Question

At the beginning of Year 1, Sports Gear Inc. (SGI) acquired a college apparel license at a cost of $28,000,000, excluding legal fees of $1,600,000 and registration fees of $400,000. The company estimated that the license would have a useful (legal) life of 15 years. For Question 3, assume that the fair value of the license at the end of Year 1, Year 2, and Year 3 is $26,600,000, $26,300,000, and $23,850,000, respectively.

Answer the questions below and enter the correct dollar amounts in the associated cells. Round to the nearest dollar.

1. What amount will the company report as the carrying value of the license asset at the end of Year 2 under U.S. GAAP?

2. If the company determines that the license asset is impaired by 3,000,000 at the beginning of Year 3, what is the total amount of of expense related to the license reported on the income statement for Year 3 under U.S. GAAP?

3. Determine the amount of revaluation gain or loss that is reported on the income statement for Year 2 under IFRS if the revaluation model is used.

Answer 1

As per Fixed Assets capitalization guidelines issued by FASB, fixed assets must be capitalized at the cost of acquisition and not just the cost of the assets. Cost of acquisition is nothing but the additional expenses incurred by the organization in procuring the assets which can be the freight charges, sales tax, transportation, installation, legal & professional charges in case of acquiring the intangible assets, overhead charges(material, labour, license etc.) for assets' constructed or internally developed sofware. In other words all expenses even if it is of revenue nature but is directly connected to procurement of fixed assets must be included as cost of acquisition and capitalized in the books.

Hence in this case the cost of acquisition is the License cost ($28M) + Legal charges ($1.6M) + Registration charges ($0.4M) i.e. Rs.$30M. The capitalization entry would be:

Fixed Assets A/c Dr. 30,000,000

To Bank A/c Cr. 30,000,000

The depreciation is the reduction in value of the assets due to booked for the wear and tear, obsolete technology and allocating the cost of the asset to operations over the estimated useful life of the asset. In this case the estimated life of the license is 15 years, hence the total acquisition cost must be equally spread over 15 years.

Here is the depreciation schedule:

	Assets' WDV	Remaining Life (Years)	Yearly Depreciation	Net Book value (WDV)
Year - 1	30,000,000	15	2,000,000	28,000,000
Year - 2	28,000,000	14	2,000,000	26,000,000
Year - 3	26,000,000	13	2,000,000	24,000,000
Year - 4	24,000,000	12	2,000,000	22,000,000
Year - 5	22,000,000	11	2,000,000	20,000,000
Year - 6	20,000,000	10	2,000,000	18,000,000
Year - 7	18,000,000	9	2,000,000	16,000,000
Year - 8	16,000,000	8	2,000,000	14,000,000
Year - 9	14,000,000	7	2,000,000	12,000,000
Year - 10	12,000,000	6	2,000,000	10,000,000
Year - 11	10,000,000	5	2,000,000	8,000,000
Year - 12	8,000,000	4	2,000,000	6,000,000
Year - 13	6,000,000	3	2,000,000	4,000,000
Year - 14	4,000,000	2	2,000,000	2,000,000
Year - 15	2,000,000	1	2,000,000	-

1) The carrying cost of the license at the end of Year - 2 is $28M (refer to depreciation schedule).

2) The impairment cost of $3M will not change the useful life of the assets and hence the life of the assets will remain as 13 (2 years already depreciated) however the depreciation will now happen on the revised carrying cost (after the impairment loss is booked) over the remaining life of the asset. The total amount of expense related to license reported on income statement for year 3 would be $4,769,231 (refer to revised depreciation schedule below)

	Assets' WDV	Remaining Life (Years)	Impairment	Yearly Depreciation	Net Book value (WDV)	Expense booked to Income statement
Year - 1	30,000,000	15	-	2,000,000	28,000,000	2,000,000
Year - 2	28,000,000	14	-	2,000,000	26,000,000	2,000,000
Year - 3	26,000,000	13	3,000,000	1,769,231	24,230,769	4,769,231
Year - 4	24,230,769	12	-	1,769,231	22,461,538	1,769,231
Year - 5	22,461,538	11	-	1,769,231	20,692,307	1,769,231
Year - 6	20,692,307	10	-	1,769,231	18,923,076	1,769,231
Year - 7	18,923,076	9	-	1,769,231	17,153,845	1,769,231
Year - 8	17,153,845	8	-	1,769,231	15,384,614	1,769,231
Year - 9	15,384,614	7	-	1,769,231	13,615,383	1,769,231
Year - 10	13,615,383	6	-	1,769,231	11,846,152	1,769,231
Year - 11	11,846,152	5	-	1,769,231	10,076,921	1,769,231
Year - 12	10,076,921	4	-	1,769,231	8,307,690	1,769,231
Year - 13	8,307,690	3	-	1,769,231	6,538,459	1,769,231
Year - 14	6,538,459	2	-	1,769,231	4,769,228	1,769,231
Year - 15	4,769,228	1	-	1,769,231	2,999,997	1,769,231

3) The carrying cost of assets at the end of Year - 2 is $26M and the fair value of the asset at the end of Year-2 is $26.3M hence there is a Revaluation Gain of $300K to be accounted in the books. The journal entry for the revaluation gain is

Fixed Asset A/c Dr. $300,000

Gain on Revaluation Cr. $300,000

As per IAS 16 the gain or loss on revaluation must be disclosed in both the statement of changes in equity and in other comprehensive income.