Narrator: Right, in this section of the course,
we are talking about long-lived assets, and to be honest,
we are making excellent progress so far.
Whenever we consider intangible assets,
there is one important distinction we have to make.
There are intangible assets with a finite life
and there are also intangible assets with an infinite life.
Examples of intangible assets with a finite life
are software licenses, concessions,
sport contracts, and so on.
And examples of intangible assets
with an infinite life are brand names, logos,
and even a company's website.
Okay, why is it important to make this distinction?
Well, depending on the type of intangible asset we have,
one with finite or infinite life,
we are going to either amortize the cost for the asset
in the same way we depreciate tangible assets
in a specific number of years.
Or alternatively, we are not going to amortize
the intangible asset at all
and we are only going to test it for impairment.
That is we are going to test if the assets value
decreased or not.
Of course, amortization is applied
for intangible assets with a finite life.
If we have a beach concession on our books
and it ends in four years,
we would want the concession to be off our books
once the concession ends in four years.
Every year, a fraction of the concessions cost
will be reported as an amortization cost.
If on the other hand, our company has an important
and well-renowned brand name on its books,
it wouldn't be able to amortize it
because a brand name has an infinite life,
it doesn't cease to exist.
So according to the IFRS and US Gap
the firm will have to test the brand name
for impairment every year.
This is carried out by a specialist
who basically values the brand name's worth
and then compares the brand name's value
to the value reported on the firm's balance sheet.
If the current market value of the brand is lower,
then the company will have to report a loss
in the current year and decrease the value
on its balance sheet.
That's quite dangerous for listed companies,
as this potentially erodes earnings
in a very significant way.
A very interesting case, which highlights the importance
of impairment testing is a project
I worked on a few years ago.
I was part of a financial advisory team whose role
was to investigate if the impairment tests carried out
for a company's brands throughout the years
were performed correctly.
The company operated in the fashion industry,
and the fact that it owned world famous brands
valued in a really expensive way on its balance sheet,
allowed it to continue to operate for several years
without declaring bankruptcy.
Every year, the impairment test defended the valuation
of these brands and showed that they are not worth less
than their balance sheet value.
However, the suspicion was that the impairment tests
were carried out with a very aggressive hypothesis,
and hence, the actuary was carrying out the valuation
in a company friendly way.
If he or she had come up with values that are lower
than the ones the company had on the balance sheet,
then the company would have had to recognize a loss
in its P&L, and its equity which was quite low,
would have become negative, which would've meant bankruptcy.
Instead, the company continued to operate for several years
until it declared bankruptcy.
These several years of additional accumulated losses
resulted in even higher losses for the company's creditors.
So yes, impairment tests can be quite important
in certain situations.
In our next lesson, we'll discuss the revaluation model.
Thanks for watching.