The purpose of the impairment test for assets
2. when to undertake an impairment test
3. how the existence of goodwill will affect the impairment test
4. the basic steps to be followed in applying the impairment test for (a) individual assets and (b) cash generating units
5. How to account for reversals of Impairment losses.
Management has also requested that you explain, by example, how other companies are applying AASB 136. So further to the above you are also required to consider the financial statements of a reporting entity (BlueScope Steel Ltd) and indicate to management the effect of impairment testing on these financial statements. In doing
This you need to indicate to management in an appendix to the report in A above, various aspects of the Annual report from BlueScope Steel Ltd:
The measurement basis for assets
2. What are the company’s assets, including Property, plant and equipment and intangible assets? Do they have goodwill?
3. Have any assets been impaired? Is there an explanation for this?
4. Has any reversal of impairment losses occurred?
5. What is the effect of asset impairment/reversals of asset impairment on the balance sheet and the income statement? (You will need to look at relevant notes to the accounts.)
Objective and Purpose of Impairment of Assets
The standard AASB 136 Impairment of Assets is issued by the Australian Accounting Standards Board under the Corporations Act 2001 on 15 July 2004. The standard is applied to each entity preparing the financial reports for particular accounting period and in accordance with the provisions of Corporation act (AASB. 2009).This report highlights the purpose of impairment of assets and other related aspects in its first part. Further, it is also discussed how efficiently the management of BlueScope Steel Ltd conduct impairment testing of its assets for the financial year. It explains the measurement basis taken up by the company as well as the affects of impairment. Lastly, a conclusion is been provided summarizing the findings of the report.
The main objective or the purpose of impairing company’s assets is to make sure that they are carried out in the reports at the amounts which are not in excess of their recoverable value. If the asset is shown at the value more than its recoverable amount then it means its carrying amount is higher than the value to be derived from its sales in future. In such case, companies are required to measure and recognize the impairment loss as that particular asset is considered to be impaired. The aim of the AASB 136 is to prescribe and define the procedures for entities which they can apply while conducting the impairment (CPA Australia. 2018).
The reason for testing an asset for impairment is that the carrying amount may not reflect its recoverable value for several reasons such as the amount of net assets is more than market capitalization; interest rates have increased during the year, significant changes taken place within the organization and many others. Due to this, a company is required to conduct an impairment test so that it can recognize any sort of impairment loss on time.
Generally, the test is conducted when asset’s carrying amount is more than its recoverable amount. According to AASB 136, there are some conditions that give indications to the company in respect to the impairment loss that might have occurred. There are some external and internal sources of information thorough which such indications are derived (Christian & Lüdenbach, 2013). They are as follows:
- The market value of the assets fall below the expected benchmark during its normal use or due to the passage of time.
- Significant changes in the economic, legal and technical environment within which the company operates and such variations have impacted the value of asset.
- Increase in the return on investments and market interest rates which affects the asset value in use and reduces its recoverable amount.
- The carrying value is higher than the market capitalization of the asset.
- Availability of the evidence in case of asset obsolescence or when the asset is physically damaged.
- The manner in which company utilized an asset changes which eventually affects its life such as discontinuation of the operation to which the asset is associated, disposing off the asset before the expected time and many others (Ball, 2006)
All the above are the situations which indicates the need of conducting impairment test for company’s assets.
The impairment test on goodwill is conducted when its carrying value exceeds its fair value. It is treated as a charge for the company and it reflects that the acquired assets of the company are not capable for generating cash flows. This impairment test has a significant impact on the income statement as it is charged directly as an expense or is written off till the goodwill is completely removed from the balance sheet (Ernst & Young. 2010). The accounting entry passed at time of goodwill impairment is:
Conditions for Conducting an Impairment Test
Impairment of goodwill a/c xxx
Accumulated Impairment of goodwill a/c xxx
Profit and Loss a/c xxx
Impairment of goodwill a/c xxx
The goodwill written down is treated as an expense and it directly influences the net income of the company bringing a reduction in it. So the impairment of goodwill has a significant impact on company’s financial statements and on impairment testing.
The first is to find out the carrying amount of the asset which is to be impaired. Such value is determined by subtracting the amount of accumulated depreciation from the original cost of asset. After that, the fair market value of the asset is calculated by using the three approaches provided by Generally Accepted Accounting Principle (GAAP). Market approach deals with the transactions containing similar assets and cost approach determines the cost of replacing the asset. Third approach is the income approach which reflects the future income, cash flow and expenses related to the asset (Dagwell, Wines & Lambert, 2015).
Once the fair value and carrying amounts are calculated the next step is to derive the value in use. VIU is the present value of the asset which is derieved on the basis of cash flows generated from it. However, it can be offset by the amount of asset disposal at the end of its life. The calculation of VIU includes projected cash flows and a discount rate at which they are to be discounted for determining the present values. After this, the recoverable amount is determined that is equal to the higher of VIU and fair value. The fair market value is adjusted by the cost incurred for selling the asset and VIU is adjusted by the cost of asset disposal.
The last step is to compare the carrying amount with the identified RA. If the carrying value is more than the recoverable value, then the asset impairment is recorded by passing a journal entry into the accounts (Carmichael & Graham, 2012).
- Impairment of CGUs
CGU stands for Cash Generating Unit which is a small group of assets which is largely independent of the cash flows generating from other assets. However, the steps are same but if it is impossible to figure out the RA of individual asset, then the entity should determine the same for CGU to which the asset is associated. The carrying amount of asset is included in the CA of CGU that can be allocated directly to it. Also the goodwill acquired for impairment testing is attributed to the group of CGUs. However, if it cannot be allocated to individual CGUs then it is impaired at lowest level within the entity which may include a group of CGU. Whenever such CGU is tested, the impairment loss is allocated in order to reduce the CA of goodwill. The remaining amount is then attributed to other assets on pro-rata basis (ACCA. 2012).
The reporting entities are required to recognize any sort of impairment loss other than goodwill which can be recovered at the end of reporting period. If such situation exists, the company then estimate the RA of the asset. However, an impairment loss recognized on goodwill cannot be repaired. As and when there are indications for impairment reversals, the recoverable amount of the asset is evaluated and the reversal amount is recognized in the income statement of the company. Once the reversal is done the charge of depreciation or amortization is adjusted in future periods which is required to allocate the revised CA of assets excluding its residual value, if any (Chen, Wang & Zhao, 2008).
In case of CGU, pro-rata basis is used to allocate the reversal of loss to the assets. While allocating the amount, the asset’s carrying amount is not raised above the lower of its recoverable value.
From the above report, it is concluded that all the reporting entities are required to go for impairment testing of their assets according to the guidance of AASB 136. Also, the indications discussed should be properly analysed before selecting an asset for impairment. The report also concludes that proper steps should be followed by the entities for impairing individual assets and CGUs.
AASB (2009).Impairment of Assets.Retrieved from: https://www.aasb.gov.au/admin/file/content105/c9/AASB136_07-04_COMPjun09_01-10.pdf
ACCA (2012).Impairment of goodwill and CGUs. Retrieved from: https://www.accaglobal.com/in/en/member/discover/cpd-articles/corporate-reporting/goodwill-cgus.html
Ball, R. (2006). International Financial Reporting Standards (IFRS): pros and cons for investors. Accounting and business research, 36(sup1), 5-27.
BlueScope (2017).ANNUAL REPORT 2016/2017. Retrieved from: https://s3-ap-southeast-2.amazonaws.com/bluescope-corporate-umbraco-media/media/2278/bluescope-steel-annual-report-2016-17-web.pdf
Carmichael, D. R., & Graham, L. (2012). Accountants' handbook, financial accounting and general topics (Vol. 1). New Jersey: John Wiley & Sons.
Chen, S., Wang, Y., & Zhao, Z. (2008). Evidence of Asset Impairment Reversals from China: Economic Reality or Earnings Management? Journal of Accounting, Auditing and Finance & KPMG Foundation Conference Retrieved from: https://web-docs.stern.nyu.edu/old_web/emplibrary/reversalsfromchina.pdf
Christian, D., & Lüdenbach, N. (2013). IFRS essentials. United Kingdom: John Wiley & Sons.
CPA Australia (2018). IAS 36 IMPAIRMENT OF ASSETS Retrieved from: https://www.cpaaustralia.com.au/~/media/corporate/allfiles/document/professional-resources/reporting/reporting-ifrsfactsheet-impairment-of-assets.pdf?la=en
Dagwell, R., Wines, G., & Lambert, C. (2015). Corporate accounting in Australia. Australia: Pearson Higher Education AU.
Ernst & Young.(2010). Impairment accounting – the basics of IAS 36 Impairment of Assets. Retrieved from: https://www.ey.com/Publication/vwLUAssets/Impairment_accounting_the_basics_of_IAS_36_Impairment_of_Assets/$FILE/Impairment_accounting_IAS_36.pdf
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