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Impairment Testing and Asset Valuations

Question:

Discuss About The Financial Statement Of Airline Companies?

Impairment testing is conducted by Common wealth bank of Australia on annual basis whenever there is indication that assets recoverable amount are lower than their carrying value. Organization has assessed impairment testing related to intangible assets such as goodwill and brand name. For the purpose of impairment testing, allocation of goodwill is done to the cash-generating unit for comparing it to recoverable amount. Determination of recoverable amount is done based on fair value by deducting cost to sells (Commbank.com.au 2018). Moreover, assets with indefinite useful lives are tested for impairment.

For conducting the impairment testing, organization allocated the goodwill to cash generating unit and does the computation of recoverable amount. Publicly available earnings multiples form the basis of calculation of recoverable amount. For determining the assessment of goodwill and other assets, recoverable amount of such assets are compared with carrying amount of individual cash generating unit or group of cash generating unit. Some of the indicators for impairment are as for equity securities that are classified as assets available for sale. An indication of impairment of any investment leads to testing of entire carrying amount of investment in any associate or joint venture by comparing the carrying amount with its recoverable amount (Commbank.com.au 2018).

Commonwealth bank of Australia has recorded loan impairment expenses in both the financial year hat is 2017 and 2016 of amount $ 1095 million and $ 1256 million respectively. These figures depict that impairment expenses on loan have reduced in the current year indicating that there was 13% decrease in the expenses amount (Commbank.com.au 2018). The reason is attributable to the lower provisional banking in market and institutional and private banking.

For determining the impairment of assets, organization relies on computation of recoverable amount using earnings multiple that is applicable to bank. Data on earning multiple are sourced from market and publicly available data. Assumption is made regarding price earning multiple that is observed from the business. Group conducts the revaluation of assumptions when there is any provision for change. Valuation techniques of assets are based on market value and are based on assumptions formed on market conditions (Commbank.com.au 2018).

Process of impairment testing of Common wealth bank of Australia does not involve any considerable subjectivity as depicted from the analysis of financial report. The methodology of impairment testing is considerably influenced by involvement of subjectivity in the estimates and assumptions made by management of group. When subjectivity is considered, there then exists possibility of recoverable value being highly sensitive (Osei 2017). If the management of organization is acting opportunistically, then there can be manipulation in assets recoverable amount. Value in use computation, determinants of cash flows and value generated and there is a possibility that there will be substantial fluctuation in the assumed value because other external factors rather than exercising subjectivity (Commbank.com.au 2018).

Commonwealth Bank of Australia's Impairment Testing Methodology

After conducting detailed analysis of annual report of Common wealth bank of Australia concerning impairment, it has been ascertained that the procedure adopted for impairment testing is a bit confusing. There has not been a segmented presentation of impairment and information considering the impairment of various is presented in a segregated way.

It has been ascertained from the evaluation of financial report of banking group that organizations make provision related to impairment of all financial assets. Receivables and loans are assessed collectively for impairment is done on collectively basis.  Bank has employed expected credit loss model as per AASB 9 that has lead to replacement of existing incurred loss model (Commbank.com.au 2018). Impairment provisions are raised for the amount that is adequate to cover losses related to credit and when there is any existence of objective evidence.

Bank has employed an approach of fair value measurement for measurement of financial liabilities and assets through income statement. Financial instruments, derivative instruments and all investments that are available for sale are measured at fair value. One of the best indicators of financial instruments that are recognized initially and the fair value is also estimated in computation of impairment of assets. Trading assets are asses using fair value that take into account credit risks (Commbank.com.au 2018).

Under the lease standard IAS 17, investors assessing the financial position of organization concerning leases will not be able to get true and fair view presentation. This is because of the critics associated with the existing standard as it makes the classification between financing and operating leases. Balance sheet profiles of companies do not reflect the actual amount of debt that company currently owes (Edeigba and Amenkhienan 2017). It is so because this standard does not obliges company to disclose operating lease in their balance sheet and most of them select to treat lease as operating lease rather than financing lease. Therefore, the existing lease standard does not reflect economic reality. It has been estimated by the accounting standard that is IASB out of total amount of commitment attributable to leases of worth 3.3 million, only 25% of lease appear on balance sheet (Sandblom and Strandberg 2015).


One of the objectives of presentation of financial report is to provide users with the information that helps in making economic decision. Under the existing standard, there is possibility that there will be unfaithful classification of leasing transactions. Investors are required to make rough estimation and calculations for computing lease commitment and brining them on balance sheets. Operating lease is also a type of liabilities but they are not represented on balance sheet but in actual sense, there is a liability that is more than total amount debt reported (Demir and Bas 2017). This explains why the debt reported on balance sheet is 66 times less than off balance sheet liabilities.

Flaws in the Existing Lease Accounting Standards

Controversy associated with existing standard regarding the leases classification into operating and financing lease explains why there is no level playing field between some airline companies. Airline companies either leases most of their aircraft fleets or they finance that is buy the fleets. It would indicate that the financial position of such organizations is different, but in reality, there might not be any difference in their financial position and they are identical (Nobes 2015).

Various flaws associated with the new lease accounting standard are responsible for making it unpopular among everyone. New standard would be focusing on capitalization of operating lease that would increase the balance sheets and debt structure of companies. Companies in receiving credit have also raised concerns and there is a possibility of violation of debt covenants. Adoption of standard will lead to hundred percent of balance sheets and this will require them to renegotiate debt covenants and exclusion of lease agreements. There would be increased administrative burden on part of management and increased cost of reporting that is making companies hesitant to adopt this standard (Czajor and Michalak 2017). There will be alterations in the system of control process, increased consultation fees, educational efforts and process of IT. Moreover, organizations are required to make an estimation of detail relating to right to lease liabilities and assets.

Implementation of new standard will help in facilitating the comparison between the financial statements of different companies. This standard will help in addressing the unfaithful presentation of lease accounting. Investors will not be required to make any rough computation and estimation of bringing back leases into balance sheets. Investors will be informed in a better way because of transparency of information relating to leases. Accounting model of organization will be altered and will benefit organizations in providing detailed information concerning leases and therefore investors will be informed and take into account the benefits that would arrive (Morales and Zamora 2018). Decision relating to leased will improved and allocation of capital will improve. Therefore, organization adopting this standard will lead to a more balanced lease versus buy decisions on part of management.

References list:

Commbank.com.au. (2018). [online] Available at: https://www.commbank.com.au/content/dam/commbank/about-us/shareholders/pdfs/annual-reports/annual_report_2017_14_aug_2017.pdf [Accessed 23 Jan. 2018].

Czajor, P. and Michalak, M., 2017. Operating Lease Capitalization-Reasons and its Impact on Financial Ratios of WIG30 and sWIG80 Companies. Przedsi?biorczo?? i Zarz?dzanie, 18(1, cz. 1 Practical and Theoretical Issues in Contemporary Financial Management), pp.23-36.

Demir, Z. and Bas, E., 2017. THE EFFECT OF TAS 17 “LEASING” STANDARD AND IMPLEMENTATION OF THE NEW IFRS 16 “LEASES” STANDARD ON THE AIRLINE COMPANIES. PressAcademia Procedia, 3(1), pp.153-173.

Edeigba, J. and Amenkhienan, F., 2017. The Influence of IFRS Adoption on Corporate Transparency and Accountability: Evidence from New Zealand. Australasian Accounting, Business and Finance Journal, 11(3), pp.3-19.

Karwowski, M., 2016. The risk in using financial reports in the study of airline business models. Journal of Air Transport Management, 55, pp.185-192.

Morales-Díaz, J. and Zamora-Ramírez, C., 2018. IFRS 16 (leases) implementation: Impact of entities' decisions on financial statements. Aestimatio, (17), pp.60-97.

Nobes, C., 2015. IFRS Ten Years on: Has the IASB Imposed Extensive Use of Fair Value? Has the EU Learnt to Love IFRS? And Does the Use of Fair Value make IFRS Illegal in the EU?. Accounting in Europe, 12(2), pp.153-170.

Osei, E., 2017. THE FINANCIAL ACCOUNTING STANDARDS BOARD (FASB), AND THE INTERNATIONAL ACCOUNTING STANDARDS BOARD (IASB) SINGS SIMILAR TUNE: COMPARING THE ACCOUNTING TREATMENT OF NEW IFRS 16 WITH THE IAS 17, AND THE NEW FASB MODEL ON LEASES. Journal of Theoretical Accounting Research, 13(1).

Sacarin, M., 2017. IFRS 16 “Leases”–consequences on the financial statements and financial indicators. The Audit Financiar journal, 15(145), pp.114-114.

Sandblom, P. and Strandberg, A., 2015. The Value Relevance of the Proposed New Leasing Standard. An event study of the European Stock Markets’ Reaction to the proposed replacement of IAS17.

You, J., 2017. The Impact of IFRS 16 Lease on Financial Statement of Airline Companies (Doctoral dissertation, Auckland University of Technology).

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