Analysis Of Impairment Of Assets At Downer EDI Limited In Essay.

Question:

Discuss About The Global Financial Other Firm Characteristics?

The report will be analyzing the annual reports of Downer EDI limited and will also be analyzing whether the company has charged any impairments on the assets of the company. The report will be analyzing and identifying the assets on which impairments has been charged.

Downer Group is a company engaged in providing infrastructure and building services for public concerns as well as private concerns. The company provides public and private, energy and infrastructure and resources all over Australia. The company has its headquarters in Sydney, Australia and the company was founded in 1933. The operating income of the company is around $6.56 billion as per the recent estimates (Downer Corporate Site 2018).

Impairment of assets refers to the reduction in the value of assets by the company as per IAS 36 which deals with impairment of assets. Downer EDI ltd is following impairment policies on intangible assets of the company. The company shows that indefinite life is possessed by goodwill and other intangible assets and the company has the policy of testing such assets annually for impairment purposes which the company (Kuzmina and Kozlovska 2012). The company also has charged impairment cost on the asset of the company such as equipment, property and plant. The others assets are also checked if there is any case of impairments on them, whenever there is any occurrence of events or circumstance change which can suggest the doubt in recoverability of the carrying amount. Trade receivable is another group which has been considered for impairment. An allowance has been made for doubtful debts which is suppose to be irrecoverable determined from the experience from the past.

The impairment of assets test of the company is done annually for intangible assets especially goodwill. Intangible assets have indefinite life of usefulness and are tested every year for impairment purposes (Capalbo 2013). The other assets which the company shows in the balance sheet are impaired whenever events or situations indicate that the carrying cost of the asset may not be recoverable. The company allocates goodwill to the cash generating units for the purpose of impairment considering the resource allocations, natural resources, how operations of the business are controlled and where flow of cash can be identified (Devalle and Rizzato 2012). As per the balance sheet analysis and notes to accounts six cash generating units have been identified which are transport, utilities, Rail, EC&M, Mining and spotless. These groups will be subjected to impairment test and goodwill allocation is done to these units (Khokan Bepari Rahman and Taher Mollik 2014).

Impairment of Assets

The company has recognized impairment charges on intangible assets such as goodwill, customers contract and relationship, brand name and acquisition and intellectual property on development of the software. This is shown as accumulated amortization and impairment charges. Except the figure of Goodwill impairment and amortization charges on all other intangible assets has increased from the previous year. The impairment of the trade receivables are also shown in the notes of accounts of the company. Thus impairment of trade receivable are also done along with the intangible assets as per the financial statement of the business.

The first major requirement for the process of testing the impairment of assets is that the company need to a make an accurate assumption of how much amount can be recovered from the Cash Generating Units (CGUs) to which allocations can be done. The group also uses the  method of value in use to determine the amount which is recoverable from the asset. Recoverable amount is the higher figure of fair value less cost to sale and the value in use. The impairment loss which arises then is taken in the profit and loss account as an expense. The assumptions which are taken into considerations are that the recoverable amount of  CGUs is analyzed with the fair value of the assets which are acquired minus the cost which is incurred for sales. The fair value is taken on the basis of the takeover offers. Downer EDI company have no such events of takeovers which can cause impairment of the assets. The key assumption are also taken in the value in use calculations of the company (Paugam and Ramond 2015). The company has made assumptions on the budgeted EBITDA, long term growth rates and discount rates as well. The projected cash flow of the company has been done on the basis of value in use calculations which uses three years cash flow projections including 2018 budgeted estimates on the basis of which value in use is calculated. The company also uses Budgeted EBITDA which is based on past experience of the group assessment. The growth rate on a long term basis is based on the future yearly growth rate till year 2021 based on GDP which are at nominal rates prevailing in the country. In case of budgeted working capital, assumption is that it will be consistent with historic trends giving the level of utilisation and operating activity.

Testing the Impairment of Assets

The company has made a lot of key assumptions and estimates in regards to the impairment process of intangible assets. If any of this area is mistaken or misstated than the figure of the impaired assets will be misstated drastically. The key estimates and assumptions of Downer EDI ltd seems a little too far stretched and might hamper the impairment process either recording less or more impairment loss in the process.

The company uses value in use method in the calculation of recoverable amount. The whole of this process is a bit complex as the company has to make a lot of key assumptions and estimates which are also considered on some basis thereby raising a series of doubts on the impairment process which is followed by the company (Shiramizu et al. 2012). The calculation area which is used for the calculations of the recoverable amount depends on a variety of estimates and assumptions out of which if any goes wrong the whole impact will come to the value of the assets on which the impairment process is being conducted.

Downer EDI’s Impairment test shows that the company uses value in use method for calculation of the recoverable amount. The impairment testing process divides the Cash generating units into six groups on which the impairment test is being conducted by the company. the company assumes various areas such as budgeted cash flows and EBITDA and  long term growth rate as well (Mazzi, Liberatore and Tsalavoutas 2016).

As per IAS 36, impairment of assets is done on the basis of carrying amount and recoverable amount. Fair value measurement states the measure of the market or intrinsic value of the aassets

As per the chairperson of IASB, Hans Hoogervorst a new standard is required for accounting for leases which can ensure full disclosures of all kind of leases in the annual reports. The chairperson considers that the former lease standard did not reveal economic reality is because most of the companies showed they had more operational leases which had no treatments in the financial statements as per the former standard. As per the chairperson currently listed companies around the world has around 3 trillion euros worth leases in most of the sectors, especially airline sector, retail and shipping. Most of theses companies as per accounting treatment of former standard show 85% of such leases as operating risks and not recorded in the financial statements. However such operating risks are capable of creating real liabilities for the company.

Key Assumptions and Estimates

As per the Chairperson of IASB, under the former lease standard the operating leases was not stated in the balance sheet. This fact was used by most of the companies and they recorded 85% of the leases as operating lease which was not recorded in the balance sheet. As the companies considered leases to be operating in nature. The debt which was shown in the balance sheet was less than such off balance sheet leases which were 66% greater as compared to debts shown in the balance sheet.

As per the chairperson, an airline which has obtained most of its aircrafts with the use of leases can make the balance sheet look more decent. However in the case of firms which purchases the air fleet has to bear the costs of such air fleets which requires a considerable amount of finances which will definitely be affecting the company’s revenue for that year. The company which is leashing air fleets does not faces the above problem. Therefore the chairperson comments that the airline company which leases its air fleet will be on a different ground as compared to the airline company which purchases its air fleets.

The chairperson is of the opinion that the basic problems which were present in the previous lease standard will be taken care of in the current lease standard. In the former lease standard which is going to be replaced the lease were recognized only of financial nature and operating risks were not shown in the balance sheet. The new standards will be tackling the problems which were present in the old standard. The new standard will be recognizing all the assets and liabilities concerning leases. The accounting process will be better in reflecting the economic consideration which a lease may have on the overall business and thus ensure that the decision making process of the management considers the lease of the company. The books of accounts is also going to reflect the effect of lease in the balance sheet. The new changes will not be welcomed by many companies accounting changes are always controversial in nature. However the chairperson has provided the assurance that IASB has looked after all the possible risk which may arise due the introduction of the new standards on lease. Another reason for the unpopularity of new standard on leasing as per the opinion of the chair[person might be the increased level of costs which will arise and which the company has to bear.

Value in Use Method

 With the introduction of the new standard on leasing the accountability of the balance sheet will increase and the stakeholders will be provided with clear information on lease agreements of the business. The new agreement will not shorten the advantages of a lease agreement but ensure that proper records of the same is maintained in the books of accounts. As per the chairperson with the introduction of the new standard the cosmetic affect which the company adds to the balance sheet is reduced showing a clear analysis of the same. The new lease agreement will be increasing the costs of the company. However it is the expectation of the IASB that the benefits associated with the introduction of the new standard can outweigh the costs factor associated with the standard. The shareholders will get the clear information on the leases and the short term and long term impacts of such leases and then they will be able to take decisions accordingly. In case of the management of the business, they will also be benefiting from the new standard as this will increase the costs of the leases and so the management can effectively measure the costs of the business while taking the lease and also the benefits which arise from taking such a lease. The company can also compare these costs and benefits and decisions can be taken accordingly.

Reference

Capalbo, F., 2013. Impairment of Assets.

Devalle, A. and Rizzato, F., 2012. The quality of mandatory disclosure: the impairment of goodwill. An empirical analysis of European listed companies. Procedia Economics and Finance, 2, pp.101-108.

 Downer Corporate Site. (2018). Downer Group. [online] Available at: https://www.downergroup.com [Accessed 24 Jan. 2018].

Khokan Bepari, M., F. Rahman, S. and Taher Mollik, A., 2014. Firms' compliance with the disclosure requirements of IFRS for goodwill impairment testing: Effect of the global financial crisis and other firm characteristics. Journal of Accounting & Organizational Change, 10(1), pp.116-149.

Kuzmina, I. and Kozlovska, I., 2012. ACCOUNTING MEASUREMENT OF LONG-LIVED ASSETS: A CASE OF IMPAIRMENT PRACTICE. Journal of Business Management, (5).

Mazzi, F., Liberatore, G. and Tsalavoutas, I., 2016. Insights on CFOs’ perceptions about impairment testing under IAS 36. Accounting in Europe, 13(3), pp.353-379.

Paugam, L. and Ramond, O., 2015. Effect of Impairment?Testing Disclosures on the Cost of Equity Capital. Journal of Business Finance & Accounting, 42(5-6), pp.583-618.

Shiramizu, B., Ananworanich, J., Chalermchai, T., Siangphoe, U., Troelstrup, D., Shikuma, C., De Grutolla, V., Sithinamsuwan, P., Praihirunkit, P., Rattanamanee, S. and Valcour, V., 2012. Failure to clear intra-monocyte HIV infection linked to persistent neuropsychological testing impairment after first-line combined antiretroviral therapy. Journal of neurovirology, 18(1), pp.69-73.