impairment of assets - karlstad university...september 2009 page 7 impairment of assets indicators...

Impairment of Assets

September 2009 Impairment of Assets

Authoritative Pronouncements

The module will cover IAS 36 Impairment of Assets, with focus on the impairment of property, plant and equipment, intangible assets and goodwill.


Main Topics Covered

► Indicators of impairment► Determination of Cash Generating Units (CGU)► Allocation of goodwill and corporate assets to the CGUs► Recoverable amount► Measurement of fair value less costs to sell, including the fair value hierarchy► Determination of value in use► Allocation/reversal of impairment loss


Scope of IAS 36IAS 36 shall be applied in accounting for impairment of all assets other than:

(a) inventories (see IAS 2 Inventories);(b) assets arising from construction contracts (see IAS 11 Construction Contracts);(c) deferred tax assets (see IAS 12 Income Taxes);(d) assets arising from employee benefits (see IAS 19 Employee Benefits);(e) financial assets that are within the scope of IAS 39 Financial Instruments: Recognition and

Measurement;(f) investment property that is measured at fair value (see IAS 40 Investment Property);(g) biological assets related to agricultural activity that are measured at fair value less estimated point-of-

sale costs (see IAS 41Agriculture);(h) deferred acquisition costs, and intangible assets, arising from an insurer’s contractual rights under

insurance contracts within the scope of IFRS 4 Insurance Contracts; and(i) non-current assets (or disposal groups) classified as held for sale in accordance with IFRS 5 Non-

current Assets Held for Sale and Discontinued Operations.


When an impairment test is required

► Annual impairment test for all intangible assets with an indefinite life and goodwill

► For all other classes of assets within the scope of IAS 36, the entity is required to assess at each balance sheet date whether there are any indicators of impairment


Indicators of impairment

External sources of information► during the period, an asset’s market value has declined significantly more than

would be expected as a result of the passage of time or normal use.► significant changes with an adverse effect on the entity have taken place during the

period, or will take place in the near future, in the technological, market, economic or legal environment in which the entity operates or in the market to which an asset is dedicated.

► market interest rates or other market rates of return on investments have increased during the period, and those increases are likely to affect the discount rate used in calculating an asset’s value in use and decrease the asset’s recoverable amount materially.

► the carrying amount of the net assets of the entity is more than its market capitalisation.



Internal sources of information► evidence is available of obsolescence or physical damage of an asset.► significant changes with an adverse effect on the entity have taken place during the

period, or are expected to take place in the near future, in the extent to which, or manner in which, an asset is used or is expected to be used. These changes include the asset becoming idle, plans to discontinue or restructure the operation to which an asset belongs, plans to dispose of an asset before the previously expected date, and reassessing the useful life of an asset as finite rather than indefinite.

► evidence is available from internal reporting that indicates that the economic performance of an asset is, or will be, worse than expected.



Evidence from internal reporting that indicates that an asset may be impaired includes the existence of:

► cash flows for acquiring the asset, or subsequent cash needs for operating or maintaining it, that are significantly higher than those originally budgeted;

► actual net cash flows or operating profit or loss flowing from the asset that are significantly worse than those budgeted;

► a significant decline in budgeted net cash flows or operating profit, or a significant increase in budgeted loss, flowing from the asset; or

► operating losses or net cash outflows for the asset, when current period amounts are aggregated with budgeted amounts for the future.


Case Study 1

Indicators of Impairment


Recoverable amount

► The recoverable amount of an asset or a cash-generating unit is the higher of its fair value less costs to sell and its value in use.

► Value in use is the present value of the future cash flows expected to be derived from an asset or cash-generating unit.


Recoverable amount

► Not always necessary to identify both VIU and FV, as if either VIU or FV is higher than the carrying amount, no impairment is necessary


Fair value less costs to sell

► The best evidence of an asset’s fair value less costs to sell is a price in a binding sale agreement in an arm’s length transaction, adjusted for incremental costs that would be directly attributable to the disposal of the asset.

► If there is no binding sale agreement but an asset is traded in an active market, fair value less costs to sell is the asset’s market price less the costs of disposal.

► If there is no binding sale agreement or active market for an asset, fair value less costs to sell is based on the best information available to reflect the amount that an entity could obtain, at the balance sheet date, from the disposal of the asset in an arm’s length transaction between knowledgeable, willing parties, after deducting the costs of disposal.


Measurement of Fair Value Less Costs to Sell

Binding agreement versus quoted market price► A company decides to renew its fleet of vehicles (trucks and vans). After the

balance sheet date the company entered into an agreement with buyer to sell 100 vans for 3,000 CU per item.

► the actual second-hand market price for such a van is 3,500 CU.

Issue:► Which amount should be used as fair value when performing the

impairment test?



Binding agreement vs quoted market price► No potential acquirer for the trucks as of the date of approval of financial

statements. ► 2 possibilities: ► Sell all the trucks to another company (similar terms of agreement as for

the vans) or► Sell them to the truck manufacturing company in exchange of newer

models of trucks. The second-hand market price for this type of trucks amounts to 40,000 CU per item.


Measurement of Fair Value Less Costs To Sell

Binding agreement vs quoted market price► Management expects to obtain a lower price if the trucks are to

be sold to the truck manufacturing company rather than to another buyer.

Issue :► Which amount should be used as fair value when performing

the impairment test?



Using valuation techniques to determine the fair valueFair value = the amount obtainable from the sale in an arm’s length transaction between knowledgeable, willing parties► FV can be determined in the absence of an active market. ► FV is based on the best information available to reflect the amount

obtainable in an arm’s length transaction► DCF can be a reliable estimate of the amount obtainable in an arm’s

length transaction.


Value in use

► The following elements shall be reflected in the calculation of an asset’s value in use:► (a) an estimate of the future cash flows the entity expects to derive from the

asset;► (b) expectations about possible variations in the amount or timing of those

future cash flows;► (c) the time value of money, represented by the current market risk-free rate of

interest;► (d) the price for bearing the uncertainty inherent in the asset; and► (e) other factors, such as illiquidity, that market participants would reflect in

pricing the future cash flows the entity expects to derive from the asset.


Basis for estimates of future cash flows

► In measuring value in use an entity shall:► (a) base cash flow projections on reasonable and supportable assumptions that

represent management’s best estimate of the range of economic conditions that will exist over the remaining useful life of the asset. Greater weight shall be given to external evidence.

► (b) base cash flow projections on the most recent financial budgets/forecasts approved by management, but shall exclude any estimated future cash inflows or outflows expected to arise from future restructurings or from improving or enhancing the asset’s performance. Projections based on these budgets/forecasts shall cover a maximum period of five years, unless a longer period can be justified.

► (c) estimate cash flow projections beyond the period covered by the most recent budgets/forecasts by extrapolating the projections based on the budgets/forecasts using a steady or declining growth rate for subsequent years, unless an increasing rate can be justified. This growth rate shall not exceed the long-term average growth rate for the products, industries, or country or countries in which the entity operates, or for the market in which the asset is used, unless a higher rate can be justified.


Composition of estimates of future cash flows

► Estimates of future cash flows shall include:► (a) projections of cash inflows from the continuing use of the asset;► (b) projections of cash outflows that are necessarily incurred to

generate the cash inflows from continuing use of the asset (including cash outflows to prepare the asset for use) and can be directly attributed, or allocated on a reasonable and consistent basis, to the asset; and

► (c) net cash flows, if any, to be received (or paid) for the disposal of the asset at the end of its useful life.


Composition of estimates of future cash flows

► Future cash flows shall be estimated for the asset in its current condition. Estimates of future cash flows shall not include estimated future cash inflows or outflows that are expected to arise from:► (a) a future restructuring to which an entity is not yet committed; or► (b) improving or enhancing the asset’s performance.


Discount rate

► The discount rate (rates) shall be a pre-tax rate (rates) that reflect(s) current market assessments of:► (a) the time value of money; and► (b) the risks specific to the asset for which the future cash flow

estimates have not been adjusted.


Recognizing and measuring an impairment loss

► 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. That reduction is an impairment loss.

► An impairment loss shall be recognized immediately in profit or loss, unless the asset is carried at revalued amount in accordance with another Standard (for example, in accordance with the revaluation model in IAS 16 Property, Plant and Equipment). Any impairment loss of a revalued asset shall be treated as a revaluation decrease in accordance with that other Standard.


Determination of cash-generating units

► If there is any indication that an asset may be impaired, recoverable amount shall be estimated for the individual asset. If it is not possible to estimate the recoverable amount of the individual asset, an entity shall determine the recoverable amount of the cash-generating unit to which the asset belongs (the asset’s cash-generating unit).

► The recoverable amount of an individual asset cannot be determined if:► the asset’s value in use cannot be estimated to be close to its fair value less

costs to sell (for example, when the future cash flows from continuing use of the asset cannot be estimated to be negligible); and

► the asset does not generate cash inflows that are largely independent of those from other assets.


Determination of cash-generating units

Example► A mining entity owns a private railway to support its mining activities. The private

railway could be sold only for scrap value and it does not generate cash inflows that are largely independent of the cash inflows from the other assets of the mine.

► It is not possible to estimate the recoverable amount of the private railway because its value in use cannot be determined and is probably different from scrap value. Therefore, the entity estimates the recoverable amount of the cash-generating unit to which the private railway belongs, ie the mine as a whole.


Case Study 2

Determination of Cash-Generating Units


Main Issues Related to Determination of CGUs

► Determination is not conditioned upon existence of indicators of impairment► Judgement and very good knowledge of the industry and of the organisation

of the company are required► Varying approaches in practice in various entities may be applied► Determination should be done at the lowest level possible► Independent cash inflows does not necessarily mean external cash inflows


Allocation of Goodwill and Corporate Assets to the CGUs

Scenario 1 – acquisition of a market share in China► A group that manufactures and distributes cosmetics has acquired an entity in

China.► The objective of this business combination was purely to acquire the market

share and distribution network of the Chinese entity .► The group intends to keep using the local brand for another 18 months during

which period this will be replaced by the brand of the group.



Scenario 1 (Cont)►Simultaneously the group will impose its own products to replace the local

ones.►The goodwill generated from this acquisition amounted to 90 million currency

units.

Question►Should this goodwill be allocated to the CGUs of the acquiree or of the

acquirer?



Solution►The goodwill should not be allocated to the CGUs of the acquiree, but to the

CGUs of the acquirer, because the synergies resulting from the business combination will benefit only the CGUs of the acquirer (it will allow the group to penetrate the market with its own products, obtain economies of scale and increase sales volume)



Scenario 2 – allocation of a patented technology►A telecommunication group has two business segments: fixed phone and mobile

phones. ►Each of these segments has several divisions.►One of the divisions, part of the mobile phones segment, has acquired in 20X2

Entity B and has identified as a separate intangible asset a specific patented technology.

► This patented technology, which is the main asset of Entity B, is used not only within the acquiring division, but also by three other divisions, part of both business segments.



Scenario 2 (Cont)►Entity B is invoicing all the divisions royalties for the use of the technology. This

represents 100% of the revenues earned by Entity B► The royalties are calculated as a percentage of the turnover generated through

the use of the respective technology► The group considered that entity B is a CGU and the patented technology was

included as an asset in this CGUQuestion►Was the group right in considering the patented technology as part of the Entity

B’s cash generating unit?



Solution►No, the decision was wrong►Although the revenues of entity B are 100% internally generated, as

there is no active market for the services rendered by B through the use of the technology entity, B is not a CGU

►The patented technology rather meets the definition of a corporate asset

►The carrying amount of the asset should be allocated to each division on the basis of the relative amount of royalties invoiced to each division


Impairment loss for a cash-generating unit

► The impairment loss shall be allocated to reduce the carrying amount of the assets of the unit (group of units) in the following order:► (a) first, to reduce the carrying amount of any goodwill allocated to the

cash-generating unit (group of units); and► (b) then, to the other assets of the unit (group of units) pro rata on the

basis of the carrying amount of each asset in the unit (group of units).


Impairment loss for a cash-generating unit

► In allocating an impairment loss, an entity shall not reduce the carrying amount of an asset below the highest of:► (a) its fair value less costs to sell (if determinable);► (b) its value in use (if determinable); and► (c) zero.

► The amount of the impairment loss that would otherwise have been allocated to the asset shall be allocated pro rata to the other assets of the unit (group of units).


Reversing an impairment loss

► An entity shall assess at each reporting date whether there is any indication that an impairment loss recognised in prior periods for an asset other than goodwill may no longer exist or may have decreased. If any such indication exists, the entity shall estimate the recoverable amount of that asset.

► The increased carrying amount of an asset other than goodwill attributable to a reversal of an impairment loss shall not exceed the carrying amount that would have been determined (net of amortisation or depreciation) had no impairment loss been recognised for the asset in prior years.

► An impairment loss recognised for goodwill shall not be reversed in a subsequent period.


Case Studies 3 and 4

Allocation of Impairment Losses

Reversal of Impairment Losses


Conclusion

►Questions?

impairment of assets - karlstad university...september 2009 page 7 impairment of assets indicators...

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