Discuss about the Business Impairment Loss for Business Accounting.
IAS 36 , ‘Impairment of Assets’, is the standard which narrates about the accounting for impairment of assets in each accounting period. The said standard has gained importance in the recent past specifically after the global financial crisis 2008. The term impairment is defined as to when an asset’s value gets reduced or diminished as compared to the amount at which it is presently recorded in the balance sheet. This standard is covered by the Australian Accounting Standard as well under AASB 136. An asset is said to be impaired if its recoverable amount is lesser than its carrying amount.
As per IAS 36 it is mandatory for every company to conduct an impairment test every year annually of all its assets but for some exceptions. These exceptions are due to the fact that they are covered in various other standards. The assets which are not impaired under IAS 36 are as under:
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
Thus apart from the asset categories mentioned above, the other assets have to go through an impairment test and if it is found that the carrying amount of the assets is more than the amount that can be recovered on selling the said asset, then the difference between the two amounts is treated as impairment loss. The said amount is then recorded in the income statement of the entity as an operational expense and the said amount is reduced from the balance of the asset reflecting in the balance sheet so that the present carrying amount can be brought down to its recoverable amount. This further leads to revision in the depreciation method applied for the said asset category, useful life of the assets and the salvage value of the asset (Henderson et.al. ., 2014).
For concluding that an asset has been impaired, an impairment test has to be conducted. Factors both internal and external to an organization are responsible for determining whether an asset is to be impaired or not.
The external factors are as under:
The assets market value has dipped steeply.
There is a negative impact felt due to an increase in the market interest rate
The legal, economical and political scenario is highly unstable.
The net asset value of a company is greater than its market capitalisation
The internal factors are enumerated as under:
Due to technological advancement an asset has become obsolescent.
The said asset is held for sale or disposal
The company has not been performing too well and its productivity has deteriorated substantially (Thornton, 2014).
Thus if the top management or the accountants are of the opinion after conducting the impairment test that the asset has been impaired then the sae should be accounted for so as to reflect the actual recoverable amount of the asset in the balance sheet of the company. This also enables to understand the liquidity position of the company in case of financial crisis or need for cash and cash equivalents.
Hence what is important is to understand and calculate the recoverable amount of the asset. But if an asset’s individual recoverable amount is not possible to derive then the amount of the cash generating unit to which the asset belongs should be derived. A cash generating unit is such an identifiable unit of the company which is capable of generating cash flows independently. Recoverable amount is the higher of the fair value of an asset after accounting for the cost of selling the asset and the value in use i.e. the net present value of an asset from the future cash flows discounted at the market risk free interest rate (iasplus.com, 2014).
The second very important issue that this standard discusses about is the fact that impaired assets can be reversed as well. Thus on conducting the impairment test annually if it is found that the asset’s value has increased then the company should ensure to reverse the amount but limited to only assets other than goodwill. Therefore goodwill is subject to impairment loss but not impairment reversal. This is applicable in case of reversal of a CGU also. The reversal of the impairment loss can take place only to the extent the value of the asset would have been had it not been impaired in the past after taking into consideration the depreciation. The reversal amount is duly recorded as an income and is added back to the asset category.
IAS 36 has defined that the impairment should be duly disclosed in the notes to financial statements. Thus the disclosure requirements as per the standard are as follows:
Following are the disclosures required to be done for each class of assets being impaired:
The amount of impairment loss that has been calculated and recognized in the profit and loss account and the line item(s) of the statement of comprehensive income in which the impairment loss is recorded.
The amount of impairment loss reversed and recognized 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 impairment loss of revalued assets which are recognized in the other comprehensive income during the period.
The impairment loss reversal of the revalued assets which is recognized in the other comprehensive income during the period (Buschhuter, & Striegel, 2011) .
For entities which also do segmental reporting, they are required to disclose the following too:
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.
If the asset being impaired is of material nature then the below mentioned disclosures are necessary:
The factors that led to impairment of an asset.
The value to which the asset is being impaired.
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 (accaglobal.com, 2014).
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.
Therefore on summarizing the said standard it is clear that it upholds the concept of recording the assets at its actual recoverable value so as to give a true picture to the suppliers, creditors, investors and the owners of the company with regards the liquidity position of the entity. It enables to prevent over-statement or under-statement of assets value in the balance sheet.
The subject case study clearly connotes that the inventories and the brand ‘Crossbow Shoe’ is not subject to any kind of impairment. The former because it is covered under IAS 2 and the later because factors do not incline towards such impairment.
Firstly the land is to be impaired as its recoverable amount is known individually. 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 is as under:
Profit and Loss Account (loss on impairment) Dr……………$29000
To accumulated impairment loss (Land)………………………………………..$29000
Further, 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 is as under:
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…………………………..$69455
References:
accaglobal.com, (2014), IAS 36 Impairment of Assets, Available at https://www.accaglobal.com/in/en/discover/cpd-articles/corporate-reporting/ias36-impairment.html (Accessed 19th September 2016)
Buschhuter, M., & Striegel, A., (2011), IAS36- Impairment of Assets, Gabler: USA
ey.com, (2014), Impairment Accounting – the basics of IAS 36 , Impairment of Assets, Available at https://www.ey.com/Publication/vwLUAssets/Impairment_accounting_the_basics_of_IAS_36_Impairment_of_Assets/$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 19th September 2016)
Henderson, S., Peirson, G., Herbohn, K., & Howieson, B., (2014), Issues in Financial Accounting, Pearson: Australia
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 19th September 2016)
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