CHAPTER 20. IMPAIRMENT of ASSETS

CHAPTER 20 IMPAIRMENT of ASSETS 1. BACKGROUND The objective of IAS 36 is to prescribe the procedures that an entity applies to ensure that its assets are not carried at amounts in excess of their recoverable amount and when an entity may reverse an impairment loss. The standard is effectively a formal procedure for ensuring that assets have not suffered a permanent diminution in value which was a provision in former accounting standards dealing with fixed assets. The standard focuses on property plant and equipment and intangible assets including goodwill. Other assets such as inventories are not covered by this standard as detailed in the scope section below. One of the problems associated with the impairment process is the ability of an entity to recognise an impairment loss against their profits in one accounting period, but then in certain circumstances, to be able to reverse that loss and credit their income statement in a later period. This opens the door to the possibility of profit smoothing and is an issue that auditors have to guard against. Many organisations have suffered material impairment losses, a good recent example being the Panasonic Corporation whose impairment loss and related expenses turned their operating profit into a pre-tax loss. The company has reported disappointing results for the 6 months to 30 September 2012 when their pre-tax loss totalled 278.7 billion yen. This was due mainly to business restructuring expenses of 355.5 billion yen, including impairment losses of goodwill and intangible assets in the solar, consumer-use lithium-ion batteries and mobile phone businesses. 2. SCOPE The following assets, amongst others, are scoped out of IAS 36: Inventories, Assets arising from construction contracts, Deferred tax assets, Assets arising from employee benefits, Financial assets within the scope of IAS 39, Investment property that is measured at fair value, and Non-current assets (or disposal groups) classified as held for sale. Chapter 20: Page 1

A Student s Guide to International Financial Reporting 3. INTERPRETING THE DEFINITIONS OF KEY TERMS An impairment loss is the amount by which the carrying amount of an asset or Cash Generating Unit (CGU) is reduced to its recoverable amount. Carrying amount is the amount at which an asset or CGU is recognised in the balance sheet after deducting any accumulated depreciation (amortisation) and accumulated impairment losses thereon. Recoverable amount is the higher of an asset s or CGU s fair value less costs to sell and its value in use. Although recoverable amount is defined as the higher of an asset s or CGU s fair value less costs to sell and its value in use, it is not always necessary to determine both. Examples of such situations include: where either the fair value less costs to sell or the value in use are determined to be greater than the asset s carrying amount, the asset is not impaired and it is not necessary to determine the other amount, where there is no reason to believe the asset s value in use materially exceeds its fair value less costs to sell, the asset s recoverable amount is its fair value less costs to sell, and where it is not possible to determine fair value less costs to sell, the recoverable amount of the asset may be taken to be its value in use. Value in use is the present value of the future cash flows expected to be derived from an asset. The following steps are necessary to estimate the value in use of an asset: (a) estimate the future cash inflows and outflows to be derived from continuing use of the asset and from its ultimate disposal, and (b) apply the appropriate discount rate to those future cash flows. When calculating value in use, the basis for estimates of future cash flows is as follows: projections shall be based on reasonable and supportable assumptions that represent managements best estimate of the range of economic conditions that will exist over the remaining useful life of the asset. (Greater weight shall be given to external evidence.) short-term (5 years or less) cash flow projections shall be based on the most recently approved budgets or forecasts, and long-term (in excess of 5 years hence) cash flow projections shall be based on an extrapolation from the short-term projections using a justifiable growth rate (stable or declining growth rates are usually appropriate). The composition of estimates of future cash flows: Shall include: projections of cash inflows from the continuing use of the asset (e.g. proceeds from the sale of goods manufactured by an item of plant), projections of cash outflows that are necessarily incurred to generate the cash inflows and are directly attributable to, or can be allocated on a reasonable basis to the asset, (e.g. the costs of manufacturing the goods to be sold including input costs and costs like routine maintenance, replacements of components that constitute day to day servicing), and net cash flows on disposal of the asset at the end of its useful life (e.g. the expected net proceeds on disposal). Chapter 20: Page 2

Chapter 20: Impairment of Assets Shall not include: cash outflows required to settle obligations that have already been recognised as liabilities, cash inflows or outflows from financing activities, income tax receipts or payments, improvements to the asset that would be capitalised to the carrying amount of the asset being tested for impairment, and outflows in respect of future restructuring activities to which the entity are not committed. The following elements shall be reflected in the calculation of an asset s value in use: an estimate of the future cash flows the entity expects to derive from the asset; expectations about possible variations in the amount or timing of those future cash flows; the time value of money 1 (i.e. the current market risk-free rate); the price of bearing the uncertainty inherent in the asset1; and other factors, such as illiquidity, that market participants would reflect in pricing the future cash flows the entity expects to derive from the asset. 1 Caution must be exercised not to double count these factors. Future foreign currency cash flows should be estimated in the foreign currency and discounted using a discount rate appropriate for that currency before being translated into the functional currency at the spot rate on the date the value in use calculation is performed. The discount rate (or rates) shall be a pre-tax market determined rate (or rates) that reflects current market assessments of the time value of money and the risks specific to the asset (i.e. the business s capital structure shall have no impact on the discount rate used but the country, currency and price risk will). Fair value less costs to sell is the amount obtainable from the sale of an asset or CGU in an arm s length transaction between knowledgeable, willing parties, less the costs of disposal. The best evidence of an asset s fair value less costs to sell is a price in a binding sale agreement in an arm s length transaction, adjusted for incremental costs that are directly attributable to the disposal of the asset. If there is no binding sale agreement, but an asset is traded in an active market, the asset s market price less costs of disposal would provide the best evidence of fair value less costs to sell. The market price is usually the current bid price or the price of the most recent transaction provided no significant changes between transaction date and estimation date has occurred. If there is no binding sale agreement or active market for an asset, fair value less costs to sell is determined based on the best information available to reflect the amount that an entity could obtain, at reporting date, from the disposal of the asset through an arm s length transaction between knowledgeable, willing parties, less the costs of disposal (for example, stamp duty and legal costs). The costs of disposal shall exclude: (a) costs that have already been recognised as liabilities, and (b) restructuring or reorganisation costs (for example, termination costs). Chapter 20: Page 3

A Student s Guide to International Financial Reporting Illustrative example 20.1: Calculation of recoverable amount Roach Limited has an item of plant which has undergone an impairment review at 31 December 20X1. At the review, the following estimates were produced: Fair value of plant: R1 400 000 Costs to sell 2% of selling price Revenue and associated costs per annum for remaining useful life: (assume all cashflows occur at the end of the year). Revenue Costs 20X2 R960,000 R240,000 20X3 R880,000 R220,000 20X4 R700,000 R290,000 The plant has an estimated residual value of R50 000. A discount rate of 10% is applicable to investments equivalent in risk to this plant. Required Calculate the recoverable amount as at 31 December 20X1 Solution Cashflows 20X2 20X3 20X4 Rand Rand Rand Revenue 960 000 880 000 700 000 Costs (240 000) (220 000) (290 000) Net Cash Inflow 720 000 660 000 410 000 Present Value Factor 0.90909 0.82645 0.75131 Present Value 654 545 545 457 308 037 Residual Value Present Value (end of 20X4: 50 000 x 0.75131) = 37 566 Value In Use = (654 545 + 545 457 + 308 037 + 37 566 = R1 545 605 Fair value less Cost to Sell = R1 400 000 2% = R1 372 000 Recoverable Amount (Greater of) = Value in use = R 1 545 605. Chapter 20: Page 4

Chapter 20: Impairment of Assets 4. IDENTIFYING A POTENTIALLY IMPAIRED ASSET An entity shall assess at each balance sheet date whether there is any indication that an asset may be impaired (i.e. an impairment review). If no indications of a potential impairment loss are present (from the impairment review), there is little risk that impairment has occurred and, consequently, there is no need to make a formal estimate of the recoverable amount. In other words only if the impairment review indicates that an impairment exists, does the entity perform an impairment test (i.e. estimate the recoverable amount of the asset and compare that value to the asset s carrying amount). However, acquired goodwill, indefinite useful life intangible assets and intangible assets not yet available for use are tested for impairment annually. In identifying whether an asset may be impaired, an entity shall consider the following indications: 1) External sources of information including: significant decline in asset s market value; significant adverse current or future changes in the technological, market, economic or legal environment in which the entity operates, or the market to which an asset is dedicated (e.g. economic sanctions imposed on the country makes future export sales impossible); an increase in market interest rates or other market rates of return on investments which are likely to decrease materially the asset s recoverable amount (as this would reduce the value of the discounted cash flows); and where the carrying amount of the entity s net assets exceed the entity s market capitalisation. 2) Internal sources of information including: evidence of obsolescence or physical damage of asset (e.g. inspection reveals visually apparent damage or reject level of machine is unusually high); current or future adverse changes in the extent to which, or manner in which, an asset is used or is expected to be used (e.g. a decision has been taken to restructure); and internal reporting indicates that the economic performance of an asset is, or will be, worse than expected. Indicators of worse than expected economic performance include: acquisition costs or subsequent funding needs are significantly higher than originally expected; significantly worse actual net cash flows or operating profit or loss flowing from the asset compared to budget; a significant decline in budgeted net cash flow or operating profit or a significant increase in loss flowing from the asset; or the existence of operating losses or net cash outflows when current period figures are aggregated with other past figures or budgeted figures. 5. RECOGNITION AND MEASUREMENT OF IMPAIRMENT LOSSES 5.1 Impairment losses If the recoverable amount of an asset (or cash generating unit) is less than its carrying amount, the difference is recognised as an impairment loss (expense) in profit or loss, except to the extent that the deficit is recognised directly in other comprehensive income because it constitutes the reversal of a prior period revaluation. If the impairment loss is greater than the carrying amount, a liability is recognised only if it is required by other IFRSs. Chapter 20: Page 5

A Student s Guide to International Financial Reporting After recognition of an impairment loss, the depreciation (amortisation) charge shall be adjusted in future periods to allocate the depreciable asset s revised carrying amount, less its residual value (if any), on a systematic basis over its remaining useful life. 5.2 Reversals of impairment losses 5.2.1 Subsequent review of an impaired asset At each reporting date, an assessment is made to see whether there is any indication that an impairment loss recognised in previous years for an asset other than goodwill may no longer exist or may have decreased. If such an indication exists, then the recoverable amount of the asset is estimated. To identify this possibility, the entity shall consider: 1) External sources of information, including: significant increase in the asset s market value; significant favourable current or future changes in the technological, market, economic or legal environment in which the entity operates or for the market to which the asset is dedicated; and a decrease in market interest rates or other market rates of return on investments, which are likely to increase materially the asset s recoverable amount. 2) Internal sources of information, including: significant current or future favourable changes in the extent to which, or manner in which, the asset is used or is expected to be used; and internal reporting indicates that the economic performance of the asset is, or will be, better than expected. 3) Assets for which the last estimate of recoverable amount was the asset s value in use: actual cash flows are materially more than those previously estimated, before any effect of discounting. 5.2.2. Recognition of reversal The carrying amount of an asset for which an impairment loss has been previously recognised shall be increased to its recoverable amount if, and only if, there has been a change in the estimates used to determine the asset s recoverable amount since the last impairment loss was recognised. This increase is recognised as income in the income statement. The increased carrying amount shall not exceed the carrying amount that would have been determined (net of amortisation or depreciation) had no impairment loss been recognised for the asset in prior years. As an exception to the above requirement, an impairment loss recognised for goodwill is not reversed. After the reversal of an impairment loss, the depreciation (amortisation) charge for an asset shall be adjusted in future periods to allocate the asset s revised carrying amount, less its residual value (if any), on a systematic basis over its remaining useful life. Chapter 20: Page 6

Chapter 20: Impairment of Assets Illustrative example 20.2: Individual asset carried at depreciated historic cost A pharmaceutical company s competitor invented a cheap cure for AIDS. This resulted in the company moth-balling its less effective AIDS treatment drug manufacturing plant on 31 December 20.8. Details of the moth-balled plant are as follows: R 000 Original cost (1 January 20.6) 1 000 Recoverable amount (31 December 20.8) zero Depreciation is provided for on the straight-line basis over 10 years to nil residual value. In December 20.9, it became apparent that the competitor s miracle cure was a hoax. Fortunately, the company had not disposed of its moth-balled plant and plans to recommence production in the 20.10 financial year. Market demand for the company s AIDS treatment drug is fully restored and the plant is once again expected to run profitably in the foreseeable future. Required: Prepare journal entries to record the write down to recoverable amount and subsequent write back. Solution: Calculation: Debit Credit R 000 R 000 31 December 20.8 Depreciation plant R1 000 000/10 years 100 Accumulated depreciation & impairment - plant 100 Depreciation for the year Impairment of plant expense (R1 000 000 cost R300 000 700 Accumulated depreciation & impairment - plant accumulated depreciation) 700 R0 recoverable amount Impairment of plant 31 December 20.9 Accumulated depreciation & impairment - plant R700 000 above R100 000 600 Reversal of impairment - expense notional depreciation 600 Reversal of impairment 5.3 Impairment (and reversal of impairment) of revalued assets For a revalued item (e.g. intangible asset or property, plant and equipment carried under the revaluation model) an impairment loss shall be recognised as follows: The impairment loss shall be recognised in profit or loss to the extent that it cannot be charged directly against any related revaluation surplus in respect of that asset. A reversal of an impairment loss shall be treated as a revaluation increase (recognised in other comprehensive income and credited to revaluation surplus in equity). However, a revaluation increase shall be recognised in profit or loss to the extent that it reverses an impairment loss of the same asset that was previously recognised in profit or loss. In measuring the reversal of the prior period impairment that is recorded in profit or loss, an adjustment is made for that historic cost depreciation that would have taken place between the date of the impairment and the reversal thereof had the asset not been impaired. This means that if part of the impairment loss was previously charged to profit or loss then, if the impairment loss reverses, part of this reversal (after adjusting for the historic cost depreciation as outlined above) is recorded in profit or loss. Chapter 20: Page 7

A Student s Guide to International Financial Reporting Illustrative example 20.3: Individual asset carried at revalued amount Zuma Limited, a listed pharmaceutical manufacturer, acquired its Mirodene plant on 1 January 20.1 at a cost of R100 million. Mirodene is a drug used exclusively by AIDS patients to prolong and improve the quality of their remaining lives. Zuma Limited depreciates plant on the straight-line method to nil residual values, over 10 years. The South African Revenue Services allows wear and tear on the straight-line method, to nil residual values, over 5 years. On 1 January 20.3, Zuma Limited revalued its Mirodene plant up to a carrying amount of R200 million. On 30 December 20.4 Nkosazana Limited, a major competitor, made a public announcement to the effect that it had developed Silodene, a miracle cure for AIDS. This development caused Zuma Limited to drastically reduce production at the Mirodene plant and to reduce the carrying amount of the Mirodene plant to R10 million. Production at reduced levels continued throughout 20.5 and 20.6. On 2 January 20.7, the World Health Organisation banned the use of Silodene, as not only had it become apparent that Silodene did not cure AIDS, but that it also caused lung cancer. The market for Mirodene was immediately restored and Zuma Limited therefore revalued its Mirodene plant up to a carrying amount of R160 million. The Mirodene plant was disposed of for R100 million cash to a foreign investor on 3 January 20.9. At all times, management considered the useful life of the Mirodene plant to be 10 years from the date of acquisition. The corporate normal tax rate was 40% throughout. Other than as can be ascertained from the information provided, there are no differences between taxable income and accounting profit. The company creates deferred taxation assets as it has convincing evidence that any such asset would be recovered. Zuma Limited releases the realised portion of the revaluation surplus reserve directly to retained earnings. Required: 1. Prepare the journal entries (including those in respect of deferred taxation and bank) ascertainable from the information provided from 1 January 20.1 to 31 December 20.9. The company operates a single plant account and uses the net replacement cost method (i.e. you are not required to differentiate between the gross carrying amount and accumulated depreciation and accumulated impairment). 2. Prepare extracts from the statement of financial position (including notes), statement of changes in equity (including notes), and statement of comprehensive income (including notes) for inclusion in the 20.4 and 20.7 annual financial statements. Comparative figures are not required. Chapter 20: Page 8

Chapter 20: Impairment of Assets Solution: 1. Journals Calculation: Debit Credit R 000 R 000 20.1 Plant Given 100 000 Bank 100 000 1 January 20.1: Acquisition of plant Depreciation plant R100 000/10 years 10 000 Plant 10 000 31 December 20.1: Depreciation for the year Deferred taxation expense 40%[(R0 CA R0 TB) (R90 000 CA R80 000 TB)] 4 000 Deferred taxation liability 4 000 31 December 20.1: Deferred taxation for the year 20.2 Depreciation plant R100 000/10 years 10 000 Plant 10 000 31 December 20.2: Depreciation for the year Deferred taxation expense 40%[R90 000 CA 80 000 TB) 4 000 (R80 000 CA R60 000 TB)] Deferred taxation liability 4 000 31 December 20.2: Deferred taxation for the year 20.3 Plant R200 000 net replacement cost R80 000 carrying amount 120 000 Revaluation surplus reserve - OCI 60%(R120 000 revaluation) 72 000 Deferred taxation - liability 40%(R120 000 revaluation) 48 000 1 January 20.3: Revaluation 20.3 Depreciation R200 000/8 years 25 000 Plant 25 000 31 December 20.3: Depreciation Revaluation surplus reserve - OCI 60%(15 000 revaluation depreciation) or 9 000 Retained earnings R72 000/8 years 9 000 31 December 20.3: Release realised portion of RSR to RE Deferred taxation liability 40%[(o/b: 200 000 CA 60 000 TB) (c/b: 175 000 2 000 CA 40 000 TB)] Deferred taxation - expense 2 000 31 December 20.3: Deferred tax for the year 20.4 Depreciation R200 000/8 years 25 000 Plant 25 000 31 December 20.4: Depreciation Revaluation surplus reserve - OCI 60%(15 000 revaluation depreciation) 9 000 Retained earnings or R72 000/8 years 9 000 31 December 20.4: Release realised portion of RSR to RE Chapter 20: Page 9

A Student s Guide to International Financial Reporting Revaluation surplus reserve - OCI 60%(150 000 CA 60 000 NHC) 54 000 Deferred taxation - liability 40%(150 000 CA 60 000 NHC) 36 000 Impairment of plant expense R60 000 NHC R10 000 RA 50 000 Plant R150 000 CA R10 000 recoverable amount 140 000 31 December 20.4: Impairment of plant Deferred taxation liability 40%[(o/b: 175 000 CA 40 000 TB) (c/b: 10 000 22 000 CA 20 000 TB)] R36 000 above Deferred taxation - expense 22 000 31 December 20.4: Deferred taxation for the year 20.5 Depreciation R10 000/6 years 1 667 Plant 1667 31 December 20.5: Depreciation for the year Deferred taxation expense 40%[(o/b: 10 000 CA 20 000 TB) 7 333 (c/b: 8 333 CA 0 TB)] Deferred taxation liability 7 333 31 December 20.5: Deferred tax for the year 20.6 Depreciation R10 000/6 years 1 667 Plant 1667 31 December 20.6: Depreciation for the year Deferred taxation liability 40%[(o/b: 8 333 CA 0 TB) 667 (c/b: 6 666 CA 0 TB)] Deferred taxation expense 667 31 December 20.6: Deferred tax for the year 20.7 Plant R160 000 new carrying amount R6 666 old carrying amount 153 333 Reversal of impairment - income R40 000 R6 666 33 334 Revaluation surplus reserve - OCI 72 000 60%(R120 000 revaluation in excess of depreciated historic cost) Deferred taxation liability 40%(R120 000) 48 000 1 January 20.7: Reversal of impairment and revaluation Depreciation R160 000/4 years 40 000 Plant 40 000 31 December 20.7: Depreciation for the year Revaluation surplus reserve - OCI 60%(30 000 revaluation depreciation) or 18 000 Retained earnings R72 000/4 years 18 000 31 December 20.7: Realised portion released to retained earnings Deferred taxation liability 40%[(o/b: 6 666 CA 0 TB) 2 666 (c/b: 120 000 CA 0 TB)] + R48 000 above Deferred taxation expense 2 666 31 December 20.7: Deferred taxation for the year 20.8 Depreciation R160 000/4 years 40 000 Plant 40 000 31 December 20.8: Depreciation for the year Revaluation surplus reserve - OCI 60%(30 000 revaluation depreciation) 18 000 Retained earnings or R72 000/4 years 18 000 31 December 20.8: Realised portion released to retained earnings Chapter 20: Page 10

Chapter 20: Impairment of Assets Deferred taxation liability 40%[(o/b: 120 000 CA 0 TB) 16 000 (c/b: 80 000 CA 0 TB)] Deferred taxation expense 16 000 31 December 20.8: Deferred taxation for the year 20.9 Bank Given 100 000 Plant R160 000 (from 20.7 revaluation) x 2/4 years remaining 80 000 Profit on disposal of plant Balancing figure 20 000 3 January 20.9: Disposal of plant Deferred taxation liability 40%[(o/b: 80 000 CA 0 TB) 32 000 (c/b: 0 CA 0 TB)] Deferred taxation expense 32 000 31 December 20.9: Deferred taxation for the year Revaluation surplus reserve - OCI 60%(R80 000 CA R20 000 DHC) 36 000 Retained earnings 36 000 31 December 20.9: Release remaining balance of RSR to RE As alternatives to journals, workings can be produced in table or graph formats. Shown below is a table format. This is somewhat quicker and easier than journals and makes the task of subsequent disclosure relatively easy. WORKING Zuma Limited Table R 000 R 000 R 000 R 000 R 000 Date Historical Cost Carrying Amount Tax Base Def Tax (40%) * Reval Reserve 1 Jan 20.1 100 000 100 000 100 000 Depreciation 20.1 (10 000) (10 000) (20 000) 31 Dec 20.1 90 000 90 000 80 000 4 000 Depreciation 20.2 (10 000) (10 000) (20 000) 31 Dec 20.2 80 000 80 000 60 000 8 000 1 Jan 20.3 Revaluation 120 000 72 000 Depreciation 20.3 (10 000) (25 000) (20 000) (9 000) 31 Dec 20.3 70 000 175 000 40 000 54 000 63 000 Depreciation 20.4 (10 000) (25 000) (20 000) (9 000) 31 Dec 20.4 Reversal of reval (90 000) (54 000) 31 Dec 20.4 Impairment (50 000) 31 Dec 20.4 60 000 10 000 20 000 (4 000) - Depreciation 20.5 (10 000) (1 667) (20 000) 31 Dec 20.5 50 000 8 333-3 333 - Depreciation 20.6 (10 000) (1 667) 31 Dec 20.6 40 000 6 666-2 666-2 Jan 20.7 Reversal of Impairment 33 334 40 000 2 Jan 20.7 Revaluation 120 000 72 000 Depreciation 20.7 (10 000) (40 000) (18 000) 31 Dec 20.7 30 000 120 000-48 000 54 000 Depreciation 20.8 (10 000) (40 000) (18 000) 31 Dec 20.8 20 000 80 000-32 000 36 000 3 Jan 20.9 Disposal (20 000) (80 000) (32 000) (36 000) -- -- -- -- -- * Carrying amount less tax base x 40% Chapter 20: Page 11

A Student s Guide to International Financial Reporting 2. Disclosure ZUMA LIMITED PARTIAL STATEMENT OF FINANCIAL POSITION AT 31 DECEMBER 20.7 and 20.4 Note 20.7 Calculation: 20.4 Calculation: R 000 R 000 ASSETS Non-current assets Property, plant and equipment 11 120 000 R160 000 x 3/4 years 10 000 Given @ 30 December 20.4 Deferred taxation 13-4 000 40%(10 000CA 20 000TB) EQUITY AND LIABILITIES Issued share capital and reserves 12?? Deferred taxation 13 48 000 40%(120 000CA 0TB) - ZUMA LIMITED PARTIAL STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 20.7 and 20.4 Note 20.7 Calculation: 20.4 Calculation: R 000 R 000 Other comprehensive income: Reversal of revaluation - (54 000) 60%(R150 000CA R60 000DHC) - Revaluation 120 000 (R160 000 R40 000DHC) Income tax on revaluation (48 000) -?? ZUMA LIMITED PARTIAL STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 20.4 Revaluation surplus reserve Retained earnings TOTAL Calculation: R 000 Balance at 1 January 20.4 60%(R175 000CA R70 000DHC) 63 000?? Total comprehensive income for the year (54 000)?? Transfer upon realisation 60%(R15 000 revaluation depreciation) (9 000) 9 000 - Balance at 31 December 20.4 -?? ZUMA LIMITED PARTIAL STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 20.7 Calculation: Revaluation surplus reserve Retained earnings TOTAL R 000 Balance at 1 January 20.7 -?? Total comprehensive income for the year 72 000 -? Transfer upon realisation 60%(R30 000 revaluation depreciation (18 000) 18 000 - Balance at 31 December 20.4 54 000?? Chapter 20: Page 12

Chapter 20: Impairment of Assets ZUMA LIMITED PARTIAL NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 20.7 and 20.4 Note 1: Accounting policies Property, plant and equipment Plant is revalued at three year intervals to its fair value in existing use at the beginning of the year. Revaluations are accounted for on the net replacement cost method. The realised portion of the revaluation surplus reserve is released to retained earnings annually. Plant is depreciated on the straight-line method to nil residual values over ten years from the date of acquisition. 20.7 20.4 Note 2: Profit from operations Calculation: R 000 R 000 Profit from operations is stated after: Depreciation - owned plant 40 000 25 000 (Reversal of impairment)/ impairmet of plant 20.7: R40 000DHC R6 667CA 20.4: R60 000DHC R10 000 recoverable amount (33 333) 50 000 Note 3: Income taxation South African income tax 20.7: 40%[(6 666CA 0 TB) (c/b: 120 000CA 0 TB)] + R48 000 Deferred ( 2 666) (22 000) 20.4: 40%[(175 000CA 40 000 TB) (c/b: 10 000CA 20 000TB)] R36 000 Note 11. Property, plant and equipment 20.7 20.4 Calculation: Plant Plant Calculation: R 000 R 000 Valuation 250 000 250 000 R100 000HC/R80 000DHC x R200 000CA Accumulated depreciation and impairment (243 334) (75 000) 1 January 6 666 175 000 Revaluation R160 000 R100 000 60 000 - Reversal of prior period devaluation R100 000 R40 000DHC 60 000 - Reversal of prior period impairment R40 000DHC R6 666CA 33 334 - Depreciation R160 000/4 years ( 40 000) ( 25 000) R200 000/8 years x 1 year Reversal of prior period revaluation - ( 90 000) R150 000CA R60 000DHC Impairment expensed - ( 50 000) R60 000DHC R10 000RA 31 December 120 000 10 000 Comprised of: Valuation 250 000 250 000 Accumulated depreciation and impairment (130 000) (240 000) Carrying amount 120 000 10 000 Depreciated historic cost R100 000 x 3/10 years 30 000 10 000 * * Depreciated historic cost can never be greater than the asset s carrying amount at reporting date. 20.4: Impairment of plant A competitor began the commercial production of a product that greatly reduced the market for the company s AIDS treatment product and consequently the company impaired its Mirodene plant to its recoverable amount. The recoverable amounts were determined in accordance with IAS 36, at the plant s value in use, determined at a discount rate of x%. These assets had not previously been tested for impairment as the Mirodene market was lucrative and the probability of an AIDS curing drug was considered to be remote. Mirodene manufacturing is reported in the pharmaceutical segment. Chapter 20: Page 13

A Student s Guide to International Financial Reporting 20.7: Reversal of impairment of plant The World Health Organisation banned a competitor s incorrectly alleged AIDS curing drug during the year. This restored the viability of the company s previously impaired Mirodene AIDS treatment and the commercial production of this product to a greatly improved market share. Plant carried at revalued amounts was revalued by independent valuers NAME. The effective date of the most recent valuation is 2 January 20.7. Note 12: Issued share capital and reserves The purpose of the revaluation surplus reserve is to record the unrealised (net of deferred tax) portion of the increase resulting from the revaluation of plant. Note 13: Deferred taxation liability Balance at 31 December - plant 6. DISCLOSURE 6.1 Impairment losses in aggregate 20.7 20.4 Calculation: R 000 R 000 Calculation: 40%(120 000CA 0TB) 48 000 ( 4 000) 40%(10 000CA 20 000CA) For each class of assets that was impaired during the period disclose: the amount of the impairment losses recognised in profit or loss during the period; the line item(s) in the statement of comprehensive income in which those impairment losses are included; and the amount of impairment losses recognised directly in other comprehensive income during the period. For each class of assets for which an impairment loss was reversed during the period disclose: the amount of the reversals of impairment losses recognised in profit or loss during the period; the line item(s) of the statement of comprehensive income in which those reversals of impairment losses are included; and the amount of reversals of impairment losses recognised directly in other comprehensive income during the period. These disclosure requirements may be satisfied by the reconciliation of the opening and closing carrying amounts required by other Standards. However, because of their size and nature this may require additional disclosures thereof in the notes to the statement of comprehensive income. An entity that reports segment information shall disclose for each reportable segment (primary segments only) the amount of the impairment loss recognised or reversed during the period in profit or loss, and other comprehensive income during the period. 6.2 Individually material impairment In respect of each material impairment loss recognised or reversed during the period for an individual asset (including goodwill) or a CGU, disclose: the events or circumstances that lead to the recognition or reversal of the impairment loss; the amount of impairment loss recognised or reversed; for individual assets: (i) the nature of the asset, and (ii) the reportable segment (i.e. primary segment) to which the asset belongs; for a CGU: (i) a description of the CGU, (ii) the amount of the impairment loss recognised or reversed by class of asset and by segment (i.e. primary segment), and (iii) if the aggregation of assets for identifying the CGU has changed since the previous estimate of the CGU s Chapter 20: Page 14

Chapter 20: Impairment of Assets recoverable amount a description of the current and former way of aggregating assets and the reasons for changing the way the cash generating unit is identified; whether the recoverable amount of the asset (CGU) is its fair value less costs to sell or its value in use; where the recoverable amount is the fair value less costs to sell, the basis used to determine fair value less costs to sell (e.g. with reference to an active market); and where the recoverable amount is the value in use, the discount rates used in the current and previous estimate of value in use. 6.3 Individually immaterial impairments For impairment losses recognised or reversed during the period that did not qualify for separate disclosure, the entity shall disclose for the aggregate impairment losses and aggregate reversals of impairment losses: the main classes of assets affected; and the main events or circumstances that led to the recognition or reversal of the impairment losses. 7. INTANGIBLE ASSETS WITH INDEFINITE USEFUL LIVES OR NOT YET AVAILABLE FOR USE The recoverable amount of an intangible asset with an indefinite useful life or an intangible asset that is not yet available for use (affected intangible assets) should be estimated annually irrespective of whether there is any indication of impairment in order to test the affected intangible assets for impairment. Annual impairment tests in respect of indefinite useful life intangible assets and intangible assets not yet ready for use may be conducted at any time during the year provided that they are conducted at the same time every year. Different intangible assets may be tested for impairment at different times. However, intangible assets that were initially recognized during the current annual period, must be tested for impairment before the end of the current annual period. (Goodwill acquired in a business combination must also be tested annually for impairment.) For the indefinite useful life intangible assets and the intangible assets not yet ready for use the most recent detailed calculation of such asset s recoverable amount made in the preceding period may be used in the current period s impairment test provided all of the following criteria are satisfied: the assets and liabilities of the CGU to which the affected intangible asset belongs have not changed significantly since the most recent recoverable amount calculation; in the most recent impairment test the recoverable amount exceeded the carrying amount by a substantial margin; and based on an analysis of events that have occurred and circumstances that have changed since the most recent recoverable amount calculation, the likelihood that a current recoverable amount determination would be less than the asset s/cgu s carrying amount is remote. The effect of this is to make annual testing redundant. Chapter 20: Page 15

A Student s Guide to International Financial Reporting Illustrative example 20.4: Impairment review On 1 January 20.4, Retail Limited acquired the Petrol brand name at a cost of R200 million. The Petrol brand is now legally registered to Retail Limited and has been assessed by Retail Limited s directors as having an indefinite useful life. Utilisation of the Petrol brand has resulted in Retail Limited being able to brand its merchandise and sell it at a 50% premium to its pre-branding selling price. In accordance with IAS 36 the Petrol brand was tested for impairment at 31 December 20.4 when its recoverable amount (i.e. value in use) was determined to be R300 million (i.e. R100 million in excess of its carrying amount). During 20.5, the Petrol brand continued to perform beyond the directors expectations resulting in Retail Limited recording a record profit for the second year in succession. The directors have no reason to believe that this trend in future profitability will decline and are most pleased with the performance of the Petrol brand. Required: Discuss the measures that IAS 36 requires Retail Limited to undertake during 20.5 in respect of the Petrol brand. Solution: Impairment indicator review At 31 December 20.5 Retail Limited is required to carry out an impairment indicator review considering external and internal sources of information. If the impairment indicator review reveals that there are indications that the assets of Retail Limited may be impaired then an impairment test must be conducted (i.e. the recoverable amount of the assets must be determined). In the case of Retail Limited at 31 December 20.5 the impairment indicator review is unlikely to find indications of impairment given that the Petrol brand exceeded all performance expectations and that the company is recording record profits and is expected to continue to do so for the foreseeable future. Indefinite useful life intangible asset Irrespective of whether there is any indication of impairment, the recoverable amount of the Petrol brand (because it has an indefinite useful life) must be estimated at 31 December 20.5 However, because at 31 December 20.4 the recoverable amount of the Petrol brand was computed (in detail) to be R300 million, that value may be used in lieu of a detailed impairment test being conducted during 20.5 because all of the following criteria are satisfied: in the most recent impairment test the recoverable amount exceeded the carrying amount by a substantial margin (evidenced by the 31 December 20.4 impairment test that showed the recoverable amount exceeded the carrying amount by 50% of the carrying amount); and the likelihood that the current recoverable amount would be less than the affected asset s carrying amount is remote (evidenced by the improved profitability of the company being attributed to the Petrol brand whose performance has exceeded the expectations of the directors and is expected to continue to do so for the foreseeable future). Chapter 20: Page 16

Chapter 20: Impairment of Assets 8. CASH-GENERATING UNITS (CGUs) 8.1 Introduction A CGU is defined as the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets. Impairment testing is preferably carried out at the level of each individual asset. However, this is not always possible because it is not always possible to determine cash inflows at this level. For example, it is not possible to determine the cash inflows for the individual assets of a mechanical production line made up of many different machines even where the fair value less costs to sell of some of the individual machines is known because the function of those machines is generic to a number of manufacturing processes. The value in use of the machines in a production line (the CGU) must therefore be determined as a whole. If the assets of a CGU (production line) are of a specialised nature (and they frequently are) then the fair value less costs to sell of the CGU will be indeterminable so its recoverable amount would be computed at its value in use. Some assets contribute to cash flows of more than one CGU (e.g. the head-office). Such assets, other than goodwill, are referred to as corporate assets (see 8.3 below). A CGU to which goodwill has been allocated shall be tested for impairment annually. For the purpose of impairment testing, goodwill shall be allocated at a level that: represents the lowest level within the entity at which the goodwill is monitored for internal management purposes; and shall not be larger than a segment. 8.2 CGUs without corporate assets and without goodwill The carrying amount of a CGU shall be determined on a basis consistent with the way the recoverable amount of the CGU is determined. To measure the impairment loss of a CGU to which no corporate assets and no goodwill have been allocated, the entity must, in addition to the points made in respect of individual assets: (a) (b) Identify the asset s CGU - the carrying amount includes the carrying amount of only those assets that can be directly attributed, or allocated on a reasonable and consistent basis, to the asset s CGU. Compute the carrying amount of the CGU - this is determined as the sum of the carrying amounts of that CGU s assets after deducting the carrying amount of a liability if, and only if, the recoverable amount of the asset s CGU cannot be determined without consideration of this liability (e.g. site restoration liability). An impairment loss shall be recognised for a CGU if, and only if, its recoverable amount is less than the aggregate of the carrying amounts of all the items of that unit. If the recoverable amount of an asset cannot be determined individually, an impairment loss shall be recognised for that asset if, and only if, an impairment loss is recognised for the asset s CGU. An asset within a CGU that the entity has made a decision to scrap (and its value in use can therefore be determined at its scrap value), shall be removed from the CGU. The recoverable amount of the asset to be scrapped can be determined without reference to the other assets of the CGU (scrap value = value in use = fair value less costs to sell). Chapter 20: Page 17

A Student s Guide to International Financial Reporting For example: Three identical machines produce the same product. One machine becomes irreparably damaged, and a decision is therefore taken to scrap that machine. The scrapped machine is removed from the CGU and tested for impairment as an individual asset as its recoverable amount = its fair value less costs to sell = its value in use = expected net proceeds from scrapping. The remaining two machines and the other assets of the CGU are tested for impairment as a CGU. Illustrative example 20.5: Impairment testing One of the machines (Machine 5A) in a production line has suffered damage due to the negligence of its operator. Although the damaged machine is currently operating less than optimally, and its estimated remaining useful life has been revised downward from ten years to two years, the CGU s value in use (taken as a whole) remains well in excess of its carrying amount. Required: Under each of the following circumstances briefly outline whether Machine 5A should be impaired: Scenario X: The directors intend keeping Machine 5A in existing use for the foreseeable future. Scenario Y: The directors have taken the decision to scrap Machine 5A and have ordered a replacement machine which is expected to arrive within two weeks. Solution: Scenario X: The Machine 5A cannot be tested for impairment on its own as its value in use is dependent upon the other machines in the CGU. As the value in use of the CGU exceeds its carrying amount the CGU is not impaired and consequently Machine 5A cannot be impaired. Scenario Y: Because the decision has been taken to scrap Machine 5A immediately its recoverable amount approximates R0. The recoverable amount is Machine 5A s value in use, which is R0 as it will generate no future cash flows. Machine 5A therefore is removed from the CGU and tested for impairment as an individual asset. Consequently, the entire remaining carrying amount of Machine 5A would be expensed. 8.2.1 Allocation of an impairment loss within a CGU The impairment loss in respect of the CGU is allocated against the assets of the CGU on a pro rata basis. However, in allocating the above impairment loss, the carrying amount shall not be reduced below the asset s fair value less costs to sell, or, if there is no fair value less costs to sell for that asset, then not below zero. This may lead to a residue of the impairment loss. The residue of the impairment loss not allocated because of the above shall be allocated: (a) firstly, to assets whose fair value less costs to sell is less than their carrying amount, on a pro rata basis based on their new carrying amount, and (b) secondly, to the other assets of the CGU on a pro rata basis based on the new carrying amount of each asset in the unit to which the excess amount of impairment loss is allocated. Chapter 20: Page 18

Chapter 20: Impairment of Assets Illustrative example 20.6: Allocation of impairment loss A CGU whose recoverable amount is R12 000 has the following assets: Carrying amount Fair value less costs to sell Rand Rand - Motor vehicle 4 000 4 000 - Plant 1 000? - Factory building 10 000 7 000 - Registered fixed period patent 5 000? 20 000 The resultant impairment of R8 000 (calculation: R20 000 carrying amount R12 000 recoverable amount) shall be allocated to the individual assets of the entity as follows: Impairment Carried forward Calculation: Rand Rand First round of allocation: - Motor vehicle R4 000/R20 000 x R8 000 impairment: Limited to nil - 1 600 - Plant R1 000/R20 000 x R8 000 impairment 400 - - Factory building R10 000/R20 000 x R8 000 impairment Limited to R3 000 3 000 1 000 - Fixed period patent R5 000/R20 000 x R8 000 impairment 2 000-5 400 2 600 Second round of allocation: - Plant (R600 plant)/(r600 plant + R3 000 patent) x R2 600 impairment carried forward from first allocation - Fixed period patent (R3 000 patent)/(r600 plant + R3 000 patent) x R2 600 impairment carried forward from first allocation 433-2 167-2 600-8.2.2 Reversals of impairments Reversals of impairments in respect of CGUs are allocated to the assets of a CGU (except goodwill) on a pro rata basis in proportion to the carrying amount of the individual assets of the CGU. An impairment of goodwill may not be reversed. The carrying amount of an asset shall not be increased above the lower of: its recoverable amount, and the carrying amount that would have been determined had no impairment loss been recognised for the asset in prior periods (i.e. depreciated historic cost). IFRIC 10 Interim financial reporting confirms that where an entity has recognised an impairment loss in a previous interim period in respect of goodwill, it may not reverse such a loss at reporting date even if conditions may have changed such that the impairment loss may have been reduced or avoided had the impairment assessment only been made at that date. (see section 9 of this chapter) Chapter 20: Page 19

A Student s Guide to International Financial Reporting Illustrative example 20.7: Reversal of impairment On 31 December 20.3, as a result of the South African Government imposing a ban on tobacco product advertisements in South Africa, Bustandboom Limited impaired its tobacco cash-generating unit down to its recoverable amount of R1 million. During 20.5, as a result of an aggressive advertising campaign in China, the profitability of Bustandboom Limited s tobacco cash-generating unit was fully restored. On 31 December 20.5, the recoverable amount of the tobacco cash-generating unit was reliably determined at R5 million. Bustandboom Limited revalued all of its plant on 1 January 20.2. On 1 January 20.2, the tobacco cash-generating unit s plant was revalued upward by R1 000 000. Revaluations are conducted every two years. The carrying amount of the tobacco cash-generating unit s plant was not adjusted on 1 January 20.4 as the carrying amount before the valuation was not materially different to its fair value on that date. The plant and factory building are depreciated on the straight-line method to nil residual values. Goodwill is carried at cost and tested for impairment annually. The implied fair value of goodwill on 31 December 20.3 was R0. Details of the assets of Bustandboom Limited s tobacco cash-generating unit, all of which arose from the acquisition, on 1 January 20.1, of a competitor s net assets, are as follows: Remaining useful life Cost Fair value less costs to sell 1 January 20.1 1 January 20.1 31 December 20.3 31 December 20.5 Years Rand Rand Rand Plant 10 2 000 000 100 000 2 000 000 Building 10 2 000 000 300 000 1 000 000 Goodwill Indefinite 571 429?? 4 571 429 Required: Compute, in accordance with IFRS, for EACH of the assets of Bustandboom Limited s tobacco cashgenerating unit: The impairment expense charged against profit from operations for the year ended 31 December 20.3; and the carrying amount at 31 December 20.5. Solution: 31 December 20.3: Impairment 1 Jan 31 Dec Revaluation 1 Jan 30 Dec Impairment/ 31 Dec 20.1 20.1 20.2 20.3 devaluation 20.3 Rand Rand Rand Rand Rand Rand Rand Plant 2 000 000 1 800 000 1 000 000 1 2 800 000 2 177 777 2 (1 569 081) 5 608 696 6 Building 2 000 000 1 800 000-1 800 000 1 400 000 3 (1 008 696) 6 391 304 7 Goodwill 571 429 571 429 4-571 429 4 571 429 4 ( 571 429) 5-4 149 206 (3 149 206) Reversal of revaluation 777 777 7 Impairment (2 371 429) Impairment expense plant Calculation: R1 569 081 above R777 777 reversal of revaluation 791 304 1 000 000 Chapter 20: Page 20