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Analysis of Long-Term Assets

Financial Statement Analysis

Presentation and Disclosure

Learning Outcome Statement:

analyze and interpret financial statement disclosures regarding property, plant, and equipment and intangible assets

Summary:

This LOS focuses on the analysis and interpretation of financial statement disclosures related to property, plant, and equipment (PPE) and intangible assets under IFRS and US GAAP. It covers the required disclosures for each class of these assets, including measurement bases, depreciation and amortization methods, useful lives, gross carrying amounts, and accumulated depreciation or amortization. It also discusses the disclosure requirements for impairment losses and the impact of these disclosures on financial analysis.

Key Concepts:

Disclosure Requirements under IFRS

Under IFRS, companies must disclose for each class of PPE and intangible assets the measurement basis, depreciation or amortization method, useful lives, gross carrying amount, accumulated depreciation or amortization, and a reconciliation of the carrying amount at the beginning and end of the period. Additional disclosures include restrictions on title, pledges as security, and contractual obligations to acquire such assets.

Disclosure Requirements under US GAAP

Under US GAAP, companies must disclose the gross carrying amounts and accumulated amortization by major class of intangible assets, aggregate amortization expense for the period, and estimated amortization expense for the next five fiscal years. For PPE, similar disclosures are required, focusing on gross carrying amounts and accumulated depreciation.

Impairment Disclosures

IFRS requires disclosure of impairment losses and reversals by class of assets, including the events leading to recognition of these losses or reversals. US GAAP requires disclosure of the description of the impaired asset, the cause of impairment, the method of determining fair value, and the amount of the impairment loss.

Use of Disclosures in Financial Analysis

Disclosures about PPE and intangible assets are used in financial analysis to assess a company's investment in these assets, changes during the reporting period, and the impact on current and future performance. Analysts use these disclosures to calculate ratios such as fixed asset turnover and asset age ratios, which provide insights into asset efficiency and the need for reinvestment.

Impairment and Derecognition of Assets

Learning Outcome Statement:

explain and evaluate how impairment and derecognition of property, plant, and equipment and intangible assets affect the financial statements and ratios

Summary:

Impairment involves writing down the carrying amount of assets that have declined in value unexpectedly, which affects financial statements by reducing net income and asset values. Derecognition involves removing an asset from the financial statements when it is disposed of or expected to provide no future benefits. The treatment of these elements varies between IFRS and US GAAP, particularly regarding the reversibility of impairments and the measurement of impairment losses.

Key Concepts:

Impairment of Property, Plant, and Equipment

Occurs when the carrying amount of an asset exceeds its recoverable amount. Impairment losses reduce the carrying amount on the balance sheet and decrease net income. These are tested for when there are indications of impairment rather than annually.

Impairment of Intangible Assets

Similar to tangible assets, intangible assets are tested for impairment when there is evidence suggesting a reduction in the foreseeable benefit of the assets. Intangibles with indefinite lives are tested at least annually.

Reversals of Impairments

IFRS allows the reversal of impairment losses if the recoverable amount increases after an impairment loss has been recognized. US GAAP does not allow reversals for assets held for use but permits reversals for assets held for sale.

Derecognition

An asset is derecognized when it no longer is expected to provide future economic benefits. This can occur through sale, disposal, or abandonment. The gain or loss on derecognition is calculated as the difference between the net disposal proceeds and the carrying amount of the asset.

Formulas:

Impairment Loss under IFRS

Impairment Loss=Carrying Amount−Recoverable AmountImpairment\ Loss = Carrying\ Amount - Recoverable\ Amount

This formula is used to calculate the impairment loss under IFRS when the carrying amount of an asset exceeds its recoverable amount.

Variables:
CarryingAmountCarrying Amount:
The amount at which an asset is recognized after deducting any accumulated depreciation and impairment losses.
RecoverableAmountRecoverable Amount:
The higher of an asset's fair value less costs to sell and its value in use.
Units: Monetary units (e.g., USD, EUR)

Impairment Loss under US GAAP

Impairment Loss=Carrying Amount−Fair ValueImpairment\ Loss = Carrying\ Amount - Fair\ Value

Under US GAAP, if the carrying amount is not recoverable, the impairment loss is measured as the difference between the carrying amount and the fair value of the asset.

Variables:
CarryingAmountCarrying Amount:
The amount at which an asset is recognized after deducting any accumulated depreciation and impairment losses.
FairValueFair Value:
The price that would be received to sell an asset in an orderly transaction between market participants at the measurement date.
Units: Monetary units (e.g., USD, EUR)

Using Disclosures in Analysis

Learning Outcome Statement:

analyze and interpret financial statement disclosures regarding property, plant, and equipment and intangible assets

Summary:

This LOS focuses on the analysis and interpretation of financial disclosures related to property, plant, and equipment (PPE) and intangible assets. It includes understanding the impact of changes in estimates and assumptions on the valuation of these assets, identifying major components of these assets, and using ratios such as fixed asset turnover and asset age ratios to assess asset efficiency and investment needs.

Key Concepts:

Impact of Growth Estimates and Discount Rates

Changes in growth estimates and discount rates can significantly affect the present value of future cash flows, thereby impacting the recoverable value of assets.

Components of Intangible Assets and PPE

Identifying the largest components of intangible assets and PPE helps in understanding the major investments of a company and their impact on financial statements.

Fixed Asset Turnover Ratio

This ratio measures how efficiently a company uses its fixed assets to generate sales. A higher ratio indicates better efficiency.

Asset Age Ratios

These ratios, including average age and remaining useful life of assets, help assess the timing of future investments in PPE necessary to maintain productive capacity.

Reinvestment Rate

Comparing annual capital expenditures to depreciation expense provides insights into whether a company is maintaining its productive capacity.

Formulas:

Fixed Asset Turnover Ratio

Fixed Asset Turnover=Total RevenueAverage Net Fixed Assets\text{Fixed Asset Turnover} = \frac{\text{Total Revenue}}{\text{Average Net Fixed Assets}}

This ratio indicates how much revenue a company generates for each unit of fixed asset investment.

Variables:
TotalRevenueTotal Revenue:
Total revenue generated by the company
AverageNetFixedAssetsAverage Net Fixed Assets:
Average value of net fixed assets during the period
Units: ratio

Estimated Total Useful Life

Estimated Total Useful Life=Historical CostAnnual Depreciation Expense\text{Estimated Total Useful Life} = \frac{\text{Historical Cost}}{\text{Annual Depreciation Expense}}

This formula estimates the total expected useful life of an asset from its cost and annual depreciation.

Variables:
HistoricalCostHistorical Cost:
Original cost of the asset
AnnualDepreciationExpenseAnnual Depreciation Expense:
Depreciation expense recorded annually
Units: years

Estimated Remaining Life

Estimated Remaining Life=Net PPEAnnual Depreciation Expense\text{Estimated Remaining Life} = \frac{\text{Net PPE}}{\text{Annual Depreciation Expense}}

This formula estimates how many years the asset will continue to be useful based on its current net book value and annual depreciation.

Variables:
NetPPENet PPE:
Net book value of property, plant, and equipment
AnnualDepreciationExpenseAnnual Depreciation Expense:
Annual depreciation expense
Units: years

Acquisition of Intangible Assets

Learning Outcome Statement:

compare the financial reporting of the following types of intangible assets: purchased, internally developed, and acquired in a business combination

Summary:

The acquisition of intangible assets can occur through purchases outside of business combinations, internal development, or through business combinations. Each method has distinct accounting treatments and implications for financial reporting. Purchased intangible assets are recorded at fair value, internally developed assets often involve expensing costs unless specific criteria are met for capitalization, and assets acquired in business combinations are allocated a portion of the purchase price based on their fair value.

Key Concepts:

Intangible Assets Purchased Outside Business Combinations

These assets are recorded at their fair value at the time of acquisition. The purchase price is allocated to each asset based on its fair value. Analysts focus more on the types of assets acquired rather than the specific values assigned.

Internally Developed Intangible Assets

Costs for developing intangible assets internally are generally expensed as incurred. However, under certain conditions, such as demonstrating technical feasibility and future economic benefit, these costs can be capitalized. This treatment affects financial comparability and trend analysis.

Intangible Assets Acquired in Business Combinations

In business combinations, intangible assets are recognized if they meet specific criteria and are separable or arise from contractual/legal rights. Any excess purchase price over the fair value of net identifiable assets is recorded as goodwill.

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