F7-Financial Reporting IAS 36 IMPAIRMENT OF ASSETS

INTRODUCTION:

IAS 36

Companies have always been required to recognised impairment losses on assets. However, until IAS 36 was issued in 1998 there were no rules as to how this should be done. IAS 36 sets out: how to identify when an impairment has occurred rules for calculating an impairment loss how impairments should be reported how impairment reversals should be treated

IAS 36 applies to all assets except for inventories (IAS 2), construction contracts (IAS 11), deferred tax assets (IAS 12), pension scheme net assets (IAS 19), financial instruments (IAS 39), investment property measured at fair value (IAS 40), biological assets measured at fair value (IAS 41), rights under insurance contracts (IFRS 4) and assets held for sale (IFRS 5). IAS 36 does not apply to goodwill arising on consolidation, so the Standard was slightly revised in March 2004 to reflect the rules in IFRS 3 covering the accounting for such goodwill (no routine amortisation but annual impairment reviews). IDENTIFYING IMPAIRMENTS: Enterprises are only required to carry out detailed impairment reviews, if there is evidence that an impairment may have occurred. Indications that an impairment might have happened can come from external or internal sources: (a) external sources of information: (i) unexpected decrease in an assets market value (ii) significant adverse changes have taken place, or are about to take place, in the technological, market, economic or legal environment (iii) increased interest rates have decreased an assets recoverable amount (iv) the enterprises net assets are measured at more than its market capitalisation internal sources of information: (i) evidence of obsolescence or damage (ii) there is, or is about to be , a material reduction in usage of an asset (iii) evidence that the economic performance of an asset has been, or will be, worse than expected

(b)

Impaired assets should be reviewed at each balance sheet date to see whether there are indications that the impairment has reversed in whole or part. Indications of a reversal are the opposite of the impairment indicators above. (a) External indicators (i) Increases in the assets market value. (ii) Favourable changes in the technological, market, economic or legal environment. (iii) Decreases in interest rates. Internal indications (i) Favourable changes in the use of the asset. (ii) Improvements in the assets economic performance.

(b)

IAS 36 additionally requires an impairment review to be carried out annually whenever: (a) an intangible asset is not being amortised because it has an indefinite useful life; or goodwill has arisen on a business combination

(b)

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F7-Financial Reporting
CALCULATING AN ACCOUNTING FOR AN IMPAIRMENT: Calculation

IAS 36

An impairment occurs if the carrying value of an asset is greater than its recoverable amount. The recoverable amount is the higher of fair value less costs to sell and value in use. Fair value less costs to sell equals the sale proceeds obtainable less the costs of disposal Value in use is the present value of future cash flows from using as asset, including its eventual disposal. The discount rate to use is a pre-tax, risk adjusted market rate. Charge Any impairment loss will be charged immediately in the income statement to the same heading as the related depreciation (e.g. cost of sales or administration). An impairment of a revalued item may be taken to the revaluation reserve (to the limit of any related surplus). Depreciation Having written the asset down to its recoverable amount, future depreciation charges will write off the impaired value over its remaining life. Reversals If an impairment is reversed then the asset can be restated to the net book value that it would have had by that time. The related credit will be recognised in the income statement (unless the loss had been taken to the revaluation reserve). ACTIVITY: Impairment of a single asset Mavis Ltd hires out motorbikes to tourists. The draft accounts for the year ending 31 December 20X3 included the following motorbike: $ Cost Depreciation Opening Charge for 20X3 4,800 2,400 (7,200) 4,800 $ 12,000

Net Book Value

The motorbike is being written off over five years and it has two years life remaining. However, the tourist market has slumped, and as a result it will only be able to generate $2,500 cash per annum in 20X4 and 20X5. It will then be scrapped in December 20X5. Alternatively, the bike could be sold immediately for $3,000 (less $200 selling costs). Market interest rates are 12% p.a. Required: (a) Calculate the impairment loss at 31 December 20X3. (b) Redraft the plant and equipment note to reflect the impairment. (c) Draft the plant and equipment note for 20X4. In December 20X4 the market for motorbike tours picked up, and the bike now has a recoverable amount of $3,900. You are required to redraft the 20X4s plant and equipment note to reflect this.

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F7-Financial Reporting
CASH GENERATING UNITS:

IAS 36

Smallest identifiable group of the assets which generates cash flow independently. The example above looked at a single asset (a motorbike) with its own identifiable cash flows. In practice, cash flows belong to groups of assets rather than to individual assets. For example, a factory production line will be made up of many individual machines and robots, but the revenues will be earned by the production line as a whole. These groups of assets are called cash-generating units. Impairment should be calculated for the unit as a whole not for the individual assets within it. Two problems arise: (i) How to deal with goodwill or other corporate assets. (ii) How to allocate the impairment loss for the unit as a whole to individual assets within that unit. CASH GENERATING UNITS AND CORPORATE ASSETS: Corporate assets include a group headquarter building or a research centre. They do not generate their own cash inflows, so do not themselves qualify as cash-generating units. They must be included in a larger group of assets that do generate their own cash inflows. Corporate assets may be apportioned between the cash generating units before the impairment review takes place. This is knows as a bottom-up test. If there is no reasonable basis for apportioning common assets then the impairment review will have to be made for the business as a whole. This is known as a top-down test. The top-down approach tends to net-off profitable and loss making units, and so reduces the chance of an impairment being identified. Example Delta Ltd has three units A, B and C. Each unit has its own income streams, and the net assets belonging to each unit have carrying amounts of $100m, $150m and $200m respectively.In addition there are head office net assets with a carrying amount totaling $150m.The chart below has apportioned these head office assets between the three units. The recoverable amount for each unit has also been noted. Cash generating units Net assets directly involved in cash-generating unit Head office net assets Total Recoverable amount A $100m $33m $133m $170m B $150m $50m $200m $160m C $200m $67m $267m $300m Total $450m $150m $600m $630m

If the apportionment of head office assets were considered to be reasonable, then a bottom-up review would identify an impairment loss of $40m in Unit B. If there was no reasonable means of apportioning the head office assets, then the impairment review would be done for the business as a whole on a top-down basis. The total recoverable amount is greater than the total net assets, therefore there has been no impairment. (In this example each units recoverable amount is greater than its identifiable net assets as well).

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F7-Financial Reporting
ALLOCATING GOODWILL TO CASH GENERATING UNITS:

IAS 36

Goodwill does not generate cash flows independently of other assets, so must be allocated to cash-generating units (or group of units) before the impairment review can take place. IAS 36 requires goodwill acquired in a business combination to be allocated to the cash-generating units that are expected to benefit from the synergies of the business combination. Each unit or group of units to which the goodwill is allocated should represent the lowest level within the entity at which the goodwill is monitored for internal management purposes. A cash-generating unit to which goodwill has been allocated must be tested for impairment annually, by comparing the carrying amount of the unit (including the goodwill) with the recoverable amount of the unit. ALLOCATION OF AN IMPAIRMENT TO THE CASH GENERATING UNITS ASSETS: If an impairment loss arises on a cash-generating unit then, in the absence of obvious impairment to indivisual assets,it is allocated among the assets in the unit in the following order: (i) To any asset that are obviously damaged/destroyed (ii) Goodwill (iii) Other assets pro rata to their carrying amount However no asset should be written down below its own separate net realisable value/NSP.

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F7-Financial Reporting
Example Tinu Ltd has identified an impairment loss of $41m for one of its cash-generating units. The carrying value of the units net assets was $150m, whereas the units recoverable amount was only $109m.

IAS 36

The net selling price of the units assets were insignificant except for the property, which had a market value of $35m. The net monetary assets will be realised in full. The table below shows how the impairment will be allocated. Draft values $m 13 20 49 35 14 19 150 Comments: (a) Firstly, the goodwill is reduced. (b) No impairment loss can be taken against the property because its net selling price is greater than its carrying value. (c) Likewise, no impairment loss can be taken against net monetary assets (receivables, cash, etc) because they will be realised in full. (d) The balance of $28m ($41m $13 m) is apportioned between the remaining assets on a pro rata basis as follows: Draft Proportion of Revised Impairment NBV $28m loss NBV $m $m $m Machinery 49 49/98 (14) 35 Vehicles 35 35/98 (10) 25 Patents 14 14/98 (4) 10 98 (28) 70 Impairment loss $m (13) (14) (10) (4) (41) Impaired values $m 20 35 25 10 19 109 Comments a b d d d c

Goodwill Property Machinery Vehicles Patents Net monetary assets

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F7-Financial Reporting

IAS 36

QUESTION

36mins

(a) IAS 36 Impairment o f assets was published in April 1998. It introduced the term cash generating units. Explain what a cash generating unit is and why it is necessary. (5 marks) (b) Identify the cash generating unit in the following cases. (i) A manufacturer can produce a product at a number of different sites. Not all the sites are used to full capacity and the manufacturer can choose how much to make at each site. However,theris not enough surplus capacity to enable any one site to be closed. The cash inflows generated by any one site therefore depend on the allocation of production across all sites. (ii) A restaurant chain has a large number of restaurants across the country. The cash inflows of each restaurant can be individually monitored and sensible allocations of costs to each restaurant can be made. (5 marks)

(c)

M Inc has a single substantial asset, the SyMIX which it uses to manufacture computer chips. The carrying value of the SyMIX after four years is $5m (cost $7m, accumulated depreciation on a straight line basis of $2m). There is no expected residual value. Due to a breakthrough in technology in the manufacture of computer chips, M Inc now expects the machine to produce 30% less in revenue terms than expected over the rest of its estimated useful life of 10 years. Net future cash flows for the next five years, based on management's best estimate after taking the 30% cut into account, are ($000): Year 1 2 3 4 5 Future cash flows 600 660 710 755 790 The expected growth rates for the following years are: Year 6 7 8 9 10 Future cash flows 2% (1)% (7)% (16)% (30)% If the machine was sold now it would realise $3.2m, net of selling costs. The discount rate to be applied to the future cash flows is 10%. Required Calculate any impairment loss and state the new carrying value of the SyMIX. (5 marks)

(d) M Inc acquired Q Inc for $20m four years ago. Q Inc has three operations based in three countries, each of which represents a cash-generating unit. On purchase, the data for Country A were: allocation of the purchase price $6m; fair value of identifiable assets $4m; goodwill $2m. Depreciation is charged on a straight-line basis over 20 years, with no residual value. At the beginning of Year 4 there had been no impairment of the goodwill arising on acquisition of Q Inc. At the end of year 4, government export restrictions were introduced that restricted production in Country A by 50%. The fair value less costs to sell for the operations in Country A cannot be estimated as it is unlikely a buyer could be found. The value in use of the operations in Country A is calculated as $2.73m.

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F7-Financial Reporting Required

IAS 36

Calculate the impairment loss and state how it should be allocated to the assets of the operations in Country A. (5 marks) (20marks)

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F7-Financial Reporting

IAS 36

Question

11 mins

On 1 January 20X2 Multiplex acquired Steamdays, a company that operates a scenic railway along the coast of a popular tourist area. The summarised statement of financial position at fair values of Steamdays on 1 January 20X2, reflecting the terms of the acquisition was: $'000 Goodwill 200 Operating licence 1,200 Property - train stations and land 300 Rail tack and coaches 300 Two steam engines 1,000 Purchase consideration 3,000 The operating licence is for ten years. It was renewed on 1 January 20X0 by the transport authority and is stated at the cost of its renewal. The carrying values of the property and rail track and coaches are based on their value in use. The engines are valued at their fair values less costs to sell. On 1 February 20X2 the boiler of one of the steam engines exploded, completely destroying the whole engine, fortunately no one was injured, but the engine was beyond repair. Due to its age a replacement could not be obtained. Because of the reduced passenger capacity the estimated value in use of the whole of the business after the accident was assessed at $2 million. Passenger numbers after the accident were below expectations even allowing for the reduced capacity. A market research report concluded that tourists were not using the railway because of their fear of a similar accident occurring to the remaining engine, in the light of this the value in use of the business was re-assessed on 31 March 20X2 at $1.8 million. On this date Multiplex received an offer of $900,000 in respect of the operating licence (it is transferable). The realisable value of the other net assets has not changed significantly. Required Calculate the carrying value of the assets of Steamdays (in Multiplex's consolidated statement of financial position) at 1 February 20X2 and 31 March 20X2 after recognising the impairment losses. (6 marks)

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