Impairment of Assets - IAS 36

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CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

§Impairment of Assets

IAS 36 set out the procedures that an entity should apply to ensure that its assets are carried at no more than their recoverable amount.

Recoverable amount :- The higher of its F.V less costs to sell and its value in use.

Value-in-use:- The discounted present value of the future cash flows expected to arise from an asset or a cash-generating unit.

Cash-generating unit:- The smallest group of assets that can be identified that generates cash flows independently of the cash flows from other assets.

Fair value less costs to sell:- The amount obtainable from the sale of an asset or cash generating unit in an arm’s-length transaction between knowledgeable, willing parties, less the costs of disposal.

Impairment loss:- The amount by which the carrying amount of an asset or cash-generating unit exceeds its recoverable amount.

Under IAS 16 “Property Plant and Equipment” any change in the useful life will be accounted prospectively.

Replies (43)

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Basic principles of Impairment

An asset may not be carried in the balance sheet at more than its recoverable amount. IAS 36 states that…………

“ If, and only if, the recoverable amount of an asset is less than its carrying amount, the carrying amount of the asset shall be reduced to its recoverable amount. The reduction is an impairment loss”

An asset’s recoverable amount represents its greatest value to the business in terms of the cash flow that it can generate. That is the higher of :

§ F.V less cost to sell; and

§ Value in use

An impairment review involves estimating an asset’s recoverable amount and comparing it with its carrying value. If the recoverable amount is lower than the carrying value, the asset is impaired and must be written down to the recoverable amount. An impairment cannot be avoided by arguing that the diminution in value is not permanent.

Goodwill has to be impairment tested at least annually under IFRS 3.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Example :- An entity has an oil platform in the sea. The entity has to decommission the platform at the end of its useful life, and a provision was set up at the commencement of production. The carrying value of the provision is 8 minr. The entity has received an offer of 20 minr (selling costs 1 minr) for the rights to the oil platform, which reflects the fact that the owners have to decommission it at the end of its useful life. The value-in-use of the oil platform is 26 minr ignoring the decommissioning costs. The current carrying value of the oil platform is 28 minr.

Determine whether the value of the oil platform is impaired.

Solution

§The fair value less costs to sell is (20 – 1) minr, or 19 minr.

§The value-in-use is (26 – 8) minr, or 18 minr.

§The carrying value is (28 – 8) minr, or 20 minr.

Therefore, the recoverable amount (19 minr) is less than its carrying value (20 minr), and the asset is impaired.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Identifying Impairment Loss

An entity should assess at each reporting date whether there is any indication of impairment. If any indication exists the entity should estimate the asset’s recoverable amount. IAS 36 emphasis that increases in the short term interest rates would not necessarily trigger an impairment review. The term “reporting date” includes not only the year end date, but also interim reporting dates.

Even if there is no indication of any impairment, following assets should be tested for impairment:

§ An intangible asset that has an indefinite useful life

§ An intangible asset that is not yet available for use

§ Goodwill that has been acquired in a business combination

IAS 36 points out that the materiality concepts applies in determining whether an impairment review is required. If previous impairment review has shown a significant excess of carrying amount over recoverable amount no review would be necessary in the absence of any event that would eliminate the excess.

For impairment, It should be higher than F.V and Value in use but lower than Carrying Value, if loss has arisen it should recognised immediately.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

IAS 36 sets out the events that might indicate that an asset is impaired. These are

§External sources of Information:- Decline in M.V, increases in market interest rates, the carrying amount of net assets being valued at more than the stock market value of the entity, and economic, legal, or technological changes that have had an adverse affect on the entity

§Internal sources of information:- Physical damage to an asset, or its obsolescence, or an asset becoming idle, or if the asset is part of a restructuring, or if the entity’s performance has suffered during the period, or if there has been a significant decline or reduction in the cash flows generated or to be generated from the asset

§Other Indications:- Actual net cash outflows or operating profit or loss may be significantly worse than budgeted, Operating losses are forecast for full period.

If there is an indication that an asset may be impaired the standard notes that the useful life, the depreciation method or the residual value for the asset need to be reviewed and adjusted if necessary under the appropriate IFRS. This applies even if no impairment loss is recognised for the asset.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Example :- An entity has purchased the whole of the share capital of another entity for a purchase consideration of Rs.20 million. The goodwill arising on the transaction was 5 minr. It was planned at the outset that the information systems would be merged in order to create significant savings.

Additionally the entity was purchased because of its market share in a particular jurisdiction and because of its research projects. Subsequently the cost savings on the information systems were made.

The government of the jurisdiction introduced a law that restricted the market share to below that anticipated by the entity, and some research projects were abandoned because of lack of funding.

Explain any potential indicators of the impairment of goodwill.

The entity would have paid for the goodwill in anticipation of future benefits arising. The benefit in terms of the cost savings on the information systems has arisen, but the market share increase and the successful outcome of the research projects has not occurred. Therefore, these events may indicate the impairment of goodwill.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Impairment Indicator

Example :- Should management adjust the carrying value of assets to reflect impairment indicators that arose after the balance sheet date. But before the financial statements were issued ?

Management should consider an impairment loss, if it become aware of conditions post balance date that must have existed at the balance sheet date (adjusting events).

The Argentine devaluation and economic crisis in early 2001 is an example of such an event. The poor performance of the Argentine economy would have been evident at the balance sheet date before the collapse in the post balance sheet date period.

A new impairment indicator arising after the balance sheet date is a non- adjusting event. Destruction of an asset or expropriation of a mine subsequent to the balance sheet date would be an example.

The event occurred post balance sheet date and was not indicative of a condition existing at balance sheet date. However, management should disclose the nature or such an event and an estimate of its financial effect.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Cash Generating Unit

Cash Generating Unit :- A cash-generating unit is the smallest identifiable group of assets that can generate cash flows from continuing use and that are mainly independent of the cash flows from other assets or groups of assets.

If an asset appears to be impaired, the recoverable amount for that asset should be calculated. However, if it is not possible to calculate the recoverable amount of an individual asset, the recoverable amount of the cash-generating unit to which the asset belongs should be calculated.

CGU should be identified on a consistent basis, period to period, for the same asset or types of asset unless the entity can justify a change.

Goodwill that has been acquired in a business combination should be allocated to cash generating units. Normally internal management records will be used for the allocation of goodwill. The reported segments of the entity will be the minimum size of cash-generating units to which goodwill will be allocated.

If an entity disposes of an operation within the CGU, the goodwill associated with that operation will be included in the carrying amount of the operation when calculating the gain or loss on disposal. The amount included in the gain or loss on disposal will be based on the proportion of the CGU that is disposed of.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Example :- The reporting entity has two plants, Plant A and Plant B. 60 % of Plant A production is sold to Plant B. 80% of Plant B’s production is sold to 3rd Party.

The issue is to determine the CGUs for Plant A and Plant B when

§ Plant A could sell its production in an active market instead of to Plant B

§ There is no active market for the production of Plant A.

In the first situation, there is an active market for Plant A’s production so its likely that Plant A is a separate CGU. Plant B would also be a separate CGU, because it sells 80% of its output externally and so generates cash flows that are largely independent of the cash flows from the other assets of the reporting entity.

In the second situation there is no active market for the output of Plant A and the cash inflows of Plant A depend on the demand for the product sold by Plant B. Plant A does not generate cash flows that are largely independent of the cash flows of assets operated by Plant B.

Also, the two plants are managed together, as the use of internal transfer prices demonstrate. Therefore, the tow plants should be treated as CGU.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

DETERMINATION OF A RECOVERABLE AMOUNT

The recoverable amount of an asset is the higher of the asset’s fair value less costs to sell and its value in use. If it is not possible to determine the fair value less costs to sell because there is no active market for the asset, the entity can use the asset’s value in use as its recoverable amount.

Where an asset is held for disposal its fair value less cost to sell will normally be close to its value in use. In such a situation, the asset is not included in the assets of a CGU, even though it might otherwise have been included has it not been held for disposal. Instead the asset is considered separately, its recoverable amount is taken as its fair value less cots to sell and this is compared to its carrying value with any resulting impairment loss being recognised immediately.

In the case of an intangible asset with an indefinite useful life, it is possible to use a calculation of the asset’s recoverable amount that has been made in the preceding period as long as certain conditions are met.

These conditions are that the intangible asset is part of CGU whose value has not changed significantly since the most recent recoverable amount calculation

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Example :- An entity is preparing its financial statements for the year ending Nov 30, 2008. Certain items of PPE were scrapped on Jan 1, 2009.

At Nov 30, 2008, these assets were being used in production by the entity and had a carrying value of 5 minr. The value-in-use of the asset at Nov 30, 2008, was deemed to be 6 minr, and its fair value less costs to sell was thought to be Rs.50,000 (the scrap value).

What is the recoverable amount of the plant and equipment at November 30, 2008?

The recoverable amount is the higher of the assets’ fair value less costs to sell and its value-in-use.

In this case, even though the assets were scrapped on Jan1, 2009, the value-in-use at Nov 30, 2008, was 6 minr, which was higher than the fair value less costs to sell and their carrying value.

Therefore, the assets are not impaired. The scrapping of the assets may be disclosed as a non adjusting post–balance sheet event if material.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

FAIR VALUE LESS COSTS TO SELL :- IAS 36 sets out how an entity should determine the fair value less costs to sell. The Standard sets out these examples:

§Where there is a buying and selling agreement, the price in that agreement less the costs to sell can be used.

§The price in an active market less the cost of disposal can be used.

§The fair value less costs to sell can be based on the best information available which reflects the proceeds that could be obtained from the disposal of the asset in an arm’s-length transaction.

§The Standard says that the best evidence is the price in a binding sale agreement in an arm’s length transaction adjusted for the costs of disposal.

VALUE-IN-USE :- These elements should be used while calculating VIU

§Estimates of the future cash flows that the entity expects to get from the asset

§Any variations that may occur in the amount or timing of the future cash flows

§The time value of money represented by the current market risk-free rate of interest

§The uncertainty inherent in the asset

§Any other factors

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

FUTURE CASH FLOWS

Any cash flow projections should be based on the most recent financial budgets and forecasts. Projection should not include any cash flows that may arise from future restructuring or from improving or enhancing the asset’s performance.

Any predictions incorporated into budgets and forecasts shall cover only 5 yr period at maximum. Extrapolation should be used for periods beyond the 5 yr period. If management is confident that projections beyond the 5 yr period are reliable, and management can demonstrate that, the cash flows that will be generated beyond 5 yr period are likely to be accurate, then it is possible to use these forecasts.

Any future cash flows should not include inflows or outflows from financing activities or income tax receipts and payments. However, they should include the estimated disposal proceeds from the asset.

If any future cash flows are in a foreign currency, they are estimated in that currency and discounted using a rate appropriate for that currency. The resultant figure will be then translated using the exchange rate at the date of the value-in-use computation

Where the economic environment in which an entity operates has become more volatile in the period since the budget/forecast was approved by management, it may be appropriate to revise the forecast made

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Composition of estimates of Future Cash Flow

The composition of the cash flows used to estimate value in use need to be considered carefully. The cash flow should include :

§ Projection of the cash inflow from the continuing use of the assets or CGU

§ Projection of cash outflows necessarily incurred to generate the cash inflows from continuing use of CGU and that are directly attributable to assets or CGU

§ Projection of such cash outflows necessarily incurred to generate the cash inflows from continuing use of the asset or CGU and that are directly attributable to assets

§ Net cash flows expected to be received for the disposal of assets or CGU at the end of their useful lives.

§ Cash outflows to maintain the operating capacity of existing assets, including for example, cash flows for day-to-day servicing.

Cash flow projections used to measure value in use should be based on reasonable and supportable assumption of the set of economic conditions that will exist and the asset’s remaining useful in life.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Management will need to make a number of assumptions in conducting an impairment review. They will need to prepare a cash flow forecast to determine the future cash inflows and outflows associated with the assets being tested for impairment.

Management should approve the projections used as well as the Group Plan from which were prepared.

The cash flows will be determined and influenced by the following factors :

§Sales Volume determined by current demand, growth in market size etc

§Sales Price determined by current prices, competition, inflation etc

§Operating Costs determined by prices of goods and service consumed.

§Other Cash flows i.e. Decommissioning costs, disposal proceeds.

The estimate of cash flows expected to be received for the disposal of assets or CGU’s at the end of their useful lives should be the amount of the expected disposal proceeds in an arm’s length transaction.