Long-Term Assets

Phase 1: Accounting · The Language of Business · Week 11 · ~20 hours (module work)

The statement-linkage capstone showed you how the three statements lock together, and the work on revenue, receivables and inventory showed you how revenue and inventory land on them. This week takes on the biggest block on most industrial balance sheets. That's long-term assets: property, plant & equipment (PP&E), intangibles and goodwill. It's also your first serious meeting with a theme that runs all through Phase 2. Management chooses how costs travel through time, and every one of those choices moves reported profit. Liabilities and financing come next.

Learning objectives

By the end of the week you can:

1. Decide whether any given expenditure should be capitalized or expensed, and quantify, year by year, what each choice does to EBIT, EBITDA, net income, CFO, and total assets.
2. Build the capitalized cost of a PP&E item from an invoice and a fact pattern (duties, freight, installation, trial runs, dismantling provisions), and state which costs must stay out.
3. Componentize an asset per IAS 16 / Ind AS 16 / Schedule II, and compute capitalized borrowing costs with both specific and general borrowings, including the IFRS-vs-US-GAAP netting difference.
4. Depreciate one asset under straight-line, written-down-value/declining-balance, and units-of-production, reconcile the three totals, and apply a change in useful life or salvage value prospectively.
5. Run the analyst's useful-life and salvage screens: depreciation rate, capex/depreciation, and average-age arithmetic, and estimate how much a life extension inflated EBIT.
6. Apply the R&D rules under US GAAP (ASC 730, with the ASC 985-20 / 350-40 software nuances) and IFRS/Ind AS (IAS 38 / Ind AS 38 development criteria), and execute the Damodaran R&D capitalization adjustment to restore comparability.
7. Execute both impairment models: the US two-step (undiscounted recoverability screen, then fair value, no reversal) and the IFRS/Ind AS recoverable-amount model (higher of value-in-use and fair value less costs of disposal, reversals allowed except goodwill), applied to the same fact pattern to explain why the answers differ.
8. Explain where goodwill comes from, how the impairment-only regime works in each framework, and read a goodwill write-off as a verdict on capital allocation.

Prerequisites & connections

Builds on. M1.01 (journal entries for purchases, depreciation, disposals, impairments). M1.02 (where D&A and impairment appear in the P&L layers). M1.03 (PP&E, accumulated depreciation as a contra asset, intangibles, goodwill). M1.04 and M1.05 (capex in CFI, D&A and impairment as non-cash add-backs in CFO). M1.06, where you've already seen cost capitalization once. Inventory absorbs cost until a sale releases it to COGS, and PP&E is the same idea stretched over years.

Feeds into. M1.08 (leased assets, and book-vs-tax depreciation creating deferred taxes). M1.09 (consolidation and purchase price allocation, where goodwill is born, previewed here). M1.10 (reading these notes in a real filing). M1.11 (the revaluation model and investment property). M2.03 (ROIC, where invested capital is mostly what this week measures). M2.06 (improper capitalization, previewed via WorldCom). M3.04 (forecasting capex). Phase 5 (asset-heavy sector playbooks).

Spine connection. Question 2 of the five asks whether ROIC is durably above the cost of capital. Invested capital is its denominator, and depreciation is inside NOPAT. If management games asset lives or capitalization, both halves of the master ratio are wrong, and this week you learn to check.

Core teaching content

10. Where all this lives in the statements and filings

Trace one capex rupee through the loop, the same reflex you built in the statement-linkage capstone. Cash leaves through CFI as capex. It then sits in PP&E or CWIP on the balance sheet. From there it's released into the P&L as depreciation, or it waits in CWIP. It's added back in indirect CFO as non-cash, and accumulated depreciation (a contra asset) keeps growing until a disposal clears both sides. Impairments shortcut the release. Capitalized interest re-routes a financing cost into the same pipe, and capitalized development does the same for engineering payroll.

When you open a real filing, look in these places. You'll do this in the mini-project.

• US 10-K: significant-accounting-policies note (useful lives, capitalization policies), PP&E note, goodwill-and-intangibles note (carrying amounts by reporting unit, impairment history), MD&A capex discussion, and the cash-flow statement's capex and D&A lines.
• Indian annual report (Schedule III + Ind AS): start with the PP&E note. It carries the full gross block / accumulated depreciation / net block reconciliation (additions, disposals, impairments), more granular than typical US disclosure. Then read CWIP with ageing and "Intangible assets under development" with ageing. Check the borrowing-costs-capitalized disclosure, and compare useful lives against Schedule II, where deviations must be justified. Finish with CARO 2020's clauses on PP&E records, physical verification and title deeds.

Common mistakes & how experts think differently

1. "Depreciation approximates the asset losing value." It doesn't. It's cost allocation, and it's blind to market value. The office building appreciates while its book value falls, and both are "correct." It follows that net book value isn't what the assets are worth, and price-to-book isn't a valuation shortcut for asset-heavy firms. Phase 3 comes back to this properly.
2. "Capitalizing vs expensing only changes timing, so it washes out." That's true for a single asset in a static firm, and false in every real case you'll meet. With growing spend, capitalization keeps profit permanently higher, as the growth table in the capitalize-or-expense section showed. Experts ask two things. What's the capex growth rate? And what would EBIT be if this item were expensed?
3. "EBITDA is immune to these choices." It's the reverse. EBITDA is the most exposed metric, because capitalization removes the cost from opex entirely and EBITDA leaves out the depreciation echo. Two identical businesses, one capitalizing development and one expensing it, can report wildly different EBITDA margins. Scan the "capitalized costs" in the notes before you trust an EBITDA comp.
4. "Impairments are non-cash, so they don't matter." They're non-cash now, and they were very much cash then. A write-off re-prices cash already spent and revises management's own forecasts downward, and it often comes before a cash restructuring. Leave the charge out of this year's earnings arithmetic if you like. Just don't ignore what it tells you.
5. "A goodwill write-off destroyed shareholder value today." The value died earlier, usually when the deal was signed, and the market typically repriced long before the auditors did. Experts use a write-off to grade management, and as a base-rate input for how much to discount this team's future deals.
6. "US GAAP and IFRS impairment are basically the same." Because of the undiscounted screen, US GAAP can carry an asset that everyone agrees is worth less than book, as in scenario A. The no-reversal rule means a US impairment in a downturn permanently lowers the depreciation base, which flatters future earnings. That's one reason "big bath" write-offs cluster in years that are already terrible. On the IFRS/Ind AS side, reversals mean a profit spike can be an accounting echo of a cycle turn. Same facts, different earnings paths, so adjust before comparing.
7. "R&D-heavy companies have weak profitability." That's a measurement artifact. Expensed R&D depresses current profit and makes the resulting asset vanish. Run the capitalization adjustment from the intangibles-and-R&D section before you compare a pharma or software firm's ROIC with an industrial's.
8. "Longer lives are always aggressive; impairments always mean bad management." Knee-jerk cynicism is as lazy as credulity. Sometimes assets really do last longer, thanks to better maintenance or different duty cycles. Sometimes impairments reflect plain bad luck, like regulation or a pandemic. Experts triangulate across peer lives, asset economics, how specific the disclosure is and management's track record. Then they quantify the effect and move on. Go by the number, and leave the adjective out.
9. Confusing depreciation with a cash outflow. Capex is the cash event, and depreciation is its accounting shadow. In any one year the two can diverge hugely. In growth, capex ≫ D&A, and in harvest, capex ≪ D&A. That gap tells you where the company is in its investment cycle.
10. Treating CWIP as inert. In capital-intensive Indian filings, experts read the CWIP ageing table first. A project stuck >3 years, with capitalized interest compounding inside and no commissioning date, is tomorrow's impairment queuing up.

Worked examples

Worked example 1: Component lifecycle with journal entries

Deccan Foods (synthetic, Ind AS) installs a bottling line for ₹30 crore and componentizes:

Purchase: Dr PP&E 30.0 / Cr Bank 30.0. Each year: Dr Depreciation expense 4.0 / Cr Accumulated depreciation 4.0.

Blend it into one asset (₹30 crore, 10-year life, 10% residual) and you'd charge (30 − 3)/10 = ₹2.7 crore. That understates early-years depreciation by ₹1.3 crore, about 33% of the proper charge, and overstates EBIT by the same amount.

End of year 4: control system replaced for ₹5 crore. The old component is fully depreciated, so derecognize it (Dr Accumulated depreciation 4.0 / Cr PP&E 4.0, no gain or loss). Then capitalize the new one (Dr PP&E 5.0 / Cr Bank 5.0) and depreciate it at ₹1.25 crore/year over its own 4-year life. Look at what componentization bought you. Now the replacement shows up as capex, cleanly visible in CFI. It isn't a "repair" smuggled through opex, and it isn't a lumpy expense shock either. Depreciation from year 5 (1.80 + 1.20 + 1.25 = ₹4.25 crore) keeps tracking the true consumption pattern.

Worked example 2: Impairment, then the cycle turns: reversal vs no-reversal

Go back to the machine from the impairment section, Scenario B: carrying ₹100 crore, 5 years left, straight-line to nil. At end-Year 0, Ind AS wrote it down to ₹72 crore (recoverable amount) and US GAAP wrote it down to ₹65 crore (fair value).

Years 1 and 2, depreciation on the new bases. Ind AS charges 72/5 = 14.4/yr, so the carrying amount at end-Year 2 = 72 − 28.8 = ₹43.2 crore. US GAAP charges 65/5 = 13.0/yr, leaving ₹39.0 crore. Notice that both now charge less depreciation than the original ₹20 crore/yr. An impairment raises all future reported margins. So "big bath" write-offs cluster in years that are already ruined.

End-Year 2: demand recovers. Recoverable amount estimates rebound. The ceiling for any Ind AS reversal is the carrying amount had no impairment occurred: 100 − 2×20 = ₹60 crore.

Ind AS then depreciates the written-up amount over the remaining 3 years. In case ii that's 60/3 = ₹20/yr, back on the original schedule, and that's what the cap is designed to do. For the analyst, an Ind AS/IFRS company coming out of a downcycle can post a profit spike that's pure accounting echo. Strip out reversals before you applaud the "turnaround." They're disclosed, usually in exceptional items. A US company on the same facts shows no spike, but it enjoys permanently thinner depreciation.

Worked example 3: Goodwill: birth, test, and the write-down waterfall

Bharat Foods (synthetic, Ind AS) buys Zesty Snacks for ₹1,000 crore. Here's the purchase price allocation, a preview of what you'll do properly with equity. Fair value of identifiable net assets = PP&E 450 + brand intangible 150 + net working capital 100 = ₹700 crore, so goodwill is ₹300 crore. The brand gets recognized because it was purchased. Zesty itself could never have booked it.

Two years later the Zesty CGU is struggling. In the impairment test, carrying amounts are PP&E 400 + brand 100 + goodwill 300 = ₹800 crore. Recoverable amount is the higher of VIU at ₹470 crore and FVLCD at ₹430 crore, so it's ₹470 crore.

Ind AS / IFRS waterfall. Total loss = 800 − 470 = ₹330 crore, applied in this order:

1. Goodwill absorbs it first: −300, which takes goodwill to nil.
2. The remaining ₹30 crore spreads pro-rata over the other assets' carrying amounts (400:100 = 4:1). PP&E takes −24 and goes to 376, and the brand takes −6 and goes to 94. Check the floor: neither falls below its own recoverable amount or zero, so you're fine.

US GAAP on the same facts. Assume the reporting unit is the CGU, with fair value of ₹470 crore. Loss = carrying − fair value = 330, but it's capped at the goodwill balance, so the impairment is ₹300 crore. PP&E and the brand keep their carrying amounts. They get their own ASC 360 test separately, which may or may not trigger. Same economics, yet there's ₹30 crore of difference in booked loss. That difference becomes permanent if Zesty later recovers, since Ind AS can reverse the PP&E and brand portion (never the goodwill) while US GAAP reverses nothing.

What should you make of it? Two years from acquisition to a full goodwill wipe-out means the deal price carried assumptions that failed almost at once. Grade the acquirer's management accordingly, and check whether they're still doing deals.

Worked example 4: The depreciation-quality screen on two peers

Alpha Forge and Beta Forge (synthetic) are same-sector, same-scale forging companies. From their PP&E notes and P&Ls (₹ crore):

Compute the screen:

Now quantify the flattery. At Alpha's 6.5% rate, Beta's depreciation would be 6.5% × 2,000 = ₹130 crore against ₹84 reported, so Beta's EBIT is overstated by ~₹46 crore (~15%) on a like-for-like basis. Then add the strategic read. Old assets plus capex/dep < 1 means a capex wall is coming, and future FCF will be far below today's. You'd want management, or the notes, to tell you when lives were last revised and why. Ask what Schedule II lives say for this class and what deviation is disclosed. Then ask for the maintenance-capex guidance. You've just done, in miniature, what a quality-of-earnings analyst does in Phase 2.

Worked example 5: Three methods on one asset, and the EBIT path each one chooses (India)

Grantha Ceramics (synthetic, Ind AS) installs a tunnel kiln for ₹40 crore, salvage ₹4 crore (10%), useful life 6 years, rated for 180,000 firing-hours (used 40k / 35k / 30k / 30k / 25k / 20k across the six years). The kiln throws off operating profit before its own depreciation (EBITDA) of ₹20 crore a year. Watch what the method choice, not the economics, does to reported EBIT.

SL = (40 − 4)/6 = 6.0. Double-declining rate = 2/6 = 33.3% on opening book value, floored at the ₹4 crore salvage in year 6. The formula charge of 1.756 would breach it, so it's cut to 1.267. The Companies-Act WDV rate would be 1 − (4/40)^(1/6) ≈ 31.9%, close to the double-declining 33.3% used here. UoP = (40 − 4)/180,000 = ₹2,000 per firing-hour. Check the units before you trust that rate. ₹36 crore is ₹36,00,00,000, and ₹36,00,00,000 ÷ 180,000 hours = ₹2,000 an hour, which is what the table's own year 1 uses (40,000 hours × ₹2,000 = ₹8.00 crore). All three release the same ₹36 crore of depreciable cost, and only the path differs.

Now subtract each from the ₹20 crore EBITDA:

It's the same kiln, the same ₹20 crore of yearly cash operating profit and the same ₹84 crore of lifetime EBIT. Yet Year-1 EBIT is ₹14 crore under straight-line, ₹12 crore under units-of-production and only ₹6.67 crore under WDV. Nothing about the business changed. Only the memo to the auditor did.

The analyst point. Worked example 4's life-stretching was a game. This is a wholly legitimate choice, and it still wrecks cross-firm comparability. Two identical competitors can report early-year EBIT far apart purely from front-loaded versus straight depreciation, and they converge only over the asset's life. ROIC can diverge the same way, since depreciation is inside NOPAT. So before comparing two capital-heavy firms' early-year margins or returns, read each depreciation-policy note. Where the methods differ, re-spread both onto one method. Method choice is supposed to mirror how the benefit is consumed, and UoP is arguably the most faithful for a kiln whose refractory wears by firing-hours. In practice, though, straight-line dominates listed books in both markets for its smoothness.

Worked example 6: A US SaaS firm capitalizes its engineers (ASC 350-40) (US)

Northwind Cloud, Inc. (synthetic, US GAAP) runs a subscription platform. Under ASC 350-40 (internal-use / SaaS software) it capitalizes the application-development-stage payroll of its engineers as "capitalized software development." Qualifying spend is $80m in Year 1 and grows 20% a year ($96m, $115.2m, $138.24m). Each vintage is amortized straight-line over 4 years, beginning the year it's spent. A product-software rival that reaches technological feasibility late (ASC 985-20) expenses nearly identical spend. Three lines move.

Northwind's advantage shrinks as older vintages' amortization stacks up, but it never closes while spend keeps growing. Reported profit stays permanently above the expensing rival's. It's the engine from the capitalize-or-expense section, in dollars.

Here's the Year-1 divergence in full, with revenue of $500m, all other cash operating costs of $350m and tax at 25%:

Two identical businesses and one accounting choice give you a 16-point EBITDA-margin gap and nearly double the net income. Watch for a "capitalized software development" line in the notes and capex that's really payroll. Check the amortization period too, because a longer life means a slower drip and a fatter current profit. To fix it, port the JLR adjustment from the intangibles-and-R&D section to software. Deduct capitalized development from EBITDA and add the unamortized balance to invested capital before you compare Northwind's margins or ROIC with a peer that expenses. Don't trust a SaaS EBITDA comp until you've read both capitalization policies.

Practice set

Work each problem fully before you open its solution. Write first, then peek. Problems 1 to 3 are guided and 4 to 9 independent. Problems 10 to 12 are timed.

P1 (guided: classify). Capitalize, expense, or exclude-from-asset? (a) Repainting the office block, ₹12 lakh. (b) New conveyor motor that doubles line throughput, ₹40 lakh. (c) Annual statutory safety inspection, ₹6 lakh. (d) Customs duty on an imported press. (e) IGST on the press, available as input credit. (f) Training operators on the press. (g) Concrete foundation poured for the press. (h) Launch advertising for products made on the press.

Solution. (a) Expense. It restores the existing condition. (b) Capitalize. It's a betterment that enhances capacity beyond the original standard. (c) Expense. It's recurring and maintains current operation. (d) Capitalize. It's a non-refundable purchase tax, part of bringing the asset to its condition and location. (e) Exclude. It's refundable via credit, so it's a receivable from the government and not part of the asset's cost. (f) Expense. Skill resides in employees, and there's no controllable future benefit. (g) Capitalize, as directly attributable site preparation. (h) Expense. Advertising never qualifies, however "essential" it seems.

P2 (guided: cost build). Ajanta Fabrication buys a laser cutter: invoice ₹80.00 lakh less 5% trade discount; customs duty ₹9.12 lakh; refundable IGST ₹13.68 lakh; freight and insurance ₹2.40 lakh; installation ₹1.90 lakh; trial-run costs ₹1.10 lakh; operator training ₹1.50 lakh; present value of a contractual dismantling obligation ₹2.48 lakh. Compute capitalized cost and give the journal entry.

Solution. Invoice net of discount = 80.00 × 0.95 = 76.00. Capitalize 76.00 + 9.12 + 2.40 + 1.90 + 1.10 + 2.48 = ₹93.00 lakh. Leave out the refundable IGST of 13.68. Training of 1.50 is expensed. Book it as Dr PP&E 93.00, Dr GST input credit 13.68, Dr Training expense 1.50, Cr Bank/Payables 105.70, Cr Provision for dismantling 2.48. Check: 93.00 + 13.68 + 1.50 = 108.18 = 105.70 + 2.48.

P3 (guided: SL and WDV). A machine costs ₹18 crore, salvage ₹3 crore, life 6 years. Compute (i) straight-line depreciation, (ii) years 1 and 2 under double-declining balance, and (iii) the Companies-Act-style WDV rate implied by the life and salvage, with year-1 depreciation at that rate.

Solution. (i) (18 − 3)/6 = ₹2.5 crore/yr. (ii) DDB rate = 2/6 = 33.33% on book value, with salvage ignored in the base. Y1 = 18 × 1/3 = 6.0, leaving BV 12.0. Y2 = 12 × 1/3 = 4.0, leaving BV 8.0. So far the 3.0 salvage floor isn't breached. (iii) rate = 1 − (3/18)^(1/6) = 1 − (0.1667)^0.1667 ≈ 1 − 0.7418 = 25.8%, so Y1 = 18 × 25.8% ≈ ₹4.65 crore. Y2 would be (18 − 4.65) × 25.8% ≈ 3.44.

P4 (independent: estimate change). A packaging machine cost ₹9 crore, salvage ₹1 crore, life 8 years, straight-line. At the start of year 4, management revises remaining life to 3 years and salvage to ₹0.6 crore. Compute depreciation for years 1–3 and for year 4 onward, and state how prior years are treated.

Solution. Years 1 to 3: (9 − 1)/8 = ₹1.0 crore/yr, so carrying at the start of year 4 = 9 − 3 = ₹6 crore. New charge = (6 − 0.6)/3 = ₹1.8 crore/yr for years 4 to 6. Prior years aren't restated, because a change in estimate is prospective under IAS 8 and Ind AS 8, and the same under US GAAP. The revision itself is information worth disclosing, so ask what changed.

P5 (independent: borrowing costs). Suvarna Chemicals (FY Apr–Mar) spends ₹240 crore on a qualifying plant on 1 July. A specific loan of ₹100 crore at 10% was drawn on 1 July; ₹40 crore of it sat idle for the first three months earning 6%. General borrowings: ₹300 crore at 8% and ₹100 crore at 12%, outstanding all year. Compute capitalized borrowing costs under Ind AS 23, and state the US GAAP figure.

Solution. Average accumulated expenditure = 240 × 9/12 = 180. For the specific layer, interest = 100 × 10% × 9/12 = 7.50 and investment income = 40 × 6% × 3/12 = 0.60. Ind AS nets them: 7.50 − 0.60 = 6.90. The weighted-average AAE funded by the specific loan = 100 × 9/12 = 75, so general-funded AAE = 180 − 75 = 105. The capitalization rate on general debt = (300×8% + 100×12%) ÷ 400 = 36/400 = 9.0%, so the general layer = 105 × 9% = 9.45. Ind AS total = 6.90 + 9.45 = ₹16.35 crore, well below the cap of total interest incurred, 43.5. US GAAP doesn't net the 0.60, so it gets 7.50 + 9.45 = ₹16.95 crore.

P6 (independent: the profit machine). Trellis Systems spends on platform development ₹60 crore in Y1, growing 25%/yr (₹75 crore Y2, ₹93.75 crore Y3). Policy A expenses it; Policy B capitalizes with 3-year straight-line (starting the year of spend). For each year compute the P&L charge under both policies and the EBIT advantage of capitalizing; state the Y1 effect on EBITDA and CFO.

Solution. Capitalized-route depreciation is Y1 = 60/3 = 20, Y2 = 20 + 25 = 45 and Y3 = 20 + 25 + 31.25 = 76.25.

The advantage shrinks, but it never dies while spend grows. Y1 EBITDA is +₹60 crore higher under capitalization, because the entire cost leaves opex and depreciation is below the EBITDA line. Y1 CFO is also +₹60 crore higher, since the outflow is reported in CFI instead. Total cash is identical.

P7 (independent: R&D adjustment). Kestrel Pharma reports EBIT ₹500 crore and invested capital ₹2,000 crore, expensing all R&D. Spend: Y1 ₹300, Y2 ₹360, Y3 (current) ₹420 crore. Capitalize R&D with a 3-year life, amortization starting the year after spend. Compute the end-Y3 research asset, Y3 amortization, adjusted EBIT, adjusted invested capital, and ROIC before vs after (25% tax).

Solution. Research asset = 420×(3/3) + 360×(2/3) + 300×(1/3) = 420 + 240 + 100 = ₹760 crore. Y3 amortization = (300 + 360)/3 = ₹220 crore. Adjusted EBIT = 500 + 420 − 220 = ₹700 crore. Adjusted IC = 2,000 + 760 = ₹2,760 crore. ROIC: unadjusted = 500×0.75/2,000 = 18.8%, adjusted = 700×0.75/2,760 = 19.0%. Here the two effects nearly cancel. ROIC doesn't always fall or always rise, and you can't know which until you run the numbers.

P8 (independent: impairment, both regimes). A plant: carrying ₹80 crore, 4 years of remaining life, pre-tax discount rate 12% (4-year annuity factor 3.037). Scenario 1: expected cash flows ₹21 crore/yr; fair value less costs of disposal ₹66 crore. Scenario 2: cash flows ₹18 crore/yr; FVLCD ₹50 crore. Compute the impairment loss under US GAAP and Ind AS in each scenario.

Solution. Scenario 1: undiscounted CF = 84 ≥ 80, so US GAAP shows no impairment. Under Ind AS, VIU = 21 × 3.037 = 63.8 and recoverable = max(63.8, 66) = 66, so the loss = 80 − 66 = ₹14 crore. Scenario 2: undiscounted CF = 72 < 80, so US GAAP measures to fair value and the loss = 80 − 50 = ₹30 crore. Under Ind AS, VIU = 18 × 3.037 = 54.7 and recoverable = max(54.7, 50) = 54.7, so the loss = 80 − 54.7 = ₹25.3 crore. On the same facts, US GAAP books nothing where Ind AS books 14, then books 30 where Ind AS books 25.3. The US loss comes later, and it comes bigger.

P9 (independent: reversal cap). Under Ind AS, equipment carried at ₹90 crore (6 years left, straight-line to nil) is impaired to ₹66 crore. Two years later the impairment's cause has reversed. Compute the maximum carrying amount after reversal and the P&L gain if the recoverable amount is now (i) ₹52 crore, (ii) ₹65 crore. What would US GAAP show?

Solution. Post-impairment depreciation = 66/6 = 11/yr, so carrying after two years = 66 − 22 = 44. The ceiling is the carrying amount had no impairment occurred, 90 − 2×15 = 60. (i) Recoverable 52 < 60, so write up to 52 for a gain of ₹8 crore. (ii) Recoverable 65 > 60, so the cap binds. Write up to 60 for a gain of ₹16 crore. US GAAP allows no reversal in either case, and carrying stays on its post-impairment schedule.

P10 (timed, 12 min: goodwill end to end). Nivara Consumer pays ₹800 crore for Dhruv Beverages; fair value of identifiable net assets is ₹620 crore. Two years later the Dhruv CGU (goodwill 180, PP&E 480, customer intangible 240, total ₹900 crore) has a recoverable amount of ₹660 crore. (i) Goodwill at acquisition. (ii) Allocate the Ind AS impairment. (iii) The US GAAP loss if the reporting unit's fair value is ₹660 crore. (iv) One sentence: what should an analyst conclude?

Solution. (i) 800 − 620 = ₹180 crore. (ii) Loss = 900 − 660 = 240. Goodwill takes −180, down to nil. The remaining 60 goes pro-rata over PP&E:intangible = 480:240 = 2:1, so PP&E takes −40 (to 440) and the intangible −20 (to 220), subject to each asset's own floor. (iii) Under US GAAP the shortfall of 240 is capped at goodwill, giving ₹180 crore. The other assets are untouched, and ASC 360 tests them separately. (iv) The acquisition's economics failed management's own assumptions within two years. Treat the team's future deal announcements and "synergy" claims with priced-in skepticism.

P11 (timed, 10 min: the life-extension screen). From a filing: gross PP&E ₹3,000 crore; accumulated depreciation ₹990 crore; depreciation expense ₹165 crore (four years ago the depreciation rate was 8.0%); capex ₹396 crore; reported EBIT ₹600 crore. The notes disclose useful lives extended from 10 to 14 years in FY3. Compute the current depreciation rate, average age, capex/depreciation, the EBIT overstatement vs the old rate, and list two follow-up checks.

Solution. Depreciation rate = 165/3,000 = 5.5%, against 8.0% before. Average age = 990/165 = 6.0 years. Capex/dep = 396/165 = 2.4×. That's heavy investment, and some of the rate decline could be mix, but a disclosed life extension is the smoking gun. At 8%, depreciation would be 240, so EBIT is overstated by ≈ ₹75 crore (12.5% of reported EBIT). For follow-ups, (1) compare the new 14-year life with named peers and Schedule II's class life, and read the stated technical justification. (2) Check the proxy or the board's report to see whether incentive compensation or covenant headroom was sensitive to EBIT in FY3. Motive matters, and so does whether segment mix shifted toward longer-life assets.

P12 (timed, 8 min: two short answers). (a) In three sentences for a portfolio manager: why does capitalizing development spend flatter EBITDA more than it flatters net income? (b) A company reports EBIT ₹420 crore and interest expense ₹70 crore, and discloses ₹30 crore of interest capitalized into CWIP. Compute reported and adjusted interest coverage.

Solution. (a) Capitalization removes the cost from operating expenses entirely, so EBITDA, which excludes D&A by construction, never sees the cost again in any year, while net income at least absorbs the depreciation echo over time. For a firm with growing spend, EBITDA is therefore permanently higher under capitalization, and not just earlier. Any EBITDA-multiple comparison against an expensing peer is meaningless until you deduct capitalized costs, which is the standard sell-side JLR adjustment. (b) Reported: 420/70 = 6.0×. Adjusted: 420/(70 + 30) = 4.2×, because the lenders' claim includes the interest hiding in CWIP.

P13 (guided: units of production and a disposal). Konkan Minerals (synthetic) buys a mobile crusher for ₹24 crore, with salvage of ₹4 crore, rated for 50,000 operating hours. It runs 12,000, 11,000 and 9,000 hours in years 1 to 3. (i) Compute units-of-production depreciation for years 1 to 3 and the carrying value at end-year 3. (ii) At the start of year 4 the crusher is sold for ₹9 crore. Compute the gain or loss, give the disposal journal entry, and state how the proceeds and the gain/loss appear in the cash-flow statement.

Solution. Rate = (24 − 4)/50,000 = ₹0.0004 crore per hour (₹40,000/hour). Charges are Y1 12,000 × 0.0004 = ₹4.8 crore, Y2 ₹4.4 crore and Y3 ₹3.6 crore. Accumulated depreciation = 12.8, so carrying value = 24 − 12.8 = ₹11.2 crore. (ii) Proceeds 9.0 − carrying 11.2 = a loss of ₹2.2 crore. Book it as Dr Bank 9.0, Dr Accumulated depreciation 12.8, Dr Loss on sale 2.2, Cr PP&E 24.0 (check: 9.0 + 12.8 + 2.2 = 24.0). In the cash-flow statement, the ₹9 crore of proceeds go in CFI. Indirect CFO adds back the ₹2.2 crore loss as a non-cash item, since it cut net income but consumed no operating cash. That's the statement-linkage loop again. A gain would be subtracted in CFO instead, so the CFI inflow isn't counted twice.

P14 (guided: the development-capitalization line). Helios Devices (synthetic, Ind AS) spends ₹120 crore developing a new controller during FY25. Its auditors accept that all six IAS 38 / Ind AS 38 criteria (PIRATE) were met only from 1 October. ₹78 crore was incurred from April to September and ₹42 crore from October to March. (i) Work out how much may be capitalized as an intangible and how much must be expensed. (ii) Say what a non-software US GAAP filer does with the same ₹120 crore. (iii) In one line, explain why Sun Pharma (Ind AS) and Pfizer (US GAAP) can report almost identical R&D accounting despite different frameworks.

Solution. (i) Capitalize only the ₹42 crore incurred after all six criteria were met. Anything spent before that, the ₹78 crore, is expensed. That's the trap: it can never be retro-capitalized, even though the same project later succeeds. (ii) Under ASC 730 the US filer expenses all ₹120 crore as incurred. Only the ASC 985-20 / 350-40 software carve-outs permit any capitalization. (iii) IFRS/Ind AS capitalization is conditional on "probable benefits" and "technical feasibility," which for innovator pharma arrive only with late-stage or regulatory success, so Sun Pharma expenses essentially all internal R&D and matches Pfizer, and the policy note, not the standard, tells you what's actually done.

P15 (independent: impairment, both regimes, US $). Cascade Robotics, Inc. (synthetic) tests a machine carried at $50m, five years of remaining life, straight-line to nil, pre-tax discount rate 9% (five-year annuity factor 3.8897). Scenario 1: expected cash flows $11m/yr, fair value less costs of disposal $40m. Scenario 2: cash flows $9m/yr, FVLCD $30m. For each scenario compute the impairment loss under US GAAP (ASC 360) and Ind AS 36, and (Scenario 2) the depreciation on the new US GAAP base next year.

Solution. Scenario 1: undiscounted cash flows = 11 × 5 = 55 ≥ 50, so US GAAP shows no impairment, because the undiscounted screen ignores the time value of money. Under Ind AS, VIU = 11 × 3.8897 = 42.79 and recoverable = max(42.79, 40) = 42.79, for a loss of $7.21m. Scenario 2: undiscounted = 45 < 50, so US GAAP measures to fair value and the loss = 50 − 30 = $20m. Under Ind AS, VIU = 9 × 3.8897 = 35.01 and recoverable = max(35.01, 30) = 35.01, for a loss of $14.99m. That's the signature pattern. US GAAP books nothing where Ind AS books $7.21m, which makes it later. Then it books $20m where Ind AS books $14.99m, which makes it bigger. In Scenario 2 the US next-year depreciation = 30/5 = $6m, down from $10m. The write-down permanently thins future depreciation, and with no reversals under US GAAP it never comes back.

P16 (independent: the pre-emptive goodwill screen). Sanchar Digital (synthetic, Ind AS) is a serial acquirer. Its balance sheet shows (₹ crore): goodwill 4,200; other intangibles 1,800; total assets 9,000; total equity 2,500. The notes add a headroom disclosure: a reasonably-possible one-point rise in the discount rate would push one CGU's recoverable amount below its carrying amount. (i) Compute goodwill + intangibles as a percentage of total assets and of equity. (ii) Compute tangible net worth (equity − goodwill − intangibles). (iii) What do you conclude, and what would you do before trusting the ₹2,500 crore equity figure?

Solution. (i) (4,200 + 1,800)/9,000 = 66.7% of total assets, and 6,000/2,500 = 240% of equity. (ii) Tangible net worth = 2,500 − 6,000 = −₹3,500 crore. The acquired intangibles alone exceed all the equity. (iii) Two-thirds of the balance sheet is deal premium and acquired intangibles, tangible net worth is negative, and the headroom note says one CGU is a single assumption-tweak away from a write-down. That's high fragility, and it's visible before any confession. Before you trust the equity, re-run the disclosed sensitivity on goodwill and read which assumptions the impairment test leans on: terminal growth, discount rate, margins. Track goodwill against tangible net worth over several years, and discount any "adjusted EBITDA excluding impairment" the same management presents. It's the goodwill section's fragility screen, run in advance.

P17 (independent: two sets of books). Pinnacle Auto Components (synthetic) capitalizes plant of ₹100 crore (no salvage). Its company-law books use a 10-year Schedule II life, straight-line; the Income-tax Act places the plant in the 15% written-down-value "block of assets." (i) Compute book and tax depreciation for years 1–3. (ii) Compute the annual and cumulative book-versus-tax timing difference over the three years. (iii) In one line: what does this gap create, and where do you learn to record it?

Solution. (i) Book (SL) = 100/10 = ₹10 crore each year. Tax at 15% WDV gives Y1 = 15% × 100 = ₹15.00 crore (WDV 85), Y2 = 15% × 85 = ₹12.75 crore (WDV 72.25) and Y3 = 15% × 72.25 = ₹10.84 crore. (ii) The timing difference (tax − book) is 5.00, 2.75 and 0.84, and cumulatively ₹8.59 crore of depreciation has been taken for tax ahead of book. (iii) With tax depreciation running ahead of book, taxable income is below book income early on, which creates a deferred tax liability. You'll build that machinery with liabilities and financing. For now you only need to see why the gap exists.

P18 (timed, 12 min: normalize the earnings). Girnar Infratech (synthetic) reports FY25 (₹ crore): EBITDA 900; depreciation and amortization 340; EBIT 560; P&L interest 120. The notes disclose the following. (A) ₹150 crore of product-development spend was capitalized instead of expensed, and it's amortized straight-line over five years from this year, so ₹30 crore of the ₹340 D&A is this year's development amortization. (B) ₹40 crore of borrowing cost was capitalized into CWIP. (C) A life extension cut plant depreciation to ₹280 crore from a like-for-like ₹360 crore. Compute (i) EBITDA had development been expensed, (ii) "cash" interest coverage on EBIT, (iii) EBIT had development been expensed and plant depreciation run at the old like-for-like rate, and (iv) one sentence to the credit committee.

Solution. (i) Expensing development returns the full ₹150 crore to operating cost, so EBITDA = 900 − 150 = ₹750 crore. Either way, the ₹30 crore amortization is below the EBITDA line. (ii) Cash coverage = EBIT ÷ (interest expensed + interest capitalized) = 560 ÷ (120 + 40) = 3.5×, against a reported 560/120 = 4.67×. Remember that the lenders' claim includes the ₹40 crore hiding in CWIP. (iii) Start from the EBITDA-expensed figure of 750. D&A now drops the ₹30 crore of development amortization but carries ₹80 crore more of old-rate plant depreciation, so D&A = 340 − 30 + 80 = 390 and EBIT = 750 − 390 = ₹360 crore (equivalently 560 − 120 − 80). Reported EBIT of ₹560 crore was flattered by about ₹200 crore across the two choices. (iv) "Normalized for capitalized development and a like-for-like depreciation rate, EBIT is about ₹360 crore, not ₹560 crore, and true interest coverage is 3.5×, not 4.7×; set covenants and any EBIT/EBITDA multiple off the normalized figures."

Applied mini-project: two balance sheets built on judgment calls

Companies. For India, use Tata Motors Passenger Vehicles Ltd for capitalized development and impairment history. When the commercial-vehicle business was demerged (effective 1 October 2025) and listed separately as Tata Motors Ltd, this JLR-owning company kept the old Tata Motors listing. For the US, use The Kraft Heinz Company for goodwill and indefinite-life intangibles. Allow about 3 hours.

Data to pull (free):

• Tata Motors Passenger Vehicles: get the latest consolidated annual report from the company's investor pages or BSE/NSE filings. Don't pull the new Tata Motors Ltd by mistake. That's the commercial-vehicle company, and it holds no JLR. You also need the FY2018-19 annual report of the pre-demerger Tata Motors for the JLR impairment note. From these, pull the PP&E note (gross block / accumulated depreciation / net block), CWIP and its ageing table, "Intangible assets under development," the intangibles note (capitalized product development), the borrowing-costs-capitalized disclosure, and the exceptional-items/impairment notes.
• Kraft Heinz: get the latest 10-K from SEC EDGAR (sec.gov → EDGAR full-text search "Kraft Heinz 10-K") and the 2018 10-K for the big impairment. You need the goodwill and intangible-assets notes (carrying amounts by reporting unit, impairment testing discussion), the PP&E policy note (useful lives), and the cash flow statement.

Tasks.

1. For each company compute: depreciation rate (dep ÷ average gross PP&E), capex/depreciation, average age and remaining life of PP&E, and (Tata) capitalized borrowing costs as a % of P&L interest.
2. Tata Motors Passenger Vehicles (JLR): quantify capitalized development spend for the latest year; recompute EBITDA as if it were expensed; state the margin difference in percentage points. Then read the FY19 impairment note: which CGU, which model (VIU or FVLCD), which assumptions moved.
3. Kraft Heinz: compute goodwill + intangibles as a % of total assets and vs shareholders' equity, note which brands are indefinite-life, and summarize the 2018 impairment (units, amounts, stated triggers) in five lines.
4. Write a one-page note per company: three findings each, with numbers, ending in one sentence on what you would watch next year.

Rubric. Score each criterion 0 = missing/wrong, 1 = attempted with gaps, 2 = correct and complete. You pass at ≥ 11/14.

Reading & resources

• Mike Piper, Accounting Made Simple. [Paid] [Beginner]: fixed assets & depreciation chapter, quick reinforcement.
• Kieso, Weygandt & Warfield, Intermediate Accounting. [Paid] [Intermediate]: the chapters on acquisition and disposition of PP&E; depreciation, impairments and depletion; and intangible assets (chs. 10–12 in recent editions); the reference text when a mechanic is unclear.
• Wharton (Bushee), Introduction to Financial Accounting, Coursera. [Free] [Beginner]: long-lived assets week.
• Farhat Lectures (YouTube). [Free] [Beginner–Intermediate]: playlists on PP&E, depreciation, impairment, goodwill; worked at exam level.
• EY, US GAAP versus IFRS: The Basics. [Free] [Intermediate]: PP&E, intangibles, and impairment sections; the fastest cross-standard reference; free PDF, updated periodically.
• Deloitte iasplus.com. [Free] [Intermediate]: standard-by-standard summaries, IAS 16, IAS 23, IAS 36, IAS 38, IFRS 3.
• Aswath Damodaran, "Research and Development Expenses: Implications for Profitability Measurement and Valuation." [Free] [Intermediate]: his R&D-converter spreadsheet (pages.stern.nyu.edu → papers/spreadsheets); the intangibles-and-R&D adjustment covered above, from the source.
• Schilit, Perler & Engelhart, Financial Shenanigans (4e). [Paid] [Intermediate]: the "shifting current expenses to a later period" chapter (improper capitalization); read now as a preview, Phase 2 works it fully.
• Primary filings. [Free] [Intermediate]: Tata Motors FY19 annual report (JLR impairment, pre-demerger) and the latest Tata Motors Passenger Vehicles AR (capitalized development); Kraft Heinz 2018 10-K (impairment note) via SEC EDGAR; Sun Pharma latest AR (R&D policy note); Delta Air Lines 10-K (flight-equipment lives).
• Schedule II, Companies Act 2013 (mca.gov.in). [Free] [Reference]: indicative useful lives; and ICAI's Ind AS 16/23/36/38 texts.
• Zerodha Varsity: Fundamental Analysis module. [Free] [Beginner]: annual-report and balance-sheet chapters.
• CFA Institute Level I reading, "Long-Lived Assets." [Paid] [Intermediate]: good drill source if you have curriculum access.
• WorldCom post-mortems. [Free] [Advanced]: the Thornburgh bankruptcy-examiner report and SEC releases (free online; search "WorldCom examiner report"); optional now, required spirit for Phase 2.
• Going deeper: Baruch Lev & Feng Gu, The End of Accounting and the Path Forward for Investors and Managers (Wiley, 2016). [Paid] [Advanced]: the empirical case that a PP&E-era balance sheet increasingly misses where value now is (internally generated intangibles) and what investors should do about it. It's optional, and it's the strategic backdrop to the intangibles-and-R&D section.
• Going deeper: Michael Mauboussin & Dan Callahan, Counterpoint Global research on intangible investment and ROIC (Morgan Stanley; free PDFs, search "Mauboussin intangibles"; check the current titles). [Free] [Intermediate]: how to reclassify GAAP-expensed intangible investment (R&D, part of SG&A) so ROIC and reinvestment read correctly. It pairs directly with the Damodaran R&D adjustment.

The Modern Analyst's Addendum

Everything above teaches this skill from first principles, by hand; that is how you learn it, and the mastery check still tests it that way. This addendum shows how a working analyst amplifies the same skill today. It adds; it never replaces. (R1/R10)

AI-Augment this skill

{
  "skill": "Capitalize-or-expense decisions, depreciation schedules, and the useful-life and impairment screens",
  "use": "(1) Ask for the capitalization argument on a specific expenditure under both IFRS/Ind AS and US GAAP, with the paragraph reference for each and the strongest argument for expensing — the frameworks differ most exactly where the money is (development costs, borrowing costs, impairment reversal). (2) Ask a document tool to extract the PP&E note, the depreciation-rate table and the impairment note from ten annual reports so the comparison is over data rather than over your memory. (3) Ask it to sanity-check your Damodaran R&D-capitalization adjustment by restating it back in its own words, then reconcile the two.",
  "tools": ["Chat assistants — Claude, ChatGPT for the IFRS-versus-US-GAAP argument pairs", "Document/PDF AI — NotebookLM or Claude file upload for PP&E and impairment notes across a peer set", "Coding assistants — for the schedule and screen code below"],
  "prompt": "For this expenditure — <PASTE FACTS> — give a table [Framework | Capitalize or expense | Test applied | Paragraph reference | Strongest counter-argument] for IFRS/Ind AS and US GAAP. Quantify, year by year for five years, what each treatment does to EBIT, EBITDA, net income, CFO and total assets. Use only the figures I have given; do not assume a useful life I have not stated.",
  "verify": "Recompute both schedules yourself and check that the two treatments converge — total expense over the asset's life is identical under either choice, and any model in which they do not converge has an error in it. Then read the filer's own depreciation-rate table rather than accepting a stated useful life: Schedule II in India and the PP&E note in a 10-K both disclose rates by class, and a life outside its class's peer range is the finding. A model asked 'is this capitalizable?' will produce an argument; the standard produces an answer (Guardrail 1-5).",
  "diy": "You must be able to build the capitalized cost from an invoice, run all three depreciation methods, and execute both impairment models by hand — that is this module's gate."
}

Modern Data Analysis

By hand first. You built the SLM, WDV and units-of-production schedules and reconciled their totals. Code like the snippet below runs the same schedules across every asset class and every peer at once, and that's the only way this week's screens become usable.

Today's workflow. Depreciation is a recurrence, and recurrences are three lines of code. Once you've written them down, the screens become one-liners across a whole peer set, and that's where the value is. Capex ÷ depreciation tells you whether the asset base is growing or being harvested. Accumulated depreciation ÷ annual depreciation estimates the average age of the fleet. The implied depreciation rate (annual depreciation ÷ gross block), compared across peers, tells you whose useful lives are out of line. None of these is a verdict on its own, and all of them are cheap once the data is a frame. On the synthetic asset below, straight-line gives ₹180 a year. The written-down-value rate implied by the same cost, salvage and life is 36.904%, which front-loads ₹369.04 into year 1. That's a 105% difference in first-year expense from a policy choice, and both still converge to the same ₹900 total.

Tools & sources (IN + US). Use pandas for the schedules and screens. For India, use the Schedule II useful-life table, the PP&E and CWIP notes and the CWIP ageing table in the annual report (BSE/NSE), plus the capital-commitments note. For the US, use EDGAR XBRL (PropertyPlantAndEquipmentGross, AccumulatedDepreciationDepletionAndAmortizationPropertyPlantAndEquipment, DepreciationDepletionAndAmortization) and the 10-K's PP&E and impairment notes.

# Synthetic asset and fleet, ₹ crore — R3: recomputed in-session
cost, salvage, life = 1000.0, 100.0, 5
slm = (cost - salvage) / life                       # 180.0 a year
wdv_rate = 1 - (salvage / cost) ** (1 / life)       # 0.36904 -> year 1 = 369.04
gross_block, accum_dep, annual_dep, capex = 8000.0, 3200.0, 1000.0, 700.0
print(round(slm, 2), round(wdv_rate, 5), round(gross_block * wdv_rate, 2))
print(round(capex / annual_dep, 2),                 # 0.7  -> shrinking asset base
      round(accum_dep / annual_dep, 2),             # 3.2  -> average age, years
      round(annual_dep / gross_block * 100, 2))     # 12.5 -> implied rate, %, vs peers

Verify. Every one of these screens is a ratio of two numbers that must come from the same scope and the same period. Most often the defect is mixing a consolidated gross block with a standalone depreciation charge. Tie the gross block, accumulated depreciation and the annual charge to the PP&E note's own roll-forward before you compute anything. Then check whether the year contained a revaluation, an acquisition or a disposal. Any of those makes the average-age arithmetic meaningless for that year.

Quantitative lens

A useful-life assumption is the highest-leverage accounting estimate most industrial companies make, and its leverage is easy to quantify. Extend the life of an ₹8,000 crore gross block from 8 years to 10, and the annual charge falls from ₹1,000 crore to ₹800 crore. That ₹200 crore goes straight into EBIT. It's 16.7% of an EBIT of ₹1,200 crore, from a disclosure most readers skim. Carry that sensitivity in your head, because it generalises. For a life extension, the EBIT effect is gross_block × (1/old − 1/new), so it's largest for asset-heavy firms and for short lives.

Across a whole sector, the screen is at its most useful. Compute the implied depreciation rate for every filer in a sector, and treat the outliers as candidates for a closer look. They aren't conclusions yet. It has limits. Asset mix really does differ between peers, and a young fleet and a long life produce the same low rate. Revaluations and acquisitions distort the ratio for a year. India's Schedule II lives also differ from US practice by class, so a cross-border rate comparison needs a class-level mapping before it means anything. What you should get out of this screen is a shortlist of companies whose notes you'll read, and never a ranking.

Do it in code. Build the implied-rate panel across a sector, standardise it within asset class, and regress the rate on asset mix to see how much of the dispersion asset mix actually explains. See G1/QM1.02 and G2/QD1.02.

Where this goes next: galaxy cross-links

• G2 · DA1.02 Pandas Data Wrangling: schedules and screens across a peer panel, where the second company costs nothing once the first is written.
• G1 · QM1.02 Hypothesis Testing & Regression: deciding whether a filer's depreciation rate is really out of line or merely at the tail of a noisy distribution, which is the difference between a finding and an accusation.
• G2 · QD1.02 Signal & Factor Construction: capex/depreciation and the accruals-adjacent screens as constructed factors, with the standardisation and winsorisation that keeps them from being driven by three outliers.

Teach it back & journal

Feynman prompt. Write a one-page explainer for a smart 15-year-old: "Two identical companies spend the same money building the same app. One reports a profit, the other a loss, and both are following the rules. Explain how (capitalize vs expense, and what depreciation is), and then explain what it means when a company later announces it is 'writing off' billions of goodwill." No jargon allowed without a one-line definition. If your explanation needs the phrase "it depends," say exactly on what.

Journal reflection. Open the annual report of any company you have already read in your company-of-the-week slot. Find one number this week changed: a capex/depreciation ratio you had ignored, a CWIP ageing bucket, a capitalized-development line, a life-extension disclosure, goodwill sitting quietly at 40% of equity. Write five lines: what you now see, what you would check next, and one sentence on how your trust in "EBITDA" has changed. Date it: Phase 2 will ask you to re-read this entry.

This module's flashcards and mastery quiz are wired into the app: see the node's Quiz and Reviews.