| Item | Impact |
| Cash flow | No impact due to no cash flow takes place |
| Assets | Lower |
| Liabilities | No impact |
| Equity | Lower due to lower income |
| Net income* | Lower as write-down is reported above the line |
| Profitability (ROE, ROA) | Lower as lower NI outweighs lower equity |
| Leverage (Debt/Equity) | Lower as lower NI outweighs lower equity |
| Liquidity (Current ratio) | No impact |
| Asset turnover | Higher due to lower assets |
Showing posts with label Analysis of Long-Lived Assets - Depreciation and Impairment. Show all posts
Showing posts with label Analysis of Long-Lived Assets - Depreciation and Impairment. Show all posts
Sunday, November 23
Impact of impairment:
Friday, November 21
Imparments
Assets are said to be impaired when their net carrying value, (acquisition cost – accumulated depreciation), is greater than the future undiscounted cash flow that these assets can provide and be disposed for.
Under U.S. GAAP impaired assets must be recognized once there is evidence of a lack of recoverability of the net carrying amount. Once impairment has been recognized it cannot be restored.
Analyst must know:
· Some foreign countries and the IASB allow companies to recognize increases in previously impaired assets.
Indicators:
· large decline in market value, physical change, use of the asset
· negative change in business climate
· large cut overruns
· forecast a large decline in LT profitability of the asset
· Changes in regulation and business climate
· Technology changes
Asset impairment occurs when there are:
· Recoverability test: (test of impariment)
· If the sum of undiscounted expected cash flows from asset for use plus disposal < value ="">write down net book value to fair market value {or PV of cash flows, if market value is not known}.
Measurement: carry value – fair market value
Rules of impairment:
· Based on evidence of irrecoverability.
· Write-down cannot be restored later in us even it recover later
· Write-down is reported above the line.
· Original cost is also written down.
· Write-down is not immediately tax deductible, and so creates deferred tax asset.
Under U.S. GAAP impaired assets must be recognized once there is evidence of a lack of recoverability of the net carrying amount. Once impairment has been recognized it cannot be restored.
Analyst must know:
· Some foreign countries and the IASB allow companies to recognize increases in previously impaired assets.
Indicators:
· large decline in market value, physical change, use of the asset
· negative change in business climate
· large cut overruns
· forecast a large decline in LT profitability of the asset
· Changes in regulation and business climate
· Technology changes
Asset impairment occurs when there are:
· Recoverability test: (test of impariment)
· If the sum of undiscounted expected cash flows from asset for use plus disposal < value ="">write down net book value to fair market value {or PV of cash flows, if market value is not known}.
Measurement: carry value – fair market value
Rules of impairment:
· Based on evidence of irrecoverability.
· Write-down cannot be restored later in us even it recover later
· Write-down is reported above the line.
· Original cost is also written down.
· Write-down is not immediately tax deductible, and so creates deferred tax asset.
Estimate the age of company assets
The disclosure found in a company's footnote section of its financial statements provides useful information about the age and possible usefulness of the assets held by the company. Using the information contained in the footnote, an analyst can estimate the total age of the assets held by a company.
Analyst can consider:
· Older asset may imply the company may loss competitive advantage and major capital expenditures will be required in the future.
There are three ways to estimate the average age of a company's fixed assets:
Average depreciable life = Gross asset value / Depreciation expense.
Average age = Accumulated depreciation / Depreciation expense.
Relative age (aka average age as a % of depr life) = accumulated depreciaton / ending gross asset value
Note:
· The estimations are affected by what is included in fixed assets (asset mix). Relative age can be used only when the assets analyzed use a straight-line depreciation method.
Analyst can consider:
· Older asset may imply the company may loss competitive advantage and major capital expenditures will be required in the future.
There are three ways to estimate the average age of a company's fixed assets:
Average depreciable life = Gross asset value / Depreciation expense.
Average age = Accumulated depreciation / Depreciation expense.
Relative age (aka average age as a % of depr life) = accumulated depreciaton / ending gross asset value
Note:
· The estimations are affected by what is included in fixed assets (asset mix). Relative age can be used only when the assets analyzed use a straight-line depreciation method.
Deprecation Methods
Process of allocating the cost of a long-lived tangible asset over its useful life.
Straight-line (SL) depreciation
SL depreciation = (Original cost - Salvage value) / Depreciable life.
Double declining balance (DDB) depreciation
Accelerate the depreciation by applying a constant rate (200%) to a decling book value
Not explicitly use salvage value but halt when salvage value is reached.
One of the common accelerated depreciation
DDB depreciation = 2 x [(Original cost – Accumulated depreciation) / Depreciable life].
Sum of year’s digits (SOYD) depreciation
One of the common accelerated depreciation.
Depreciation in year i = (n-i+1) (Original cost – salvage value) / SOYD
n - remaining depreciable life
SOYD = n! = Sum [1 + 2 + …+ n ].= (n)(n+1)/2
Note:
· As most assets generate more benefits in their early years, accelerated depreciation method is more appropriate.
Units-of-production (UOP) depreciation
UOP = (Original cost - Salvage value) x (Units produced in a given period / Total units expected over depreciable life).
Hours-of-service Depreciation
· Same concept as unit of production depreciation except that the depreciation expense is a function of total hours of service used during an accounting period.
Sunking fund depreication
· A decelerated depreciation method
· Must know cash flows and IRR produced by the asset
· Prohibited in US
Depreciation in year i = cash flow in year i –(IRR x book value at beginning of year i)
Effect of inflation
Economic logic requires that depreciation be based on the current cost of assets. But in some environments, firms continue to use historical costs, which understates expense and overstates earnings.
Accelerated depreciation delays taxes payable (like interest free loan), which is positive considering time value of money.
Economic depreciation
Allowance for the replacement of all asset
Straight-line (SL) depreciation
SL depreciation = (Original cost - Salvage value) / Depreciable life.
Double declining balance (DDB) depreciation
Accelerate the depreciation by applying a constant rate (200%) to a decling book value
Not explicitly use salvage value but halt when salvage value is reached.
One of the common accelerated depreciation
DDB depreciation = 2 x [(Original cost – Accumulated depreciation) / Depreciable life].
Sum of year’s digits (SOYD) depreciation
One of the common accelerated depreciation.
Depreciation in year i = (n-i+1) (Original cost – salvage value) / SOYD
n - remaining depreciable life
SOYD = n! = Sum [1 + 2 + …+ n ].= (n)(n+1)/2
Note:
· As most assets generate more benefits in their early years, accelerated depreciation method is more appropriate.
Units-of-production (UOP) depreciation
UOP = (Original cost - Salvage value) x (Units produced in a given period / Total units expected over depreciable life).
Hours-of-service Depreciation
· Same concept as unit of production depreciation except that the depreciation expense is a function of total hours of service used during an accounting period.
Sunking fund depreication
· A decelerated depreciation method
· Must know cash flows and IRR produced by the asset
· Prohibited in US
Depreciation in year i = cash flow in year i –(IRR x book value at beginning of year i)
Effect of inflation
Economic logic requires that depreciation be based on the current cost of assets. But in some environments, firms continue to use historical costs, which understates expense and overstates earnings.
Accelerated depreciation delays taxes payable (like interest free loan), which is positive considering time value of money.
Economic depreciation
Allowance for the replacement of all asset
Depreciation, Depletion and Amortization
Depreciation
The process of allocating the cost of a long-lived tangible asset over its useful life.
Depletion
The allocation of the value of a natural resource {also called wasting assets- crude oil, ore, etc.} as it is exploited. Use unit-of product for depreication.
Amortization
· Allocation of the cost of intangible assets over their life.
· Most firms use SL method
· Goodwill and other intangible assets with indefinite lives are not amortized but subject to impairment test at least annually. If the asset is impaired, the expense is recognized in the income statement.
The process of allocating the cost of a long-lived tangible asset over its useful life.
Depletion
The allocation of the value of a natural resource {also called wasting assets- crude oil, ore, etc.} as it is exploited. Use unit-of product for depreication.
Amortization
· Allocation of the cost of intangible assets over their life.
· Most firms use SL method
· Goodwill and other intangible assets with indefinite lives are not amortized but subject to impairment test at least annually. If the asset is impaired, the expense is recognized in the income statement.
Cost of long term asset and property, plant and equipment
Long term asset is reported in the carrying value or book value (cost minus accumulated depreciation)
Property, plant & equipment (PP&E)
· used in the production or sale of other assets
· distingish them from prepaid expense
· not held to sold (unlike inventory)
· longer useful life than current asset
Cost of plant
· The cost that was made prior and necessary for placing the asset in services
· Include transportation, installment cost, initial time cost, broker cost, legal fee for title transfer
· For constructing plant, also include capitalized cost e.g. material, labour, interest, reasonable amt of overhead, architectual fee.
Cost of land
· Include search cost, real estate commission, title transfer, back property tax, surveying, landscaping
Cost of intangible assets
· Allocated as prescribed by law
· Subject to amortization not exceeding 40 years and based on SL method
Property, plant & equipment (PP&E)
· used in the production or sale of other assets
· distingish them from prepaid expense
· not held to sold (unlike inventory)
· longer useful life than current asset
Cost of plant
· The cost that was made prior and necessary for placing the asset in services
· Include transportation, installment cost, initial time cost, broker cost, legal fee for title transfer
· For constructing plant, also include capitalized cost e.g. material, labour, interest, reasonable amt of overhead, architectual fee.
Cost of land
· Include search cost, real estate commission, title transfer, back property tax, surveying, landscaping
Cost of intangible assets
· Allocated as prescribed by law
· Subject to amortization not exceeding 40 years and based on SL method
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