CFA Level 1 Long-Lived Assets: Intangibles, Depreciation, Impairment & Derecognition
Acquisition of Intangible Assets: Three Categories
How an intangible asset is acquired determines how it gets recognized on the balance sheet. The CFA curriculum identifies three distinct categories with different accounting treatments.
| Category | Treatment | Key Details |
|---|---|---|
| Purchased (standalone) | Capitalize at cost (purchase price + directly attributable costs) | Recorded at fair value, which equals the purchase price in an arm’s-length transaction. Straightforward — no judgment calls here. |
| Internally developed | Depends on IFRS vs. US GAAP (see below) | Research costs are always expensed. Development costs differ: IFRS allows capitalization under strict conditions; US GAAP generally requires expensing. |
| Acquired in a business combination | Recognized at fair value at acquisition date | All identifiable intangibles are separately recognized. Excess purchase price over fair value of net identifiable assets = goodwill. |
Internally Developed Intangibles: IFRS vs. US GAAP
This is one of the most frequently tested IFRS vs. US GAAP differences in the entire FRA section.
| Phase | IFRS | US GAAP |
|---|---|---|
| Research costs | Expensed as incurred | Expensed as incurred |
| Development costs | Capitalized if six criteria are met (technical feasibility, intent to complete, ability to use or sell, probable future economic benefits, adequate resources, ability to measure costs reliably) | Expensed — with one exception: certain software development costs must be capitalized once technological feasibility is established |
Business Combinations and Goodwill
When one company acquires another, the acquirer uses the acquisition method:
- Allocate the purchase price to each identifiable asset and liability at fair value
- Any excess of purchase price over the fair value of net identifiable assets = goodwill
Goodwill is not amortized under either IFRS or US GAAP. Instead, it’s tested for impairment at least annually. This makes goodwill impairment testing one of the most judgment-heavy areas in financial reporting.
Depreciation Methods
Depreciation allocates the cost of a tangible asset over its useful life. Amortization does the same for intangibles with finite lives. The method chosen affects the pattern of expense recognition.
Three Main Depreciation Methods
| Method | Annual Expense | Pattern |
|---|---|---|
| Straight-Line | (Cost − Residual Value) / Useful Life | Equal expense each year. Most common in practice. Simplest to calculate. |
| Double-Declining Balance (DDB) | (2 / Useful Life) × Beginning Book Value | Higher expense in early years, declining over time. Ignores residual value in the formula (but stops depreciating when book value = residual value). |
| Units of Production | (Cost − Residual Value) × (Units Produced / Total Estimated Units) | Expense tied to actual usage. Best for assets whose wear depends on activity, not time (e.g., mining equipment, vehicles). |
Impact of Depreciation Method Choice
| Financial Item | Straight-Line (Early Years) | Accelerated (Early Years) |
|---|---|---|
| Depreciation expense | Lower | Higher |
| Net income | Higher | Lower |
| Total assets (book value of asset) | Higher | Lower |
| ROE and ROA | Higher initially | Lower initially, but higher in later years |
| Tax expense (if used for tax) | Higher initially | Lower initially (tax deferral benefit) |
| Total depreciation over asset life | Same — the method only changes the timing, not the total amount | |
Changing Estimates
Management can change the estimated useful life, residual value, or depreciation method. These are treated as changes in accounting estimates — applied prospectively (going forward), not retrospectively. Be alert: extending an asset’s useful life reduces annual depreciation expense and boosts short-term income, which is a tool for earnings management.
Impairment: IFRS vs. US GAAP
An asset is impaired when its carrying amount exceeds its recoverable amount. Impairment testing differs significantly between IFRS and US GAAP — this is among the most testable areas in LM 7.
Impairment of PP&E and Finite-Life Intangibles
| Feature | IFRS (IAS 36) | US GAAP |
|---|---|---|
| When to test | When indicators of impairment exist | When indicators of impairment exist |
| Recoverability test | Compare carrying amount to recoverable amount (higher of fair value less costs to sell and value in use) | Two-step: (1) Compare carrying amount to undiscounted future cash flows. (2) If not recoverable, measure loss as carrying amount minus fair value. |
| Impairment loss | Carrying amount − recoverable amount | Carrying amount − fair value (only if step 1 fails) |
| Key difference in measurement | Uses present value of future cash flows (value in use) — discounted | Uses undiscounted cash flows for the recoverability test, then fair value for the loss measurement |
| Reversal of impairment | Required if conditions improve (limited to original carrying amount before impairment) | Prohibited |
Impairment of Goodwill and Indefinite-Life Intangibles
| Asset | Testing Frequency | Key Rule |
|---|---|---|
| Goodwill | At least annually (both IFRS and US GAAP) | Tested at the reporting unit (US GAAP) or cash-generating unit (IFRS) level. Impairment is never reversed under either standard. |
| Indefinite-life intangibles | At least annually | Tested for impairment but not amortized. Under IFRS, impairment reversal is permitted; under US GAAP, it is not. |
Impact of Impairment on Financial Statements
| Statement | Impact |
|---|---|
| Income statement | Impairment loss reduces net income (non-cash charge) |
| Balance sheet | Carrying amount of asset is reduced; equity decreases through retained earnings |
| Cash flow statement | No impact on operating cash flow — it’s a non-cash charge (added back under indirect method) |
| Future depreciation | Lower carrying amount → lower future depreciation expense → higher future income |
| Activity ratios | Asset turnover improves (lower asset base) |
| Solvency ratios | Debt-to-equity worsens (lower equity) |
Derecognition (Disposal)
When a long-lived asset is sold, retired, or otherwise disposed of:
The gain or loss is reported on the income statement. It’s typically classified as a non-operating item. Analysts should note that gains on asset sales are non-recurring — they inflate current income but aren’t sustainable. Companies selling assets to boost short-term earnings is a reporting quality concern.
Assets Held for Sale
Under both IFRS and US GAAP, assets classified as “held for sale” are measured at the lower of carrying amount and fair value less costs to sell. They are not depreciated while classified as held for sale.
Revaluation Model (IFRS Only)
IFRS allows companies to revalue PP&E and intangible assets to fair value using the revaluation model. US GAAP requires the cost model only.
| Aspect | Revaluation Model (IFRS) | Cost Model (Both) |
|---|---|---|
| Measurement after acquisition | Fair value at revaluation date minus subsequent depreciation and impairment | Cost minus accumulated depreciation and impairment |
| Upward revaluation | Credited to other comprehensive income (revaluation surplus in equity) | Not permitted |
| Downward revaluation | Charged to profit or loss (unless reversing a previous upward revaluation) | Recognized only through impairment |
| Requirement | Must be applied to the entire class of assets, not selectively | N/A |
Presentation and Disclosure
Both IFRS and US GAAP require disclosure of depreciation methods, useful lives, gross carrying amounts, accumulated depreciation, and a reconciliation of beginning to ending balances. Analysts should use these disclosures to:
- Estimate the average age of assets: Accumulated Depreciation / Annual Depreciation Expense
- Estimate average useful life: Gross PP&E / Annual Depreciation Expense
- Estimate remaining useful life: Net PP&E / Annual Depreciation Expense
- Compare capitalization and depreciation policies across competitors
- Identify unusual changes in estimated lives that could signal earnings management
Connecting Long-Lived Assets to the Broader Curriculum
| Concept | Where It Connects |
|---|---|
| Capitalization vs. expensing | Financial Reporting Quality — aggressive capitalization inflates assets and income |
| Depreciation and capex | Free cash flow calculation; cash flow statement analysis |
| Deferred taxes from depreciation differences | Income Taxes — accelerated depreciation for tax vs. straight-line for books creates deferred tax liabilities |
| Goodwill impairment | Corporate Issuers — M&A value destruction; goodwill as a proportion of equity |
| Asset turnover ratios | Financial Reporting — DuPont decomposition of ROE |
Study Strategy for Long-Lived Assets
- Nail the three intangible categories. Purchased, internally developed, acquired in business combination — know the recognition and measurement rules for each.
- Know IFRS vs. US GAAP on R&D cold. IFRS capitalizes development costs; US GAAP expenses them (except software). This gets tested every exam.
- Practice depreciation calculations. Be able to calculate straight-line, DDB, and units of production. The DDB method trips people up — remember it ignores residual value in the formula but stops at residual value.
- Master the impairment frameworks. The IFRS one-step (recoverable amount with discounted cash flows) vs. the US GAAP two-step (undiscounted then fair value) is a guaranteed exam topic. Work through the numerical examples.
- Remember which reversals are allowed. IFRS: impairment reversal permitted for PP&E and finite-life intangibles, but never for goodwill. US GAAP: no reversals for any long-lived assets.
For all formulas, see the CFA Level 1 Formula Sheet. For broader exam strategy, check Tips & Strategies.
Key Takeaways
- Intangible assets are recognized differently depending on how they’re acquired: purchased (at cost), internally developed (IFRS allows development cost capitalization; US GAAP generally expenses), and in business combinations (at fair value, with excess = goodwill).
- Straight-line depreciation produces equal annual expense. Accelerated methods (DDB) front-load expense — lower early-year income but higher later-year income. Total depreciation is the same regardless of method.
- IFRS requires component depreciation; US GAAP permits it but doesn’t require it.
- IFRS impairment uses recoverable amount (higher of fair value less costs to sell and value in use, which uses discounted cash flows). US GAAP uses a two-step process with undiscounted cash flows for recoverability.
- IFRS requires reversal of impairment losses for PP&E and finite-life intangibles if conditions improve. US GAAP prohibits all impairment reversals.
- Goodwill is tested annually for impairment but never amortized. Impairment of goodwill is never reversed under either IFRS or US GAAP.
- Gains on asset sales are non-recurring — treat them accordingly when assessing earnings quality.
- Use disclosure data to estimate asset age, useful life, and remaining useful life. Compare policies across competitors to identify aggressive vs. conservative choices.
Frequently Asked Questions
What’s the difference between depreciation and impairment?
Depreciation is the systematic allocation of an asset’s cost over its useful life — it’s expected and planned. Impairment is an unexpected decline in an asset’s value below its carrying amount. Depreciation happens every period; impairment is recognized only when specific indicators trigger a test and the asset fails that test. Both reduce the carrying amount, but impairment is a non-recurring charge that reflects a fundamental change in the asset’s economic value.
Why does the IFRS impairment test trigger more write-downs than US GAAP?
Because IFRS compares the carrying amount to the present value (discounted) of future cash flows, while US GAAP’s first step uses undiscounted future cash flows. Discounting makes the recoverable amount smaller, so the carrying amount is more likely to exceed it. An asset can fail the IFRS test while passing the US GAAP test, as the numerical examples in the curriculum demonstrate.
Can goodwill impairment losses be reversed?
No — under both IFRS and US GAAP, goodwill impairment is permanent. This is an exception to the IFRS rule that allows impairment reversals for other long-lived assets. The logic is that any subsequent increase in value would represent internally generated goodwill, which accounting standards don’t permit to be recognized.
How does the depreciation method affect free cash flow?
It doesn’t — depreciation is a non-cash expense, so it has no direct impact on cash flow. However, it affects taxable income and therefore tax payments. Using accelerated depreciation for tax purposes (even while reporting straight-line to shareholders) creates a deferred tax liability but provides real cash savings in early years through lower tax payments. Free cash flow equals operating cash flow minus capital expenditures, and while depreciation doesn’t affect cash flow directly, the choice of tax depreciation method affects the timing of tax payments.
What should analysts look for in long-lived asset disclosures?
Key items to examine: changes in estimated useful lives (extending lives reduces depreciation and boosts income), capitalization policies compared to competitors (more aggressive = higher assets and income), the ratio of accumulated depreciation to gross assets (indicates how old the asset base is), goodwill as a percentage of total assets or equity (high goodwill means significant impairment risk), and whether goodwill impairment testing assumptions appear reasonable or skewed to avoid write-downs.
How does the IFRS revaluation model work for PP&E?
Under IFRS, companies can elect to carry PP&E at revalued amounts (fair value at revaluation date minus subsequent depreciation and impairment). Upward revaluations are credited to equity through other comprehensive income, not through the income statement. Downward revaluations go to profit or loss unless they reverse a previous upward revaluation. The election must apply to an entire class of assets. US GAAP does not permit the revaluation model — it requires the cost model only.