IAS 36 Impairment of assets. IAS 36 Impairment of assets Véronique Weets

IAS 36 Impairment of assets Véronique Weets Instituut der Bedrijfsrevisoren

FACILITATOR VÉRONIQUE WEETS Dr. Véronique Weets is a Professor of International Accounting and a faculty member at two Belgian universities. In that role she is responsible a general IFRS course and a Financial Instruments course. At regular occasions she participates in Master Programs of UAMS, Programs of Vlerick and the Solvay Business School. Véronique Weets was also associated with the IFRS Technical desk of Deloitte in Belgium, where she was involved in client work on matters such as the transition to IFRS and the subsequent application of IFRS to listed companies. She was also responsible for client trainings as well as trainings of the professional staff. As from 2006 Véronique Weets created her own company in which she helps clients with the application of IFRS on a daily basis through trainings or consultancy. This means that she actively searches for the practical translation of this principle based framework of accounting in order to provide realistic solutions to the clients. Therefore, facilitation sessions provided by Véronique Weets always have a strong theoretical basis that is translated to practical applications that are relevant to the business environments of the delegates. In addition to this, Véronique Weets is also an author of a long list of technical accounting literature in English, French and Dutch. DISCLAIMER Whilst every effort is made to ensure that the contents of its case studies and other material handed out during or in connection with courses are accurate and up-to-date, we shall not be under any liability whatsoever for any inaccuracy or misleading information whether arising for negligence or otherwise and in particular we shall not be liable for any consequential damage or expense of any loss of profit or any liability to third parties incurred as a result of reliance on such inaccurate or misleading information. REFERENCES (OTHER THAN THE OFFICIAL PUBLICATIONS OF THE IASB) Deloitte, igaap 2005 IFRS Reporting in the UK, CCH Ernst & Young, IAS 36 Impairment testing: Practical Issues, January 2007 Financial Reporting Council, Review of goodwill impairment disclosures, October 2008 KPMG, Insights into IFRS 2005/6 Edition, Thomson. PWC, IAS 36 Impairment Frequently asked questions, IFRS News, June 2007 supplement PWC, Manual of Accounting IFRS for the UK 2007, CCH Instituut der Bedrijfsrevisoren

OVERVIEW Basic principles Scope Special topics Definitions Identifying impaired assets Measuring recoverable amount o Fair value less costs to sell o Value in use Recognition and measurement of impairment loss Cash generating units o General principles o Impairment of goodwill Reversal of an impairment loss Non-controlling interests Impairment of revalued assets Corporate assets Restructurings an disposals Introduction of IFRS 8 Interim financial reporting and impairment (IFRIC 10) Instituut der Bedrijfsrevisoren

11/3/2008 IAS 36 -Impairment of assets Overview Basic principles Scope Definitions Identifying impaired assets Measuring recoverable amount Fair value less costs to sell Value in use Recognition and measurement of impairment loss Cash generating units General principles Impairment of goodwill Reversal of an impairment loss 2 Overview Special topics Non-controlling interests Impairment of revalued assets Corporate assets Restructurings an disposals Introduction of IFRS 8 Interim financial reporting and impairment (IFRIC 10) 3 1

11/3/2008 Basic principles Agenda Scope Definitions Identifying impaired assets Measuring recoverable amount Fair value less costs to sell Value in use Recognizing and measuring an impairment loss Cash-generating units General principles Impairment of goodwill Reversal of an impairment loss 5 Scope IAS 36 shall be applied in accounting for the impairment of all assets other than those that are within the scope of another standard Inventories (IAS 2) Assets arising from construction contracts (IAS 11) Deferred tax assets (IAS 12) Assets arising from employee benefits (IAS 19) Financial assets that are within the scope of IAS 39 Assets held for sale (IFRS 5) measured at fair value Investment property that is measured at fair value (IAS 40) Biological assets related to agricultural activity that is measured at fair value less estimated point-of-sale costs (IAS 41) 6 2

11/3/2008 Definitions An asset is impaired when its carrying value (CV) exceeds its recoverable amount (RA) Carrying amount : amount at which an asset is recognized after deducting any accumulated depreciation (amortization) and accumulated impairment losses thereon Recoverable amount: higher of fair value less costs to sell and value in use Fair value less costs to sell: amount obtainable from the sale of an asset or cash-generating unit in an arm s length transaction between knowledgeable willing parties, less the costs of disposal Value in use: present value of the future cash flows expected to be derived from an asset or cash-generating unit 7 Identifying impaired assets Assess at the end of each reporting period whether there is any indication that an asset may be impaired If there is an indication of impairment, the recoverable amount must be calculated and compared with the carrying amount Irrespective of whether there is any indication for impairment an asset shall test yearly Intangible assets with an indefinite useful life; Intangible assets that are not yet available for use Goodwill acquired in a business combination 8 Identifying impaired assets External indicators Market value declines more than expected Adverse changes entity s environment Interest rates or rates of return on investments have increased Carrying amount of net assets exceeds market capitalization Internal indicators Obsolescence or physical damage Adverse changes to the entity Worse than expected economic performance of an asset 9 3

11/3/2008 Identifying impaired assets Evidence from internal reporting that indicates that an asset may be impaired Cash flows for acquiring the asset, or subsequent cash needs for operating or maintaining it, that are significantly higher than those originally budgeted; Actual net cash flows or operating profit or loss flowing from the asset are significantly worse than those budgeted; A significant decline in budgeted net cash flows or operating profit, or a significant increase in budgeted loss, flowing from the asset; or Operating losses or net cash outflows for the asset when current period amounts are agregated with budgeted amounts for the future 10 Identifying impaired assets Even if no impairment loss is recognized, the indications may require an adjustment of The useful life The residual amount The depreciation (amortization) method 11 Measuring the recoverable amount Recoverable amount = Higher of Value in use Present value of future cash flows expected from asset or cash generating unit Fair value - costs to sell Amount from sale of asset or CGU in arm s length transaction, less costs of disposal 12 4

11/3/2008 Fair value less costs to sell Best evidence: Arm s length binding sale agreement less disposal costs Next best If traded in active market: Market price (current bid price) less costs of disposal Otherwise: Base on best information available to reflect arm's length transaction (not forced sale) Costs to sell: Legal costs, stamp duty, transaction taxes, costs of removing the asset, direct incremental costs to bring asset into selling condition 13 Value in use Reflect Estimate of future cash flows to derive from the asset Expectations about possible variations in amount or timing of those future cash flows* Time value of money (risk-free rate of interest) Price for bearing the uncertainty inherent in the asset* Other factors, such as illiquidity, that market participants would reflect in pricing the future cash flows* Two steps: Estimate future cash inflows and outflows to be derived from continuing use of the asset and from its ultimate disposal; and Apply the appropriate discount rate to those future cash flows * Can be reflected as adjustments to future cash flows or as adjustment to the discount rate. 14 Value in use Inflation If discount rate includes the effect of price increases attributable to general inflation Future cash flows are estimated in nominal terms If discount rate excludes the effect of price increases attributable to general inflation Future cash flows are estimated in real terms (but include future specific price increases or decreases) Foreign currency cash flows Are estimated in the currency in which they are generated and discounted using an appropriate discount rate Translate using spot exchange rate at the date of the value in use calculation 15 5

11/3/2008 Value in use Traditional approach Uses a single set of estimated cash flows and a single discount rate Assumes that a single discount rate convention can incorporate all the expectations about the future cash flows and the appropriate risk premium Expected cash flow approach Uses all expectations about possible cash flows and timing of those cash flows 16 Value in use Estimate future pre-tax cash inflows/outflows from continuing use and from ultimate disposal; Use current asset condition over remaining useful life Do not include future capital expenditures Do not assume future restructurings Basis is management s own internal forecasts based on recent approved budgets, up to five years Inflows from continuing use of assets and net cash to be received (or paid) for disposal at the end of useful life Outflows necessary to generate the inflows; Not cash inflows or outflows from financing activities Not income tax receipts or payments Not outflows required to settle obligations (decommissioning provision) Thereafter, extrapolate using a steady or declining growth rate Consistent with that of the product, industry or country, unless there is clear evidence to suggest another basis 17 Value in use Use pre-tax discount rate reflecting market rate and specific risks to the asset to discount the cash flows Rate of return that investors would require if they were to chose an investment that would generate cash flows similar in timing, risk and amount to those that the entity expects to derive from the asset Independent of financing Often the only observable market rate is post-tax Many entities use Weighted average cost of capital Should be adjusted to make it pre-tax and independent from the capital structure Most appropriate: WACC of a listed entity that has a single asset with a similar asset that is being tested for impairment Incremental borrowing rate Other market borrowing rates The pre-tax rate is the rate of return that will, after tax has been deducted, give the required post-tax rate of return. 18 6

11/3/2008 Value in use Conclusion: Unless fair value less costs to sell is higher, an asset is regarded as impaired if it is not expected to earn a current market-related rate of return on its carrying value. 19 Recognition and measurement of an impairment loss If the recoverable amount is less than carrying amount, the carrying amount must be reduced Recognize impairment loss as expense unless the asset is being accounted for using the revaluation method and the decline reverses a previous increase in value When the amount estimated for an impairment loss is greater than the carrying amount, it may be necessary to recognize a liability After recognition of an impairment loss, adjust the related depreciation (amortization ) charge and deferred tax assets or liabilities. 20 Cash generating unit (CGU) General principles In some cases, the recoverable amount of an individual asset cannot be determined if the asset does not generate independent cash inflows the asset must be assigned to a CGU A CGU is the smallest identifiable group of assets that generates cash inflows from continuing use that are largely independent of the cash inflows from other groups Includes all attributable assets Usually excludes liabilities The impairment test is then performed on the entire CGU 21 7

11/3/2008 Cash generating unit (CGU) General principles If an active market exists for the output by an asset or group of assets that group is identified as a CGU Even if some or all of the output is used internally If cash-flows are affected by internal pricing Use management s best estimate of future price(s) that could be achieved in arm s length transactions Period for cash flow projections Asset with the longest useful life What with undetermined useful life? 22 Cash generating unit (CGU) Goodwill Must be allocated to CGU (or groups of CGU) that are expected to benefit from the synergies of the combination at the date of the business combination Lowest level within the entity at which the goodwill is moniteroed for internal management purposes; and At least segment level Must be tested for impairment Before the end of the period in which the business combination took place Whenever there is an indication for impairment At least annually (at the same time every year) 23 Cash generating unit (CGU) Goodwill If the (group of) CGU s containing goodwill is impaired, allocate impairment: First to goodwill Secondly to all other assets in the CGU on a pro-rata basis Any asset (CGU) cannot be reduced below Its fair value less costs to sell (if determinable); Its value in use (if determinable); zero 24 8

11/3/2008 Reversing an impairment loss Assess at the end of each reporting period whether there is any indication than an impairment loss recognised in prior periods may not longer exist or may have decreased Indicators mirror those of a potential impairment loss Include costs incurred during the period to improve or enhance the asset s performance or restructure the operation to which the asset belongs Reverse only when recoverable amount changes Service potential must increase not solely because present value of future cash inflows increases as they become closer Recognize reversal as: income for assets carried at cost revaluation increase for assets carried at revalued amount 25 Reversing an impairment loss Maximum loss reversal is to pre-impairment carrying amount net of amortization or depreciation Impairment loss on goodwill cannot be reversed 26 Impairment of assets special topics 9

11/3/2008 Overview Non-controlling interests Impairment of revalued assets Corporate assets Restructurings an disposals Introduction of IFRS 8 28 Non-controlling interests IFRS 3 (revised) applicable for annual periods starting on or after 1/7/2009 gives entities the choice to measure the noncontrolling intrests At their proportionate interest in the net identifiable assets of the subsidiary or At fair value Measurement at their proportionate interest Goodwill attributable to non-controlling interests is included in the recoverable amount but not in the carrying amount of the CGU Gross-up carrying amount of goodwill before comparison with recoverable amount Allocate impairment loss to parent and non-controlling interest, but do not recognise impairment loss on goodwill attributable to the noncontrolling interest 29 Non-controlling interests If a subsidiary is itself a CGU, the impairment loss is allocated between the parent and the noncontrolling interest on the same basis as that on which profit or loss is allocated Is part of a larger CGU The impairment loss is allocated to the parts of the CGU that have a non-controlling interest and the parts that do not Based on relative carrying values of the goodwill for the part that relates to GW Based on relative carrying values of the assets for the remaining part 30 10

11/3/2008 Impairment of revalued assets Depends on the basis used to determine fair value If the fair value is its market value, the only difference between fair value and fair value less costs to sell is the direct incremental costs to dispose of the asset If disposal costs negligible, the recoverable amount of the revalued asset is close to, or greater than, its revalued amount Unlikely that there is an impairment and recoverable amount need not be estimated If disposal costs are not negligible, the fair value less costs to sell is less than fair value Revalued asset will be impaired if value in use is less than revalued amount Value in use needs to be calculated If the fair value has an other basis than the market value, the revalued amount may be greater or lower than the recoverable amount IAS 36 has to be applied to determine whether the asset may be impaired 31 Impairment of intangible assets with an indefinite useful life Annual impairment calculation, irrespective of whether there is any indication that it may be impaired Most recent detailed calculation may be used if The intangible asset does not generate cash inflows from continuing use that are largely independent of those from other assets or groups of assets and is therefore tested for impairment as part of a cash-generating unit to which it belongs and the assets an liabilities of that unit have not significantly changed The most recent recoverable amount calculation resulted in an amount that exceeded the asset s carrying amount by a substantial margin; and Based on an analysis of events that have occurred and circumstances that have changed since the most recent recoverable amount calculation, the likelihood that a current recoverable amount determination would be less than the asset carrying amount is remote 32 Corporate assets Corporate assets include the corporation s headquarters and other assets that cannot be directly related to CGUs Corporate assets must be allocated to CGUs on a reasonable basis Example: the corporate headquarters may be allocated to CGUs based on the proportion of total revenues that are earned by each CGU 33 11

11/3/2008 Corporate assets When testing a CGU (say CGU 1), include any allocated corporate assets &/or goodwill in its carrying value Account for any impairment loss Segment If corporate assets &/or goodwill cannot be allocated perform a second test on the larger group of CGUs containing the corporate asset e.g. CGU B Account for any additional impairment loss Goodwill must be attributed to at least segment level CGU A CGU B CGU 1 CGU 2 34 Restructurings and disposals Goodwill associated with an operation disposed of shall be Included in the carrying amount of the operation when determining the gain or loss on disposal; and Measured on the basis of the relative values of the operation disposed of and the portion of the cash-generating unit retained, unless the entity can demonstrate that some other method better reflects the goodwill associated with the operation disposed of 35 Restructurings and disposals If an entity reorgaises its reporting structure in a way that changes the composition of one or more cash-generating units to wich goodwill has been allocated Reallocate goodwill using a relative value approach, unless the entity can demonstrate that some other method better reflects the goodwill associated with the reorganised units 36 12

11/3/2008 Introduction of IFRS 8 Requires reviewing the level at which goodwill is tested for impairment Changes are expected to be rare Trait as a change of accounting policy (retrospective application) but use only information that was available at the time the impairment test would have been made 37 IFRIC 10- Interim Financial Reporting and Impairment IFRIC 10 Interim reporting and impairment Issue: IAS 34: The frequency of an entity s reporting shall not affect the measurement of its annual results IAS 36: An impairment loss recognized for goodwill shall not be reversed in a subsequent period 13

11/3/2008 IFRIC 10 Interim reporting and impairment Issue: IAS 39: Impairment losses recognized in profit or loss for an investment in an equity instrument classified as available for sale shall not be reversed through profit or loss Impairment losses for financial assets carried at cost should not be reversed. IFRIC 10 Interim reporting and impairment An entity shall not reverse an impairment loss recognized in a previous interim period in respect of goodwill or an investment in an equity instrument or a financial asset carried at cost Effective date: 1/11/2006 Transition: in accordance with IAS 8 Disclaimer The instructor takes every care in preparing course material to ensure that the content is accurate and up to date. This course material does not provide an exhaustive presentation of treatment of topics presented in accordance with IFRS. As such, when evaluating the underlying accounting treatment, the original IFRS Standards and Interpretations should be consulted, and an advice of a qualified IFRS expert should be obtained when deemed necessary. No responsibility for loss occasioned to any person acting or refraining from acting as a result of such material can be accepted by the instructor or the company for which she works. 42 14

Cases IAS 36 Impairment of assets Cases Véronique Weets Instituut der Bedrijfsrevisoren 1

Cases TABLE OF CONTENT Table of content... 2 IAS 36 Impairment of assets... 3 Recoverable amount... 3 Value in use... 4 Discount rate... 5 cash-generating units... 6 Cash-generating units including goodwill... 8 Reversing an impairment loss... 10 Non-controlling interests... 12 Allocation of corporate assets... 13 Comprehensive case... 14 Instituut der Bedrijfsrevisoren 2

Recoverable amount IAS 36 IMPAIRMENT OF ASSETS RECOVERABLE AMOUNT 1. A company has seven assets (labeled A to G) for which there are indications of possible impairment. The carrying amount, fair value less costs to sell and value in use for each asset are as shown below. Carrying amount Fair value less costs to sell Value in use Asset A 10 000 12 000 18 000 Asset B 11 000 9 000 13 000 Asset C 7 000 11 500 n/d Asset D 8 500 6 500 7 000 Asset E 12 750 n/d 16 800 Asset F 10 000 14 000 12 000 Asset G 21 000 15 000 10 000 Note: n/d = not determined Determine the amount of any impairment loss arising in relation to each asset(melville). Instituut der Bedrijfsrevisoren 3

Value in use VALUE IN USE 1. An asset has an aggregate carrying value at 31 December 20X4 of 123 000 CU. The fair value less costs to sell of the asset is determined by reference to used machinery prices obtained from a prominent dealer. After deducting estimated disposal costs, the fair value less costs to sell is calculated as 84 500 CU. Future cash flows are estimated as follows: Year Costs Revenues Net cash flow X05 28 000 75 000 47 000 X06 42 000 80 000 38 000 X07 55 000 65 000 10 000 X08 15 000 20 000 5 000 Totals 140 000 240 000 100 000 Value in use is determined with reference to the expected cash inflows and outflows, discounted at 5%. Determine if the asset suffered an impairment loss and indicate how this should be treated. Instituut der Bedrijfsrevisoren 4

Discount rate DISCOUNT RATE 1. At the end of 20X0, the carrying amount of an asset is 1 757 and its remaining useful life is 5 years. The tax base in 20X0 is the cost of the asset. The cost is fully deductible at the end of 20X1. The tax rate is 20%. The discount rate for the asset can be determined only on a post-tax basis and is estimated to be 10%. At the end of 20X0, cash flow projections determined on a pre-tax basis are as follows: 20X1 20X2 20X3 20X4 20X5 Pre-tax profit 449 249 149-151 -251 Depreciation Pre-tax cash-flows Tax depreciation Taxable profit Tax CF Post- tax cash flow a. Determine the pre-tax cash flows and the post tax cash flows b. Calculate the value in use using post tax cash flows and the post tax discount rate c. Calculate the pre-tax discount rate ). Instituut der Bedrijfsrevisoren 5

Cash generating units CASH-GENERATING UNITS 1. For each of the following cases, what are the cash-generating units? 1.1. Store X belongs to a retail store chain M. X makes all its retail purchases through M s purchasing centre. Pricing, marketing, advertising and human resources policies (except for hiring X s cashiers and sales staff) are decided by M. M also owns five other stores in the same city as X (although in different neighborhoods) and 20 other stores in other cities. All stores are managed in the same way as X. X and four other stores were purchased five years ago and goodwill was recognized. 1.2. A significant raw material used for plant Y s final production is an intermediate product bought from plant X of the same entity. X s products are sold to Y at a transfer price that passes all margins to X. Eighty per cent of Y s final production is sold to customers outside of the entity. Sixty per cent of X s final production is sold to Y and the remaining 40 per cent is sold to customers outside of the entity. a. X could sell the products it sells to Y in an active market. Internal transfer prices are higher than market prices. b. There is no active market for the products X sells to Y. 1.3. Entity M produces a single product and owns plants A, B and C. Each plant is located in a different continent. A produces a component that is assembled in either B or C. The combined capacity of B and C is not fully utilized. M s products are sold worldwide from either B or C. For example, B s production can be sold in C s continent if the products can be delivered faster from B than from C. Utilization levels of B and C depend on the allocation of sales between the two sites. a. There is an active market for A s products. b. There is no active market for A s products. 1.4. A publisher owns 150 magazine titles of which 70 were purchased and 80 were self-created. The price paid for a purchased magazine title is recognized as an intangible asset. The costs of creating magazine titles and maintaining the existing titles are recognized as an expense when incurred. Cash inflows from direct sales and advertising are identifiable for each magazine title. Titles are managed by customer segments. The level of advertising income for a magazine title depends on the range of titles in the customer segment to which the magazine title relates. Management has a policy to abandon old titles before the end of their economic lives and replace them immediately with new titles for the same customer segment. 1.5. M is a manufacturing company. It owns a headquarters building that used to be fully occupied for internal use. After down-sizing, half of the building is now used internally and half rented to third parties. The lease agreement with the tenant is for five years. Instituut der Bedrijfsrevisoren 6

Cash generating units 2. Avendus owns and operates an item of plant that had a carrying value of 400 000 CU and an estimated remaining life of 5 years. It has just been damaged due to incorrect operation by an employee. It is not economic to repair the plant but it still operates in a limited capacity although it is now no longer expected to last for 5 years. As the plant is damaged it could only be sold for 50 000 CU. The cost of replacing the plant is 1 million. The plant does not generate cash flows independently and is part of a group of assets that have a carrying value of 5 million CU and an estimated recoverable amount of 7 million CU ACCA (Question 26 b) i))) Explain how the above item of plant should be treated in the financial statements of Avendus. Your answer should consider the situations where the plant continues to be used and where it would be replaced. 3. A company operates a mine in a country were legislation requires that the owner must restore the site on completion of its mining operations. The cost of restoration includes the replacement of the overburden, which must be removed before operations commence. A provision for the costs to replace the overburden was recognized as soon as the overburden was removed. The amount provided was recognized as part of the cost of the mine and is being depreciated over the mine s useful life. The carrying amount of the provision for restoration costs is 500, which is equal to the present value of the restoration costs. The entity is testing the mine for impairment. The cash-generating unit for the mine is the mine as a whole. The entity has received various offers to buy the mine at a price of around 8. This price reflects the fact that the buyer will assume the obligation to restore the overburden. Disposal costs for the mine are negligible. The value in use of the mine is approximately 1 200, excluding restoration costs. The carrying amount of the mine is 1000. Determine the carrying amount of the cash-generating unit and determine whether there is an impairment loss 4. An entity has an identifiable asset with a carrying amount of 1 000. Its recoverable amount is 650. The tax rate is 30 % and the tax base of the asset is 800. Impairment losses are not deductible for tax purposes. Calculate the effect of the impairment loss on the deferred taxes. Instituut der Bedrijfsrevisoren 7

Cash generating units including goodwill CASH-GENERATING UNITS INCLUDING GOODWILL 1. One of the cash generating units of Amneris contains goodwill and has to be tested for impairment. The carrying amounts of the assets of that cash generating unit are as follows: Carrying amount Goodwill 400 000 Property, plant and equipment 1 200 000 Equipment 600 000 The recoverable amount of this cash-generating unit is 1560 000. The fair value less costs to sell of the property, plant and equipment is 1 000 000. 2 200 000 a. Calculate the impairment loss and allocate the impairment loss to the different elements in the cash-generating unit. b. How would your answer change if the fair value les costs to sell of the property, plant and equipment was 1 100 000? Instituut der Bedrijfsrevisoren 8

Cash generating units including goodwill 2. Avendus recently acquired a company called Fishright, a small fishing and fish processing company for 2 million CU. Avendus allocated the purchase consideration as follows ACCA (Question 26 b) iii))) Goodwill 240 000 Fishing quotas 400 000 Fishing boats (2 of equal value) 1 000 000 Other fishing equipment 100 000 Fish processing plant 200 000 Net current assets 60 000 2 000 000 Shortly after the acquisition, one of the fishing boats sank in a storm and this has halved the fishing capacity. Due to this reduction in capacity, the value in use of the fishing business as a going concern is estimated at only 1.2 million CU. The fishing quotas now represent a greater volume than one boat can fish and it is not possible to replace the lost boat as it was rather old and no equivalent boats are available. However the fishing quotas are much in demand and could be sold for 600 000 CU. Avendus has been offered 250 000 for the fish processing plant. The net current assets consist of accounts receivable and payable. Calculate the amounts that would appear in the consolidated financial statements of Avendus in respect of Fishright's assets after accounting for the impairment loss. Instituut der Bedrijfsrevisoren 9

Reversing an impairment loss REVERSING AN IMPAIRMENT LOSS 1. At the end of 20X0, enterprise F, tests a machine for impairment. It is carried at depreciated historical cost and its carrying amount is 150 000. It has an estimated remaining useful life of 10 years. For the purpose of this example, it is assumed that the machine s net selling price is not determinable. Therefore, the machine s recoverable amount is its value in use. Value in use is calculated using a pre-tax discount rate of 14%. Management approved budgets reflect: estimated costs necessary to maintain the level of economic benefit expected to arise from the machine in its current condition; and that in 20X4, costs of 25 00 will be incurred to enhance the machine s performance by increasing its productive capacity. Year Estimated cash flows excluding effects of costs of enhancement Estimated cash flows including effects of costs of enhancement X01 22 165 22 165 X02 21 450 21 450 X03 20 550 20 550 X04 24 725 24 725 X05 25 325 30 321 X06 24 825 32 750 X07 24 123 31 721 X08 25 533 31 950 X09 24 234 33 100 X10 22 850 27 999 Calculate the carrying amount at the end of 20X0, 20X1, 20X2, 20X3, 20X4, 20X5 (Illustrative example 6, IAS 36). Instituut der Bedrijfsrevisoren 10

Reversing an impairment loss 2. At the end of 20X0, entity K tests a plant for impairment. The plant is a cash-generating unit. The plant s assets are carried at depreciated historical cost. The plant has a carrying amount of CU3 000 and a remaining useful life of 10 years. The plant s recoverable amount (ie higher of value in use and fair value less costs to sell) is determined on the basis of a value in use calculation. Value in use is calculated using a pre-tax discount rate of 14 %. Management approved budgets reflect that: at the end of 20X3, the plant will be restructured at an estimated cost of CU100. Since K is not yet committed to the restructuring, a provision has not been recognized for the future restructuring costs. there will be future benefits from this restructuring in the form of reduced future cash outflows. Future cash flows excluding benefits from restructuring Future cash flows including benefits from restructuring 20X1 300 300 20X2 280 280 20X3 420 (1) 420 20X4 520 570 20X5 350 380 20X6 420 450 20X7 480 510 20X8 480 510 20X9 460 480 20X10 400 410 (1) Excludes estimated restructuring costs At the end of 20X2, K becomes committed to the restructuring. The costs are still estimated to be CU100 and a provision is recognized accordingly. At the end of 20X3, actual restructuring costs of CU100 are incurred and paid Give the appropriate calculations at the end of 20X0, 20X1, 20X2 and 20X3 Instituut der Bedrijfsrevisoren 11

Non-controlling interests NON-CONTROLLING INTERESTS 1. Parent acquires an 80 % ownership interest in Subsidiary for 2 100 on 1 January 20X3. At that date, Subsidiary's net identifiable assets have a fair value of 1 500. Parent chooses to measure the non-controlling interests as the proportionate interest of Subsidiary's net identifiable assets of 300 (20% of 1 500). Goodwill of CU900 is the difference between the aggregate of the consideration transferred and the amount of the noncontrolling interests (CU2 100 + CU300) and the net identifiable assets (CU1 500). The assets of Subsidiary together are the smallest group of assets that generate cash inflows that are largely independent of the cash inflows from other assets or groups of assets. Therefore Subsidiary is a cashgenerating unit. Because other cash-generating units of Parent are expected to benefit from the synergies of the combination, the goodwill of CU500 related to those synergies has been allocated to other cash-generating units within Parent. Because the cash-generating unit comprising Subsidiary includes goodwill within its carrying amount, it must be tested for impairment annually, or more frequently if there is an indication that it may be impaired. At the end of 20X3, Parent determines that the recoverable amount of cash-generating unit Subsidiary is CU1 000. The carrying amount of the net assets of Subsidiary, excluding goodwill, is CU1 350. Determine how to account for the impairment loss. 2. Parent acquires an 80 % ownership interest in Subsidiary for CU2 100 on 1 January 20X3. At that date, Subsidiary's net identifiable assets have a fair value of CU1 500. Parent chooses to measure the non-controlling interests at fair value, which is CU350. Goodwill of CU950 is the difference between the aggregate of the consideration transferred and the amount of the non-controlling interests (CU2 100 + CU350) and the net identifiable assets (CU1 500). The assets of Subsidiary together are the smallest group of assets that generate cash inflows that are largely independent of the cash inflows from other assets or groups of assets. Therefore, Subsidiary is a cashgenerating unit. Because other cash-generating units of Parent are expected to benefit from the synergies of the combination, the goodwill of CU500 related to those synergies has been allocated to other cash-generating units within Parent. Because Subsidiary includes goodwill within its carrying amount, it must be tested for impairment annually, or more frequently if there is an indication that it might be impaired. At the end of 20X3, Parent determines that the recoverable amount of cash-generating unit Subsidiary is CU1 650. The carrying amount of the net assets of Subsidiary, excluding goodwill, is CU1 350. a. Determine how to account for the impairment loss. Suppose that the assets of Subsidiary will generate cash inflows together with other assets or groups of assets of Parent. Therefore, rather than Subsidiary being the cash-generating unit for the purposes of impairment testing, Subsidiary becomes part of a larger cash-generating unit, Z. Other cash-generating units of Parent are also expected to benefit from the synergies of the combination. Therefore, goodwill related to those synergies, in the amount of CU500, has been allocated to those other cash-generating units. Z's goodwill related to previous business combinations is CU800. At the end of 20X3, Parent determines that the recoverable amount of cash-generating unit Z is CU3 300. The carrying amount of the net assets of Z, excluding goodwill, is CU2 250. b. Determine how to account for the impairment loss. Instituut der Bedrijfsrevisoren 12

Allocation of corporate assets ALLOCATION OF CORPORATE ASSETS 1. Entity M has three cash-generating units: A, B and C. The carrying amounts of those units do not include goodwill. There are adverse changes in the technological environment in which M operates. Therefore, M conducts impairment tests of each of its cash-generating units. At the end of 20X0, the carrying amounts of A, B and C are CU100, CU150 and CU200 respectively. The operations are conducted from a headquarters. The carrying amount of the headquarters is CU200: a headquarters building of CU150 and a research centre of CU50. The relative carrying amounts of the cashgenerating units are a reasonable indication of the proportion of the headquarters building devoted to each cash-generating unit. The carrying amount of the research centre cannot be allocated on a reasonable basis to the individual cash-generating units. The remaining estimated useful life of cash-generating unit A is 10 years. The remaining useful lives of B, C and the headquarters are 20 years. The headquarters is depreciated on a straight-line basis. The recoverable amount (ie higher of value in use and fair value less costs to sell) of each cash-generating unit is based on its value in use. Value in use is calculated using a pre-tax discount rate of 15 %. Year Future cash flows A B C M Discount at 15% Future cash flows Discount at 15% Future cash flows Discount at 15% Future cash flows Discount at 15% 1 18 16 9 8 10 9 39 34 2 31 23 16 12 20 15 72 54 3 37 24 24 16 34 22 105 69 4 42 24 29 17 44 25 128 73 5 47 24 32 16 51 25 143 71 6 52 22 33 14 56 24 155 67 7 55 21 34 13 60 22 162 61 8 55 18 35 11 63 21 166 54 9 53 15 35 10 65 18 167 48 10 48 12 35 9 66 16 169 42 11 36 8 66 14 132 28 12 35 7 66 12 131 25 13 35 6 66 11 131 21 14 33 5 65 9 128 18 15 30 4 62 8 122 15 16 26 3 60 6 115 12 17 22 2 57 5 108 10 18 18 1 51 4 97 8 19 14 1 43 3 85 6 20 10 1 35 2 71 4 VIU 199 164 271 720* *It is assumed that the research centre generates additional future cash flows for the entity as a whole. Therefore, the sum of the value in use of each individual cash-generating unit is less than the value in use of the business as a whole. The additional cash flows are not attributable to the headquarters building. Account for the impairment loss Instituut der Bedrijfsrevisoren 13

Comprehensive case COMPREHENSIVE CASE 1. At the end of 20X0, entity T acquires entity M for CU10 000. M has manufacturing plants in three countries. End of 20X0 Allocation of purchase price Fair value of identifiable assets Goodwill (1) Activities in Country A 3000 2 000 1 000 Activities in Country B 2 000 1 500 500 Activities in Country C 5 000 3 500 1 500 Total 10 000 7 000 3 000 (1) Activities in each country represent the lowest level at which the goodwill is monitored for internal management purposes (determined as the difference between the purchase price of the activities in each country, as specified in the purchase agreement, and the fair value of the identifiable assets) Because goodwill has been allocated to the activities in each country, each of those activities must be tested for impairment annually or more frequently if there is any indication that it may be impaired. The recoverable amounts (ie higher of value in use and fair value less costs to sell) of the cash-generating units are determined on the basis of value in use calculations. At the end of 20X0 and 20X1, the value in use of each cash-generating unit exceeds its carrying amount. Therefore the activities in each country and the goodwill allocated to those activities are regarded as not impaired. At the beginning of 20X2, a new government is elected in Country A. It passes legislation significantly restricting exports of T s main product. As a result, and for the foreseeable future, T s production in Country A will be cut by 40 %. The significant export restriction and the resulting production decrease require T also to estimate the recoverable amount of the Country A operations at the beginning of 20X2. T uses straight-line depreciation over a 12-year life for the Country A identifiable assets and anticipates no residual value. To determine the value in use for the Country A cash-generating unit, T: (a) prepares cash flow forecasts derived from the most recent financial budgets/forecasts for the next five years (years 20X2 20X6) approved by management. 20X2: 230 20X3: 253 20X4: 273 20X5: 290 20X6: 304 (b) estimates subsequent cash flows (years 20X7 20Y2) based on declining growth rates. The growth rate for 20X7 is estimated to be 3 %. This rate is lower than the average long-term growth rate for the market in Country A. 20X8: (2)% 20X9: (6)% 20Y0: (15)% 20Y1: (25)% 20Y2: (67)% (c) selects a 15 % discount rate, which represents a pre-tax rate that reflects current market assessments of the time value of money and the risks specific to the Country A cash-generating unit. Instituut der Bedrijfsrevisoren 14

Comprehensive case Calculate the recoverable amount of the Country A cash generating unit. Calculate and allocate the impairment loss 2. At the beginning of 20X2, the tax base of the identifiable assets of the Country A cash-generating unit is 900. Impairment losses are not deductible for tax purposes. The tax rate is 40 %. Account for the deferred taxes 3. In 20X3, the government is still in office in Country A, but the business situation is improving. The effects of the export laws on T s production are proving to be less drastic than initially expected by management. As a result, management estimates that production will increase by 30 %. This favorable change requires T to re-estimate the recoverable amount of the net assets of the Country A operations. The cashgenerating unit for the net assets of the Country A operations is still the Country A operations. The recoverable amount of the Country A cash-generating unit is now CU1 910. Take into account that after the recognition of the impairment loss at the beginning of 20X2, T revised the depreciation charge for the Country A identifiable assets (from 166,7 per year to 123, per year) based on the revised carrying amount and remaining useful life (11 years). Account for the favorable change in circumstances Instituut der Bedrijfsrevisoren 15

Solutions IAS 36 Impairment of assets Solutions Véronique Weets Instituut der Bedrijfsrevisoren 1

Solutions TABLE OF CONTENT Table of content... 2 IAS 36 Impairment of assets... 3 Recoverable amount... 3 Value in use... 4 Discount rate... 5 cash-generating units... 6 Cash-generating units including goodwill... 10 Reversing an impairment loss... 12 Non-controlling interests... 17 Allocation of corporate assets... 20 Comprehensive case... 23 Instituut der Bedrijfsrevisoren 2

Recoverable amount IAS 36 IMPAIRMENT OF ASSETS RECOVERABLE AMOUNT 1. A company has seven assets (labeled A to G) for which there are indications of possible impairment. The carrying amount, fair value less costs to sell and value in use for each asset are as shown below. Carrying amount Fair value less costs to sell Value in use Asset A 10 000 12 000 18 000 Asset B 11 000 9 000 13 000 Asset C 7 000 11 500 n/d Asset D 8 500 6 500 7 000 Asset E 12 750 n/d 16 800 Asset F 10 000 14 000 12 000 Asset G 21 000 15 000 10 000 Note: n/d = not determined Determine the amount of any impairment loss arising in relation to each asset(melville). Carrying amount Recoverable amount Impairment loss Asset A 10 000 18 000 0 Asset B 11 000 13 000 0 Asset C 7 000 11 500 (at least) 0 Asset D 8 500 7 000 1 500 Asset E 12 750 16 800 (at least) 0 Asset F 10 000 14 000 0 Asset G 21 000 15 000 6 000 Instituut der Bedrijfsrevisoren 3

Value in use VALUE IN USE 1. An asset has an aggregate carrying value at 31 December 20X4 of 123 000 CU. The fair value less costs to sell of the asset is determined by reference to used machinery prices obtained from a prominent dealer. After deducting estimated disposal costs, the fair value less costs to sell is calculated as 84 500 CU. Future cash flows are estimated as follows: Year Costs Revenues Net cash flow X05 28 000 75 000 47 000 X06 42 000 80 000 38 000 X07 55 000 65 000 10 000 X08 15 000 20 000 5 000 Totals 140 000 240 000 100 000 Value in use is determined with reference to the expected cash inflows and outflows, discounted at 5%. Determine if the asset suffered an impairment loss and indicate how this should be treated. Year Cash flows Discount factor 5% Net present value X05 47 000 0.95238 44 762 X06 38 000 0.90703 34 467 X07 10 000 0.86384 8 638 X08 5 000 0.82270 4 114 Value in use 91 981 The recoverable amount is the higher of fair value less costs to sell (84 500 CU) and value in use (91 981 CU). The asset is impaired as its carrying amount (123 000 CU) exceeds recoverable amount (91 981 CU) by 31 019 CU. The loss would be recorded as follows: Dr Impairment loss 31 019 Cr Asset 31 019 * Take loss to equity if it relates to a revalued asset Instituut der Bedrijfsrevisoren 4

Discount rate DISCOUNT RATE 1. At the end of 20X0, the carrying amount of an asset is 1 757 and its remaining useful life is 5 years. The tax base in 20X0 is the cost of the asset. The cost is fully deductible at the end of 20X1. The tax rate is 20%. The discount rate for the asset can be determined only on a post-tax basis and is estimated to be 10%. At the end of 20X0, cash flow projections determined on a pre-tax basis are as follows: 20X1 20X2 20X3 20X4 20X5 Pre-tax profit 449 249 149-151 -251 Depreciation Pre-tax cash-flows Tax depreciation Taxable profit Tax CF Post- tax cash flow a. Determine the pre-tax cash flows and the post tax cash flows 20X1 20X2 20X3 20X4 20X5 Pre-tax profit 449 249 149-151 -251 Depreciation 351 351 351 351 351 Pre-tax cash-flows 800 600 500 200 100 Tax depreciation -1757 Taxable profit -957 600 500 200 100 Tax CF -191,4 120 100 40 20 Post- tax cash flow 991,4 480 400 160 80 b. Calculate the value in use using post tax cash flows and the post tax discount rate NPV(10%, 991,4;480;400;160;80)=1 757 c. Calculate the pre-tax discount rate A pre-tax discount rate can be determined by an iterative computation so that value in use determined using pre-tax cash flows and a pre-tax discount rate equals value in use determined using post-tax cash flows and a post-tax discount rate. IRR (-1 757; 800;600;500;200;100) Comment: In most cases grossing up the post-tax discount rate does not lead to the right result This tax rate would be 10%/(1-0.20)= 12.5%. This gives a value in use of 1 717. (This method is only correct if there is no growth in cash flows and no deferred tax). Instituut der Bedrijfsrevisoren 5

Cash generating units CASH-GENERATING UNITS 1. For each of the following cases, what are the cash-generating units? 1.1. Store X belongs to a retail store chain M. X makes all its retail purchases through M s purchasing centre. Pricing, marketing, advertising and human resources policies (except for hiring X s cashiers and sales staff) are decided by M. M also owns five other stores in the same city as X (although in different neighborhoods) and 20 other stores in other cities. All stores are managed in the same way as X. X and four other stores were purchased five years ago and goodwill was recognized. In identifying X s cash-generating unit, an entity considers whether, for example: (a) internal management reporting is organized to measure performance on a store-by-store basis; and (b) the business is run on a store-by-store profit basis or on a region/city basis. All M s stores are in different neighborhoods and probably have different customer bases. So, although X is managed at a corporate level, X generates cash inflows that are largely independent of those of M s other stores. Therefore, it is likely that X is a cash-generating unit. If X s cash-generating unit represents the lowest level within M at which the goodwill is monitored for internal management purposes, M applies to that cash-generating unit the impairment test described in paragraph 90 of IAS 36. If information about the carrying amount of goodwill is not available and monitored for internal management purposes at the level of X s cash-generating unit, M applies to that cash-generating unit the impairment test described in paragraph 88 of IAS 36. 1.2. A significant raw material used for plant Y s final production is an intermediate product bought from plant X of the same entity. X s products are sold to Y at a transfer price that passes all margins to X. Eighty per cent of Y s final production is sold to customers outside of the entity. Sixty per cent of X s final production is sold to Y and the remaining 40 per cent is sold to customers outside of the entity. a. X could sell the products it sells to Y in an active market. Internal transfer prices are higher than market prices. X could sell its products in an active market and, so, generate cash inflows that would be largely independent of the cash inflows from Y. Therefore, it is likely that X is a separate cash-generating unit, although part of its production is used by Y (see paragraph 70 of IAS 36). It is likely that Y is also a separate cash-generating unit. Y sells 80 per cent of its products to customers outside of the entity. Therefore, its cash inflows can be regarded as largely independent. Internal transfer prices do not reflect market prices for X s output. Therefore, in determining value in use of both X and Y, the entity adjusts financial budgets/forecasts to reflect management s best estimate of future prices that could be achieved in arm s length transactions for those of X s products that are used internally (see paragraph 70 of IAS 36). b. There is no active market for the products X sells to Y. It is likely that the recoverable amount of each plant cannot be assessed independently of the recoverable amount of the other plant because: (a) the majority of X s production is used internally and could not be sold in an active market. So, cash inflows of X depend on demand for Y s products. Therefore, X cannot be considered to generate cash inflows that are largely independent of those of Y. Instituut der Bedrijfsrevisoren 6