Discuss about the Interpretation Loss and Application.
The aim of this essay is to provide a brief understanding about Impairment loss in context of accounting. It also describes the nature of impairment loss along with its accounting treatment. The essay contains two parts. One is the theory part and another one is practical application of the theory. International Accounting Standard 36 ‘Impairment of Assets’ deals with impaired assets of a company and the key requirements of the standard regarding impairment have also been discussed in the essay. Procedures applied by a company for determining impaired assets value is also discussed in the essay. Finally, the essay concludes with identifying required disclosures in relation to impairment of assets.
The term ‘impairment’ refers to the permanent reduction in the market value of a company’s fixed asset and goodwill. It indicates an unexpected decline in an asset’s value below its carrying amount. Impairment loss occurs when the difference between fair value and recorded value of an asset becomes unrecoverable (Glaum et al., 2013). Fair value refers to the amount that is received on selling an asset or paid to transfer a liability during an ordinary course of transaction at the current price. Book value refers to the value at which an asset is recorded in a company’s balance sheet after taking accumulated depreciation and impairment loss into account. Impairment loss is generally associated with long-lived assets like buildings, land, machinery, and equipment of a company.
The issues related to impairment of assets are governed by International Accounting Standard (IAS) 36. As per this standard, impairment is caused to an asset when the amount that could be recovered from its sale or use exceeds its recorded value (Jordan et al., 2015). In such a case, the impaired asset is deemed to have lost its value. IAS 36 is applied to all those assets which are recorded at their costs or revalued amounts in accordance with other applicable accounting standards. Also AASB 136 contains specific requirements to allocate the impairment losses arising in relation to CGU (Cash-generating unit).
As per the principles of IAS 36, a company must not carry its assets at a value more than its recoverable amount. The decline in the value of a company’s assets can occur due to various reasons like wear and tear, poor management of assets, increased competition, and technological advancements (Harris et al., 2014). IAS 36 provides a set of procedures for the companies to recognize impairment loss of an asset as an expense in profit and loss account and credited to the asset. The loss decreases the income in profit and loss account and also the total assets in balance sheet.
However, when an impaired asset is revalued under IAS 16 and IAS 38 then such impairment loss is considered as a revaluation reduction, decreasing the revaluation gain for the asset (Lavi, 2016). It is then recognized in comprehensive income statement. If the amount of impairment loss is higher than the revaluation gain then the remaining loss is recorded as an expense in the income statement of the company. An impairment loss is recognized only when book value of assets is higher than their recoverable value.
Intangible assets, having indefinite useful lives and, intangibles which are not yet available for use are statutorily required to be tested annually for determining their impaired value (Christian, and Lüdenbach, 2013). Also, Goodwill acquired in a business combination must undergo through impaired test. The IAS 36 permits companies to perform impairment test at any time during an annual period, provided that every year, the test should be performed at the same time.
The impairment cost can be computed by using two methods. First one is Incurred loss model and the second one is expected loss model.
Under this model, investments of a company are recorded in P&L account as impaired assets; if it is deemed that collection of future cash flows associated with the investments are uncertain (Avallone and Quagli, 2015). Such an uncertainty may occur when the company is growing through financial crisis or the company has failed fulfil its principle obligations or interest thereon. It may also occur when the company is experiencing unfavourable economic changes. In such circumstances, the company needs to determine recoverable amount of its impaired investments. After then, impairment cost of investments is calculated as follows:
Impairments cost = Recoverable amount – Carrying value
Expected Loss Model:
Under this model, present value of investments is assessed using estimates of future cash flows, made on continuous basis. These revised estimates are discounted at the same effective rate of interest which was used at the time of purchase of investments.
Indications of impaired assets:
External sources of information:
External sources signify that an asset has impaired. These sources include significant fall in the market value of an asset, unfavourable changes in technology, economic and market conditions, laws and regulations, and rise in interest rates and rates of return.
Internal sources indicating impairment of assets include obsolescence or physical damage to an asset, idleness of asset, disposal or restructuring of asset and worse economic performance of an asset.
In case of investments in subsidiaries, jointly controlled entity or associates, the book value of investee’s net assets is lower than the carrying value of assets (Ballas et al., 2015). Also the comprehensive income of the investee is lower than the amount of dividend declared.
Moreover, the indication of asset being impaired depicts that the company should review or adjust useful life, depreciation method or residual value of the asset.
Sometimes, non-existence or decrease in recognized impairment loss, except goodwill may be indicated by external and internal sources of information. In such circumstances, the impairment loss which was recorded earlier in the P&L account is reversed (Stice and Stice, 2011). However, reversal of impairment loss is allowed only when, there is a change in any one of the estimates employed to assess the asset’s recoverable price. It means that a company cannot reverse impairment loss of its assets merely due to passing of time or advancement in the general market conditions.
In US GAAP, impairment loss for long-lasting assets that was previously recognized cannot be reversed. Also, reversal of impairment losses for goodwill is specifically not allowed by IAS 36 (Majid and Adam, 2015). Reversal of Impairment losses are always recognized in profit and loss account of a company. In addition to this, adjustment of depreciation for future periods is also required in order to reflect revised carrying amount of an asset.
In case of cash-generating unit, allocation of reversal of impairment losses to an asset of the unit, other than goodwill, is made (Zhuang, 2016). Such an allocation is made with the carrying amount of these assets on pro-rata basis. However, recorded amount of an asset shall not exceed above the lower of its recoverable amount and the recordable amount before taking into account any impairment loss.
Assets which do not require Impairment test:
Inventories, Deferred Tax Assets and assets held for resale are not required to undergo Impairment test, as specified by IAS 36.
Disclosures
Disclosures regarding impairment tests performed and recognition of impairments by a company are required as per International Accounting Standard 36 (Epstein and Jermakowicz, 2010). Disclosure requirements for impairment loss of Goodwill are vast than that of other assets. The important disclosure requirements are as follows:
Amount of Impairment losses recognized in the profit and loss account of a company along with the amount by which impairment loss was reversed are required to be disclosed.
Disclosure of events and circumstances that have led to the impairment loss of assets of the company is required to be disclosed.
Description and amount of impairment loss of cash-generating unit is also required to be disclosed.
Disclosures regarding the valuation method used to estimate recoverable amount and the key assumptions applied in determining the appropriate valuation method is also required.
Calculation of Impairment Loss:
= Carrying Amount – Recoverable Amount
=$(171,000 + 180,000 + 160,000 + 700,000 + 400,000 + 40,000) – $1420, 000
= $1651, 000 – $1420, 000
=$231,000
Remaining Impairment loss = $ 231,000 – $40,000
= $191,000
Allocation of Impairment loss against all assets:
|
Carrying Amount (1) |
Pro-rata (2) |
Impairment loss allocated (3) |
Adjusted carrying amount (1-3) |
|
|
Goodwill |
40,000 |
40,000 |
0 |
|
|
Land |
200,000 |
29,000 |
171,000 |
|
|
Inventory products |
180,000 |
18*191,000/144 |
23875 |
156125 |
|
Brand ‘Crossbow Shoes’ |
160,000 |
16*191,000/144 |
21222 |
138778 |
|
Shoe factory |
700,000 |
70*191,000/144 |
92847 |
607153 |
|
Machinery for manufacturing shoes |
400,000 |
40*191,000/144 |
53056 |
346994 |
|
144,0000 |
191000 |
1420,000 |
Journal Entries: Amount ($) Amount ($)
Dr. Impairment loss 260,000
Cr. Goodwill 40,000
Cr. Land 29000
Cr. Impairment loss- Inventory products 23875
Cr. Impairment loss- Brand ‘Crossbow Shoes’ 21222
Cr. Impairment loss- Shoe factory 92847
Cr. Impairment loss- Machinery for manufacturing shoes 53056
Since the asset goodwill can arise only in business combination and cannot be separately recognized, therefore, FV – CD for goodwill cannot be determined (Detzen, et al., 2015). Also, AASB 136 specifies that goodwill must be allocated to the lower level at which company evaluates the goodwill.
Also, where recorded value of asset is greater than recoverable value, it is equals to impairment loss.
If impairment loss is occurred in a CGU in case of goodwill, following allocation principles shall be applied:
Decrease the recorded value of CGU’s goodwill, to zero.
Other assets of the CGU should be allocated on a pro-rata basis (Majid and Adam, 2015).
Crossbow Ltd. has identified an impairment loss of $231,000. The remaining impairment loss is calculated as $191,000.
Conclusion
From the above discussions and practical application, it is concluded that Impairments are an essential component of the Financial Reporting process. Determination of impairment loss of a company’s asset may become a complex and time-consuming process, but still the company’s owners need to assess impairment loss of their assets, which have lost their value. It is also concluded that the finance team of a company must possess required skills and knowledge in order to select most appropriate approach and method for valuation of assets. Also, the top management of the company should also provide support and guidance while adopting the valuation process so as to fulfil the IAS 36 requirements.
References
Avallone, F. and Quagli, A., (2015) Insight into the variables used to manage the goodwill impairment test under IAS 36. Advances in Accounting, 31(1), pp.107-114.
Ballas, A., Panagiotou, V. and Tzovas, C., (2015) Accounting Choices for Tangible Assets: A Study of Greek Firms. SPOUDAI-Journal of Economics and Business, 64(4), pp.18-38.
Christian, D. and Lüdenbach, N. (2013) IFRS Essentials. US: John Wiley & Sons.
Epstein, B. and Jermakowicz, E. (2010) WILEY Interpretation and Application of International Financial Reporting. US: John Wiley & Sons.
Glaum, M., Schmidt, P., Street, D.L. and Vogel, S., (2013) Compliance with IFRS 3-and IAS 36-required disclosures across 17 European countries: company-and country-level determinants. Accounting and business research,43(3), pp.163-204.
Harris, P., Jermakowicz, E.K. and Epstein, B.J., (2014) Converting Financial Statements from US GAAP to IFRS. The CPA Journal, 84(1), p.20.
Jordan, C.E. and Clark, S.J., (2015) Do Canadian Companies Employ Big Bath Accounting When Recording Goodwill Impairment?. International Journal of Economics and Finance, 7(9), p.159.
Lavi, M. (2016) The Impact of IFRS on Industry. US: John Wiley & Sons.
Stice, E and Stice, J. (2011) Intermediate Accounting. US: Cengage Learning.
Zhuang, Z., (2016) Discussion of ‘An evaluation of asset impairments by Australian firms and whether they were impacted by AASB 136’. Accounting & Finance, 56(1), pp.289-294.
Detzen, D., Wersborg, T.S.G. and Zülch, H., (2015) Bleak Weather for Sun-Shine AG: A Case Study of Impairment of Assets. Issues in Accounting Education, 30(2), pp.18-39.
Majid, J.A. and Adam, N.C., (2015) Resistance to Institutional Change through Decoupling. Mediterranean Journal of Social Sciences, 6(4), p.531.
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