11 Impairment of assets PDF

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Solutions to GAAP: Graded Questions

Impairment of assets

Solution 11.1 Part A a) False. The recoverable amount of an asset (or a cash-generating unit) is defined as ‘the higher of its fair value less costs of disposal and its value in use’. IAS 36.6 b) False. The recoverable amount does not always need to be calculated every year. The recoverable amount will need to be calculated: • annually if the asset is an intangible asset  with an indefinite useful life; or  that is not yet available for use; • annually if the asset is an intangible asset that is goodwill; or • whenever an impairment indicator suggests a material impairment may have occurred. See IAS 36.9-10

Furthermore, if the asset is an intangible asset with an indefinite useful life, it is possible that the recoverable amount for the current year need not be calculated and, instead, ‘the most recent detailed calculation of such an asset’s recoverable amount made in a preceding period may be used in the impairment test for that asset in the current period, provided all of the following criteria are met: • if the intangible asset is part of a cash-generating unit, the assets and liabilities making up that unit have not changed significantly since the most recent recoverable amount calculation; • the most recent recoverable amount calculation resulted in an amount that exceeded the asset’s carrying amount by a substantial margin; and • considering events that have occurred since the most recent recoverable amount calculation, the likelihood that a current recoverable amount determination would be less than the asset’s carrying amount is remote. See IAS 36.24 c) False. Value in use includes the net cash flows from the use of the asset, as well as disposal of the asset at the end of its useful life. See IAS 36.31 & 39 The term ‘fair value less costs of disposal’ contains two terms: • fair value, which is determined in accordance with IFRS 13, where it is defined ‘as the price that would be received to sell an asset … in an orderly transaction between market participants at the measurement date.’ See IFRS 13.9 • ‘costs of disposal’, which are defined in IAS 36 as the ‘incremental costs directly attributable to the disposal of an asset or cash-generating unit, excluding finance costs and income tax expense’. See IAS 36.6 d) True. ‘Estimates of future cash flows shall not include estimated future cash inflows or outflows that are expected to arise from: • a future restructuring to which an entity is not yet committed; or • improving or enhancing the asset’s performance.’ IAS 36.44 e) True. When calculating value in use, we use a pre-tax discount rate to discount the future cash flows. See IAS 36.55 © Service & Kolitz, 2018

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Solutions to GAAP: Graded Questions

Impairment of assets

Solution 11.1 continued … f) False. The recoverable amount is C30 000. Explanation: • The recoverable amount is defined as the higher of an asset's value in use (C30 000) and its fair value less costs of disposal (C20 000). • Thus, the asset's recoverable amount is C30 000 (i.e. represented by its value in use). g) False. It is true that, at the end of each reporting period, an entity must assess whether there is an indication that an asset may be impaired. If any indication exists, the entity must estimate the recoverable amount of the asset. IAS 36.9 However, IAS 36 lists certain assets the recoverable amount of which must be calculated irrespective of whether there is an indication of an impairment (i.e. intangible assets with an indefinite useful life / not yet available for use and goodwill). See IAS 36.10 h) False. ‘An impairment loss on a non-revalued asset is recognised in profit or loss. However, an impairment loss on a revalued asset is recognised in other comprehensive income to the extent that the impairment loss does not exceed the amount in the revaluation surplus for that same asset. Such an impairment loss on a revalued asset reduces the revaluation surplus for that asset.’ IAS 36.61 i)

True. Disposal costs are defined as only those costs that ‘are incremental costs directly attributable to the disposal of an asset (or cash-generating unit), excluding finance costs and income tax expense’. IAS 36.6

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Solutions to GAAP: Graded Questions

Impairment of assets

Solution 11.1 continued … Part B a) With regard to an impairment indicator review, evidence of obsolescence or physical damage, plans to discontinue the operation to which an asset belongs and reassessing the useful life of an asset from indefinite to finite are examples of internal sources of information, while observable indications that the assets value has declined and increases in the market interest rate which will affect the discount rate used in calculating an asset’s value in use are examples of external sources of information. b) The recoverable amount is defined as the higher of the fair value less costs of disposal and the value in use. c) False. Estimates of future cash flows will not include future restructuring to which the entity is not committed; thus, if the entity is committed to future restructuring, we will include those cash flows. However, it is true that the estimate of future cash flows will never include improvements to an asset (i.e. we would not include them even if we had committed to them). See IAS 36.44 d) The five elements are: • Estimates of future cash flows that the entity expects to derive from the asset. • The expectations about possible variations in the timing or amount of future cash flows. • The time value of money, represented by the current market risk-free rate of interest. • The price for bearing the uncertainty that is inherent in the asset. • Other factors that market participants would reflect in pricing the future cash flows the entity expects to derive from the asset (e.g. illiquidity). See IAS 36.30 e) The discount rate used in the calculation of value in use will be a pre-tax, that reflects market assessments of time value of money and risks specific to the asset for which future cash flows have not been adjusted. See IAS 36.55 f) False Costs of disposal exclude any costs that have already been recognised as a liability. See IAS 36.28

g) False The impairment loss reversal will be recognised in profit or loss, except where the asset is measured at a revalued amount in terms of another IFRS, in which case, any reversal of an impairment loss will be accounted for as a revaluation increase in terms of that other IFRS (e.g. an increase of the carrying amount above the depreciated cost of an asset that is PPE measured under the revaluation model, is treated as a revaluation surplus (OCI)). See IAS 36.119

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Solutions to GAAP: Graded Questions

Impairment of assets

Solution 11.2 Situation 1 Debit CA:80 500 – RA:64 400 Impairment loss – PPE (E) Machine: accum. impairment loss (-A) Impairment of asset (cost model) in terms of IAS 36

Credit

16 100 16 100

Explanation: • An asset must be measured at the lower of its carrying amount (C80 500) and recoverable amount (C64 400). Situation 2 Debit Machine: accum. impairment loss (-A) Impairment loss reversal – PPE (I)

CA:72 450 – RA:96 600, limited to 80 500 depreciated cost

Credit

8 050 8 050

Impairment reversal of asset (cost model) in terms of IAS 36 Explanation: • As the asset's carrying amount (cost model) of the asset is less than its depreciated cost, it means that the asset had been impaired previously. • Now that the recoverable amount has subsequently increased, an impairment loss reversal is required. • However, because the asset is measured under the cost model, the carrying amount may not be increased above depreciated cost. Thus, since the recoverable amount was higher than the depreciated cost we need to be careful to limit the impairment loss. Situation 3 Debit Revaluation surplus Impairment loss – PPE (E)

CA:96 600 – Depreciated cost: 92 575 Depreciated cost: 92 575 – RA: 80 500

Credit

4 025 12 075

Machine: accum. impairment loss (-A) CA: 96 600 – RA: 80 500 Impairing an asset (revaluation model) in terms of IAS 36

16 100

Situation 4 Debit Machine: accum. impairment loss (-A)CA:72 450 – RA:96 600, limited Impairment loss reversal – PPE (I) Revaluation surplus (OCI)

to depreciated fair value of 84 525 CA:72 450 – RA:96 600, limited to depreciated cost of 80 500 Depreciated cost 80 500 – RA: 96 600, limited to depreciated fair value of 84 525

Credit

12 075 8 050 4 025

Reversing a previous impairment of an asset (revaluation model) in terms of IAS 36

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Solutions to GAAP: Graded Questions

Impairment of assets

Solution 11.2 continued … Explanation: • As the carrying amount (revaluation model) of the asset was previously impaired, any subsequent increase in the asset's recoverable amount would be processed as a reversal of the impairment (thus we debit the accumulated impairment loss). • When reversing an impairment, we never increase the carrying amount above the carrying amount that the asset would have had, had it not previously been impaired. In the case of a revaluation model, this would be the asset's depreciated fair value (C84 525). See IAS 36.117 • In this example, the RA was higher than the depreciated fair value, with the result that the impairment reversal was limited to C12 075 (CA: 72 450 – Depreciated FV: 84 525). • The increase in CA of C12 075:  up to depreciated cost of C80 500 would be recognised as income in P/L (C8 050) whereas;  above depreciated cost, limited to its depreciated fair value of C84 525, would be recognised in OCI (C4 025). See IAS 36.120 Situation 5 Debit 31 December 20X7 Machine: cost (A) Revaluation income (I) Revaluation surplus (OCI)

CA:72 450 – RA:96 600, limited to depreciated fair value of 84 525 CA:72 450 – RA:96 600, limited to depreciated cost of 80 500 Depreciated cost 80 500 – RA: 96 600, limited to depreciated fair value of 84 525

Credit

12 075 8 050 4 025

Reversing a previous revaluation decrease expense of an asset (revaluation model) in terms of IAS 36 Explanation: • The carrying amount of this asset (revaluation model) was lower than its depreciated cost, but it had decreased below its depreciated cost because of a devaluation and not because of a prior impairment. Thus, a subsequent increase in the carrying amount is recognised as a revaluation income (revaluation increase through P/L) rather than as an impairment loss reversal (there are no prior impairments losses to be reversed). • The recoverable amount is higher than the carrying amount, but we are using the revaluation model, so we may increase the carrying amount above its depreciated cost but we must be sure not to increase the carrying amount above its current fair value, or if the current fair value is not known, then its depreciated fair value (i.e. last known fair value less subsequent accumulated depreciation):  Any increase up to depreciated cost is recognised as a revaluation income in P/L;  Any increase above depreciated cost is recognised as a revaluation surplus in OCI.

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Solutions to GAAP: Graded Questions

Impairment of assets

Solution 11.3 a) Does IAS 36 Impairment of assets apply to this property The land is investment property measured under the cost model and thus is subject to IAS 36 Impairment of assets. The land was purchased with the intention of holding it for capital appreciation or development into a property that would earn rental income (thus meeting the definition of investment property) – rather than for use in the production or supply of goods or services, or for administrative purposes (which would have made it PPE), or for sale in the ordinary course of business (which would have made it inventory). This land is thus classified as investment property and accounted for in terms of IAS 40 Investment properties. See IAS 40.5 Although this land is accounted for as investment property in terms of IAS 40 Investment properties, it is measured under the cost model, and thus it must be tested for impairment in terms of IAS 36 Impairment of assets. If the land had been measured under IAS 40's fair value model instead it would not have been subject to IAS 36's impairment testing because the fair values would automatically reflect impairments in the value of the asset. b) Calculations The land's carrying amount presented in the SOFP is the lower of carrying amount (cost, in this example) and recoverable amount, as indicated in bold in the table below. Reporting date

Lower of Calculations/ explanations CA (Cost) and RA

31/12/X2

225 000

Impairment = None: CA C225 000 < RA C292 500 RA = higher of FV-COD: C292 500 & VIU: C247 500 = C292 500 CA (cost) = C225 000

31/12/X3

225 000

Impairment = None: CA C225 000 < RA C270 000 RA = higher of FV-COD: C202 500 & VIU: C270 000= C270 000 CA (cost) = C225 000

31/12/X4

202 500

Impairment loss = C22 500: CA C225 000 > RA C202 500 Thus IL = 225 000 – 202 500 = 22 500 RA = higher of FV-COD: C180 000 & VIU: C202 500= C202 500 CA (cost) = C225 000

31/12/X5

225 000

Impairment loss reversed = C22 500: CA C202 500 < RA C270 000, but since the CA is lower because of a prior impairment, the CA should now be increased to the RA. However, we are using the cost model, and thus we must lnot increase the CA above depreciated cost of C225 000, thus CA C202 500 < RA C270 000, limited to depreciated cost C225 000 Thus ILR = 202 500 – 225 000 = 22 500 RA = higher of FV-COD: C270 000 & VIU: C247 500= C270 000, but because we are using the cost model, we must limit this to depreciated cost of C225 000 CA (previous RA) = C202 500 Impairment of C22 500 is reversed

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Solutions to GAAP: Graded Questions

Impairment of assets

Solution 11.3 continued … c) Journals Debit 31 December 20X4 Impairment loss: land (E) Land: accum imp losses (-A) Impairment of land at the end of 20X4

See part (b)

31 December 20X5 See part (b) Land: accum imp losses (-A) Impairment loss reversal (I) Reversal of the impairment loss on land at the end of 20X5

Credit

22 500 22 500

22 500 22 500

d) Discussion regarding how to account for the situation in 20X6 Depending on whether or not the effect of the situation in June 20X6 is considered to be permanent determines how it would be accounted for: •

If the effect of the situation in June 20X6 is considered to be temporary (even if temporary means for a year or two), the land should simply be impaired to a nil residual value. The residual value is nil because:  its FV-CoD is nil, since it cannot be sold, and  its VIU is nil because it can no longer be redeveloped to earn rental income from shops and factories or even rented to farmers in its current form. If the situation subsequently reverses and the recoverable amount increases from nil, an impairment reversal can then be processed.

•

Property that is 'permanently withdrawn from use and no future economic benefits are expected from its disposal' must be derecognised. See IAS 40.66 Thus, if the effects of the situation in June 20X6 are considered to be permanent, the land should be impaired to nil (see explanation in the first bullet above) and then derecognised.

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Solutions to GAAP: Graded Questions

Impairment of assets

Solution 11.4 Jelly Bean Machine An impairment test is required to be performed when there is evidence, either internal or external to the business, which indicates that the asset may be impaired. The age of a machine itself is not an indicator of impairment, however, the fact that it had been purchased so many years ago together with the rapid advancement in technology may have meant that there was a risk of obsolescence. Thus, it was reasonable for Violet to have calculated the recoverable amount of the Jelly Bean Machine at the end of the last financial year on the basis of possible obsolescence rather than simply its age. The recoverable amount need only be assessed if there is evidence of a possible impairment. Furthermore, the concept of materiality should be applied when deciding whether the recoverable amount for this machine would need to be estimated at the end of the current year. In other words, ‘if previous calculations show that an asset’s recoverable amount is significantly greater than its carrying amount, the entity need not re-estimate the asset’s recoverable amount if no events have occurred that would eliminate that difference’ IAS 36.15 In this case: • • •

there is a previous calculation of the recoverable amount of the machine where the recoverable amount (value in use) was significantly greater than the carrying amount (the prior recoverable amount was double that of the carrying amount on that date); and there are no events that have occurred since this prior calculation to indicate that this difference would be eliminated (there has been no change in the market interest rate used to calculate the prior value in use and there is no evidence that demand for and thus future net cash inflows from the sale of beans has diminished in any way).

Thus, a calculation of recoverable amount is not necessary at the end of the current year. (The logic being that the carrying amount would have decreased due to depreciation and yet the value in use would still be relatively high). There would be no point in measuring the fair value less costs of disposal since the recoverable amount is the higher of value in use and fair value less costs of disposal and since the value in use is already expected to be higher than the carrying amount, even if the fair value less costs of disposal was lower than the carrying amount, the asset would not be impaired. Seriously Smart Sugar Sherbet Machine An asset only needs to be tested for impairment when an indication of impairment exists. The legal interdict preventing Willie Wonker from selling Seriously Smart Sugar Sherbet without labelling each packet thereof with a health warning, is an indicator of a possible impairment and thus the recoverable amount of this machine must be calculated. Since the legal interdict was a high-profile case, featuring in most newspapers, this legal interdict was public knowledge, and is thus an example of an external indicator of impairment. The negative impact that the legal interdict had on the sales of the sherbet, as evidenced by the rapid decrease from roughly 175 million units in 20X6 to 140 million units in 20X7, and the fact that management expects that this drop in demand is unlikely to recover, is a further indication of a possible impairment This internal sales data (comparing actual and forecast sales) and management expectations as to the forecast sales in future, is an example of an internal indicator of a possible impairment.

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Solutions to GAAP: Graded Questions

Impairment of assets

Solution 11.4 continued ... Brain-boosting Bar Recipe Although no impairment indicator exists, an intangible asset which has not been brought into use is required to be tested for impairment annually. It would therefore be necessary to calculate the recoverable amount for the recipe. The recoverable amount of an intangible asset not yet available ...