Week 4: Impairment of Assets Financial Accounting BFA201 Learning Objectives To demonstrate your understanding of the following: • How and when to revalue an item of property, plant and equipment • Upward revaluations to ‘fair value’ and downward revaluations to ‘recoverable amount’ • Impairment losses and how to account for them 2 Readings and references • Deegan Chapter 6 • AASB 116 Property, Plant and Equipment • AASB 136 Impairment of Assets 3 Independent Study Tasks Tutorial questions (for workbooks) • What does the ‘impairment of an asset’ mean? How should impairment of an item of property, plant and equipment be accounted for? • Deegan Challenging Questions 22 and 25 from Chapter 6 Independent study questions (not for workbooks) • Deegan Chapter 6 Review Questions 3, 16, 19 and an additional question (Quiggly Ltd) on MyLO 4 Introduction to Revaluations • Criticisms of historical cost • Option to revalue non current assets • Asset revaluations – what are they? • Reassessment of the carrying amount of a noncurrent asset to fair value as at a particular date (excludes impairment) 5 Measurement: AASB 116 Asset Measurement Models Based on Asset Classes (para. 29) Cost Model Revaluation Model (para. 30) (para. 31) • Original COST • FAIR VALUE • Depreciation • Regular revaluation • Impairment loss AASB 136 • Impairment loss AASB 136 6 Cost model – para 30 • Gross carrying amount (acquisition cost) Cost Loss / Expense NBV Carrying value Gross carrying amount – NEVER changes Accum Dep & Impair 7 Revaluation value model AASB 116 para. 31 • Gross carrying amount (fair value) Fair value Expense/ Reval NBV Carrying value Class of assets regularly revalued Accum Dep & Impair 8 Choice: COST or FAIR VALUE? • Same Class = same model F V Land & Buildings C o s t Office Equipment F V Aircraft C o s t Motor Vehicles • Any revaluation fair value • Able to be measured reliably; sufficient regularity 9 AASB 116: Disclosure requirements (para 73-79) • For each class of depreciable asset, the following must be disclosed: – Measurement bases used for determining gross carrying amount – Depreciation methods used – Useful lives or depreciation rates used – Gross carrying amount and accumulated depreciation at the beginning and end of the period – Detailed reconciliation of the carrying amount at the beginning and end of the period 10 Impairment AASB136 • Both models (cost and revaluation) refer to impairment (AASB 136) • Are assets overstated? Test for impairment: – asset’s carrying amount (CA) is MORE than its recoverable amount (RA) • Exempted from test: – – – – – Inventories Construction contracts Assets from Employee benefits Deferred tax assets Assets held for resale The specific requirements in relation to these assets are covered in the AASBs that deal with these balances 11 Impairment of assets • AASB 136 • Q - Any indication of impairment ? Reporting date assessment Impairment Test • Calculate RA • Is carrying value > recoverable amount ? • MUST write down to recoverable amount Impairment Loss • Revalued asset? • Treat as revaluation decrease 12 When to test for impairment? • When there is an indication (or evidence) of impairment • Each reporting period – assess indicators • The following assets must be tested annually for impairment: • Intangibles with indefinite useful lives • Intangibles not yet available for use • Goodwill acquired in a business combination Reason annual testing is required … the CA of these assets is more uncertain than that of other assets 13 Indicators of impairment For individual assets or cash-generating units: • EXTERNAL – Market declines Not – Technological changes impaired? – Economic or legal changes Ask if previously – Interest rates impaired? – Net assets > market capitalisation Yes! • INTERNAL Reverse. – Obsolete – Physical damage – Restructuring – Poor performance 14 Cash-generating units (CGUs) • “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” (AASB136: para 6) • RA = The higher ↑ of Fair Value Less Costs to Sell (FVLCTS) and Value In Use (VIU) • Individual machine in a factory? – Value due to relationship with other assets • Impairment allocated to cash-generating unit (CGU) • IMPAIRMENT LOSS - pro-rata basis 15 Measuring Recoverable Amount . Carrying amount is compared to Recoverable amount Which is the higher of? Fair value less costs to sell Value in use 16 Fair value less costs to sell • Measured in accordance with; – AASB 13 Fair Value Measurement – The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (Appendix A) • Two parts to the definition: • Fair value • Costs of disposal BFA201_13 17 Value in use • “ … the present value of future cash flows expected to be derived from an asset or cash-generating unit” para 6 • 5 elements (para 30) 1. Estimate of future cash flows 2. Possible variations in future cash flows 3. Time value of money 4. Risk factor 5. Other factors eg. illiquidity • STEPS (para 31): 1. estimate future cash flows 2. apply a discount rate 18 Value in use – determining the discount rate • The discount rate should reflect: The pre-tax time value of money • The entity’s WACC • The entity’s incremental borrowing rate • Other market borrowing rates The risks specific to the asset for which future cash flows have not been adjusted • Country risk • Currency risk • Price risk 19 Recording an impairment loss for an individual asset • Impairment loss = CA > RA • Cost model: impairment loss is recognised immediately in profit and loss 20 Cost model: Impairment Loss Suppose an asset having a carrying amount of $100 (original cost $160, and accumulated depreciation $60) has a recoverable amount of $90 The journal entry for the impairment loss would be: 30 June X8 Impairment loss 10 Accumulated depreciation and impairment losses 10 To record the Impairment loss on asset Depreciation expense now based on recoverable amount. Eg. If residual value 0 and useful life remaining 3 yrs = 90/3 = $30 pa 21 Revaluation (NOT cost model) • Revaluation increments AASB 116 para. 39 part of owners’ equity (other comprehensive income) not P&L • DR Asset CR XXXX Revaluation surplus XXXX • However there is an exception to this as include in P&Lwhere it is reversing a previous decrement (see later) 22 Lecture Example 1 • If land recorded at $200,000 and latest valuation is $250,000, then the net effect is: Debit Land (Asset) $ 50 000 Credit Revaluation surplus $ 50 000 » If it is a depreciating asset always write down asset to its carrying amount first (see later)! 23 Revaluation Increments HOWEVER: If increase reverses a previous revaluation decrease It must be recognised in profit & loss 24 Lecture Example 2 • From previous example, land acquired for $200 000; revalued to $250,000. • Journal entries: Dr Land $50 000 Cr Reval. surplus $50 000 • A new airport is located near the land resulting in a decline in the value of the land to $147 000. • Decrement required is $250 000 - $147 000 = $ 103 000 Journal entry: Dr Revaluation Surplus $50 000 Dr Loss on Revaluation (expense) $53 000 Cr Land $103 000 25 Revaluation decrements AASB 116 para. 40 Decrease to Profit & Loss DR Loss on revaluation (expense) XXXX CR Land XXXX HOWEVER if decrease reverses a previous revaluation increase DR Revaluation surplus (upward reval.) DR Loss on revaluation (any excess) CR Asset (total revaluation) [Note: always check if you need to first reverse a previous revaluation] 26 Lecture Example 3 1/7/07: Z Ltd purchased land for $200,000 (Reval. Model) 30/6/08 - revalued to fair value $150,000 30/6/10 – revalued to fair value $210,000 1/7/07 Dr Land Cr 30/6/08 Dr $200,000 Cash $200,000 Loss on revaluation $50,000 Cr Land $50,000 30/6/10 Dr Land $60,000 Cr Gain from reversal of previous revaluation Cr Revaluation Surplus $50,000 $10,000 27 Revaluing Depreciable Assets • Gross method OR • Net-amount method NET METHOD: 1st • Depreciate • (for prior period if applicable) 2nd • Close Accum.Depreciation A/c • DR Acc Dep; CR Asset 3rd • Revalue NET amount • DR / CR asset • Next period – Recalculate depreciation 28 Lecture Example 4 • Durango Ltd purchased an item of plant on 1 July 2000 and chose the revaluation model to account for assets in that class. The plant cost $100 000 and was to be depreciated using the straight line basis over 20 years. On 30 June 2002 its fair value was $180 000, while on 30 June 2004 it’s fair value was $50 000. On 1 July 2004 the plant was sold for $60 000. Required • Prepare the journal entries to record the above events in accordance with AASB 116 ‘Property, plant and equipment’. Use the net amount method for your treatment of accumulated depreciation. 29 Solution 1/7/X0 Plant Cash at bank DR 100,000 CR 100,000 30/6/X1 Depreciation expense Accumulated depreciation - Plant 5,000 30/6/X2 Depreciation expense Accumulated depreciation - Plant 5,000 Accumulated depreciation Plant 10,000 Plant Revaluation surplus 90,000 5,000 5,000 10,000 90,000 30 Solution cont. 30/6/X3 Depreciation expense Accumulated depreciation - Plant 10,000 30/6/X4 Depreciation expense Accumulated depreciation - Plant 10,000 1/7/X4 10,000 10,000 Accumulated depreciation Plant 20,000 Revaluation surplus Loss on revaluation Plant 90,000 20,000 Cash at bank Gain on disposal Plant 60,000 20,000 110,000 10,000 50,000 Revaluation surplus =$0; No entry to retained earnings 31 Recording an impairment loss for an individual asset : revaluation model • Impairment loss = CA > RA • Revaluation model - impairment loss is treated as a revaluation decrement • Subsequent depreciation/amortisation is based on the new recoverable amount. 32 Lecture Example 5 • Asset has carrying amount of $100 (fair value of $120 and accumulated depreciation $20) and a recoverable amount of $90. • How does your answer change if the carrying amount of $100 was the result of a previous revaluation? 33 Solution • Journal Entries: Dr Accumulated depreciation Cr Asset Dr Revaluation write-down Cr Asset 20 (120 – 100) 20 10 (100 – 90) 10 • If the revalued asset had a previous revaluation: Dr Revaluation surplus 10 Cr Asset 10 34 Lecture Example 6: Impairment losses and CGUs • A Ltd has identified an impairment loss of $12,000 on one of its CGUs • The CGU consists of the following assets (stated at current carrying amounts): Buildings $500,000 Equipment $300,000 Land $250,000 Fittings $150,000 a) Calculate the allocation of impairment loss against all assets in the CGU. b) Recalculate if the FVLCTS of the building is $497,000. 35 Solution a) CA Pro- Impairment rata loss allocated 5/12 5,000 Buildings 500,000 3/12 3,000 Equipment 300,000 2,500 Land 250,000 2.5/12 1,500 Fittings 150,000 1.5/12 1,200,000 Adjusted CA 495,000 297,000 247,500 148,500 12,000 36 Solution b) If the FV of the building is $497,000 this is the max to which these assets could be reduced. Balance of $2,000 needs to be allocated across the other assets in the CGU Adjusted CA Prorata Impairment Total loss impairment allocated loss allocated Buildings Equipment 3,000 Land 297,000 247,500 Fittings 148,500 693,000 From last column of previous slide 247.5/693 857 714 3,857 3,214 148.5/693 429 1,929 2,000 12,000 297/693 37 Solution cont. General Journal Entries: Dr Cr Impairment Loss $12 000 Acc.dep.& impair losses – Building $3 000 Acc.dep.& impair losses – Equipment $3 857 Land $3 214 Acc.dep. & impair losses – Fittings $1 929 (Recognition of the impairment losses) 38 Reversal of impairment losses • Impairment losses: reassessed annually • If recoverable amount now exceeds the carrying amount: – The asset’s carrying amount is increased to its recoverable amount; and – An income item ‘reversal of impairment loss’ is recognised (offsetting prior expense) 39 Reversal of impairment losses cont. • Recoverable amount exceeds carrying amount: – If previously revalued then CR Revaluation Surplus – CANNOT REVERSE IMPAIRMENT ON GOODWILL • NOTE: the carrying amount cannot be increased to an amount in excess of the carrying amount that would have been determined had no impairment loss been recognised. • i.e. RE-WORK DEPRECIATION 40 Lecture Example 7 • On 30 June 2005 Ablett Ltd owns an item of factory machinery. It has an original cost of $200 000 with accumulated depreciation of $40 000 (one year’s depreciation). It is being depreciated on a straight line basis over 5 years and it is estimated that it has no residual value. • On 30 June 2005, Ablett Ltd estimates that the factory machinery is impaired (certain indicators are that the present value of net cash flows from the machine are lower than expected), as its value in use is estimated to now be $120 000. 41 Lecture example 7 cont. • On 30 June 2006 (after depreciation for the year has been recorded), information comes to light that the output of the factory machinery will be significantly in demand in future years and that the machinery’s value in use is now $170 000. Required Show journal entries relating to this asset on • 30 June 2005, • 30 June 2006 and • 30 June 2007. BFA201_13 42 Solution 30/6/X5 30/6/X6 Impairment loss Accumulated depreciation and impairment losses Recording impairment loss (200,000 - 40,000) -120,000 40,000 Profit and loss Impairment loss Closing entry 40,000 Original cost Accumulated depreciation and impairment losses Depreciation this year (120,000/4) CARRYING AMOUNT Recoverable Amount at 30/6/X6 40,000 40,000 Now 200,000 80,000 30,000 90,000 170,000 Accumulated depreciation and impairment losses Income - impairment loss reversal To record impairment loss reversal (120,000 - 90,000) 30,000 Income - impairment loss reversal Profit and loss Closing entry 30,000 Without impairment loss 200,000 40,000 40,000 120,000 30,000 30,000 43 Solution cont. 30/6/X7 Depreciation Accumulated depreciation and impairment losses To record depreciation for the year (120,000/3) 40,000 Profit and loss Depreciation Closing entry 40,000 40,000 40,000 44 Economic consequences of asset revaluations • If contracts in place are tied to reported profits (debt or management compensation), management might have an incentive not to revalue • However, if assets are increased a revaluation might loosen constraints such as debt-to-assets restrictions • Firms subject to political scrutiny might be more likely to undertake upward revaluation resulting in a reduction in profits • As the perceived competence of independent valuers increases, audit time might be reduced 45 Next Week Accounting for Intangible Assets and Goodwill © Copyright University of Tasmania, School of Accounting & Corporate Governance All rights reserved. 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