Non-current assets are assets other than those which meet the criteria for classification as current assets. They are also referred to as long-term assets and long-lived assets. Typical non-current assets include property, plant, and equipment (PPE), investment property, intangible assets, goodwill, financial assets, and deferred tax assets.
Property, plant and equipment
Property, plant, and equipment (PPE) represent tangible assets used by a company in its operations over a period longer than one year. These include land, buildings, machinery, etc. They are accounted for using the cost model, but IFRSs also allow the revaluation model.
Under the cost model, PPE is carried at amortized cost which equals historical minus accumulated depreciation and impairment. Historical cost includes all costs incurred in making an asset operable and may include purchase price, delivery costs, installation costs, etc. Depreciation represents the process through which an asset’s cost is written down over the period.
Impairment of PPE
Impairment refers to an unanticipated decline in an asset’s value. It occurs when an asset’s carrying amount exceeds its recoverable value. Under IFRS, the recoverable amount is the higher of fair value less cost to sell and value in use. Value is use is the present value of future cash flows that are expected to be generated using the asset.
Impairment losses are charged to the income statement. IFRSs, but not US GAAP, allow reversal of impairment loss.
Under the revaluation model, an asset’s carrying value equals fair value minus accumulated depreciation since the last valuation. Changes in value under the revaluation model are reflected either in equity or in profit and loss.
IFRS labels items of PPE which are held to earn rental income or capital appreciation (or both) as an investment property and allows companies to account for it using either the cost model or the fair value model.
Cost model vs fair value model
Under the cost model, investment property is held at historical cost less accumulated depreciation and accumulated impairment. Under the fair value model, investment property is carried at fair value with any changes reflected in the profit and loss.
Intangible assets are identifiable non-monetary assets without physical substance. An identifiable asset is one that can be separated from other assets. Examples of intangible assets include patents, copyrights, etc.
Cost model vs revaluation model for intangible assets
In accounting for intangible assets, IFRS allows companies to use either the cost model or revaluation model (if an active market for the intangible). US GAAP doesn’t allow the revaluation model. A company amortizes an intangible asset with a finite useful life on a systematic basis. At least annually, the company reviews the amortization method, the useful life and whether any impairment has occurred.
Intangible assets with indefinite useful life
In case of an intangible asset with an indefinite useful life, a company records no amortization but reviews the assumption of indefinite life and any impairment at least annually. While some analysts assign zero value to all intangible assets, a better approach to look at each individual asset. In certain situations, a company may record an internally-generated intangible asset but in most cases, it doesn’t assets such as reputation, management skill, etc., but these are valuable, and at least in theory, a company’s stock price reflects their value.
Treatment of research and development costs under IFRS and US GAAP
Under IFRS, identifiable intangible assets are recorded on the balance sheet if it is probable that economic benefits will flow to the entity and the cost of the asset can be measured reliably. Companies must separately identify the research phase and development phase and capitalize expenses incurred in the development phase if certain criteria (such as technological feasibility, ability to sell the resulting asset, etc.) have been met. All other costs are expensed.
Under US GAAP, no expenses incurred on internally generated goodwill may be capitalized. Typical items expensed include internally generated brands, mastheads, etc., startup costs, training costs, advertising and promotion, relocation costs, etc. When intangible assets are acquired when another company is acquired, they are capitalized separately from goodwill if they arise from contractual rights (such as licensing), other legal rights (such as patents), or have the ability to be separated and sold (such as customer lists).
Under both IFRS and US GAAP, goodwill arising from an acquisition is capitalized. It equals the difference between the amount an acquiring company pays for a target company (called purchase consideration) over the fair value of the target company’s net assets.
When the fair value of net assets exceeds the purchase consideration, the transaction is called a bargain purchase and its effect is recorded in profit and loss.
Goodwill arises because (a) certain items are not reflected in the target company’s financial statements, (b) target company’s expenditure on research and development may not have resulted in recognition of an asset, and (b) the acquiring company may be able to tap certain strategic advantages and synergies.
Accounting goodwill vs economic goodwill
While some professionals look at goodwill as an indication of expected future excess returns, others look at it with skepticism. Analysts should focus on economic goodwill. Goodwill not amortized but is tested for impairment annually. Companies are required to provide significant disclosures related to goodwill. Analysts need to look at goodwill carefully because it is affected significantly by management judgment. Analysts often adjust financial statements to exclude the impact of goodwill by removing goodwill from the balance sheet and any associated impairment from the income statement.
A financial instrument is a contract that gives rise to a financial asset of one entity or financial liability or equity investment of another entity. Examples of financial assets include investments in stocks or bonds of another company. Some assets, such as derivatives, may be classified as either a financial asset or a liability depending on their value. Subsequent to initial recognition, a financial asset is carried either at fair value or amortized cost.
Amortized cost vs held to maturity
Under IFRS, financial assets are subsequently measured at amortized cost if the asset’s cash flows occur on specified dates and consist solely of principal and interest and if the business model is to hold the asset to maturity. In US GAAP, such a category is called held-to-maturity. Examples include bonds, loans to other companies, etc. Financial assets not measured at amortized cost are measured at fair value. Any realized gains or losses are reflected in profit and loss. However, there are two ways in which the associated unrealized gains or losses may be recorded: in profit and loss, or other comprehensive income.
Fair value through other comprehensive income (FVOCI) vs available for sale
Under IFRS, unrealized fair value changes in debt investments are reflected in the fair value through other comprehensive income (FVOCI) if the business model’s objective request both collection of cash flows and selling the financial asset. However, a company can also designate an equity investment at fair value through other comprehensive income (but irrevocably). The US GAAP equivalent is available for sale investments (but which is exclusive to debt securities).
Fair value through profit and loss (FVTPL) and held for trading
Under IFRS, unrealized gains and losses are reflected in fair value through profit and loss (FVPL) if they are neither accounted for under amortized cost nor FVOCI. Further, IFRS allows companies to designate some assets as FVTPL irrevocably. The US GAAP equivalent is the trading securities. Under US GAAP, all equity investments (other than those resulting in significant influence) are measured at fair value with any unrealized gains or losses taken to profit and loss. US GAAP also allows debt securities that are acquired with the intent of selling it rather than holding it, to be classified as trading securities.
Deferred tax assets
A deferred tax asset arises when tax authorities charge a tax in the current year on income which would appear on the income statement in future periods or defers any deduction of expenses currently included in the income statement to some future period. This causes a company’s taxable profit in the current period to exceed its accounting profit resulting in the company paying higher taxes today. This excess payment of tax is recorded as an asset and carried over to future periods for better matching of revenues and expenses.
Deferred tax assets also arise from carrying forward unused tax losses and credits. However, these should be recorded only if sufficient future taxable profits are available in the future.