FSA M7 - Analysing Long Term Assets

IFRS identifiable intangible asset criteria and goodwill

Under IFRS, an identifiable intangible asset must meet 3 definitional criteria: (1) identifiable — separable from the entity or arising from contractual/legal rights; (2) under the company's control; (3) expected to generate future economic benefits. It must also meet 2 recognition criteria: (1) probable future economic benefits will flow to the company; (2) cost can be reliably measured. Goodwill is not an identifiable intangible asset — it arises when the acquisition price of a company exceeds the fair value of net identifiable assets acquired (tangible + identifiable intangible assets, minus liabilities).

Intangible assets purchased outside a business combination

These are treated like long-lived tangible assets — recorded at fair value when acquired, assumed equal to purchase price; if acquired as a group, the price is allocated to each asset by fair value. Analytically, since fair values involve significant judgment, analysts often focus more on the types of intangible assets acquired (insight into strategy and future potential) than on the precise values assigned.

US GAAP treatment of research and development costs

US GAAP generally requires both research and development costs to be expensed as incurred, but requires capitalization of certain software development costs. Software for sale: expensed until technological feasibility is established, then capitalized. Software for internal use: expensed until it's probable the project will be completed and used as intended, then capitalized (probability of completion is easier to demonstrate than technological feasibility). Capitalized costs include employees who build/test the software. This treatment is broadly similar to IFRS's treatment of internally developed intangibles.

Intangible assets acquired in a business combination

Business combinations use the acquisition method: the acquirer allocates the purchase price to each asset acquired and liability assumed at fair value; any excess over amounts allocable to identifiable net assets is recorded as goodwill (which cannot be identified separately from the business). Under IFRS, an asset not meeting the definitional/recognition criteria for an identifiable intangible is folded into goodwill. Under US GAAP, an acquired intangible is recognized separately from goodwill if it either arises from contractual/legal right

Impairment concept and PP&E impairment testing/measurement

Impairment reflects an unanticipated decline in an asset's value (vs. depreciation/amortization, which allocates planned cost). Both IFRS and US GAAP require write-downs of impaired assets; IFRS permits reversals for identifiable long-lived assets, US GAAP typically does not. PP&E is tested for impairment only when there's an indication of impairment (obsolescence, demand decline, tech change), not annually. IFRS: impairment loss = carrying amount − recoverable amount, where recoverable amount = higher of (fair value - costs to sell) or (value in use, i.e. PV of future cash flows). US GAAP: separate 2-step test — carrying amount of the asset group is unrecoverable if it exceeds UNDISCOUNTED future cash flows; if so, loss = fair value − carrying amount, the loss is written on the income statement. The IFRS write-down (to value in use) can be smaller than the US GAAP write-down (to fair value), affecting book value of equity. Either way, the loss reduces carrying amount and net income and is a non-cash item.

Impairment of intangibles: finite life vs indefinite life

Finite-life intangibles are amortized and tested for impairment only on a significant triggering event (e.g., a market price drop or adverse legal/economic change) — impairment accounting mirrors tangible assets (reduces carrying amount and net income). Indefinite-life intangibles are not amortized, are carried at historical cost, and must be tested for impairment at least annually; impairment exists when carrying amount exceeds fair value.

Impairment of assets held for sale and reversals of impairment

An asset is reclassified from held-for-use to held-for-sale when management intends to sell it, the sale is highly probable, and it's available for immediate sale in its present condition; at reclassification it's tested for impairment and written down to fair value less costs to sell if carrying amount exceeds that. Held-for-sale assets stop being depreciated/amortized. On reversals: IFRS allows reversing impairment losses if recoverable amount increases (held for use or sale), but never above the original pre-impairment carrying amount. US GAAP: no reversal ever for assets held for use; for assets held for sale, a reversal is allowed if fair value increases.

Derecognition and sale of long-lived assets

A company derecognizes an asset when disposed of or expected to provide no further benefit; disposal can be by sale, exchange, abandonment, or distribution to shareholders. On sale, gain or loss = sales proceeds − carrying amount at time of sale (carrying amount is usually net book value unless already adjusted for impairment/revaluation). The gain/loss appears on the income statement (as "other gains/losses" or a separate line if material). Under the indirect cash flow method, net income is adjusted to remove the gain/loss from operating cash flow, and sale proceeds are shown as investing cash inflow.

Disposal other than by sale: retirement, abandonment, and exchange

Assets to be disposed of other than by sale (abandoned, exchanged, or spun off) stay classified as held for use — and keep being depreciated and tested for impairment — until disposal or until they meet held-for-sale/distribution criteria. Retirement/abandonment: accounted like a sale but with no cash proceeds; the asset's carrying amount is removed and a loss equal to that carrying amount is recorded. Exchange: remove the carrying amount of the asset given up, record the asset acquired at fair value (using the given-up asset's fair value unless the acquired asset's is more clearly evident), and recognize the difference as a gain or loss; if no reliable fair value exists, the acquired asset is recorded at the carrying amount given up and no gain/loss is reported.

Spin-offs

A spin-off typically involves distributing an entire cash-generating unit (with all its assets) to existing shareholders, and generally results in no gain or loss — unlike a partial sale of that ownership (e.g., via an IPO), which can produce a recognized gain.

IFRS PP&E disclosure requirements

For each class of PP&E, IFRS requires disclosure of: measurement basis, depreciation method, useful life (or depreciation rate), gross carrying amount and accumulated depreciation at period start/end, and a reconciliation of carrying amount over the period. Also required: restrictions on title/pledges as security, contractual agreements to acquire PP&E, and (if the revaluation model is used) the revaluation date, how fair value was obtained, carrying amount under the cost model, and the revaluation surplus. Companies must also disclose depreciation expense for the period, balances of major depreciable-asset classes, accumulated depreciation by class or in total, and a general description of the depreciation method(s) used.

IFRS vs US GAAP intangible asset disclosures

Under IFRS, for each class of intangible asset a company discloses whether useful life is indefinite or finite. If finite: useful life/amortization rate, amortization method, gross carrying amount and accumulated amortization at period start/end, where amortization appears on the income statement, and a reconciliation of carrying amount. If indefinite: the carrying amount and why it's considered indefinite. Restrictions on title/pledges, acquisition contracts, and (if revaluation model used) revaluation date/fair value basis/cost-model carrying amount/revaluation surplus are also required, similar to PP&E. Under US GAAP, companies disclose gross carrying amounts and accumulated amortization (in total and by major class), aggregate amortization expense for the period, and estimated amortization expense for each of the next five fiscal years.

Impairment disclosure requirements: IFRS vs US GAAP

Under IFRS, for each class of assets, a company discloses the amounts of impairment losses and reversals recognized in the period and where they're recognized on the financial statements, plus (in aggregate) the main asset classes affected and the main events/circumstances leading to recognition. Under US GAAP, there is no reversal of impairment losses for assets held for use; disclosures instead cover a description of the impaired asset, what led to the impairment, the method used to determine fair value, the amount of the loss, and where it's recognized.

Fixed asset turnover ratio

Fixed asset turnover ratio = total revenue ÷ average net fixed assets. It reflects the relationship between revenues and PP&E investment; a higher ratio means more sales generated per unit of fixed-asset investment and is often read as an indicator of greater efficiency.

Estimated average age of asset base

Estimated (average) age of a company's asset base = accumulated depreciation ÷ annual depreciation expense.

Estimated average remaining life of asset base

Estimated remaining life of a company's asset base = net PP&E ÷ annual depreciation expense.

Estimated total useful life of asset base

Estimated total useful life = historical cost ÷ annual depreciation expense. This equals estimated age + estimated remaining life (since historical cost = accumulated depreciation + net PP&E). These estimates assume straight-line depreciation and no salvage value, and apply primarily to PP&E under the cost model — under the revaluation model (IFRS only, not US GAAP), carrying amount can diverge from depreciated historical cost, distorting the relationship.

Limitations of asset age ratio estimates

These estimates are hard to make precisely in practice because companies use non-straight-line depreciation methods, hold numerous assets with varying useful lives/salvage values (including fully depreciated ones), and fixed asset disclosures are often general. They're best used as approximations to flag areas for further investigation, not precise measures.

Capital expenditures vs. depreciation expense

Comparing annual capital expenditures to annual depreciation expense gives a general indication of whether productive capacity is being maintained — it signals the rate at which a company is replacing PP&E relative to the rate PP&E is being depreciated. Capex exceeding depreciation expense suggests replacement is outpacing depreciation.