Impairment Test In Accounting

Concept of Impairment Test

Discuss about the Accounting Finance Standard and Practices.

Impairment test analyses whether the items from balance sheet are worth the stated amount in the balance sheet. The amount in the balance sheet shall be reduced if impairment test signifies lower value. The testing for impairment can be applied for tax accounts as well as commercial that is audit accounts (Guthrie and Pang 2013). Impairment is the accounting principle that states permanent reduction of the value of company’s assets, generally the fixed assets. While the test for impairment is carried out, total profit, other benefits and cash flow that are expected to be created from particular asset are compared periodically with the book value of the assets (Bepari, Rahman and Mollik 2014).

While determining the assets recoverable amount in absence of the quoted market price, the estimates are made for the present value of the future tax cash flows. The estimates need considerable management judgements and the judgements are subject to uncertainty and risk that are beyond the company’s control (Bond, Govendir and Wells 2016). Therefore, possibilities are there that the changes in the circumstances will alter the projections materially that may impact the asset’s recoverable amount at the reporting date. Further, the projections are made from the judgement of market participant that includes volumes for future production, prices, tax attributes, discount rates and operating costs.

For the year ended 30^th June 2017, BHP Billiton charged US$ 193 million under impairment. Out of total US$ 193 million, charges for impairment for various assets are as follows –

• Petroleum sector – US$ 102 million
• Copper sector – US$ 14 million
• Iron ore – US$ 52 million
• Coal sector – US$ 20 million
• Group and unallocated items or eliminations – US$ 5 million

Further, out of total impairment of US$ 193 million, US$ 160 million was charged against the plant, property and equipment and balance US$ 33 million was charged against goodwill and other intangible assets. 

Tests for impairment are carried out yearly for goodwill. Apart from this, the impairment test for all the assets are carried out while any indication is there for impairment. If carrying amount of asset is more than the recoverable amount then the assets is impaired. Thereafter the amount of impairment loss is charged against the income statement for reducing the carrying amount in balance sheet to the recoverable amount (BHP 2018). Further, the assets which are previously impaired except the goodwill are reviewed if there is any chance for reversal of impairment at every reporting date. However, the reversal amount of impairment cannot be more than the carrying amount that would have been computed if no impairment loss was recognised for the assets under cash generating unit. For the year ended 30^th June 2017 there was no reversal for impairment.

Determining Recoverable Amount of Assets

Recoverable amount of any asset is higher among the fair value of asset reduced by disposal cost and the value in use. For assessing the impairment, the assets are grouped at lowest levels for which separately the cash flows separately (BHP 2018).

Fair value reduced by disposal cost – it is the estimate of the amount that the market participants are ready to pay for the assets or the cash generating unit reduced by disposal cost.

Value in use – it is computed as present value of projected future cash flows that is expected to be generated from continuous use of asset in the present form and the eventual disposal.

Assets values are under microscope as the market scenario is challenging. Further managing the investor’s trust with regard to transparency and accurateness of the asset’s value is crucial. However, the regulators and the investors are continuously concerned for the asset’s recoverability under the uncertain market (Khokan Bepari, Rahman and Taher Mollik 2014). In such scenario, the robust testing for impairment is critical. Further, as 20% of the ASX listed companies are valued by market reduced by book value of the assets, disconnect among the management valuation and investors perceptions are clear.  Apart from this, the main issues in impairment testing are as follows –

• CGU and segments – the most important issue in impairment testing is the selection of level at which the test shall be carried out. The answer to this issue will depend on asset’s testing and dependency on other assets for generating cash inflows. If the asset requires other assets under the value chain for supporting their carrying amount then it shall be tested with other smallest group of asset for impairment. Further, the method of allocation may be inappropriate if the non-performing assets are recognized along with other assets those are successful for the business.
• Difference among value in use and fair value – Understanding the difference among value in use and fair value is crucial. Value in use includes the economies of scale and synergies specific to the business. On the other hand, fair value of the asset includes risk, cost and benefits of improvements or restructuring of the assets that are not included in the balance sheet. However, forecasts of costs and the benefits are not always reasonable. Further, the assumptions regarding the synergies and restructuring are not always correct (Kabir and Rahman 2016).
• Using appropriate rate of discount – most of the companies use CAPM and WACC to determine the discount rates for the purpose of computing the value in use. However, practically different CGU uses different discount rates owing to difference in currency risk, country risk, market maturity and the product risk.
• Tax – tax is the added source of complexity for impairment testing. The common mistake is including the inconsistent assumptions for tax in the model. The company may discount the cash flows (pre-tax) wrongly through using the post tax discount rate (Linnenluecke et al. 2015). If post tax discount rate is applied, the post tax cash flows are also required to be assumed other wise 30% will be added up to the cash flows effectively. Apart from this, another common mistake is including the benefits of previous year’s looses on account of tax under the value in use method.

• Impairment losses amount that is recognized under the profit and loss account and line items under the statement of the comprehensive income where the impairment losses are recognized.
• Impairment loss amount on the revalued assets that is recognized under the comprehensive income for the period
• Amount for impairment loss reversal recognized under the profit or loss account and line items under the comprehensive income statement under which the impairment losses are reversed.
• Amount for impairment loss reversal recognised in other comprehensive income

It was found that BHP Billiton for the year ended 30^th June 2017 disclosed impairment test as per the requirements of AASB 136 on Impairment test. The company disclosed the details of impairment test through note no. 12. It stated the details of the measurement and recognition criteria, calculation of recoverable amount and details of the assets that were impaired along with the values (Legislation.gov.au 2018). 

As per the requirement of general purpose financial reporting the company disclosed various segments for which the impairment losses have been recognised. Further, it stated that there was no reversal of impairment for the year ended 30^th June 2017 (Ji 2013). The company also disclosed the individual goodwill or CGU for which the impairment loss have been recognized. However, it did not mention the circumstances or events that led to reversal or recognition of impairment loss. For better transparency the company should have stated the reason that led to impairment.

References

Bepari, M.K., Rahman, S.F. and Mollik, A.T., 2014. Firms’ compliance with the disclosure requirements of IFRS for goodwill impairment testing: Effect of the global financial crisis and other firm characteristics. Journal of Accounting and Organizational Change, 10(1), pp.116-149.

BHP., 2018. BHP Billiton | A leading global resources company. [online] Available at: https://www.bhp.com/ [Accessed 22 Apr. 2018].

Bond, D., Govendir, B. and Wells, P., 2016. An evaluation of asset impairments by Australian firms and whether they were impacted by AASB 136. Accounting & Finance, 56(1), pp.259-288.

Guthrie, J. and Pang, T.T., 2013. Disclosure of Goodwill Impairment under AASB 136 from 2005–2010. Australian Accounting Review, 23(3), pp.216-231.

Ji, K., 2013. Better late than never, the timing of goodwill impairment testing in Australia. Australian Accounting Review, 23(4), pp.369-379.

Kabir, H. and Rahman, A., 2016. The role of corporate governance in accounting discretion under IFRS: Goodwill impairment in Australia. Journal of Contemporary Accounting & Economics, 12(3), pp.290-308.

Khokan Bepari, M., F. Rahman, S. and Taher Mollik, A., 2014. Firms’ compliance with the disclosure requirements of IFRS for goodwill impairment testing: Effect of the global financial crisis and other firm characteristics. Journal of Accounting & Organizational Change, 10(1), pp.116-149.

Legislation.gov.au., 2018. AASB 136 – Impairment of Assets – August 2015. [online] Available at: https://www.legislation.gov.au/Details/F2017C00297 [Accessed 22 Apr. 2018].

Linnenluecke, M.K., Birt, J., Lyon, J. and Sidhu, B.K., 2015. Planetary boundaries: implications for asset impairment. Accounting & Finance, 55(4), pp.911-929.