Letter To The CFO Of The Wentnor Dairy Company Ltd On CGUs And Impairment Testing: Essay.

Write a letter to the chief financial officer of The Wentnor Dairy Company Ltd, including the following:
A. Define a CGU.
B. Explain why impairment testing requires the use of CGUs, rather than being based on single assets.
C. Explain the factors that the chief financial officer should consider in determining the CGUs for The Wentnor Dairy Company Ltd.

Defining CGUs under AASB 136

As per the case study which is provided in the question, Wentnor Dairy Company Ltd is engaged in running of dairy farms and also diversified its business by purchasing factories that produces milk products. The Chief Financial Officer of company of Wentnor Dairy ltd wants to effectively identify Cash generating units of the business for the purpose of impairment of assets as per AASB 136. 

As per the para 6 of AASB 136 which is issued by Australia Accounting Standard Board, a cash generating unit can be defined as identification of smallest group of assets which are identifiable and which are capable of generating cash and are also regarded as independent from other groups of assets (Qasim, Haddad  and Abughazaleh 2013). 

As per the provision which are stated AASB 136, the impairment tests of asset require comparisons of recoverable amount to be made with the higher of the asset’s value in use and fair value less the cost of disposals of the asset. The value in use as per the standard requires are given below:

• The estimate of the future cash flows that the business anticipates to derive from the use of asset.
• Expectation about the timing of the cash flow
• The price for bearing the uncertainty of the asset.

There are certain assets which are used certain business which do not have a cash flow of its own and such assets can only generate cash flows when the taken together in a group of assets of similar nature. In case of the Wentnor Dairy ltd, the machines which are used for extraction and purification of milk cannot generate cash flow of its own. The main cash flow generating product is the milk which is extracted and purified by such machines. The machine when used together can be considered to be a cash generating unit. The machinery which is used by the business is combination generates cash inflows for the business. 

There are various factors which the Chief financial officer must consider before identifying the cash generating units of the asset. The CFO of the business needs to firstly understand that CGU’s are the lowest value of assets which can independently generate cash flows for the business. The factors which are stated in Para 69 to Para 71 of AASB 136 states how the management monitors the operations of the business which includes product liens, individual locations, district or regional area. The chief financial officer how would he identify the cash generating units of the business following the relevant standards which are issued by the AASB.

The cash generating units of the business needs to identified from a particular time period to another consistently for any assets unless there are certain changes associated with the asset. The recognition of cash generating units requires accurate judgements on the part of the management and also following the AASB 136 which is on Impairment of assets of the business. 

Explanation on impairment testing with CGUs

As per the requirement of the question, significant ratios are to be computed which are based on profitability, solvency, efficiency and capital structure. The ratios are an important tool which is used to analyze the financial performance of Woolsworth ltd. The calculation of different ratios which are shown in the appendix section represents the vital ratio which shows the financial performance of the business. 

The current ratio of the company shows that the liquidity position of the company is not at all good as the estimate is shown to be less than 1. The acid test ratio which is shown in the calculation in the appendix section also reveals that the business is facing liquidity issues. The current ratio and acid test ratio of the company is shown as 0.793 and 0.330 respectively. The ratio also reveals that the estimate of current ratio and acid test ratio has decreased from previous year’s estimates which makes it clear that the business has shortage of liquid cash which can be an issue. The gross profit margin of the business has increased from previous year which suggest that the business is progressing in terms of profitability. The increase in the gross profit of the company is also considered to be a financial indicator of the business. The business has significantly improved in terms of gross profit margin of the business. The receivable turnover ratio of the company also shows an increase in the same which is considered to be favorable sign for the business as this suggest. The receivable turnover ratio suggests that the business the credit policy of the business is also strong which is the result that the receivable turnover ratio of the company is favorable. The return on net sales and return on assets of the has tremendously improved for the business from the previous year’s figure as shown in ratio computations which is shown in the appendix section. In 2016, the results of return on sales and return on equity shows that Woolsworth ltd had negative returns from where the business has significantly improved and have made the returns which are earned by the business significant and appropriate (Lecy and Searing 2015). The return on equity is considered to be a financial indicator which is reviewed the potential investors of the business in order to take decisions whether they are going to invest in the shares of the company or not. In addition to this, the favorable return on equity also means that the business is meeting the needs of the shareholders and earning appropriate returns for the same. The dividend payout ratio of the business has also significantly improved from previous year which shows that the business is now concerned with the wealth maximization principle for the shareholders of the business (Makkar and Singh 2013). The dividend payout ratio for 2017 is shown as 70.35% which has tremendously improved from the previous year’s analysis. Thus, from the above discussions it is clear that the business is favorable for making investments and the investor should invest in the shares of the company (Al Karim and Alam 2013). The company however needs to maintain and improve the liquidity position of the company and thereby ensure that the business does not face any liquidity crisis. Thus, it can be said the investor should invest in the shares of the company. 

Factors for CFO to consider in determining CGUs for The Wentnor Dairy Company Ltd

As per the computation of ratios which is shown in Requirement A, the current ratio and the acid test ratio of the company shows that the business does not have favorable ratio for the year 2017 which is shown as 0.793 and 0.330 respectively. The ratio which are calculated for the company does not matches the ideal standards which is 2:1 in case of a current ratio and 1.5:1 in case of quick ratio (Delen, Kuzey and Uyar 2013). As the company’s ratio as shown in the calculation does not matches the standard which means that the business might be facing liquidity crisis which is important to solve from general operation’s point of view of the business. 

As per the question which has a paragraph included in it from the annual reports of Qantas ltd which deals with the translation of foreign currency into domestic currency. Qantas ltd has engaged in foreign transaction during the year for which the business has received certain revenues which if the business wants to record in the financial statement needs to be translated. The most used techniques which maximum number of business uses for translation is current rate method.

The reason due to which foreign exchange transaction arise is due to the fluctuation the rate of foreign currency in terms of home currency (Jackson 2013). This may be due to a number of factors such as governmental policies, inflation in home and foreign country and other factors as well. The difference in foreign currency is recognized in the comprehensive income statement and any gains is transferred to the Foreign currency translation reserve account. 

Reference

Al Karim, R. and Alam, T., 2013. An evaluation of financial performance of private commercial banks in Bangladesh: Ratio analysis. Journal of Business Studies Quarterly, 5(2), p.65.

Delen, D., Kuzey, C. and Uyar, A., 2013. Measuring firm performance using financial ratios: A decision tree approach. Expert Systems with Applications, 40(10), pp.3970-3983.

Jackson, J.K., 2013. Foreign ownership of US financial assets: Implications of a withdrawal.

Lecy, J.D. and Searing, E.A., 2015. Anatomy of the nonprofit starvation cycle: An analysis of falling overhead ratios in the nonprofit sector. Nonprofit and Voluntary Sector Quarterly, 44(3), pp.539-563.

Makkar, A. and Singh, S., 2013. Analysis of the financial performance of Indian commercial banks: A comparative study. Indian Journal of Finance, 7(5), pp.41-49.

Qasim, A., Haddad, A. and Abughazaleh, N., 2013. Goodwill accounting in the United Kingdom: The effect of international financial reporting standards.