Chapter 14

Question 1

What does the standard IAS 36 impairment of assets consist of?

Answer 1

These standards provide consistency in determining the carrying value of assets. It involves calculating the recoverable amount of an asset, which is the higher of its fair value less costs to sell and its value in the use of the company. If the recoverable amount is lower than the carrying value, an impairment loss is recognized, lowering the asset’s carrying value. Otherwise, no impairment loss is recognized.

Question 2

Why is IAS 36 introduced?

Answer 2

Because the basic approach may conflict with the prudence convention, which emphasises caution in financial reporting to avoid misleading creditors an lenders.

Question 3

What is the objective of IAS 36?

Answer 3

The essential objective of IAS 36 is to ensure that assets are not carried at a figure greater than their recoverable amount.

Question 4

What is An Impairment loss?

Answer 4

Is the amount by which the carrying amount of an asset or a cash-generating unit exceeds its recoverable amount.

Question 5

What is the carrying amount?

Answer 5

Is the amount at which an asset is recognized after deducting any accumulated depreciation (amortization) and accumulated impairment losses thereon.

Question 6

What is depreciation?

Answer 6

(amortization) is the systematic allocation of the depreciable amount of an asset over its useful life.

Question 7

What is the recoverable amount?

Answer 7

• The recoverable amount of an asset or a cash-generating unit is the higher of its fair value less costs of disposal and its value in use.

Question 8

What does the useful life mean?

Answer 8

• Useful life is either:
  – the period over which an asset is expected to be used by the entity
  or
  – the number of production or similar units expected to be obtained from the asset by the entity.

Question 9

What is the fair value?

Answer 9

• Fair value is the 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.

Question 10

What is the cost of disposal?

Answer 10

• Costs of disposal are incremental costs directly attributable to the disposal of an asset or cash-generating unit, excluding finance costs and income tax expenses.

Question 11

What is the value in use?

Answer 11

• Value in use is the present value of the future cash flows expected to be derived from an asset or cash-generating unit.

Question 12

What is the cash-generating unit?

Answer 12

• A cash-generating unit is 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.

Question 13

What are corporate assets?

Answer 13

• Corporate assets are assets other than goodwill that contribute to the future cash flows of both the cash-generating unit under review and other cash-generating units.

Question 14

What happens when the fair value exceeds the carrying amount of an asset?

Answer 14

If either fair value less costs of disposal or value in use exceeds the asset’s carrying amount, then the other figure need not be determined at all. If fair value less costs of disposal is unobtainable even by reliable estimate because of the absence of an active market, then the recoverable amount can be taken as equal to value in use.

Question 15

Which steps need to be followed when estimating the value?

Answer 15

1 Estimating the future cash inflows and outflows to be derived from the continuing use of the asset and its ultimate disposal.
2 Applying the appropriate discount rate to these future cash flows.

Question 16

How should future cashflow be estimated?

Answer 16

Future cash flows should be estimated for the asset in its current condition. It follows that estimates of future cash flows should not include estimated future cash inflows or outflows.

Question 17

How can cash inflows or outflow arise?

Answer 17

• a future restructuring to which an entity is not yet committed, or
• future (uncommitted) capital expenditure that will improve or enhance the asset over its originally assessed standard of performance.

Question 18

How is the net cash flow received determined?

Answer 18

The estimate of net cash flows to be received (or paid) for the disposal of an asset at the end of its useful life is determined similarly to an asset’s fair value less costs to sell.

Question 19

What are challenges when determining the net cash flow received?

Answer 19

1 An entity uses prices prevailing at the date of the estimate for similar assets that have reached the end of their useful life and that have operated under conditions similar to those in which the asset will be used.
2 Those prices are adjusted for the effect of both future price increases due to general inflation and specific future price increases (decreases). However, if estimates of future cash flows from the asset’s continuing use and the discount rate exclude the effect of general inflation, this effect is also excluded from the estimate of net cash flows on disposal.

Question 20

What is a discount rate?

Answer 20

The discount rate (or rates) should be a pre-tax rate) that reflect current market assessments of the time value of money and risks specific to the asset. The discount rate should not reflect risks for which future cash flow estimates have been adjusted, as this would involve double counting.

Question 21

What could be starting points when determining the discount rate?

Answer 21

• the entity’s weighted average cost of capital is determined using techniques such as the capital asset pricing model
• the entity’s incremental borrowing rate
• other market borrowing rates.

Question 22

Why are these rates adjusted?

Answer 22

• to reflect the way that the market would assess the specific risks associated with the projected cash flows
• to exclude risks that are not relevant to the projected cash flows.

Question 23

What does the standard require?

Answer 23

The Standard requires that 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.

Question 24

How should an impairment loss be recognised?

Answer 24

An impairment loss should be recognized immediately as an expense in the income statement unless the asset is carried at a revalued amount under another Standard.

Question 25

What happens when the impairment loss is greater than the carrying value of the relevant asset?

Answer 25

If the estimated impairment loss is greater than the carrying value of the relevant asset, the asset is simply reduced to nil, with a corresponding expense. Only if required by another Standard should a liability be recognized.

Question 26

What is the point of impairment losses?

Answer 26

The point of impairment losses is that they represent unusual reductions in asset numbers (carrying values) as used in financial statements. As with impairment losses, we again have a two-stage process. Management will first check to see whether there is any indication that an impairment loss recognized in earlier years may have decreased.

Question 27

What is a formal requirement for reversing impairment losses?

Answer 27

The formal requirement for reversing impairment losses for an asset other than goodwill (there is no reversal possibility with goodwill.)is that an impairment loss recognized for an asset in prior years must be reversed if, and only if, there has been a change in the estimates used to determine the asset’s recoverable amount since the last impairment loss was recognized.

Question 28

What is not allowed when reversing impairment losses?

Answer 28

The reversal of an impairment loss should in no circumstances increase the carrying value of an asset above what it would have been at this balance sheet date if no impairment loss had been recognized in prior years.

Question 29

Where in allocating a reversal of an impairment loss for a cash-generating unit, the carrying amount of an asset should not be increased above the lower of?

Answer 29

• the recoverable amount (if determinable)
• the carrying amount that would have been determined (net of amortization or depreciation) had no impairment loss been recognized for the asset in prior years.

Question 30

What should an estimate in future cashflows include?

Answer 30

Estimates of future cash flows should include:
1. (a) projections of cash inflows from the continuing use of the asset, net of projections of cash outflows that are necessarily incurred to generate the cash inflows (including cash outflows to prepare the asset for use) and that can be directly attributed, or allocated on a reasonable and consistent basis, to the asset
2. (b) net cash flows, if any, to be received (or paid) for the disposal of the asset at the end of its useful life.