Corporate Accounting And Reporting For Economics And Business

Impairment Test for Goodwill and Intangible Asset

Discuss about the Corporate Accounting and Reporting for Economics and Business.

AASB 36 on impairment of asset ensures that the asset of a company must not carried at greater than the recoverable amount. The recoverable amount is taken as the value obtained by deducting the disposal cost from the fair value and value in use, whichever is higher. One exception to the general rule of impairment is that for intangible assets and goodwill, companies are required to conduct the test for impairment annually, if there is a signal of impairment of asset. The test can also be carried out for cash generating unit that are not generating cash on regular basis.

The main purpose of impairment test is as follows:

To find out whether there is any signal of impairment, the recoverable amount for any asset and identification of any cash generating unit

To find out the recoverable amount for intangible asset, goodwill with their useful life and requirement of measuring the asset with regard to impairment whether any indication exist or not (Bond, Govendir and Wells 2016)

Impairment test for existence of goodwill are carried out as follows:

Goodwill requires the test for impairment annually, even if there is no indication for impairment. The requirement is to ensure that the goodwill obtained by the business is allocated to cash generating unit base on the proper method of allocation. When any cash generating unit is disposed, then the allocated goodwill to that unit will be re-allocated over the other units and again the test for impairment will be carried out. The impairment test of cash generating unit to which the goodwill are allocated can be done at during any time of the year and the test have to be done at the same time of each year. Various cash generating unit can be tested in different times. However, if any cash generating unit to which the total goodwill or part of goodwill has been allocated are sold or acquired by in business combination process in the present year, that unit must be tested before the closing of annual period. AASB 136 allows the latest calculation for the previous year for the calculation of recoverable amount of any cash generating unit on which goodwill is allocated for using in the test in current year, if the requirements are met (Laing and Perrin 2014).

Entry for goodwill impairment will be as follows:

Steps in Applying Impairment Test

Impairment of goodwill a/c debit                            xxx

To accumulated impairment for goodwill                         xxx

Profit and loss a/c debit                                          xxx

To goodwill impairment                                                       xxx 

Steps in applying impairment test are as follows:

Identifying the asset for impairment:  At the end of every closing period, the company must assess the indication of impairment for the asset. If there is any signal for impairment, the asset’s recoverable amount must be estimated.  Intangible assets should be tested for impairment on annual basis even if there is no indication of impairment. If the indication of impairment exists for any particular asset, then the recoverable amount of that asset must be calculated (Khokan Bepari, Rahman and Taher Mollik 2014). If the estimation is not feasible, then the asset’s cash generating unit’s recoverable amount shall be measured. The cash generating unit is the least group for identifiable asset that create inflow of cash, which are not dependent on the cash inflow of other asset group. 

Calculation of recoverable amount: The recoverable amount for a unit generating cash or for an asset is the higher among the two: (a) value in use (b) fair value less disposable cost. If any of these two costs is more than the carrying value of the asset, then the estimation of other value is not required as the asset is not under the process of impairment. Fair value is the expected revenue from the sale of the unit generating cash or the asset. Whereas, disposal cost include the cost directly dedicated to the cash-generating unit or asset. Disposal cost does not include expenses for income tax and finance cost (Zhuang 2016).  

Fair value is the net present value of the expected future cash inflows to be obtained from the asset or unit. The elements that should be taken into consideration while calculating value in use are – Expected future cash flows, probable alteration in the estimated time or amount of the future cash flows, calculation of time value of money with regard to the risk free interest rate in the market, cost of bearing the inherent risk of uncertainty, any other factors, such as, participants in the market, liquidity that can affect the future flow of cash

Recognition and measurement of impairment loss: only if the carrying amount of any asset is more than its recoverable amount, then only the carrying amount should be revaluated and recognised at recoverable amount. The difference then is known as the impairment loss. The amount of impairment loss shall immediately be recognized in the income statement. The general exception to this rule is that the asset is carried out at revalued amount as per any other standard (D’Arcy and Tarca 2016). Then the loss from impairment will be treated as revaluation loss and not as impairment loss (Kabir and Rahman 2016).  However, the carrying amount should not be reduced below the higher of the following: (a) Fair value less disposable cost, if measurable (b) Value in use, if measurable (c) Zero

Recognition and Measurement of Impairment Loss

Reversing the impairment loss: Impairment loss identified in the past period must be recognized in the income statement immediately, except the goodwill. Impairment loss shall be reversed through allocation to the other asset of the cash generating unit on a pro-rata basis except the goodwill (Barch, Treadway and Schoen 2014). The increased carrying amount for the asset attributable upon the reversal of impairment must not be more than the carrying value that would have been calculated, if no impairment had taken place. Impairment loss for goodwill are not reversible in the future period (Khodashenas et al. 2015). 

Calculation of impairment loss will be as follows:

Carrying amount of the asset = $16,80,000

Recoverable amount               = $14,20,000

Impairment loss                        = $2,60,000

Loss from impairment will fisrt be used to write off the goodwill amounted to $40,000.

Balance loss amounted to ($260,000 – $40,000) = $ 220,000 will be allocated to other assets except the inventory. It is assumed that inventory is recorded at lower of realisable value and cost.

Asset	Carrying amount	proportion	Allocation of loss	Net carrying amount
Land	$ 171,000	171/1431	$26,290	$144,710
Brand	$ 160,000	160/1431	$24,598	$135,402
Shoe factory	$ 700,000	700/1431	$107,617	$592,383
Machinery	$ 400,000	400/1431	$61,495	$338,505
Total	$14,31,000		$220,000

Table 1: Allocation of impairment loss

(Source: Created by author)

Journal entries for impairment loss will be as follows;

Impairment loss                                Dr        $260,000

Goodwill                                            Cr                                $40,000

Land                                                   Cr                                $26,290

Brand – Crossbow shoes               Cr                                $24,598

Shoe factory                                     Cr                                $107,617

Machinery for manufacturing        Cr                                $61,495

[Being the loss from impairment allocated]

References:

Barch, D.M., Treadway, M.T. and Schoen, N., 2014. Effort, anhedonia, and function in schizophrenia: reduced effort allocation predicts amotivation and functional impairment. Journal of abnormal psychology, 123(2), p.387.

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.

D’Arcy, A. and Tarca, A., 2016. Reviewing goodwill accounting research: What do we really know about IFRS 3 and IAS 36 implementation effects. Working paper). Vienna University of Economics and Business.

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.

Khodashenas, P.S., Rivas-Moscoso, J.M., Klonidis, D., Thouénon, G., Betoule, C. and Tomkos, I., 2015, September. Impairment-aware resource allocation over flexi-grid network with all-optical add/drop capability. In Optical Communication (ECOC), 2015 European Conference on (pp. 1-3). IEEE.

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.

Laing, G.K. and Perrin, R.W., 2014. Deconstructing an accounting paradigm shift: AASB 116 non-current asset measurement models. International Journal of Critical Accounting, 6(5-6), pp.509-519.

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.