Impairment Loss And New Lease Standard: Foster’s Group Case Study

Impairment Loss Accounting

Impairment loss is the loss taken place due to reduction in the carrying amount of the asset as compared to its market value. Impairment is carried out for both intangible assets like goodwill, brand names, patents and the tangible assets like plant, equipment, property land and building (Bond, Govendir and Wells 2016). The loss owing to impairment loss is accounted for under the current year’s income statement. Further, the asset will be recorded in the balance sheet at the revised value that is at the value after adjusting the impairment loss (M Carlin, Finch and Manh 2014). 

Various tangible as well as intangible assets were considered for impairment test by Foster’s Group. The intangible assets are –

• Licence and brand names
• IT development cost
• Goodwill

The intangible assets were not amortised but they were considered for impairment test once in each year or more frequently when any indication is there or any event indicates that the asset may get impaired. After impairment, the assets are carried over at cost less the value of impairment loss.

The tangible assets considered for impairment are as follows –

• Land
• Leasehold buildings
• Freehold buildings
• Plant and the equipment

At each of the reporting date the company analyses whether any indication is there that any asset may get impaired. If any indication is there for impairment or when the annual impairment testing is needed, the company makes the formal assessment for the recoverable amount (Amel-Zadeh, Faasse and Meeks 2016). When the carrying amount of the asset exceeds the value of recoverable amount then the asset is accounted as impaired and then the asset is written down to the recoverable amount. Recoverable amount of the asset is greater among the fair value less selling expenses and the value in use. The procedure is carried on for each asset unless the value in use of particular asset cannot be determined. In such cases, the cash generating units (CGU) value in use is calculated under which the asset belongs. For the purpose of computation of value in use, the projected cash flows are discounted to bring them at present value. Pre-tax rate for discount is used for discounting the assets. Losses with regard to impairment are accounted for in the current year’s income statement. Further, the previously recognized loss for impairment is reverse if only any changes in the estimates had been made for determining the asset’s value. However, the impairment losses recognised under goodwill are not allowed to be reversed.  

Impairment Test Conducted by Foster’s Group Ltd

For the year ended 2011, Foster’s Group Limited recorded the following under impairment expenditures –

Item	Amount ($ Million)
Intangible assets
Licences and Brand names	Nil
IT development cost	5.2
Goodwill	Nil
Tangible assets
Land	Nil
Freehold buildings	0.4
Leasehold buildings	1.8
Plant and equipment	14.9

For conducting the impairment test, Foster’s Group Limited made various assumptions. The fair value of the financial instruments which are not dealt under the active market is valued using through the valuation techniques (Amiraslani, Iatridis and Pope 2013). Various methods are used by the company and it made various assumptions based on the condition of the market that existed on the reporting date. Quoted prices in the market or by the dealer for the same type of assets are used for estimating the fair value of the asset. Further, the discount rates used for computing the fair value under various regions are as follows –

• 12% for Carlton United Brewers
• 14% in EMA Wine
• 5% for American Wine
• 14% for ANZ Wine

IAS 36 on Impairment of assets is considered as the unusual and different standard from the other standards in IFRS. The major differentiation is that it requires the subjectivity interpretation and it has to be acceptable as per the managerial requirements (Bepari and Mollik 2015). Further, this standard does not limit imaginative and resourceful accounting. As per the financial statement of Foster’s Group Limited, the goodwill and other intangible assets are tested for impairment when there is an indication that the asset may be impaired. Therefore, the management has the option of manipulating their discretion and the assets may be tested for impairment opportunistically. Thus, there involved high level of subjectivity. The above statement can be justified with the fact that when the active price for the asset is not available or not determinable, allocation of the asset to CGU and determination of recoverable amount are carried out in such a way that may involve the discretion fact.

It is identified from the above mentioned facts and going through the financial statement of Foster’s Group Limited that the most confusing and difficult part of the impairment test is the impairment indication. There are some external and internal indications that the asset may get impaired. However, the management is also responsible for identifying the indication. Therefore, the most confusing part is that if the management is not able to identify the indication or they are not sure about whether to carry out the test or not then what will be the deciding factor regarding this. Further, as the resting procedure is carried on annually or more frequently, then what will be the deciding factor regarding the frequency in which the test is to be carried out. Therefore, there is involvement of subjectivity and opportunity in the management’s hand to carry out the test during the economic downturn to report more amounts under impairment loss.

New Lease Standard: Need and Changes

New insight gained through the impairment test is the computation of the impairment loss. It is computed through taking into consideration the fair value of the asset less cost of disposal and the value in use. Te fair value is computed through the asset’s value in the active market or the value mentioned in the sales agreement (Kimbro and Xu 2016). The value at which the asset can be sold by the company is also considered for computing the fair value. On the other hand, as per IAS 36, value in use is computed as the present value of future cash flows that is estimated to be received from the asset or the CGU of the asset to which the asset belongs.

The fair value of the asset is determined through valuation techniques. The valuation technique includes the present arm’s length price in the market, present value of another similar asset and the projected cash flow of the underlying asset (Andrews 2012). Further, in accordance with IFRS 13, the fair value is calculated through –

• Sales agreement
• Based on the best available information at which the asset of the company can be sold.
• Asset value in the active market in which the assets are traded.

The former model for lease accounting required the lessor and lessees to classify the leases as operating lease or financial lease. It further required accounting 2 different leases differently. As per the old model the operating leases were not accounted under the balance sheet ((Fitó, Moya and Orgaz 2013). As a result most of the companies did not analyses the leases associated with the short term leases or service agreements that were considered as operating leases. As per present scenario companies who follow the IFRS or US GAAP have leased asset for an amount of also 3.3 trillion. Out of these, almost 85% do not account this amount in their balance sheet as the leases were considered as operating lease. Therefore, the balance sheet does not state the actual financial status of company and the investors take biased decision based on the financial information. Thus, it is established that the previous lease standard does not reveal the actual economic reality.

Under the previous lease standard, almost 1 out of 2 companies did not reported 85% of their lease liability under the balance sheet. The reason behind this is that they used to classify the leases as operating lease and as per the old standard the operating leases were not required to report under the balance sheet (M2.com.au 2018). Therefore in actual, when the companies had large amount of liabilities, their balance sheet shown lesser amount of for the same. Further, during the time of financial crises most of the companies count not adjust their status with the real economic status and eventually went bankrupt. Therefore the liability towards lease, under the arrangement for off-balance sheet were 66 times more than the recorded amount under balance sheet as debt.

Challenges in Adopting New Lease Standard

Under the former lease standard the information regarding the undiscounted commitments for the off balance sheet leases are recorded through notes related to the financial statements (Ifrs.org 2018). Whereas the sophisticated investors can use this data for estimating the liabilities and assets generated from these leases, some retail investors are not able to do such analysis. Further, most of the airlines accounted their leases as operating as per the previous standard. Therefore, the airline companies who arrange their aircraft fleet through leases show different results as compared to those airline companies who arrange their aircraft fleet through purchases (Jorissen et al. 2014). Therefore, it is stated that among these airline entities there is no existence of level playing field.

The new standard will affect approximately 50% of the companies listed and is therefore expected that it will not be popular to all the entities. There are various reasons for these. The 1^st and most important factor is that the companies shall prepare themselves for accepting the changes under the new standard (Jennings and Marques 2012). There always exists the controversy that the changes will have adverse financial as well as economic impact on the company. Therefore, the companies will make changes in their income statement and balance sheet. Further, various banking arrangements and contractual liabilities associated with the company will be affected by the changes as the profit targets for the purpose of paying the bonus to employees or the balance between debt and equity may required to be revised before stepping into the new  standard (Lee and Hooy 2012). One more major issue is that the company intending to apply the new standard have to state the concept and changes of new standard to all its departments including the human resource, IT, finance, investor relation and asset procurement department and make them understand before implementation (Dye, Glover and Sunder 2014). Owing to all these issues the new standard may not be popular with all the companies.

Under the previous accounting standard most of the companies classified their leases as operating lease and recorded that as off-balance sheet items. Therefore, the financial statements are misstated regarding the liability and the investors are not able to get the actual picture of the company (Benson et al. 2015). Further, the result of the company who leases the assets significantly varies with those who purchase. The proposed new standard for leases will amend the IFRS 16 and it will give precise information regarding the associated costs. Therefore, the changes will create better situation for the investors to take their decisions and will reflect lease – versus – buy decisions better for the management (Cotter 2012).

Reference 

Amel-Zadeh, A., Faasse, J., Li, K. and Meeks, G., 2016. Stewardship and Value Relevance in Accounting for the Depletion of Purchased Goodwill.

Amiraslani, H., Iatridis, G.E. and Pope, P.F., 2013. Accounting for asset impairment: a test for IFRS compliance across Europe. Centre for Financial Analysis and Reporting Research (CeFARR).

Andrews, R., 2012. Fair Value, earnings management and asset impairment: The impact of a change in the regulatory environment. Procedia Economics and Finance, 2, pp.16-25.

Benson, K., Clarkson, P.M., Smith, T. and Tutticci, I., 2015. A review of accounting research in the Asia Pacific region. Australian Journal of Management, 40(1), pp.36-88.

Bepari, M.K. and Mollik, A.T., 2015. Effect of audit quality and accounting and finance backgrounds of audit committee members on firms’ compliance with IFRS for goodwill impairment testing. Journal of Applied Accounting Research, 16(2), pp.196-220.

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.

Cotter, D., 2012. Advanced financial reporting: A complete guide to IFRS. Financial Times/Prentice Hall.

Dye, R.A., Glover, J.C. and Sunder, S., 2014. Financial engineering and the arms race between accounting standard setters and preparers. Accounting Horizons, 29(2), pp.265-295.

Fitó, M.À., Moya, S. and Orgaz, N., 2013. Considering the effects of operating lease capitalization on key financial ratios. Spanish Journal of Finance and Accounting/Revista Española de Financiación y Contabilidad, 42(159), pp.341-369.

Ifrs.org., 2018. IFRS. [online] Available at: https://www.ifrs.org/ [Accessed 12 Jan. 2018].

Jennings, R. and Marques, A., 2012. Amortized cost for operating lease assets. Accounting Horizons, 27(1), pp.51-74.

Jorissen, A., Lybaert, N., Orens, R. and Van Der Tas, L., 2014. Constituents’ Participation in the IASC/IASB’s due Process of International Accounting Standard Setting: A Longitudinal Analysis. In Accounting and Regulation (pp. 79-110). Springer New York.

Kimbro, M.B. and Xu, D., 2016. The accounting treatment of goodwill, idiosyncratic risk, and market pricing. Journal of Accounting, Auditing & Finance, 31(3), pp.365-387.

Lee, C.H. and Hooy, C.W., 2012. Determinants of systematic financial risk exposures of airlines in North America, Europe and Asia. Journal of Air Transport Management, 24, pp.31-35.

M Carlin, T., Finch, N. and Manh Tran, D., 2014. IFRS compliance in the year of the pig: Hong Kong impairment testing. Journal of Economics and Development, 16(1), p.23.

M2.com.au. (2018). [online] Available at: https://m2.com.au/investor-centre/reports-presentations-and-resources/annual-reports/ [Accessed 12 Jan. 2018].