Business Impairment Loss For Business Accounting Impairment

Part A

Describe about the Business Impairment Loss for Business Accounting Impairment.

Before we understand the standard that narrates about the accounting for impairment loss and the relevant disclosure requirements what is important to understand is the meaning of the word ‘Impairment’ first. When there is devaluation in the value of any asset it is termed as impairment. The said concept is covered under IAS 36 of the International Accounting Standard and AASB 136 of the Australian Accounting Standard. However the meaning and the accounting is same. The said standard gained importance off lately around a decade ago specifically after the global financial crisis which took place due to incorrect reporting of the assets by various companies (accaglobal.com, 2014).

At the end of each accounting period every entity as per IAS 36 is required to conduct an impairment test of all its assets mentioned in the balance sheet except for the following:

Inventories – IAS 2

Construction Contract – IAS 11

Deferred Tax Asset- IAS 12

Employee Benefits- IAS 19

Financial Assets – IAS 39

Investment properties held at fair value – IAS 40

Agricultural assets held at fair value- IAS 41

Insurance contracts- IFRS 4

Non-Current Assets held for sale- IFRS 5

After identifying which assets have undergone impairment i.e. the carrying amount is greater than the recoverable amount of the asset then the difference between the two is recorded as an impairment loss. Double entry for the same is done as per the accounting standard. Firstly the amount of impairment is treated as an operational expense and the said amount is deducted from the respective asset as ‘accumulated impairment loss’

Whether an asset has been impaired or not can be understood by conducting an impairment test. This test comprises of various factors- external and internal. The external factors which enable one to conclude that an asset has been impaired are as under:

If the market value of an asset has deteriorated considerably.

If the market interest rate has increased to such an extent so as to give a negative impact of the same.

An unfavourable change in the legal, political or economic scenario.

The net asset value of a company is greater than its market capitalisation

The factors internal to the asset are as under:

If the asset has become obsolescent.

If the asset is held for sale or disposal.

If the company’s performance has deteriorated considerably (Thornton,2014).

Impairment Meaning and Standard

However if the management feels that the asset should be impaired after conducting due tests then it is very important and necessary to revisit the useful life of the asset, the depreciation method to be used and the residual or the salvage value of the asset.

After all tests, the company should find out what is the expected amount of an asset that can be recovered. However if the individual recoverable amount per asset is not possible then the recoverable amount of the cash generating unit to which such an asset belongs should be calculated.  A cash generating unit is basically a group of assets of a company which is capable of producing cash flows for the company independently.

It is therefore very important to understand the calculations for finding out the recoverable amount of the asset. It is the higher of the far value of the asset less the cost of selling the same or the value in use of the asset i.e. the net present value of the future cash flows that is expected to be generated from the asset. The discount rate that is used while calculating the NPV is the current market risk free interest rate (pwc.com, 2014).

It is very important to understand that once an asset gets impaired it can always be reversed. If on conducting the impairment test it is understood that the value of an asset that was previously impaired no more exists then the impairment loss can be reversed but for goodwill. Thus the value of all assets which has been impaired can be reversed but the value of goodwill once impaired can never be reinstated. If the value of the cash generating unit is to be reversed even then the value of all assets can be subject to such reversal but for goodwill. The reversal cannot exceed the carrying amount of an asset that would have been had the asset not been impaired previously after deducting requisite depreciation from it. The accounting entries for such reversal is a revaluation increase in the profit and loss account and the said amount si added back to the respective asset (ifrs.org., 2014).

The standard also specifies the disclosure norms for such impairment. They are enumerated as under:

The below mentioned detail should be mentioned for each class of the asset:

The impairment loss that has been recorded in the profit and loss account and the line item(s) of the statement of comprehensive income in which the impairment loss is recorded.

Identification of Impairment

The impairment loss reversed and recorded in the income statement of the company and the line item(s) of the statement of comprehensive income in which the impairment loss reversal is recorded.

The value of the loss due to impairment of revalued assets which are recognized in the other comprehensive income during the period.

The value of the amount of impairment reversed of the revalued assets which is recognized in the other comprehensive income during the period (iasplus.com, 2014).

In case the company does segmental reporting then the following is required to be disclosed with regards impairment.

The impairment loss which is recorded in the income statement and in the equity during the accounting period.

The impairment loss amount which is reversed and recorded in the income statement and in the equity during the accounting period.

Every company is required to disclose the following in case the impairment is of a material nature of an asset or a CGU including goodwill.

The factors both internal and external that led to the recognition or reversal of impairment.

The amount by which the asset is being impaired or the loss being reversed.

For single assets the entity is required to disclose the nature of the asset and in case it does segmental reporting as per IFRS 8, then the segment to which the impaired asset belongs to is also required to be mentioned in the disclosures of the said standard.

For a cash generating unit being impaired, disclosures with regards the nature of the CGU and the amount of impairment recognized or reversed of the assets in the CGU (Ec.europa.eu, 2010).

Thus on a concluding note, it is very important to conduct impairment tests periodically so as to portray a true picture of the assets of the company to the investors and its customers. It is critical to disclose the same in the notes to the financial statements so that the users of the annual report can understand the data about impairment without much ambiguity involved.

In the said case study first and foremost inventory is the only asset which is not subject to impairment and is covered under the standard IAS 2. Thus the assets which would be impaired are goodwill, shoe factory, and machinery for manufacturing of the shoes. However the brand ‘Crossbow Shoes ‘ will not subjected to any impairment as the company has simply shifted its mode of selling to online which is a clear indication fot he fact that the said asset is not subject to impairment.

First and foremost is land. Land is one such asset whose impaired amount is known separately. The total financial position of the entity as on the date of reporting is $1680000 and the recoverable amount is $1420000. Thus it is clear since the recoverable amount is lesser than the carrying amount hence the assets are subject to impairment. The total impairment is $1680000- $1420000 = $260000. Now since the recoverable amount of the land is known separately i.e. $171000, hence the impairment loss of land is $200000- $171000 = $29000.

The journal entry for the same is

Profit and Loss Account (loss on impairment) Dr……………$29000

To accumulated impairment loss (Land)………………………………………..$29000

Next, as per IAS 36, since the recoverable amount of the other individual assets is not known hence first and foremost the goodwill will be impaired to the full. After the same the rest of the assets will be reduced on a prorate basis (ey.com, 2014). Thus the remaining amount of impairment after allocation of $29000 to land is $231000 ($260000 – $29000), of which $40000 is allocated to goodwill and $191000 is allocated to the factory and the machinery in the ratio of 7:4. Thus the impairment loss for factory is 7/11*191000 = $121545 and for machinery is 4/11*191000= $69455.

The Journal Entries for the same is :

Profit and Loss Account (loss on impairment) Dr……………..$231000

To goodwill A/c………………………………………………………………………….$40000

To accumulated impairment loss (Shoe Factory)A/c………………………$121545

To accumulated impairment loss (machinery) A/c…………………………..$69455 

References:

accaglobal.com, (2014), IAS 36 Impairment of Assets, Available at https://www.accaglobal.com/in/en/discover/cpd-articles/corporate-reporting/ias36-impairment.html (Accessed 19th September 2016)

Ec.europa.eu, (2010), International Accounting Standard 36- Impairment of Assets, Available at https://ec.europa.eu/internal_market/accounting/docs/consolidated/ias36_en.pdf (Accessed 19th September 2016)

ey.com, (2014), Impairment Accounting – the basics of IAS 36 , Impairment of Assets, Available at https://www.ey.com/Publication/vwLUAssets/Impairment_accounting_the_basics_of_IAS_36_Impairment_of_Assets/$FILE/Impairment_accounting_IAS_36.pdf (Accessed 19th September 2016)

iasplus.com, (2014), IAS 36 – Impairment of Assets, Available at https://www.iasplus.com/en/standards/ias/ias36 (Accessed 19th September 2016)

ifrs.org., (2014), IAS 36- Impairment of Assets, Available at https://www.ifrs.org/IFRSs/Documents/Technical-summaries-2014/IAS%2036.pdf (Accessed 19^th September 2016)

pwc.com, (2014), Making Sense of a complex world- IAS 36 Impairment of Assets, Available at https://www.pwc.com/gx/en/communications/pdf/ias36_impairment_of_assets_final.pdf (Accessed 19th September 2016)

Thornton, G., (2014), Impairment of Assets- A Guide to applying IAS 36 in practice, Available at file:///C:/Users/E-ZONE/Downloads/IAS%2036%20Impairment%20of%20Assets%20-%20A%20guide%20to%20applying%20IAS%2036%20in%20practice.pdf (Accessed 19^th September 2016)