Week - PowerPoint Presentation

Slide1

Week 4: Impairment of Assets

Financial Accounting BFA201Slide2

Learning ObjectivesTo demonstrate your understanding of the following:How and when to revalue an item of property, plant and equipmentUpward revaluations to ‘fair value’ and downward revaluations to ‘recoverable amount’

Impairment losses and how to account for them

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Readings and referencesDeegan Chapter 6AASB 116 Property, Plant and EquipmentAASB 136 Impairment of Assets

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4Independent Study TasksTutorial 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

MyLOSlide5

Introduction to RevaluationsCriticisms of historical costOption to revalue non current assetsAsset revaluations – what are they?Reassessment of the

carrying amount of a non-current asset to fair value as at a particular date (excludes impairment)

5Slide6

Measurement: AASB 116

Cost

Model

(

para

. 30)

Asset Measurement Models

Based

on Asset

Classes

(

para

. 29)

Revaluation Model

(

para

. 31)

Original

COST

Depreciation

Impairment

loss AASB 136

FAIR VALUE

Regular revaluation

Impairment loss AASB 136

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Cost model – para 30Gross carrying amount (acquisition cost)

Gross carrying amount –

NEVER

changes

Loss / Expense

Carrying value

7Slide8

Revaluation value model AASB 116 para. 31Gross carrying amount (fair value)

Class of assets regularly

revalued

Expense/

Reval

Carrying value

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Choice: COST or FAIR VALUE?Same Class = same model Land & Office Aircraft MotorBuildings Equipment

Vehicles Any revaluation fair valueAble to be measured reliably; sufficient regularity

FV

FV

Cost

Cost

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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 amountDepreciation methods usedUseful lives or depreciation rates usedGross 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 period10Slide11

Impairment AASB136Both 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

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Impairment of assets AASB 136Revalued asset? Treat as revaluation decrease

yes

yes

12Slide13

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 livesIntangibles 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

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Indicators of impairmentFor individual assets or cash-generating units:EXTERNALMarket declines Technological changesEconomic or legal changesInterest ratesNet assets > market

capitalisationINTERNALObsolete Physical damageRestructuringPoor performance

Not

impaired?

Ask if previously impaired?

Yes! Reverse.

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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

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Measuring Recoverable Amount.

Which is the higher of?

Carrying amount

Recoverable amount

Fair value

less

costs to sell

Value in use

is compared to

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Fair value less costs to sellMeasured in accordance with; AASB 13 Fair Value MeasurementThe 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 valueCosts of disposal

BFA201_13

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Value in use“ … the present value of future cash flows expected to be derived from an asset or cash-generating unit” para 65 elements (para 30)

Estimate of future cash flows Possible variations in future cash flows

Time value of money

Risk factor

Other factors

eg

. illiquidity

STEPS (

para

31):

estimate future cash flows

apply a discount rate

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Value in use – determining the discount rateThe discount rate should reflect:The pre-tax time value of money

The entity’s WACC The entity’s incremental borrowing rateOther market borrowing rates

The

risks

specific to the asset for which future cash flows have not been adjusted

Country risk

Currency risk

Price risk

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Recording an impairment loss for an individual assetImpairment loss = CA > RACost model: impairment loss is recognised immediately in profit and loss

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Cost model: Impairment LossSuppose an asset having a carrying amount of $100 (original cost $160, and accumulated depreciation $60) has a recoverable amount of $90The 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

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Revaluation (NOT cost model)Revaluation increments AASB 116 para. 39 part of owners’ equity (other comprehensive income) not P&L DR Asset XXXX CR Revaluation surplus XXXXHowever there is an exception to this as include in

P&Lwhere it is reversing a previous decrement (see later)

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Lecture Example 1If 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)!

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Revaluation IncrementsHOWEVER:If

It must be recognised in

profit & loss

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Lecture Example 2From 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

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Revaluation decrements AASB 116 para. 40Decrease to Profit & Loss DR

Loss on revaluation (expense) XXXX CR Land XXXXHOWEVER if

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]

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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 $200,000 Cr Cash $200,00030/6/08 Dr Loss on revaluation $50,000

Cr Land $50,000

30/6/10

Dr Land $60,000

Cr Gain from reversal of previous revaluation $50,000

Cr Revaluation Surplus $10,000

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Revaluing Depreciable AssetsGross method OR Net-amount method

Next

period – Recalculate depreciation

NET METHOD:

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Lecture Example 4Durango 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.

RequiredPrepare 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.

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Solution

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Solution cont.

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Recording an impairment loss for an individual asset : revaluation modelImpairment loss = CA > RARevaluation model - impairment loss is treated as a revaluation decrement

Subsequent depreciation/amortisation is based on the new recoverable amount.32Slide33

Lecture Example 5Asset 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?

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SolutionJournal Entries: Dr Accumulated depreciation 20 Cr Asset 20

Dr Revaluation write-down 10 Cr Asset 10

If the

revalued

asset had a previous revaluation:

Dr Revaluation surplus 10

Cr Asset 10

(120 – 100)

(100 – 90)

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Lecture Example 6: Impairment losses and CGUs A Ltd has identified an impairment loss of $12,000 on one of its CGUsThe CGU consists of the following assets (stated at current carrying amounts):

Buildings $500,000Equipment $300,000Land $250,000

Fittings $

150,000

Calculate the allocation of impairment loss against all assets in the CGU.

Recalculate if the

FVLCTS

of the building is $497,000.

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Solution a)

CA

Pro-rata

Impairment loss allocated

Adjusted CA

Buildings

500,000

Equipment

300,000

Land

250,000

Fittings

150,000

5/12

5,000

495,000

3/12 3,000

297,000

2.5/12

2,500 247,500

1.5/12

1,500

148,500

1,200,000

12,000

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Solution b)

Adjusted CA

Pro-rata

Impairment loss allocated

Total impairment loss allocated

Buildings

3,000

Equipment

Land

Fittings

297,000

297/693

857

3,857

247,500

247.5/693

714

3,214

148,500

148.5/693

429

1,929

693,000 2,000

12,000

From last column of previous slide

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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 CGUSlide38

Solution cont.General Journal Entries: Dr CrImpairment Loss $12 000Acc.dep.& impair losses – Building $3 000Acc.dep.& impair losses – Equipment $3 857

Land $3 214Acc.dep. & impair losses – Fittings $1 929(Recognition of the impairment losses)

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Reversal of impairment lossesImpairment losses: reassessed annuallyIf recoverable amount now exceeds the carrying amount:The asset’s carrying amount is increased to its recoverable amount; andAn income item ‘reversal of impairment loss’ is recognised

(offsetting prior expense)39Slide40

Reversal of impairment losses cont.Recoverable amount exceeds carrying amount:If previously revalued then CR Revaluation SurplusCANNOT REVERSE IMPAIRMENT ON GOODWILLNOTE: 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

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Lecture Example 7On 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.

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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.RequiredShow journal entries relating to this asset on 30 June

2005, 30 June 2006 and 30 June 2007.

BFA201_13

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Solution 43Slide44

Solution cont.44Slide45

Economic consequences of asset revaluationsIf contracts in place are tied to reported profits (debt or management compensation), management might have an incentive not to revalueHowever, if assets are increased a revaluation might loosen constraints such as debt-to-assets restrictionsFirms 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

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Next WeekAccounting for Intangible Assets and Goodwill© Copyright University of Tasmania, School of Accounting & Corporate Governance

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