Intangible assets and goodwill having indefinite lives are tested for impairment by comparing cash generating unit carrying amount. Impairment of loan assets have been held at amortized cost and they are regularly assessed and reviewed for possible impairment. Impairment reversal on subsidiaries has been conducted.
The impairment testing is done by consolidated entity by considering the factors such as recoverable amount, fair value or value in use. If there is an indication that any investment in joint venture or any associate needs to be impaired, then the entire carrying mount of investment is tested for impairment. This is done by comparing the carrying amount with the recoverable amount that is higher of fair value less sales cost and value in use. Assets are grouped at lowest level for the purpose of assessing impairment and there are cash flows from such assets that are identified separately and they are not dependent upon cash that is flowing from other assets or group of assets (Amiraslani et al. 2013). Testing of impairment for intangible assets and goodwill are done by comparing carrying amount of cash generating unit to recoverable amount.
During the current period, Macquarie group has recorded impairment expenditure in relation to intangible assets and equity investments. Investment charge on investment securities available for sale decreased from $ 121 million in year 2016 to $ 47 million. Impairment expenditure was incurred on interests in joint ventures and associates. Charge increased from $ 24 million in year 2016 to $ 27 million in year 2017. Furthermore, impairment expenditure was also incurred on intangible and other financial assets of amount $ 99 million in year 2017. Compared to prior year, there were lower provisions on impairment expenditures.
The procedures adopted by Macquarie group concerning impairment includes the factors that have the possibility of materially impacting the fair value and usage of assets and updating of their understanding of prevailing conditions in market. Organization evaluates the appropriateness of methodology of impairment assessment and making the assumptions about calculations of value in use. Estimates for asset impairment are used by management of group that is based on historical loss experience for assets with objective evidence for impairment and credit risk characteristics that is similar to portfolio when its future cash flow is scheduled. Accurate estimation of assets carrying value is done by realized value of certain assets with benefit highlights. Testing certain controls and evaluation of measurement and recognition of impairment and reversal impairment is done for impairment in subsidiaries. The recoverable amount of assets is done by making estimation and any change in such estimates leads to recognition of impairment losses in the income statement (Arrozio et al. 2016).
During the recent financial crisis, process of impairment testing has become more difficult. If an organization exercise higher level of compliance in asset class and this higher compliance is associated with lower degree of subjectivity. Analysis of annual report of Macquarie group depicts that there were little bit subjectivity involved in the process of impairment testing. Organization performs the evaluation of whether impairment of any assets is required or not. Organization makes the provision for impairment by making use of incurred loss model and performing re assessment at each balanced date (Khokan et al. 2014). Impairment loss is recognized for different financial assets in the income statement.
The outcome of impairment testing is considerably influenced by involvement of subjectivity. When testing goodwill, degree of subjectivity provides opportunistic behaviors among management and the impairment testing for assets is done is done opportunistically when calculation of recoverable amount of cash generating unit is subjected to discretion (Cheng 2015).
The existence of impairment is indicated by objective evidence of impairment resulting from one or more events that has the likelihood of influencing future cash flow of financial assets that can be measured reliably. Understating of the impairment testing seems interesting because the outcome for impairment testing varies from organization to organization and it differs when management has incentives to act opportunistically. Quality of earning of organization is impacted by opportunistic behavior and involvement of subjectivity as it pushes up the agency costs (Romild 2017).
A new guidance has been released by Financial accounting standard board that has simplified the process of goodwill impairment testing. Organizations are now a day’s adopting simplified way of conducting impairment testing that leads to more precision and reduces efforts and costs. They are opting for one single step quantitative test while qualitative assessment remains optional. Impairment charge of goodwill is recorded as difference between fair value and carrying value of reporting unit. Loss that arises from this impairment testing is measured at the amount that is excess of carrying amount of reporting unit over its fair value. However, this new method of impairment calculation is regarded as less precise because calculations are not specifically done for assets but that are done at reporting unit level. It has been found that this method of calculating impairment using fair value requires valuation of resources independently.
Provisions of fair value have been adopted by Macquarie group of AASB 2 share based payments. Fair value measurement can be retained by investor when an equity method is applied by investment entity to a joint venture or associate of entity investors by non investment entity investors. Accounting policies of investor can be confirmed by reversing fair value measurement. Group adheres to AASB 13 fair value measurements that require them to use price that is more representative of fair value that is within the bid offer spread. Mid market price is typically generated by valuation system (Linnenluecke et al. 2015). The fair value of financial instruments is determined by trading them at fair value through loss and profit and making reference to quoted market price when available.
The former accounting standard for leases came with flaws as the criteria for designation of capital lease was eluded. Leased assets were allowed to be kept in their books of account not for long-term but briefly. Former accounting for leases does not come with the requirement of featuring operating leases on balance sheet of reporting entity. This entails them to not make the representation of resulting liabilities and assets on their financial statement. An organization might have thousand worth of assets under agreement of operating lease that makes it impossible to show up in financial metrics and resulting in understatement of liabilities. Current accounting requirement does not make it necessary for firms to record operating lease on their balance sheet. As a result, the reported balance sheet liabilities were multiple times less that off balance sheet liabilities that deceived investors. This creates real liabilities for business and provides deceptive information to investors. Substantial lease obligations are calculated by company by making guesses and come with lack of transparency (Kusano et al. 2016). Therefore, the financial statement of reporting entity does not provides users with true economic reality as they seek information from the reported balance sheet. Programs on other hand are articulated as strategy of managing human resource.
Former account standard of leases historically focused on identification when there is a similarity between purchasing the assets that is being leased to leases that are done economically. Lease is classified as finance lease when lease is determined to be similar economically to underlying assets that have been purchased. It was reported on the balance sheet of lessee’s. The classifications of remaining leases are done as operating lease and the effect of which is not reported on the balance sheet of lessee. Even if such leases are not mentioned in the balance sheet, it is certain that compared to financial lease commitments; operating lease also comes with commitment. Operating lease generates similar financial liabilities but it is not being reported in balance sheet under current accounting standard (Moore and Nagy 2013). While the balance sheet depicts that there are no liabilities on part of lease, but in actual scenario, leasing of assets generates liabilities that are not being reported in balance sheet. There is no off balance sheet accounting and structuring of transactions that leads to considerable difference in operating lease and accounting for finance.
As a consequence of this, investors are provided misleading picture about assets and actual leverage used in operations by business. Therefore, the total amount of debt that is reported by entity on their balance sheet is considerably less than off balance sheet liabilities.
An investor intending to make investment in airline companies have the difficulties in assessing the financial position of entities. An airline company buying most of its fleet appears to be significantly different from its competitors who lease most of its aircraft fleets. However, in actual scenario, the financial position or financial obligations might be quite similar and this makes it difficult for them to perform comparison. This made it difficult for investors to make comparison of operating flexibility and financial leverage of such companies. Under current lease, the undiscounted commitment for companies regarding their off balance sheet leases is mentioned in the notes to financial statements (Psaros and Seamer 2015). It becomes difficult for investors to make analysis of estimates of liabilities and assets arising from such leases.
Adoption of new standard on lease will have wider implications for business in terms of change in system and internal control. It will be required by companies to make assessment about their current accounting policies robustness for tracking and capturing necessary data for lease recognition. In order to compile enhanced disclosure for providing adequate information, organization needs to upgrade their system. Moreover, the assessment of adequacy of knowledge of employees should be done by management concerning the impact on internal control system and new standard requirement. Impact of change in financial metrics due to adoption of standard requires companies to consider negotiation of any loan or other agreements. This will incur additional cost for business that might make reduce businesses profitability in initial year.
Furthermore, the rent expenses incurred by companies will be replaced with two different expenses under new lease standard. Depreciation expense on side of leased assets and interest expense on lease liabilities. There might be adverse economic impacts followed by defaults on debt covenants (Hartwig 2015). In the initial year of lease, reported net profit after tax of company could be reduced and this makes new standard controversial and unpopular among companies.
The recognition of total lease liability in the lease term and identification of circumstances and relevant facts requires judgment impacting the lease term. More specifically, economic incentive forms the basis of reasonable certainty of options that is being exercised. Concerning this, entity is required to take into consideration all economic factors that are pertinent to the assessment of lease when they are asset based, contract based, entity based and market based. Consideration of economic factors concerning lease involves existence of significant improvement in leasehold, terms and conditions of contracts for optional period compared to market rates, cost concerning lease termination, past practice relating to lease by lessee over whom particular assets have been used, relevance of underlying asset to operations of lessee. Net standard also considers economic reasons that are associated with recognition of leases (Sandell et al. 2017). All this helps in reflecting real economic reality and investors are not required to perform rough calculations for adding back operating leases onto entity’s balance sheet. Organizations will not be required to structure their obligations concerning lease to remain off their balance sheet in order to look attractive in investor’s eyes. This will provide investors with informed decision while making investment in any particular entity. In the absence of information of leases from balance sheet does not provide investors with absolute picture organization’s financial position. It makes difficult for them to make comparison between companies leasing assets and buying assets (Cortesi et al. 2015). With the introduction of new standard, there will be creation of buy decisions versus balanced lease.
References list:
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).
Arrozio, M.M., Gonzales, A. and da Silva, F.L., 2016. Changes in the financial ratios of the wholesale and retail sector companies arising from the new accounting of the operating lease. Revista Eniac Pesquisa, 5(2), pp.139-159.
Cheng, J., 2015. Small and Medium Sized Entities Management’s Perspective on Principles-Based Accounting Standards on Lease Accounting. Technology and Investment, 6(01), p.71.
Cortesi, A., Tettamanzi, P., Scaccabarozzi, U., Spertini, I. and Castoldi, S., 2015. Advanced Financial Accounting: Financial Statement Analysis–Accounting Issues–Group Accounts. EGEA spa.
Edwards, J.R., 2013. A History of Financial Accounting (RLE Accounting) (Vol. 29). Routledge.
Hartwig, F., 2015. Swedish and Dutch listed companies’ compliance with IAS 36 paragraph 134. International Journal of Disclosure and Governance, 12(1), pp.78-105.
Hoyle, J.B., Schaefer, T. and Doupnik, T., 2015. Advanced accounting. McGraw Hill.
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.
Kusano, M., Sakuma, Y. and Tsunogaya, N., 2016. Economic consequences of changes in the lease accounting standard: Evidence from Japan. Journal of Contemporary Accounting & Economics, 12(1), pp.73-88
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.
Malthus, S., 2013. Advanced Financial Accounting: An International Approach. Journal of Accounting & Organizational Change.
Mazzi, F., André, P., Dyonisia, D. and Tsalavoutas, I., 2013. Goodwill related mandatory disclosure and the cost of equity capital. In 36th EAA Annual Congress, Paris, France.
Moore, S. and Nagy, A., 2013. CONTRACT STRUCTURING UNDER THE NEW LEASE ACCOUNTING RULES: THE CASE OF CUSTOM DESIGN RETAIL, INC. Global Perspectives on Accounting Education, 10, p.81.
Poll, G.H., Miller, C.A. and van Hell, J.G., 2015. Evidence of compensatory processing in adults with developmental language impairment: Testing the predictions of the procedural deficit hypothesis. Journal of communication disorders, 53, pp.84-102.
Psaros, J. and Seamer, M., 2015. Ranking Corporate Governance of Australia’s Top Companies: A Decade On. Australian Accounting Review, 25(4), pp.405-412.
Randolph, A., 2016. MACC 531-02 Advanced Financial Accounting.
Sandell, N., Sandell, N., Svensson, P. and Svensson, P., 2017. Writing write-downs: The rhetoric of goodwill impairment. Qualitative Research in Accounting & Management, 14(1), pp.81-102.
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