Presentation on theme: "IAS 36 Impairment of Assets"— Presentation transcript:
1 IAS 36 Impairment of Assets KPMG International Financial Reporting GroupPresented By: Tony Boutros & Walid Farran
2 Agenda Background and scope Indications of impairment and frequency of testingRecoverable amountFair value less costs to sellValue in useCash-generating units, goodwill and corporate assetsAccounting aspectsDisclosure
3 BackgroundObjectiveassets should be carried at no more than their recoverable amount.
4 Scope Applies to all assets except Inventories (IAS 2; lower of cost or NRV)construction contracts (IAS 11; a loss is booked when it is probable that total contract costs will exceed total contract revenue)deferred taxes (IAS 12; an assets is booked only when its recovery is probable)financial assets (IAS 39)assets arising from employee benefits (IAS 19)investment properties, measured at fair value (IAS 40)biological assets at fair value less estimated point-of-sale costs (IAS 41)deferred acquisition costs (IFRS 4)non-current assets classified as held for sale (IFRS 5)
5 Definitions (1) Recoverable amount of an asset or a CGU is the higher of an assets fair value less costs to sell and its value in use.Fair value less costs to sellis the amount obtainable from the sale of an asset or CGU in an arm’s length transaction between knowledgeable, willing parties, less the costs of disposal.Value in useis the present value of future cash flows expected to be derived from an asset or a CGU.
6 Definitions (2) Cash Generating Unit (CGU) is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or group of assets.Impairment lossis the amount by which the carrying amount of an asset or a cash generating unit exceeds its recoverable amount.
7 Agenda Background and scope Indications of impairment and frequency of testingRecoverable amountFair value less costs to sellValue in useCash-generating units, goodwill and corporate assetsAccounting aspectsDisclosure
8 Indications of impairment At each balance sheet date an entity should assess whether there is any indication that an asset or a CGU may be impaired. If any such indication exists, the entity should estimate the recoverable amount of the asset.If no indication exists, no need to make a formal estimate of recoverable amount; except for:
9 Frequency of testing (1) Recent calculation can be used if criteria are metGoodwill acquired in business combinationIntangible assets with an indefinite useful lifeIntangible assets not yet available for useImpairment testannually,andat each reporting date, whenever there is an indication that an asset may be impaired;before the end of the period of initial recognitionAny time within an annual reporting periodneeds to be consistent (same time every year)Trade mark (see example # 8 in IAS 38 page 1632)
10 Frequency of testing (2) Recent calculation can be used if the following criteria are met:CGU did not change substantiallyMost recent recoverable amount was substantially higher than carrying amountAnalysis of events and circumstances – likelihood that recoverable amount is lower than carrying amount is remote
11 recent calculation can be used if criteria are met Frequency - summaryAsset / CGUimpairmenttestyesIndication?impairmenttestnoCGU GW alloc/intangible assetswithin the scopeof IAS 36impairmenttestrecent calculation can be used if criteria are metyesIndication?impairmenttest at leastannuallyany time within an annual reporting periodconsistencyno
12 Indications of impairment (1) External sourcessignificant decline in market valuetechnological, market, economic, legal environmentchanges in interest rates or rates of returnlow market capitalisationInternal sourcesevidence of obsolescence or physical damagediscontinuance, disposal, idleasset performance declining or expected to declineHigh maintenanceNet cash flow is worse than budgetedOperating lossesExample 1: A company that owns a subsidiary that operates in a country which economy has moved into a deep recession.Example 2: Introduction of a new machine which will reduce the cost of units produced and the competitors announced its purchase.Introduction of new environmental laws.Example 3: Government has recently announced an increase in interests ratesExample 4: market capitalization of a company has recently fallen below the carrying value of its net assetsExample 5: Destruction of a property, Specialized tools bought and not being used.Example 6: Plan to dispose an asset, Plan to discontinue a line of business.Example 7: A company has capitalized certain development costs. Sales were well below forecast.
13 Indications of impairment (2) If there is an indication that an asset may be impaired, this may indicate that the remaining useful life, the depreciation (amortization) method or the residual value for the asset needs to be reviewed and adjusted in accordance with the Standard applicable to the asset, even if no impairment loss is recognized for the asset.
14 Agenda Background and scope Indications of impairment and frequency of testingRecoverable amountFair value less costs to sellValue in useCash-generating units, goodwill and corporate assetsAccounting aspectsDisclosure
15 Recoverable amount (1)RECOVERABLEAMOUNTGreater ofandVALUE INUSEFAIR VALUELESS COSTSTO SELLInclude example illustration 8 separatelyIt is not always necessary to determine both an asset’s fair value less costs to sell and its value in use. If either of these amounts exceeds the asset's carrying amount, the asset is not impaired and it is not necessary to estimate the other amount.
16 Recoverable amount (2) 900 1,050 1,050 1,000 No impairment Value in Fair value Recoverable Carrying CommentUse less costs amount is: amountto sell900 1,050 1, , No impairment, Impairment of 20, Impairment of 40
17 Agenda Background and scope Indications of impairment and frequency of testingRecoverable amountFair value less costs to sellValue in useCash-generating units, goodwill and corporate assetsAccounting aspectsDisclosure
18 Fair value less costs to sell (1) Binding sale agreementNo binding sale agreementactive market (current bid price, or most recent transactions.)No active marketbest information available (results of recent transactions In the same industry.Costs of disposal (eg: legal costs, stamp duty, cost of removing the asset, other direct costs to bring the asset into condition for its sale)Costs of disposal exclude:reorganisation costs (restructuring cost)costs already recognised as liabilities
19 Fair value less costs to sell (2) X operates in leased premises. It owns a bottling plant which is situated in a single factory unit. Bottling plants are sold periodically as a complete assets.Professional valuers have estimated that the plant might be sold for $100,000. They have charged a fee of $1,000 for providing this valuation.X would need to dismantle the asset and ship it to any buyer. Dismantling and shipping would cost $ 5,000. Specialist packaging would cost a further $4,000 and legal fees $ 1,500.Compute fair value less costs to sell:
20 Fair value less costs to sell (3) $Sales price ,000Dismantling and shipping (5,000)Packaging (4,000)Legal fees (1,500)Fair value less costs to sell 89,500
21 Agenda Background and scope Indications of impairment and frequency of testingRecoverable amountFair value less costs to sellValue in useCash-generating units, goodwill and corporate assetsAccounting aspectsDisclosure
22 Value in useValue in use is the present value of future cash flows expected to be derived from an asset. Estimating it involves:Estimating the future cash inflows and outflows to be derived from continuing use of the asset and from its ultimate disposal; andApplying appropriate discount rate to those future cash flows.PV = FV(1+i)n
23 Value in use – measurement Reasonable and supportable assumptions that reflects management’s best estimateMost recent financial budgets/forecasts approved by management (excluding future restructurings and improvements to enhance performance)Short term projections: 5 years (unless a longer period can be justified)
24 Value in use – composition (1) Estimates of future cash flows should include:Projections of cash inflows from the continuing use of the asset.Projections of cash outflows that are necessarily incurred to generate cash inflows from the continuing use of the asset.Net cash flows to be receive (or paid) from the disposal of the asset at the end of its useful life.
25 Discount ratesCurrent market assessments of time value of money and risks specific to the assetWACC of a listed entity that has a single asset (or portfolio of assets) similar to the asset/CGU under review.If not available, then use following as a starting point:Entity’s WACC (using CAPM capital asset pricing model);Entity’s incremental borrowing rate;Other market borrowing rates (for similar companies and/or assets);However, these rates must be adjusted to reflect specific risks associated with the projected cash flows.
26 WACC – formula WACC = (D/V x Rd) + (E/V x Re), where: D = Debt E = EquityV = E + DRd = borrowing rate or return on debtRe = return on equity
27 Example – WACC calculation Suppose that company XYZ has £2 million of debts and 100,000 shares selling at £30 per share (both measured at fair value and reflecting the company’s long term financing policy). It’s current borrowing rate is 8%, and the CFO thinks that the stock is priced to offer a 15% return.What is the WACC of company XYZ?
28 Solution – WACC calculation WACC = (D/V x Rd) + (E/V x Re)WACC = (2/5 x 0.08) + (3/5 x 0.15)WACC = 12.2%
29 Agenda Background and scope Indications of impairment and frequency of testingRecoverable amountFair value less costs to sellValue in useCash-generating units, goodwill and corporate assetsAccounting aspectsDisclosure
30 CGUs (1) Estimate recoverable amount for VIU cannot be estimated to be close to FVLCSasset doesn’t generate independent CFEstimate recoverable amount forthe individual asset, or if not possiblethe asset’s CGUApply CGU concept when the asset does not generate cash flows which are independent from other assetsExample in IAS page 1390The smallest identifiable group of assets that generates cash inflows from continuing use that are largely independent from other assets of groups of assets
31 CGUs (2)Example 1:An entity owns a dry dock with a large crane to support its activities. The crane could only be sold for scrap value and cash inflows from its use cannot be identified separately from all of the operations directly connected with the dry dock.It is not possible to estimate the recoverable amount of the crane because its value in use cannot be determined. Therefore, the entity estimates the recoverable amount of the cash-generating unit to which the crane belongs, i.e. the dry dock as a whole.
32 CGUs (3)Example 2:A bus company provides services under contract with a municipality that requires minimum service on each of five separate routes. Assets devoted to each route and the cash flows from each route can be identified separately. One of the routes operates at a significant loss.Because the entity does not have the option to curtail any one bus route, the lowest level of identifiable cash inflows that are largely independent of the cash inflows from other assets or group of assets is the cash inflows generated by the five routes together. The cash generating unit for each route is the bus company as a whole.
33 CGUs (4)Smallest group of assets with largely independent cash inflowsIAS 36 emphasises that CGUs should be identified for the lowest level of aggregation of assets possible (BfC 99).Please read through IAS – 72 and especially note the following:Judgement is / has to be involved.Cash inflows are inflows from third parties.Existing active market for the output indicates CGU (as we see later in issue 3: Transfer Price).CGUs should be identified consistently.Common mistake is that The CGU is on a too high level (as possible under US GAAP)Cashflows are in practise are harder to prepareVarious factors including:How management monitors (product lines, individual locations, regional areas etc)How decisions are made about continuing or disposing of the entity’s assets and operations.
34 GoodwillGoodwill acquired in a business combination represents a payment made by an acquirer in anticipation of future economic benefits arising from assets that are not capable of being individually identified and separately recognised.Does not generate independent cash flows
35 Allocation of goodwill (1) assets + liabs + synergiessynergiesCGU ACGU BBasic principle:Goodwill is allocated to the acquirer’s CGU (or group of CGUs) that are expected to benefit from the synergies of the business combination, irrespective of whether other assets or liabilities of the acquiree are assigned to those units
36 Allocation of goodwill (2) Initial allocation: If the initial allocation of goodwill acquired in a business combination cannot be completed before the end of the annual period in which the business combination is effected, that initial allocation shall be completed before the end of the first annual period beginning after the acquisition dateEach unit or group of units shall:Represent the lowest level within the entity at which goodwill is monitored for internal management purposesNot be larger than entity’s primary or secondary reporting format (IAS 14 Segment Reporting)Disposal of operations: allocated to the carrying amount of the operation when calculating gain/loss
37 Allocation of goodwill (3) Once goodwill has been allocated to a cash generating unit, that unit must be tested for impairmentAnnuallyand whenever there is an indication that the unit may be impairedIf the carrying amount of the unit (including goodwill) exceeds the recoverable amount of the unit, the entity shall recognize impairment loss.
38 Example: GoodwillEntity Q is a wholly owned subsidiary of M and has 3 divisions, X,Y,Z.There are indications that Y is impaired and Q has estimated its recoverable amount to be $230m. There are no indications that X and Z are impaired.The value of Q has been estimated, by M, to be $1,380m.The management of M have allocated $450m of the goodwill held in the group accounts to Q. As X, Y, and Z are separately reported to M, they are considered to be the lowest level within the entity that goodwill is monitored
39 Example: Goodwill (continue) Cash generating unit X Y Z Total$m $m $m $mNet assets directlyinvolved in the activitiesof the unitGoodwillTotal ,200The goodwill has been allocated in the ratio that the directly attributed assets bear to each other.
40 Example: Goodwill (continue) The carrying value of (Y) that would be compared to the recoverable amount is $240m.Y$mCarrying amount 240Recoverable amount (230)Impairment loss 10Thus an impairment loss of $10m should be recognized even though the fair value of Q as a whole ($1,380m) is greater than its carrying value ($1,200m).
41 Agenda Background and scope Indications of impairment and frequency of testingRecoverable amountFair value less costs to sellValue in useCash-generating units, goodwill and corporate assetsAccounting aspectsDisclosure
42 Recognizing 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 should be reduced to its recoverable amount. That reduction is an impairment loss.An impairment loss should be recognized as an expense in the income statement immediately, unless the asset is carried at a revalued amount under another IAS.Any impairment loss of a revalued asset should be treated as a revaluation decrease under that other IAS.
43 Accounting for impairment loss The credit entry would usually be taken to an impairment account (much lie the accumulated depreciation account). This is then set against the cost of the asset for presentational purposes.Dr Income statementCr Impairment account (balance sheet)After impairment, the carrying value of the asset less any residual value is depreciated (amortized) over its remaining expected useful life.
44 Example: Accounting aspects CV Rec I/S EquityamtAssets are Dr 0Carried at historicCost.2) Historic cost DrRevalued to 1503) Historic cost Dr 50Dr
45 Allocation within a cash generating unit The impairment loss should be allocated to the CGU in the following order:Goodwill allocated to the CGUThen, to the other assets of the unit on a pro-rata basis based on the carrying amount of each asset in the unit.In allocating an impairment loss the carrying amount of an asset should not be reduced below the highest of:Its fair value less costs to sell (if determinable);Its value in use (if determinable); andZeroThe amount of the impairment loss that would otherwise have been allocated to the asset should be allocated to the other assets of the unit on a pro-rata basis.
46 Example (1)At 1 January, an entity paid $2,800 for a company whose main activity consists of refuse collection. The acquired company owns four refuse vehicles and a local government license without which it could not operate.At 1 January, the fair value less costs to sell of each vehicle and of the license are $500. The company has no insurance cover.At 1 February, one vehicle crashed. Because of its reduced capacity, the entity estimates the value in use of the business at $2,220.How the impairment loss is allocated ?
47 Example (1): Solution 1 1 Imp. January February loss Goodwill (80)Intangible assetVehicles 2, , (500)2, , (580)An impairment loss of 500 is recognized first to the vehicle that crashed because its recoverable amount can be assessed individually. (It no longer forms part of the cash generating unit. The remaining loss is attributed to Goodwill.
48 Example (2) Following from Example 1: At 22 May the government increased the interest rates. The entity re-determined the value in use of the business as $1,860. The fair value less costs to sell of the license had decreased to $480 (as a result of market reaction to the increased interest rates). The demand for vehicles was hit hard by the increase in rates and the selling prices were adversely affected.How the impairment loss is allocated ?
49 Example (2): Solution 1 February 22 May Imp. loss Goodwill 220 0 (220) Intangible asset (20)Vehicles 1, , (120)2, , (360)First 220 is charged to the goodwill to reduce it to zero. The balance of 140 must be pro-rated between the remaining assets in proportion to their carrying value.The ratio that the remaining assets bear to each other is 500:1,500. This implies that 25%*140=35 should be allocated to the intangible asset. However, this would reduce its carrying value below its fair value less costs to sell and this is not allowed. The maximum that may be allocated is 20 and the remaining 15 must be allocated to the vehicles.
50 Subsequent review (1)An entity shall assess at each reporting date whether there is any indication that an impairment loss recognized in prior periods for an assets other than goodwill may no longer exist or may have decreased.An entity should consider, as minimum, the following indications:Internal sources:Significant favourable changes in the actual or expected extent or manner of use of the asset. (e.g. capital expenditures incurred enhances the asset)Evidence is available from internal reporting that indicates that the economic performance of the asset is, or will be, better than expected.
51 Subsequent review (2) External sources: Significant increase in the asset's market value during the period.Significant changes with a favourable 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 which the asset is dedicated.Market interest rates or other market rates of return on investments have decreased during the period and those decreases are likely to affect the discount rate used in calculating the assets value in use and increase the asset’s recoverable amount materially.
52 Reversals of impairment Losses (1) 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 amortization or depreciation) had no impairment loss been recognized for the assets in prior years.Any increase in the carrying amount of an asset other than goodwill above the carrying amount that would have been determined (net of amortization or depreciation) had no impairment loss been recognized for the assets in prior years is a revaluation. In accounting for such a revaluation, the entity applies the Standard applicable to the asset.
53 Reversals of impairment Losses (2) A reversal of an impairment loss for an asset other than goodwill shall be recognized immediately in profit or loss.A reversal of an impairment loss on a revalued asset should be treated as a revaluation increase under the relevant IAS. This will usually mean that the increase in value will be credited to the revaluation reserve unless it reserves an impairment that has been previously recognized as an expense in income. In this case it is recognized as income to the extent that it was previously recognized as an expense.
54 Reversals of impairment Losses (3) In allocating a reversal of impairment loss for a CGU, the carrying amount of an asset should not be increase above the lower of:Its recoverable amount (if determinable);The carrying amount that would have been determined (net of depreciation or amortization) had no impairment loss been recognized for the asset in prior years.An impairment loss recognized for goodwill shall not be reversed in a subsequent period.
55 Agenda Background and scope Indications of impairment and frequency of testingRecoverable amountFair value less costs to sellValue in useCash-generating units, goodwill and corporate assetsAccounting aspectsDisclosure
56 Key disclosures Disclose the following for each class of assets: Events and circumstances that led to the recognition or reversal of the impairment loss.Amount of impairment losses recognised / reversed during the period inincome statement anddirectly to equitySegment reporting information (if required)Disclosure where impairment losses are material for an individual assetIf impairment losses recognized (reversed) are material in aggregate.Information on basis used for recoverable amountDiscount rate usedMention that several key disclosures are required so that users can obtain an understanding of the impact of impairments for the business.As per the last point it is important to disclose the information that forms the basis of the calculation of the recoverable amount and in particular what the main assumptions are. This gives users a better understanding and leaves them free to form their own judgment on the reliability of those resulting estimates.Refer to the following slide that details the relevant accounting policy note and numerical disclosures.