The Disposal of Fixed Assets and the Presentation of Discontinued Operations gets an overhaul!! Robert Kirk reviews the key features of FRED 32 and provides some practical examples of its implementation Introduction The convergence of accounting standards worldwide is one of the key objectives of the International Accounting Standards Board (IASB). As part of this process, in recent months, the Standards Board (FASB) in the USA and the IASB have been working closely together to try and iron out differences between their standards and come with a consensus treatment. One of the topics addressed is US standard FAS 144 Accounting for the Impairment or Disposal of Long Lived Assets. FAS 144 addresses three issues: the accounting treatment of impaired long lived assets; the classification, measurement and presentation of assets held for sale; and the classification and presentation of discontinued There are, however, substantial differences between IFRSs and US Gaap as regards the accounting treatment of the impairment of long lived assets and therefore it has been excluded from the project. The result has been the publication of FRED 32 Disposal of Non Current Assets and Presentation of Discontinued Operations in July 2003 (ED5 equivalent for the IASB). It will result in a number of changes to FRS 3 Presentation of Financial Information. Objective The objective of the proposed standard is to improve the information currently being disclosed by reporting entities regarding both assets and disposal groups that are about to be sold by the entity as well as how to account for discontinued It tries to achieve this by specifying: * the requirements for the measurement, presentation and disclosure of non-current assets and disposal groups; and * the presentation and disclosure of discontinued Scope The proposed standard will apply to all financial statements intending to give a true and fair view except those reporting under the FRSSE. In particular, it will be applied to all recognised non-current assets except: * goodwill; * deferred tax assets; * financial assets included within the scope of IAS 39; * assets arising from employee benefits; and * financial assets arising under leases. A disposal group could either be a group of cash generating units (CGUs) or even a part of a single CGU. It is really the disposal of a group of assets and liabilities as part of a single transaction and does incorporate goodwill. Classification of Non Current Assets As Held for Sale One of the lynchpins of FRED 32 is to identify any noncurrent assets that are held for sale and disclose them separately from ongoing activities. Non current assets represent mainly fixed assets but they do include any asset which does not meet the definition of a current asset. Assets and disposal groups should be classified as such if the assets/disposal groups are to be recovered principally Page 23
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through a sale rather than through continuing use. However, to achieve such a classification all of the following criteria must be met. (a) management must be committed and also have the authority to approve the action to sell the assets/disposal groups; (b) the asset/disposal group must be available for immediate sale in their present condition subject to normal selling terms; (c) an active programme to locate a buyer has been initiated; (d) the sale is highly probable and is expected to qualify for recognition as a completed sale; (e) the asset/disposal group is being actively marketed for sale at a reasonable price in relation to its fair value; (f) actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or the plan withdrawn. FRED 32 provides a number of useful examples to aid entities in taking their decisions as to whether or not the assets/disposal groups meet the necessary criteria. For example, any delay in transfer of an asset, despite a firm commitment to sell would probably result in a failure to meet criteria (b). However it may be possible to breach the immediate sale requirement by permitting sales beyond one year to be still classified as held for sale provided a delay is caused by factors outside the entity s control and there is still sufficient evidence of a commitment to sell. Readers are referred to Appendix B of the FRED for further details. Non current assets to be abandoned These are not included as held for sale. However, if the disposal group to be abandoned is a component of an entity then the entity should present the results and cash flows of the disposal group as discontinued on the date it ceases to be used. FRED 32 provides the following examples to help clarify whether or not an abandonment should be classified as held for sale. Examples Assume that an entity ceases to use a manufacturing plant because demand has suddenly declined. However, the plant is still maintained in workable condition and it is expected to be brought back into use if demand picks up. It is therefore not regarded as abandoned. In October 2005 an entity decides to abandon one of its cotton mills. It is a CGU that meets the definition of a component of the entity. All work stops during 2005. For that year the results and cash flows should be treated as part of continuing operations but in 2006 the entity should disclose the information required for discontinued operations including a restatement of any comparative figures. Measurement of a Non Current Asset (Or Disposal Group) Classified As Held For Sale An entity should measure a non-current asset (or disposal group) classified as held for sale at the lower of its carrying amount and fair value less costs to sell. If a newly acquired asset meets the criteria as held for sale it should be measured initially at fair value less costs to sell. Where, rarely, the sale takes more than one year to complete, it should be measured at present value. The carrying amounts of any assets not covered by FRED 32 but included in a disposal group should be measured in accordance with other FRSs before the fair value less costs to sell has been measured. For assets that have not been revalued an entity should recognise: an impairment loss for any initial write-down to fair value less costs to sell; and a gain for any subsequent increase in fair value less costs to sell but not in excess of the cumulative impairment loss recognised under this FRED or FRS 11 Impairment of Fixed Assets and Goodwill. FRED 32 sets out the requirements for the recognition of impairment losses and subsequent gains for assets that, before classification as held for sale, were measured at revalued amounts under previous IFRSs. The impairment loss should reduce the carrying amount of the non-current assets in the group that are included in the scope of the IFRS. A gain or loss not previously recognised by the time of the sale of a non-current asset should be recognised at the date of sale. Strangely FRED 32 proposes that a non-current asset should not be depreciated whilst classified as held for resale or while it is part of a disposal group classified as held for sale even though it is in use by the entity. Changes to a plan of sale If an asset or disposal group has been previously classified as held for sale but now the criteria for held for sale are no longer met then the entity should cease to classify the asset or group as held for sale. On cessation from classification as held for sale a noncurrent asset should be valued at the lower of its: (i) carrying amount before asset or group classified as adjusted for depreciation that would have been recognised had the asset no been classified; and (ii) recoverable amount at the date of the subsequent decision not to sell. The entity should include, in income from continuing operations, any required adjustments to the carrying value of a non-current asset that ceases to be classified as held for sale. Page 25
If an entity removes an individual asset or liability from a disposal group, the remaining net assets should continue to be measured as a group. However, this should only be to the extent that a group meets the held for sale criteria. Otherwise, the remaining non-current assets of the group, that individually meet the criteria, should be measured individually at the lower of their carrying amounts and fair values less costs to sell at that date. Any non-current assets not meeting the criteria should then cease to be classified as held for resale. Presentation and Disclosure Information should be presented to enable users to evaluate the financial effects of both discontinued operations and disposals of non-current assets. Presenting discontinuing operations A component of an entity comprises operations and cash flows that can clearly be distinguished from the rest of the entity. It may be a CGU or any group of CGUs. A discontinued operation will in the future be defined as a component of an entity that has either been disposed of or is classified as held for sale and (a) the operations and cash flows have been eliminated from ongoing operations, and (b) the entity will have no significant continuing involvement in that component after its disposal. FRED 32 provides a number of examples to help distinguish discontinued operations from ongoing activities: Example An entity that manufactures and sells consumer products has several product groups, each with different product lines and brands. A product group is the lowest level at which the operations and cash flows can be clearly distinguished, operationally and for financial reporting purposes, from the rest of the entity. Each product group is a component of the entity The entity has experienced losses associated with certain brands in its beauty care products group. (a) the entity decides to exit the beauty care business and is committed to a plan to sell the product group. It is classified as held for sale at the date. The operations and cash flows of the product group will be eliminated from ongoing It is clearly a discontinued operation. (b) The entity decides to remain in the beauty care business but will discontinue the loss making brands. Because these are part of a larger CGU and do not, in aggregate, represent a group that is a component of the entity, the conditions are not met for a discontinuing operation. Example An entity has a franchise in the fast food business but also operates company canteens. An individual canteen is the lowest level at which operations and cash flows can be clearly distinguished. Each canteen is therefore a component of the entity. (a) The entity has experienced losses on its canteens in one region. The entity decides to exit the fast food business in that region and to sell the canteens. The canteens are classified as held for sale at that date. The conditions for discontinued operations are met. (b) Based on its evaluation of the ownership mix of its restaurants, the entity commits itself to sell its canteens in one region to an existing franchisee. However it still receives franchise fee income and is still having significant continuing involvement in the operations of its canteens. This would not meet the definition of a discontinued operation. Page 26
Example An entity that manufactures sporting goods has a bicycle division which is the lowest level of operations and cash flows that can be clearly distinguished operationally and for financial reporting purposes. It is therefore a component of the entity. The entity has experienced losses in its bicycle (a) The entity decides to exit the bicycle business and plans to sell it. The division can be regarded as a discontinued operation and must be eliminated from ongoing (b) The entity decides to remain in the bicycle business but to outsource the manufacturing. It should be classified as held for sale at that date. As it is still part of a larger CGU and is not a component of the entity it must not be classified as a discontinued operation. Under FRED 32 an entity will have to disclose for all periods presented: (a) The revenue, expenses and pre-tax profit or loss of discontinued operations and income tax expense relating to the ordinary activities of the discontinued operation for the period plus corresponding amounts for each prior period presented. (b) The gain or loss recognised on the remeasurement to fair value less costs to sell for the discontinued operation relating to the gain/loss on discontinuance. (c) The net cash flows attributable to the operating, investing and financing activities of discontinued The disclosures required by (a) must be on the face of the income statement but the others may be presented in the notes or on the face of the income statement. Gains or losses relating to continuing operations Any gain/loss on remeasurement of a non-current asset that does not meet the definition of a component shall be included in the profit/loss from continuing Presentation of a non current asset or disposal group classified as held for sale These should be separately disclosed from other assets. The liabilities of a disposal group classified as held for sale shall be presented separately from other liabilities. These assets and liabilities shall not be offset but separately disclosed on the face of the balance sheet. Additional disclosure The following should be disclosed in the notes: (a) a description of the facts and circumstances leading to the expected disposal and manner and timing of that disposal; (b) the gain or loss on impairment or subsequent increase in fair value for assets previously not revalued. (c) If applicable, the segment in which the non-current asset is presented under SSAP 25 Any changes to a plan should be described and the facts and circumstances leading to the decision to change the plan provided. Likely overall impact on Irish reporting Existing Irish Gaap does not require any separate presentation of assets held for sale and thus additional headings will be required on the balance sheet as well as additional disclosure in the notes. Another impact will be the need to cease depreciation immediately an asset or disposal group is classified as held for sale. However, the most important change is in the definition of a discontinued activity. In FRS 3 four criteria had to met including the requirement for a sale/termination to be permanently ceased or sold, either in the accounting period or within three months of the start of the subsequent period. In addition it had to have a material effect on the nature and focus of the entity s The criteria in FRED 32 are not as detailed and merely require held for sale components to be clearly distinguished both operationally and for financial accounting purposes from continuing operations and for the entity to have no significant continuing involvement in the component after disposal. It is very likely that this will result in discontinued operations being more frequently reported than under FRS 3, particularly in that there is no reference to materiality in FRED 32. There is a danger that they will be become so popular that they will become indistinguishable from ongoing activity and it will be become normal to have such activities on a regular basis. Altogether there are seven paragraphs in FRS 3 relating to discontinued operations that will have to be withdrawn when FRED 32 becomes fully operable as a financial reporting standard. Effective Date The deadline for comments on the FRED is not until the end of October so it will probably not be published as a full standard before early Spring 2004. Summary FRED 32 will not result in revolutionary changes to Irish reporting but it is symptomatic of the very many minor adjustments that will have to be made to nearly every single accounting standard in Ireland, as a result of the USA/IASB convergence project. That is, in addition, to the process of converging existing SSAPs and FRSs to IFRSs. The juggernaut is starting to move!! Robert J Kirk is Professor of Financial Reporting at The University of Ulster Page 27