Revaluation of fixed assets under US GAAP
February 20, 2015
Valuation of fixed assets has always been a contradictory issue for standards setters. Accounting for fixed assets at historical costs decreases the likelihood of manipulation, while accounting for fixed assets at fair values provides more relevant information to users of financial statements. In this article we will review US GAAP rules about initial measurement and subsequent accounting for fixed assets, and compare them with the IFRS requirements.
Fixed assets are tangible items used in production or supply of goods or services during more than one period. Fixed assets have physical substance and can be touched. Property, plant and equipment typically consist of land, buildings, machinery and equipment, as well as furniture and fixtures.
According to US GAAP, all fixed assets are accounted for using the historical cost model, which stipulates that non-current assets are initially recognized at cost and are subsequently carried at cost less accumulated depreciation and cumulative impairment losses. Any upward adjustments due to changing circumstances are prohibited.
In the case of business combinations, however, fixed assets are measured at their fair values by the acquiring entity.
The cost model allows only downward adjustment due to impairment losses. Consequently, long-lived assets shall be tested for impairment if circumstances indicate that their carrying amount exceeds their market value. Usually, the following circumstances indicate the need for impairment:
- Significant adverse changes in economic, legal or technological environment;
- A significant unexpected decrease in the asset’s market value;
- An asset perpetually underperforms budget or there is material reduction in usage of an asset;
- It is expected with probability of more than 50 per cent that an asset will be sold before the end of its previously estimated useful life.
If an impairment loss is recognized, the adjusted carrying amount of a fixed asset becomes its new cost basis, which shall be depreciated over the remaining useful life of that asset. At the same time, restoration of a previously recognized impairment loss is prohibited.
For instance, if in 20X0 Snow Ltd Company (a fictitious entity) bought a new building for $100,000, but in 20X5 its value had significantly deteriorated to $50,000, then the company should recognize an impairment loss in its 20X5 financial statements. Assuming a 20 years useful life for the building and straight-line depreciation, the impairment loss would amount to $25,000 calculated by comparing building carrying value of $75,000 (i.e., book value minus accumulated depreciation for 5 years: $100,000 - $100,000 x 5 ÷ 20) with the market value of $50,000. The next 20X6 year depreciation would be $3,333 (i.e., new cost of $50,000 divided by the remaining 15 years useful life). Even in case of significant jump in the real estate prices, the company would continue to carry the building at the impaired cost of $50,000 less accumulated depreciation.