PP&E disclosures, fixed asset turnover and asset age

What do the PP&E and intangibles notes tell you?

They tell you how the assets are measured, how fast they are being used up and how they changed during the year. The face of the statements shows only totals. Under International Financial Reporting Standards (IFRS), for each class of PP&E disclosures the notes give:

• the measurement basis (cost or revaluation), the depreciation method and the useful life or depreciation rate;
• gross carrying amount and accumulated depreciation at the start and end of the period, with a reconciliation of the movement (additions, disposals, depreciation, impairments);
• pledges as security and contractual commitments to buy PP&E.

A company that uses the revaluation model also discloses the date, how fair value was obtained, the carrying amount it would have under the cost model and the revaluation surplus . US generally accepted accounting principles (GAAP) require the cost model for PP&E.

For intangibles the notes say whether lives are finite or indefinite, the lives and methods, gross amounts, accumulated amortization and a reconciliation. US GAAP adds the expected amortization expense for each of the next five years, a free forecast of a profit drag. Impairment notes give the asset, the cause, the amount and where it sits in the statements. IFRS also discloses reversals.

Disclosures on PP&E and intangibles

• PP&E (per class) Use it IFRS
  • Basis and method cost or revaluation; depreciation method; lives
  • Amounts gross cost, accumulated depreciation, reconciliation
  • Restrictions pledges, purchase commitments
  • Revaluation model only date, fair value method, cost-model amount, surplus
• Intangibles Use it finite or indefinite; amortization; reconciliation
  • US GAAP extra expected amortization for the next five years
• Impairments Use it losses, reasons, location; IFRS also reversals

Depreciation can appear on the face of the income statement or only in the notes. Under IFRS it appears separately if expenses are grouped by nature, but is buried inside cost of sales and selling, general, and administrative expenses (SG&A) if grouped by function. The cash flow statement shows additions and disposals in investing and, under the indirect method, adds depreciation back in operating.

How do you estimate age and remaining life from the notes?

Divide each piece of the gross-accumulated-net identity by annual depreciation. If depreciation is straight-line with no salvage value, depreciation expense is a constant slice of gross cost, so the ratios become years: the estimated total useful life , the estimated average age (years already used) and the estimated remaining useful life .

$$T = \frac{\text{Gross PP\&E}}{\text{Depreciation expense}}$$

$$Age = \frac{\text{Accumulated depreciation}}{\text{Depreciation expense}}$$

$$Rem = \frac{\text{Net PP\&E}}{\text{Depreciation expense}}$$

Gross cost equals accumulated depreciation plus net PP&E, so age plus remaining life always equals total life. Use it as a check.

Gross PP&E ÷ depreciation = estimated total life

• Accumulated depreciation ÷ depreciation Memorize estimated average age
• Net PP&E ÷ depreciation Memorize estimated remaining life

What does fixed asset turnover tell you?

How much revenue each unit of PP&E supports. A higher fixed asset turnover is usually read as greater efficiency. Use the average of beginning and ending net PP&E, because revenue accumulates over the year.

$$FAT = \frac{\text{Revenue}}{\text{Average net PP\&E}}$$

Now compare a peer with the same revenue and the same cost, but a newer fleet: gross PP&E 4,800, accumulated depreciation 600, depreciation 400. Its age is 1.5 years, its net PP&E is steady at 4,200, and its turnover is 7,200 ÷ 4,200 = 1.71 times. Northline looks 46% more efficient, but only because its equipment is over a third used up and carried at a lower value.

Is the company reinvesting enough?

Compare capital expenditure to depreciation . Depreciation is the rate at which the asset base is being consumed, and capital expenditure is the rate at which it is replaced.

$$CapEx\ ratio = \frac{\text{Capital expenditure}}{\text{Depreciation expense}}$$

Above 1.0, the company is replacing assets faster than they wear out. Below 1.0, the base is shrinking or aging. Combine it with the age ratios: an old base (high share of life used) plus a ratio below 1.0 suggests heavy spending ahead. When capex is not given, it can be estimated as the rise in net PP&E plus depreciation, ignoring disposals and impairments. Northline’s figures are worked below.

Exam tip High turnover plus a high share of life used is a warning, not a compliment. The next question is how much it will cost to replace.

Where do these estimates break down?

They are only as good as their assumptions. They assume straight-line depreciation, no salvage value and the cost model. Real companies use accelerated methods, hold many classes with different lives, carry fully depreciated assets and own land. Under the revaluation model, carrying amounts and depreciation no longer track historical cost, so the ratios do not apply. Treat the results as a prompt for further investigation.

Go deeper Reading the five-year amortization schedule

US GAAP companies disclose expected amortization for each of the next five years. If the figure falls sharply, many acquired intangibles are close to fully amortized, so reported profit will get a lift without any change in the business. If it rises, new purchases have outweighed the run-off. Use the schedule to forecast earnings before amortization, and separate real improvement from an accounting tailwind.

Go deeper Excluding land

Land is not depreciated, so including it inflates gross PP&E and the total-life estimate. When the notes show land separately, subtract it from gross PP&E. When land is buried inside “land and buildings”, accept the estimate as rough, as long as land is a small share of the total.