Requirement i)
Fair fax media limited has conducted the impairment of assets such as investments that accounted for using the method of equity. Such investments are tested for impairment at each reporting date when there is indication of impairment. At the end of each reporting period, assets that suffered impairment are reviewed for reversal impairment. Some of the intangible assets of organization such as trade names and mastheads having indefinite lives are tested on annual basis for impairment. Goodwill is also tested for impairment on annual basis along with other assets such as radio licenses, database, software and websites. The indication of existence of impairment is provided due to occurrence of one or more events in relation to any particular assets (fairfaxmedia.com.au 2018).
Requirement ii)
The process of allocation of such assets that is goodwill and intangible assets to cash generating units does impairment testing of indefinite lives of intangible. It is required by group to assess recoverable amount of cash generating unit in association with making considerable judgments regarding the factors such as forecasting of cash flows, conditions of industry, decline and growth rate, terminal growth rate and discount rates. Assets that are impaired through testing of cash generating unit involves property, equipment and plan worth $ 1.1 million and intangibles worth $ 14.7 million (fairfaxmedia.com.au 2018). Impairment of other assets such as plant, equipment and property is carried by reviewing the carrying value of such assets on annual basis whether they are exceeding the recoverable amount or not. Present value of expected future cash flow forms the basis of estimating the recoverable amount. Amount of impairment of plant and equipment along with intangibles is recorded at $ 28.9 million. Total amount of impairment for investments, intangibles and property, equipment and plants for the financial year 2016 and 2017 is recorded at $ 1153087 million and 34124 million respectively (fairfaxmedia.com.au 2018).
Recognition of impairment charge is done in any particular reporting period, when the carrying value of assets is more than their recoverable amount. The impairment expenses have been recorded during financial year 2017 of $ 1.5 million and 186.1 million in year 2016 on plant, equipment and property. Assessment of recoverable amount of assets as identified by indicators has resulted in total impairment charge of $ 14.4 million (fairfaxmedia.com.au 2018).
For determination of impairment, Fair fax media limited conduct the impairment testing by estimating the carrying values of liabilities and assets. Determination of carrying values is based on assumptions and estimates regarding future events. Computation of value in use forms the basis of recoverable amount determination of cash generating unit. Making of assumptions makes management to use the methodology of discounted cash flow. Assumptions have been made about discount rate, terminal cash flow forecast, forecasts of cash flow, terminal growth rates and terminal cash flow forecasts. Any sort of changes in assumptions might lead to impairment, as it would cause the carrying amount to be more than their recoverable amount. Furthermore, assumptions are made by management in relation to earnings multiple, forecasted revenue and any recent investments that are made by third parties (fairfaxmedia.com.au 2018).
Practice and involvement of subjectivity in the methodology of impairment testing may fail to produce reliable and relevant benefits, as the information might be skewed or inaccurate. Some of the organizations do the allocation and measurement of reporting unit in conducting annual impairment testing of goodwill might allow for subjectivity and possible earnings management. Subjectivity in the valuation process is also attributable to unobservable and observable inputs. Estimates and extents of subjectivity will affect the impairment testing accuracy (Alfredson et al. 2015). Management making judgments in respect of information and inputs has the likelihood of exercising subjectivity that might not provide users with appropriate depiction about impairment.
From the analysis of section of key and audit matters of Fair fax limited, it has been found that auditors make the assessment whether organization meets the criteria of incorporating substantial subjectivity in the process of impairment testing (fairfaxmedia.com.au 2018). Therefore, after evaluating this particular aspect, it can be said that Fair Fax limited has exercised some degree of subjectivity and performed the testing methodology opportunistically.
Requirement vi)
Conducting the evaluation of impairment testing methodology of Fair Fax limited, it is ascertained that testing process is interesting and surprising. All the information concerning the impairment is presented by properly segregating it in different sections. One interesting fact about the impairment was that recognition and measurement of each individual assets whether intangibles and tangibles are presented separately. Accounting policy used in estimation of recoverable and carrying amount of all assets is explained in detail. All the impaired assets are provided with estimates recoverable values that are based on assumptions made by management (fairfaxmedia.com.au 2018). The auditor’s report also assesses the impairment of assets and whether the methodology meets the requirement of AASB 136 of Impairment of assets”.
Group has conducted the sensitivity analysis relating to its cash-generating unit for assessing the requirement of conducting impairment if there recoverable amount is lower than their carrying amount. Estimates and judgments regarding the assets impairment are assessed for the adequacy of information. Impairment of Fair Fax limited also involved related party loan receivable, equity accounted investments along with intangible assets (fairfaxmedia.com.au 2018).
Hedge accounting of group takes into account hedges of fair value of recognized liabilities and assets or commitment of firms. Determination of interest swap fair value is done by referring to market values of similar instruments.
Computation of fair value is done by discounting future cash flows by interest rates concerning liabilities with profiles of similar risks. Fair value of financial instruments is estimated by various methods such as quoted process, inputs for liabilities and assets that are not based on apparent market data and inputs other than quoted prices are within several levels. Fair value of items of sales investment is done by evaluation of exchange traded listed share prices (fairfaxmedia.com.au 2018).
Requirement i)
The main factor that is associated with not reflecting economic reality under the former lease standard is related to incentives given by companies to classify lease contracts as operating lease. Principle underlying the standard does not obliges company to disclose the leases liabilities and assets under operating lease in the balance sheet. Rather they are disclosed as expenses relating to rental arrangement in the notes to financial statements and this keep the balance sheet profiles unchanged (Espinosa et al. 2015). In reality, companies might have actual liabilities concerning lease that might be more than the lease reported off balance sheets. It is estimated by IASB that out of $ 3.3 million worth of lease, only 25% of lease commitments is reported on balance sheets (Christensen et al. 2015). Therefore, the actual worth of lease commitments is not disclosed and this is the reason why the existing standard does not reflect true economic reality.
One of the major flaws of IAS 17 is associated with the incentive given to company for treating lease as operating lease. Treating lease as operating lease does not increase the balance sheet as the expenses concerning such lease are mentioned in the notes of financial statements. On other hand, financing lease impacts the balance sheets as it gives rise to liabilities and assets. Organizations have their debt to equity ratio worsen if they treat lease as financing lease and it is considered more favorable to classify lease as operating lease rather than financing lease (Bhat et al. 2014). Therefore, organization that classifies lease as operating will have actual lease commitments and liabilities that might be more than the total amount of debt that is represented in the balance sheets. It is prepared for enabling their financial position to look more attractive to investors that they essentially are. Total liabilities of companies might be more than on balance sheets liabilities and the flaw of former standard helps in explaining why the debt reported on balance sheets is 66 times more than off balance sheet liabilities.
Former lease accounting standard IAS 17 had ongoing controversy related to classification of lease as operating and financing lease. Under the existing or former standard, it is not essential for organization to reveal their operating lease commitments on balance sheets as against operating lease. Airline companies either lease most of their aircraft fleets or they purchase their fleets, and this might make look financial position of organization different (Kajüter and Meinhövel 2016). It can be explained with the help of an instance, German airline Lufthansa buys most of their fleets and its competitors Emirates airlines acquires most of their fleets by leasing them and this might create difference in financial position of such companies. However, in actual there might be similarity between financial position. Companies leasing few of their aircraft fleets have higher leverage and assets base against companies having lower or leasing few of their aircraft fleets (Feldmann and Le 2017). This depicts why there was no level playing field between airline companies under the former lease standard.
Some of the companies especially who relies more on operating lease will have their financial position being influenced considerably with the implementation of the new lease accounting standard. Knock on effects of new standard is affecting several key performance indicators, as balance sheets will be more expanded due to recognition of leased liabilities and assets. Now days, credit given by banks are associated with debt covenants that are tied to various financial ratios (Donkersley et al. 2017). Hence, there needs to be a renegotiation of existing debt covenants. Organizations might be keen on using short-term lease, as it would not influence the balance sheet to a considerable extent. Increase in size of debt structure and balance sheets would lead to organizations facing difficulties in receiving credit and experience problems with creditors. Consequence of higher cost of transition and administrative burden on management is another reason for making new lease standard unpopular. Alterations in lease accounting will need educational efforts from top-level management and all way to organization’s local parts as most of lease contracts are entered on local level (Bassemir 2017). Some of the administrative burden on organization will be witnessed in terms of increased cost and complexities of reporting, updating of accounting system and installation of new IT system. Increased investment will be needed on part of management in new system and consumption of time, as they will have to make detailed estimation concerning lease that is right to use and lease liabilities compared to former lease standard.
Application of new lease standard IFRS 16 makes it mandatory for all companies in essence for all leases to make the disclosure of all leased liabilities and assets on their balance sheets at the present value of future lease payments that are not avoidable. Recognition of interest payable on leased liabilities and depreciation related to lease assets are depicted in the income statement. New standard will have impact on some key financial ratios are highly crucial to some companies. Investors will be provided with the information about the change in structure of debt in the annual report of company. Disclosure of operating lease on the balance sheets will have considerable impact on operating profits, asset turnover, interest cover, cash flows and other financial ratios (Findeisen and Adolph 2016). It would help in depicting actual scenario and financial position of companies and there will be decision that is more informed since this will lead to actual reflection of lease commitments. For evaluation of financial performance of any business requires outsiders of companies and users of financial statements to make guesswork and rough computation and calculations for estimating actual lease commitments in the existing lease standard. Such process might lead to occurrence of errors and there exists possibility of reflection of financial scenario that does not exist. IFRS 16 will help in brining much needed transparency and facilitating comparisons between different companies (Florou and Kosi 2015). There will be clear and enhanced understanding of actual liabilities relating to lease commitments. Furthermore, new standard implementation will help in better allocation of capital and making analysts and investors with enhanced leasing methods and will help in making balanced leased versus buy decision on part of management.
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Alfredson, K., Leo, K., Picker, R., Pacter, P., Radford, J. and Wise, V., 2015. Applying international accounting standards. John Wiley & Sons.
Ali, A., Akbar, S. and Ormrod, P., 2016, March. Impact of international financial reporting standards on the profit and equity of AIM listed companies in the UK. In Accounting Forum (Vol. 40, No. 1, pp. 45-62). Elsevier.
Bassemir, M., 2017. Why do private firms adopt IFRS?. Accounting and Business Research, pp.1-27.
Bhat, G., Callen, J.L. and Segal, D., 2014. Credit risk and IFRS: The case of credit default swaps. Journal of Accounting, Auditing & Finance, 29(2), pp.129-162.
Christensen, H.B., Lee, E., Walker, M. and Zeng, C., 2015. Incentives or standards: What determines accounting quality changes around IFRS adoption?. European Accounting Review, 24(1), pp.31-61.
DeGennaro, M., 2016. An Economic Comparison of US GAAP and IFRS. J. Int’l Bus. & L., 16, p.249.
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Espinosa, C., Maquieira, C., Diaz, F. and Abarca, A., 2015. Adoption of IFRS in an emerging market: the Chilean case. Academia Revista Latinoamericana de Administración, 28(4), pp.442-460.
Fairfaxmedia.com.au. (2018). [online] Available at: https://www.fairfaxmedia.com.au/ArticleDocuments/193/2017%20Fairfax%20Annual%20Report_Book.pdf.aspx?Embed=Y [Accessed 24 Jan. 2018].
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Florou, A. and Kosi, U., 2015. Does mandatory IFRS adoption facilitate debt financing?. Review of Accounting Studies, 20(4), pp.1407-1456.
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