IAS 36

1. IAS 36 Impairment of Assets KPMG International Financial Reporting Group Presented By: Tony Boutros & Walid Farran

2. Agenda Background and scope Indications of impairment and frequency of testing Recoverable amount Fair value less costs to sell Value in use Cash-generating units, goodwill and corporate assets Accounting aspects Disclosure

3. Background Objective • assets should be carried at no more than their recoverable amount.

4. Scope • Applies to all assets except • Inventories (IAS 2; lower of cost or NRV) • construction contracts (IAS 11; a loss is booked when it is probable that total contract costs will exceed total contract revenue) • deferred taxes (IAS 12; an assets is booked only when its recovery is probable) • financial assets (IAS 39) • assets arising from employee benefits (IAS 19) • investment properties, measured at fair value (IAS 40) • biological assets at fair value less estimated point-of-sale costs (IAS 41) • deferred acquisition costs (IFRS 4) • non-current assets classified as held for sale (IFRS 5)

5. Definitions (1) • Recoverable amount of an asset or a CGU • is the higher of an assets fair value less costs to sell and its value in use. • Fair value less costs to sell • is the amount obtainable from the sale of an asset or CGU in an arm’s length transaction between knowledgeable, willing parties, less the costs of disposal. • Value in use • is the present value of future cash flows expected to be derived from an asset or a CGU.

6. Definitions (2) • Cash Generating Unit (CGU) • is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or group of assets. • Impairment loss • is the amount by which the carrying amount of an asset or a cash generating unit exceeds its recoverable amount.

7. Agenda Background and scope Indications of impairment and frequency of testing Recoverable amount Fair value less costs to sell Value in use Cash-generating units, goodwill and corporate assets Accounting aspects Disclosure

8. Indications of impairment • At each balance sheet date an entity should assess whether there is any indication that an asset or a CGU may be impaired. If any such indication exists, the entity should estimate the recoverable amount of the asset. • If no indication exists, no need to make a formal estimate of recoverable amount; except for:

9. Frequency of testing (1) Recent calculation can be used if criteria are met • Goodwill acquired in business combination • Intangible assets with an indefinite useful life • Intangible assets not yet available for use • Impairment test • annually, and • at each reporting date, whenever there is an indication that an asset may be impaired; • before the end of the period of initial recognition Any time within an annual reporting period needs to be consistent (same time every year)

10. Frequency of testing (2) • Recent calculation can be used if the following criteria are met: • CGU did not change substantially • Most recent recoverable amount was substantially higher than carrying amount • Analysis of events and circumstances – likelihood that recoverable amount is lower than carrying amount is remote

11. Frequency - summary impairment test Asset / CGU yes Indication? impairment test no CGU GW alloc/ intangible assets within the scope of IAS 36 impairment test recent calculation can be used if criteria are met yes Indication? impairment test at least annually • any time within an annual reporting period • consistency no

12. Indications of impairment (1) • External sources • significant decline in market value • technological, market, economic, legal environment • changes in interest rates or rates of return • low market capitalisation • Internal sources • evidence of obsolescence or physical damage • discontinuance, disposal, idle • asset performance declining or expected to decline • High maintenance • Net cash flow is worse than budgeted • Operating losses

13. Indications of impairment (2) • If there is an indication that an asset may be impaired, this may indicate that the remaining useful life, the depreciation (amortization) method or the residual value for the asset needs to be reviewed and adjusted in accordance with the Standard applicable to the asset, even if no impairment loss is recognized for the asset.

14. Agenda Background and scope Indications of impairment and frequency of testing Recoverable amount Fair value less costs to sell Value in use Cash-generating units, goodwill and corporate assets Accounting aspects Disclosure

15. Recoverable amount (1) Greater of and RECOVERABLE AMOUNT VALUE IN USE FAIR VALUE LESS COSTS TO SELL It is not always necessary to determine both an asset’s fair value less costs to sell and its value in use. If either of these amounts exceeds the asset's carrying amount, the asset is not impaired and it is not necessary to estimate the other amount.

16. Recoverable amount (2) Value in Fair value Recoverable Carrying Comment Use less costs amount is: amount to sell 900 1,050 1,050 1,000 No impairment 900 980 980 1,000 Impairment of 20 960 925 960 1,000 Impairment of 40

17. Agenda Background and scope Indications of impairment and frequency of testing Recoverable amount Fair value less costs to sell Value in use Cash-generating units, goodwill and corporate assets Accounting aspects Disclosure

18. Fair value less costs to sell (1) • Binding sale agreement • No binding sale agreement • active market (current bid price, or most recent transactions.) • No active market • best information available (results of recent transactions In the same industry. • Costs of disposal (eg: legal costs, stamp duty, cost of removing the asset, other direct costs to bring the asset into condition for its sale) • Costs of disposal exclude: • reorganisation costs (restructuring cost) • costs already recognised as liabilities

19. Fair value less costs to sell (2) X operates in leased premises. It owns a bottling plant which is situated in a single factory unit. Bottling plants are sold periodically as a complete assets. Professional valuers have estimated that the plant might be sold for $100,000. They have charged a fee of $1,000 for providing this valuation. X would need to dismantle the asset and ship it to any buyer. Dismantling and shipping would cost $ 5,000. Specialist packaging would cost a further $4,000 and legal fees $ 1,500. Compute fair value less costs to sell:

20. Fair value less costs to sell (3) Fair value less costs to sell: $ Sales price 100,000 Dismantling and shipping (5,000) Packaging (4,000) Legal fees (1,500) Fair value less costs to sell 89,500

21. Agenda Background and scope Indications of impairment and frequency of testing Recoverable amount Fair value less costs to sell Value in use Cash-generating units, goodwill and corporate assets Accounting aspects Disclosure

22. Value in use • Value in use is the present value of future cash flows expected to be derived from an asset. Estimating it involves: • Estimating the future cash inflows and outflows to be derived from continuing use of the asset and from its ultimate disposal; and • Applying appropriate discount rate to those future cash flows. • PV = FV (1+i)n

23. Value in use – measurement • Reasonable and supportable assumptions that reflects management’s best estimate • Most recent financial budgets/forecasts approved by management (excluding future restructurings and improvements to enhance performance) • Short term projections: 5 years (unless a longer period can be justified)

24. Value in use – composition (1) Estimates of future cash flows should include: • Projections of cash inflows from the continuing use of the asset. • Projections of cash outflows that are necessarily incurred to generate cash inflows from the continuing use of the asset. • Net cash flows to be receive (or paid) from the disposal of the asset at the end of its useful life.

25. Discount rates • Current market assessments of time value of money and risks specific to the asset • WACC of a listed entity that has a single asset (or portfolio of assets) similar to the asset/CGU under review. • If not available, then use followingas a starting point: • Entity’s WACC (using CAPM capital asset pricing model); • Entity’s incremental borrowing rate; • Other market borrowing rates (for similar companies and/or assets); However, these rates must be adjusted to reflect specific risks associated with the projected cash flows.

26. WACC – formula • WACC = (D/V x Rd) + (E/V x Re), where: D = Debt E = Equity V = E + D Rd = borrowing rate or return on debt Re = return on equity

27. Example – WACC calculation • Suppose that company XYZ has £2 million of debts and 100,000 shares selling at £30 per share (both measured at fair value and reflecting the company’s long term financing policy). It’s current borrowing rate is 8%, and the CFO thinks that the stock is priced to offer a 15% return. • What is the WACC of company XYZ?

28. Solution – WACC calculation • WACC = (D/V x Rd) + (E/V x Re) • WACC = (2/5 x 0.08) + (3/5 x 0.15) • WACC = 12.2%

29. Agenda Background and scope Indications of impairment and frequency of testing Recoverable amount Fair value less costs to sell Value in use Cash-generating units, goodwill and corporate assets Accounting aspects Disclosure

30. CGUs (1) • VIU cannot be estimated to be close to FVLCS • asset doesn’t generate independent CF • Estimate recoverable amount for • the individual asset, or if not possible • the asset’s CGU • Apply CGU concept when the asset does not generate cash flows which are independent from other assets The smallest identifiable group of assets that generates cash inflows from continuing use that are largely independent from other assets of groups of assets

31. CGUs (2) Example 1: An entity owns a dry dock with a large crane to support its activities. The crane could only be sold for scrap value and cash inflows from its use cannot be identified separately from all of the operations directly connected with the dry dock. It is not possible to estimate the recoverable amount of the crane because its value in use cannot be determined. Therefore, the entity estimates the recoverable amount of the cash-generating unit to which the crane belongs, i.e. the dry dock as a whole.

32. CGUs (3) Example 2: A bus company provides services under contract with a municipality that requires minimum service on each of five separate routes. Assets devoted to each route and the cash flows from each route can be identified separately. One of the routes operates at a significant loss. Because the entity does not have the option to curtail any one bus route, the lowest level of identifiable cash inflows that are largely independentof the cash inflows from other assets or group of assets is the cash inflows generated by the five routes together. The cash generating unit for each route is the bus company as a whole.

33. Smallest group of assets with largely independent cash inflows CGUs (4) • Various factors including: • How management monitors (product lines, individual locations, regional areas etc) • How decisions are made about continuing or disposing of the entity’s assets and operations.

34. Goodwill • Goodwill acquired in a business combination represents a payment made by an acquirer in anticipation of future economic benefits arising from assets that are not capable of being individually identified and separately recognised. • Does not generate independent cash flows

35. Allocation of goodwill (1) Goodwill Basic principle: Goodwill is allocated to the acquirer’s CGU (or group of CGUs) that are expected to benefit from the synergies of the business combination, irrespective of whether other assets or liabilities of the acquiree are assigned to those units synergies assets + liabs + synergies CGU A CGU B

36. Allocation of goodwill (2) • Initial allocation: If the initial allocation of goodwill acquired in a business combination cannot be completed before the end of the annual period in which the business combination is effected, that initial allocation shall be completed before the end of the first annual period beginning after the acquisition date • Each unit or group of units shall: • Represent the lowest level within the entity at which goodwill is monitored for internal management purposes • Not be larger than entity’s primary or secondary reporting format (IAS 14 Segment Reporting) • Disposal of operations: allocated to the carrying amount of the operation when calculating gain/loss

37. Allocation of goodwill (3) Once goodwill has been allocated to a cash generating unit, that unit must be tested for impairment • Annually • and whenever there is an indication that the unit may be impaired • If the carrying amount of the unit (including goodwill) exceeds the recoverable amount of the unit, the entity shall recognize impairment loss.

38. Example: Goodwill Entity Q is a wholly owned subsidiary of M and has 3 divisions, X,Y,Z. There are indications that Y is impaired and Q has estimated its recoverable amount to be $230m. There are no indications that X and Z are impaired. The value of Q has been estimated, by M, to be $1,380m. The management of M have allocated $450m of the goodwill held in the group accounts to Q. As X, Y, and Z are separately reported to M, they are considered to be the lowest level within the entity that goodwill is monitored

39. Example: Goodwill (continue) Cash generating unit X Y Z Total $m $m $m $m Net assets directly involved in the activities 350 150 250 750 of the unit Goodwill 210 90 150 450 Total 560 240 400 1,200 The goodwill has been allocated in the ratio that the directly attributed assets bear to each other.

40. Example: Goodwill (continue) The carrying value of (Y) that would be compared to the recoverable amount is $240m. Y $m Carrying amount 240 Recoverable amount (230) Impairment loss 10 Thus an impairment loss of $10m should be recognized even though the fair value of Q as a whole ($1,380m) is greater than its carrying value ($1,200m).

41. Agenda Background and scope Indications of impairment and frequency of testing Recoverable amount Fair value less costs to sell Value in use Cash-generating units, goodwill and corporate assets Accounting aspects Disclosure

42. Recognizing an impairment loss • If, and only, if the recoverable amount of an asset is less than its carrying amount, the carrying amount of the asset should be reduced to its recoverable amount. That reduction is an impairment loss. • An impairment loss should be recognized as an expense in the income statement immediately, unless the asset is carried at a revalued amount under another IAS. • Any impairment loss of a revalued asset should be treated as a revaluation decrease under that other IAS.

43. Accounting for impairment loss The credit entry would usually be taken to an impairment account (much lie the accumulated depreciation account). This is then set against the cost of the asset for presentational purposes. Dr Income statement Cr Impairment account (balance sheet) After impairment, the carrying value of the asset less any residual value is depreciated (amortized) over its remaining expected useful life.

44. Example: Accounting aspects CV Rec. I/S Equity amt • Assets are 100 80 20 Dr 0 Carried at historic Cost. 2) Historic cost 100 150 125 0 25Dr Revalued to 150 3) Historic cost 100 150 95 5 Dr 50Dr Revalued to 150

45. Allocation within a cash generating unit The impairment loss should be allocated to the CGU in the following order: • Goodwill allocated to the CGU • Then, to the other assets of the unit on a pro-rata basis based on the carrying amount of each asset in the unit. In allocating an impairment loss the carrying amount of an asset should not be reduced below the highest of: • Its fair value less costs to sell (if determinable); • Its value in use (if determinable); and • Zero The amount of the impairment loss that would otherwise have been allocated to the asset should be allocated to the other assets of the unit on a pro-rata basis.

46. Example (1) At 1 January, an entity paid $2,800 for a company whose main activity consists of refuse collection. The acquired company owns four refuse vehicles and a local government license without which it could not operate. At 1 January, the fair value less costs to sell of each vehicle and of the license are $500. The company has no insurance cover. At 1 February, one vehicle crashed. Because of its reduced capacity, the entity estimates the value in use of the business at $2,220. How the impairment loss is allocated ?

47. Example (1): Solution 1 1 Imp. January February loss Goodwill 300 220 (80) Intangible asset 500 500 0 Vehicles 2,000 1,500 (500) 2,800 2,220 (580) An impairment loss of 500 is recognized first to the vehicle that crashed because its recoverable amount can be assessed individually. (It no longer forms part of the cash generating unit. The remaining loss is attributed to Goodwill.

48. Example (2) Following from Example 1: At 22 May the government increased the interest rates. The entity re-determined the value in use of the business as $1,860. The fair value less costs to sell of the license had decreased to $480 (as a result of market reaction to the increased interest rates). The demand for vehicles was hit hard by the increase in rates and the selling prices were adversely affected. How the impairment loss is allocated ?

49. Example (2): Solution 1 February 22 May Imp. loss Goodwill 220 0 (220) Intangible asset 500 480 (20) Vehicles 1,500 1,380 (120) 2,220 1,860 (360) First 220 is charged to the goodwill to reduce it to zero. The balance of 140 must be pro-rated between the remaining assets in proportion to their carrying value. The ratio that the remaining assets bear to each other is 500:1,500. This implies that 25%*140=35 should be allocated to the intangible asset. However, this would reduce its carrying value below its fair value less costs to sell and this is not allowed. The maximum that may be allocated is 20 and the remaining 15 must be allocated to the vehicles.

50. Subsequent review (1) An entity shall assess at each reporting date whether there is any indication that an impairment loss recognized in prior periods for an assets other than goodwill may no longer exist or may have decreased. An entity should consider, as minimum, the following indications: Internal sources: • Significant favourable changes in the actual or expected extent or manner of use of the asset. (e.g. capital expenditures incurred enhances the asset) • Evidence is available from internal reporting that indicates that the economic performance of the asset is, or will be, better than expected.