Module 3: Analysing Balance Sheets

What is an intangible asset?

An identifiable, non-monetary asset that lacks physical substance. Examples include patents, copyrights, trademarks, licences, franchises, customer relationships, and operating rights.

What three characteristics define an intangible asset?

An intangible asset is identifiable, non-monetary, and lacks physical substance.

Does an asset qualify as an intangible simply because it lacks physical substance?

No. Marketable securities lack physical substance but are financial assets, not intangible assets.

When is an intangible asset identifiable?

An intangible asset is identifiable if either (1) it is separable and can be sold, transferred, or licensed independently, or (2) it arises from contractual or legal rights.

What major asset is not separately identifiable?

Goodwill. Goodwill cannot be separated from the business and arises as a residual in a business combination.

What are the three main origins of intangible assets?

Separately purchased; acquired in a business combination; internally developed.

How is a separately purchased intangible asset initially measured?

At cost.

How is an identifiable intangible acquired in a business combination initially measured?

At fair value at the acquisition date.

What is fair value?

The price that would be received to sell an asset in an orderly transaction between market participants at the measurement date. It is a market-based exit price.

Is fair value necessarily what the company originally paid for an asset?

No. Historical cost and current fair value can differ.

Is fair value the unique internal value of an asset to the company?

No. Fair value is market-based rather than entity-specific.

Can an acquirer recognize an intangible asset that was not recognized on the acquiree's balance sheet?

Yes. An identifiable intangible that was internally generated by the acquiree can be recognized separately at fair value by the acquirer in a business combination.

What subsequent measurement models does IFRS permit for intangible assets?

The cost model and, when an active market exists, the revaluation model.

What is the cost-model formula for the carrying amount of an intangible asset?

Carrying amount = Cost − Accumulated amortization − Accumulated impairment.

When can IFRS use the revaluation model for an intangible asset?

Only when an active market exists for the relevant intangible asset.

What is an active market?

A market in which transactions occur with sufficient frequency and volume to provide ongoing pricing information.

Why is the IFRS revaluation model rarely used for intangible assets?

Active markets rarely exist for unique intangible assets such as patents, brands, trademarks, and customer relationships.

Does US GAAP permit the revaluation model for intangible assets?

No. US GAAP uses the cost model.

How are finite-life intangible assets subsequently accounted for?

They are systematically amortized over their estimated useful lives and tested for impairment when impairment indicators arise.

How are indefinite-life intangible assets subsequently accounted for?

They are not amortized and are tested for impairment at least annually.

Does indefinite useful life mean infinite useful life?

No. It means there is currently no foreseeable limit to the period over which the asset is expected to generate economic benefits.

What must management reconsider annually for an indefinite-life intangible asset?

Whether the indefinite-life classification remains appropriate.

What is the key finite-life versus indefinite-life intangible rule?

Finite life = Amortize + impairment test when indicators arise. Indefinite life = No amortization + impairment test at least annually.

Are the useful life and amortization method for a finite-lived intangible fixed forever?

No. They are reviewed at least annually.

What are the two phases of an internally developed project under IFRS?

Research phase and development phase.

What is the research phase under IFRS?

The early investigative stage of an internal project aimed at discovering new knowledge, products, or processes.

How are research costs treated under IFRS?

Research costs are expensed as incurred.

What is the development phase under IFRS?

The post-research stage in which research findings are applied to the design, construction, or testing of a new or improved product or process.

How are development costs treated under IFRS?

Development costs are capitalized only after all six IFRS development criteria are satisfied.

What are the six IFRS development capitalization criteria?

Technical feasibility; intention to complete; ability to use or sell; probable future economic benefits; adequate resources to complete; ability to measure expenditure reliably.

What is a mnemonic for the six IFRS development capitalization criteria?

F-I-A-B-R-M = Feasible, Intend, Able, Benefits, Resources, Measure.

What happens if only five of the six IFRS development criteria are satisfied?

The development costs are expensed. All six criteria must be satisfied before capitalization begins.

When does capitalization of development costs begin under IFRS?

Capitalization begins when all six development criteria have been satisfied.

Can research costs previously expensed be retrospectively capitalized once a project becomes feasible?

No. Costs incurred before the capitalization criteria are satisfied remain expensed.

How does US GAAP generally treat research and development costs?

Both research and development costs are generally expensed as incurred.

What is the major US GAAP exception to the general rule of expensing R&D?

Certain software development costs can be capitalized.

For US GAAP software developed for sale, when does capitalization generally begin?

Once technological feasibility has been established.

For US GAAP internal-use software, when does capitalization generally begin?

Once the application development stage begins.

How are internally generated brands, mastheads, publishing titles, and customer lists generally treated under IFRS and US GAAP?

Expensed rather than capitalized.

How are start-up costs generally treated under IFRS and US GAAP?

Expensed.

How are training costs generally treated under IFRS and US GAAP?

Expensed.

How are advertising and promotion costs generally treated under IFRS and US GAAP?

Expensed.

How are general administrative overhead costs related to internal intangible development generally treated?

Expensed rather than capitalized.

How are relocation and reorganization costs generally treated?

Expensed.

An IFRS company has EUR 2.015m of research costs and EUR 1.410m of qualifying development costs. How much is capitalized?

Research expense = EUR 2.015m. Development capitalized = EUR 1.410m. Therefore, capitalized intangible asset = EUR 1.410m.

Using the same example, how much would generally be expensed under US GAAP if no software exception applies?

Total R&D expense = EUR 2.015m + EUR 1.410m = EUR 3.425m.

Compared with immediate expensing, what is the initial effect of capitalizing development costs?

Capitalization generally results in higher assets, higher equity, higher current-period net income, and lower current-period expense.

What happens to earnings in subsequent periods after development costs have been capitalized?

Future amortization expense reduces earnings.

What intangible-asset disclosures are useful to analysts?

Gross carrying amount, accumulated amortization, useful lives or amortization rates, amortization methods, income-statement location of amortization, carrying-value reconciliations, impairment losses or reversals, and restrictions or pledges.

Why should analysts treat reported intangible-asset values cautiously?

Intangible values may be company-specific, difficult to sell independently, and highly dependent on the business continuing as a going concern.

What is the formula for tangible book value?

Tangible book value = Total equity − Intangible assets.

A company has total equity of USD 500m and intangible assets of USD 150m. Calculate tangible book value.

Tangible book value = USD 500m − USD 150m = USD 350m.

Should analysts automatically assign all intangible assets a value of zero?

No. Analysts should assess each intangible based on its economic characteristics and adjust selectively.

When does accounting goodwill arise?

Only in a business combination.

Can internally generated reputation or internally generated goodwill be recognized as accounting goodwill?

No. Accounting goodwill is recognized only through an acquisition.

Why might an acquirer pay more than the fair value of identifiable net assets?

Expected synergies, reputation, trained workforce, distribution advantages, R&D value not separately identifiable, and other expected economic benefits.

What is the basic goodwill formula?

Goodwill = Purchase price − Fair value of identifiable net assets acquired.

What is the formula for fair value of identifiable net assets?

Fair value of identifiable net assets = Fair value of identifiable assets − Fair value of liabilities.

Should goodwill be calculated directly from the target's book value of net assets?

No. Identifiable assets and liabilities must first be adjusted to their acquisition-date fair values.

An acquirer pays GBP 187m. Book net assets are GBP 124m, PP&E has a GBP 14m fair-value uplift, an unrecorded customer relationship is worth GBP 9m, and an unrecorded contingent liability is GBP 4m. Calculate fair value of identifiable net assets.

FV identifiable net assets = GBP 124m + GBP 14m + GBP 9m − GBP 4m = GBP 143m.

Using purchase price of GBP 187m and fair value of identifiable net assets of GBP 143m, calculate goodwill.

Goodwill = GBP 187m − GBP 143m = GBP 44m.

Why is an identifiable customer relationship recognized separately rather than included in goodwill in a business combination?

Because an identifiable intangible asset is separately recognized at its acquisition-date fair value.

What happens to goodwill if the fair value of identifiable acquired assets increases, all else equal?

Goodwill decreases because Goodwill = Purchase price − FV identifiable net assets.

What happens to goodwill if the fair value of acquired liabilities increases, all else equal?

Goodwill increases because higher liabilities reduce fair value of identifiable net assets.

What is a bargain purchase?

A business combination in which the purchase price is less than the fair value of identifiable net assets acquired.

What is recognized when purchase price is below fair value of identifiable net assets?

A bargain purchase gain is recognized in profit or loss rather than negative goodwill.

An acquirer pays USD 90m for identifiable net assets with fair value of USD 100m. Calculate the bargain purchase gain.

Bargain purchase gain = USD 100m − USD 90m = USD 10m.

Is goodwill amortized under IFRS and US GAAP in the curriculum treatment?

No. Goodwill is not amortized and is tested for impairment at least annually.

Where is goodwill tested for impairment under IFRS?

At the cash-generating unit (CGU) level.

Where is goodwill tested for impairment under US GAAP?

At the reporting unit level.

How does a goodwill impairment affect the financial statements?

Impairment expense increases; net income decreases; goodwill and total assets decrease; retained earnings and total equity decrease.

Is a goodwill impairment charge a cash expense in the period of impairment?

No. It is a non-cash charge.

Can a goodwill impairment be reversed under IFRS?

No.

Can a goodwill impairment be reversed under US GAAP?

No.

What is the core goodwill exam memory rule?

Acquisition only; no amortization; impairment test at least annually; goodwill impairment cannot be reversed.

What is accounting goodwill?

The residual amount recognized in an acquisition after subtracting the fair value of identifiable net assets from the purchase price.

What is economic goodwill?

The economic value associated with a company's ability to earn returns above the required return on its identifiable net assets.

Can a company have substantial economic goodwill but zero accounting goodwill?

Yes. An organically developed company may have valuable reputation, customer loyalty, workforce, and competitive advantages without having acquired another company.

Can a company have substantial accounting goodwill but little economic goodwill?

Yes. This can occur when management overpays for acquisitions.

Why might an analyst exclude goodwill when comparing companies?

Companies growing through acquisitions can report substantial goodwill while organically growing companies may not, reducing comparability of balance-sheet ratios.

Which ratios can be materially affected by goodwill?

ROA, asset turnover, debt-to-assets, financial leverage, and book value measures.

Why might ROA mechanically increase after a goodwill impairment?

ROA = Net income ÷ Average total assets. A goodwill impairment reduces the asset denominator, so subsequent ROA can rise even without improved operating efficiency.

What can repeated material goodwill impairments suggest?

Management may have repeatedly overpaid for acquisitions or failed to achieve expected acquisition synergies.

What is a financial instrument?

A contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another.

What are common examples of financial assets?

Investments in bonds, investments in shares, loans receivable, notes receivable, and derivatives.

What are the two broad subsequent measurement bases for financial assets?

Amortized cost and fair value.

What is the general formula for amortized cost of a financial asset?

Amortized cost = Initial recognition amount − Principal repayments +/− Discount or premium amortization − Impairment.

What is the key accounting question when a financial asset is carried at fair value?

Whether unrealized fair-value gains and losses are recognized in profit or loss or in OCI.

What two concepts determine IFRS classification of debt financial assets?

The business model for managing the asset and the contractual cash-flow characteristics.

What does SPPI stand for?

Solely Payments of Principal and Interest.

What are the IFRS conditions for amortized-cost classification?

SPPI test is satisfied + business model is hold to collect contractual cash flows.

What is the IFRS amortized-cost classification shortcut?

SPPI + Hold to Collect = Amortized Cost.

What are the IFRS conditions for debt FVOCI classification?

SPPI test is satisfied + business model is hold to collect and sell.

What is the IFRS debt FVOCI classification shortcut?

SPPI + Hold to Collect and Sell = FVOCI.

When is FVTPL generally used under IFRS?

For financial assets that do not qualify for amortized cost or FVOCI, including trading assets, derivatives, debt securities failing SPPI, and equity securities without an FVOCI election.

What is the basic IFRS financial-asset classification memory rule?

Hold to collect + SPPI = AC. Hold to collect and sell + SPPI = FVOCI. Everything else = FVTPL.

Where do ordinary unrealized market-value changes on amortized-cost financial assets go?

They are generally not recognized merely because market fair value changes.

Where do unrealized gains and losses on debt FVOCI investments go?

Other comprehensive income (OCI).

Where do unrealized gains and losses on FVTPL investments go?

Profit or loss.

Which financial-asset classification generally creates the greatest reported net-income volatility?

FVTPL because unrealized fair-value changes are recognized directly in profit or loss.