MODULE 7: ANALYSIS OF LONG-TERM ASSETS

Intangible Long-Lived Assets

1) Measurement of Long‑Lived Assets

A. Cost Model (IFRS and U.S. GAAP)

• Record at historical cost minus accumulated depreciation and any impairment losses.
• Required under U.S. GAAP; permitted under IFRS.
• Example: Business car cost ₹1,000,000; accumulated depreciation ₹300,000; impairment ₹50,000 → carrying value ₹650,000.

Rules summary: - U.S. GAAP: must use cost model (no revaluation). - IFRS: may use cost model or revaluation model.

B. Revaluation Model (IFRS only)

• Periodically remeasure to fair value; then depreciate from revalued amount.
• Upward revaluation → OCI (revaluation surplus). Downward → P&L (unless reversing prior surplus).
• U.S. GAAP prohibits revaluation for PP&E and intangible assets (other than certain specialized cases not in scope here).

2) Research and Development Treatment

A. IFRS

• Research phase: always expensed (no reliably measurable future benefit).
• Development phase: capitalize only if all six are met: 1) Technical feasibility; 2) Intention to complete; 3) Ability to use/sell; 4) Future economic benefits; 5) Adequate resources; 6) Reliable measurement of cost.
• Capitalizable examples: direct materials/labor; testing/prototypes; engineering and design tied to the asset.
• Always expensed: admin and general overhead, training, wasted materials/inefficiencies, advertising/promotional.

B. U.S. GAAP

• General rule: expense both research and development.
• Software development exception:
• Before technological feasibility → expense.
• After technological feasibility → capitalize; maintenance/bug fixes → expense.

3) General Capitalization Rule (Both IFRS and U.S. GAAP)

• Capitalize only costs that clearly add future economic benefit; expense costs that do not.
• Common “always expense” items: general/admin overhead, selling/marketing, staff training, startup losses, research phase costs, repairs that only maintain (not improve) the asset.

4) IFRS vs U.S. GAAP — Snapshot

• PP&E measurement: IFRS = cost or revaluation; U.S. GAAP = cost only.
• Research: expensed under both.
• Development: IFRS may capitalize if criteria met; U.S. GAAP expensed (except software after technological feasibility).
• Software development: IFRS capitalize only when development criteria met; U.S. GAAP capitalize only after technological feasibility.

Impairment and Derecognition

1. Depreciation and amortization are normal spreading of cost over useful life. Impairment is different: value falls unexpectedly below carrying value. Derecognition is the final step when the asset is sold, exchanged, abandoned, or retired.
2. IFRS (International Financial Reporting Standards): the asset is impaired when carrying value exceeds recoverable amount. Recoverable amount is the higher of fair value less selling costs and value in use. Value in use is the present value of future cash flows from continued use and disposal.

1. U.S. GAAP (Generally Accepted Accounting Principles): first apply the recoverability test. If carrying value is greater than future undiscounted cash flows, the asset is impaired. Then measure the loss using fair value, or discounted future cash flows if fair value is not known.

2. Once impairment is recorded, the asset is written down on the balance sheet and a loss goes through the income statement. Assets fall. Equity falls through retained earnings. In the impairment year, Return on Assets (ROA) and Return on Equity (ROE) usually fall because net income falls.

1. In later periods, depreciation or amortization will be lower because the asset now has a lower carrying amount. That can push up future net income, ROA, ROE, and asset turnover. This is an accounting effect, not proof that the business improved. The PDF also says impairment has no cash flow impact when recognized because it is an unrealized loss until disposal.

1. If the firm intends to sell the asset and the sale is probable, the asset becomes held for sale. Then depreciation or amortization stops. The asset is impaired if carrying value exceeds fair value less selling costs. If value later recovers, loss reversal is allowed for held-for-sale assets under both IFRS and U.S. GAAP, but only up to the original impairment loss.

2. Under IFRS, impairment loss on an identifiable long-lived asset held for use can also be reversed later if value recovers, but only up to the original impairment loss. Under U.S. GAAP, recovery of impairment loss for held-for-use assets is typically not allowed.

3. Derecognition rule: when a long-term asset is sold, remove it from the balance sheet and record gain or loss in the income statement as:

You compare what you got in cash with what the asset was still worth on the books.

1. If the cash flow statement uses the indirect method, this gain or loss is removed from net income in cash flow from operations because the sale proceeds belong in investing cash flow, not operating cash flow.

2. Brownfield example from the PDF:

Same asset, different reported loss, because IFRS compares directly with recoverable amount while U.S. GAAP uses an undiscounted cash flow screen first and fair value second.

Long-Term Asset Disclosures

1. The learning outcome here is sacred: analyze and interpret financial statement disclosures regarding property, plant, and equipment and intangible assets. Do not stop at “net property, plant, and equipment went up.” Ask what changed underneath: new purchases, depreciation, impairments, disposals, revaluations, acquisitions, and foreign currency translation.

2. The balance sheet gives you the final carrying amount. The notes tell you the movie. A factory might show net property, plant, and equipment of USD 500 million, but the note may reveal that gross cost is USD 1,500 million and accumulated depreciation is USD 1,000 million. That is a very different story from a brand-new factory costing USD 500 million.

1. Under International Financial Reporting Standards (IFRS), for each class of property, plant, and equipment, the company must disclose the measurement basis, depreciation method, useful life or depreciation rate, gross carrying amount, accumulated depreciation at the beginning and end of the period, and a reconciliation of carrying amount from beginning to end.
2. For property, plant, and equipment, the notes also disclose restrictions on title, assets pledged as security, and contractual commitments to buy more property, plant, and equipment. This matters because an asset that is pledged to lenders is not as financially flexible as a clean asset.
3. If the company uses the revaluation model under International Financial Reporting Standards, the notes must show the date of revaluation, how fair value was obtained, what the carrying amount would have been under the cost model, and the revaluation surplus. Under US GAAP (U.S. GAAP), the cost model is used for property, plant, and equipment.

1. For intangible assets under International Financial Reporting Standards, first split the world into finite useful life and indefinite useful life. Finite-life intangibles are amortized. Indefinite-life intangibles are not amortized, but they are tested for impairment.

2. For finite-life intangible assets, the company discloses useful life or amortization rate, amortization method, gross carrying amount, accumulated amortization at the beginning and end of the period, where amortization appears in the income statement, and the reconciliation from opening carrying amount to closing carrying amount.

3. For indefinite-life intangible assets, the company must disclose the carrying amount and why the useful life is considered indefinite. This is where you should slow down. “Indefinite” does not mean “immortal.” It means there is no foreseeable limit based on the information available.

4. Under U.S. GAAP, companies disclose gross carrying amount and accumulated amortization in total and by major class of intangible assets, aggregate amortization expense for the period, and estimated amortization expense for the next five fiscal years.

5. Impairment disclosures are your “what went wrong?” section. Under International Financial Reporting Standards, the company discloses impairment losses and reversals by class of asset, where they appear in the financial statements, the main asset classes affected, and the events and circumstances that caused the impairment or reversal.

6. Under U.S. GAAP, there is no reversal of impairment losses for assets held for use. The company discloses a description of the impaired asset, what caused the impairment, how fair value was determined, the amount of the impairment loss, and where the loss is recognized.

7. Orange, the French telecom company used in the curriculum, is a perfect example. In 2016, it recognized large impairment losses because assumptions changed in places such as Poland, Egypt, Congo, Cameroon, and Niger. The story was not just “assets fell.” The notes explained the business reasons: weaker competitiveness, worse revenue assumptions, country risk, currency depreciation, political uncertainty, lower purchasing power, regulation, and more competition.

8. Real-world memory hook: WorldCom became infamous partly because it treated roughly USD 3.8 billion of ordinary line costs as capital assets instead of expenses. A normal telecom would expense those network access costs as the service is used. WorldCom parked them on the balance sheet and dripped them slowly through depreciation, which made profit look better for a while. Different scandal, same analyst instinct: when assets grow suspiciously and expenses look too smooth, read the long-term asset notes like a detective.

9. Another memory hook: telecom companies often look like asset mountains. They spend heavily on towers, fiber networks, licenses, and software. If customer growth slows but the network keeps getting older, the notes will tell you whether management is still investing enough or just squeezing old assets.

WHERE LONG-TERM ASSET DISCLOSURES SHOW UP

1. Balance sheet: shows the carrying value of property, plant, and equipment, goodwill, and other intangible assets.

2. Income statement: may show depreciation and amortization separately, or bury them inside cost of sales or selling, general, and administrative expenses depending on presentation.

3. Statement of cash flows: purchases and sales of fixed assets appear in investing cash flow. If the indirect method is used, depreciation and amortization are usually added back while reconciling net income to operating cash flow because they are non-cash charges.

4. Notes: usually give the richest detail: accounting methods, useful life ranges, historical cost by asset class, accumulated depreciation, impairment movement, amortization movement, and capital commitments.

ANALYSIS RATIOS FROM DISCLOSURES

1. Fixed asset turnover measures how much revenue the company generates from its average net property, plant, and equipment.

High fixed asset turnover usually means the company generates more sales per unit of fixed assets. But do not blindly call it “better.” A software firm and a steel plant should not have the same asset intensity.

1. Apple and Walmart make this idea easy. An Apple Store has historically generated around USD 5,500 of sales per square foot, while Walmart has been closer to around USD 400 per square foot. Apple can sell expensive phones, laptops, and watches from a small premium store. Walmart needs massive stores, warehouses, parking lots, and shelves to sell lower-margin goods. The ratio is not saying Apple is morally better than Walmart. It is saying the business models convert physical space and assets into sales very differently.

2. Average age of depreciable assets uses accumulated depreciation divided by annual depreciation expense.

Plain English: if the company has already recorded USD 70 of accumulated depreciation and records USD 10 of depreciation each year, the asset base looks about 7 years old.

1. Estimated remaining useful life uses net property, plant, and equipment divided by annual depreciation expense.

Plain English: if net property, plant, and equipment is USD 60 and depreciation is USD 10 each year, the assets look like they have about 6 years left.

1. Estimated total useful life uses historical cost divided by annual depreciation expense.

These three ratios are connected:

1. Reinvestment check: compare capital expenditures with depreciation expense.

If capital expenditures are consistently below depreciation, the company may be underinvesting in productive capacity. If capital expenditures are consistently above depreciation, it may be expanding or replacing assets aggressively.

1. These asset age ratios work best when assets are reported under the cost model, depreciation is roughly straight-line, and land is not a big part of property, plant, and equipment. Land is not depreciated, so including land can muddy the calculation.

2. Be careful comparing companies. Different asset mixes, depreciation methods, useful life estimates, acquisitions, divestitures, revaluations, and disclosure categories can make two companies look different even before business performance enters the picture.

3. The exam angle is simple: disclosures help you answer four questions. What assets does the company own? How old are they? How fast is the company replacing them? Did any write-down reveal that old assumptions were too optimistic?