The purpose of the impairment test for assets
Impairment of an asset occurs when its realisable value is less than the value at which it is recorded in the firm’s financial statements i.e. its carrying value. Asset impairment is a kind of loss to the entity which must be accounted for immediately in the books of account. Whenever there are indications of impairment from internal or external sources, it becomes necessary for the firm to conduct an impairment test. After conducting the impairment test, if is it observed that the assets are actually impaired in reality then the carrying values of the assets must be revised to bring them down to the level of their realisable value in the market. The assets that are non-current in nature are subject to impairment. It is not always necessary that an entity may have to face impairment of its individual assets, but in certain situations, entire cash generating units of the entity gets impaired.
An impairment test of an asset measures whether such asset is worth the value that is incorporated in the firm’s financial statements. As per the international accounting standards on impairment, the carrying value of the assets must be brought down to the value that could be realised from the sale of such assets in the market at that particular point of time (Dagwell, Wines & Lambert, 2015).
As per the International Financial Reporting Standards (IFRS), entities must conduct impairment testing on the annual basis for the assets that have uncertain lives like non-depreciable items such as goodwill or any other brand assets (Li, Shroff, Venkataraman & Zhang, 2011). However, if there are some indications of asset impairment then the tests of impairment must be conducted at shorter interval. There can be various sources of indications of asset impairment from both internal and external environment (Ernst & Young, 2010). Though there is no comprehensive list of internal or external indicators but internal indicators are those indicators that could be controlled by management such as the underperformance of a business unit. External indicators, on the other side, are not within the control of the entity such as the variations in the economic conditions. IAS 36 Impairment sets out certain circumstances that indicate the possibility of impairment of the assets held by the entity (Dagwell, Windsor & Wines, 2004). Those situations are listed below:
Internal Environment:
- When there are evidences of asset obsolescence or its physical damage, available with the entity.
- When there are evidences that the asset’s future financial performance is going to be worse than its current actual performance or that what was expected from it.
- When there are modifications in entity’s operating plans such as discontinuation of a business unit or restructuring of the business unit to which such asset belongs (ACCA, 2012).
External Environment:
- When there is a reduction in the asset’s market value which is quite higher than the reduction that was normally expected from such asset due passage of time or its usage.
- When there are significant negative changes in various factors such as technology, market, economic conditions or laws in relation to the asset (Hayn & Hughes, 2006).
- When the market capitalisation of the reporting entity is lower than its net assets
- When there is significant increase in the market interest rates (Ramanna & Watts, 2012).
The above lists are not exhaustive rather they are inclusive. However, impairment test for the cash generating unit can be undertaken when a particular asset from the entire unit is not generating sufficient cash flows which are considerably dependent of cash flows from various other assets of the same unit.
Even if there is no indication, the goodwill that is acquired due to business combination must be test for impairment each year at the date of balance sheet. To conduct the impairment test on goodwill, the acquiring firm must allocate it to each of its cash generating unit or the groups of such CGUs that are anticipated to be benefited by the synergies achieved from business combination. This allocation has to be done irrespective of whether other items of target firm are assigned to such CGUs or not. A CGU to which goodwill has been assigned must have impairment test for at least once in a year by matching the carrying amount of entire CGU (including goodwill) with their recoverable price (Duangploy, Shelton & Omer, 2005). If it is found that the recoverable sum of the unit is less than its total carrying value, then impairment loss arises in respect of such unit and such loss must be accounted for immediately in the books of account in the following manner:
- Firstly the carrying value of goodwill which forms part of CGU must be reduced to the maximum possible extent.
- Then for the remaining amount of impairment loss, the carrying value of other assets that forms part of CSU must be adjusted on the pro-rata basis (basis of their individual carrying amounts).
- Identification of asset that may have impairment loss: At the balance sheet a company must assess as to whether there is a presence of indication that suggests the possibility of asset impairment.
- Determining its total recoverable value: The recoverable amount of the asset that is expected to be impairment is to be identified. Recoverable amount is the greater of fair market value of the asset or its value in use. However, the fair market value of the asset expected to be impaired must be adjusted for the cost incurred for selling the asset and the value in use of such asset is adjusted for the cost of disposal of the asset. The asset’s fair value is determined in compliance with IFRS 13 i.e. the fair value measurement (Ball, 2006). In case, where the fair value net of disposal cost of asset is more than the amount by which asset is carried in the balance sheet, then there is no requirement to determine the other value. However, when the value in use cannot be identified, then the recoverable value is regarded as the value in use (Chen, Wang & Zhao, 2008).Value in use is the present value of all the anticipated cash flows that are related with the asset to be impaired. The projection for cash flows must be done on the basis of reasonable assumptions, budgets and the forecasts.
- Determination of discounting rate: To compute the present values of the future cash flows, the discounting rate has to be identified. The rate of discounting must be pre tax rate and it must reflect the recent market assessments in relation to time value of money (Lhaopadchan, 2010).
When to undertake an impairment test
The loss on account of impairment of any asset can be reversed when the recoverable value of such asset exceeds the price at which such asset is carried in the balance sheet. However, as per IAS 36, the impairment loss on goodwill cannot be reversed in any year. The amount by which impairment loss on any asset is reversed must be credited back to the profit and loss except in the situation when impairment loss on such asset was formerly charged to the revaluation account created in respect of that particular asset (Jahmani, Dowling & Torres, 2010). The increased amount of the asset due to reversal of impairment loss must not be higher than what depreciable historical cost of such asset could have been in the situation when impairment loss had not been charged to it. After making revisions to the carrying values of the assets on the grounds of reversal of impairment, the amount of depreciation or amortisation must also be revised for their further allocation in the subsequent periods (AASB, 2009).
While reviewing the annual report of BlueScope Steel Limited for the year ended 2017, it has been observed that different assets are measured on different bases.
- The inventories have been measured at lower of the cost and the net realisable value of such inventories.
- Trade receivables of the company were originally measured at the fair value and subsequently they were measured at the amortised values.
- The emission unit which is an intangible asset to the company is measured at its cost for the purpose of recognition in the financial statements.
- The property plant and equipment of the company are valued at the historical cost net of accumulated depreciation and/or impairment.
- Goodwill is measured as the difference between the acquisition cost of business and the fair market value of the tangible and non-tangible assets that are identifiable in nature and also the liabilities transferred to the company through the purchase of business. In more simple terms, goodwill is recorded at the acquisition cost net of accumulated impairment losses (BlueScope, 2017).
- The intangible assets of the company are measured at cost on their initial recognition. The cost of the intangible assets that have been obtained in the business combination is the fair market value of such assets on the date of their acquisition (AASB, 2004).
Current Assets:
- Cash and cash equivalents
- Trade and other receivables
- Inventories
- Operating intangible assets: Emission Unit Permits
- Derivative financial instruments
- Deferred charges and prepayments
Non- Current Assets:
- Trade and other receivables
- Inventories
- Operating intangible assets
- Derivative financial instruments
- Investments
- Property, plant and equipment
- Land
- Buildings
- Iron and Steel
- Coating Lines
- Building components
- Other plant and equipment
- Intangible assets
- Goodwill
- Patents, trademarks and other rights
- Computer software
- Customer relationships
- Other Intangible assets
- Deferred tax assets
- Deferred charges and prepayments
- Non-financial assets
- Cash generating Units
- Building North America
- North Star Blue Scope Steel LLC
While reviewing the financial report of BlueScope Steel Limited for the year ended 2017, it has been found that following assets have been impaired in 2017:
Building Products: The impairment in the current year in regards to building products is because of uncertain conditions of regulatory environment surrounded to the business of BlueScope Steels such as tariffs, importation quotas and various other regulatory measures and also the margin compression that is on-going in the market (Hsieh & Wu, 2005). The impairment of the said assets was based on their then recoverable value of $ 190 Million.
The goodwill of the company is never amortised, rather it is subject to impairment test on the annual basis or even on more frequent intervals when there are events or circumstances that indicate the chances of impairment test.
In the current period, other building products are also impaired i.e. the assets within ASEAN countries, North America as well as Indian Segment. These are the fixed assets which are written off for the impairment purpose for the amount of $ 4.7 Million in regards to the business assets that are meant engineered building solutions as they are no longer in requirement of the business.
The BlueScope Buildings are also written off at the amount of $ 43.9 Million in relation to the assets that are not going to be required for any longer (BlueScope, 2017).
Further, the debts for which evidences are found for their non-collections are required to be identified and hence the company has identified such trade receivables and created a provision of impairment.
While examining the annual report of BlueScope Steel Limited for the year ended 2017, it has been found that there is no case of reversal of impairment loss in the current year. In case of no asset, the recoverable price of the asset has exceeded the amount carried by them in the financial statements (CPA Australia, 2018).
Impact of goodwill on the impairment test
The effect of the impairment of the assets on the financial statements of BlueScope Steel Limited for the year ended 2017 is that the carrying amounts of certain assets for the year, 2017 were revised to account for the impairment losses (Carmichael & Graham, 2012). In the present year, total impairment loss of amount $ 98.9 million was reported by the entity. This impairment has been determined by calculating the excess of carrying amount over the recoverable amount of such assets. By studying the notes to accounts in relation to impairment of assets as contained in the annual reports, it has been found that the building products that belonged to Indian property plant and equipment has been impaired for the amount of $ 4.7 million and the buildings of china and the goodwill and other assets have been impaired for the amount of $ 43.9 million. This impairment amount comprises of loss on goodwill of $ 12 million and loss on other intangible assets of $ 3.3 million and $ 28.6 million for the loss of property plant and equipment for which evidences were available that such assets will no longer be used in the business of the company. Further, the building products belonging to Indonesian property plants and equipment has suffered the impairment loss of 50.3 million. Due to these impairment losses the carrying values of the said properties, plants and equipment were adjusted for the impairment losses in their respective categories (BlueScope, 2017).
From the above evaluation of annual report of BlueScope Steel Limited for the year ended 2017, it can be said that the company has appropriately given the adjustments for all the impairments that have occurred in respect of its property plant and equipment along with goodwill and various other intangible assets. The company has followed adequate procedures to account for the impairment losses that have taken place in the current year. All the procedures that have been followed by the company are found to be in line with the international financial reporting standards prescribed by the international bodies of accounting standards (Christian & Lüdenbach, 2013). Not only, the measurement of impairment loss is correctly undertaken by the company but also the recognition of such impairment losses has been made appropriately by charging such losses to the profit and loss account and by revising the carrying value of such assets in the statement of financial position i.e. the balance sheet. Moreover, the disclosure of such impairment losses is made by complying with all the disclosure requirements of the relevant accounting standard i.e. IAS 136 (Reinstein & Lander, 2004). Proper disclosures have been made adequately in the annual report of the company by way of notes to accounts.
Conclusion:
In summary it can be said that the effect of impairment of the assets is quite significant as it directly affects the profitability of the company. Therefore, impairment tests must be conducted by an entity on the reasonable intervals whenever there is any indication that casts the possibility of the impairment of an asset or an entire cash generating unit. If impairment losses are not adequately accounted for by the reporting entities, the true state of affairs of the company will not be depicted by its financial statements and this will ultimately mislead the stakeholders of the company about its overall profitability.
References
AASB (2009).Impairment of Assets. Retrieved from: https://www.aasb.gov.au/admin/file/content105/c9/AASB136_07-04_COMPjun09_01-10.pdf
ACCA (2012). .Impairment of goodwill and CGUs. Retrieved from: https://www.accaglobal.com/in/en/member/discover/cpd-articles/corporate-reporting/goodwill-cgus.html
Ball, R. (2006). International Financial Reporting Standards (IFRS): pros and cons for investors. Accounting and business research, 36(sup1), 5-27.
BlueScope (2017).ANNUAL REPORT 2016/2017. Retrieved from: https://s3-ap-southeast-2.amazonaws.com/bluescope-corporate-umbraco-media/media/2278/bluescope-steel-annual-report-2016-17-web.pdf
Carmichael, D. R., & Graham, L. (2012). Accountants’ handbook, financial accounting and general topics (Vol. 1). New Jersey: John Wiley & Sons.
Chen, S., Wang, Y., & Zhao, Z. (2007). Evidence of Asset Impairment Reversals from China: Economic Reality or Earnings Management?.
Chen, S., Wang, Y., & Zhao, Z. (2008). Evidence of Asset Impairment Reversals from China: Economic Reality or Earnings Management? Journal of Accounting, Auditing and Finance & KPMG Foundation Conference
Christian, D., & Lüdenbach, N. (2013). IFRS essentials. United Kingdom: John Wiley & Sons.
CPA Australia (2018). IAS 36 IMPAIRMENT OF ASSETS Retrieved from: https://www.cpaaustralia.com.au/~/media/corporate/allfiles/document/professional-resources/reporting/reporting-ifrsfactsheet-impairment-of-assets.pdf?la=en
Dagwell, R., Windsor, C., & Wines, G. (2004, February). The proposed goodwill impairment test–implications for preparers, auditors and corporate governance. In One-Day Symposium on Accountability, Governance and Performance in Transition.
Dagwell, R., Wines, G., & Lambert, C. (2015). Corporate accounting in Australia. Australia: Pearson Higher Education AU.
Duangploy, O., Shelton, M., & Omer, K. (2005). The value relevance of goodwill impairment loss: while the market discounts the importance of goodwill amortization, it does not disregard goodwill impairment loss as irrelevant. Bank Accounting & Finance, 18(5), 23-29.
Ernst & Young. (2010). Impairment accounting – the basics of IAS 36 Impairment of Assets. Retrieved from: https://www.ey.com/Publication/vwLUAssets/Impairment_accounting_the_basics_of_IAS_36_Impairment_of_Assets/$FILE/Impairment_accounting_IAS_36.pdf
Hayn, C., & Hughes, P. J. (2006). Leading indicators of goodwill impairment. Journal of Accounting, Auditing & Finance, 21(3), 223-265.
Hsieh, W. T., & Wu, C. T. Z. (2005). Determinants and market reaction of assets impairment in Taiwan. Taiwan Accounting Review, 6(1), 59-95.
IFRS. (2017). IAS 36 Impairment of Assets. Retrieved at: < https://www.ifrs.org/issued-standards/list-of-standards/ias-36-impairment-of-assets/> Accessed on 12-01-2018.
Jahmani, Y., Dowling, W. A., & Torres, P. D. (2010). Goodwill impairment: a new window for earnings management. Journal of Business & Economics Research, 8(2), 19-23.
Lhaopadchan, S. (2010). Fair value accounting and intangible assets: Goodwill impairment and managerial choice. Journal of Financial Regulation and Compliance, 18(2), 120-130.
Li, Z., Shroff, P. K., Venkataraman, R., & Zhang, I. X. (2011). Causes and consequences of goodwill impairment losses. Review of Accounting Studies, 16(4), 745-778.
Ramanna, K., & Watts, R. L. (2012). Evidence on the use of unverifiable estimates in required goodwill impairment. Review of Accounting Studies, 17(4), 749-780.
Reinstein, A., & Lander, G. H. (2004). Implementing the impairment of assets requirements of SFAS No. 144: An empirical analysis. Managerial Auditing Journal, 19(3), 400-411.
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