CFA Level 1 · Module 04 Financial Statement Analysis · Chapter 7
Long-lived assets are the resources a company expects to use for more than one period to run its business: the factories, machines, and vehicles grouped under property, plant, and equipment (PP&E), and the patents, brands, licenses, and goodwill grouped under intangible assets. They are usually among the largest numbers on the balance sheet, and unlike inventory they are consumed slowly, over years, through depreciation and amortization. The whole reading is about a single question with several faces: once a company spends money that will benefit future periods, how much of that spending sits on the balance sheet as an asset, how is it spread across the income statement over time, and what happens when its value changes.
We build the tools in order. First, the choice to capitalize an expenditure as an asset or expense it at once, and how the initial cost of PP&E is assembled. Second, the three depreciation methods, how component depreciation and changing estimates alter reported income, and a full straight-line versus double-declining-balance schedule. Third, how intangible assets are reported differently depending on whether they were purchased, built internally, or acquired in a business combination, and where goodwill comes from. Fourth, the revaluation model that IFRS permits and the cost model that US GAAP requires. Fifth, impairment, where IFRS and US GAAP diverge in both measurement and reversal. Sixth, derecognition when an asset is sold. Seventh, the disclosures and the ratios an analyst uses to judge how old a company assets are. Every company and every number below is invented by MidhaFin to teach the mechanics; none is taken from the source curriculum or any prep provider. Concepts, definitions, and formulas are shared knowledge and are used freely.
Every time a company spends money, the accountant asks one question: does this spending create a benefit that reaches beyond the current period? If it does, the cost is capitalized, meaning it is recorded as an asset on the balance sheet and then charged to the income statement gradually over the years it is used, through depreciation or amortization. If it does not, the cost is expensed, meaning it is charged to the income statement in full right away. This single decision drives much of what follows, because it changes the shape of reported profit through time even when the total amount spent is identical.
The trade-off is worth stating plainly. Capitalizing an expenditure raises assets and, because only a slice of the cost hits the income statement this year, it raises current-period net income relative to expensing. But that higher asset must be depreciated in every later period, so capitalizing lowers future income. Expensing does the reverse: it depresses current income and leaves nothing on the balance sheet to depreciate, so future income is higher. Over the whole life of the asset the total expense is the same under both treatments; only the timing differs. Capitalizing also lifts operating cash flow, because the outflow is classified as investing rather than operating, while an expensed cost sits inside operating cash flow.
Capitalizing does not change how much a company spends or how much profit it earns over the life of the asset. It only moves the expense forward or backward in time. A firm that capitalizes aggressively will look more profitable and better capitalized early on, then carry a drag of depreciation for years afterward. When you compare two companies, always ask whether they draw the capitalize-or-expense line in the same place, because a difference in policy can explain a difference in margins that has nothing to do with the underlying business.
Once the decision to capitalize is made, the next task is to measure the cost at which the asset first enters the balance sheet. For property, plant, and equipment the rule is that cost includes the purchase price, net of any trade discounts, plus all the expenditures necessary to bring the asset to the location and condition needed for its intended use. That means freight to deliver it, duties, installation, assembly, and the cost of testing that it works. Costs that are not necessary to get the asset ready, such as staff training, promotional launch costs, or the losses from operating below capacity in an early period, are period costs and are expensed.
where costs to bring to working condition include freight, non-refundable duties, installation, and testing, but exclude training, launch, and other period costs, which are expensed as incurred.
Setup. Cobalt Manufacturing, an invented company, buys a stamping machine with a list price of 500,000 and negotiates a 4% trade discount. It also pays 12,000 for freight, 18,000 for installation, and 10,000 for a test run to confirm the machine works. Separately, it pays 5,000 to train operators to use the machine. Determine the amount capitalized as the cost of the machine and the amount expensed.
Answer: the machine is capitalized at 520,000, and 5,000 of training is expensed in the period. So what does this number mean? The 520,000 is the base that will be depreciated over the life of the machine, so getting it right matters for every future year of depreciation, not just today. If Cobalt had wrongly capitalized the 5,000 of training as well, it would have overstated both the asset and current income by 5,000 (less a sliver of extra depreciation), and understated income in every year afterward. The line between what belongs in the asset and what does not is exactly the capitalize-or-expense judgement, applied cost by cost.
Do not assume every cash outflow connected to buying an asset gets capitalized. The test is whether the cost was necessary to bring the specific asset to working condition, not simply whether it was spent around the same time. Training, marketing the new capability, and early operating losses fail that test and are expensed, even though they were part of the same project. Sweeping them into the asset is a classic way to flatter both the balance sheet and current earnings.
Depreciation is the systematic allocation of the cost of a tangible long-lived asset over the periods it is used. It is not an attempt to track market value, and it is not a source of cash; it is an accounting device for matching the cost of an asset against the revenue it helps produce. Three pieces of information drive every method: the cost of the asset, its estimated residual value (also called salvage value, the amount expected to be recovered at the end of its life), and its estimated useful life. The cost minus the residual value is the depreciable base, the total amount that will be charged to expense over the life of the asset. Every method writes off the same depreciable base; they differ only in the pattern.
The straight-line method spreads the depreciable base evenly across the useful life, charging the same amount every year. It is the simplest method and the most common for financial reporting.
where the numerator is the depreciable base and the same amount is charged in every full year until the carrying amount reaches residual value.
The declining-balance method is an accelerated method: it charges more depreciation in the early years and less in the later years. The most common version is double-declining-balance (DDB), which applies a fixed rate of twice the straight-line rate to the asset carrying amount (its cost less accumulated depreciation) at the start of each year. Two features are easy to trip over. First, the residual value is not subtracted before applying the rate; it is used only as a floor. Second, the asset is never depreciated below its residual value, so in a late year the charge is reduced to whatever is needed to bring the carrying amount exactly down to residual value.
where the rate = 2 ÷ useful life is applied to the beginning carrying amount each year, residual value is ignored in the calculation, and the charge is capped so the carrying amount never falls below residual value.
The units-of-production method ties depreciation to actual use rather than to the passage of time. It computes a rate per unit of output and multiplies it by the units produced in the period, so a busy year carries more depreciation than a quiet one.
where the bracketed term is the depreciation rate per unit, and total expected output is the estimated units, hours, or kilometers the asset will deliver over its life.
Setup. Thistle Logistics, an invented company, buys a sorting machine for 800,000 with an estimated residual value of 100,000 and a useful life of 4 years. Build the full depreciation schedule under the straight-line method and under double-declining-balance, and compare the pattern.
Answer: straight-line charges 175,000 in each of the four years, while DDB charges 400,000, 200,000, 100,000, and 0. So what does this number mean? Both methods write off the same total of 700,000 and both leave the asset at its 100,000 residual value, but they distribute the expense very differently. In Year 1, DDB reports 225,000 more depreciation than straight-line, so it reports lower profit and a lower asset early on; by Year 4 the positions have reversed and DDB reports 175,000 less depreciation and higher profit. An analyst comparing a company on DDB with a peer on straight-line must remember that lower early margins can reflect the depreciation method alone, not weaker operations.
| Year | Straight-line charge | SL carrying amount | DDB charge | DDB carrying amount |
|---|---|---|---|---|
| Start | 800,000 | 800,000 | ||
| 1 | 175,000 | 625,000 | 400,000 | 400,000 |
| 2 | 175,000 | 450,000 | 200,000 | 200,000 |
| 3 | 175,000 | 275,000 | 100,000 | 100,000 |
| 4 | 175,000 | 100,000 | 0 | 100,000 |
| Total | 700,000 | 700,000 |
The units-of-production method fits assets whose wear depends on use rather than on age, such as a vehicle measured in kilometers or a machine measured in units produced. The next example shows the mechanics.
Setup. Harrow Quarry, an invented company, buys a crusher for 460,000 with an estimated residual value of 40,000 and an expected total output of 700,000 tonnes over its life. In the first year it crushes 120,000 tonnes. Compute the units-of-production depreciation for the year.
Answer: first-year depreciation is 72,000, matching the 120,000 tonnes actually crushed. So what does this number mean? Depreciation now moves with activity, so a slow year automatically carries a smaller charge and a busy year a larger one, which keeps the expense aligned with the revenue the asset helped generate. The catch is that the method depends on a reliable estimate of total lifetime output; if that estimate is too high, depreciation each year is too low, and the asset is written off too slowly.
Many assets are really bundles of parts with different lives. A building has a roof, elevators, and a structural shell that wear out at different rates. Under component depreciation, which IFRS requires and US GAAP permits but rarely uses, a company separates a large asset into its significant components and depreciates each over its own useful life. This produces a more faithful expense pattern: the roof depreciated over twenty years, the elevators over fifteen, the shell over forty, rather than one blended rate applied to the whole building.
Two estimates sit behind every depreciation figure: the useful life and the residual value. Both are judgements made when the asset is first recorded, and both can be revised as new information arrives. When a company changes such an estimate, accounting treats it as a change in accounting estimate, which is applied prospectively. That means the past is not restated; instead, the remaining carrying amount, less any revised residual value, is spread over the remaining useful life from the date of the change.
Setup. Larkspur Utilities, an invented company, buys equipment for 900,000 with an original estimated useful life of 10 years and a residual value of 100,000, depreciated straight-line. After 4 years, engineers conclude the equipment will last only 4 more years (8 in total) and the residual value will be just 60,000. Compute the new annual depreciation.
Answer: annual depreciation rises from 80,000 to 130,000 from the date of the change forward. So what does this number mean? Shortening the life and cutting the residual value pushes 50,000 more of expense into each remaining year, lowering reported profit going forward, but nothing in the first four years is restated because a change in estimate is prospective. An analyst should watch estimate revisions closely: lengthening a useful life quietly lowers depreciation and lifts income, which is a lever management can pull to flatter earnings without any change in the underlying assets.
| Method | Pattern of expense | Driver | Residual value |
|---|---|---|---|
| Straight-line | Equal each year | Passage of time | Subtracted before the charge is computed |
| Declining-balance (DDB) | High early, low late (accelerated) | Passage of time | Ignored in the rate, used only as a floor |
| Units-of-production | Varies with activity | Actual output or usage | Subtracted before the per-unit rate is set |
Three traps recur. First, in double-declining-balance do not subtract residual value before applying the rate; residual value only stops the last charge. Second, a change in useful life or residual value is prospective, so never restate prior years; work from the current carrying amount over the remaining life. Third, an accelerated method reports lower income and lower assets in the early years than straight-line, which raises early return on assets denominators and lowers early margins, so a method difference alone can make two identical businesses look different.
An intangible asset is an identifiable non-monetary asset without physical substance, such as a patent, a trademark, a customer list, a license, or a franchise right. Whether and how it appears on the balance sheet depends heavily on how the company obtained it. The reading groups intangibles into three origins, and the accounting differs sharply across them, which is the single most testable idea in this section.
Purchased intangibles, bought individually from an outside party, are the simplest: they are recorded at cost, just like a piece of equipment. If a company pays 300,000 for a software license or a patent, that 300,000 is capitalized as an intangible asset and then amortized over its useful life.
Internally developed intangibles are treated far more conservatively, because the future benefit of in-house research and development is uncertain. The general rule under both frameworks is that internal development costs are expensed as incurred, which is why enormously valuable brands and technologies built in-house often appear nowhere on the balance sheet. There is one important divergence. Under US GAAP, research and development costs are generally expensed as incurred (with a specific exception for certain software development costs). Under IFRS, the two phases are split: research costs are always expensed, but development costs are capitalized once the company can demonstrate technical feasibility, an intention and ability to complete and use or sell the asset, and the probability of future economic benefits. So an IFRS company can carry a capitalized development asset that a US GAAP company doing the identical work would have expensed.
Intangibles acquired in a business combination arise when one company buys another. The acquirer records all the identifiable assets and liabilities of the target at their fair value on the acquisition date, and that includes identifiable intangibles the target may never have recorded itself, such as its brand names, customer relationships, and technology. Whatever the acquirer pays above the fair value of the identifiable net assets it acquires becomes goodwill, a residual figure that captures things like reputation, workforce, and expected synergies that cannot be sold separately.
where identifiable net assets are the fair values of the acquired assets (including separately identifiable intangibles) minus the fair values of the acquired liabilities. Goodwill is only recognized in a business combination; it is never recorded for an internally generated business.
Once an intangible is on the balance sheet, its subsequent treatment depends on whether its life is finite or indefinite. A finite-life intangible, such as a patent with a fixed legal term, is amortized over its useful life, usually straight-line, exactly like depreciation of a tangible asset. An indefinite-life intangible, such as a renewable brand or a broadcast license expected to continue indefinitely, is not amortized. Instead it is tested for impairment at least annually. Goodwill is also not amortized and is tested for impairment at least annually. The reason is intuitive: you cannot sensibly spread a cost over a life you cannot estimate, so instead you check each year whether the asset has lost value.
| Origin | Initial recognition | Subsequent treatment |
|---|---|---|
| Purchased separately | Recorded at cost | Finite life: amortized; indefinite life: impairment tested |
| Internally developed | Generally expensed; IFRS capitalizes development (not research) once feasibility is met | Any capitalized amount amortized over its useful life |
| Acquired in a business combination | Identifiable intangibles at fair value; excess price becomes goodwill | Finite life amortized; indefinite life and goodwill impairment tested, not amortized |
The origin of an intangible, not its economic nature, decides whether it is on the balance sheet. A brand a company builds itself is largely invisible, because the marketing that created it was expensed. The identical brand, once bought as part of an acquisition, appears at fair value, and any premium paid shows up as goodwill. This is why a company that grows by acquisition can carry huge intangible and goodwill balances, while an equally valuable company that grew organically carries almost none. The difference is accounting origin, not business quality.
Do not treat all research and development the same across frameworks. Under US GAAP nearly all of it is expensed as incurred. Under IFRS only the research phase is always expensed, while development costs are capitalized once strict feasibility criteria are met. Because the IFRS firm capitalizes and then amortizes, while the US GAAP firm expenses immediately, two companies doing identical work can report different current profit, different assets, and different operating cash flow. Adjusting for this is a standard cross-border comparison step.
After an asset is recorded, a company must choose how to carry it going forward. Under the cost model, the asset is carried at its cost less accumulated depreciation (or amortization) and less any accumulated impairment losses. Its balance-sheet value only ever moves down, through depreciation and impairment; it is never written up for a rise in market value. US GAAP requires the cost model for property, plant, and equipment and for intangible assets.
IFRS permits an alternative, the revaluation model, under which an asset whose fair value can be measured reliably may be carried at its fair value at the revaluation date, less subsequent depreciation and impairment. If a company elects the revaluation model, it must apply it to the whole class of assets, not cherry-pick individual items, and it must revalue often enough that the carrying amount does not drift far from fair value. The direction in which a revaluation flows through the financial statements depends on whether it is an increase or a decrease, and on the asset history.
The core rule is a mirror. A revaluation increase is recorded in other comprehensive income and accumulated in equity as a revaluation surplus, and it does not touch net income, unless it reverses a decrease that was previously charged to the income statement, in which case the reversal runs through the income statement up to the amount of that earlier loss. A revaluation decrease is recognized in the income statement, unless there is an existing revaluation surplus for that asset, in which case the decrease first reduces the surplus in other comprehensive income and only the excess hits the income statement. In short, gains go to equity and losses go to profit, except to the extent each reverses the other.
where a positive adjustment (an increase) goes to the revaluation surplus in other comprehensive income, and a negative adjustment (a decrease) goes to the income statement, with each rule reversed to the extent it offsets a prior movement of the opposite kind.
The asymmetry is the exam point. An upward revaluation usually bypasses net income and lands in other comprehensive income as a revaluation surplus, so it lifts equity and assets without ever flowing through reported profit. A downward revaluation usually hits net income directly. This means a company on the revaluation model can build equity through surpluses that never appear in earnings, so an analyst comparing it with a cost-model company must look at comprehensive income and the revaluation surplus, not net income alone, to see the full picture.
Depreciation spreads cost over time on a planned schedule, but sometimes an asset loses value faster than the schedule assumes, because demand collapses, technology moves on, or the asset is damaged. Impairment is the recognition that an asset carrying amount is no longer recoverable and must be written down. Both frameworks require impairment testing, but they test and measure differently, and this is one of the sharpest IFRS versus US GAAP contrasts in the reading.
Under IFRS, an asset is impaired when its carrying amount exceeds its recoverable amount. The recoverable amount is the higher of two figures: the fair value less costs to sell (what you would net from selling it) and the value in use (the present value of the future cash flows the asset is expected to generate by continuing to use it). If the carrying amount is above that recoverable amount, the asset is written down to the recoverable amount and the difference is the impairment loss, recognized in the income statement.
where an impairment is recognized only if the carrying amount exceeds the recoverable amount; the asset is then written down to the recoverable amount and the loss reduces net income.
Under US GAAP, the test for assets held for use is a two-step process. Step one is a recoverability test: compare the carrying amount with the undiscounted sum of the expected future cash flows from the asset. If the carrying amount is less than or equal to those undiscounted cash flows, the asset is not impaired and nothing is recorded, even if fair value has fallen. Only if the carrying amount exceeds the undiscounted cash flows does the asset fail step one. Step two then measures the loss as the carrying amount minus the asset fair value. The use of undiscounted cash flows in step one makes the US GAAP test harder to trip, so an asset can be impaired under IFRS while passing the US GAAP screen.
Setup. Foxglove Chemicals, an invented company, owns a production line with a carrying amount of 700,000. Its fair value less costs to sell is 520,000, its value in use (the present value of expected future cash flows) is 560,000, and the undiscounted expected future cash flows total 660,000. Measure the impairment loss under IFRS and under US GAAP.
Answer: the impairment loss is 140,000 under IFRS and 180,000 under US GAAP, on the identical asset. So what does this number mean? IFRS writes the asset down to its value in use of 560,000, while US GAAP, once the asset fails step one, measures against fair value and writes it down further to 520,000, producing a larger loss. The two frameworks do not merely differ in size; they can differ in whether any loss is recognized at all, because a company whose undiscounted cash flows still exceed the carrying amount records nothing under US GAAP even as IFRS records a loss. An analyst comparing impairment charges across frameworks must keep the different tests in mind.
Impairment strikes intangibles too. A finite-life intangible is tested only when events suggest its carrying amount may not be recoverable, the same trigger-based approach as PP&E. An indefinite-life intangible and goodwill are tested at least annually, because they are not being amortized and so nothing else is systematically reducing their carrying amount. Whatever the asset, an impairment loss lowers the asset on the balance sheet, lowers net income in the year it is taken, and therefore lowers assets and equity. Because it shrinks the asset base, it tends to raise future return on assets and asset turnover, which can make a company look more efficient in the years after a big write-down, a point analysts watch for.
The frameworks also part company on reversal. Under IFRS, if the conditions that caused an impairment improve, the loss on most assets (PP&E and finite- and indefinite-life intangibles) may be reversed, but only up to what the carrying amount would have been had the impairment never happened. The one exception is goodwill: an impairment of goodwill is never reversed, under either framework. Under US GAAP, reversal of an impairment loss on an asset held for use is prohibited entirely; once written down, the reduced amount becomes the new cost basis.
| Feature | IFRS | US GAAP (held for use) |
|---|---|---|
| Trigger to test | Indication of impairment; goodwill and indefinite-life intangibles at least annually | Indication of impairment; goodwill and indefinite-life intangibles at least annually |
| Impaired when | Carrying amount > recoverable amount | Carrying amount > undiscounted future cash flows |
| Loss measured as | Carrying amount − recoverable amount | Carrying amount − fair value |
| Recoverable amount | Higher of fair value less costs to sell and value in use | Not used; measurement is against fair value |
| Reversal allowed | Yes, except goodwill, capped at the original carrying amount | No, prohibited for assets held for use |
Hold two contrasts ready. On measurement, IFRS uses a single test against recoverable amount (the higher of fair value less costs to sell and value in use), while US GAAP uses a two-step test where step one screens with undiscounted cash flows and step two measures against fair value. On reversal, IFRS permits it (never for goodwill, capped at the pre-impairment carrying amount) and US GAAP forbids it for held-for-use assets. If a question gives you undiscounted cash flows, it is testing the US GAAP screen; if it gives you value in use, it is testing IFRS.
An asset leaves the balance sheet, or is derecognized, when it is sold, exchanged, or abandoned. At that moment the company removes both the asset cost and its accumulated depreciation, and compares what it received with what the asset was still carried at. The gain or loss on disposal is simply the net proceeds minus the carrying amount at the date of sale. A positive figure is a gain, a negative figure is a loss, and both are reported in the income statement, typically outside of the core operating lines because they are not part of normal operations.
where carrying amount = original cost − accumulated depreciation (and less any accumulated impairment). A result above zero is a gain; below zero is a loss.
Setup. Juniper Distribution, an invented company, sells a delivery van that originally cost 240,000 and has accumulated depreciation of 180,000. Compute the gain or loss if the van is sold for 75,000, and separately if it is sold for 50,000.
Answer: the van produces a 15,000 gain if sold for 75,000 and a 10,000 loss if sold for 50,000. So what does this number mean? The gain or loss is not a measure of how well the van was used; it mostly reflects whether the depreciation estimates over its life were too fast or too slow. A gain means the asset was carried below what a buyer would pay, so depreciation was, with hindsight, too aggressive; a loss means the opposite. Because these amounts are one-time and unrelated to ongoing operations, analysts usually strip disposal gains and losses out before judging recurring earnings.
The balance sheet shows long-lived assets as a few summary lines, but the notes carry the detail that makes analysis possible. For property, plant, and equipment, companies typically disclose the depreciation method and the useful lives or depreciation rates by class of asset, the gross carrying amount and the accumulated depreciation at the start and end of the period, and a reconciliation of the changes (additions, disposals, depreciation, and impairments). For intangible assets, companies disclose whether useful lives are finite or indefinite, the amortization method and lives for finite-life assets, and the carrying amounts by class, along with any impairment losses and, under IFRS, any reversals. Goodwill carries its own disclosures about the amounts and any impairment.
These disclosures let an analyst estimate how old a company assets are and how much life they have left, which matters because an aging asset base signals future capital spending that a young one does not. Three back-of-envelope ratios, built from the depreciation disclosures, do most of the work. The average age of assets approximates how much of their life has already been used; the total useful life approximates the full span the company assumes; and the remaining useful life approximates how much is left. They are estimates, because they assume straight-line depreciation and a single vintage of assets, but they are quick and revealing.
with the companion estimates total useful life ≈ gross PP&E ÷ annual depreciation expense, and remaining useful life ≈ net PP&E ÷ annual depreciation expense. The three tie together because average age plus remaining life should approximate total life.
Setup. Meadowbrook Foods, an invented company, reports gross property, plant, and equipment of 900,000, accumulated depreciation of 360,000, and annual depreciation expense of 90,000. Estimate the average age of its assets, the total useful life it assumes, and the remaining useful life.
Answer: the assets are on average about 4 years old, are assumed to last about 10 years in total, and have about 6 years of life remaining. So what does this number mean? Meadowbrook is roughly 40% of the way through the life of its asset base, so it is not facing an imminent wave of replacement spending, but it is not brand new either. If a competitor showed an average age of 8 years against the same 10-year total life, an analyst would expect that rival to need heavy capital expenditure soon, which affects free cash flow and future depreciation. These crude ratios turn a depreciation footnote into a forward-looking read on the capital cycle.
The asset-age ratios are approximations, not precise measures, and they can mislead when a company uses accelerated depreciation, holds assets of very different vintages, or has recently revalued or impaired assets. Treat them as a first screen: a rising average age across several years is a reliable signal that replacement spending is coming, even if the exact number of years is imprecise. Always read them alongside the actual capital expenditure trend rather than in isolation.
A company buys a machine for a net price of 400,000 and pays 15,000 freight, 25,000 installation, 8,000 to test it, and 6,000 to train staff. At what amount is the machine capitalized?
The machine is capitalized at 400,000 + 15,000 + 25,000 + 8,000 = 448,000. Freight, installation, and testing are all necessary to bring the machine to working condition, so they are capitalized. The 6,000 of training is a period cost and is expensed immediately, not added to the asset.
An asset costs 500,000, has a residual value of 50,000, and a useful life of 5 years. Using double-declining-balance, what is depreciation in Year 2?
The DDB rate is 2 ÷ 5 = 40%. Year 1 depreciation = 500,000 × 40% = 200,000, leaving a carrying amount of 300,000. Year 2 depreciation = 300,000 × 40% = 120,000. Note that residual value is not subtracted before applying the rate; it only acts as a floor in the final years.
Under IFRS, how are the research phase and the development phase of an internal project treated?
Research costs are always expensed as incurred. Development costs are capitalized as an intangible asset once the company can demonstrate technical feasibility, the intention and ability to complete and use or sell the asset, and probable future economic benefits. Under US GAAP, by contrast, research and development are generally both expensed as incurred, so an IFRS firm can carry a capitalized development asset that a US GAAP firm would not.
Under the IFRS revaluation model, where does an upward revaluation of PP&E go, and where does a downward revaluation go?
An upward revaluation (an increase) is recorded in other comprehensive income and accumulated in equity as a revaluation surplus, and does not affect net income, unless it reverses a prior decrease that hit the income statement. A downward revaluation (a decrease) is recognized in the income statement, unless there is an existing revaluation surplus for that asset, which it reduces first. Gains go to equity and losses go to profit, except to the extent each reverses the other.
An asset has a carrying amount of 600,000, a value in use of 480,000, a fair value less costs to sell of 450,000, and undiscounted expected cash flows of 620,000. Is it impaired under IFRS, and under US GAAP?
Under IFRS the recoverable amount is the higher of value in use (480,000) and fair value less costs to sell (450,000), which is 480,000. Because the carrying amount of 600,000 exceeds 480,000, the asset is impaired and written down by 120,000. Under US GAAP, step one compares the carrying amount (600,000) with undiscounted cash flows (620,000); since 600,000 is below 620,000, the asset passes the recoverability test and no impairment is recorded. The same asset is impaired under IFRS but not under US GAAP.
Can an impairment loss be reversed under IFRS and under US GAAP, and does the answer change for goodwill?
Under IFRS, an impairment loss on PP&E and on finite- and indefinite-life intangibles may be reversed if conditions improve, but only up to the carrying amount that would have existed had no impairment been recognized. Under US GAAP, reversal is prohibited for assets held for use. For goodwill the answer is the same under both frameworks: an impairment of goodwill is never reversed.
A company reports gross PP&E of 1,200,000, accumulated depreciation of 480,000, and annual depreciation expense of 120,000. Estimate the average age and the remaining useful life of its assets.
Average age ≈ accumulated depreciation ÷ annual depreciation = 480,000 ÷ 120,000 = 4 years. Remaining useful life ≈ net PP&E ÷ annual depreciation = (1,200,000 − 480,000) ÷ 120,000 = 720,000 ÷ 120,000 = 6 years. Total useful life is about 10 years, and average age plus remaining life ties back to that total.
Capitalizing records a cost as an asset on the balance sheet and charges it to the income statement gradually, through depreciation or amortization, over the periods that benefit; expensing charges the whole cost to the income statement in the current period. Capitalizing raises current assets and current net income and lifts operating cash flow, but it lowers income in future periods as the asset is depreciated. Expensing does the reverse. Over the full life of the asset the total expense is identical under both treatments; only the timing of when it hits profit differs, which is why comparing two companies requires knowing where each draws the line.
The cost of PP&E is the purchase price, net of any trade discounts, plus every expenditure necessary to bring the asset to the location and condition needed for its intended use. That includes freight, non-refundable duties, installation, assembly, and testing that the asset works. Costs that are not necessary to get the asset ready, such as staff training, promotional launch costs, and losses from operating below capacity early on, are period costs and are expensed as incurred rather than capitalized into the asset.
Straight-line spreads the depreciable base, which is cost minus residual value, evenly across the useful life, so the charge is the same every year. Double-declining-balance is an accelerated method that applies a fixed rate of twice the straight-line rate to the asset carrying amount at the start of each year, so it charges much more depreciation early and less later. Two rules matter: residual value is not subtracted before applying the DDB rate, and the asset is never depreciated below residual value, so the final charge is capped. Both methods write off the same total over the life of the asset.
It is treated as a change in accounting estimate and applied prospectively, which means prior periods are not restated. From the date of the change, the remaining carrying amount, less any revised residual value, is spread over the remaining useful life. If a company shortens the life or cuts the residual value, depreciation rises and future income falls; if it lengthens the life, depreciation falls and future income rises. Because lengthening a useful life quietly boosts income without any change in the underlying assets, analysts watch estimate revisions closely.
Because the general rule is that internal development costs are expensed as incurred, since the future benefit of in-house research is uncertain. As a result, valuable brands, technologies, and know-how that a company builds itself often appear nowhere on the balance sheet, even though they are worth a great deal. The main exception is under IFRS, where development costs (not research costs) are capitalized once the company can demonstrate technical and commercial feasibility. Under US GAAP nearly all research and development is expensed. This is why a company that grew by acquisition can carry large intangible balances while an organically grown peer carries almost none.
Goodwill arises only in a business combination. When one company acquires another, it records the identifiable assets and liabilities of the target at fair value, and any amount it pays above the fair value of those identifiable net assets becomes goodwill, a residual that captures reputation, workforce, and expected synergies that cannot be sold separately. Goodwill is not amortized. Instead it is tested for impairment at least annually, and an impairment of goodwill can never be reversed under either IFRS or US GAAP.
Under IFRS an asset is impaired when its carrying amount exceeds its recoverable amount, defined as the higher of fair value less costs to sell and value in use, and the loss is the difference. Under US GAAP the test for assets held for use has two steps: first a recoverability test compares the carrying amount with the undiscounted sum of expected future cash flows, and only if the carrying amount exceeds that sum is the asset impaired; then the loss is measured as carrying amount minus fair value. Because US GAAP screens with undiscounted cash flows, an asset can be impaired under IFRS while passing the US GAAP test, and the measured losses can differ in size.
It depends on the framework and the asset. Under IFRS, an impairment loss on PP&E and on finite- and indefinite-life intangibles may be reversed if the conditions that caused it improve, but only up to the carrying amount the asset would have had if it had never been impaired. Under US GAAP, reversal is prohibited for assets held for use: once written down, the reduced amount becomes the new cost basis. The one point both frameworks share is goodwill: an impairment of goodwill is never reversed. This means an IFRS company can report a recovery that a US GAAP company holding identical assets cannot.
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