Non-current Assets, Intangibles and Impairment

Introduction

Non-current assets often represent a substantial proportion of an entity’s invested capital and productive capacity. Their accounting affects profit, asset values, return measures, borrowing covenants and management incentives. Because benefits may extend across many periods, accounting standards require careful judgments about recognition, measurement, depreciation or amortisation, revaluation, derecognition and impairment.

This chapter applies the principal requirements of IAS 16 Property, Plant and Equipment, IAS 40 Investment Property, IAS 23 Borrowing Costs, IAS 38 Intangible Assets, IFRS 3 Business Combinations and IAS 36 Impairment of Assets. References to IFRS requirements should be read alongside applicable local legislation and reporting requirements.

Learning Objectives

After studying this chapter, students should be able to:

1. Recognise and initially measure property, plant and equipment.
2. calculate depreciation using appropriate methods and component accounting.
3. account for revaluations and disposals.
4. distinguish investment property from owner-occupied property and inventory.
5. identify and capitalise eligible borrowing costs.
6. apply recognition and measurement rules to intangible assets and development expenditure.
7. calculate goodwill arising in a business combination.
8. conduct asset-level and cash-generating-unit impairment tests.
9. evaluate the professional, ethical and governance implications of asset accounting judgments.

1. Property, Plant and Equipment

1.1 Nature and recognition

Property, plant and equipment—commonly abbreviated to PPE—comprises tangible items held for production, supply, rental or administrative purposes and expected to be used for more than one reporting period.

An item is recognised as PPE when:

• it is probable that future economic benefits associated with the item will flow to the entity; and
• its cost can be measured reliably.

Major spare parts, standby equipment and servicing equipment are PPE when they meet this definition. Otherwise, they are usually inventory. Day-to-day repairs are expensed because they maintain, rather than create or replace, separately identifiable benefits.

1.2 Initial measurement

Qualifying PPE is initially measured at cost. Cost normally includes:

• purchase price, net of trade discounts and rebates;
• import duties and non-refundable purchase taxes;
• directly attributable costs of bringing the asset to the location and condition necessary for its intended operation; and
• the initial estimate of dismantling, removal and site-restoration obligations, measured at present value when a present obligation exists.

Directly attributable costs can include site preparation, delivery, installation, professional fees and testing. Administration, general overhead, training, initial operating losses and abnormal waste are normally expensed.

Proceeds and related costs from selling items produced before PPE is available for intended use are recognised in profit or loss under the applicable standards; the proceeds are not deducted from the PPE’s cost.

Worked Example 1: Initial cost and depreciation

A manufacturer purchases equipment with the following amounts:

Training does not bring the equipment to the physical location and condition necessary for operation, so it is expensed.

If residual value is $45,000 and useful life is ten years, annual straight-line depreciation is:

1.3 Subsequent expenditure and component accounting

Subsequent expenditure is capitalised only when it satisfies the recognition criteria. When a significant component is replaced, the new component is recognised and the carrying amount of the replaced component is derecognised, even if it was not separately identified originally.

Significant components with different useful lives must be depreciated separately. For example, an aircraft’s engines, airframe and major inspection component may have different consumption patterns.

2. Depreciation

Depreciation systematically allocates an asset’s depreciable amount over its useful life. It is an allocation process, not an attempt to measure changes in market value.

Here, an amount substituted for cost may be a revalued amount. Residual value is the estimated amount currently obtainable from disposal, less disposal costs, assuming the asset were already of the age and condition expected at the end of its useful life.

Under straight-line depreciation:

where D_t is annual depreciation in currency units, C is cost or revalued amount, R is residual value, and n is useful life in years. This formula assumes an even consumption pattern.

Under the reducing-balance method:

where r is the annual depreciation rate and CA_t−1 is the opening carrying amount. Any residual-value constraint must still be respected.

Under a units-of-production method:

where q_t is output in the period and Q is estimated total lifetime output, measured consistently—for example, in units or machine hours.

Depreciation begins when an asset is available for use. It does not cease merely because the asset becomes idle, although a units-of-production charge may be zero when there is no production. Useful life, residual value and depreciation method are reviewed at least annually. Changes are accounted for prospectively as changes in estimates under IAS 8.

3. Subsequent Measurement and Revaluation

An entity chooses either the cost model or revaluation model for an entire class of PPE.

• Cost model: cost less accumulated depreciation and accumulated impairment losses.
• Revaluation model: fair value at the revaluation date less subsequent depreciation and impairment.

The revaluation model is available when fair value can be measured reliably. Revaluations must be sufficiently regular to prevent material differences between carrying amount and fair value.

A revaluation increase is normally recognised in other comprehensive income and accumulated in revaluation surplus. It is recognised in profit or loss to the extent that it reverses a previous revaluation decrease of the same asset recognised in profit or loss. A decrease is normally recognised in profit or loss, except to the extent of an existing surplus relating to that asset.

Worked Example 2: Correct revaluation mechanics

A building has a gross carrying amount of $600,000 and accumulated depreciation of $240,000 immediately before revaluation. Its net carrying amount is therefore:

Its fair value is $450,000, producing a $90,000 increase.

Accumulated-depreciation elimination method: accumulated depreciation of $240,000 is eliminated against the gross carrying amount. The resulting net amount is $360,000, after which the asset is increased by $90,000. The revised gross and net carrying amount is $450,000, with no accumulated depreciation immediately after revaluation.

Proportionate-restatement method: the restatement factor is:

The restated balances are:

Thus, the net carrying amount is correctly reported as $750,000 − $300,000 = $450,000.

The revaluation surplus may be transferred directly to retained earnings as the asset is used or disposed of. Such transfers are not made through profit or loss.

4. Derecognition and Disposal

PPE is derecognised on disposal or when no future economic benefits are expected from use or disposal. The disposal gain or loss is:

Suppose equipment costing $200,000 has accumulated depreciation of $150,000 and is sold for $62,000. Its carrying amount is $50,000, so the gain is $12,000. Disposal gains are not classified as revenue in the ordinary course of business unless selling such assets is itself part of ordinary activities under another standard.

5. Investment Property

Investment property is land or a building, or part of one, held to earn rentals, for capital appreciation, or both. It is distinguished by purpose:

Mixed-use property is separated when portions can be sold or leased separately. If separation is impossible, the entire property is investment property only when owner-occupied use is insignificant.

Investment property is initially measured at cost. Subsequently, an entity selects:

• the fair value model, under which fair-value changes are recognised immediately in profit or loss and depreciation is not charged; or
• the cost model, under which IAS 16 measurement requirements are applied, subject to IAS 40 disclosures, including fair value where required.

Transfers into or out of investment property occur only when there is evidence of a change in use, not merely a change in management intention.

6. Borrowing Costs

IAS 23 requires directly attributable borrowing costs to be capitalised as part of the cost of a qualifying asset. A qualifying asset necessarily takes a substantial period to become ready for intended use or sale. Examples may include major construction projects, certain intangible development projects and some inventories requiring lengthy maturation.

Capitalisation begins when the entity:

1. incurs expenditure on the asset;
2. incurs borrowing costs; and
3. undertakes activities necessary to prepare the asset for use or sale.

Capitalisation is suspended during extended periods in which active development is interrupted, unless the delay is necessary to the process. It ceases when substantially all preparation activities are complete.

For general borrowings:

The capitalisation rate is the weighted-average borrowing rate applicable to qualifying general borrowings. The amount capitalised cannot exceed borrowing costs incurred during the period.

Worked Example 3: General borrowing capitalisation

Construction expenditure is $1,200,000 on 1 January, $600,000 on 1 April and $400,000 on 1 October. Construction continues throughout the year, and the applicable general borrowing rate is 8%.

This result assumes at least $140,000 of borrowing costs was incurred and that all relevant expenditure was financed from general borrowings.

7. Intangible Assets

An intangible asset is an identifiable non-monetary asset without physical substance. It is identifiable when it is separable or arises from contractual or other legal rights.

Recognition requires probable future economic benefits and reliable cost measurement. Control is also essential: the entity must have power to obtain benefits and restrict others’ access to them.

Examples include patents, licences, purchased software, copyrights and qualifying development expenditure. Internally generated brands, mastheads, publishing titles, customer lists and similar items are not recognised because their cost cannot be distinguished reliably from the cost of developing the business as a whole.

7.1 Initial and subsequent measurement

Separately acquired intangible assets are initially measured at cost. Intangible assets acquired in a business combination are generally measured at acquisition-date fair value separately from goodwill when identifiable.

After recognition, IAS 38 permits:

• the cost model, which is always available; or
• the revaluation model, which is available only when fair value can be measured by reference to an active market.

Active markets for unique intangible assets are uncommon. The absence of an active market does not prevent use of the cost model.

7.2 Research and development

Research expenditure is expensed as incurred because an entity cannot yet demonstrate an asset that will generate probable benefits.

Development expenditure is capitalised from the date on which all six conditions are demonstrated:

1. technical feasibility of completion;
2. intention to complete and use or sell;
3. ability to use or sell;
4. probable future economic benefits, including a market or internal usefulness;
5. adequate technical, financial and other resources; and
6. ability to measure attributable expenditure reliably.

Expenditure previously recognised as an expense cannot later be reinstated as an intangible asset. Capitalisation is therefore prospective from the date all criteria are met.

7.3 Useful lives and amortisation

A finite-life intangible asset is amortised systematically over its useful life from the date it is available for use. Its method should reflect the consumption pattern; otherwise, straight-line amortisation is used.

An indefinite-life intangible asset is not amortised. It is tested annually for impairment and whenever impairment indicators exist. Indefinite does not mean infinite: it means there is no foreseeable limit to the period over which net cash inflows are expected. The assessment is reviewed annually.

8. Goodwill

Goodwill arises in a business combination and represents future economic benefits from assets that are not individually identified and separately recognised. Internally generated goodwill is not recognised.

Under the acquisition method:

NCI denotes non-controlling interests. Its measurement may include either fair value or the proportionate share of identifiable net assets, depending on the permitted election for the transaction.

Worked Example 4: Goodwill

An acquirer pays $4,800,000 for 80% of a company. NCI is measured at fair value of $1,100,000, and identifiable net assets have a fair value of $5,400,000.

A negative result is a bargain-purchase gain, recognised in profit or loss only after reassessing the identification and measurement of all relevant amounts.

Goodwill is not amortised under IFRS. It is allocated to cash-generating units or groups of units expected to benefit from the acquisition synergies and is tested annually for impairment.

9. Impairment of Assets

An asset is impaired when its carrying amount exceeds its recoverable amount.

Value in use is the present value of future cash flows expected from continuing use and ultimate disposal. Cash-flow forecasts and discount rates must be internally consistent. IAS 36 generally uses pre-tax cash flows and a pre-tax discount rate reflecting the time value of money and asset-specific risks not already included in cash flows.

Here, CF_t is the expected net cash flow in period t, k is the consistent periodic discount rate, n is the explicit forecast horizon and TV_n is terminal value at the end of that horizon. Units and timing must be consistent; annual cash flows require an annual rate.

9.1 Indicators and annual testing

External indicators include market-value declines, adverse technological or legal changes and increases in market interest rates. Internal indicators include obsolescence, damage, restructuring, underperformance and plans to discontinue an operation.

Goodwill, indefinite-life intangibles and intangible assets not yet available for use require annual impairment testing, irrespective of indicators.

Worked Example 5: Individual asset impairment

An asset has a carrying amount of $900,000, fair value less costs of disposal of $710,000 and value in use of $760,000.

The carrying amount becomes $760,000, and future depreciation is based on this revised amount, adjusted for residual value and remaining useful life.

9.2 Cash-generating units

When an asset does not generate cash inflows largely independent of other assets, it is tested within a cash-generating unit, or CGU. A CGU is the smallest identifiable group generating substantially independent cash inflows.

A CGU impairment loss is allocated:

1. first to goodwill allocated to the CGU; and
2. then pro rata to other assets within the CGU.

No asset is reduced below the highest of its individual fair value less costs of disposal, its value in use when determinable, and zero. Any unallocated loss is then reassigned as required by IAS 36.

Figure: Decision process for identifying and allocating an impairment loss.

9.3 Reversals

An impairment loss other than one relating to goodwill is reversed when estimates used to determine recoverable amount improve. The revised carrying amount cannot exceed the amount that would have existed, net of depreciation or amortisation, had no impairment occurred. An impairment loss recognised for goodwill is never reversed under IAS 36.

10. Integrated Illustrative Case: Nova Manufacturing Group

Background

Nova Manufacturing Group is a fictional entity preparing IFRS financial statements. During the year, it acquired a production line, purchased a rental property, incurred research and development costs and tested an acquired business for impairment.

Problem and analysis

Production line: The invoice price was $2,000,000. Delivery cost $120,000, installation and testing cost $180,000, and the present value of restoration obligations was $160,000. Staff training of $40,000 was incurred separately.

The recognised cost is:

Training is expensed. With a residual value of $60,000 and an eight-year useful life, annual straight-line depreciation is:

Investment property: A building acquired solely for rental income cost $1,500,000. Nova applies IAS 40’s fair value model. At year-end, fair value is $1,620,000. The $120,000 increase is recognised in profit or loss, and no depreciation is charged.

Research and development: Nova incurred $180,000 on preliminary research, $120,000 on development before all IAS 38 criteria were demonstrated, and $480,000 after the demonstration date. The first $300,000 is expensed. The subsequent $480,000 is capitalised, assuming it is directly attributable and reliably measured.

CGU impairment: At year-end, a CGU contains PPE of $2,160,000 after depreciation, capitalised development expenditure of $480,000 and goodwill of $360,000. Total carrying amount is $3,000,000. Recoverable amount is $2,550,000, so the impairment loss is $450,000.

Goodwill is reduced first by $360,000. The remaining $90,000 is allocated pro rata between PPE and development expenditure, assuming neither asset’s individual floor restricts allocation.

Rounded carrying amounts become $2,086,364 for PPE and $463,636 for development expenditure. Goodwill becomes zero.

Outcome and learning points

The case demonstrates that classification determines the accounting model. It also shows that expenditure should not be capitalised merely because management expects future benefits: each standard’s recognition conditions must be satisfied. Impairment testing links asset recognition to evidence about recoverability.

11. Professional Judgment, Governance and Technology

Useful lives, residual values, restoration obligations, fair values, development feasibility and impairment forecasts can materially affect earnings. Optimistic estimates may defer expenses or conceal poor acquisitions. Directors and audit committees should therefore challenge assumptions, compare forecasts with past outcomes and ensure valuation specialists are independent and competent.

Controls should maintain complete asset registers, component records, impairment indicators and links between physical assets and ledger balances. Enterprise asset-management systems can automate depreciation and identify idle assets. Artificial intelligence may assist by detecting unusual useful lives, forecasting maintenance or screening CGUs for impairment indicators. However, models cannot replace accountable professional judgment, reliable evidence or required disclosures.

Climate-related regulation, technological disruption and changing consumer demand may shorten useful lives, reduce residual values or trigger impairment. These effects must be reflected in existing IFRS estimates where material; they are not postponed merely because a separate sustainability report discusses them.

Chapter Summary

PPE is recognised when future benefits are probable and cost is reliably measurable. Initial cost includes purchase and directly attributable preparation costs, together with qualifying restoration obligations. Depreciation allocates cost or a substituted amount, less residual value, over useful life, with significant components depreciated separately.

IAS 16 permits cost and revaluation models. Revaluation changes are generally recognised in other comprehensive income or profit or loss according to their nature and previous revaluations. Investment property is distinguished by its rental or capital-appreciation purpose and may subsequently follow the fair value or cost model. IAS 23 requires eligible borrowing costs attributable to qualifying assets to be capitalised.

IAS 38 permits the cost model for all recognised intangible assets; revaluation requires an active market. Research is expensed, while development is capitalised only after all recognition criteria are demonstrated. Goodwill arises only through a business combination and is tested annually rather than amortised.

Under IAS 36, recoverable amount is the higher of value in use and fair value less costs of disposal. Impairment losses reduce assets or CGUs to recoverable amount, with CGU losses allocated first to goodwill. Goodwill impairment cannot be reversed.

Key Terms

Active market: A market with sufficiently homogeneous items, willing buyers and sellers, and publicly available prices.

Borrowing costs: Interest and related finance costs incurred in connection with borrowing funds.

Carrying amount: The amount at which an asset is recognised after accumulated depreciation, amortisation and impairment.

Cash-generating unit: The smallest identifiable asset group generating substantially independent cash inflows.

Component accounting: Separate depreciation of significant parts of an asset with different useful lives or consumption patterns.

Cost model: Measurement at cost less accumulated depreciation or amortisation and impairment.

Depreciable amount: Cost or another amount substituted for cost, less residual value.

Development: Application of research findings or knowledge to a plan or design before commercial production or use.

Fair value less costs of disposal: Disposal fair value less directly attributable incremental disposal costs.

Goodwill: Unidentifiable future economic benefits arising from assets acquired in a business combination.

Impairment loss: The excess of carrying amount over recoverable amount.

Indefinite useful life: A useful life with no foreseeable limit to expected net cash inflows.

Intangible asset: An identifiable non-monetary asset without physical substance.

Investment property: Property held for rentals, capital appreciation, or both.

Qualifying asset: An asset requiring a substantial period to become ready for intended use or sale.

Recoverable amount: The higher of value in use and fair value less costs of disposal.

Research: Original investigation undertaken to obtain new scientific or technical knowledge.

Residual value: Estimated disposal proceeds, less disposal costs, assuming the asset is at its expected end-of-life condition.

Revaluation surplus: Accumulated other comprehensive income arising principally from upward asset revaluations.

Value in use: Present value of future cash flows expected from an asset or CGU.

Review Questions

Short Answer Questions

1. State the two recognition criteria for property, plant and equipment.
2. When does depreciation begin?
3. Why is an active market relevant to the IAS 38 revaluation model?
4. Define a cash-generating unit.
5. How are fair-value changes on investment property treated under the fair value model?

Long Answer Questions

1. Explain the components of PPE cost and distinguish capital from revenue expenditure.
2. Compare the IAS 16 cost and revaluation models, including the treatment of increases and decreases.
3. Explain the recognition, measurement and amortisation requirements for intangible assets.
4. Discuss the accounting distinction between research and development expenditure.
5. Explain the purpose and operation of an IAS 36 impairment test, including CGU allocation and reversals.

Analytical / Application Questions

1. A factory contains significant structural, machinery and inspection components. Design an appropriate component-depreciation approach and explain the judgments required.
2. Evaluate how optimistic cash-flow forecasts, discount rates and useful lives could distort reported performance and propose governance controls.
3. A property changes from owner occupation to third-party rental. Analyse the evidence needed for the change in use and the accounting consequences under IAS 16 and IAS 40.

Multiple Choice Questions with Answers

Question 1

Equipment has an eligible initial cost of $585,000, residual value of $45,000 and a ten-year useful life. What is annual straight-line depreciation?

A. $45,000

B. $54,000

C. $58,500

D. $63,000

Correct Answer: B. $54,000

Question 2

Which expenditure is normally excluded from the initial cost of newly installed production equipment?

A. Delivery to the operating site

B. Installation and testing

C. Staff training

D. Present value of a legal restoration obligation

Correct Answer: C. Staff training

Question 3

Before revaluation, an asset has a gross carrying amount of $600,000 and accumulated depreciation of $240,000. Fair value is $450,000. Under proportionate restatement, what are the revised gross amount and accumulated depreciation?

A. $450,000 and $0

B. $600,000 and $150,000

C. $690,000 and $240,000

D. $750,000 and $300,000

Correct Answer: D. $750,000 and $300,000

Question 4

Which statement correctly describes subsequent measurement under IAS 38?

A. The cost model is available only when an active market exists.

B. The cost model is always available, while revaluation requires an active market.

C. All intangible assets must use the revaluation model.

D. Internally generated brands must be revalued annually.

Correct Answer: B. The cost model is always available, while revaluation requires an active market.

Question 5

When may development expenditure first be capitalised?

A. From the beginning of the research phase

B. When management approves the project budget

C. From the date all IAS 38 development recognition criteria are demonstrated

D. After the product generates its first sale

Correct Answer: C. From the date all IAS 38 development recognition criteria are demonstrated

Question 6

An asset has value in use of $760,000 and fair value less costs of disposal of $710,000. What is its recoverable amount?

A. $710,000

B. $735,000

C. $760,000

D. $1,470,000

Correct Answer: C. $760,000

Question 7

An asset’s carrying amount is $900,000 and recoverable amount is $760,000. What impairment loss is recognised?

A. $140,000

B. $190,000

C. $760,000

D. $900,000

Correct Answer: A. $140,000

Question 8

Weighted-average accumulated expenditure on a qualifying asset is $1,750,000 and the applicable general borrowing rate is 8%. Assuming sufficient borrowing costs were incurred, what amount is capitalised?

A. $14,000

B. $80,000

C. $140,000

D. $218,750

Correct Answer: C. $140,000

Question 9

How is a $120,000 increase in the fair value of investment property treated under IAS 40’s fair value model?

A. Recognised in profit or loss

B. Recognised only in a revaluation surplus

C. Deferred until the property is sold

D. Deducted from accumulated depreciation

Correct Answer: A. Recognised in profit or loss

Question 10

Which impairment loss is prohibited from reversal under IAS 36?

A. Impairment of machinery

B. Impairment of a finite-life patent

C. Impairment of a building

D. Impairment of goodwill

Correct Answer: D. Impairment of goodwill