Tangible Assets

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Tangible Assets are physical assets, contrary to Intangible Assets.

Recognizing Tangible Assets

To properly record an asset on the balance sheet and determine which accounting standards apply, it is essential to classify them. Assets can be current (e.g. inventory, explained in Inventories and Provisions) or non-current assets. Non-current tangible assets are classified into Investment Property and Property, Plant, Equipment.

Investment Property vs Plant, Property, Equipment

If the primary use of a property is to earn rentals or for capital appreciation, it is classified as Investment Property (IAS 40). Otherwise, if the property is used in the production or supply of goods or services, it is classified as Property, Plant, Equipment (IAS 16) (except for agricultural properties).

Once the classification is determined, an accountant has to conduct:

• Recognition: Does the transaction result in an asset and this is asset recorded on the balance sheet?
• Initial Measurement: At which value is the asset recorded at first?
• Presentation: Where is the asset presented in the financial statements? (this is mostly determined by the classification)
• Subsequent Measurement: At which value is the asset recorded after initial recognition?
• Disclosure: What information has to be disclosed in the notes to the financial statements?
• Derecognition: When is the asset removed from the balance sheet?

Recognition

An asset is recorded in the balance sheet if:

• it’s probable that future economic benefits will flow to the entity
• the cost of the investment property can be measured reliably

For investment property controlled by an entity, these criteria are almost always met.

Under German GAAP, these criteria are slightly different:

• the tangible assets has the properties of a fixed asset
• it is personally and objectively attributable to the merchant

Initial Measurement

The initial measurement of tangible assets applies to both classifications. There are two options: Cost of purchase and cost of construction.

Cost of Purchase

This method is used when an asset is acquired from a third party. The cost of purchase includes:

• Purchase price (after deducting trade discounts and rebates)
• Import duties and non-refundable purchase taxes (not VAT)
• Costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating (e.g. delivery and handling costs, installation costs, professional fees; but not overheads or administrative costs)

Cost of Construction

This method is used when an asset is constructed by the entity itself. The cost of construction includes:

• Costs of materials
• Costs of conversion, including fixed and variable production overheads (e.g. direct labor, depreciation of production equipment)
• Costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating (e.g. delivery and handling costs, installation costs, professional fees; but not overheads or selling costs)

Subsequent Measurement

After the the asset has been recorded initially, it has to be subsequently measured at the fiscal year end. The carrying amount is the amount at which an asset is recognized after deducting any accumulated depreciation and accumulated impairment losses. Value decreases are recorded as expenses.

For both classifications, there are two options available. The cost model applies to both, the other options are explained below in Investment Property and Property, Plant, Equipment. Transitions between methods are allowed if there is evidence that the new method provides more reliable and relevant information.

Under German GAAP, only the cost model is allowed.

Cost Model (IAS 40.56)

The value of the asset is reduced by depreciation over its useful life and impairment losses, regardless of actual market value. For this, any Depreciation Methods may be applied, and Impairment tests must be conducted.
Land is not depreciated as it has an unlimited useful life.

Investment Property

An investment property is property (e.g. land or a building, or both) held to earn rentals and/or capital appreciation.

Once a method of subsequent measurement has been chosen between cost model and fair value model, it must be applied consistently to all investment property.

Fair Value Model (IAS 40.33 f.)

In the fair value model, investment property is measured at the current fair value at fiscal year end. Value increases are recognized as income in profit or loss for the period in which they arise.

Fair value is the price that would be received for the orderly sale of an asset, therefore the market price.

Property, Plant, Equipment

Property, plant and equipment refer to tangible assets that are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes, and are expected to be used during more than one period.

Once a method of subsequent measurement has been chosen between cost model and revaluation model, it must be applied consistently to the entire class of property. Different classes of property may use different methods.

Revaluation Model (IAS 16.31 f.)

The revaluation model is similar to the fair value model in that it regularly values an asset at its fair value. However, this revaluation does not happen every year, but every 2nd to 5th, depending on the volatility of the asset’s fair value. Besides the remeasurement, the asset’s carrying amount is depreciated every year (based on the last measured value), even in measurement years. Impairment is still applied if necessary.

If the revaluation decreases an asset’s carrying amount, this is recognized as expense. An increase is recognized in other comprehensive income and accumulated in equity under the heading of revaluation surplus. However, an increase is recognized in profit or loss to the extent that it reverses a revaluation decrease of the same asset previously recognized in profit or loss (not depreciation).

Depreciation Methods (external)

Depreciation is the allocation of the depreciable amount of an asset over its useful life. The depreciable amount is the cost of an asset, or other amount substituted for cost, less its residual value.

Straight-Line Method

The depreciable amount of an asset is allocated on a straight-line basis over its useful life, therefore the same amount of depreciation is recognized for each period, and the carrying amount of the asset decreases linearly over its useful life.
$\text{Depreciation Expense}=\frac{\text{Asset Cost}-\text{Residual Value}}{n}$
This is the same as linear depreciation in cost accounting.

Diminishing Balance Method

A constant rate of depreciation is applied to the carrying amount of the asset at the beginning of each period, therefore the amount of depreciation decreases over time, and the carrying amount of the asset decreases exponentially over its useful life.

$$\begin{array}{rl}\text{Depreciation Expense}& =\text{Carrying Amount at Beginning of Period}\times \text{Depreciation Rate}\\ \text{Depreciation Rate}& =\sqrt[n]{\text{Residual Value}\times \text{Asset Cost}}\end{array}$$

This is the same as geometric-regressive depreciation in cost accounting.

Units of Production Method

This method depends on the expected number of units the asset will produce over its useful life. The depreciation expense is calculated based on the actual production in the period. When more units are produced, the depreciation expense is higher, and vice versa down to 0.

$$\begin{array}{rl}\text{Depreciation Expense}& =\frac{\text{Actual Production in Period}}{\text{Total Expected Production}}\times (\text{Asset Cost}-\text{Residual Value})\end{array}$$

Impairment

An impairment test is conducted when there is an indication (e.g. goodwill) that a cash-generating unit may be carrying an asset at more than its recoverable amount. If the carrying amount exceeds the recoverable amount, an impairment loss is recognized.

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.

The recoverable amount is the higher of an asset’s fair value less costs to sell, and its value in use.

The value in use is the present value of the future cash flows expected to be derived from an asset or cash-generating unit. The cashflow is forecasted for the asset’s current use for up to 5 years, then extrapolated. No restructurings are considered and taxes and financing activities are excluded. To determine the discount factor, a pre-tax rate that reflects current market assessments of the time value of money and the risks specific to the asset is used.

Finally, the revised carrying amount is the lower value between the current carrying amount and the recoverable amount: $\text{Revised Carrying}=\min (\text{Carrying Amount},\max (\text{Fair Value less Costs to Sell},\text{Value in Use}))$

Discounting

Discounting is further explained Discounting. It is the process of determining the present value of a future amount of money or stream of cash flows given a specified rate of return.

Future cash flows are estimated and discounted to give their present values. The sum of all present values is the net present value (NPV), which is used to evaluate the attractiveness of an investment or project.

Indications for Impairment

Indicators that an asset may be impaired may be external or internal.

External Indicators:

• Significant decline in market value
• Adverse changes in the market or regulatory environment
• Long-term increase in market interest rates used for discounting cash flows

Internal Indicators:

• Physical damage, obsolescence, or changes in operations
• Major reorganizations/restructuring
• Loss of key personnel that affects the asset’s value
• Expected continued losses from operations

Derecognition

When derecognizing an asset, the asset with its carrying amount is removed from the balance sheet, and any gain or loss on derecognition is recognized in profit or loss. Assets are derecognized on:

• Disposal: When an asset is sold or otherwise disposed of.
• When no future economic benefits are expected from its use or disposal (e.g. asset is scrapped).

Influence on Earnings Management

Tangible asset accounting gives managers discretion that can shift reported earnings without changing underlying cash flows.

Managers can influence reported earnings and key performance indicators (KPIs) through their choices:

• Depreciation Method Choice: Different methods change the timing of expense recognition, affecting current profit and KPI levels (e.g., RoA).
• Subsequent Measurement Choice (Cost vs Fair Value / Revaluation): Measurement models influence both net income (through depreciation or fair value changes) and total assets, directly impacting ratios such as RoA.

Earnings Management Implications

• Managers can increase or decrease current-period profit by choosing methods that defer or accelerate expenses, shifting earnings between periods.
• These choices also manipulate asset values, shifting RoA and other asset-based metrics.
• Incentives tied to performance measures (e.g., RoA-based bonuses) can encourage method selection for short-term appearance rather than long-term accuracy.