The developments within conceptual accounting frameworks over the last few decades have at their heart an attempt to bring greater relevance and use for users of financial reporting. As it perhaps feels there is even more significant economic uncertainty these days, one area that has gained greater attention is that of assets; in particular, the values they are being carried at. In today’s article, we will look at International Accounting Standard (IAS) 36 Impairment of Assets and the crucial rules it contains for today’s accountant.
Several definitions are essential to set out before digging too far into asset impairment weeds. In particular, the following we must have a common understanding of:
The standard deems the value of an asset in a reporting entity’s books has been impaired when its carry value is greater than the asset’s recoverable amount.
The carrying value of an asset is generally the purchase price less accumulated depreciation.
We move onto an asset’s recoverable amount. The recoverable amount is the higher of its fair value, lower costs to sell or the asset’s value in use.
Fair Value Less Costs to Sell
This is an amount that the owner could obtain from an asset’s disposal on an open market to a willing buyer, less any expenses incurred in preparing and bringing that asset to market. We can also use a substitute asset in this test, which may be necessary for very specialised asset types.
Value in Use
The value in use for an asset is the standard definition of being the present value of future cash flows it generates in its use and any anticipated net disposal proceeds.
Identifying an Assets Impairment
IAS 36 sets out a list for both external and internal indicators firms must be watchful for in making their impairment assessments. Management must ensure their assessment programs have fed into them these types of data.
The non-exhaustive list for internal factors management should be mindful of include:
- physical damage;
- restructuring plans;
- accelerated wear and tear; and
- reductions in an asset’s overall operating performance.
The Standard goes onto list several external factors that should also be monitored by management and included within their impairment assessment program:
- environmental regulations and standards;
- changes in legislation, regulations or case law;
- material changes in interest rates and the firm’s borrowing costs;
- changes in similar or substitute technologies; and
- movements in the secondary market.
If any of these internal or external factors are present, management must determine an asset’s recoverable amount and decide whether an impairment has occurred.
With the complexity of many businesses, it may be challenging to establish the recoverable value of a particular asset as it generates no cash flow in itself; instead, it’s part of a business system if we take a coffee machine in a cafe as an example. The coffee machine itself doesn’t generate a cash flow for the business, although it is a critical part of that business. However, it is a collection of systems that generates the cash rather than the coffee machine itself. So although we estimate a disposal value, a present value of cash flows will be harder to accomplish.
To get around this problem, we are introduced to cash generation units (CGU) by IAS 36. They define a CGU is the smallest group you break down a system that still generates a cash flow, independent of other individual or CGU assets.
In our cafe example, we would probably have to say it would be an individual cafe shop itself, rather than any particular asset or group within that system.
However, IAS 36 then requires that if an impairment of a CGU has been determined and brought into account, this impairment must be applied down to the individual assets with the CGU. So let’s look at how this would work in our cafe example.
Well, hopefully, you are still with us on this impairment of assets journey. The good news is it’s not too far from here; we start to look at some numbers and journal entries.
Let’s say our trusty ABC Ltd has decided to branch out into the cafe business and recently acquired a local cafe. It has come to the end of the financial year 20XY, and as part of this process, management has an internal process to assess asset impairment. From this review it has noted several factors:
- there has been a significant downturn in the economy, with a particular impact on cafes through government restrictions. It assessments this downturn in trade going forward to be at least 30% compared to previous data; and
- there has been an approximate 20 per cent drop in second hand prices for coffee machines.
As noted above, under Asset Groups and CGUs, as no individual asset within the cafe can be treated independently in terms of operation and cash flow, it is treated as a CGU. The carrying value of cafes in ABC’s accounts is $250,000.
In assessing the available data, ABC’s management has determined the cafe CGU has suffered a 30% impairment. It will now bring this impairment to account for its end of year reporting 20XX. ABC operates a simple cost model for its cafe assets as it deemed a revaluation model was complexity not required.
So let’s look at how we could account for the cafe impairment. Let us say of the $250,000 cafe carry value the coffee machines, three of them, have a value of $25,000. We will ignore the assets within the CGU, for example, fixtures and fittings, cash registers, ovens, etc.
Journal Entry – Impairment Expense
The coffee machines have to be written down by 30%:
$25,000 x 30% = $7,500
|31 March||Impairment Expense||7,500|||
If ABC had not been using a cost model for recognising the coffee machines, the debit above would have been to a revaluation account, if available. Any difference of putting such an account into debit would be taken instead straight to an impairment expense – as we did above.
Journal Entry – Impairment Reversal
Carrying on with our example, let us say in a few years, economic conditions improve, and the impairment brought to account in 20XY is no longer applicable. ABC decides to reverse the impairment, with the following journal made in the 20XZ end of year accounts process:
|31 March||Coffee Machines||7,500|||
And that brings us to the end of this article looking at ISA 36. We looked at what defines an impairment, the factors that indicate impairment of assets may have taken place and the issue around determining recoverable amounts and the use of CGUs. Our example with ABC and its cafe business showed entries for both the cost and revaluation asset models.