machinery
(821,739)
- Equipment (adjusted cost basis) (532,608)
- Furniture and fixtures (adjusted cost basis) (295,653)
- Prototypes (intangible assets)
(500,000)
- Unpatented technology
(1,000,000)
- In-process R&D
(750,000)
- Contracts with key employees
(250,000)
- Masthead and brandname
(500,000)
- Customer database
(100,000)
- Distribution system
(900,000)
Goodwill (minimized)
500,000

Up to this point, the presented values were intentionally rounded not only for readability, but to indicate that estimates made using various simplifying assumptions (see technology example, prototypes, 500,000 for a discussion this issue).
Here, more realistic values are presented to indicate they were made in a rigorous manner.
Goodwill
1/1/X1, XYZ acquired ABC for 10,000,000 in cash.
1/1/X1 / 1.1.X1
Assets 9,000,000
Goodwill 1,000,000
Cash 10,000,000

The Assets acquired in business combination illustration examines this in more detail.
In its simplest form, goodwill results from this calculation:
+ Cash paid to the (previous) owners of the business
10,000,000
- The fair value that business's net assets
(9,000,000)
= Goodwill
1,000,000

In addition to cash, IFRS 3.37 | ASC 805-30-30-7 outline various other forms the consideration that can be paid (transferred) including, for example, the acquiring company's shares (next example).
Interestingly, while both US GAAP and IFRS use the term consideration, neither define it.
This is not because its general meaning is unclear: it is the cash (or something of value like shares) paid in a transaction for something else of value (a product, service or, in this case, a company).
It is because its precise meaning is surprisingly difficult to pin down.
For example, entering "consideration" into Black's online law dictionary (link: thelawdictionary.org) brings up a blank page while Britannica (link: britannica.com), although it does define it, quickly goes off on a tangent about, among other things, love and affection.
... This definition, however, leaves unanswered the question of what is sufficient consideration. During certain periods of history, nominal consideration was held to be sufficient-even a cent or a peppercorn. Gradually, the courts came to require that the consideration be valuable, although not necessarily equal in value to what is received. The courts have had to decide specifically whether acts of forbearance on the faith of a promise, the giving of a counterpromise, money payments, preexisting duties to the promisor, preexisting duties to third parties, moral obligations, love and affection, surrender of another legal claim, or performance of a legal duty were sufficient, and the answer has varied considerably over time...
Fortunately, a quick google search (link: google.com) quickly brings up perhaps the best definition (link: law.cornell.edu).
In addition to consideration, IFRS 3.32 | ASC 805-30-30-1 also specifies the purchase price should include noncontrolling (minority) interest (if any) and any previously held equity (if the acquisition was done in stages).
It also specifies liabilities should be deducted from assets before the calculation is made.
A "business" may be a company (legal entity, or group of consolidated or combined legal entities) but it may also be an operating unit, division or segment.
What is important is that it could be a viable company if it were a stand-alone company.
To make this point, IFRS 13.B5-B12D | ASC 805-10-55-3A to 6 and 805-10-55-8 and 9 stipulate what an acquisition must have in order to be a "business."
As outlined in IFRS 3.3 | ASC 805-10-25-1, goodwill may only be recognized if the acquired entity is a business. Otherwise, the acquisition is treated as an asset acquisition.
In general, as outlined in IFRS 3.B7 | ASC 805-10-55-4, a business is an entity with 1. inputs, 2. processes and 3. outputs.
Put simply:
Inputs are suppliers, employees, machinery, equipment, furniture, fixtures, patents, copyrights, etc.
A process is the factory (or office) where the material, parts or services supplied by the suppliers are combined or transformed into products (consumed providing services) by the employees using the machinery, equipment, furniture, fixtures, patents, copyrights, etc.
Outputs are the product or services produced in the processes. These are then sold to customers, who can be external (unrelated companies) or internal (operating units, divisions, segments or other related entities).
While inputs and a process are essential elements of a business, "outputs are not required for an integrated set to qualify as a business" (IFRS 3.B7 | ASC 805-10-55-4).
"However, to be considered a business, the set must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create output" (IFRS 3.B8 | ASC 805-10-55-5).
This implies, if an acquired operating unit only produced goods for other operating units, whether or not it had actual outputs (goods sold to unrelated, third parties) is beside the point. Whether it is capable of having these outputs is the point.
Note: IFRS 3.7A to C outline a simplified "concentration test" to assess if the assets acquired/liabilities assumed constitute a business. ASC 805-10-55 does not outline a similar test.
Also note: while both IFRS (IFRS 3.IE73 to IE123) and US GAAP (ASC 805-10-55-51 to 96) include various illustrative examples of how to determine if a business is a business, they do not use the same examples.
Net assets = assets - liabilities. An illustration of how liabilities are treated is presented below.
Cash and shares
1/1/X1, XYZ acquired ABC for 5,000,000 in cash and issued shares with a market value of 5,000,000.
IFRS 3.33 | ASC 805-30-30-2 specifies that acquisition-date fair value should be used to measure consideration transferred.
If the consideration includes shares traded on a liquid market, fair value would equal their market price.
While the guidance does not explicitly require it to be used, IFRS 3.IE72 | ASC 805-10-55-42 suggests that this market price be the closing market price on the day the acquisition closes.
Note: while acquisition announcements generally cause significant swings in share price, by the time the acquisition closes, the market has priced in its impact, giving a fair representation of fair value.
The guidance does however specify that, if acquiree's equity interests are more reliably measurable, their fair value should be used.
This would likely occur only if the acquiree's shares were publicly traded while the acquirer's was not.
In situations where one public company acquires another public company, applying this guidance means the market price of the more liquid shares (higher trading volumes) should be used.
1/1/X1 / 1.1.X1
Assets 9,000,000
Goodwill 1,000,000
Cash 5,000,000
Equity 5,000,000

As outlined in IFRS 3.37 | ASC 805-30-30-7, consideration comprises:
a. Cash
b. Other assets (including, for example, shares in companies other than the acquirer)
c. Contingent consideration
d. Common or preferred equity instruments
e. Options
f. Warrants
g. Member interests of mutual entities
IFRS 3 | ASC 805 defines continent consideration: Usually an obligation of the acquirer to transfer additional assets or equity interests to the former owners of an acquiree as part of the exchange for control of the acquiree if specified future events occur or conditions are met. However, contingent consideration also may give the acquirer the right to the return of previously transferred consideration if specified conditions are met.
Additional guidance is provided in IFRS 3.39 and 40 | ASC 805-30-25-5 to 7.
In the past, if shares instead of cash were used to fund the acquisition, goodwill was not recognized.
Under current guidance, it makes no difference if the acquirer paid with cash, its own shares, or a combination.
Options and warrants are similar in that they convey the right the purchase equity instruments.
They differ in that options are generally issued by an investor that holds the company's shares, while warrants are issued by the company itself.
As a result, funding an acquisition with options does not create new equity for the acquirer.
Warrants and options and are similar in that they convey the right the purchase equity instruments.
They differ in that warrants are issued by the company itself, while options are generally issued by an investor that holds the company's shares.
As a result, funding an acquisition with warrants creates new equity for the acquirer.
Note: consideration also includes liabilities incurred by the acquirer to former owners of the acquiree.
Also note: the fair value of noncontrolling interest and the acquirer's previously held equity interest (for business combinations achieved in stages) are also included.
Assumed liabilities
1/1/X1, XYZ acquired ABC for 5,000,000 in cash and assumed 5,000,000 liabilities.
1/1/X1 / 1.1.X1
Assets 9,000,000
Goodwill 1,000,000
Cash 5,000,000
Liabilities 5,000,000

Net asset = total assets - liabilities assumed.
In contrast to recognizing assets, identifying liabilities is rarely the task of accountants.
Instead, it is better left to experts who specialize in due diligence.
Identifying, recognizing and measuring previously unrecognized assets (previous illustration) is not (usually) particularly difficult.
In contrast, identifying liabilities, especially those the acquired company's management may have gone out of its way to not disclose, is better left to experts (such as former FBI agents who left the agency due to its strict retirement policies) skilled wielding instruments not generally found in any accountant's toolbox.
Obviously, once all the potential liabilities have been identified, the accounting department is still responsible for their recognition, measurement and disclosure but, assuming the due diligence was performed rigorously, relying on it should be sufficient.
It is important to note that responsibility is jurisdictional.
In the United States, section 302 of the Sarbanes Oxley act specifies the CEO and CFO are responsible for the company's financial reports.
Obviously, they can rely on additional individuals, for example a chief accountant or controller who certifies the company's accounts are SOX compliant. However, to "pass down" SOX responsibility, the CEO and CFO must be sure they are relying on individuals with sufficient professional expertise to understand the repercussions of certifying the company's SOX compliance.
This implies, even if a chief accountant did certify that the acquiring company has recognized, measured and disclosed all the acquired company's liabilities, unless his skill set includes forensic audit, it is unlikely this certification will be sufficient to absolve the CEO and CFO of their SOX responsibility.
In contrast, IFRS is applied in various jurisdictions with varying requirements.
For example, in some EU member states, if a company employs the services of a court certified valuer, the valuer, not company's officers, bear the responsibility for the content of the valuer's report.
In such a jurisdiction, if the court certified valuer's report outlines the assets acquired and liabilities assumed in a business combination, this report, not the judgment of the company's accounting department, serves as the basis for recognition and measurement of those assets and liabilities.
When IFRS it applied in such a jurisdiction, that jurisdiction's rules and regulations may determine how IFRS is applied.
In a real-world example, company A acquired company B. Company B was domiciled in a jurisdiction where the acquisition price needed to be certified by a court appointed valuer.
Company B then used this valuer's report to draft an "IFRS compliant" financial report. This report was certified by a statutory auditor licensed to express its opinion in this jurisdiction because, from the perspective of that jurisdiction's legislation, the report was consistent with IFRS.
In an attempt to save time and effort, company A simply took this IFRS report and, with no significant adjustments (and in the belief IFRS and US GAAP were comparable), recognized the assets and liabilities it included.
However, as company A's shares were listed on a US exchange, its financial report was then reviewed by a US certified public accountant.
Rather than accept a qualified auditor's report (and risk a possible SOX compliance review), company A discarded company B's IFRS report and spent the next three months creating a report consistent with US GAAP.
The result?
What had been originally been bargain purchase, was magically transformed into an acquisition with goodwill (not in the same amount).
While some of the difference was due to inadequately measured assets, most was caused by liabilities not fully captured in the original valuer's report.
Bargain purchase
Negative goodwill (a.k.a. badwill) is the opposite of goodwill.
It would be calculated thusly:
+ Consideration transferred to the (previous) owners of the business
9,000,000
- The fair value of business's net assets
(10,000,000)
= Badwill
(1,000,000)

Negative goodwill may not be reported on the balance sheet. It is recognized as a gain in the P&L | income statement.

No illustration given.
While IFRS 3.34 to 36 | ASC 805-30-25-2 to 4 specify that a bargain purchase is possible, in practice it generally means the acquirer did not correctly measure the acquiree's assets and, much more likely, failed to identify and measure all the acquiree's liabilities, especially provisions and contingent liabilities.
For this reason, as outlined in IFRS 3.36 | ASC 805-30-25-4, before recognizing any bargain purchase gain, it is imperative the acquirer repeat due diligence (this time thoroughly).
As recognizing a bargain purchase gain is practically never justifiable no illustrate is provided.
The only time we have ever encountered a company that considered recognizing a bargain purchase, on further review, it was determined the company had simply misapplied the guidance.
Fortunately, the company corrected its error before a whistle was blown (also see link: sec.gov).
Components
IFRS versus US GAAP
If a company acquires an asset with significant parts, IFRS requires it to apply component accounting.
A component is a spare part that:
1. would cost more than 10% to 20% of the cost of the entire asset if acquired separately, and
IAS 16.43: Each part of an item of property, plant and equipment with a cost that is significant in relation to the total cost of the item shall be depreciated separately.
While IFRS does not quantify the term significant, in practice it is generally understood to mean between 10% to 20%.
This implies that no asset should have more than 5 to 10 components.
2. has a useful life that differs by more than 10% to 20% from the useful life of the asset.
Although IAS 16.43 only outlines a single (cost) criteria, IAS 16.45 suggests that useful life should also be considered.
IAS 16.43: Each part of an item of property, plant and equipment with a cost that is significant in relation to the total cost of the item shall be depreciated separately.
IAS 16.45 states: A significant part of an item of property, plant and equipment may have a useful life and a depreciation method that are the same as the useful life and the depreciation method of another significant part of that same item. Such parts may be grouped in determining the depreciation charge.
Thus even if two parts had significant values, they would not be considered separate components unless their useful lives also differed significantly.
IAS 16.43: Each part of an item of property, plant and equipment with a cost that is significant in relation to the total cost of the item shall be depreciated separately.
In contrast, US GAAP does not require components, but it does allow them.
US GAAP does not specify how assets must be depreciated. It merely requires a "systematic and rational" method to be used.
ASC 360-10-35-4: The cost of a productive facility is one of the costs of the services it renders during its useful economic life. Generally accepted accounting principles (GAAP) require that this cost be spread over the expected useful life of the facility in such a way as to allocate it as equitably as possible to the periods during which services are obtained from the use of the facility. This procedure is known as depreciation accounting, a system of accounting which aims to distribute the cost or other basic value of tangible capital assets, less salvage (if any), over the estimated useful life of the unit (which may be a group of assets) in a systematic and rational manner. It is a process of allocation, not of valuation.
As the component approach is systematic and rational, it is allowed even though, unlike IFRS, it is not required.
Since the component approach is required under IFRS, IFRS has also developed a methodology (see above).
As this methodology is not contrary to any US GAAP guidance, it may be used for US GAAP purposes.
The only methods US GAAP specifically disallows are the ACRS and annuity method.
ASC 360-10-35-9: If the number of years specified by the Accelerated Cost Recovery System of the Internal Revenue Service (IRS) for recovery deductions for an asset does not fall within a reasonable range of the asset's useful life, the recovery deductions shall not be used as depreciation expense for financial reporting.
ASC 360-10-35-10: Annuity methods of depreciation are not acceptable for entities in general.
It is important to note, however, neither IFRS nor US GAAP specify the unit of account that is to be divided into components.
In contrast to tax law and many national GAAPs, neither IFRS nor US GAAP include an arbitrary list of items that are to be considered individual assets for recognition, measurement or disclosure purposes.
3-year property.
Tractor units for over-the-road use.
Any race horse over 2 years old when placed in service. (All race horses placed in service after December 31, 2008, and before January 1, 2015, are deemed to be 3-year property, regardless of age.)
Any other horse (other than a race horse) over 12 years old when placed in service.
Qualified rent-to-own property (defined later).
5-year property.
Automobiles, taxis, buses, and trucks.
Computers and peripheral equipment.
Office machinery (such as typewriters, calculators, and copiers).
Any property used in research and experimentation.
Breeding cattle and dairy cattle.
Appliances, carpets, furniture, etc., used in a residential rental real estate activity.
Certain geothermal, solar, and wind energy property.
7-year property.
Office furniture and fixtures (such as desks, files, and safes).
Agricultural machinery and equipment.
Any property that does not have a class life and has not been designated by law as being in any other class.
Certain motorsports entertainment complex property (defined later) placed in service before January 1, 2015.
Any natural gas gathering line placed in service after April 11, 2005. See Natural gas gathering line and electric transmission property , later.
10-year property.
Vessels, barges, tugs, and similar water transportation equipment.
Any single purpose agricultural or horticultural structure.
Any tree or vine bearing fruits or nuts.
Qualified small electric meter and qualified smart electric grid system (defined later) placed in service on or after October 3, 2008.
15-year property.
Certain improvements made directly to land or added to it (such as shrubbery, fences, roads, sidewalks, and bridges).
Any retail motor fuels outlet (defined later), such as a convenience store.
Any municipal wastewater treatment plant.
Any qualified leasehold improvement property (defined later) placed in service before January 1, 2015.
Any qualified restaurant property (defined later) placed in service before January 1, 2015.
Initial clearing and grading land improvements for gas utility property.
Electric transmission property (that is section 1245 property) used in the transmission at 69 or more kilovolts of electricity placed in service after April 11, 2005. See Natural gas gathering line and electric transmission property , later.
Any natural gas distribution line placed in service after April 11, 2005 and before January 1, 2011.
Any qualified retail improvement property placed in service before January 1, 2015.
20-year property.
Farm buildings (other than single purpose agricultural or horticultural structures).
Municipal sewers not classified as 25-year property.
Initial clearing and grading land improvements for electric utility transmission and distribution plants.
25-year property. This class is water utility property, which is either of the following.
Property that is an integral part of the gathering, treatment, or commercial distribution of water, and that, without regard to this provision, would be 20-year property.
Municipal sewers other than property placed in service under a binding contract in effect at all times since June 9, 1996.
Residential rental property. This is any building or structure, such as a rental home (including a mobile home), if 80% or more of its gross rental income for the tax year is from dwelling units. A dwelling unit is a house or apartment used to provide living accommodations in a building or structure. It does not include a unit in a hotel, motel, or other establishment where more than half the units are used on a transient basis. If you occupy any part of the building or structure for personal use, its gross rental income includes the fair rental value of the part you occupy.
Nonresidential real property. This is section 1250 property, such as an office building, store, or warehouse, that is neither residential rental property nor property with a class life of less than 27.5 years.
Note: while this list was taken from the US tax code, similar lists are part of most nations' tax codes and/or National GAAPs.
Consequently, it is not uncommon for a company to define an asset such as a production line to be the unit of account with its constituent machines (laths, mills, robots, conveyors, etc.) treated as parts for component accounting purposes.
As a general rule, good accounting is to treat any assemblage of parts acquired together, used together and disposed of together an asset item even if, in different circumstances, those parts would be considered asset items in their own right.
Another rule of thumb is to consider the next organization level down from the cash-generating unit / asset group to be the asset item.
IAS 36.6: A cash-generating unit is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets.
ASC 360-10-20: An asset group is the unit of accounting for a long-lived asset or assets to be held and used, which represents the lowest level for which identifiable cash flows are largely independent of the cash flows of other groups of assets and liabilities.
IAS 16.9 states: This Standard does not prescribe the unit of measure for recognition, ie what constitutes an item of property, plant and equipment. Thus, judgement is required in applying the recognition criteria to an entity's specific circumstances. …
The IFRS master glossary defines: unit of account - The level at which an asset or a liability is aggregated or disaggregated in an IFRS for recognition purposes.
In contrast "unit of measure for recognition" is not a defined term.
Thus, although the term "unit of account" was introduced and defined by IFRS 13, it can be considered a synonym to IAS 16's "unit of measure for recognition".
Instead of stating that it does not prescribe a unit of account, ASC 360 simply does not prescribe a unit of account.
Single component
1/1/X1, XYZ acquired production machine #321 for 60,000, intending to use it for 12 years. It estimated the machine could be sold for 9,000 at the end of its useful life.
It also determined the machine to have one significant part, which would need replacing in 6 years. It estimated the part's cost at 12,000 (a significant amount) and estimated that it could be sold as scrap for 1,200 at the end of its useful life.
IAS 16.43: Each part of an item of property, plant and equipment with a cost that is significant in relation to the total cost of the item shall be depreciated separately.
It elected to use a straight-line depreciation method both the machine and its component.
Dr/Cr
1/1/X1 | 1.1.X1
Machine #321 60,000
Accounts payable 60,000

12/31/X1 to X6 | 31.12.X1 to X6
Depreciation expense 5,150
Accumulated depreciation: Machine #321 3,350
Accumulated depreciation: Machine: #321 a 1,800

3,350 = (60,000 - 12,000 + 1,200 - 9,000) ÷ 12
1,800 = (12,000 - 1,200) ÷ 6
1/1/X7, XYZ made the replacement. The replaced part cost 14,000 and XYZ spent 500 on removal and 1,000 on installation and break-in. It sold the used part for 1,350. XYZ also revaluated the asset's salvage value, determining that replacement had little effect on its expected, 9,000 selling price.
1/1/X7 | 1.1.X7
Accumulated depreciation: Machine: #321 a 10,800
Cash in bank 1,350
Asset: Machine #321 a 12,000
Disposal gain 150
Asset: machine #321 a 15,500
Accounts payable 14,000
Cash, Payables, Wages and salaries, etc. 1,500

12/31/X7 to X12 | 31.12.X7 to X12
Depreciation expense 5,733
Accumulated depreciation: Machine #321 3,686
Accumulated depreciation: Machine: #321 a 2,048

3,686 = (60,000 - 12,000 - (3,350 x 6) - 9,000 x (60,000 - 12,000 - (3,350 x 6)) ÷ ((60,000 - 12,000 - (3,350 x 6)) + 15,500)) ÷ 6
2,048 = (15,500 - 9,000 x 15,500 ÷ (60,000 - 12,000 - (3,350 x 6) + 15,500)) ÷ 6
12/31/X12 | 31.12.X12
Accumulated depreciation: Machine #321 42,214
Accumulated depreciation: Machine: #321 a 12,286
Cash 8,500
Loss 500
Machine #123 63,500

63,500 = 60,000 - 12,000 + 15,500
Several components
1/1/X1, XYZ acquired machine #345 that it intended to use for 12 years. The machine was composed of four major parts (a, b, c and d) with useful lives of 2, 4, 6 and 12 years. Part d was not replaceable. The machine cost 55,000, and 5,000 was spent on installation and break-in. If purchased separately, the stand-alone selling price of the parts would have been 16,300, 13,700, 15,000 and 21,000. XYZ estimated each part's salvage value at 10% of its cost, an amount it expected to remain constant as the parts were replaced.
Dr/Cr
1/1/X1 | 1.1.X1
Machine #345 60,000
Accounts payable 55,000
Wages and salaries 3,000
Material 2,000

Component Part price Weight Allocated cost Salvage value Depreciable value Useful life Depreciation
A B = A ÷ ??A C = 55,000 x B D = A x 10% E = C - D F G = E ÷ F
a 16,300 0.25 13,583 1,630 11,953 2 5,977
b 13,700 0.21 11,417 1,370 10,047 4 2,512
c 15,000 0.23 12,500 1,500 11,000 6 1,833
d 21,000 0.32 22,500 2,100 20,400 12 1,700
66,000 60,000 6,600 53,400 12,022

22,500 = 21,000 x 0.32 + 5,000
XYZ allocated all installation and break-in costs to this core component as it did not expect this component to be replaced.
In cases where an asset does not have a core component, in that all its parts are expected to be replaced during its useful life, acquisition related costs such as installation and break-in should be recognized as a separate component and depreciated over the aggregate useful life.
They should not be assigned to the other components on a pro-rata or other basis, as this would result in front-loaded depreciation expense recognition.
12/31/X1 & X2 | 31.12.X1 & X2
Depreciation expense 12,022
Accumulated depreciation: Machine #345 a 5,977
Accumulated depreciation: Machine #345 b 2,512
Accumulated depreciation: Machine #345 c 1,833
Accumulated depreciation: Machine #345 d 1,700

12/31/X2, XYZ expended 16,000 to buy and 500 to replace component A, which it sold for 1,590.
In contrast to initial installation and break-in, subsequent installation and break-in (as well as other acquisition costs such as transportation or non-refundable taxes and fees), should be assigned to the components being replaced.
Costs associated with component replacement may only be capitalized if they meet these criteria for PP&E recognition:
IAS 16.7 states: The cost of an item of property, plant and equipment shall be recognised as an asset if, and only if:
(a) it is probable that future economic benefits associated with the item will flow to the entity; and
(b) the cost of the item can be measured reliably.
IAS 16.10 states: An entity evaluates under this recognition principle all its property, plant and equipment costs at the time they are incurred. These costs include costs incurred initially to acquire or construct an item of property, plant and equipment and costs incurred subsequently to add to, replace part of, or service it. …
IAS 16.12 states: Under the recognition principle in paragraph 7, an entity does not recognise in the carrying amount of an item of property, plant and equipment the costs of the day-to-day servicing of the item. …
IAS 16.13 states: Parts of some items of property, plant and equipment may require replacement at regular intervals. … Under the recognition principle in paragraph 7, an entity recognises in the carrying amount of an item of property, plant and equipment the cost of replacing part of such an item when that cost is incurred if the recognition criteria are met. …
Obviously, since de-installing the old component and installing the new component is a prerequisite to an asset's ability to contribute economic benefits, both removal and installation costs should be capitalised.
Similarly, additional acquisition costs such as transportation, non-refundable taxes and fees, etc. should also be capitalised.
ASC 360-10-25 does not, unfortunately, provide similarly comprehensive recognition guidance.
In its entirety, ASC 360-10-25 states only the following:
General
25-1 See the Impairment or Disposal of Long-Lived Assets Subsection of Section 360-10-45 for a discussion of held-for-use and held-for-sale classifications of assets and asset groups.
> Acquisition of the Residual Value in Leased Assets by a Third Party
25-2 This Section provides guidance on how a third-party entity shall account for the following:
a. The acquisition from a lessor of the unconditional right to own and possess, at the end of the lease term, an asset subject to a lease
b. The acquisition of the right to receive all, or a portion, of the proceeds from the sale of a leased asset at the end of the lease term.
25-3 At the date the rights in the preceding paragraph are acquired, both transactions involve a right to receive, at the end of the lease term, all, or a portion, of any future benefit to be derived from the leased asset and shall be accounted for as the acquisition of an asset. Both transactions are referred to as the acquisition of an interest in the residual value of a leased asset.
25-4 An interest in the residual value of a leased asset shall be recorded as an asset at the date the right is acquired.
> Planned Major Maintenance Activities
25-5 The use of the accrue-in-advance (accrual) method of accounting for planned major maintenance activities is prohibited in annual and interim financial reporting periods.
> Business Combinations
25-6 See Section 805-20-25 for general guidance related to the recognition of the acquisition of property, plant, and equipment in a business combination.
However, as the principals are the same, the guidance provided by IAS 16 is consistent with both common practice and the logic of US GAAP's guidance on initial measurement.
ASC 360-10-30-1: Paragraph 835-20-05-1 states that the historical cost of acquiring an asset includes the costs necessarily incurred to bring it to the condition and location necessary for its intended use. As indicated in that paragraph, if an asset requires a period of time in which to carry out the activities necessary to bring it to that condition and location, the interest cost incurred during that period as a result of expenditures for the asset is a part of the historical cost of acquiring the asset.
ASC 360-10-30-2 See the glossary for a definition of activities necessary to bring an asset to the condition and location necessary for its intended use.
Activities
The term activities is to be construed broadly. It encompasses physical construction of the asset. In addition, it includes all the steps required to prepare the asset for its intended use. For example, it includes administrative and technical activities during the preconstruction stage, such as the development of plans or the process of obtaining permits from governmental authorities. It also includes activities undertaken after construction has begun in order to overcome unforeseen obstacles, such as technical problems, labor disputes, or litigation.
They should not be assigned to the asset as a whole, as this would result in back-loaded depreciation expense recognition.
12/31/X2 | 31.12.X2
Accumulated depreciation: Machine #345 a 11,953
Cash in bank 1,590
Loss on disposal 40
Machine #345 16,500
Machine #345 13,583
Accounts payable 16,000
Wages and salaries 500
Or simply

12/31/X2 | 31.12.X2
Accumulated depreciation: Machine #345 a 11,953
Cash in bank 1,590
Loss on disposal 40
Machine #345 2,917
Accounts payable 16,000
Wages and salaries 500
Component Cost Salvage value Depreciable value Useful life Depreciation
A B C = A - B D E = C ÷ D
a 16,500 1,600 14,900 2 7,450
b 11,417 1,370 10,047 4 2,512
c 12,500 1,500 11,000 6 1,833
d 22,500 2,100 20,400 12 1,700
62,917 6,570 56,347 13,495

In contrast to initial installation and break in, subsequent installation and break-in is assigned to individual the component not the entire asset.
12/31/X3 & X4 | 31.12.X3 & X4
Depreciation expense 13,495
Accumulated depreciation: Machine #345 a 7,450
Accumulated depreciation: Machine #345 b 2,512
Accumulated depreciation: Machine #345 c 1,833
Accumulated depreciation: Machine #345 d 1,700

12/31/X4, XYZ expended 16,500 and 14,500 to buy and 600 to replace components A and B, which it sold for 1,650 and 1,350.
12/31/X4 | 31.12.X4
Accumulated depreciation: Machine #345 a 14,900
Accumulated depreciation: Machine #345 b 10,047
Cash in bank 2,950
Machine #345 31,600
Machine #345 27,917
Gain on disposal 30
Accounts payable 31,000
Wages and salaries 600
Or simply

12/31/X4 | 31.12.X4
Accumulated depreciation: Machine #345 a 14,900
Accumulated depreciation: Machine #345 b 10,047
Cash in bank 2,950
Machine #345 3,683
Gain on disposal 30
Accounts payable 31,000
Wages and salaries 600
Component Cost Salvage value Depreciable value Useful life Depreciation
A B C = A - B D E = C ÷ D
a 16,800 1,650 15,150 2 7,575
b 14,800 1,450 13,350 4 3,338
c 12,500 1,500 11,000 6 1,833
d 22,500 2,100 20,400 12 1,700
66,600 6,700 59,900 14,446

XYZ also could have determined the installation cost of each component separately or allocated the installation cost on a pro-rata basis:
Component Cost Salvage value Depreciable value Useful life Depreciation
A B C = A - B D E = C ÷ D
a 16,819 1,650 15,169 2 7,585
b 14,781 1,450 13,331 4 3,333
c 12,500 1,500 11,000 6 1,833
d 22,500 2,100 20,400 12 1,700
66,600 6,700 59,900 14,451

However, since the amounts involved were not material, it chose the simplest method available.
Etc.
Subsequent recognition of component
1/1/X1, XYZ acquired production machine #456 for 60,000, intending to use it for 12 years. It estimated the machine could be sold for 9,000 at the end of its useful life and that it did not have any major parts which would need replacing.
Nevertheless, 1/1/X6, XYZ replaced a part that had malfunctioned.
The replaced part cost 14,000 and XYZ spent 500 on removal and 1,000 on installation and break-in. The new part increased the asset's output by 20% and XYZ sold the replaced part, as scrap, for 800.
As improvement in functionality was significant, it represents a future economic benefit that will flow to the entity and so is capitalizable per IAS 16.7.
IAS 16.7: The cost of an item of property, plant and equipment shall be recognised as an asset if, and only if:
(a) it is probable that future economic benefits associated with the item will flow to the entity; and
(b) the cost of the item can be measured reliably.
XYZ was able to determine that the value of the part when new was 12,000.
IAS 16.70: If ... an entity recognises in the carrying amount of an item of property, plant and equipment the cost of a replacement for part of the item, then it derecognises the carrying amount of the replaced part regardless of whether the replaced part had been depreciated separately.
US GAAP does not provide guidance on how to account for components. Thus, while the same procedure could be used, it would be unusual. Instead, the replacement would likely be treated as a betterment (see discussion below).
Dr/Cr
From 1/1/X1 to 12/31/X6, XYZ had recognized:
12/31/X1 to X5 | 31.12.X1 to X5
Depreciation 4,250
Accumulated depreciation: Asset #456 4,250

4,250 = (60,000 - 9,000) ÷ 12
Had it initially recognized the component, it would have recognized:
12/31/X1 to X5 | 31.12.X1 to X5
Depreciation 5,557
Accumulated depreciation: Asset #456 3,317
Accumulated depreciation: Asset #456 a 1,867

5,557 = (48,000 - 8,200) ÷ 12 + (12,000 - 800) ÷ 5
1/1/X6 | 1.1.X6
Accumulated depreciation: Asset #456 4,667
Adjustment 6,533
Cash in bank 800
Asset #456 12,000
Asset #456 15,500
Accounts payable 14,000
Wages and salaries 1,500

Judgment is required to determine how the adjustment is recognized.
The first issue is to consider if the replacement was foreseeable.
If replacement relates to an asset that commonly has significant replaceable parts (i.e. a ship, furnace, production line, building, etc.), the component should have been identified at initial recognition. As it was not, the adjustment would be a correction of an error (mistakes in applying accounting policies) and accounted for retrospectively.
The policy that was mistakenly applied was that the entity did not depreciated separately a part of an item of property, plant and equipment with a cost that is significant in relation to the total cost as required by IAS 16.43.
IAS 8.42: Subject to paragraph 43, an entity shall correct material prior period errors retrospectively in the first set of financial statements authorised for issue after their discovery by:
(a) restating the comparative amounts for the prior period(s) presented in which the error occurred; or
(b) if the error occurred before the earliest prior period presented, restating the opening balances of assets, liabilities and equity for the earliest prior period presented.
If replacement relates to an asset that does not commonly have significant replaceable parts (i.e. a personal automobile, some production machines, most computers, peripherals or office equipment, etc.), the replacement could not have been reasonably foreseeable. In this case, the adjustment could be treated as a change in estimate (IAS 8.32.d) and recognized in the current period.
IAS 8.32: As a result of the uncertainties inherent in business activities, many items in financial statements cannot be measured with precision but can only be estimated. Estimation involves judgements based on the latest available, reliable information. For example, estimates may be required of: ... (d) the useful lives of, or expected pattern of consumption of the future economic benefits embodied in, depreciable assets; ...
IAS 8.37: To the extent that a change in an accounting estimate gives rise to changes in assets and liabilities, or relates to an item of equity, it shall be recognised by adjusting the carrying amount of the related asset, liability or equity item in the period of the change.
The second issue to consider is if the replacement indicates a change in manner the asset (perhaps even the entire asset class) is used.
For example, a production machine could have been assigned to a new task which subjects its parts to greater wear and tear causing them to fail where previously they did not. In this situation, the adjustment would be treated as a change in accounting policy and, if it effected more than the one machine, applied to the entire class or perhaps several asset classes.
It is important to note, however, that a change in policy cannot be made arbitrarily, but requires justification.
IAS 8.14 states: An entity shall change an accounting policy only if the change:
(a) is required by an IFRS; or
(b) results in the financial statements providing reliable and more relevant information about the effects of transactions, other events or conditions on the entity's financial position, financial performance or cash flows.
If it becomes apparent that an asset (asset class) has components where before it did not, recognizing those components provides more reliable and more relevant information, which would justify the change.
While the same general logic would be applicable under US GAAP, as US GAAP does not require the component approach, it would be highly unusual for an adjustment to be made at all.
Instead, the replacement would likely be treated as a betterment (see discussion below).
6,533 = 5,557 x 5 - 4,250 x 5
XYZ was not able to determine that the value of the part when new.
IAS 16.70 ... If it is not practicable for an entity to determine the carrying amount of the replaced part, it may use the cost of the replacement as an indication of what the cost of the replaced part was at the time it was acquired or constructed.
US GAAP does not provide guidance on how to account for components. Thus, while the same procedure could be used, it would be unusual. Instead, the replacement would likely be treated as a betterment (see discussion below).
Dr/Cr
From 1/1/X1 to 12/31/X6, XYZ had recognized:
12/31/X1 to X5 | 31.12.X1 to X5
Depreciation 4,250
Accumulated depreciation: Asset #456 4,250

4,250 = (60,000 - 9,000) ÷ 12
Had it initially recognized the component, it would have recognized:
12/31/X1 to X5 | 31.12.X1 to X5
Depreciation 5,790
Accumulated depreciation: Asset #456 3,150
Accumulated depreciation: Asset #456 a 2,640

5,557 = (46,000 - 8,200) ÷ 12 + (14,000 - 800) ÷ 5
1/1/X6 | 1.1.X6
Accumulated depreciation: Asset #456 5,500
Adjustment 7,700
Cash in bank 800
Asset #456 12,000
Asset #456 15,500
Accounts payable 14,000
Wages and salaries 1,500

Judgment is required to determine how the adjustment is recognized.
The first issue is to consider if the replacement was foreseeable.
If replacement relates to an asset that commonly has significant replaceable parts (i.e. a ship, furnace, production line, building, etc.), the component should have been identified at initial recognition. As it was not, the adjustment would be a correction of an error (mistakes in applying accounting policies) and accounted for retrospectively.
The policy that was mistakenly applied was that the entity did not depreciated separately a part of an item of property, plant and equipment with a cost that is significant in relation to the total cost as required by IAS 16.43.
IAS 8.42: Subject to paragraph 43, an entity shall correct material prior period errors retrospectively in the first set of financial statements authorised for issue after their discovery by:
(a) restating the comparative amounts for the prior period(s) presented in which the error occurred; or
(b) if the error occurred before the earliest prior period presented, restating the opening balances of assets, liabilities and equity for the earliest prior period presented.
If replacement relates to an asset that does not commonly have significant replaceable parts (i.e. a personal automobile, some production machines, most computers, peripherals or office equipment, etc.), the replacement could not have been reasonably foreseeable. In this case, the adjustment could be treated as a change in estimate (IAS 8.32.d) and recognized in the current period.
IAS 8.32: As a result of the uncertainties inherent in business activities, many items in financial statements cannot be measured with precision but can only be estimated. Estimation involves judgements based on the latest available, reliable information. For example, estimates may be required of: ... (d) the useful lives of, or expected pattern of consumption of the future economic benefits embodied in, depreciable assets; ...
IAS 8.37: To the extent that a change in an accounting estimate gives rise to changes in assets and liabilities, or relates to an item of equity, it shall be recognised by adjusting the carrying amount of the related asset, liability or equity item in the period of the change.
The second issue to consider is if the replacement indicates a change in manner the asset (perhaps even the entire asset class) is used.
For example, a production machine could have been assigned to a new task which subjects its parts to greater wear and tear causing them to fail where previously they did not. In this situation, the adjustment would be treated as a change in accounting policy and, if it effected more than the one machine, applied to the entire class or perhaps several asset classes.
It is important to note, however, that a change in policy cannot be made arbitrarily, but requires justification.
IAS 8.14 states: An entity shall change an accounting policy only if the change:
(a) is required by an IFRS; or
(b) results in the financial statements providing reliable and more relevant information about the effects of transactions, other events or conditions on the entity's financial position, financial performance or cash flows.
If it becomes apparent that an asset (asset class) has components where before it did not, recognizing those components provides more reliable and more relevant information, which would justify the change.
While the same general logic would be applicable under US GAAP, as US GAAP does not require the component approach, it would be highly unusual for an adjustment to be made at all.
Instead, the replacement would likely be treated as a betterment (see discussion below).
7,700 = 5,790 x 5 - 4,250 x 5
Inspection
1/1/X1, XYZ acquired a machine for 60,000. The machine had a useful life of 12 years, salvage value of 9,000 and one component (fair value of 12,000, useful life 4 years, salvage value 1,200). XYZ also recognized a major inspection occurring every two years, estimating its cost at 1,500 (500 wages and salaries, 1,000 external inspector). The first inspection was performed on 12/31/X2 at an actual cost of 1.350. XYZ estimated the cost of second inspection at 1,500. 12/31/X4, XYZ replaced the component spending 14,000 for a replacement, 500 on removal and 1,000 on installation and break-in. It sold the used component as scrap for 1,450 (IFRS only).
IAS 16.14 states: A condition of continuing to operate an item of property, plant and equipment (for example, an aircraft) may be performing regular major inspections for faults regardless of whether parts of the item are replaced. When each major inspection is performed, its cost is recognised in the carrying amount of the item of property, plant and equipment as a replacement if the recognition criteria are satisfied. Any remaining carrying amount of the cost of the previous inspection (as distinct from physical parts) is derecognised. This occurs regardless of whether the cost of the previous inspection was identified in the transaction in which the item was acquired or constructed. If necessary, the estimated cost of a future similar inspection may be used as an indication of what the cost of the existing inspection component was when the item was acquired or constructed.
US GAAP does not provide any specific guidance for inspection costs.
The only guidance related to this issue is provided for the airline industry (ASC 908).
However, this guidance does not specifically address inspection costs, nor is it generally applicable to other industries.
However, the general consensus (among both practitioners and auditors) is that they are expensed as incurred, not capitalized.
Dr/Cr
1/1/X1 | 1.1.X1
Asset: machine #123 60,000
Accounts payable 60,000

12/31/X1 | 31.12.X1
Depreciation expense 7,325
Accumulated depreciation: Machine: #123 3,875
Accumulated depreciation: Machine: #123 a 2,700
Accumulated depreciation: Machine: #123 i 750

While the (SIC 23) requirement that an inspection or overhaul component must be separately identified and accounted for at acquisition was removed from IAS 16 in a 2003 revision, recognizing expected inspection at the time the asset is recognized is both good accounting and consistent with IAS 16.14.
IAS 16.14 states that "Any remaining carrying amount of the cost of the previous inspection ... is derecognised ... regardless of whether the cost of the previous inspection was identified in the transaction in which the item was acquired or constructed".
This implies that recognizing an expected inspection as part of the transaction in which the item was acquired is acceptable.
12/31/X2 | 31.12.X2
Depreciation expense 7,325
Accumulated depreciation: Machine: #123 3,875
Accumulated depreciation: Machine: #123 a 2,700
Accumulated depreciation: Machine: #123 i 750
Accumulated depreciation: Machine: #123 1,320
Accounts payable 1,000
Wages and salaries 320

12/31/X3 | 31.12.X3
Depreciation expense 7,235
Accumulated depreciation: Machine: #123 3,875
Accumulated depreciation: Machine: #123 a 2,700
Accumulated depreciation: Machine: #123 i 660
Repairs and betterments
Repair
1/1/X1, XYZ acquired production machine #456 for 60,000, intending to use it for 12 years. It estimated the machine could be sold for 9,000 at the end of its useful life and that it did not have any major parts which would need replacing. 1/1/X6, it replaced a part that had malfunctioned. The replaced part cost 1,400 and XYZ spent 50 on removal and 100 on installation. The new part neither increased the asset's output not extended its useful life. XYZ sold the replaced part, as scrap, for 80.
Dr/Cr
1/1/X1 | 1.1.X1
Asset: machine #123 60,000
Accounts payable 60,000

12/31/X1 to X5 | 31.12.X1 to 31.12.X5
Depreciation expense 4,250
Accumulated depreciation: Machine: #123 4,250

1/1/X6 | 1.1.X6
Repairs and maintenance expense 1,550
Accounts payable 1,400
Wages and salaries 150

12/31/X6 to X12 | 31.12.X6 to 31.12.X12
Depreciation expense 4,250
Accumulated depreciation: Machine: #123 4,250
Maintenance
XYZ generally spends approximately 10,000 per quarter on maintenance. During Q1.X1, actual maintenance costs (comprising: spare parts (taken from spare patrs inventory) 760, spare parts (purchased from various venders) 1,140, services provided by various vendors 1,525 and wages and salaries 6,450) were 9,875. Of the maintenance, 60% was related to production equipment and machinery, 25% to sales equipment and the remainder to office equipment (for illustration purposes, only a single, quarter-end entry is shown).
Dr/Cr
3/31/X1 | 31.3.X1
Cost of sales: Repairs and maintenance 5,925
Selling and distribution: Repairs and maintenance 2,469
Administrative and general: Repairs and maintenance 1,481
PP&E: Spare parts inventory 760
Accounts payable (various venders) 2.675
Wages and salaries 6,450

IAS 16 previously referred to spare parts held to service property plant and equipment as inventory leading some to erroneously conclude believe that spare parts should be disclosed as "inventory" alongside raw materials, work in progress and finished goods.
IAS 16 (2011) 8: Spare parts and servicing equipment are usually carried as inventory and recognised in profit or loss as consumed. However, major spare parts and stand-by equipment qualify as property, plant and equipment when an entity expects to use them during more than one period. Similarly, if the spare parts and servicing equipment can be used only in connection with an item of property, plant and equipment, they are accounted for as property, plant and equipment.
IAS 2.6 defines inventory as:
(a) held for sale in the ordinary course of business;
(b) in the process of production for such sale; or
(c) in the form of materials or supplies to be consumed in the production process or in the rendering of services.
This definition makes clear that spare parts held to repair or maintain PP&E cannot considered "inventory" (raw materials, work in progress and finished goods held for sale or eventual sale) but only inventory (a collection of resources held for a variety of purposes).
While distinctions such as this are generally clear to native English speakers (accustomed interpreting English terminology based on context), they are less clear to native speakers of other languages (especially languages where literal interpretations are prevalent).
As a result, old IAS 16's offhand reference to spare parts inventory not only caused confusion, but even lead some international practitioners to conclude that IFRS was illogical and self-contradictory.
To clear up the confusion, the 2009-2011 improvements cycle amended IAS 16.9 to state: Items such as spare parts, stand-by equipment and servicing equipment are recognized in accordance with this IFRS when they meet the definition of property, plant and equipment. Otherwise, such items are classified as inventory.
While US GAAP does not (and never has) specifically mention spare parts, there is no confusion about their being recognized as PP&E until they are consumed.
6/30/X0, XYZ had purchased two lots of spare parts. Lot 1 had cost 700 and consisted of 10 parts while lot 2 had cost 4,000 and also consisted of 10 parts.
Lot 1 comprised gear assemblies which did not start to lose value until installed. Lot 2 comprised control units which lost value as they became obsolete (which XYZ estimated at 5 years).
The 31/3/X1 repair and maintenance task required 6 lot 1 parts and 1 lot 2 part.
6/30/X0 | 30.6.X0
Spare parts inventory: #1 700
Spare parts inventory: #2 4,000
Accounts payable 4,700

12/31/X0 | 31.12.X0
Depreciation expense 400
Accumulated depreciation: Spare parts inventory: #2 400

For illustration purposes, depreciation expense is recognized annually.
400 = 4,000 ÷ (5 x 4) x 2
3/31/X1 | 31.3.X1
Accumulated depreciation: Spare parts inventory: #2 60
Repairs and maintenance 760
Spare parts inventory: #1 420
Spare parts inventory: #2 400
MRE Allowance
Same facts as above except, XYZ performs the majority of its maintenance and all planned repairs in August, during a summer vacation shutdown. Instead of charging recognizing MRE (maintenance and repairs expense) as it goes, it uses an MRE Allowance. In August X1, 19,650 was spent on maintenance and 16,125 on planned repairs. In October X1, an unplanned repair of 3200 was performed (for illustration purposes only aggregate period-end, entries are shown).
ASC 360-10-25-5 states: "The use of the accrue-in-advance (accrual) method of accounting for planned major maintenance activities is prohibited in annual and interim financial reporting periods."
However, this prohibition was introduced by FSP AUG AIR-1, whose aim was to disallow the recognition of liabilities.
FSP AUG AIR-1.5: This FSP prohibits the use of the accrue-in-advance method of accounting for planned major maintenance activities in annual and interim financial reporting periods.
FSP AUG AIR-1.3: The Board believes that the accrue-in-advance method of accounting for planned major maintenance activities results in the recognition of liabilities that do not meet the definition of a liability in FASB Concepts Statement No. 6, Elements of Financial Statements, because it causes the recognition of a liability in a period prior to the occurrence of the transaction or event obligating the entity. The fact that an entity may incur future maintenance costs to improve the operating efficiency of an asset, comply with regulatory operating guidelines, or extend the useful life of the asset does not embody a present duty or responsibility of the entity prior to the obligating transaction or event. The entity can decide whether to use the asset in such a way to avoid the need for future maintenance activities.[1]
In contrast, as explained in FASB Statement No. 143, Accounting for Asset Retirement Obligations, and as demonstrated in examples in FASB Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations, the liability required to be recorded for an asset retirement obligation is based on a legal obligation for which the event obligating the entity has occurred.
This implies that ASC 360-10-25-5 should not be interpreted as prohibiting allowances (recognized as contra-assets) for planned major maintenance activities, but as prohibiting provisions (recognized as liabilities) for planned major maintenance activities.
Likewise, IAS 37 prohibits recognizing provisions (and explains why) for repairs and maintenance but does not prohibit recognizing allowances.
IAS 37.Example 11 Repairs and maintenance
Some assets require, in addition to routine maintenance, substantial expenditure every few years for major refits or refurbishment and the replacement of major components. IAS 16 Property, Plant and Equipment gives guidance on allocating expenditure on an asset to its component parts where these components have different useful lives or provide benefits in a different pattern.
IAS 37.Example 11A Refurbishment costs - no legislative requirement
A furnace has a lining that needs to be replaced every five years for technical reasons. At the end of the reporting period, the lining has been in use for three years.
Present obligation as a result of a past obligating event - There is no present obligation.
Conclusion - No provision is recognised (see paragraphs 14 and 17-19).
The cost of replacing the lining is not recognised because, at the end of the reporting period, no obligation to replace the lining exists independently of the company's future actions-even the intention to incur the expenditure depends on the company deciding to continue operating the furnace or to replace the lining. Instead of a provision being recognised, the depreciation of the lining takes account of its consumption, ie it is depreciated over five years. The re-lining costs then incurred are capitalised with the consumption of each new lining shown by depreciation over the subsequent five years.
IAS 37.Example 11B Refurbishment costs - legislative requirement
An airline is required by law to overhaul its aircraft once every three years.
Present obligation as a result of a past obligating event - There is no present obligation.
Conclusion - No provision is recognised (see paragraphs 14 and 17-19).
The costs of overhauling aircraft are not recognised as a provision for the same reasons as the cost of replacing the lining is not recognised as a provision in example 11A. Even a legal requirement to overhaul does not make the costs of overhaul a liability, because no obligation exists to overhaul the aircraft independently of the entity's future actions-the entity could avoid the future expenditure by its future actions, for example by selling the aircraft. Instead of a provision being recognised, the depreciation of the aircraft takes account of the future incidence of maintenance costs, ie an amount equivalent to the expected maintenance costs is depreciated over three years.
9/30/X0, 12/31/X0, 3/31/X1 and 6/30/X1 | 30.9.X0, 31.12.X0 31.3.X1 and 30.6.X1
Repairs and maintenance expense 10,000
MRE allowance (X1) 10,000

8/31/X1 | 31.8.X1
MRE allowance (X1) 39,775
Cash, Spare parts inventory, Accounts payable, Wages and salaries, Etc. 39,775

9/30/X1 | 30.9.X1
Repairs and maintenance expense 10,000
MRE allowance (X2) 10,000

10/15/X1 | 15.10.X1
Repairs and maintenance expense 2,975
MRE allowance (X1) 225
Cash, Spare parts inventory, Accounts payable, Wages and salaries, Etc. 3,200

The MRE allowance should never be accumulated from one period to the next.
If it is not possible, as illustrated in this example, to charged off the balance without significant delay, the balance should be reversed in the period the MRE is performed.
Betterment
1/1/X1, XYZ acquired production machine #456 for 60,000, intending to use it for 12 years. It estimated the machine could be sold for 9,000 at the end of its useful life and that it did not have any major parts which would need replacing.
Nevertheless, 1/1/X6, XYZ replaced a part that had malfunctioned.
The replaced part cost 14,000 and XYZ spent 500 on removal and 1,000 on installation and break-in. The new part increased the asset's output by 20% and XYZ sold the replaced part, as scrap, for 800.
IFRS
Per IFRS, the item should have been recognized as a component (see: Subsequent recognition of component).
US GAAP
Please be aware that betterment accounting inflates the value of assets.
As a result, its use is controversial and not recommended by this web site.
Instead, this site recommends component accounting, which produces vastly superior results.
Nevertheless, as betterment accounting is not disallowed under US GAAP, the policy shown in this example would not be an error.
1/1/X1 | 1.1.X1
Asset: machine #123 60,000
Accounts payable 60,000

12/31/X1 to X5 | 31.12.X1 to 31.12.X5
Depreciation expense 4,250
Accumulated depreciation: Machine: #123 4,250

1/1/X6 | 1.1.X6
Asset: machine #456 14,000
Repairs and maintenance (MRE) 700
Cash 800
Accounts payable 14,000
Wages and salaries 1,500

While it is almost universally acknowledged that removal costs are expensed, whether installation costs should be capitalized is open to interpretation.
Similarly open to interpretation is whether the sales price of any replaced parts should be offset or disaggregated.
Since this web site considers betterment accounting in general to be inappropriate, the example interprets US GAAP in a way that minimizes the negative impact of applying this accounting policy.
12/31/X6 to12/31/X12 | 31.12.X6 to 31.12.X12
Depreciation expense 6,250
Accumulated depreciation: Machine: #456 6,250

6,250 = (60,000 - 9,000 - 4,250 x 5 + 14,000) ÷ 7
Life extension
1/1/X1, XYZ acquired production machine #456 for 60,000, intending to use it for 12 years. It estimated the machine could be sold for 9,000 at the end of its useful life and that it did not have any major parts which would need replacing.
Nevertheless, 1/1/X6, to extend the asset's useful life, XYZ replaced a major part.
The replaced part cost 14,000 and XYZ spent 500 on removal and 1,000 on installation and break-in. The replaced part was sold, as scrap, for 800.
IFRS
Per IFRS, the item should have been recognized as a component (see: Subsequent recognition of component).
US GAAP
1/1/X1 | 1.1.X1
Asset: machine #123 60,000
Accounts payable 60,000

12/31/X1 to X5 | 31.12.X1 to 31.12.X5
Depreciation expense 4,250
Accumulated depreciation: Machine: #123 4,250

1/1/X6 | 1.1.X6
Accumulated depreciation: Machine: #123 15,500
Accounts payable 14,000
Wages and salaries 1,500

12/31/X6 to 6/30/X15 | 31.12.X1 to 30.6.X15
Depreciation expense 4,250
Accumulated depreciation: Machine: #123 4,250

6/30/X16 | 30.6.X16
Depreciation expense 2,750
Accumulated depreciation: Machine: #123 2,750
Depreciation
Units of production
1/1/X1, XYZ acquired a die for 12,000. As outlined in its engineering specifications, the die would be used to produce 120,000 parts before it had to be scrapped. It's scrap value was insignificant. As a result, XYZ elected to use a usage based depreciation method.
IAS 16.56 states: The future economic benefits embodied in an asset are consumed by an entity principally through its use. ... (a) Usage is assessed by reference to the asset's expected capacity or physical output.
Although paragraph 56 addresses the depreciation period rather than depreciation method, basing the depreciation method on expected capacity or physical output is consistent with paragraph 62.
IAS 16.62: A variety of depreciation methods can be used to allocate the depreciable amount of an asset on a systematic basis over its useful life. These methods include the straight-line method, the diminishing balance method and the units of production method. ...
While ASC 360-10-35 does not give similarly detailed guidance, as the logic is the same, the same method should be used per US GAAP.
During X1, 24,060 parts were produced. In X5, the production run for which the die had been acquired ended. In total, 119,894 parts had been produced. The die was sold as scrap metal for 35.
Dr/Cr
1/1/X1 | 1.1.X1
Die #123 12,000
Accounts payable 12,000

12/31/X1 | 31.12.X1
Depreciation 2,406
Accumulated depreciation: Die #123 2,406

12/31/X9 | 24.11.X9
Accumulated depreciation: Die #123 11,989
Petty cash 35
Loss on disposal 71
Die #123 12,000
Straight-line
1/1/X1, XYZ acquired press #123 for 12,000. Press #123 replaced press #3 that had cost 10,500, been used for 20 years and was sold for 1,750.
XYZ replaced press #3 because its physical deterioration made its continued use uneconomical. During the 20 years press #3 had been used, apart from seasonal fluctuation, its output remained constant. As a result, XYZ elected to use a linear depreciation method. Press #123 was sold for 2,250 on 1/1/X21.
IAS 16.56 states: The future economic benefits embodied in an asset are consumed by an entity principally through its use. ... (b) expected physical wear and tear, which depends on operational factors such as the number of shifts for which the asset is to be used and the repair and maintenance programme, and the care and maintenance of the asset while idle.
Although paragraph 56 addresses the depreciation period rather than depreciation method, basing the depreciation method on expected physical wear and tear is consistent with paragraph 62.
IAS 16.62: A variety of depreciation methods can be used to allocate the depreciable amount of an asset on a systematic basis over its useful life. These methods include the straight-line method, the diminishing balance method and the units of production method. ...
While ASC 360-10-35 does not give similarly detailed guidance, as the logic is the same, the same method should be used per US GAAP.
Dr/Cr
1/1/X1 | 1.1.X1
Press #123 12,000
Accounts payable 12,000

12/31/X1 to X20| 31.12.X1 yo X20
Depreciation 500
Accumulated depreciation: Press #123 500

1/1/X21 | 1.1.X21
Accumulated depreciation: Press #123 10,000
Cash in bank 2,250
Press #123 12,000
Gain on disposal 250
Sum-of-the-year's-digits
1/1/X1, XYZ acquired circuit printing machine #345 for 12,000. XYZ commonly uses this class of machine for 5 years and sells them for 16.7% of their acquisition cost.
In general, as this class of machine ages, the inflation adjusted sales price of its product declines, while production costs remain fairly constant. As a result, XYZ elected to use an accelerated depreciation method.
Per IFRS, an entity considers how the economic benefits embodied in asset are consumed. As the economic benefits embodies in machine #345 are consumed at a decelerating rate (the highest consumption being in the earliest periods), an accelerated depreciation method is appropriate.
IAS 16.60 states: The depreciation method used shall reflect the pattern in which the asset's future economic benefits are expected to be consumed by the entity.
Although basing a depreciation method on revenue is prohibited, this prohibition is intended to counter the effects of inflation.
IAS 16.62A: A depreciation method that is based on revenue that is generated by an activity that includes the use of an asset is not appropriate. The revenue generated by an activity that includes the use of an asset generally reflects factors other than the consumption of the economic benefits of the asset. For example, revenue is affected by other inputs and processes, selling activities and changes in sales volumes and prices. The price component of revenue may be affected by inflation, which has no bearing upon the way in which an asset is consumed.
IAS 16.BC33D: The IASB noted that even though revenue could sometimes be considered to be a measurement of the output generated by the asset, revenue does not, as a matter of principle, reflect the way in which an item of property, plant and equipment is used or consumed. The IASB observed that the price component of revenue may be affected by inflation and noted that inflation has no bearing upon the way in which an asset is consumed.
Likewise, IAS 16.56 considers selling price to be valid indicator of useful life implying it can also be used in determining how the economic benefits embodied in an asset are consumed (assuming the effects of inflation are taken into consideration).
IAS 16.56 states: The future economic benefits embodied in an asset are consumed by an entity principally through its use. ... (b) expected physical wear and tear, which depends on operational factors such as the number of shifts for which the asset is to be used and the repair and maintenance programme, and the care and maintenance of the asset while idle.
Although paragraph 56 addresses the depreciation period rather than depreciation method, basing the depreciation method on expected physical wear and tear is consistent with paragraph 62.
IAS 16.62: A variety of depreciation methods can be used to allocate the depreciable amount of an asset on a systematic basis over its useful life. These methods include the straight-line method, the diminishing balance method and the units of production method. ...
Since ASC 630-10-35-7 specifically discusses an asset's revenue generating ability, the same logic is applicable per US GAAP.
ASC 630-10-35-7 states: The declining-balance method is an example of one of the methods that meet the requirements of being systematic and rational. If the expected productivity of the asset or ability of the asset to generate revenue is relatively greater during the earlier years of its life, or maintenance charges tend to increase during later years, the declining-balance method may provide the most satisfactory allocation of cost. That conclusion also applies to other methods, including the sum-of-the-years'-digits method, that produce substantially similar results.
XYZ chose the SYD method for its simplicity and sold the machine for 2,250 on 12/31/X5.
Although simple to apply, SYD always leads to the same expense pattern, which makes it inferior to the declining balance method.
ASC 360-10-35-7 states: The declining-balance method is an example of one of the methods that meet the requirements of being systematic and rational. ... That conclusion also applies to other methods, including the sum-of-the-years'-digits method ....
While not specifically mentioned as an alternative, SYD is not prohibited and so considered acceptable for IFRS reporting purposes (provided that adequate disclosures are made).
IAS 16.62 states: A variety of depreciation methods can be used to allocate the depreciable amount of an asset on a systematic basis over its useful life. These methods include the straight-line method, the diminishing balance method and the units of production method.
While it is possible to interpret paragraph 62 as requiring straight-line, diminishing balance or units of production, the more common interpretation is that the paragraph is providing examples of acceptable methods rather than an exhaustive list.
Dr/Cr

Year Year's Digit SYD Factor Depreciation expense Accumulated depreciation
A = life (life-1) B = A ÷ ??A C = B x 10,000 D = C + D(D-1)
1 5 5 ÷ 15 3,333 -
2 4 4 ÷ 15 2,667 3,333
3 3 3 ÷ 15 2,000 6,000
4 2 2 ÷ 15 1,333 8,000
5 1 1 ÷ 15 667 9,333
?? 15 10,000

1/1/X1 | 1.1.X1
Machine #345 12,000
Accounts payable 12,000

12/31/X1 | 31.12.X1
Depreciation 3,333
Accumulated depreciation: Machine #345 3,333

12/31/X5 | 31.12.X5
Depreciation 667
Accumulated depreciation: Machine #345 667
Accumulated depreciation: Machine #345 10,000
Cash in bank 2,250
Machine #345 12,000
Gain on disposal 250
Reducing balance
1/1/X1, XYZ acquired wafer-etching machine # 456 for 12,000. While machines of this type can be useful 6 to 8 years, XYZ's policy is to disposes of them after 5 years for, on averaged, 16.7% of their acquisition cost.
In general, as this class of machine ages, the inflation adjusted sales price of its product declines, while production costs remain fairly constant. As a result, XYZ elected to use an accelerated depreciation method.
Per IFRS, an entity considers how the economic benefits embodied in asset are consumed. As the economic benefits embodies in machine #345 are consumed at a decelerating rate (the highest consumption being in the earliest periods), an accelerated depreciation method is appropriate.
IAS 16.60 states: The depreciation method used shall reflect the pattern in which the asset's future economic benefits are expected to be consumed by the entity.
Although basing a depreciation method on revenue is prohibited, this prohibition is intended to counter the effects of inflation.
IAS 16.62A: A depreciation method that is based on revenue that is generated by an activity that includes the use of an asset is not appropriate. The revenue generated by an activity that includes the use of an asset generally reflects factors other than the consumption of the economic benefits of the asset. For example, revenue is affected by other inputs and processes, selling activities and changes in sales volumes and prices. The price component of revenue may be affected by inflation, which has no bearing upon the way in which an asset is consumed.
IAS 16.BC33D: The IASB noted that even though revenue could sometimes be considered to be a measurement of the output generated by the asset, revenue does not, as a matter of principle, reflect the way in which an item of property, plant and equipment is used or consumed. The IASB observed that the price component of revenue may be affected by inflation and noted that inflation has no bearing upon the way in which an asset is consumed.
Likewise, IAS 16.56 considers selling price to be valid indicator of useful life implying it can also be used in determining how the economic benefits embodied in an asset are consumed (assuming the effects of inflation are taken into consideration).
IAS 16.56 states: The future economic benefits embodied in an asset are consumed by an entity principally through its use. ... (b) expected physical wear and tear, which depends on operational factors such as the number of shifts for which the asset is to be used and the repair and maintenance programme, and the care and maintenance of the asset while idle.
Although paragraph 56 addresses the depreciation period rather than depreciation method, basing the depreciation method on expected physical wear and tear is consistent with paragraph 62.
IAS 16.62: A variety of depreciation methods can be used to allocate the depreciable amount of an asset on a systematic basis over its useful life. These methods include the straight-line method, the diminishing balance method and the units of production method. ...
Since ASC 630-10-35-7 specifically discusses an asset's revenue generating ability, the same logic is applicable per US GAAP.
ASC 630-10-35-7 states: The declining-balance method is an example of one of the methods that meet the requirements of being systematic and rational. If the expected productivity of the asset or ability of the asset to generate revenue is relatively greater during the earlier years of its life, or maintenance charges tend to increase during later years, the declining-balance method may provide the most satisfactory allocation of cost. That conclusion also applies to other methods, including the sum-of-the-years'-digits method, that produce substantially similar results.
XYZ sold the machine 2,250 on 1/1/X6.
Diminishing balance
As it is explicitly mentioned by IFRS, XYZ elected to use a diminishing balance method.
IAS 16.62: A variety of depreciation methods can be used to allocate the depreciable amount of an asset on a systematic basis over its useful life. These methods include the straight-line method, the diminishing balance method and the units of production method.
While similar, the diminishing and declining balance methods calculate the depreciation charge somewhat differently.
The declining balance methods starts with straight-line depreciation (most often expressed as a percentage) which it multiples by a factor (most often two). In the final period, the depreciation expense is the difference between accumulated depreciation and salvage (residual) value.
In contrast, the demising balance method calculates a diminishing factor based on acquisition cost, residual (salvage) value and useful life.
Each method has its advantages and disadvantages.
The declining balance method allows the company to fine tune the depreciation expense by selecting any factor. It does, however, shorten the depreciation period, frontloading the expense (the math required in the final period is also not particularly elegant).
The diminishing balance leads to a more systematic allocation of depreciation expense but, like the SYD method, always leads to the same pattern of expense recognition.
In general, both the diminishing and declining balance methods may be used under both IFRS and US GAAP provided that adequate footnote disclosures are made.
Dr/Cr

P DB Factor Net book value Depreciation Accumulated depreciation
A = 1 - (2,000 ÷ 12,000)(1÷5) B = B(B-1) - C C = A x B D = C + D(D-1)
1 30.12% 12,000 3,614 -
2 30.12% 8,386 2,526 3,614
3 30.12% 5,860 1,765 6,140
4 30.12% 4,095 1,233 7,905
5 30.12% 2,862 862 9,138
10,000

1/1/X1 | 1.1.X1
Machine # 456 12,000
Accounts payable 12,000

12/31/X1 | 31.12.X1
Depreciation 3,614
Accumulated depreciation: Machine # 456 3,614

12/31/X5 | 31.12.X5
Depreciation 862
Accumulated depreciation: Machine # 456 862

1/1/X6 | 1.1.X6
Accumulated depreciation: Machine # 456 10,000
Cash in bank 2,250
Machine # 456 12,000
Gain on disposal 250
Declining balance
As it is preferred by US GAAP, XYZ elected to use a declining balance method.
ASC 360-10-35-7: The declining-balance method is an example of one of the methods that meet the requirements of being systematic and rational. If the expected productivity or revenue-earning power of the asset is relatively greater during the earlier years of its life, or maintenance charges tend to increase during later years, the declining-balance method may provide the most satisfactory allocation of cost. That conclusion also applies to other methods, including the sum-of-the-years'-digits method, that produce substantially similar results.
While similar, the diminishing and declining balance methods calculate the depreciation charge somewhat differently.
The declining balance methods starts with straight-line depreciation (most often expressed as a percentage) which it multiples by a factor (most often two). In the final period, the depreciation expense is the difference between accumulated depreciation and salvage (residual) value.
In contrast, the demising balance method calculates a diminishing factor based on acquisition cost, residual (salvage) value and useful life.
Each method has its advantages and disadvantages.
The declining balance method allows the company to fine tune the depreciation expense by selecting any factor. It does, however, shorten the depreciation period, frontloading the expense (the math required in the final period is also not particularly elegant).
The diminishing balance leads to a more systematic allocation of depreciation expense but, like the SYD method, always leads to the same pattern of expense recognition.
In general, both the diminishing and declining balance methods may be used under both IFRS and US GAAP provided that adequate footnote disclosures are made.
Dr/Cr

P DDB Factor Net book value Depreciation Accumulated depreciation
A = 20% x 2 B = B(B-1) - C C = A x B D = C + D(D-1)
1 40% 12,000 4,800 -
2 40% 7,200 2,880 4,800
3 40% 4,320 1,728 7,680
4 40% 2,592 1,037 592 9,408
10,000

While any factor can be used, 2 (resulting in a double declining balance) is most common.
In the final period, instead of recognizing the calculated 1,037, only the difference between accumulated depreciation and salvage value is recognized.
Also interesting to note, the declining balance method could, theoretically, be used indefinitely and would only result in the asset's net book value dropping to zero due to the effect of rounding (in year twenty, in this example).
1/1/X1 | 1.1.X1
Machine # 456 12,000
Accounts payable 12,000

12/31/X1 | 31.12.X1
Depreciation 4,800
Accumulated depreciation: Machine # 456 4,800

12/31/X4 | 31.12.X4
Depreciation 592
Accumulated depreciation: Machine # 456 592

1/1/X6 | 1.1.X6
Accumulated depreciation: Machine # 456 10,000
Cash in bank 2,250
Machine # 456 12,000
Gain on disposal 250
Annual review
1/1/X1 XYZ acquired machine #321 to replace machine #12. Machine #12 had been purchased for 10,000, used for 5 years and sold for 1,700. During its life, machine #12's output did not significantly vary. Machine #321 cost 12,000 and, as XYZ intended to use it a similar manner, it based its depreciation policy on this past experience.
Historical experience is the most common way to estimate depreciation period, method and salvage value.
Generally, this is done by asset class, but is also possible for a particular asset.
Obviously, since historical experience has its limitations, a rigorous review should be performed as soon after the asset is acquired (asset class significantly updated) as reliable, relevant data becomes available.
Dr/Cr
1/1/X1 | 1.1.X1
Accumulated depreciation: Machine #12 8,500
Cash in bank 1,700
Machine #12 10,000
Disposal gain 200
Machine #321 12,000
Accounts payable 12.000

12/31/X1 | 31.12.X1
Depreciation 2,000
Accumulated depreciation: Machine: #321 2,000
During its (annual) review (performed 30/6/R2), XYZ's accounting department learned that machine #321 had been relocated to a different production line where it would be useful for 5 additional years while its salvage value would be 1,000. To reflect increased maintenance down time for repairs and maintenance, the depreciation method was also changed to diminishing balance (XYZ recognizes depreciation annually).
While IAS 16.51 and 61 require the depreciation period, residual value and depreciation method to be reviewed each fiscal year, ASC 360-10-35-11 does not require an annual review. Changes is thus made only if evidence shows that an estimate needs to be revised.
IAS 16.51 The residual value and the useful life of an asset shall be reviewed at least at each financial year-end and, if expectations differ from previous estimates, the change(s) shall be accounted for as a change in an accounting estimate in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.
IAS 16.61 The depreciation method applied to an asset shall be reviewed at least at each financial year-end and, if there has been a significant change in the expected pattern of consumption of the future economic benefits embodied in the asset, the method shall be changed to reflect the changed pattern. Such a change shall be accounted for as a change in an accounting estimate in accordance with IAS 8.
ASC 360-10-35-11 See paragraphs 250-10-45-17 through 45-20 for guidance on the accounting and presentation of changes in methods of depreciation.
ASC 250-10-45-17: A change in accounting estimate shall be accounted for in the period of change if the change affects that period only or in the period of change and future periods if the change affects both. A change in accounting estimate shall not be accounted for by restating or retrospectively adjusting amounts reported in financial statements of prior periods or by reporting pro forma amounts for prior periods.
ASC 250-10-45-18: Distinguishing between a change in an accounting principle and a change in an accounting estimate is sometimes difficult. In some cases, a change in accounting estimate is affected by a change in accounting principle. One example of this type of change is a change in method of depreciation, amortization, or depletion for long-lived, nonfinancial assets (hereinafter referred to as depreciation method). The new depreciation method is adopted in partial or complete recognition of a change in the estimated future benefits inherent in the asset, the pattern of consumption of those benefits, or the information available to the entity about those benefits. The effect of the change in accounting principle, or the method of applying it, may be inseparable from the effect of the change in accounting estimate. Changes of that type often are related to the continuing process of obtaining additional information and revising estimates and, therefore, shall be considered changes in estimates for purposes of applying this Subtopic.
ASC 250-10-45-19: Like other changes in accounting principle, a change in accounting estimate that is affected by a change in accounting principle may be made only if the new accounting principle is justifiable on the basis that it is preferable. For example, an entity that concludes that the pattern of consumption of the expected benefits of an asset has changed, and determines that a new depreciation method better reflects that pattern, may be justified in making a change in accounting estimate effected by a change in accounting principle. (See paragraph 250-10-45-12.)
ASC 250-10-45-20: However, a change to the straight-line method at a specific point in the service life of an asset may be planned at the time some depreciation methods, such as the modified accelerated cost recovery system, are adopted to fully depreciate the cost over the estimated life of the asset. Consistent application of such a policy does not constitute a change in accounting principle for purposes of applying this Subtopic.
While IAS 16 requires a review "at least at each financial year-end", another review can also be performed any time during the fiscal year. Thus it is not uncommon for companies to perform a through, in depth review fiscal year (usually during the slowest month or quarter) and simply review the review at year end (when the accounting department has more than enough work to keep itself busy).
Dr/Cr

P DB Factor Net book value Depreciation Accumulated depreciation
A = 1 - (2,000 ÷ 10,000)(1÷9) B = B(B-1) - C C = A x B D = D(D-1) + C
Y2 16.37% 10,000 1,637 1,637
Y3 16.37% 8,363 1,369 3,007
- - - - -
Y9 16.37% 2,860 568 7,608
Y10 16.37% 2,392 392 8,000

12/31/X2 | 31.12.X2
Depreciation 2,257
Accumulated depreciation: Machine: #321 2,257

Same facts, except that, XYZ neglected to perform any reviews and make adjustments.
During its audit of X5 in the first quarter of X6, XYZ's auditor discovered the error and determined it was material.
While the auditors could have discovered the error earlier, it is fairly common that they only discover errors when they become apparent (as in when a company continues to use an asset it should have disposed of).
IAS 8.42:42 Subject to paragraph 43, an entity shall correct material prior period errors retrospectively in the first set of financial statements authorised for issue after their discovery by:
(a) restating the comparative amounts for the prior period(s) presented in which the error occurred; or IAS 8
(b) if the error occurred before the earliest prior period presented, restating the opening balances of assets, liabilities and equity for the earliest prior period presented.
ASC 250-10-45-2345-23: Any error in the financial statements of a prior period discovered after the financial statements are issued or are available to be issued (as discussed in Section 855-10-25) shall be reported as an error correction, by restating the prior-period financial statements. Restatement requires all of the following:
a. The cumulative effect of the error on periods prior to those presented shall be reflected in the carrying amounts of assets and liabilities as of the beginning of the first period presented.
b. An offsetting adjustment, if any, shall be made to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position) for that period.
c. Financial statements for each individual prior period presented shall be adjusted to reflect correction of the period-specific effects of the error.
12/31/X1 to X5 | 31.12.X1 to X5: reversing entries
Accumulated depreciation: Machine: #321 2,000
Depreciation 2,000
Both IFRS and US GAAP require errors to be corrected retrospectively. However, while IFRS only requires two-year restatements, the US SEC requires 5 years of historical data so five-year restatements are standard practice under US GAAP.
12/31/X1 | 31.12.X1: correcting entry
Depreciation 1,637
Accumulated depreciation: Machine: #321 1,637
12/31/X2 | 31.12.X2: correcting entry
Depreciation 1,369
Accumulated depreciation: Machine: #321 1,369
12/31/X3 | 31.12.X3: correcting entry
Depreciation 1,145
Accumulated depreciation: Machine: #321 1,145
12/31/X4 | 31.12.X4: correcting entry
Depreciation 958
Accumulated depreciation: Machine: #321 958
12/31/X5 | 31.12.X5: correcting entry
Depreciation 801
Accumulated depreciation: Machine: #321 801
Partial year depreciation
5/15/X1, XYZ acquired machine #789 with 5-year useful life and 2,000 salvage value for 12,000. XYZ uses the SYD method and recognizes a full month's depreciation in the month of acquisition. It sold the asset for 1,750 on 6/1/X6.
Dr/Cr

P SYD Factor Depreciable value Partial year Factor Partial year depreciation Depreciation in year
A = yd ÷ syd B = 10,000 x A C = m ÷ y D = B x C E = D(D+1)
5 to 12/1 5 ÷ 15 3,333 8 ÷ 12 2,222 2,222
1 to 4/2 5 ÷ 15 3,333 4 ÷ 12 1,111
5 to 12/2 4 ÷ 15 2,667 8 ÷ 12 1,778 2,889
1 to 4/3 4 ÷ 15 2,667 4 ÷ 12 889
5 to 12/3 3 ÷ 15 2,000 8 ÷ 12 1,333 2,222
1 to 4/4 3 ÷ 15 2,000 4 ÷ 12 667
5 to 12/4 2 ÷ 15 1,333 8 ÷ 12 889 1,556
1 to 4/5 2 ÷ 15 1,333 4 ÷ 12 444
5 to 12/5 1 ÷ 15 667 8 ÷ 12 444 889
1 to 4/6 1 ÷ 15 667 4 ÷ 12 222 222
10,000

The difference is due to rounding.
5/15/X1 | 15.5.X1
Machine #789 12,000
Accounts payable 12,000

12/31/X1 | 31.12.X1
Depreciation 2,222
Accumulated depreciation: Machine #789 2,222

12/31/X5 | 31.12.X5
Depreciation 889
Accumulated depreciation: Machine #789 889

5/31/X6 | 31.5.X6
Depreciation 222
Accumulated depreciation: Machine #789 222

6/1/X6 | 1.6.X6
Accumulated depreciation: Machine #789 10,000
Cash 1,750
Loss on disposal 250
Machine #789 12,000

Same facts except XYZ's policy is to recognize depreciation in the month subsequent to the month of acquisition.

P SYD Factor Depreciable value Partial year Factor Partial year depreciation Depreciation in year
A = yd ÷ syd B = 10,000 x A C = m ÷ y D = B x C E = D(D+1)
6 to 12/1 5 ÷ 15 3,333 7 ÷ 12 1,944 1,944
1 to 5/2 5 ÷ 15 3,333 5 ÷ 12 1,389
6 to 12/2 5 ÷ 15 2,667 7 ÷ 12 1.556 2,944
- - - - - -
1 to 5/6 1 ÷ 15 667 5 ÷ 12 278 278
10,000

Additional issues
Asset retirement obligation
1/1/X1, XYZ built a GSM transmission tower for 1,000,000 on land that was for leased 15 years. It estimated the cost to demolish the tower and re-cultivate the land at 500,000. All risks associated with the obligation were captured in this estimate. The risk-free and XYZ's credit adjusted rates were 2% and 6% respectively.
A additional discussion of how a retirement obligation is calculated is provided in the self-constructed asset section (below).
IFRS / US GAAP
1/1/X1 | 1.1.X1
Transmission station #123 1,371,507
Cash (payables) 1,000,000
Disposal obligation (asset #123) 371,507

371,507 = 500,000 ÷ (1+2%)15
IFRIC-items-not-taken-onto-the-agenda-IAS-January-2015.pdf: The Committee observed that paragraph 47 of IAS 37 states that 'risks specific to the liability' should be taken into account in measuring the liability. The Committee noted that IAS 37 does not explicitly state whether or not own credit risk should be included. The Committee understood that the predominant practice today is to exclude own credit risk, which is generally viewed in practice as a risk of the entity rather than a risk specific to the liability.
P Provision Discount rate Accretion
A B = BB+1 + D C D = B x C
1 371,507 2% 7,430
2 378,938 2% 7,579
- - - -
14 480,584 2% 9,612
15 490,196 2% 9,804
500,000

12/31/X1 | 31.12.X1
Depreciation expense 91,434
Interest expense 7,430
Accumulated depreciation (asset #123) 91,434
Disposal obligation (asset #123) 7,430

91,434 = (1,000,000 + 371,507) ÷15
12/31/X15 | 31.12.X15
Accumulated depreciation (asset #123) 1,371,507
Disposal obligation (asset #123) 500,000
Transmission station #123 1,371,507
Cash 500,000

At beginning year 2, the risk-free rate changed to 2.5%.
1/1/X2 | 1.1.X2
Disposal obligation (asset #123) 17,644
Transmission station #123 17,644

P Provision Discount rate Accretion
A B = BB+1 + D C D = B x C
- - - -
2 353,864 2.5% 8,847
- - - -
15 487,805 2.5% 12,195
500,000

12/31/X2 | 31.12.X2
Depreciation expense 90,174
Interest expense 8,847
Accumulated depreciation (asset #123) 90,174
Disposal obligation (asset #123) 8,847
At the beginning of year 6, (due to a change in environmental law) the expected disposal cost increased by 250,000. At this time, the risk-free rate was 3%.
1/1/X6 | 1.1.X6
Transmission station #123 204,207
Disposal obligation (asset #123) 204,207

P Provision Discount rate Accretion
A B = BB+1 + D C D = B x C
- - - -
6 558,070 3% 16,742
- - - -
15 728,155 3% 21,845
750,000

12/31/X6 | 31.12.X6
Depreciation expense 110,594
Interest expense 16,742
Accumulated depreciation (asset #123) 110,594
Disposal obligation (asset #123) 16,742

110,594 = (1,558,070 - 91,434 - 360,694) ÷ 10
1/1/X1 | 1.1.X1
Disposal expense 115,798
Disposal obligation (asset #123) 115,798
1/1/X1 | 1.1.X1
Transmission station #123 1,208,633
Cash (payables) 1,000,000
Disposal obligation (asset #123) 208,633

208,633 = 500,000 ÷ (1+6%)15
ASC 410-20-30-1: An expected present value technique will usually be the only appropriate technique with which to estimate the fair value of a liability for an asset retirement obligation. An entity, when using that technique, shall discount the expected cash flows using a credit-adjusted risk-free rate. Thus, the effect of an entity's credit standing is reflected in the discount rate rather than in the expected cash flows. ...
P Provision Discount rate Accretion
A B = BB+1 + D C D = B x C
1 208,633 6% 12,518
2 221,150 6% 13,269
- - - -
14 444,998 6% 26,700
15 471,698 6% 28,302
500,000

12/31/X1 | 31.12.X1
Depreciation expense (alternatively) 80,576
Accretion expense 12,518
Accumulated depreciation (asset #123) 80,576
Disposal obligation (asset #123) 12,518

80,576 = (1,000,000 + 208,633) ÷ 15
XYZ amortized the disposal cost in year X1.
ASC 410-20-35-2: ... Application of a systematic and rational allocation method does not preclude an entity from capitalizing an amount of asset retirement cost and allocating an equal amount to expense in the same accounting period. ...
12/31/X1 | 31.12.X1
Decommissioning expense 208,633
Depreciation expense (alternatively) 66,667
Accretion expense 12,518
Transmission station #123 208,633
Accumulated depreciation (asset #123) 66,667
Disposal obligation (asset #123) 12,518

66,667 = 1,000,000 ÷ 15
XYZ amortized the disposal cost over a different (5-year) period.
US GAAP requires capitalized asset retirement costs to be expensed using a rational method over their useful lives.
ASC 3410-20-35-2: An entity shall subsequently allocate that asset retirement cost to expense using a systematic and rational method over its useful life. Application of a systematic and rational allocation method does not preclude an entity from capitalizing an amount of asset retirement cost and allocating an equal amount to expense in the same accounting period. For example, assume an entity acquires a long-lived asset with an estimated life of 10 years. As that asset is operated, the entity incurs one-tenth of the liability for an asset retirement obligation each year. Application of a systematic and rational allocation method would not preclude that entity from capitalizing and then expensing one-tenth of the asset retirement costs each year.
While uncommon in practice, in certain situations it would not be irrational to determine that the useful life of the asset retirement cost differs from the useful life of the underlying asset.
12/31/X1 | 31.12.X1
Depreciation expense 108,393
Accretion expense 12,518
Accumulated depreciation (asset #123) 108,393
Disposal obligation (asset #123) 12,518

108,393 = (1,000,000 ÷ 15) + (208,633 ÷ 5)
12/31/X15 | 31.12.X15
Accumulated depreciation (asset #123) 1,208,633
Disposal obligation (asset #123) 500,000
Transmission station #123 1,208,633
Cash 500,000

At the beginning of year 6, (due to a change in environmental law) the expected disposal cost increased by 250,000. At this time, the risk-free rate was 3% and XYZ's credit adjusted rate was 8%. For simplicity, the US GAAP example is based on an expense in period policy.
beginning
P Provision Discount rate Accretion Provision Discount rate Accretion Total Accretion
A B = BB+1 + D C D = B x C E = EE+1 + D F G = E x F H = D + G
- - - - - - - -
6 279,197 6% 16,752 115,798 8% 9,264 26,016
- - - - - - - -
15 471,698 6% 28,302 231,481 8% 18,519 46,820
500,000
250,000

12/31/X6 | 31.12.X6
Accretion expense 26,016
Disposal obligation (asset #123) 26,016

At the beginning of year 11, the estimate was lowered by 150,000.
Estimate Weight Historical rate Weighted historical rate
A B = A ÷ ??A C D = B x C
500,000 0.667 6.00% 4.00%
250,000 0.333 8.00% 2.67%
750,000 6.67%

P Provision Disc. Accretion Provision Disc. Accretion Provision Disc. Accretion Provision
A B=B(B+1)+D C D=BxC E=E(E+1)+G F G=ExF H=H(H+1)+J I J=HxI K=D+G+J
- - - - - - - - - - -
11 373,629 6% 22,418 170,146 8% 13,612 (181,049) 6.67% (12,070) 171,688
12 396,047 6% 23,763 183,757 8% 14,701 (193,119) 6.67% (12,875) 185,583
13 419,810 6% 25,189 198,458 8% 15,877 (205,994) 6.67% (13,733) 200,602
14 444,998 6% 26,700 214,335 8% 17,147 (219,727) 6.67% (14,648) 216,833
15 471,698 6% 28,302 231,481 8% 18,519 (234,375) 6.67% (15,625) 234,375

Capitalized interest
IFRS vs US GAAP
IFRS refers to borrowing costs while US GAAP discusses interest. However, since both standards define the terms similarly, borrowing costs are generally considered synonymous with interest.
IAS 23.5: Borrowing costs are interest and other costs that an entity incurs in connection with the borrowing of funds.
IAS 23.5.6 Borrowing costs may include:
(a) interest expense calculated using the effective interest method as described in IFRS 9; ...
(d) interest in respect of lease liabilities recognised in accordance with IFRS 16Leases; and
(e) exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs.
ASC 835-20-20 Interest cost includes interest recognized on obligations having explicit interest rates, interest imputed on certain types of payables in accordance with Subtopic 835-30, and interest related to a finance lease determined in accordance with Topic 842. With respect to obligations having explicit interest rates, interest cost includes amounts resulting from periodic amortization of discount or premium and issue costs on debt.
The only notable difference is that US GAAP does not explicitly mention foreign currencies or exchange rates.
Nevertheless, ASC 835-20-30-4 does state: "For some multinational entities, it may be appropriate for each foreign subsidiary to use an average of the rates applicable to its own borrowings".
Since foreign borrowing at foreign subsidiaries are often made in foreign currencies, this implies that the effects of exchange rates should be taken into consideration, even if they are not specifically addressed by the guidance.
Specific borrowing
From 1/1/X1 to 6/30/X2 self -constructed production line #123. It financed the construction with a 5% line of credit. It repaid the balance on 12/31/X2.
During construction, quarterly costs of 400,000, 200,000, 500,000, 300,000, 100,000 and 400,000 were incurred and quarterly interest payments of 2,433, 6,096, 10,487, 15,393, 17,452 and 20,707 were made.
ASC 835-20-30-3 states: The amount capitalized in an accounting period shall be determined by applying the capitalization rate to the average amount of accumulated expenditures for the asset during the period. ... However, ASC 835-20-30-5 states: Reasonable approximations of net capitalized expenditures may be used. For example, capitalized costs for an asset may be used as a reasonable approximation of capitalized expenditures unless the difference is material.
Similarly, IAS 23.14 states: ... the entity shall determine the amount of borrowing costs eligible for capitalisation by applying a capitalisation rate to the expenditures on that asset.
Thus, as long as the difference is not material, costs (accrued expenses) can be used instead of expenditures (cash outflows) under both US GAAP and IFRS
While IAS 23 does not explicitly discuss materiality, IAS 8.8 states: IFRSs set out accounting policies that the IASB has concluded result in financial statements containing relevant and reliable information about the transactions, other events and conditions to which they apply. Those policies need not be applied when the effect of applying them is immaterial.
Dr/Cr

3/31/X1 | 31.3.X1
Production line #123 in progress 402,433
Accounts payable 400,000
Cash 2,433

For illustration purposes, only quarterly entries are shown.
ASC 835-20-30-3 states: The amount capitalized in an accounting period shall be determined by applying the capitalization rate to the average amount of accumulated expenditures for the asset during the period.
However, ASC 835-20-30-2 also states: The amount of interest cost to be capitalized for qualifying assets is intended to be that portion of the interest cost incurred during the assets' acquisition periods that theoretically could have been avoided ... if expenditures for the assets had not been made.
In deciding to capitalize interest as it was paid (rather than applying a capitalization rate as required by ASC 835-20-30-3), XYZ considered that the interest it paid on the line of credit would have been avoided (practically, not just theoretically) if a line of credit had not been used. It also considered that capitalizing interest actually paid better represented the economics of the transaction. It also considered that ASC 835-20-30-2 to 7 primarily address general borrowings and that specific borrowing referred to in ASC 835-20-30-3 is a lump sum-loan rather than line of credit. It also evaluated the effect of not using a capitalization rate and found it to be immaterial. On the basis of these considerations, it concluded that benefits of capitalizing interest as it was paid (greater accuracy, easier application, lower susceptibility to mathematical errors) outweighed the costs (not adhering to the letter of ASC 835-20-30-3).
In contrast to US GAAP, IAS 23.12 states: To the extent that an entity borrows funds specifically for the purpose of obtaining a qualifying asset, the entity shall determine the amount of borrowing costs eligible for capitalisation as the actual borrowing costs incurred on that borrowing during the period less any investment income on the temporary investment of those borrowings.
Thus, since XYZ drew on the line to fund construction (did not reinvest any funds), capitalising interest as it is paid is consistent with the letter of this guidance.
For illustration purposes, construction costs are credited to accounts payable and interest to cash.
The example also assumes XYZ drew from the line on a daily basis in a linear fashion:
1/1/X1 | 1.1.X1
Cash 4,444
Line of credit 4,444

1/2/X1 | 2.1.X1
Cash 4,444
Line of credit 4,444

Etc.
1/4/X1 | 1.4.X1
Cash 2,198
Line of credit 2,198

Etc.
To calculate interest, a daily rate of 0.013368% = (1+5%)(1÷365) - 1 is applied to the outstanding loan balance.
Etc.
6/30/X2 | 30.6.X2
Production line 1,972,569
Production line #123 in progress 420,707
Accounts payable 400,000
Cash 20,707
Production line #123 in progress 1,972,569

9/30/X2 | 30.9.X2
Interest expense 23,317
Cash 23,317

IAS 23.22 An entity shall cease capitalising borrowing costs when substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete.
ASC 835-20-25-5: The capitalization period shall end when the asset is substantially complete and ready for its intended use. ...
12/31/X2 | 31.12.X2
Line of credit 1,900,000
Interest expense 23,317
Cash 1,923,317

Same facts except XYZ borrowed a lump-sum of 1,900,000 on 1/1/X1 and agreed to make intrest only payments of 23,317 each quarter (a 5% annual rate).
Dr/Cr

3/31/X1 | 31.3.X1
Production line #123 in progress 402,454
Interest expense 20,863
Accounts payable 400,000
Cash 23,317

P Beg. cum. cost Period cost End cum. cost Av. cum. cost Q. capitalization rate Capitalized int.
A=A+A(B+1) B=cost+F(F+1) C=B+B(B+1) D=(A+C)÷2 E=(1+5%)1÷4-1 F=DxE
X1 Q1 0 400,000 400,000 200,000 1.23% 2,454
X1 Q2 400,000 202,454 602,454 501,227 1.23% 6,151
X1 Q3 602,454 506,151 1,108,606 855,530 1.23% 10,499
X1 Q4 1,108,606 310,499 1,419,105 1,263,855 1.23% 15,510
X2 Q1 1,419,105 115,510 1,534,615 1,476,860 1.23% 18,124
X2 Q2 1,534,615 418,124 1,952,740 1,743,677 1.23% 21,399
74,138

IAS 23.18: The average carrying amount of the asset during a period, including borrowing costs previously capitalised, is normally a reasonable approximation of the expenditures to which the capitalisation rate is applied in that period.
ASC 835-20-30-3: The amount capitalized in an accounting period shall be determined by applying the capitalization rate to the average amount of accumulated expenditures for the asset during the period.
While US GAAP does not specifically mention previously capitalized interest, since interest is an expenditure, accumulating it would be reasonable.
The period over which a capitalization rate must be applied not specified.
While annual periodicity is most common, since interest was paid each quarter and since a quarterly calculation leads to a more accurate result, XYZ decided to apply the capitalization rate each quarter.
IAS 23.12 states: To the extent that an entity borrows funds specifically for the purpose of obtaining a qualifying asset, the entity shall determine the amount of borrowing costs eligible for capitalisation as the actual borrowing costs incurred on that borrowing during the period less any investment income on the temporary investment of those borrowings.
Care must be taken when interpreting the phrase "actual borrowing costs incurred on that borrowing" as it should not be taken to mean the total interest paid in the period should be capitalized.
This is the case even if, as in this example, the unused funds are not lent out, and no "investment income on the temporary investment" is earned.
This interpretation of paragraph 12 becomes clear when a self-constructed asset financed with a line of credit (see above) is compared to an asset financed with a lump-sum borrowing.
Since the economics in both cases are the same, the amounts capitalized must also be the same (or at minimum comparable).
US GAAP does not suffer from this interpretation problem as ASC835-20-30-3 states: The amount capitalized in an accounting period shall be determined by applying the capitalization rate to the average amount of accumulated expenditures for the asset during the period. The capitalization rates used in an accounting period shall be based on the rates applicable to borrowings outstanding during the period. If an entity's financing plans associate a specific new borrowing with a qualifying asset, the entity may use the rate on that borrowing as the capitalization rate to be applied to that portion of the average accumulated expenditures for the asset that does not exceed the amount of that borrowing. ...
More IFRS vs US GAAP
While not generally significant issues in practice, some additional differences between IFRS and US GAAP do exist.
Obviously, US GAAP does address the netting of reinvested funds, since using a capitalization rate for both specific and general borrowings moots the issue.
Less clear is the issue of foreign exchange rate differences.
While IAS 23.6 is quite explicit (Borrowing costs may include: ... (e) exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs), ASC 835-20-20 makes no mention foreign currencies or exchange rates.
Interest cost includes interest recognized on obligations having explicit interest rates, interest imputed on certain types of payables in accordance with Subtopic 835-30, and interest related to a finance lease determined in accordance with Topic 842. With respect to obligations having explicit interest rates, interest cost includes amounts resulting from periodic amortization of discount or premium and issue costs on debt.
Nevertheless, ASC 835-20-30-4 does state: "For some multinational entities, it may be appropriate for each foreign subsidiary to use an average of the rates applicable to its own borrowings".
Since foreign borrowing at foreign subsidiaries are often made in foreign currencies, this implies that the effects of exchange rates should be taken into consideration, even if they are not specifically addressed by the guidance.
6/30/X1 | 30.6.X1
Production line #123 in progress 206,151
Interest expense 17,166
Accounts payable 200,000
Cash 23,317

Etc.
General borrowing
1/1/X1, XYZ began to self-construct production line #123. It did not borrow specifically to finance the acquisition but it did have several applicable, general borrowings.
IAS 23.14: To the extent that an entity borrows funds generally and uses them for the purpose of obtaining a qualifying asset, the entity shall determine the amount of borrowing costs eligible for capitalisation by applying a capitalisation rate to the expenditures on that asset. The capitalisation rate shall be the weighted average of the borrowing costs applicable to the borrowings of the entity that are outstanding during the period, other than borrowings made specifically for the purpose of obtaining a qualifying asset. The amount of borrowing costs that an entity capitalizes during a period shall not exceed the amount of borrowing costs it incurred during that period.
ASC 835-20-30-4: In identifying the borrowings to be included in the weighted average rate, the objective is a reasonable measure of the cost of financing acquisition of the asset in terms of the interest cost incurred that otherwise could have been avoided. Accordingly, judgment will be required to make a selection of borrowings that best accomplishes that objective in the circumstances. For example, depending on the facts and circumstances, it may be appropriate to include all borrowings of the parent entity and its consolidated subsidiaries or to include only the borrowings of the corporate entity constructing the qualifying asset. For some multinational entities, it may be appropriate for each foreign subsidiary to use an average of the rates applicable to its own borrowings. However, the use of judgment in determining capitalization rates shall not circumvent the requirement that a capitalization rate be applied to all capitalized expenditures for a qualifying asset to the extent that interest cost has been incurred during an accounting period.
1/1/X1 to 6/30/X1, XYZ had three loans: 1,500,000 at a 4.8% annual rate, 3,000,000 at 4.5% and 5,500,000 at 4.1%. It repaid loan one on 6/30/X1, loan two on 12/31/X1 and loan three on 3/31/X2.
3/31/X2 it took out loan four for 500,000 at 5% annually.
Dr/Cr
3/31/X1 | 31.3.X1
Production line #123 2,128
Interest expense 2,128

P Loan Annual interest rate Quarterly interest rate Weight Weighted period rate
A B C = (1+B%)1÷4 - 1 D = A ÷ ??A E=CxD
X1 Q1 & Q2 1,500,000 4.80% 1.18% 0.15 0.18%
3,000,000 4.50% 1.11% 0.30 0.33%
5,500,000 4.10% 1.01% 0.55 0.56%
10,000,000 1.06%

P Loan Annual interest rate Quarterly interest rate Weight Weighted period rate
A B C = (1+B%)1÷4 - 1 D = A ÷ ??A E=CxD
X1 Q3 & Q4 3,000,000 4.50% 1.11% 0.35 0.39%
5,500,000 4.10% 1.01% 0.65 0.65%
8,500,000 1.04%

P Beg. cum. cost Period cost End. cum. cost Ave. cum. cost Cap. rate Capitalized interest
A=C(C+1) B=cost+F(F+1) C=A+B D=C(C+1)+(B÷2) E F=DxE
X1 Q1 0 400,000 400,000 200,000 1.06% 2,128
X1 Q2 400,000 202,128 02,128 501,064 1.06% 5,332
X1 Q3 602,128 505,332 1,107,460 854,794 1.04% 8,922
X1 Q4 1,107,460 308,922 1,416,382 1,261,921 1.04% 13,172
X2 Q1 1,416,382 113,172 1,529,554 1,472,968 1.01% 14,871
X2 Q2 1,529,554 414,871 1,944,425 1,736,990 1.23% 21,365 6,136
50,562

3/31/X2 | 31.3.X2
Production line #123 6,136
Interest expense 6,136

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