CHAPTER 30 DEPLETION * Financial Analysis: Evaluating Important Accounting

the capital costs, operating costs, Considerations:

1. Explain exploration and evaluation and potential revenue to determine * Capitalization vs. Expensing:
of mineral resources. the project's profitability. Generally, exploration and evaluation
(Detailed Answer - As provided in * Environmental Impact costs are capitalized as assets if they
my previous example) Assessment: Assessing the potential are expected to lead to a successful
Exploration and evaluation of mineral environmental impacts of the mining mine. If the exploration is
resources refer to the systematic operation and developing mitigation unsuccessful, the costs are
process of searching for and measures. expensed.
assessing the potential economic The exploration and evaluation * Impairment: Capitalized
viability of mineral deposits. This process is iterative, with the results exploration and evaluation assets
process involves a series of stages, of each stage informing the are subject to impairment testing. If
each with specific objectives and subsequent stages. The goal is to there are indicators that the asset's
techniques: progressively reduce uncertainty and carrying value exceeds its
* Exploration: This stage focuses on make informed decisions about recoverable amount, an impairment
identifying potential mineral deposits. whether to proceed with mine loss is recognized.
It includes activities like: development. * Classification: Exploration and
* Geological Surveys: Mapping evaluation assets are typically
rock formations, identifying mineral 2. Explain exploration and evaluation classified as intangible assets or
indicators, and understanding the expenditures. property, plant, and equipment
geological history of the area. Answer: (PP&E) on the balance sheet,
* Geophysical Surveys: Using Exploration and evaluation depending on the nature of the costs.
techniques like magnetic, gravity, expenditures are the costs incurred
and seismic surveys to detect by a company in the process of 3. Explain the measurement of
subsurface anomalies that might searching for and assessing mineral exploration and evaluation asset.
indicate mineral deposits. resources. These costs are typically Answer:
* Geochemical Surveys: Analyzing capitalized (recorded as assets) The measurement of exploration and
soil, rock, and water samples to when it's expected that the evaluation assets involves
identify anomalous concentrations of exploration efforts will lead to a determining the appropriate value to
target minerals. commercially viable mine. Here's a be recorded on the balance sheet.
* Remote Sensing: Using satellite breakdown: Here's a breakdown of the key
imagery and aerial photography to * Direct Costs: considerations:
identify geological features and * Salaries and Wages: For * Initial Recognition:
potential mineralized zones. geologists, engineers, technicians, * Cost Model: Initially, exploration
* Drilling: Extracting core samples and support staff involved in and evaluation assets are measured
from the subsurface to analyze the exploration and evaluation activities. at cost, which includes all
mineral content and geological * Drilling Costs: Including drilling rig expenditures directly attributable to
structure. rental, labor, supplies, and analysis the exploration and evaluation
* Evaluation: Once a potential of core samples. activities. This aligns with the
deposit is identified, the evaluation * Geological and Geophysical historical cost principle.
stage focuses on determining its Survey Costs: Fees for conducting * Subsequent Measurement:
size, grade, and economic viability. surveys, data acquisition, and * Cost Model: After initial
This involves: interpretation. recognition, the cost model is
* Resource Estimation: Using * Lease Acquisition Costs: typically used, meaning the asset is
geological data and statistical Payments made to secure mineral carried at its historical cost less
methods to estimate the tonnage and rights on a specific property. accumulated amortization or
grade of the mineral deposit. * Transportation and Travel: Costs depletion (if applicable) and any
* Feasibility Studies: Conducting related to moving personnel and accumulated impairment losses.
detailed technical and economic equipment to exploration sites. * Impairment Testing: Regularly,
studies to assess the potential * Materials and Supplies: Costs of the asset's carrying value must be
profitability of mining the deposit. equipment, tools, and consumables assessed for impairment. If there's
This includes: used in exploration. evidence that the carrying value is
* Mine Planning: Designing the * Indirect Costs: greater than the recoverable amount
mining operation, including extraction * Overhead Allocation: A portion of (the higher of fair value less costs to
methods, infrastructure, and administrative and support costs sell and value in use), an impairment
production schedules. allocated to exploration and loss is recognized, reducing the
* Metallurgical Testing: evaluation activities. asset's carrying value.
Determining the optimal methods for * Depreciation of Equipment: * Specific Considerations:
processing the ore and extracting the Depreciation on equipment * Capitalization Cut-Off:
valuable minerals. specifically used for exploration. Companies need to establish clear
criteria for determining when
exploration and evaluation costs * Costs of Preparing the Asset for
should be capitalized. This often 5. Explain wasting assets. Extraction: This includes costs of
involves assessing the probability of Answer: building access roads, removing
finding commercially viable reserves. Wasting assets are natural resources overburden (waste rock), and
* Allocation of Costs: If costs relate that are physically consumed or constructing infrastructure needed
to multiple potential deposits, a depleted over time through extraction for extraction.
rational and systematic method is or use. They are distinct from fixed * Cost of Equipment: Costs of
needed to allocate the costs among assets (like buildings or equipment) acquiring mining equipment, drilling
the different areas. which provide benefits over multiple rigs, and other machinery.
* Treatment of Overheads: A periods. Here's a breakdown: * Estimated Restoration Costs:
consistent policy is needed for * Characteristics: * Costs of Restoring the Land After
allocating overhead costs to * Physical Depletion: The asset's Extraction: This includes costs of
exploration and evaluation activities. quantity diminishes as it is extracted reclamation, environmental
or used. remediation, and site closure.
4. Explain classification of * Non-Renewable: They are Important Note: The cost of a
exploration and evaluation asset. generally non-renewable or take a wasting asset is typically capitalized
Answer: very long time to replenish. and then allocated to expense over
The classification of exploration and * Natural Origin: They are derived the asset's useful life through
evaluation assets on the balance from natural resources, such as depletion.
sheet depends on the nature of the minerals, oil, gas, or timber.
costs and the applicable accounting * Examples: 7. Explain acquisition cost of wasting
standards. Here are the common * Mineral Deposits: Coal mines, asset.
classifications: gold mines, copper mines, etc. Answer:
* Intangible Assets: * Oil and Gas Reserves: Oil fields, The acquisition cost of a wasting
* Exploration Rights: Costs natural gas fields. asset specifically refers to the costs
associated with acquiring the legal * Timberlands: Forests where incurred to obtain the legal rights to
rights to explore for minerals on a timber is harvested. extract the natural resources. It's a
specific property. This includes lease * Accounting Treatment: key component of the total cost of
acquisition costs, permits, and * Depletion: The process of the asset. Here's a more detailed
licenses. allocating the cost of a wasting asset explanation:
* Geological Data: Costs over its useful life is called depletion. * Purchase Price: This is the most
associated with geological surveys, This is similar to depreciation for significant component and
geophysical surveys, and other data fixed assets. represents the price paid to the
gathering activities. * Inventory: Extracted resources previous owner for the mineral rights
* Property, Plant, and Equipment are typically treated as inventory until or the land containing the resources.
(PP&E): they are sold. * Legal Fees: Costs associated with
* Drilling Rigs and Equipment: title searches, legal documentation,
Costs of drilling equipment, vehicles, 6. Explain the cost of a wasting and securing the ownership rights.
and other machinery specifically asset. * Brokerage Commissions: Fees
used for exploration and evaluation. Answer: paid to real estate agents or other
* Infrastructure: Costs of roads, The cost of a wasting asset intermediaries who facilitated the
bridges, and other infrastructure built represents the total expenditure transaction.
to support exploration activities. incurred to acquire and prepare the * Option Payments: Payments made
Key Considerations: asset for its intended use. Here's a to secure the right to purchase the
* Nature of the Asset: The breakdown of the cost components: mineral rights within a specific time
classification depends on whether * Acquisition Cost: frame.
the asset has a physical substance * Purchase Price: The price paid to * Bonus Payments: Payments made
(PP&E) or is intangible (no physical acquire the mineral rights or the land to the lessor (owner) for the right to
substance). containing the natural resources. explore and extract minerals.
* Accounting Standards: Different * Legal Fees: Costs associated Important Considerations:
accounting standards (e.g., IFRS, with securing the legal title to the * Fair Value: If the acquisition
US GAAP) may have specific property. involves a non-monetary exchange
requirements for classifying * Brokerage Commissions: Fees or other complex transaction, the
exploration and evaluation assets. paid to intermediaries involved in the acquisition cost is measured at the
* Management Intent: The acquisition. fair value of the asset received.
company's intent for the asset can * Exploration and Evaluation Costs: * Capitalization: The acquisition cost
also influence its classification. For * As discussed in Question 2. is capitalized as part of the total cost
example, if the company intends to Costs incurred in searching for and of the wasting asset and is
use drilling rigs for future mining assessing the mineral resources. subsequently depleted over the
operations, they might be classified * Development Costs: asset's useful life.
as PP&E.
8. Explain exploration cost of wasting * Expensing: Costs of unsuccessful and other underground or surface
asset. wells (dry holes) are expensed workings.
Answer: immediately. * Equipment Acquisition: Costs of
The exploration cost of a wasting * Focus: This method focuses on purchasing and installing mining
asset refers to the expenditures capitalizing only those costs that equipment, such as excavators,
incurred during the initial phase of directly contribute to the discovery of trucks, and processing facilities.
searching for and identifying proven reserves. * Construction of Processing Plants:
commercially viable mineral * Full Cost Method: Costs of building facilities to process
deposits. Here's a breakdown: * Capitalization: All exploration the extracted minerals.
* Geological and Geophysical costs, both successful and Accounting Treatment:
Surveys: Costs associated with unsuccessful, are capitalized within a * Capitalization: Development costs
conducting surveys to identify cost center (usually a country). are typically capitalized as part of the
potential mineral deposits. * Amortization: The capitalized wasting asset, as they are directly
* Drilling Costs: Costs of drilling core costs are then amortized (depleted) related to preparing the asset for its
samples to analyze the mineral over the estimated useful life of the intended use.
content and geological structure. cost center's reserves. * Depletion: The capitalized
* Geochemical Analysis: Costs of * Focus: This method focuses on development costs are then depleted
analyzing soil, rock, and water matching the costs of exploration over the estimated useful life of the
samples to identify anomalous with the revenues generated from mine or the reserves extracted.
concentrations of target minerals. the production of reserves within a
* Remote Sensing: Costs of using cost center. 11. Define stripping in connection
satellite imagery and aerial Key Differences: with wasting asset.
photography to identify potential * Treatment of Dry Holes: The Answer:
mineralized zones. primary difference lies in the Stripping, in the context of a wasting
* Feasibility Studies: Costs treatment of costs associated with asset (particularly in surface mining),
associated with conducting dry holes. The successful efforts refers to the process of removing
preliminary studies to assess the method expenses them immediately, overburden (waste rock, soil, and
potential economic viability of the while the full cost method capitalizes vegetation) to expose the mineral
deposit. them. deposit for extraction. Here's a more
Accounting Treatment: * Profitability: The full cost method detailed explanation:
* Capitalization: Generally, tends to result in higher reported * Overburden Removal: Stripping
exploration costs are capitalized as profits in the early stages of involves excavating and transporting
part of the wasting asset if they are exploration, as costs are capitalized the materials that lie above the ore
expected to lead to a successful rather than expensed. body.
mine. * Volatility: The successful efforts * Preparation for Mining: It's a
* Expensing: If exploration efforts method can lead to more volatile necessary step to access the mineral
are unsuccessful, the costs are earnings, as the costs of dry holes deposit and make it feasible for
expensed as incurred. can significantly impact profitability in extraction.
* Impairment: Capitalized a given period. * Capitalization: The costs of
exploration costs are subject to stripping are often capitalized as part
impairment testing. If there are 10. Explain development cost of of the wasting asset, as they
indicators that the carrying value wasting asset. contribute to the development of the
exceeds the recoverable amount, an Answer: mine.
impairment loss is recognized. The development cost of a wasting
asset refers to the expenditures 12. Explain stripping costs during the
9. Explain the successful effort and incurred to prepare the mineral development of a mine.
full cost method of accounting for deposit for commercial production Answer:
exploration cost. after a commercially viable reserve Stripping costs incurred during the
Answer: has been identified. Here's a development phase of a mine are the
The successful efforts and full cost breakdown: expenses associated with removing
methods are two primary accounting * Access Roads and Infrastructure: overburden to prepare the site for
methods used to account for Costs of building roads, bridges, and initial production. Here's a
exploration costs in the oil and gas other infrastructure needed to access breakdown:
industry. While they are less the deposit and transport extracted * Initial Overburden Removal:
common in other mining sectors, materials. Significant amounts of overburden
they provide a valuable comparison: * Overburden Removal: Costs of are often removed during the
* Successful Efforts Method: removing waste rock and soil that development phase to create access
* Capitalization: Only costs directly covers the mineral deposit. to the ore body and establish the
related to successful wells (those * Mine Development: Costs of initial mining layout.
that discover commercially constructing mine shafts, tunnels, * Capitalization: These costs are
producible reserves) are capitalized. typically capitalized as part of the
development cost of the wasting ore) will flow to the entity as a result * Unit-of-Production Method: The
asset. of the stripping activity. most common method of calculating
* Depletion: The capitalized stripping depletion is the unit-of-production
costs are then depleted over the 15. Explain estimated restoration method, which allocates cost based
useful life of the mine or the reserves cost of wasting asset. on the actual units extracted during
extracted. Answer: the period.
The estimated restoration cost of a * Matching Principle: Depletion
13. Explain stripping costs during the wasting asset is the present value of aligns with the matching principle by
production phase of a mine. the costs expected to be incurred to matching the cost of the wasting
Answer: restore the land and environment asset with the revenue generated
Stripping costs incurred during the after mining operations are from the sale of the extracted
production phase of a mine are the completed. Here's a breakdown: resources.
expenses associated with removing * Legal or Constructive Obligation:
overburden to maintain access to the Companies often have a legal or 17. Explain the common method of
ore body as mining progresses. constructive obligation to restore the computing depletion.
Here's a breakdown: land to its original state or to a state Answer:
* Ongoing Overburden Removal: As that meets environmental standards. The most common method of
mining operations continue, * Costs Included: Restoration costs computing depletion is the
overburden must be removed to may include: unit-of-production method. Here's
expose new sections of the ore body. * Reclamation: Recontouring the how it works:
* Inventory or Expense: Stripping land, replacing topsoil, and * Calculate the Depletion Rate:
costs during production can be re-vegetating the site. * Depletion Rate = (Total Cost of
treated in one of two ways: * Environmental Remediation: Wasting Asset) / (Estimated Total
* Inventory: If the stripping activity Cleaning up contaminated soil and Recoverable Units)
creates a benefit in the form of water. * Calculate Depletion Expense:
access to ore that will be extracted in * Dismantling and Removal: * Depletion Expense = Depletion
future periods, the costs may be Removing mining equipment and Rate x Units Extracted During the
capitalized as part of the inventory of infrastructure. Period
ore. * Ongoing Monitoring: Costs of Example:
* Expense: If the stripping activity monitoring the site for environmental Assume a company purchased a
primarily benefits the current period's impacts after closure. coal mine for $10 million. The
production, the costs are expensed * Accounting Treatment: estimated recoverable coal is 5
as incurred. * Provision: The estimated million tons. During the first year, 1
* Unit-of-Production Method: restoration cost is recognized as a million tons of coal are extracted.
Stripping costs may be allocated to provision (liability) when the * Depletion Rate: $10,000,000 /
the units of ore extracted using a obligation arises. 5,000,000 tons = $2 per ton
unit-of-production method. * Capitalization: The present value * Depletion Expense: $2 per ton x
of the restoration cost is capitalized 1,000,000 tons = $2,000,000
14. What are the conditions for the as part of the cost of the wasting
recognition of stripping activity asset. 18. Explain fully how mining
asset? * Depletion: The capitalized equipment should be depreciated.
Answer: restoration cost is then depleted over Answer:
The conditions for recognizing a the useful life of the mine or the Mining equipment should be
stripping activity asset are outlined in reserves extracted. depreciated in a manner that reflects
accounting standards like IFRS and the pattern in which its economic
US GAAP. Here's a breakdown: 16. Explain depletion. benefits are consumed. Here's a
* Improved Access: The stripping Answer: breakdown:
activity must improve access to the Depletion is the systematic allocation * Factors to Consider:
ore body that will be extracted in of the cost of a wasting asset over its * Useful Life: The estimated period
future periods. useful life as the natural resources over which the equipment is
* Identified Component: The are extracted. It's similar to expected to be used.
improved access must be identifiable depreciation for fixed assets but * Salvage Value: The estimated
as a separate component of the ore applies specifically to natural residual value of the equipment at
body. resources. Here's a breakdown: the end of its useful life.
* Reliable Measurement: The cost of * Allocation of Cost: Depletion * Usage Pattern: The expected
the stripping activity must be reliably allocates the cost of the wasting pattern of usage or consumption of
measurable. asset (including acquisition, the equipment's economic benefits.
* Probability of Future Economic exploration, development, and * Depreciation Methods:
Benefits: It must be probable that restoration costs) to the units of * Straight-Line Method: Allocates
future economic benefits (i.e., natural resources extracted. an equal amount of depreciation
revenue from the sale of extracted expense over the equipment's useful
life. This is appropriate if the legal principles, such as fraudulent 1. Explain the cost model of
equipment's usage is relatively conveyance laws and insolvency measuring property, plant, and
consistent over time. laws. However, it still serves as a equipment.
* Units-of-Production Method: reminder of the importance of Answer:
Allocates depreciation expense protecting creditors' rights. The cost model is the most common
based on the actual units produced method for measuring PP&E. It
or hours used. This is appropriate if 20. Discuss the wasting asset involves carrying the asset at its
the equipment's usage varies doctrine. historical cost, less any accumulated
significantly over time. Answer: depreciation and accumulated
* Declining Balance Method: The wasting asset doctrine is an impairment losses.
Allocates a higher amount of accounting principle that recognizes * Historical Cost: This includes the
depreciation expense in the early the unique characteristics of natural purchase price of the asset, plus any
years of the equipment's life and a resources and requires that their costs directly attributable to bringing
lower amount in later years. This is costs be allocated over their useful the asset to its location and condition
appropriate if the equipment is lives through depletion. Here's a for its intended use. Examples
expected to be more productive in its breakdown: include:
early years. * Recognition of Depletion: The * Purchase price (less trade
* Specific Considerations for Mining doctrine emphasizes the importance discounts and rebates)
Equipment: of recognizing depletion as an * Import duties and non-refundable
* Harsh Operating Conditions: expense to match the cost of the purchase taxes
Mining equipment often operates in wasting asset with the revenue * Costs of site preparation
harsh environments, which can generated from its extraction. * Initial delivery and handling costs
shorten its useful life. * Unit-of-Production Method: The * Installation and assembly costs
* Technological Obsolescence: unit-of-production method is the * Professional fees (e.g.,
Rapid technological advancements preferred method for calculating architects, engineers)
in mining equipment can lead to depletion, as it reflects the actual * Costs of testing whether the
obsolescence. consumption of the natural asset is functioning properly
* Maintenance Costs: Maintenance resources. * Accumulated Depreciation: This
costs for mining equipment can be * Importance of Cost Allocation: The represents the systematic allocation
significant and should be considered doctrine highlights the need to of the asset's cost over its useful life.
when estimating its useful life. allocate the costs of acquiring, * Accumulated Impairment Losses:
exploring, developing, and restoring If the asset's carrying amount
19. Discuss the trust fund doctrine. natural resources in a systematic exceeds its recoverable amount (the
Answer: and rational manner. higher of fair value less costs to sell
The trust fund doctrine is a legal * Financial Reporting: The wasting and value in use), an impairment
principle that states that a asset doctrine ensures that the loss is recognized.
corporation's capital is a trust fund financial statements of companies Advantages of the Cost Model:
for the benefit of its creditors. This involved in natural resource * Simplicity: It's relatively
means that a corporation cannot extraction accurately reflect the straightforward to apply.
distribute its assets to shareholders if consumption of these assets over * Reliability: Historical cost is based
doing so would leave the corporation time. on actual transactions and is
insolvent and unable to pay its debts. Key Points: generally considered reliable.
Here's a breakdown: * Natural Resources are Unique: Disadvantages of the Cost Model:
* Purpose: The trust fund doctrine is Wasting assets are fundamentally * Relevance: It may not reflect the
intended to protect creditors by different from other types of assets current value of the asset, especially
ensuring that a corporation maintains because they are physically during periods of inflation or
sufficient assets to satisfy its consumed or depleted over time. deflation.
obligations. * Depletion is Essential: Depletion is * Comparability: Assets acquired at
* Limitations on Distributions: The a crucial accounting concept that different times may not be
doctrine places limitations on the ensures that the costs of natural comparable due to changes in price
ability of a corporation to distribute resources are properly recognized as levels.
assets to shareholders, particularly in expenses.
situations where the corporation is * Unit-of-Production Method is
insolvent or nearing insolvency. Preferred: The unit-of-production
* State Laws: The trust fund doctrine method provides the most accurate 2. Explain the revaluation model of
is primarily a matter of state law, and and reliable way to allocate the costs measuring property, plant, and
its application can vary from state to of wasting asset. equipment.
state. Answer:
* Modern Interpretation: In modern CHAPTER 31 REVALUATION The revaluation model allows
corporate law, the trust fund doctrine companies to carry PP&E at its fair
has been largely replaced by other value at the date of revaluation, less
any subsequent accumulated * Transfer to Retained Earnings:
depreciation and impairment losses. 4. What is the basis of revaluation? The revaluation surplus may be
* Fair Value: This is the price that Answer: transferred to retained earnings as
would be received to sell an asset or The basis of revaluation is the the asset is used or when it is
paid to transfer a liability in an asset's fair value at the date of derecognized (sold or disposed of).
orderly transaction between market revaluation. Common methods for This transfer can be made directly or
participants at the measurement determining fair value include: through depreciation.
date. * Market-Based Evidence: Using
* Revaluation Increases: If the fair quoted prices in active markets for 7. Explain the proportional approach
value of an asset increases, the similar assets (e.g., land and of recording revaluation.
increase is recognized in other buildings). Answer:
comprehensive income (OCI) and * Income Approach: Discounting The proportional approach adjusts
accumulated in equity under the future cash flows expected to be both the gross carrying amount and
heading "revaluation surplus." generated by the asset. the accumulated depreciation of the
* Revaluation Decreases: If the fair * Cost Approach: Estimating the asset in the same proportion as the
value of an asset decreases, the cost to replace the asset with a new change in the carrying amount.
decrease is recognized as an asset of similar utility. * Calculation: The new gross
expense in profit or loss. However, if carrying amount and accumulated
there's a revaluation surplus related 5. Explain fair value and depreciated depreciation are calculated using the
to the same asset, the decrease is replacement cost. ratio of the revalued carrying amount
first charged against the surplus. Answer: to the old carrying amount.
Advantages of the Revaluation * Fair Value: As defined earlier, fair * Example: If the carrying amount
Model: value is the price that would be increases by 20%, both the gross
* Relevance: It provides more received to sell an asset or paid to carrying amount and accumulated
relevant information about the transfer a liability in an orderly depreciation are increased by 20%.
current value of the asset. transaction between market
* Comparability: Assets are participants at the measurement 8. Explain the elimination approach
measured at their current value, date. It represents the current market of recording revaluation.
improving comparability. value. Answer:
Disadvantages of the Revaluation * Depreciated Replacement Cost: The elimination approach eliminates
Model: This is the current cost of replacing the accumulated depreciation
* Subjectivity: Fair value can be an asset with a new asset of similar against the gross carrying amount,
subjective and require significant utility, less accumulated depreciation. and the net amount is restated to the
judgment. It's a specific application of the cost revalued amount.
* Cost: Revaluations can be costly approach to fair value measurement. * Elimination: The accumulated
and time-consuming. It's often used when market-based depreciation is eliminated against the
* Volatility: Revaluation gains and evidence is not available. gross carrying amount, resulting in a
losses can lead to volatility in equity Key Difference: net carrying amount of zero.
and profit or loss. * Fair value aims to reflect the price * Restatement: The gross carrying
a willing buyer would pay, amount is then restated to the
3. Explain the frequency of considering all relevant factors. revalued amount.
revaluation. * Depreciated replacement cost * Example: If the asset has a gross
Answer: focuses on the cost of replacing the carrying amount of $100,000 and
The frequency of revaluations asset's service potential, adjusted for accumulated depreciation of
depends on the volatility of the fair depreciation. $40,000, the accumulated
value of the assets being revalued. depreciation is eliminated, and the
* Regular Revaluations: If the fair 6. Explain the treatment of gross carrying amount is restated to
value of an asset changes revaluation surplus. the new revalued amount.
significantly and regularly, Answer:
revaluations should be performed A revaluation surplus is the increase 9. Explain the reversal of a
frequently (e.g., annually). in the carrying amount of an asset revaluation surplus.
* Infrequent Revaluations: If the fair arising from a revaluation. Answer:
value of an asset changes * Recognition in OCI: The A revaluation surplus is reversed
insignificantly, revaluations may be revaluation surplus is recognized in when the asset is subsequently
performed less frequently (e.g., other comprehensive income (OCI) revalued and its fair value
every 3-5 years). and accumulated in equity. decreases, or when the asset is
* Specific Events: Revaluations may * Separate Component of Equity: It's derecognized.
also be triggered by specific events, presented as a separate component * Revaluation Decrease: If the fair
such as a significant change in of equity under the heading value of the asset decreases, the
market conditions or a major "revaluation surplus." decrease is first charged against any
acquisition.
existing revaluation surplus related to used for a different purpose or has arm's length transaction between
that asset. been idled. knowledgeable, willing parties, after
* Derecognition: When the asset is * Adverse internal reports: Reports deducting the costs of disposal.
derecognized (sold or disposed of), showing poor performance or * Fair Value: As defined earlier, it's
any remaining revaluation surplus declining profitability related to the the price that would be received in a
related to that asset is transferred to asset. current transaction to sell the asset.
retained earnings. * Restructuring or discontinuation * Costs of Disposal: These are the
plans: Plans to restructure incremental costs directly attributable
10. What are the disclosures related operations or dispose of the asset to the disposal of an asset, excluding
to revaluation? before its previously estimated useful finance costs and income tax
Answer: life. expenses. Examples include:
Companies that apply the revaluation * Significant decline in the asset's * Legal costs
model must disclose the following performance: The asset is * Broker commissions
information: generating significantly less cash * Costs of dismantling or removing
* Revaluation Date: The date of the flow than expected. the asset
revaluation. * Costs necessary to make the
* Basis of Revaluation: The methods 3. What are the external sources of asset ready for sale
used to determine fair value. information that would indicate
* Carrying Amount: The carrying possible impairment? 6. Explain value in use.
amount of the asset if the cost model Answer: Answer:
had been used. External sources of information that Value in use is the present value of
* Revaluation Surplus: The amount may suggest impairment include: the future cash flows expected to be
of the revaluation surplus, indicating * Significant decline in market value: derived from the asset's continued
the movement during the period and The asset's market value has fallen use and its ultimate disposal. It's an
any restrictions on the distribution of significantly below its carrying entity-specific value, reflecting the
the surplus. amount. entity's expectations about the
* Useful Life: The useful life or * Adverse changes in technology, asset's future cash flows.
depreciation rate used for each class markets, or regulations: Changes in * Future Cash Flows: These are the
of revalued assets. the external environment have estimated cash inflows and outflows
* Nature of the Index: If an index is negatively impacted the asset's expected to arise from the asset's
used to determine fair value, the value. continued use and its eventual
nature of the index must be * Increases in market interest rates: disposal.
disclosed. Higher interest rates can reduce the * Discount Rate: A pre-tax discount
present value of future cash flows, rate that reflects current market
CHAPTER 32 IMPAIRMENT making the asset less valuable. assessments of the time value of
1. Define impairment of asset. * Industry or economic indicators: money and the risks specific to the
Answer: Economic downturns or asset is used to calculate the present
Impairment of an asset occurs when industry-specific problems can lead value.
its carrying amount (the amount at to asset impairment.
which it's recorded on the balance 7. Explain the reversal of an
sheet) exceeds its recoverable 4. Explain recoverable amount of an impairment loss.
amount (the higher of its fair value asset. Answer:
less costs to sell and its value in Answer: An impairment loss can be reversed
use). Essentially, it means the The recoverable amount of an asset if there has been a change in the
asset's value has declined below its is the higher of: estimates used to determine the
book value, and the company won't * Fair Value Less Costs to Sell: The asset's recoverable amount since the
be able to recover that carrying price that would be received to sell last impairment loss was recognized.
amount through its future use or an asset in an orderly transaction * Conditions for Reversal:
disposal. between market participants, less the * The recoverable amount has
costs of disposal. increased.
2. What are the internal sources of * Value in Use: The present value of * The increase is related to an
information that would indicate the future cash flows expected to be event occurring after the impairment
possible impairment? derived from the asset's continued loss was recognized.
Answer: use and its ultimate disposal. * Limitations: The increased carrying
Internal sources of information that amount cannot exceed the carrying
may suggest impairment include: 5. Explain fair value less cost of amount that would have been
* Evidence of physical damage or disposal. determined had no impairment loss
obsolescence: The asset is damaged Answer: been recognized in prior years (less
or outdated. Fair value less costs of disposal is depreciation).
* Significant changes in the way the the net amount that an entity can
asset is used: The asset is being obtain from the sale of an asset in an
 * Recognition: The reversal is allocate impairment losses directly to * The cost of the asset can be
recognized as income in the profit or them. measured reliably.
loss. * Allocation Method: If a reasonable
and consistent basis for allocation 4. Explain the initial measurement of
8. Define cash generating unit. can be identified, corporate assets intangible asset.
Answer: may be allocated to CGUs. If not, the Answer:
A cash generating unit (CGU) is the impairment loss is recognized for the Intangible assets are initially
smallest identifiable group of assets smallest group of CGUs to which the measured at cost.
that generates cash inflows that are corporate assets can be allocated on * Separately Acquired Intangible
largely independent of the cash a reasonable and consistent basis. Asset: The cost includes the
inflows from other assets or groups purchase price, import duties, and
of assets. Essentially, it's the lowest CHAPTER 33 INTANGIBLE ASSET non-refundable purchase taxes, and
level at which the cash inflows from 1. Define intangible asset. any directly attributable cost of
an asset (or group of assets) can be Answer: preparing the asset for its intended
identified. An intangible asset is an identifiable use.
* Purpose: CGUs are used for non-monetary asset without physical * Intangible Asset Acquired in a
impairment testing when it's not substance. It's an asset that Business Combination: The cost is
possible to estimate the recoverable provides future economic benefits to its fair value at the acquisition date.
amount of an individual asset. a company, but lacks a physical * Intangible Asset Acquired by Way
form. Examples include patents, of a Government Grant: The cost is
9. Explain the allocation of trademarks, copyrights, and goodwill. its fair value at the date the grant is
impairment loss across the assets of received.
a cash generating unit. 2. Explain the criteria for defining an * Intangible Asset Acquired by
Answer: intangible asset. Exchange: The cost is measured at
When an impairment loss is Answer: the fair value of the asset received or
recognized for a CGU, it's allocated To be classified as an intangible the fair value of the asset given up,
to reduce the carrying amount of the asset, an asset must meet the whichever is more reliably
assets of the unit in the following following criteria: measurable.
order: * Identifiable: The asset must be
* Goodwill: First, the impairment loss separable (capable of being 5. Explain the measurement of cost
is allocated to reduce the carrying separated or divided from the entity of an intangible asset acquired
amount of any goodwill allocated to and sold, transferred, licensed, separately.
the CGU. rented, or exchanged) or arise from Answer:
* Other Assets: Then, the remaining contractual or other legal rights. As mentioned in the previous
impairment loss is allocated to the * Non-Monetary: The asset is not answer, the cost of a separately
other assets of the CGU on a cash or a right to receive a fixed or acquired intangible asset includes:
pro-rata basis based on their determinable number of units of * Purchase Price: The actual price
carrying amounts. currency. paid for the asset.
* Limitation: The carrying amount of * Without Physical Substance: The * Import Duties and Non-Refundable
an asset cannot be reduced below asset lacks a physical form. Purchase Taxes: Any duties or taxes
the highest of: * Controlled by the Entity: The entity that the entity must pay to acquire
* Its fair value less costs of has the power to obtain the future the asset.
disposal (if measurable). economic benefits flowing from the * Directly Attributable Costs of
* Its value in use (if measurable). asset and to restrict the access of Preparing the Asset for Intended
* Zero. others to those benefits. Use: These are costs directly related
* Future Economic Benefits: The to bringing the asset to its working
10. Explain corporate assets. asset is expected to generate future condition for its intended use.
Answer: economic benefits that will flow to the Examples include:
Corporate assets are assets that entity. * Legal fees
contribute to the future cash flows of * Professional fees
both the CGU under review and 3. What are the two conditions for * Costs of testing whether the
other CGUs. the recognition of an intangible asset is functioning properly
* Examples: asset?
* Head office buildings Answer: 6. Explain the measurement of an
* Centralized research and An intangible asset is recognized if, intangible asset as part of a business
development facilities and only if: combination.
* Shared IT infrastructure * It is probable that the future Answer:
* Allocation Challenge: Corporate economic benefits that are When an intangible asset is acquired
assets don't generate independent attributable to the asset will flow to as part of a business combination, its
cash flows, making it difficult to the entity. cost is its fair value at the acquisition
date. Fair value is the price that
would be received to sell an asset or * Development Phase: Expenditures asset. (Active markets are rare for
paid to transfer a liability in an on development are capitalized as intangible assets)
orderly transaction between market an intangible asset only if all of the
participants at the measurement following criteria are met: 12. Explain the amortization and
date. * Technical feasibility of completing impairment of intangible assets.
* Identifying the Asset: The the asset. Answer:
intangible asset must be identifiable * Intention to complete and use or * Amortization: Intangible assets
and meet the recognition criteria. sell the asset. with a finite useful life are amortized
* Determining Fair Value: Various * Ability to use or sell the asset. over their useful life. Amortization is
valuation techniques may be used to * Probability of generating future the systematic allocation of the cost
determine the fair value, such as: economic benefits. of an intangible asset over its useful
* Market-based evidence (if * Availability of adequate technical, life. This is similar to depreciation for
available) financial, and other resources to tangible assets.
* Income approach (discounted complete development and use or * Impairment: Intangible assets
cash flow analysis) sell the asset. (both finite and indefinite) are tested
* Cost approach (estimating * Ability to measure the for impairment when there is an
replacement cost) expenditure reliably. indication that the asset may be
* Cost: The cost of an internally impaired. An impairment loss is
7. Explain measurement of intangible generated intangible asset is the recognized when the carrying
asset acquired by government grant. sum of the expenditures incurred amount of the asset exceeds its
Answer: from the date when the intangible recoverable amount (the higher of
When an intangible asset is acquired asset first meets the recognition fair value less costs to sell and value
by way of a government grant, its criteria. in use).
initial measurement can be treated in
one of two ways: 10. Explain identifiable and 13. Explain the amortization period of
* Fair Value: The asset can be unidentifiable intangible assets. an intangible asset.
initially recognized at its fair value. Answer: Answer:
* Nominal Amount Plus Directly * Identifiable Intangible Assets: The amortization period is the period
Attributable Costs: The asset can be These assets are capable of being over which an intangible asset with a
recognized at a nominal amount separated or arise from contractual finite useful life is expected to
(e.g., zero) plus any directly or legal rights. Examples include: generate economic benefits. This is
attributable costs of preparing the * Patents also referred to as the useful life of
asset for its intended use. * Trademarks the intangible asset.
The choice of method depends on * Copyrights * Legal or Contractual Rights: The
the specific circumstances and the * Customer lists amortization period may be limited
accounting standards applied. * Licenses by legal or contractual rights.
* Unidentifiable Intangible Assets: * Management Estimates: When
8. Explain the measurement of cost These assets cannot be separated there are no legal or contractual
of an intangible asset acquired by from the business as a whole. The rights, the amortization period is
exchange. most common example is goodwill, determined based on management's
Answer: which represents the future best estimate of the period over
When an intangible asset is acquired economic benefits arising from which the asset will contribute to
in exchange for another asset, its assets that are not capable of being cash flows.
cost is measured at: individually identified and separately
* Fair Value of the Asset Received: recognized. 14. Explain the amortization method
If the fair value of the asset received for an intangible asset.
can be reliably measured. 11. Explain the measurement of Answer:
* Fair Value of the Asset Given Up: intangible asset after recognition. The amortization method for an
If the fair value of the asset received Answer: intangible asset should reflect the
cannot be reliably measured. After initial recognition, an intangible pattern in which the asset's
asset is measured using either: economic benefits are consumed.
9. Explain the cost of an internally * Cost Model: The asset is carried at * Straight-Line Method: This is the
generated intangible asset. cost less accumulated amortization most commonly used method,
Answer: and accumulated impairment losses. allocating an equal amount of
Internally generated intangible * Revaluation Model: The asset is amortization expense over each
assets are not recognized as assets carried at its fair value at the date of period.
unless they meet specific criteria. revaluation less any subsequent * Diminishing Balance Method: This
* Research Phase: Expenditures on accumulated amortization and results in higher amortization
research are always expensed as impairment losses. The revaluation expense in the earlier years of the
incurred. model is allowed only if there is an asset's life.
active market for the intangible
 * Units-of-Production Method: This An intangible asset is derecognized
allocates amortization expense (removed from the balance sheet) CHAPTER 34 IDENTIFIABLE IA
based on the asset's actual usage or when: 1. Define a patent.
output. * Disposed Of: The asset is Answer:
If the pattern of consumption cannot disposed of through sale or other A patent is a government-granted
be reliably determined, the means. exclusive right to an inventor,
straight-line method should be used. * No Future Economic Benefits are preventing others from making,
Expected: No future economic using, or selling an invention for a
15. Explain the useful life of an benefits are expected from its use or specified period. It provides legal
intangible asset. disposal. protection for new and useful
Answer: * Gain or Loss: Any gain or loss inventions.
The useful life of an intangible asset arising from the derecognition of an
is the period over which the asset is intangible asset is recognized in 2. Explain the cost of patent.
expected to be available for use by profit or loss. It is calculated as the Answer:
the entity or the number of difference between the net disposal The cost of a patent includes:
production or similar units expected proceeds and the carrying amount of * Purchase Price: If the patent is
to be obtained from the asset by the the asset. acquired from another party.
entity. * Legal Fees: Costs incurred in
* Finite Useful Life: An intangible 18. Explain goodwill. applying for and obtaining the patent.
asset has a finite useful life if the Answer: * Registration Fees: Fees paid to
entity expects to use it for a limited Goodwill is an asset representing the government agencies for registering
period. future economic benefits arising from the patent.
* Indefinite Useful Life: An intangible other assets acquired in a business * Directly Attributable Costs: Costs
asset has an indefinite useful life if combination that are not individually necessary to bring the patent to its
there is no foreseeable limit to the identified and separately recognized. intended use.
period over which the asset is It represents the premium paid by an
expected to generate net cash acquirer for the target company's 3. Explain the amortization and
inflows for the entity. ability to generate superior earnings. impairment of patent.
* Arises from a Business Answer:
16. Explain the residual value of an Combination: It only arises when a * Amortization: Patents have a finite
intangible asset. company acquires another company. useful life (usually the legal life or the
Answer: * Not Separately Recognizable: It expected economic life, whichever is
The residual value of an intangible cannot be sold, transferred, or shorter). The cost of the patent is
asset is the estimated amount that licensed independently. amortized over its useful life using a
an entity would currently obtain from * Tested for Impairment: It is not systematic method (usually
disposal of the asset, after deducting amortized but is tested for straight-line).
estimated costs of disposal, if the impairment at least annually. * Impairment: Patents are tested for
asset were already of the age and in impairment when there is an
the condition expected at the end of 19. Explain the residual approach of indication that their carrying amount
its useful life. measuring goodwill. may exceed their recoverable
* Assumption: It's assumed that a Answer: amount. An impairment loss is
third party would purchase the asset The residual approach is used to recognized if the recoverable amount
at the end of its useful life. calculate goodwill in a business is less than the carrying amount.
* Usually Zero: The residual value of combination.
an intangible asset is usually * Calculation: Goodwill = Acquisition 4. Define a trademark.
assumed to be zero unless there is: Cost - Fair Value of Net Identifiable Answer:
* A commitment by a third party to Assets Acquired A trademark is a symbol, design, or
purchase the asset at the end of its * Rationale: Goodwill represents the phrase legally registered to represent
useful life, or excess of the acquisition cost over a company or product. It
* An active market for the asset at the fair value of the identifiable net distinguishes the source of goods or
the end of its useful life, and the assets acquired. services from those of others.
residual value can be determined by
reference to that market. 20. Explain the direct approach of 5. Explain the amortization and
measuring goodwill. impairment of trademark.
Answer: Answer:
There is no direct approach to * Amortization: Trademarks can
measuring goodwill as a standalone have either a finite or indefinite
asset. Goodwill arises only in a useful life.
17. Explain derecognition of an business combination and is * Finite: If the trademark has a
intangible asset. calculated using the residual limited useful life, it is amortized over
Answer: approach. that period.
 * Indefinite: If the trademark is 10. Explain initial franchise fee and Organization costs are costs incurred
expected to generate cash flows periodic franchise fee. in forming a corporation, such as
indefinitely, it is not amortized but is Answer: legal fees, incorporation fees, and
tested for impairment annually or * Initial Franchise Fee: This is a underwriting fees. These costs are
more frequently if there are one-time payment made by the typically expensed as incurred.
indications of impairment. franchisee to the franchisor for the
* Impairment: Trademarks, whether right to operate the franchise. It's 15. Explain the accounting treatment
finite or indefinite, are tested for capitalized as an intangible asset of web site development cost.
impairment when there is an and amortized over the franchise's Answer:
indication of impairment. useful life. The accounting treatment of web site
* Periodic Franchise Fee: These are development costs depends on the
6. Define a copyright. recurring payments made by the stage of development:
Answer: franchisee to the franchisor, usually * Planning Stage: Costs are
A copyright is a legal right granted to based on sales or profits. They are expensed as incurred.
the creator of original works of expensed as incurred. * Application and Infrastructure
authorship, including literary, Development Stage: Costs are
dramatic, musical, and certain other 11. Explain leasehold improvement capitalized as an intangible asset if
intellectual works. It provides and depreciation of leasehold they meet the criteria for
exclusive rights to reproduce, improvement. capitalization (e.g., probability of
distribute, perform, display, and Answer: future economic benefits, reliable
create derivative works. * Leasehold Improvement: These measurement).
are modifications made by a lessee * Graphical Design Stage: Costs are
7. Explain the amortization and to a leased property. They are capitalized if they meet the
impairment of copyright. capitalized as an asset because they capitalization criteria.
Answer: provide future economic benefits to * Content Development Stage:
* Amortization: Copyrights have a the lessee. Costs are expensed as incurred
finite useful life (usually the legal life * Depreciation: Leasehold unless they are directly related to the
or the expected economic life, improvements are depreciated over application and infrastructure and
whichever is shorter). The cost of the the shorter of the lease term or the meet the capitalization criteria.
copyright is amortized over its useful useful life of the improvements. The * Operating Stage: Costs are
life. depreciation method used should expensed as incurred.
* Impairment: Copyrights are tested reflect the pattern of consumption of
for impairment when there is an the benefits. CHAPTER 35 RESEACH AND
indication that their carrying amount DEVELOPMENT COST:
may exceed their recoverable 12. Explain a customer list. 1. Define research and development.
amount. Answer: Answer:
A customer list is a compilation of * Research: Original and planned
8. Define a franchise. information about a company's investigation undertaken with the
Answer: customers, including names, contact prospect of gaining new scientific or
A franchise is a contractual details, and purchase history. It can technical knowledge and
agreement where one party (the be a valuable intangible asset. understanding.
franchisor) grants another party (the * Development: Application of
franchisee) the right to operate a 13. Explain the amortization and research findings or other knowledge
business using the franchisor's impairment of customer list. to a plan or design for the production
business model, trademarks, and Answer: of new or substantially improved
products or services. * Amortization: Customer lists materials, devices, products,
usually have a finite useful life, processes, systems, or services
9. Explain the amortization and depending on customer attrition rates before the start of commercial
impairment of franchise. and the expected duration of production or use.
Answer: customer relationships. The cost of
* Amortization: Franchises typically the customer list is amortized over its 2. Identify the research activities.
have a finite useful life (the term of useful life. Answer:
the franchise agreement). The cost * Impairment: Customer lists are Research activities are aimed at
of the franchise is amortized over its tested for impairment when there is discovering new knowledge.
useful life. an indication that their carrying Examples include:
* Impairment: Franchises are tested amount may exceed their * Activities aimed at obtaining new
for impairment when there is an recoverable amount. knowledge.
indication that their carrying amount 14. Explain the accounting treatment * The search for evaluations and
may exceed their recoverable of organization cost. selection of applications of research
amount. Answer: findings or other knowledge.
 * The search for alternatives for development and to use or sell the
materials, devices, products, intangible asset. 9. Explain the amortization and
processes, systems, or services. * Reliable Measurement: Ability to impairment of a computer software.
* The formulation, design, measure the expenditure attributable Answer:
evaluation, and final selection of to the intangible asset reliably during * Amortization: Capitalized software
possible alternatives for new or its development. development costs are amortized
improved materials, devices, If these criteria are not met, over the software's useful life. The
products, processes, systems, or development costs are expensed as amortization method should reflect
services. incurred. the pattern in which the software's
economic benefits are consumed
3. Identify the development activities. 6. What are the criteria for the (e.g., straight-line,
Answer: recognition of development cost as units-of-production).
Development activities involve an intangible asset? * Impairment: Software assets are
applying research findings to create Answer: tested for impairment when there is
new or improved products or As answered in question 5, the an indication that their carrying
processes. Examples include: criteria for the recognition of amount may exceed their
* The design, construction, and development cost as an intangible recoverable amount. An impairment
testing of pre-production prototypes asset are: loss is recognized if the recoverable
and models. * Technical Feasibility amount is less than the carrying
* The design of tools, jigs, molds, * Intention to Complete amount.
and dies involving new technology. * Ability to Use or Sell
* The design, construction, and * Probability of Future Economic 10. Explain the statement
operation of a pilot plant that is not of Benefits classification of a computer software.
a scale economically feasible for * Availability of Resources Answer:
commercial production. * Reliable Measurement Computer software can be classified
* The design, construction, and as either:
testing of selected alternatives for 7. Explain the treatment of an * Intangible Asset: If it meets the
new or improved materials, devices, internally developed computer definition and recognition criteria for
products, processes, systems, or software. an intangible asset (i.e., identifiable,
services. Answer: non-monetary, without physical
The accounting treatment of substance, controlled by the entity,
4. Explain the accounting for internally developed computer and expected to generate future
research cost. software depends on the stage of economic benefits). Software
Answer: development: developed for internal use is often
Research costs are expensed as * Research Phase: Costs are classified as an intangible asset.
incurred. This is because the expensed as incurred. * Inventory: If the software is held for
outcome of research is uncertain, * Development Phase: Costs are sale in the ordinary course of
and it's difficult to determine if future capitalized as an intangible asset if business.
economic benefits will arise. they meet the criteria for * Property, Plant, and Equipment
capitalization (as outlined in question (PP&E): If the software is an integral
5. Explain the accounting for 5). part of a tangible asset (e.g.,
development cost. * After Technological Feasibility: software embedded in a machine).
Answer: Once technological feasibility is The classification depends on the
Development costs are capitalized established (meaning the software specific facts and circumstances,
as an intangible asset if, and only if, can be completed), costs are including the purpose for which the
all of the following criteria are met: capitalized. software is developed and used.
* Technical Feasibility: Completing * Maintenance and Training: Costs
the intangible asset so that it will be related to maintenance and training
available for use or sale. are expensed as incurred.
* Intention to Complete: Intention to
complete the intangible asset and 8. Explain technological feasibility.
use or sell it. Answer:
* Ability to Use or Sell: Ability to use Technological feasibility is
or sell the intangible asset. established when the enterprise has
* Probability of Future Economic completed all planning, designing,
Benefits: The intangible asset will coding, and testing activities that are
generate probable future economic necessary to establish that the
benefits. software can be produced to meet its
* Availability of Resources: design specifications, including
Adequate technical, financial, and functions, features, and technical
other resources to complete the performance requirements.