International Financial Reporting Standards_guide.pdf

Chapter 10 Property, Plant, and Equipment (IAS 16) 115
TABLE 10.1 Effects of Capitalizing vs. Expensing Costs
Variable Expensing Capitalizing
Shareholders’ Equity Lower because earnings are lower Higher because earnings are higher
Earnings Lower because expenses are higher Higher because expenses are lower
Pretax Cash Generated
from Operating Activities
Cash Generated from
Investing Activities
Pretax Total Cash Flow
Lower because expenses are higher
None because no long-term asset is put on
the Statement of Financial Position
Same because amortization is not a cash
expense
Higher because expenses are lower
Lower because a long-term asset is acquired
(invested in) for cash
Same because amortization is not a cash
expense
Profit Margin Lower because earnings are lower Higher because earnings are higher
Asset Turnover Higher because assets are lower Lower because assets are higher
Current Ratio
Same on a pretax basis because only longterm
assets are affected
Same on a pretax basis because only longterm
assets are affected
Debt-to-Equity Higher because shareholders’ equity is lower Lower because shareholders’ equity is higher
Return on Assets
Return on Equity
Stability over Time
Lower because the earnings are lower
percentage-wise than the reduced assets
Lower because the earnings are lower
percentage-wise than the reduced
shareholders’ equity
Less stable earnings and ratios because large
expenses may be sporadic
Higher because the earnings are higher
percentage-wise than the increased assets
Higher because the earnings are higher
percentage-wise than the increased
shareholders’ equity
More stable earnings and ratios because
amortization smooths earnings over time
10.6.7 Management must make three choices when deciding how to depreciate assets:
■ the method of depreciation that will be used (straight-line, accelerated consumption, or
depletion in early years);
■ the useful life of the asset, which is the time period over which the depreciation will
occur; and
■ the residual value of the asset.
In IFRS financial statements, these choices are determined by the application of the principles
in IAS 16.
10.6.8 The easiest way to understand the impact of using straight-line versus accelerated
depreciation is as follows: An accelerated consumption method will increase the depreciation
expense in the early years of an asset’s useful life relative to what it would be if the
straight-line method were used. This lowers reported income and also causes the book value
of the long-term assets reported on the Statement of Financial Position to decline more
quickly relative to what would be reported under the straight-line method. As a result, the
shareholders’ equity will be lower in the early years of an asset’s life under accelerated depreciation.
Furthermore, the percentage impact falls more heavily on the smaller income value
than on the larger asset and shareholders’ equity values. Many of the key financial ratios that
are based on income, asset values, or equity values will also be affected by the choice of
depreciation method.