Factors Contributing to Impairment
Discuss about the Impairment Loss for Joint Ventures.
Before understanding the concept of impairment loss it is very important to know the meaning of the word ‘impairment’. It is basically a drop in the value of an asset as reflected in the balance sheet. The said word connotes to those set of assets which has a long market but the value of such an asset in the market has devalued significantly. Thus in simple terms the difference between assets’s carrying amount or a cash generating unit and the actual recoverable amount is termed as impairment loss. Impairment happens only of assets and the accounting standard that spells out the same is IAS 36 – Impairment of Assets. For the same it is very important to understand how carrying amount is calculated (investopedia.com, 2016). The amount of an asset which is recorded in the balance sheet of a company after reducing the same with the depreciation and the impairment loss accumulated is termed as carrying amount. The broad category of asses which fall under this purview are assets such as goodwill, plant and machinery, investments in subsidiaries, joint ventures, buildings and other intangible assets.
The main aim of the said accounting standard is to ensure that the true recoverable amount of the assets of a company are known to the investors and the shareholders of the company which would further enable to determine the true worth of the company. As per the accounting standard it is mandatory that the provision for the same is duly made under the head ‘impairment loss’ (iasplus.com, 2014). The amount is treated as an expense in the income statement of the company and is reduced from the value of the respective asset while disclosing the same in the balance sheet. The said standard applies to all the assets except the following mentioned below simply because there are separate standards which deals with these assets. They are:
- Inventories – IAS 2
- Construction contract assets – IAS 11
- Deferred tax asset- IAS 12
- Employee benefits- IAS 19
- Financial assets such as financial lease- IAS 39
- Investment properties that are carried at fair value- IAS 40
- Agricultural assets carried at fair value- IAS 41
- Insurance contract- IFRS 4
- Non-current assets which are held for sale- IFRS 5
Upon completion of every Financial Year or triggering of any predefined date / period, it is mandatory for every entity to carry out a test of impairment in spite of no apparent sign of the same. There are various indications (external and internal) of impairment which enable an enterprise to decide whether to impair the asset or not. Factors such as a demur of the market value, technological, economical or changes in the legal system which has a negative impact, increase in the market interest rates or an imbalance between the net assets of the company and the market capitalization wherein the inclination is towards a higher net asset value of the company are all factors external in nature. Further internal factors such as obsolescence of the asset, assets held for sale, the performance of the company is worse or in case of mergers and acquisitions if the carrying amount of the assets is greater than the carrying amount of the investee’s assets are also contributory to the impairment of assets. If there seems to be indication of impairment then it is very crucial to revisit the life of the asset, method of depreciation to be used and residual value (accaglobal.com, 2014).
Reversal of Impairment Loss
For example where an asset is held for sale then the carrying amount of the said asset should be revised to the amount that would be recovered on sale of the said asset rather that the future cash flows that the said asset would generate.
However the said standard not only tells about the accounting for the diminution in the value of the assets but also deals with situations wherein the impairment loss may be reversed as well. The said amount should be reversed only to the extent of the depreciated historical cost of the asset that would have been had the said asset not been impaired. Apart from the reversal with regards the revalued asset, the impairment loss that is being reversed is recognized in the profit and loss account. After the same is done the depreciation for the future period should also be accounted for. One exception to the reversal of impairment loss is that the same is not applicable in case of goodwill.
IAS 36- Impairment of assets, states certain disclosure requirements. They are as under:
As per the said disclosure requirement it asks for disclosing the impairment loss which is being recognized and the loss which is being reversed in the profit and loss account. The line item(s) of the statement of comprehensive income, the losses due to impairment recognized and reversed on the revalued assets in other comprehensive income are also to be disclosed under the said sub-heading.
The reportable segments of the company under segmental reporting also has various assets, therefore the disclosure of the recognized and the reversed impairment losses if the assets of the segments are to be disclosed.
If the loss of impairment or reversal is of substance then the same should be disclosed as per IAS 36.130. The disclosure would be the circumstances due to which such a reversal or recognition is being done, the amount, the asset to which is being impaired or reversed, the cash generating unit and the allocation of the individual amount to the class of assets. Further to this if the recoverable amount is determined as the balance of the fair value and the cost of selling the asset then IFRS 13 should be applied for determination of the fair value of the asset (pwc.com, 2014).
As per the Australian Accounting Standard Board, impairment of assets is described under standard AASB 136 which is similar to the International Accounting Standards. Fort he Australian Companies or the companies registered in Australia, the same is applicable on or after January 1st, 2005. There are times when it is not possible to determine the impairment amount of assets of a company individually. In such a situation a concept of cash generating unit (CGU) arises wherein the recoverable amount of the CGU to which the impaired asset belongs is determined. If the situation is so then the amount of impairment is first and foremost allocated to the goodwill and then the remaining impairment amount is allocated to the assets in the CGU on a prorate basis (Australian Accounting Standards Board, 2009).
Therefore the disclosure requirements of IAS 36- Impairment of Assets are comprehensive and exhaustive so as to determine each and every detail about the asset being impaired along with the reasons for the same and the amount of impairment. These data is of utmost importance and hence are made compulsory by the accounting standards acclaimed internationally. Further the Australian Standard for the same is also very similar to IAS 36.
The assets being impaired are land, shoe factory, machinery for manufacturing shoes and Goodwill on acquisition of competing companies. The brand ‘ Crossbow Shoes’ will not be impaired as the impairment of assets are being done due to online buying strategy which clearly shows that the brand value of the company is nowhere hampered and due to the same it is being able to enter the online selling market easily. Further inventory is not subject to impairment as the valuation of the same is covered under IAS 2.
Since the recoverable amount of land is known separately hence separate accounting for impairment is required to be done for the same. The total financial position of the company as on 30 June 2015 was $1680000. However the recoverable amount is estimated at $1420000. Thus the total impairment is of $1680000 - $1420000 = $260000. Out of the same the recoverable amount of land is separately known as $171000, therefore the amount of impairment loss for the land is $200000 - $171000 = $29000.
As per IAS 36, since the recoverable amount of the other individual assets is not known hence first and foremost the goodwill will be reduced. After the same the rest of the assets will be reduced on a prorate basis (ey.com, 2014). Thus the remaining amount of impairment after allocation of $29000 to land is $231000, of which $40000 is allocated to goodwill and $191000 is allocated to the factory and the machinery in the ratio of 7:4. Thus the impairment loss for factory is 7/11*191000 = $121545 and for machinery is 4/11*191000= $69455.
The Journal Entries for the impairment loss occurring as on 30 June 2015 are as under:
- For impairment of land:
Profit and Loss Account (loss on impairment) Dr...............$29000
To accumulated impairment loss (Land)...............................................$29000
- For impairment of other assets:
Profit and Loss Account (loss on impairment) Dr.................$231000
To goodwill A/c.....................................................................................$40000
To accumulated impairment loss (Shoe Factory)A/c...........................$121545
To accumulated impairment loss (machinery) A/c................................$69455
accaglobal.com, (2014), IAS 36 Impairment of Assets, Available at https://www.accaglobal.com/in/en/discover/cpd-articles/corporate-reporting/ias36-impairment.html (Accessed 14th September 2016)
Australian Accounting Standards Board, (2009), Impairment of Assets- AASB 136, Available at https://www.aasb.gov.au/admin/file/content105/c9/AASB136_07-04_COMPjun09_01-10.pdf (Accessed 15th September 2016)
Dagwell, R., Wines, G., & Lambert, C., (2012), Corporate Accounting in Australia, Pearson: Australia
ey.com, (2014), Impairment Accounting – the basics of IAS 36 , Impairment of Assets, Available at https://www.ey.com/Publication/vwLUAssets/Impairment_accounting_the_basics_of_IAS_36_Impairment_of_Assets/$FILE/Impairment_accounting_IAS_36.pdf (Accessed 14th September 2016)
iasplus.com, (2014), IAS 36 – Impairment of Assets, Available at https://www.iasplus.com/en/standards/ias/ias36 (Accessed 14th September 2016)
investopedia.com, (2016), Impairment, Available at https://www.investopedia.com/terms/i/impairment.asp (Accessed 15th September 2016)
pwc.com, (2014), Making Sense of a complex world- IAS 36 Impairment of Assets, Available at https://www.pwc.com/gx/en/communications/pdf/ias36_impairment_of_assets_final.pdf (Accessed 14th September 2016)
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