Corporate Accounting Impairment Test

Question: Discuss about the Corporate Accounting for Impairment Test. Answer: The rationale behind test of impairment of assets is that values of assets in the Balance Sheet arent being carried in excess of the recoverable amount or the assets are recorded at its fair value not at overstated amount. Impairment arises in situation where carrying value of assets is higher in comparison to recoverable amount. Purpose of Impairment Test IAS 36 states about impairment of all tangible and intangible Assets, except for assets that are covered by other IFRS. It is not necessary for an organisation to conduct impairment test annually for all the assets. But where there is an indication of impairment then the organisation must test the relevant assets. According to Amiraslani, Iatridis and Pope (2013), the main objective behind conducting impairment test is to ascertain whether the assets are overstated or not in books of account. It is essential to record asset at its fair value on the balance sheet. As a no. of decisions relating to investment are taken by users of financial statements after reviewing the financial position of the organisation. The need of impairment arises in situation where carrying value of assets is higher in comparison to recoverable amount (Amiraslani, Iatridis and Pope, 2013). Assets are kept out of the purview of IAS 36 are Inventories (All Kind of Inventory i.e. Finished Goods, Work in Progress Goods and Raw Material), Assets held for Resale and Deferred Tax Assets. In accordance with the provisions of stated standards, it is essential to conduct impairment test of assets on annual basis by considering its indefinite useful lives, Goodwill acquired in a business combination andIntangibles not accessible for use and. Effect of Impairment Test on Existing Goodwill The assets that should be tested for impairment annually comprise of the Intangible assets which are not up till now accessible for the use. It also includes goodwill assimilated through transactions of business combination and intangibles with indefinite useful lives. In accordance with AASB 136, in case cash generating units consist goodwill specific requirement for accounting the existing impairment loss arising in relation to CGU is available (Rennekamp, Rupar and Seybert, 2014). Goodwill is an enduring balance, including assets that cannot be ascertained or identified on separate basis. Thus, it is not conceivable to ascertain the Fair Value deducting cost of sale in each situation (i.e. the value ascertained from selling of asset at arms length transaction by making reduction of the cost incurred for its disposal) or to determine cash flow relating specifically to goodwill. AASB 136 specifies that goodwill to be apportioned at the lowermost level while assessment of asses. Hence goodwill can be tested for impairment only at CGU level. Rules Relating to CGU in the Case of Arising of Impairment Loss where Goodwill Exists: The carrying value of goodwill relating to cash generating unit must be reduced to zero. Distribution of the balance amount of remaining assets is done on a pro-rata basis. Revaluation of recognised loss is done annually. Accounting of reversal of evaluated impairment loss is recording on an asset for which reversal is done; i.e. whether it is an individual asset, goodwill or CGU. Indicators applied for reversal of impairment should be same as were used at the time of applying impairment. Impairment loss relating to the individual asset can be reversed if the rules are satisfied. It is important to make certain that the new carrying amount is not greater in comparison to existing amount which would have been used for recording of asset in case no impairment loss was recognised. The ProvisionRegarding Reverse of Impairment Loss: The impairment loss relating to cash generating unit which is apportioned across the assets is reversed on impairment loss. No reversal is done for impairment loss relating to goodwill. Accounting of reversal of impairment loss of particular assets will be the same as an individual asset. Disclosure to be Provided in Financial Statements: The amount of impairment loss provided in profit in loss account during the year must be disclosed. The disclosure must also be done with the amount relating to the reversal of impairment loss provided in books of accounts and on revaluation of asset accounted directly in equity. The loss of impairment related to the revaluation of asset recognised directly in equity (Pajunen and Saastamoinen, 2013). Basic Steps Followed for the Applicability of Impairment Test Conducting Impairment Test- It is not necessary for an organisation to conduct impairment test annually but where there are indicators which suggest that impairment test should be conducted, then it must be conducted. Sources or Indicators of impairment test can be classified as: External sources/ Evidences Internal Sources/ Evidence Reduction in Market Value Physical Damage to Asset Hostile alteration in entitys environment/ market Change in Asset use Higher Interest Rates Assets economic performance is worse than expected Market Capitalization Step 1: Determination of Recoverable Amount: First step in the identification of impairment loss is to determine recoverable amount. Recoverable amount is equal to higher of (Fair value - cost of Disposal) and value in use. Fair Value refers to amount receivable if asset is sold at arm length price reduced by the cost of disposal. It is quite easy to compute the fair value of an asset in comparison of value in use. As per the study Khokan Bepari, Rahman and Mollik (2014), the value in use refers to the net present value of the cash flows that would be generated by that particular asset. Recoverable Amount will be equivalent to Higher of (Fair value - cost of Disposal) or Value in use Step 2: Comparison of the Recoverable amount with Carrying amount of that asset. Situation 1: When Recoverable amount Carrying Amount. If recoverable amount is lower in comparison to carrying amount, then it states that there is an impairment loss and it needs to be debited to revenue account. Situation2: When Recoverable amount Carrying Amount: If amount to be recovered is more than the carrying amount then no supplementary accounting is to be done (Anderson and Wenzel, 2014.). Methods of Accounting An impairment loss can be accounted in any of two methods explained below: The first is cost model, in which the evaluated impairment loss is recorded in income statement at that time. According to Avallone and Quagli (2015), the another method is revaluation model in which the impairment loss is treated as revaluation decrement. Any further amortisation or depreciation is evaluated on the new recoverable amount. References Amiraslani, H., Iatridis, G.E. and Pope, P.F. 2013. Accounting for asset impairment: a test for IFRS compliance across Europe. Centre for Financial Analysis and Reporting Research (CeFARR). Amiraslani, H., Iatridis, G.E. and Pope, P.F. 2013. Accounting for asset impairment. London: Cass Business School. Rennekamp, K., Rupar, K.K. and Seybert, N., 2014. Impaired judgment: The effects of asset impairment reversibility and cognitive dissonance on future investment. The Accounting Review, 90(2). Pp.739-759. Pajunen, K. and Saastamoinen, J., 2013. Do auditors perceive that there exists earnings management in goodwill accounting under IFRS? Finnish evidence. Managerial Auditing Journal. 28(3) .Pp.245-260. Khokan Bepari, M., F. Rahman, S. and Taher Mollik, A. 2014. Firms' compliance with the disclosure requirements of IFRS for goodwill impairment testing: Effect of the global financial crisis and other firm characteristics. Journal of Accounting Organizational Change. 10(1), Pp.116-149. Andersson, S. and Wenzel, F., 2014. Application of IAS 36Impairment of fixed assets-A qualitative study about the main challenges for companies regarding impairments. Avallone, F. and Quagli, A. 2015. Insight into the variables used to manage the goodwill impairment test under IAS 36. Advances in Accounting. 31(1). Pp.107-114.