Impairment of assets: AASB 136
In the excel file “Find Your Company” you will find the listed company you have been given for this course. This file will be made available on Friday of Week 4. Complete this assignment for the company you have been given. Please be careful to use the listed company you have been given. Your assignment will not be marked if you use a different company to the one you have been given; and you will be asked to resubmit your assignment using the right company. Go to the website of your company, by clicking on the URL next to your company in the list of companies in the file “Your Company”. Then go to the Investor Relations section of the website. This section may be called, “Investors”, “Shareholder Information” or similar name. In this section, go to your firm’s annual reports and save to your computer your firm’s latest annual report. For example, these may be dated 30 June 2015 or 31 March 2016. Do not use your firm’s interim financial statements or their concise financial statements. You are need to do the following tasks: Please read the relevant footnotes of your firm’s financial statements carefully and include information from these footnotes in your answer. Within your firm’s latest annual report
(i) From your firm’s annual report find out the asset/s that your firm has tested for impairment.
(ii) How did your firm conduct the impairment testing?
(iii)Has your firm recorded any impairment expenditures during the period?
(iv)Identify the key estimates and assumptions used by your firm in conducting the impairment testing.
(v) Do you find any sort of subjectivity involved in the impairment testing process? How can this subjectivity influence the outcome of the impairment testing?
(vi)What do you find interesting, confusing, surprising or difficult to understand about the impairment testing?
(vii) What new insights, if any, have you gained about how companies conduct impairment testing?
(viii) Based on your assignment, comment on the “fair value measurement”. For your understanding of the impairment testing process, you may download and read the following articles using ProQuest:
In an address entitled 'introductory comment to the European parliament' (made in Brussels, Belgium) on 11 January 2016, the Chairperson of the IASB, Hans Hoogervorst, made the following comments in relation to the new accounting for leases (as reported 11 January 2016 on the IASB website at www.ifrs.org): I would like to make some comments about our upcoming Leases Standard, which we will publish the day after tomorrow. Currently, listed companies around the world have around 3 trillion euros’ worth of leases, especially in sectors such as the airline industry, retail and shipping. Under current accounting requirements, over 85 per cent of these leases are labelled as operating leases and are not recorded on the balance sheet. Clearly, the accounting today does not reflect economic reality. Despite operating leases being off balance sheet, there can be no doubt that they create real liabilities. During the financial crisis, some major retail chains went bankrupt because they were unable to adjust quickly to the new economic reality. They had significant long-term operating lease commitments on their stores, and yet had deceptively lean balance sheets. In fact, their off balance sheet lease liabilities were up to 66 times greater than the debt reported on their balance sheet. Moreover, the current accounting for leases leads to a lack of comparability. An airline that leases most of its aircraft fleet looks very different from its competitor that bought most of its fleet, even when in reality their financing obligations may be very similar. There is no level playing field between these companies. These problems will be resolved in the upcoming Leases Standard. All leases will be recognised as assets and liabilities by lessees. The accounting will better reflect the underlying economics. This change is expected to affect roughly half of all listed companies and will not be popular with everyone. Accounting changes are often controversial and can be met with warnings of adverse economic effects and costs of system changes. The IASB has looked at all these possible risks very carefully and we will publish a detailed effect analysis on the Standard. Our conclusion is that the risks and costs of the new Leases Standard are manageable. First of all, IFRS 16 will not put the leasing industry out of business. Leases will remain attractive as a flexible source of finance. It will remain appealing to companies to lease assets so that they do not bear the risks of owning them. While the cosmetic accounting benefits of leasing will disappear, the real business benefits of leasing will not change as a result of the new Standard. We do not deny there will be costs involved in updating systems to implement the new Leases Standard, but we have done our best to keep these costs to a minimum. For example, we are not requiring companies to recognise assets and liabilities for short term and small ticket leases. This should be especially beneficial for smaller companies. In sum, we expect the benefits of the new Leases Standard to greatly outweigh its costs. The new visibility of all leases will lead to better informed investment decisions by investors, and to more balanced lease-versus-buy decisions by management. IFRS 16 will lead to improved capital allocation, which should be beneficial for economic growth.
(i) Explain why the chairperson of the IASB believes that the former accounting standard for leases did ‘not reflect economic reality’? (ii)Explain the reason why, under the former accounting standard, reporting entities’ ‘off balance sheet lease liabilities were up to 66 times greater than the debt reported on their balance sheet’.
(iii) Why does the Chairperson of the IASB argue that under the former accounting standard for leases there was ‘no level playing field’ between some airlines companies?
(iv) Why do you think the Chairperson of the IASB said that the new accounting standard for leases ‘will not be popular with everyone’? What would cause this unpopularity?
(v) What are some of the possible reasons why the chairperson of the IASB would say “the new visibility of all leases will lead to better informed investment decisions by investors, and to more balanced lease versus buy decisions by management?
Impairment of assets: AASB 136
Financial accounting is the most complex process in the business organization as it involves managing all the accounting and finance process and reports them in the financial report. Preparation of the financial report involves using the financial reporting standards. The main purpose of this report is to make evaluation of make major accounting standards related to impairment of assets (AASB 136) and accounting leases (IFRS 16). In order to understand the process of impairment testing the annual report of Automotive Holdings Group Limited has been used. The annual report of Automotive Holdings Group Limited for year 2016 has been taken from the company website in investor relations section. The accounting standard related to accounting for leases has also been examined in details in the second part of this report (Henderson, Peirson, Herbohn and Howieson, 2015).
Impairment of assets (AASB 136) and examination of impairment testing in Automotive Holdings Group Limited
The main objective of the AASB 136 is that the value of assets recorded in the balance of the company is not carried more than its recoverable amount. An asset is regarded to be carried more than carrying amount if the value to be recovered from its sale is less the carrying value. In the case where the carrying value is more than the recoverable amount than there is needs to carry out the impairment of asset and impair the value of such assets to extent of recoverable amount (Henderson, Peirson, Herbohn and Howieson, 2015). This accounting standard has to be followed by all the companies that prepare the general purpose financial reports. The scope of the accounting standard is very limited and it applies to assets such as inventories, assets arising from construction contracts, deferred tax assets, assets arising from employee benefits, financial assets that are Financial Instruments, assets such as property, plant and equipments, and goodwill and other non-current assets. Any asset that is kept for sale has been put outside the scope of this accounting standard (Henderson, Peirson, Herbohn and Howieson, 2015).
Assets that are tested for the impairment purpose by the Automotive Holdings Group Limited
On the basis of the notes to financial statements provided in the annual report of the Automotive Holdings Group Limited, impairment testing is carried out on the number of non-current assets that includes both tangible as well as intangible assets. The tangible assets are listed under the common heading property, plant and equipment that contain assets such as land and building, plant and equipment, capitalized leased assets, leasehold improvements and assets under construction. The intangible assets that are processed for the impairment testing are goodwill and franchise rights & distribution agreements. All these assets are tested for the impairment purpose by the Automotive Holdings Group Limited (Annual report 2016: Holdings Group Limited).
Impairment testing at Automotive Holdings Group Limited
Process used by the Automotive Holdings Group Limited to conduct the impairment testing
Automotive Holdings Group Limited has used the same process as mentioned in the AASB 136 to conduct the process of impairment testing. In order to test the property, plant and equipment for the purpose of impairment the recoverable amount of the assets are compared with the carrying value of assets. If the carrying value of assets is greater than the recoverable amount that impairment is performed (Dagwell, Wines and Lambert, 2015). Here carrying value means historical value of asset less the deprecation amount where as recoverable amount means value at which assets can be sold in the market. The goodwill and franchise rights are tested annually for the impairment purpose. They are impaired if the cash flows from cash generating units are less than the carrying value of these assets. The present values of cash flows from the cash generating units are estimated using the management best assumptions and calculations using the discount rate. The cash flows projections are made for the five years in order to determine the units recoverable cost and to compare it with the carrying value of the goodwill and franchise rights (Annual report 2016: Holdings Group Limited).
Impairment expenditures recorded by the Holdings Group Limited in their financial statements
After inspecting the notes to accounts following calculations has been seen in relation to the impairment of assets;
(Annual report 2016: Holdings Group Limited)
On the basis of above table it can be said that an impairment asset under constructions has been carried out in year 2016 and rest of assets are correctly valued.
(Annual report 2016: Holdings Group Limited)
Looking at the above table it can be said that there are no impairment expenses in goodwill while impairment charge of $ 3,000,000 has charged to Franchise Rights & Distribution Agreements.
Estimates and assumptions used by the Holdings Group Limited in the process of impairment testing
The main assumptions that are required to make is when the value in use for each CGU is calculated for the purpose to estimate the recoverable amount in case of intangible assets. The pre tax discount rate of 11% is used to discount the cash flow projections from the CGUs. Following are the main estimations used in calculation for value in use:
- A range of discount rates from 10% to 15%
- Value-in-use calculations based on estimated future cash flows after discounted them using the appropriate discount rate ((Annual report 2016: Holdings Group Limited)
Subjectivity involved in the impairment testing process
It has been analysis that the accuracy of the impairment testing clearly depends upon the subjectivity of the assumptions and estimations made by the management in regards to the calculation of value in use while carrying out the impairment testing of the goodwill and Franchise Rights & Distribution Agreements. The change in assumptions can change the amount of value in use that can increase or decrease the value of recoverable amount of and Franchise Rights & Distribution Agreements (Annual report 2016: Holdings Group Limited).
Accounting for leases: IFRS 16
I find the process the impairment testing the most difficult has it involves cash flow projections that are based on estimation and management understanding of the future environment. I have gained no new insights while analysis the process of impairment testing done by the company.
Fair value measurement
The process of the impairment is truly based on the fair value measurement concept as the main motive of the fair value measurement accounting standard is to measures the assets at fair value which is either historical value less depreciation or recoverable amount whichever is less (Dagwell, Wines and Lambert, 2015).
(I)The article entitled ‘'introductory comment to the European parliament’ has addressed the comments made by the Chairperson of the IASB in relation to the drawbacks in the present leases accounting standard and the need for introducing new standard. The article has stated that the IASB chairperson beliefs that the former accounting standard for leases was not effective in depicting the real economic scenario. The major reason regarding this belief is that the former accounting leases standard has not directed the firms to record the financial transaction related to leases in the balance sheet. The accounting standard has not categorized the leases into asset and liabilities section in the balance sheet but have included 80 per cent of the leases under the operating leases only. The operating leases are not reported under the balance sheet by businesses. Therefore, the leases standard of IAS 17 needs to be changed for protecting the interests of the stakeholders of business such as shareholders, investors and creditors. The stakeholders analyze the financial performance of the companies through its financial reports and as such it is the major responsibility of IASB to implement such accounting rules that align with the stakeholders interests. The former accounting standard does not depict the real debt position of the companies as it does not report leases in the balance sheet and therefore represents manipulated financial information to the end-users (IFRS 16: The leases standard is changing, 2016).
(ii)The former leases accounting standard of IAS 17 has not proved to be useful in disclosing the real financial performance of the companies to the end-users. In this context, it has been reported that business companies around the world are having about 3 trillion euro’s worth of leases and these companies mainly belong to the airline, retail and shipping sector. This is largely due to the ineffectiveness of the leases standard of IAS 17 in reporting the leases under the asset and liabilities section in the balance sheet. Thus, non-disclosure of the operating leases in the balance sheet lead to the development of real liabilities. The financial crisis has also highlighted the inefficiency of the former accounting standard in depicting a true picture of the financial position of an entity. The large retail companies faced bankruptcy during the financial crisis as their real balance sheet reported 66 times more debt than that represented in their balance sheet disclosed to the end-users. As such, the retail companies were not able to meet their large amount of liabilities under the period of slow economic growth during the financial crisis and thus were collapsed (Stice and Stice, 2013).
Drawbacks of the former accounting standard for leases
(iii)The IASB Chairperson has argued that former accounting standard for leases caused no level playing field between some airline companies due to its ineffectiveness to compare the financial position of the companies. The airline companies incorporate the use of leases for its aircraft feet and therefore generally have high amount of operating leases. Therefore, in the case when an airline company is adopting the use of leasing for its aircraft fleet and other is purchasing the fleet then the former accounting standard cannot evaluate the financial performance between these two companies. Thus, the IASB Chairperson has emphasized on the drawbacks of the former accounting lease standard by illustrating the example from the airline sector. This has also caused the need for developing new accounting standard that will report the operating leases under assets and liabilities in the balance sheet and therefore useful in undertaking the comparability analysis between two companies (Ryan, 2007).
(iv): The article ahs also expressed the concerns of the IASB Chairperson regarding the unpopularity of the new accounting standard for leases, that is, IFRS 16. The new accounting standard was developed by the IASB to address the shortcomings in the former accounting standard 1AS 17and thereby improving the accounting reporting practices at a global level. However, business entities might not accept such changes widely due to complexities involved in implementing the new accounting standard. The implementation of the IFRS 16 for recognition and measurement of leases will cause the business companies to change their accounting systems and process to a large extent. The lessees will require providing more data about their leases for categorizing them adequately under the assets and liabilities section in the balance sestet. The adoption of such accounting changes will prove to be largely expensive for small business companies and therefore they may not welcome such move of the IASB. Also, there is high risk involved in adoption of such changes because the adverse economic effects it can cause in the financial market. The financial professionals are also viewing such changes to negatively impact the growth of the leasing industry. In this context, the IASB is required to provide proper knowledge to all the business entities worldwide regarding the necessity and usefulness of the new accounting standard to ensure its large acceptance. IASB need to explain that though it will incur some initial expenditure by businesses but its benefits will outweigh its costs in the long-term. Also, IASB need to clarify that leasing will remain an attractive option for businesses to gain finance under the new accounting standard for leases (Hussey and Ong, 2017).
(v)The IASB Chairperson believes that the implementation and adoption of the new accounting standard for leases by business across the world will lead to making better informed decisions by the investors they gain accurate and relevant financial information. This is because the incorporation of leases in the balance sheet will help the investors in analyzing the actual debt condition of a firm and therefore making their investment decisions in consideration of the same. The management of the companies can also make better decisions by gaining actual information about their debt position by categorization of leases into relevant assets and liabilities section. The IFRS 16 will lead to better capital allocation by the investor and the management and therefore stimulating the economic growth and development. Thus, it can be said that the current accounting standard of IASB will help in overcoming all the drawbacks of the former accounting standard and depicting the real economic scenario (IFRS 16: The leases standard is changing, 2016).
Annual report 2016: Holdings Group Limited. [Online]. Available at: https://www.ahgir.com.au/download/2016-ahg-annual-report-to-shareholders.pdf [Accessed on: 21 January 2018].
Dagwell, R., Wines, G. and Lambert, C. 2015. Corporate Accounting in Australia. Pearson Higher Education AU.
Henderson, S., Peirson, G., Herbohn, K. and Howieson, B. 2015. Issues in Financial Accounting. Pearson Higher Education AU.
Hussey, R. and Ong, A. 2017. Corporate Financial Reporting. Springer.
IFRS 16: The leases standard is changing. 2016. [Online]. Available at: https://www.pwc.com.au/assurance/ifrs/assets/ifrs16lease-brochure.pdf [Accessed on: 21 January 2018].
Ryan, S. 2007. Financial Instruments and Institutions: Accounting and Disclosure Rules. John Wiley & Sons.
Stice, E. and Stice, J. 2013. Intermediate Accounting. Cengage Learning.
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