ASEM IFRS SEMINAR Shanghai, 25-26 March 2006

1. ASEM IFRS SEMINARShanghai, 25-26 March 2006 Impairment of Assets Dr Allister Wilson Technical & Audit Partner Ernst & Young, UK Senior Advisor to the EUROPEAN COMMISSION

2. Highlights • When is an asset impaired? • When is an impairment test necessary? • What is “Recoverable Amount” • Steps in the value in use test • Disclosure

3. When is an asset impaired? An asset is impaired if it is stated in the balance sheet at an amount that is more than the amount that will be recovered through the use of the asset in the business or its sale Essentially, this means that assets should not be carried at more than their “fair value”

4. What is the purpose of the impairment test? Therefore, the purpose of the impairment test is to ensure that the carrying value of any fixed asset is not greater than its “recoverable amount”

5. When is an impairment test necessary? Annually for • Goodwill • Intangible assets with indefinite economic life • Intangible assets not yet available for use Whenever there is an indication of impairment • if there is, a full impairment test is needed to estimate the recoverable amount of the asset

6. Impairment triggers – External • A significant decline in the asset’s 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 company’s assets • The company’s reported net assets exceed its market capitalisation These are changes in market circumstances rather than changes in the company or its business

7. Impairment triggers – 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

8. Examples of evidence of impairment from internal reporting • the cash needs for operating or maintaining the asset are significantly higher than those originally budgeted • the actual net cash flows or operating profit or loss flowing from the asset are significantly worse than those budgeted • there is a significant decline in the budgeted net cash flows or operating profit, that are expected to flow from the asset • It is expected that there will be operating losses or net cash outflows for the asset, when current period amounts are aggregated with budgeted amounts for the future

9. The meaning of recoverable amount Carrying Value Recoverable Amount is compared to which is the higher of Fair value less cost to sell Value In Use

10. Recoverable amount – definitions • Recoverable amount is the higher of an asset’s fair value less cost to sell and its value in use • Fair value less cost to sell is the amount obtainable from the sale of an asset in an arm’s 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 How do you measure “fair value less cost to sell” where there are no markets?

11. Steps in the “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 identified

12. What are “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 Presents difficulties in some industries with many hundreds of CGUs vs. those with only one very large CGU

13. 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

14. Forecast cash flows should • Be based on reasonable and supportable assumptions that represent management’s best estimate • 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 modest growth • Be translated at spot rates at balance sheet date

15. Forecast cash flows • Cash flows should be based on the asset in its current condition • Therefore, estimates of future cash flows should not include: • A future restructuring to which the enterprise is not yet committed • Future capital expenditure that will improve or enhance the asset • Estimated cash flows from ultimate disposal of the asset based on an arm’s length transaction These are artificial assumptions that management would never make in real life

16. Discount rate should be • This is difficult to determine and can have a big impact on whether or not an impairment charge is recorded • It should reflect the current market rate appropriate for the risks specific to the asset or cash generating unit - that is, the rate of return that the market would expect to earn on an equally risky investment • Determined after considering • The company’s weighted average cost of capital • The company’s incremental borrowing rate • Other market borrowing rates • The adjustments needed to reflect different risks

17. Impairment loss on assets • If the carrying amount of an asset exceeds its recoverable amount, it should be written down • The impairment loss is normally expensed in the income statement, unless the asset had been revalued in which case 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

18. Reversal of an impairment loss • In subsequent periods, companies should look for indications that an impairment loss has reversed • Increase in an asset’s market value • Favourable changes in the company’s 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

19. Reversal of impairment losses on assets • 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 as appropriate • However, a goodwill impairment may never be reversed

20. Disclosure requirements • Very detailed disclosure requirements • Impairments per IAS 14 segment • Events and circumstances leading to impairment • Requirement to disclose sensitive information • Carrying amount of goodwill allocated to CGUs • Description of key assumptions used in value-in-use calculation • Description of key assumptions used in determining fair value less costs to sell • Where a reasonably possible change in assumptions might cause an impairment charge

21. Contact Information Allister Wilson Ernst & Young LLP +44 20 7951 1443 awilson@uk.ey.com www.gaap.co.uk