ACCA F7 (INT) Financial Reporting - Study text - 2010

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Paper F7 (INT)

Financial reporting

CHAPTER

Impairment of assets

Contents

1 Intangible assets: IAS36

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Impairment of assets: IAS36

 Objective and scope of IAS36

 Identifying impairment or possible impairment

 Accounting for impairments

 Measuring recoverable amount

 Cash-generating units

 Allocating an impairment loss to the assets of a cash generating unit

 Reversal of an impairment loss

 Disclosure requirements for the impairment of assets

1 Impairment of assets: IAS36

1.1 Objective and scope of IAS36

The objective of IAS36 Impairment of assets is to ensure that assets are ‘carried’

(valued) in the financial statements at no more than their recoverable amount.

Recoverable amount of assets

The recoverable amount of an asset is defined as the higher of its:

 fair value minus costs to sell, and

 value in use.

Fair value less costs to sell is the amount obtainable from the sale of an asset in an

arm’s length transaction between knowledgeable, willing parties, less the costs of

disposal.

Value in use is the present value of future cash flows from using an asset, including

its eventual disposal.

Scope of IAS36

IAS36 applies to all assets, with the following exceptions that are covered by

another accounting standard:

 inventories (IAS2)

 construction contracts (IAS2)

 deferred tax assets (IAS12)

 assets arising from employee benefits (IAS19)

 financial assets covered by IAS39

 investment property held at fair value (IAS40)

 non-current assets classified as held for sale (IFRS5).

Chapter 9: Impairment of assets

1.2 Identifying impairment or possible impairment

Impairment means a loss in quality. When an asset is impaired, it loses value

because it loses quality. IAS36 defines an impairment loss as ‘the amount by which

the carrying amount of an asset (or a cash-generating unit) exceeds its recoverable

amount.’

An entity must carry out an impairment review when there is evidence or an

indication that impairment may have occurred. At the end of each reporting period,

an entity should assess whether there is any indication that impairment might have

occurred. If such an indication exists, the entity must estimate the recoverable

amount of the asset, in order to establish whether impairment has occurred and if

so, the amount of the impairment.

Indicators of impairment

The following are given by IAS36 as possible indicators of impairment. These may

be indicators outside the entity itself (external indicators), such as market factors

and changes in the market. Alternatively, they may be internal indicators relating to

the actual condition of the asset or the conditions of the entity’s business operations.

 External sources

Examples of external indicators of impairment are:

− Asset values generally declining in the period more significantly than would

usually be expected.

− Significant changes in the technological, economic, market or legal

environment. (For an example an asset may become impaired because it is

becoming technologically out-of-date.)

− Increases in interest rates that change the calculation of the asset’s value in

use.

 Internal sources

Examples of internal indicators of impairment are:

− Evidence of physical damage, obsolescence or poor performance

− The asset becomes idle, or there are new plans to restructure that part of the

business in which the asset is used (without the asset being classified as held

for sale).

Additional requirements for testing for impairment

The following assets must be reviewed for impairment at least annually, even when

there is no evidence of impairment:

 an intangible asset with an indefinite useful life

 goodwill acquired in a business combination. (This is explained in more detail

later.)

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1.3 Accounting for impairments

Impairment of an asset should be identified and accounted for as follows.

(1) At the end of each reporting period, the entity should assess whether there are

any indications that an asset may be impaired.

(2) If there are such indications, the entity should estimate the asset’s recoverable

amount.

(3) When the recoverable amount is less than the carrying value of the asset, the

entity should reduce the asset’s carrying value to its recoverable amount. The

amount by which the value of the asset is written down is an impairment loss.

(4) This impairment loss is recognised as a loss for the period.

(5) However, if the impairment loss relates to an asset that has previously been

re-valued upwards, it is first offset against any remaining revaluation surplus

for that asset. When this happens it is reported as other comprehensive

income for the period (a negative value) and not charged against profit.

(5) Depreciation charges for the impaired asset in future periods should be

adjusted to allocate the asset’s revised carrying amount, minus any residual

value, over its remaining useful life (revised if necessary).

Example

A non-current asset had a carrying amount of $80,000 in the statement of financial

position of an entity at the beginning of the financial year. The asset had previously

been revalued, and there was a revaluation surplus of $5,000 relating to it in the

revaluation reserve.

At the end of the financial year, the entity suspected that the asset had been

impaired. It therefore estimated the recoverable amount of the asset and found this

to be $60,000. The depreciation charge for the asset for the year would be $8,000.

There is an impairment loss of $20,000 (= $80,000 - $60,000). Of this, $5,000 may be

offset against the revaluation reserve (the remaining revaluation surplus for the

asset) and reported as a negative amount in ‘other comprehensive income’ for the

year. The remaining $15,000 must be written off as an expense for the period, and

the asset should be re-stated at its recoverable amount ($60,000) in the statement of

financial position.

In the next year, depreciation should be based on the new carrying value of the asset

($60,000) less any expected residual value.

Example

On 1 January Year 1 Entity Q purchased for $240,000 a machine with an estimated

useful life of 20 years and an estimated residual value of $0. Entity Q depreciates

such machines on a straight-line basis. On 1 January Year 4 an impairment review

showed the machine’s recoverable amount to be $100,000 and its remaining useful

life to be 10 years.

Chapter 9: Impairment of assets

Required

(a) Calculate the amounts to be included in the statement of comprehensive

income for Year 4.

(b) Calculate the amounts to be included in the statement of comprehensive

income for Year 4 if the asset had been re-valued on 1 January Year 3 to

$250,000, but with no change in useful life at that date.

Answer

Part (a)

On 31 December Year 3 the machine was stated at the following amount

Cost 240,000

Accumulated depreciation (3 × (240,000 ÷ 20)) (36,000)

–

–––––––

Carrying amount 204,000

–

–––––––

The statement of comprehensive income for Year 4 will reflect an impairment loss of

$104,000 (= $204,000 – $100,000) at the beginning of Year 4, reducing the reported

profit. In addition, there will be a depreciation charge in Year 4 of $10,000 (=

$100,000 ÷ 10). The depreciation charge is based on the recoverable amount of the

asset.

Part (b)

When the asset is revalued on 1 January Year 3, depreciation is charged on the

revalued amount over its remaining expected useful life. On 31 December Year 3 the

machine was therefore stated at:

Valuation at 1 January (re-valued amount) 250,000

Accumulated depreciation in Year 3 (= $250,000 ÷ 18)) (13,889)

–

–––––––

Carrying amount 236,111

–

–––––––

In addition, there is a revaluation surplus. This arises when the asset was re-valued

to $250,000 on 1 January Year 3. The revaluation surplus is $34,000.

Cost 240,000

Accumulated depreciation at 1 January Year 3 (2 years × (240,000 ÷ 20)) (24,000)

–

–––––––

Carrying amount 216,000

Valuation at 1 January Year 3 250,000

–

–––––––

Revaluation surplus 34,000

–

–––––––

On 1 January Year 4 the impairment review shows an impairment loss of $136,111

(= $236,111 – $100,000).

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 An impairment loss of $34,000 will be taken to the revaluation reserve, which is

the revaluation surplus previously recorded for the asset. This part of the loss is

also reported as negative income within ‘other comprehensive income’ in the

statement of comprehensive income for Year 4.

 The statement of comprehensive income for Year 4 will include the remaining

impairment loss of $102,111 (= $136,111 – $34,000) and a depreciation charge of

$10,000 (= $100,000 ÷ 10 years), both as expenses for the year.

1.4 Measuring recoverable amount

It has been explained that recoverable amount is the higher of (1) fair value less

costs to sell and (2) value in use. If either of these amounts is higher than the

carrying value of the asset, there has been no impairment.

IAS36 sets out the requirements for measuring ‘fair value less costs to sell’ and

‘value in use’.

Measuring fair value less costs to sell

Fair value is normally market value. If no active market exists, it may be possible to

estimate the amount that the entity could obtain from the disposal.

Direct selling costs normally include legal costs, stamp duty and costs necessary to

bring the asset into a condition to be sold. However, redundancy and similar costs

(for example, where a business is reorganised following the disposal of an asset) are

not direct selling costs.

IAS36 comments that ‘the best evidence of an asset’s fair value less costs to sell is a

price in a binding sale agreement in an arm’s length transaction, adjusted for

incremental costs that would be directly attributable to the disposal of the asset.’

Calculating value in use

Value in use is a value that represents the present value of the expected future cash

flows from use of the asset, discounted at a suitable discount rate or cost of capital.

Value in use is therefore calculated by:

 estimating future cash flows from the use of the asset (including those from

ultimate disposal)

 discounting them to present value.

Estimates of future cash flows should be based on reasonable and supportable

assumptions that represent management’s best estimate of the economic conditions

that will exist over the remaining useful life of the asset.

The discount rate used should be the rate of return that the market would expect

from an equally risky investment.

Chapter 9: Impairment of assets

However, both the expected future cash flows and the discount rate might be

adjusted to allow for uncertainty about the future – such as the business risk

associated with the asset and expectations of possible variations in the amount of

timing of expected future cash benefits from using the asset.

1.5 Cash-generating units

It is not always possible to calculate the recoverable amount of individual assets.

Value in use often has to be calculated for groups of assets, because assets may not

generate cash flows in isolation from each other. An asset that is potentially

impaired may be part of a larger group of assets which form a cash-generating unit.

IAS 36 defines a cash generating unit as the smallest identifiable group of assets

that generates cash outflows that are largely independent of the cash inflows from

other assets or groups of assets.

Goodwill

The existence of cash-generating units may be particularly relevant to goodwill

acquired in a business combination. Purchased goodwill must be reviewed for

impairment annually, and the value of goodwill cannot be estimated in isolation.

Often, goodwill relates to a whole business.

It may be possible to allocate purchased goodwill across several cash-generating

units. If allocation is not possible, the impairment review is carried out in two

stages:

1 Carry out an impairment review on each of the cash generating units

(excluding the goodwill) and recognise any impairment losses that have

arisen.

2 Then carry out an impairment review for the entity as a whole, including the

goodwill.

1.6 Allocating an impairment loss to the assets of a cash generating unit

When an impairment loss arises on a cash generating unit, the impairment loss is

allocated across the assets of the cash-generating unit in the following order:

 first, to the goodwill allocated to the cash-generating unit

 next, to the other assets in the cash-generating unit, on a pro-rata basis (i.e. in

proportion to the carrying amount of the assets of the cash generating unit).

However, the carrying amount of an asset cannot be reduced below the highest of:

 its fair value less costs to sell (if determinable);

 its value in use (if determinable); and

 zero.

Paper F7: Financial reporting (International)

Example

A cash-generating unit is made up of the following assets.

Property, plant and equipment 90

Goodwill 10

Other assets 60

–

–––

160

–

–––

The recoverable amount of the cash-generating unit has been assessed as $140 million.

Required

Show how the impairment loss would be allocated across the assets of the cash-

generating unit.

Answer

There is a total impairment loss of $20 million (= $160m – $140m). Of this, $10

million is allocated to goodwill, to write down the goodwill to $0. The remaining

$10 million is then allocated to the other assets pro-rata. Therefore:

 $6 million (= $10m × 90/150) of the impairment loss is allocated to property,

plant and equipment, and

 $4 million (= $10m × 60/150) of the loss is allocated to the other assets in the

unit.

1.7 Reversal of an impairment loss

An impairment loss may be reversed when there is evidence that this has happened.

Any reversal:

 must be justifiable, by reference to an improvement in the indicators of

impairment, and

 should not lead to a carrying amount in excess of what the carrying amount of

the asset would have been without the recognition of the original impairment

loss.

A reversal should be:

 recognised immediately in profit or loss, unless

 the original impairment was charged to the revaluation reserve, in which case

the reversal should be credited to the revaluation reserve (and reported in the

same way as a revaluation in ‘other comprehensive income’ for the period).

Depreciation charges for future periods should be adjusted to allocate the asset’s

revised carrying amount, minus any residual value, over its remaining useful life.

Chapter 9: Impairment of assets

An impairment loss that has arisen on purchased goodwill cannot be reversed. (This

is because any reversal of an impairment loss to goodwill is likely to be caused by

an increase in internally-generated goodwill rather than a reversal of the

impairment of purchased goodwill. Internally-generated goodwill must not be

reported as an asset.)

1.8 Disclosure requirements for the impairment of assets

For all impairments, the following disclosures should be made for each class of

assets.

 The amount of impairment losses recognised in profit or loss for the period and

the line item in the statement of comprehensive income in which those items are

included.

 Similar information about reversals of impairment losses recognised in profit or

loss for the period.

 The amount of impairment losses on revalued assets that have been recognised

(or reversed) in other comprehensive income for the period (and in the

revaluation reserve).

 If the recognition or reversal of an individual impairment loss is material to the

financial statements, there should be additional disclosure of:

− the events that led to the recognition or reversal of the impairment loss

− the amount of the impairment loss recognised or reversed

− the nature of the asset

− whether the recoverable amount is fair value minus costs to sell or value in

use, and how the figure for the recoverable amount was calculated.

Paper F7: Financial reporting (International)

ACCA F7 (INT) Financial Reporting - Study text - 2010 - Emile Woolf Publishing

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