Write in this section of the course we're 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 support contracts
and so on and examples of intangible assets with an infinite life are brand names logos and even a company's
Web site.
OK why is it important to make this distinction.
Well depending on the type of intangible asset we have won 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 that 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 U.S. 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 names worth and then compares
the brand names value to the value reported on the firm's balance sheet.
If the current market value of the brand is lower than 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 own 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 PNL and its equity which was quite low would
have become negative which would have 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.