Implementation and Applications of IFRS on Asset Impairment and Asset Held For Sale

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Implementation and Applications of IFRS on Asset
Impairment and Asset Held For Sale

• Vienna, March 14, 2006
• By Thierry Bertrand, Partner, EY
• Olivier Lemaire, Partner, EY
• Renaud Breyer, Manager, EY

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Agenda

• Asset impairment
• Refresh
• Indicators of impairment
• Recoverable amount
• Cash-generating units ( CGUs )
• Impairment measurement
• First-time adoption issues
• Non current asset held for sale
• Refresh
• Classification as held for sale
• Measurement
• Asset held for sale and discontinued operations

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Refresh IAS 36 does not deal with the
impairment of

• inventories
• assets arising from construction contracts
• deferred tax assets
• assets arising from employee benefits
• financial assets (other than subsidiaries,
  associates and joint ventures)
• investment properties, if measured at fair value
• biological assets related to agricultural
  activity, if measured at fair value less
  point-of-sale costs

IAS 36 applies to all other assets including
goodwill, intangible assets with undefinite
useful live, intangible assets with finite useful
life, tangible assets,
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Refresh - When is an impairment review necessary?

• Companies need to consider, at each balance sheet
  date, whether there is any indication that an
  asset may be impaired
• If there is, a full impairment review is needed
  to estimate the recoverable amount of the asset
• Otherwise, no further action is required

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Refresh - Indications of impairment external

• A significant decline in the assets market value
• A significant adverse change in the
  technological, market, economic or regulatory
  environment in which the company operates
• An increase in interest rates or other market
  rates of return that affect the return required
  on the companys assets
• The companys reported net assets exceed its
  market capitalisation

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Refresh - Indications of impairment internal

• Obsolescence or physical damage affecting the
  asset
• Significant changes affecting the asset, such as
  plans to discontinue or restructure certain
  activities
• Internal reporting systems showing or predicting
  poor performance from particular assets or
  business units

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Refresh - Impairment review

• At the end of each annual reporting period,
  irrespective of whether any indication of
  potential impairment exists, an entity shall
• estimate the recoverable amount of intangible
  assets with an indefinite useful life or not yet
  available for use however, the most recent
  detailed calculation of recoverable amount made
  in the preceding period may be used in the
  current period provided specific criteria are met
• test goodwill acquired in a business combination
  for impairment

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Indicators of impairment

• Scenario 1
• Group A, a conglomerate operating in very
  diversified industries, has acquired Entity B in
  September 20X4.
• Entity B specializes in performing technical
  inspections and surveys of ships.
• As a result of the business combination, Group A
  has recognized a trademark and goodwill.
• The trademark was fair valued using the royalty
  relief method.
• The trademark is protected over a period of 20
  years and can be renewed for an insignificant
  cost therefore, it has an indefinite useful life.

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Indicators of impairment

• Scenario 1 (Cont)
• The goodwill arising on the acquisition of B
  remains allocated to Entity B, as a group of
  CGUs.
• The CFO has decided to use the following as
  indicators of impairment
• Significant adverse changes in the regulatory
  environment in which Entity B operates
• Significant decline in the budgeted cash flows
• Significant decline of the market share

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Indicators of impairment

• Scenario 1 (Cont)
• At the end of 20X5 the CFO looked at the above
  indicators and he decided there is no need to
  perform an impairment test due to the following
• The market share has slightly increased by 0.8
  compared to prior year
• No changes occurred in the regulatory environment
  in which the company operates
• The budgeted cash flows reflect the increase in
  the market share and the steady growth of the
  shipping industry in which most of the companys
  clients are operating.
• Question
• No impairment test has been performed since
  September 20X4. Should we be concerned about this?

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Indicators of impairment

• Solution
• The Group should perform an impairment test.
  According to IAS 36.10, an entity shall test an
  intangible asset with indefinite useful life and
  the goodwill for impairment annually,
  irrespective of whether there is an indication of
  impairment.
• In the case described, it means that although the
  circumstances point out that there is no need for
  an impairment test to be performed, the test
  should be performed anyway because the asset is
  not amortised.

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Indicators of impairment

• Solution (Cont)
• This impairment test may be performed at any time
  during the year, provided it is performed at the
  same time every year.
• The impairment test for the brand may be
  performed at a different time than the test for
  goodwill, but for practical reasons it would be
  more relevant to perform both tests at the same
  time.

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Recoverable amount definitions

• The objective of the impairment test is to ensure
  that the carrying value of an asset is not
  greater that its recoverable amount
• Recoverable amount is the higher of an assets
  net selling price and its value in use
• Net selling price is the amount obtainable from
  the sale of an asset in an arms length
  transaction between knowledgeable, willing
  parties, less the costs of disposal
• Value in use is the present value of estimated
  future cash flows expected to arise from the
  continuing use of an asset and its disposal at
  the end of its useful life

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Recoverable amount Value in use test

• Identify cash generating units
• Allocate assets to these units
• Forecast future cash flows for each unit
• Identify discount rate and discount the cash
  flows
• Compare resulting value in use with carrying
  value
• Write down as necessary to reflect any impairment
  loss thus identified

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Recoverable amount Value in use

• The following elements should be reflected in the
  calculation of an assets value in use
• an estimate of the future cash flows an entity
  expects to derive from the asset
• the time value of money
• expectations about possible variations in the
  amount and/or timing of those future cash flows
• the price for bearing the uncertainty inherent in
  the asset
• other factors, such as illiquidity
• The use of assumptions is an essential element
  of the expected cash flow method !

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Cash generating units

• Defined as the smallest identifiable group of
  assets that generates cash flows from continuing
  use that are largely independent of the cash
  flows from other assets or groups of assets
• Identification of units should be based on
  judgement, influenced by how they are monitored
  internally
• Once chosen, units should be consistently defined
  thereafter unless there are good reasons for
  change

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Cash generating units

• Determination is not conditioned upon existence
  of indicators of impairment
• Judgement and very good knowledge of the industry
  and of the organisation of the company are
  required
• Varying approaches in practice in various
  entities may be applied
• Determination should be done at the lowest level
  possible
• Independent cash inflows does not necessarily
  mean external cash inflows

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Cash generating units determination

• Scenario 1
• A tour operator owns three hotels of a similar
  class, offering the same facilities, near the
  beach at a large holiday resort.
• These hotels are advertised as alternatives in
  the operator's brochure, at the same price.
• Holidaymakers are frequently transferred from one
  to another and there is a central booking system
  for independent travelers.
• The reporting system of the tour operator allows
  it to identify the cash flows generated by each
  of these hotels.
• Solution
• The three hotels can be regarded as offering
  genuinely substitutable products by a
  sufficiently high proportion of potential guests
  and can be grouped together as a single
  cash-generating unit. The hotels are run as a
  single hotel on three sites.

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Cash generating units determination (contd)

• Scenario 2
• A luxury-clothing producer M owns three stores in
  the same city (although in different
  neighbourhoods) and 20 stores in other cities.
• All stores are managed in the same way and all
  stores purchase from the same factory owned by M.
  Pricing, advertising, marketing and human
  resources policies (except for hiring specific
  sales staff) are managed centrally by M.
• The management does not have any intention to
  sell any of these stores because of their
  strategic location.
• Frequent transfers of products take place between
  the three stores in order to satisfy customers
  demands and the customers have no preferences
  between the three stores as long as they find the
  product they want in any of them.
• Solution
• It is likely that the cash inflows generated by
  one store alone are not independent of the cash
  inflows generated by the other stores located in
  the same city.Therefore, we may consider that a
  clothing retailer with an established brand name
  would be justified in treating its three stores
  in same city as a single CGU.

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Cash generating units determination (contd)

• Scenario 3
• A gas industry company has a certain number of
  customer contracts for whose fulfilment it uses
  several gas fields located in the same
  geographical area.
• The gas fields are not dedicated to a particular
  contract.
• The company is using the same distribution
  network (pipelines, etc) for all the gas fields.
• The gas field that will be the delivery source
  will depend on the companys centralised
  allocation decision.
• Solution
• The three gas fields represent a cash-generating
  unit

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Cash generating units Allocation

• Attribute all identifiable assets and liabilities
  to the appropriate cash generating units
• Exclude tax assets and liabilities, interest
  bearing debt, and other items relating wholly to
  financing
• For items, such as corporate assets and goodwill,
  that cannot be allocated or apportioned to
  individual cash generating units, a second value
  in use test at a higher level of aggregation may
  be needed
• Ensure that the allocation of carrying values is
  done on the same basis

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Cash generating units Allocation

• Goodwill should be tested for impairment as part
  of the impairment testing the CGU to which it
  relates (annually and whenever there is an
  indication that it may be impaired)
• The carrying amount of goodwill should be
  allocated to each of the smallest CGU to which a
  portion of that carrying amount can be allocated
  on a reasonable and consistent basis
• Allocation is consistent with the lowest level at
  which management monitors the return on
  investment
• The CGU cannot be larger than a segment based
  either on primary or secondary reporting format

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Impairment measurement

• Forecast cash flows should
• Include all the relevant cash flows of that
  particular asset or cash generating unit
• Reflect the asset or unit in its present state
• Exclude cash flows relating to tax and financing
• Be consistent with up-to-date budgets and plans
• Beyond the period covered by budgets, assume only
  steady state or declining growth

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Impairment measurement (contd)

• Discount rate should be
• The current market rate appropriate for the risks
  specific to the asset or cash generating unit
• Pre-tax
• Consistent with the forecasts treatment of
  inflation
• Determined after considering
• The companys weighted average cost of capital
• The companys incremental borrowing rate
• Other market borrowing rates
• The adjustments needed to reflect different risks

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Impairment measurement individual assets

• If the carrying amount of an asset exceeds its
  recoverable amount, it should be written down
• The reduction in value the impairment loss is
  normally expensed in the income statement
• If the asset had been revalued, the impairment
  loss is treated as a revaluation decrease
• An asset should not be written down below zero
  unless it is required to recognise a liability
  under another standard
• The new carrying amount forms the basis for
  future depreciation and revised deferred tax
  balances

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Impairment measurement cash generating units

• The impairment loss should be allocated
• First to any goodwill in the unit
• Then, on a pro rata basis, against the other
  assets in the unit, but not so as to write down
  any below the highest of
• its net selling price (if determinable)
• its value in use (if determinable)
• Zero
• Any amount remaining unallocated should only be
  treated as a liability if required by another
  standard

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Impairment measurement Reversal of an
impairment loss

• In subsequent periods, companies should look for
  indications that an impairment loss has reversed
• Increase in an assets market value
• Favourable changes in the companys environment
• Decreases in interest rates/other rates of return
• Favourable changes within the company
• Improved performance of the asset
• If these exist, the recoverable amount should be
  re-estimated, and the loss reversed if
  appropriate

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Impairment measurement Reversal of an
impairment loss

• The reversal is limited to the amount that brings
  the asset back to the carrying amount it would
  now be stated as if no loss had been recognised
• The reversal is credited to the income statement,
  or treated as a revaluation increase for revalued
  assets
• In a cash generating unit, it should be allocated
  pro rata to assets other than goodwill to restore
  them to their previous amounts, only if
• The loss was caused by a specific external event
  of an exceptional nature that will not recur, and
• That specific event has now been reversed
• The reversal of the impairment loss recognised
  for goodwill is prohibited

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First-time adoption issues

• Impacts of IAS 36 on financial reporting
• As IAS 36 prescribes very precise indicators for
  triggering impairment tests, entities will
  probably have to perform such tests more
  frequently than under previous GAAP.
• The lower-level aggregation of assets may lead to
  the recognition of impairment losses that do not
  arise under existing local GAAP.
• IAS 1 requires that all amortization amounts and
  impairment losses are reported under results from
  continuing operations in the income statement.
• IAS 36 prescribes numerous disclosures relating
  to the impairment of assets, even if they are of
  confidential nature

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First-time adoption issues (contd)

• Except for goodwill, first-time adopters have the
  benefit of a number of exemptions from the
  requirement of full restatement of opening IFRS
  balance sheet, in particular the fair value as
  deemed cost for fixed assets.
• Impairment test is required if there is any
  indication that an asset is impaired. If a
  first-time adopter recognise or reverse any
  impairment losses, it should disclose detailed
  information.

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Refresh Classification as held for sale

• A non current asset is classified as held for
  sale if its carrying amount will be recovered
  principally through a sale transaction rather
  than through continuing use
• It must be available for immediate sale, and sale
  must be highly probable, which requires that
• management is committed to a plan to sell it
• an active programme to fulfil the plan has been
  started
• it must be being marketed at a reasonable price
• a completed sale within a year must be expected
• significant changes to the plan must be unlikely
• Non current asset held for sale is different from
  assets to be abandoned

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Classification as Held for Sale Scenario

• Scenario
• Good Group acquires through foreclosure a
  property comprising land and buildings that it
  intends to sell.
• After the renovations are completed and the
  property is classified as held for sale but
  before a firm purchase commitment is obtained,
  Good Group becomes aware of environmental damage
  requiring remediation. The Good Group still
  intends to sell the property immediately after
  the remediation is completed.
• Question
• Did Good Group corrrectly classify the property
  as held for sale?
• Answer
• No, Good Group did not correctly classify the
  property. Even if Good Group still intends to
  sell the property after the remediation is
  completed, Good Group does not have the ability
  to transfer the property to a buyer until after
  the remediation is completed. The delay in the
  timing of the transfer of the property imposed by
  others before a firm purchase commitment is
  obtained demonstrates that the property is not
  available for immediate sale (different
  requirements could apply if this happened after a
  firm commitment is obtained). The criterion of
  IFRS 5.7 has not been met. The property should be
  reclassified as held and used.

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Measurement

• Once classified as held for sale, assets or
  disposal groups are valued at
• Lower of
• Carrying Value AND (Fair value -
  Selling Costs)
• Depreciation is discontinued
• Initial and subsequent changes in value treated
  as impairment

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Measurement

• No Previous Revaluation
• Initial change in CV recognised in PL
• Subsequent decrease in value recognised in PL
• Subsequent increase in value recognised in PL
• Only up to reversal of the impairment loss
  recognised

• Previous Revaluation
• Initial changes in CV recognised in revaluation
  reserve until used, then PL.
• Subsequent decrease in value recognised in
  revaluation reserve until used, then PL.
• Subsequent increase in value to reverse
  write-down recorded above

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Assets Held for Sale and Discontinued Operations
An asset held for sale should not be confused
with a discontinued operation that is a component
of an entity that either has been disposed of, or
is classified as held for sale, and

• represents a separate major line of business or
  geographical area of operations
• is part of a single co-ordinated plan to dispose
  of a separate major line of business or
  geographical area of operations or
• is a subsidiary acquired exclusively with a view
  to resale.

In such case, the company would present the
income statement of the discontinued operation in
one single line in the consolidated income
statement.
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QA