Standard 28: Impairment of Assets

Standard 28: Impairment of Assets · Complied AI

(b)

if the asset’s fair value is determined on a basis other than its market value, its revalued amount (fair value) may be greater or lower than its recoverable amount. Hence, after the revaluation requirements have been applied, an enterprise applies this Standard to determine whether the asset may be impaired.

Definitions

4. The following terms are used in this Standard with the meanings specified:

4.1 Recoverable amount is the higher of an asset’s net selling price and its value in use.

4.2 Value in use is the present value of estimated future cash flows expected to arise from the continuing use of an asset and from its disposal at the end of its useful life.

Proviso

Provided that in the context of Small and Medium-sized Companies, as defined in Appendix 1 to this Compendium, and in the context of Micro, Small and Medium-sized non-company entities (MSMEs), as defined in Appendix 1 to this Compendium, that are otherwise not exempted from applying this standard, the definition of the term ‘value in use’ would read as follows:

“ Value in use is the present value of estimated future cash flows expected to arise from the continuing use of an asset and from its disposal at the end of its useful life, or a reasonable estimate thereof. ”

Explanation

Explanation:

The definition of the term ‘value in use’ in the proviso implies that instead of using the present value technique, a reasonable estimate of the ‘value in use’ can be made. Consequently, if an SMC /MSME chooses to measure the ‘value in use’ by not using the present value technique, the relevant provisions of AS 28, such as discount rate etc., would not be applicable to such an SMC/MSME.

4.3 Net selling price 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.

4.4 Costs of disposal are incremental costs directly attributable to the disposal of an asset, excluding finance costs and income tax expense.

4.5 An impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable amount.

4.6 Carrying amount is the amount at which an asset is recognised in the balance sheet after deducting any accumulated depreciation (amortisation) and accumulated impairment losses thereon.

4.7 Depreciation (Amortisation ) is a systematic allocation of the depreciable amount of an asset over its useful life. 3

4.8 Depreciable amount is the cost of an asset, or other amount substituted for cost in the financial statements, less its residual value.

4.9 Useful life is either:

(b)

if the discount rate used in calculating the asset’s value in use is likely to be affected by the increase in these market rates but previous sensitivity analysis of recoverable amount shows that:

(i)

it is unlikely that there will be a material decrease in recoverable amount because future cash flows are also likely to increase. For example, in some cases, an enterprise may be able to demonstrate that it adjusts its revenues to compensate for any increase in market rates; or

(ii)

the decrease in recoverable amount is unlikely to result in a material impairment loss.

13. If there is an indication that an asset may be impaired, this may indicate that the remaining useful life, the depreciation (amortisation) method or the residual value for the asset need to be reviewed and adjusted under the Accounting Standard applicable to the asset, such as Accounting Standard (AS)10, Property, Plant and Equipment 4 , even if no impairment loss is recognised for the asset.

Measurement of Recoverable Amount

14. This Standard defines recoverable amount as the higher of an asset’s net selling price and value in use. Paragraphs 15 to 55 set out the requirements for measuring recoverable amount. These requirements use the term ‘an asset’ but apply equally to an individual asset or a cash-generating unit.

15. It is not always necessary to determine both an asset’s net selling price and its value in use. For example, 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. It may be possible to determine net selling price, even if an asset is not traded in an active market. However, sometimes it will not be possible to determine net selling price because there is no basis for making a reliable estimate of the amount obtainable from the sale of the asset in an arm’s length transaction between knowledgeable and willing parties. In this case, the recoverable amount of the asset may be taken to be its value in use.

17. If there is no reason to believe that an asset’s value in use materially exceeds its net selling price, the asset’s recoverable amount may be taken to be its net selling price. This will often be the case for an asset that is held for disposal. This is because the value in use of an asset held for disposal will consist mainly of the net disposal proceeds, since the future cash flows from continuing use of the asset until its disposal are likely to be negligible.

18. Recoverable amount is determined for an individual asset, unless the asset does not generate cash inflows from continuing use that are largely independent of those from other assets or groups of assets. If this is the case, recoverable amount is determined for the cash-generating unit to which the asset belongs (see paragraphs 63 to 86 ), unless either:

(b)

the asset’s value in use can be estimated to be close to its net selling price and net selling price can be determined.

19. In some cases, estimates, averages and simplified computations may provide a reasonable approximation of the detailed computations illustrated in this Standard for determining net selling price or value in use.

Net Selling Price

20. The best evidence of an asset’s net selling price is a price in a binding sale agreement in an arm’s length transaction, adjusted for incremental costs that would be directly attributable to the disposal of the asset.

21. If there is no binding sale agreement but an asset is traded in an active market, net selling price is the asset’s market price less the costs of disposal . The appropriate market price is usually the current bid price. When current bid prices are unavailable, the price of the most recent transaction may provide a basis from which to estimate net selling price, provided that there has not been a significant change in economic circumstances between the transaction date and the date at which the estimate is made.

22. If there is no binding sale agreement or active market for an asset, net selling price is based on the best information available to reflect the amount that an enterprise could obtain, at the balance sheet date, for the disposal of the asset in an arm’s length transaction between knowledgeable, willing parties, after deducting the costs of disposal. In determining this amount, an enterprise considers the outcome of recent transactions for similar assets within the same industry. Net selling price does not reflect a forced sale, unless management is compelled to sell immediately.

23 Costs of disposal, other than those that have already been recognised as liabilities, are deducted in determining net selling price. Examples of such costs are legal costs, costs of removing the asset, and direct incremental costs to bring an asset into condition for its sale. However, termination benefits and costs associated with reducing or reorganising a business following the disposal of an asset are not direct incremental costs to dispose of the asset.

24. Sometimes, the disposal of an asset would require the buyer to take over a liability and only a single net selling price is available for both the asset and the liability. Paragraph 76 explains how to deal with such cases.

Value in Use

25. Estimating the value in use of an asset involves the following steps:

(c)

cash flow projections beyond the period covered by the most recent budgets/forecasts should be estimated by extrapolating the projections based on the budgets/forecasts using a steady or declining growth rate for subsequent years, unless an increasing rate can be justified. This growth rate should not exceed the long-term average growth rate for the products, industries, or country or countries in which the enterprise operates, or for the market in which the asset is used, unless a higher rate can be justified.

27. Detailed, explicit and reliable financial budgets/forecasts of future cash flows for periods longer than five years are generally not available. For this reason, management’s estimates of future cash flows are based on the most recent budgets/forecasts for a maximum of five years. Management may use cash flow projections based on financial budgets/forecasts over a period longer than five years if management is confident that these projections are reliable and it can demonstrate its ability, based on past experience, to forecast cash flows accurately over that longer period.

28. Cash flow projections until the end of an asset’s useful life are estimated by extrapolating the cash flow projections based on the financial budgets/ forecasts using a growth rate for subsequent years. This rate is steady or declining, unless an increase in the rate matches objective information about patterns over a product or industry lifecycle. If appropriate, the growth rate is zero or negative.

29. Where conditions are very favourable, competitors are likely to enter the market and restrict growth. Therefore, enterprises will have difficulty in exceeding the average historical growth rate over the long term (say, twenty years) for the products, industries, or country or countries in which the enterprise operates, or for the market in which the asset is used.

30. In using information from financial budgets/forecasts, an enterprise considers whether the information reflects reasonable and supportable assumptions and represents management’s best estimate of the set of economic conditions that will exist over the remaining useful life of the asset.

Composition of Estimates of Future Cash Flows

31. Estimates of future cash flows should include:

(b)

to exclude risks that are not relevant to the projected cash flows.

Consideration is given to risks such as country risk, currency risk, price risk and cash flow risk.

52. To avoid double counting, the discount rate does not reflect risks for which future cash flow estimates have been adjusted.

53. The discount rate is independent of the enterprise’s capital structure and the way the enterprise financed the purchase of the asset because the future cash flows expected to arise from an asset do not depend on the way in which the enterprise financed the purchase of the asset.

54. When the basis for the rate is post-tax, that basis is adjusted to reflect a pre-tax rate.

55. An enterprise normally uses a single discount rate for the estimate of an asset’s value in use. However, an enterprise uses separate discount rates for different future periods where value in use is sensitive to a difference in risks for different periods or to the term structure of interest rates.

Recognition and Measurement of an Impairment Loss

56. Paragraphs 57 to 62 set out the requirements for recognising and measuring impairment losses for an individual asset. Recognition and measurement of impairment losses for a cash-generating unit are dealt with in paragraphs 87 to 92.

57. 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.

58. An impairment loss should be recognised as an expense in the statement of profit and loss immediately, unless the asset is carried at revalued amount in accordance with another Accounting Standard (see Accounting Standard (AS) 10, Property, Plant and Equipment ), in which case any impairment loss of a revalued asset should be treated as a revaluation decrease under that Accounting Standard.

59. An impairment loss on a revalued asset is recognised as an expense in the statement of profit and loss. However, an impairment loss on a revalued asset is recognised directly against any revaluation surplus for the asset to the extent that the impairment loss does not exceed the amount held in the revaluation surplus for that same asset.

60. When the amount estimated for an impairment loss is greater than the carrying amount of the asset to which it relates, an enterprise should recognise a liability if, and only if, that is required by another Accounting Standard.

61. After the recognition of an impairment loss, the depreciation (amortisation) charge for the asset should be adjusted in future periods to allocate the asset’s revised carrying amount, less its residual value (if any), on a systematic basis over its remaining useful life.

62. If an impairment loss is recognised, any related deferred tax assets or liabilities are determined under Accounting Standard (AS) 22, Accounting for Taxes on Income (see Illustration 3 given in the Illustrations attached to the Standard).

Cash-Generating Units

63. Paragraphs 64 to 92 set out the requirements for identifying the cash- generating unit to which an asset belongs and determining the carrying amount of, and recognising impairment losses for, cash-generating units.

Identification of the Cash-Generating Unit to Which an Asset Belongs

64. If there is any indication that an asset may be impaired, the recoverable amount should be estimated for the individual asset. If it is not possible to estimate the recoverable amount of the individual asset, an enterprise should determine the recoverable amount of the cash- generating unit to which the asset belongs (the asset’s cash-generating unit).

65. The recoverable amount of an individual asset cannot be determined if:

(b)

the asset does not generate cash inflows from continuing use that are largely independent of those from other assets. In such cases, value in use and, therefore, recoverable amount, can be determined only for the asset’s cash-generating unit.

Example

A mining enterprise owns a private railway to support its mining activities. The private railway could be sold only for scrap value and the private railway does not generate cash inflows from continuing use that are largely independent of the cash inflows from the other assets of the mine.

It is not possible to estimate the recoverable amount of the private railway because the value in use of the private railway cannot be determined and it is probably different from scrap value. Therefore, the enterprise estimates the recoverable amount of the cash-generating unit to which the private railway belongs, that is, the mine as a whole.

66. As defined in paragraph 4, an asset’s cash-generating unit is the smallest group of assets that includes the asset and that generates cash inflows from continuing use that are largely independent of the cash inflows from other assets or groups of assets. Identification of an asset’s cash-generating unit involves judgement. If recoverable amount cannot be determined for an individual asset, an enterprise identifies the lowest aggregation of assets that generate largely independent cash inflows from continuing use.

Example

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 enterprise does not have the option to curtail any one bus route, the lowest level of identifiable cash inflows from continuing use that are largely independent of the cash inflows from other assets or groups 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.

67. Cash inflows from continuing use are inflows of cash and cash equivalents received from parties outside the reporting enterprise. In identifying whether cash inflows from an asset (or group of assets) are largely independent of the cash inflows from other assets (or groups of assets), an enterprise considers various factors including how management monitors the enterprise’s operations (such as by-product lines, businesses, individual locations, districts or regional areas or in some other way) or how management makes decisions about continuing or disposing of the enterprise’s assets and operations. Illustration 1 in the Illustrations attached to the Standard illustrates identification of a cash- generating unit.

68. If an active market exists for the output produced by an asset or a group of assets, this asset or group of assets should be identified as a separate cash-generating unit, even if some or all of the output is used internally. If this is the case, management’s best estimate of future market prices for the output should be used:

(b)

in determining the value in use of other cash-generating units of the reporting enterprise, when estimating the future cash outflows that relate to the internal use of the output.

69. Even if part or all of the output produced by an asset or a group of assets is used by other units of the reporting enterprise (for example, products at an intermediate stage of a production process), this asset or group of assets forms a separate cash-generating unit if the enterprise could sell this output in an active market. This is because this asset or group of assets could generate cash inflows from continuing use that would be largely independent of the cash inflows from other assets or groups of assets. In using information based on financial budgets/forecasts that relates to such a cash-generating unit, an enterprise adjusts this information if internal transfer prices do not reflect management’s best estimate of future market prices for the cash-generating unit’s output.

70. Cash-generating units should be identified consistently from period to period for the same asset or types of assets, unless a change is justified.

71. If an enterprise determines that an asset belongs to a different cash- generating unit than in previous periods, or that the types of assets aggregated for the asset’s cash-generating unit have changed, paragraph 121 requires certain disclosures about the cash-generating unit, if an impairment loss is recognised or reversed for the cash-generating unit and is material to the financial statements of the reporting enterprise as a whole.

Recoverable Amount and Carrying Amount of a Cash- Generating Unit

72. The recoverable amount of a cash-generating unit is the higher of the cash- generating unit’s net selling price and value in use. For the purpose of determining the recoverable amount of a cash-generating unit, any reference in paragraphs 15 to 55 to ‘an asset’ is read as a reference to ‘a cash-generating unit’.

73. The carrying amount of a cash-generating unit should be determined consistently with the way the recoverable amount of the cash-generating unit is determined.

74. The carrying amount of a cash-generating unit:

(b)

does not include the carrying amount of any recognised liability, unless the recoverable amount of the cash-generating unit cannot be determined without consideration of this liability.

This is because net selling price and value in use of a cash-generating unit are determined excluding cash flows that relate to assets that are not part of the cash-generating unit and liabilities that have already been recognised in the financial statements, as set out in paragraphs 23 and 35 .

75. Where assets are grouped for recoverability assessments, it is important to include in the cash-generating unit all assets that generate the relevant stream of cash inflows from continuing use. Otherwise, the cash-generating unit may appear to be fully recoverable when in fact an impairment loss has occurred. In some cases, although certain assets contribute to the estimated future cash flows of a cash-generating unit, they cannot be allocated to the cash-generating unit on a reasonable and consistent basis. This might be the case for goodwill or corporate assets such as head office assets. Paragraphs 78 to 86 explain how to deal with these assets in testing a cash-generating unit for impairment.

76. It may be necessary to consider certain recognised liabilities in order to determine the recoverable amount of a cash-generating unit. This may occur if the disposal of a cash-generating unit would require the buyer to take over a liability. In this case, the net selling price (or the estimated cash flow from ultimate disposal) of the cash-generating unit is the estimated selling price for the assets of the cash-generating unit and the liability together, less the costs of disposal. In order to perform a meaningful comparison between the carrying amount of the cash-generating unit and its recoverable amount, the carrying amount of the liability is deducted in determining both the cash-generating unit’s value in use and its carrying amount.

Example

A company operates a mine in a country where legislation requires that the owner must restore the site on completion of its mining operations. The cost of restoration includes the replacement of the overburden, which must be removed before mining operations commence. A provision for the costs to replace the overburden was recognised as soon as the overburden was removed. The amount provided was recognised as part of the cost of the mine and is being depreciated over the mine’s useful life. The carrying amount of the provision for restoration costs is Rs. 50,00,000, which is equal to the present value of the restoration costs.

The enterprise is testing the mine for impairment. The cash-generating unit for the mine is the mine as a whole. The enterprise has received various offers to buy the mine at a price of around Rs. 80,00,000; this price encompasses the fact that the buyer will take over the obligation to restore the overburden. Disposal costs for the mine are negligible. The value in use of the mine is approximately Rs. 1,20,00,000 excluding restoration costs. The carrying amount of the mine is Rs. 1,00,00,000.

The net selling price for the cash-generating unit is Rs. 80,00,000. This amount considers restoration costs that have already been provided for. As a consequence, the value in use for the cash-generating unit is determined after consideration of the restoration costs and is estimated to be Rs. 70,00,000 (Rs. 1,20,00,000 less Rs. 50,00,000). The carrying amount of the cash-generating unit is Rs. 50,00,000, which is the carrying amount of the mine (Rs. 1,00,00,000) less the carrying amount of the provision for restoration costs (Rs. 50,00,000).

77 For practical reasons, the recoverable amount of a cash-generating unit is sometimes determined after consideration of assets that are not part of the cash-generating unit (for example, receivables or other financial assets) or liabilities that have already been recognised in the financial statements (for example, payables, pensions and other provisions). In such cases, the carrying amount of the cash-generating unit is increased by the carrying amount of those assets and decreased by the carrying amount of those liabilities.

Goodwill

78 In testing a cash-generating unit for impairment, an enterprise should identify whether goodwill that relates to this cash-generating unit is recognised in the financial statements. If this is the case, an enterprise should:

(b)

if, in performing the ‘bottom-up’ test, the enterprise could not allocate the carrying amount of goodwill on a reasonable and consistent basis to the cash-generating unit under review, the enterprise should also perform a ‘top-down’ test, that is, the enterprise should:

(i)

identify the smallest cash-generating unit that includes the cash-generating unit under review and to which the carrying amount of goodwill can be allocated on a reasonable and consistent basis (the ‘larger ’ cash- generating unit); and

(ii)

then, compare the recoverable amount of the larger cash- generating unit to its carrying amount (including the carrying amount of allocated goodwill) and recognise any impairment loss in accordance with paragraph 87 .

79. Goodwill arising on acquisition represents a payment made by an acquirer in anticipation of future economic benefits. The future economic benefits may result from synergy between the identifiable assets acquired or from assets that individually do not qualify for recognition in the financial statements. Goodwill does not generate cash flows independently from other assets or groups of assets and, therefore, the recoverable amount of goodwill as an individual asset cannot be determined. As a consequence, if there is an indication that goodwill may be impaired, recoverable amount is determined for the cash-generating unit to which goodwill belongs. This amount is then compared to the carrying amount of this cash-generating unit and any impairment loss is recognised in accordance with paragraph 87.

80. Whenever a cash-generating unit is tested for impairment, an enterprise considers any goodwill that is associated with the future cash flows to be generated by the cash-generating unit. If goodwill can be allocated on a reasonable and consistent basis, an enterprise applies the ‘bottom-up’ test only. If it is not possible to allocate goodwill on a reasonable and consistent basis, an enterprise applies both the ‘bottom-up’ test and ‘top-down’ test (see Illustration 7 given in the Illustrations attached to the Standard).

81. The ‘bottom-up’ test ensures that an enterprise recognises any impairment loss that exists for a cash-generating unit, including for goodwill that can be allocated on a reasonable and consistent basis. Whenever it is impracticable to allocate goodwill on a reasonable and consistent basis in the ‘bottom-up’ test, the combination of the ‘bottom-up’ and the ‘top-down’ test ensures that an enterprise recognises:

(b)

can be determined only for the cash-generating unit to which the machine belongs (the production line).

The production line is not impaired, therefore, no impairment loss is recognised for the machine. Nevertheless, the enterprise may need to reassess the depreciation period or the depreciation method for the machine. Perhaps, a shorter depreciation period or a faster depreciation method is required to reflect the expected remaining useful life of the machine or the pattern in which economic benefits are consumed by the enterprise.

Assumption 2 : Budgets/forecasts approved by management reflect a commitment of management to replace the machine and sell it in the near future. Cash flows from continuing use of the machine until its disposal are estimated to be negligible.

The machine’s value in use can be estimated to be close to its net selling price. Therefore, the recoverable amount of the machine can be determined and no consideration is given to the cash-generating unit to which the machine belongs (the production line). Since the machine’s net selling price is less than its carrying amount, an impairment loss is recognised for the machine.

92. After the requirements in paragraphs 87 and 88 have been applied, a liability should be recognised for any remaining amount of an impairment loss for a cash-generating unit if that is required by another Accounting Standard.

Reversal of an Impairment Loss

93. Paragraphs 94 to 100 set out the requirements for reversing an impairment loss recognised for an asset or a cash-generating unit in prior accounting periods. These requirements use the term ‘an asset’ but apply equally to an individual asset or a cash-generating unit. Additional requirements are set out for an individual asset in paragraphs 101 to 105, for a cash-generating unit in paragraphs 106 to 107 and for goodwill in paragraphs 108 to 111.

94. An enterprise should assess at each balance sheet date whether there is any indication that an impairment loss recognised for an asset in prior accounting periods may no longer exist or may have decreased. If any such indication exists, the enterprise should estimate the recoverable amount of that asset.

95. In assessing whether there is any indication that an impairment loss recognised for an asset in prior accounting periods may no longer exist or may have decreased, an enterprise should consider, as a minimum, the following indications:

External sources of information

(c)

if recoverable amount was based on net selling price: a change in estimate of the components of net selling price.

100. An asset’s value in use may become greater than the asset’s carrying amount simply because the present value of future cash inflows increases as they become closer. However, the service potential of the asset has not increased. Therefore, an impairment loss is not reversed just because of the passage of time (sometimes called the ‘unwinding’ of the discount), even if the recoverable amount of the asset becomes higher than its carrying amount.

Reversal of an Impairment Loss for an Individual Asset

101. The increased carrying amount of an asset due to a reversal of an impairment loss should not exceed the carrying amount that would have been determined (net of amortisation or depreciation) had no impairment loss been recognised for the asset in prior accounting periods.

102. Any increase in the carrying amount of an asset above the carrying amount that would have been determined (net of amortisation or depreciation) had no impairment loss been recognised for the asset in prior accounting periods is a revaluation. In accounting for such a revaluation, an enterprise applies the Accounting Standard applicable to the asset.

103. A reversal of an impairment loss for an asset should be recognised as income immediately in the statement of profit and loss, unless the asset is carried at revalued amount in accordance with another Accounting Standard (see Accounting Standard (AS) 10, Property, Plant and Equipment ) in which case any reversal of an impairment loss on a revalued asset should be treated as a revaluation increase under that Accounting Standard.

104. A reversal of an impairment loss on a revalued asset is credited directly to equity under the heading revaluation surplus. However, to the extent that an impairment loss on the same revalued asset was previously recognised as an expense in the statement of profit and loss, a reversal of that impairment loss is recognised as income in the statement of profit and loss.

105. After a reversal of an impairment loss is recognised, the depreciation (amortisation) charge for the asset should be adjusted in future periods to allocate the asset’s revised carrying amount, less its residual value (if any), on a systematic basis over its remaining useful life.

Reversal of an Impairment Loss for a Cash-Generating Unit

106. A reversal of an impairment loss for a cash-generating unit should be allocated to increase the carrying amount of the assets of the unit in the following order:

(b)

the main events and circumstances that led to the recognition (reversal) of these impairment losses for which no information is disclosed under paragraph 121.

123. An enterprise is encouraged to disclose key assumptions used to determine the recoverable amount of assets (cash-generating units) during the period.

Proviso

Provided that a Micro, Small and Medium Sized non-company entity, as defined in Appendix 1 to this Compendium, that is otherwise not exempted from applying this standard, may not comply with paragraph 123.

Transitional Provisions 7

124. On the date of this Standard becoming mandatory, an enterprise should assess whether there is any indication that an asset may be impaired (see paragraphs 5- 13 ). If any such indication exists, the enterprise should determine impairment loss, if any, in accordance with this Standard. The impairment loss, so determined, should be adjusted against opening balance of revenue reserves being the accumulated impairment loss relating to periods prior to this Standard becoming mandatory unless the impairment loss is on a revalued asset. An impairment loss on a revalued asset should be recognised directly against any revaluation surplus for the asset to the extent that the impairment loss does not exceed the amount held in the revaluation surplus for that same asset. If the impairment loss exceeds the amount held in the revaluation surplus for that same asset, the excess should be adjusted against opening balance of revenue reserves.

125. Any impairment loss arising after the date of this Standard becoming mandatory should be recognised in accordance with this Standard (i.e., in the statement of profit and loss unless an asset is carried at revalued amount. An impairment loss on a revalued asset should be treated as a revaluation decrease).

Illustrations

These illustrations do not form part of the Accounting Standard. The purpose of these Illustrations is to illustrate the application of the Accounting Standard to assist in clarifying its meaning.

All these illustrations assume the enterprises concerned have no transactions other than those described.

Illustration 1 - Identification of Cash-Generating Units

The purpose of this Illustration is:

(b)

the business is run on a store-by-store profit basis or on region/city basis.

A3. All M’s stores are in different neighbourhoods and probably have different customer bases. So, although X is managed at a corporate level, X generates cash inflows that are largely independent from those of M’s other stores. Therefore, it is likely that X is a cash-generating unit.

A4. If the carrying amount of the goodwill can be allocated on a reasonable and consistent basis to X’s cash-generating unit, M applies the ‘bottom-up’ test described in paragraph 78 of this Standard. If the carrying amount of the goodwill cannot be allocated on a reasonable and consistent basis to X’s cash-generating unit, M applies the ‘bottom-up’ and ‘top-down’ tests.

B - Plant for an Intermediate Step in a Production Process

Background

A5. A significant raw material used for plant Y’s final production is an intermediate product bought from plant X of the same enterprise. X’s products are sold to Y at a transfer price that passes all margins to X. 80% of Y’s final production is sold to customers outside of the reporting enterprise.

60% of X’s final production is sold to Y and the remaining 40% is sold to customers outside of the reporting enterprise.

For each of the following cases, what are the cash-generating units for X and Y?

Case 1: X could sell the products it sells to Y in an active market. Internal transfer prices are higher than market prices.

Case 2: There is no active market for the products X sells to Y.

Analysis

Case 1

A6. X could sell its products on an active market and, so, generate cash inflows from continuing use that would be largely independent of the cash inflows from Y. Therefore, it is likely that X is a separate cash-generating unit, although part of its production is used by Y (see paragraph 68 of this Standard).

A7. It is likely that Y is also a separate cash-generating unit. Y sells 80% of its products to customers outside of the reporting enterprise. Therefore, its cash inflows from continuing use can be considered to be largely independent.

A8. Internal transfer prices do not reflect market prices for X’s output. Therefore, in determining value in use of both X and Y, the enterprise adjusts financial budgets/forecasts to reflect management’s best estimate of future market prices for those of X’s products that are used internally (see paragraph 68 of this Standard).

Case 2

A9. It is likely that the recoverable amount of each plant cannot be assessed independently from the recoverable amount of the other plant because:

(b)

although there is an active market for the products assembled by B and C, cash inflows for B and C depend on the allocation of production across the two sites. It is unlikely that the future cash inflows for B and C can be determined individually.

A16. As a consequence, it is likely that A, B and C together (i.e., M as a whole) is the smallest identifiable group of assets that generates cash inflows from continuing use that are largely independent.

D - Magazine Titles

Background

A17. A publisher owns 150 magazine titles of which 70 were purchased and

80 were self-created. The price paid for a purchased magazine title is recognised as an intangible asset. The costs of creating magazine titles and maintaining the existing titles are recognised as an expense when incurred. Cash inflows from direct sales and advertising are identifiable for each magazine title. Titles are managed by customer segments. The level of advertising income for a magazine title depends on the range of titles in the customer segment to which the magazine title relates. Management has a policy to abandon old titles before the end of their economic lives and replace them immediately with new titles for the same customer segment.

What is the cash-generating unit for an individual magazine title?

Analysis

A18. It is likely that the recoverable amount of an individual magazine title can be assessed. Even though the level of advertising income for a title is influenced, to a certain extent, by the other titles in the customer segment, cash inflows from direct sales and advertising are identifiable for each title. In addition, although titles are managed by customer segments, decisions to abandon titles are made on an individual title basis.

A19. Therefore, it is likely that individual magazine titles generate cash inflows that are largely independent one from another and that each magazine title is a separate cash-generating unit.

E - Building: Half-Rented to Others and Half-Occupied for Own Use

Background

A20. M is a manufacturing company. It owns a headquarter building that used to be fully occupied for internal use. After down-sizing, half of the building is now used internally and half rented to third parties. The lease agreement with the tenant is for five years.

What is the cash-generating unit of the building?

Analysis

A21. The primary purpose of the building is to serve as a corporate asset, supporting M’s manufacturing activities. Therefore, the building as a whole cannot be considered to generate cash inflows that are largely independent of the cash inflows from the enterprise as a whole. So, it is likely that the cash- generating unit for the building is M as a whole.

A22. The building is not held as an investment. Therefore, it would not be appropriate to determine the value in use of the building based on projections of future market related rents.

Illustration 2 - Calculation of Value in Use and Recognition of an Impairment Loss

In this illustration, tax effects are ignored.

Background and Calculation of Value in Use

A23. At the end of 20X0, enterprise T acquires enterprise M for Rs. 10,000 lakhs. M has manufacturing plants in 3 countries. The anticipated useful life of the resulting merged activities is 15 years.

Schedule 1. Data at the end of 20X0 (Amount in Rs. lakhs)

End of 20X0

Allocation of purchase price

Fair value of identifiable assets

Goodwill (1)

Activities in Country A

3,000

2,000

1,000

Activities in Country B

2,000

1,500

500

Activities in Country C

5,000

3,500

1,500

Total

10,000

7,000

3,000

1 Activities in each country are the smallest cash-generating units to which goodwill can be allocated on a reasonable and consistent basis (allocation based on the purchase price of the activities in each country, as specified in the purchase agreement).

A24. T uses straight-line depreciation over a 15-year life for the Country A assets and no residual value is anticipated. In respect of goodwill, T uses straight-line amortisation over a 5 year life.

A25. In 20X4, a new government is elected in Country A. It passes legislation significantly restricting exports of T’s main product. As a result, and for the foreseeable future, T’s production will be cut by 40%.

A26. The significant export restriction and the resulting production decrease require T to estimate the recoverable amount of the goodwill and net assets of the Country A operations. The cash-generating unit for the goodwill and the identifiable assets of the Country A operations is the Country A operations, since no independent cash inflows can be identified for individual assets.

A27. The net selling price of the Country A cash-generating unit is not determinable, as it is unlikely that a ready buyer exists for all the assets of that unit.

A28. To determine the value in use for the Country A cash-generating unit (see Schedule 2), T:

(307)

Carrying amount after impairment loss

1,360

Illustration 3 - Deferred Tax Effects

A33. An enterprise has an asset with a carrying amount of Rs. 1,000 lakhs. Its recoverable amount is Rs. 650 lakhs. The tax rate is 30% and the carrying amount of the asset for tax purposes is Rs. 800 lakhs. Impairment losses are not allowable as deduction for tax purposes. The effect of the impairment loss is as follows:

Amount in Rs. lakhs

Impairment Loss recognised in the statement of profit and loss

350

Impairment Loss allowed for tax purposes

Timing Difference

350

Tax Effect of the above timing difference at 30% (deferred tax asset)

105

Less: Deferred tax liability due to difference in depreciation for accounting purposes and tax purposes [(1,000 - 800) x 30%]

Deferred tax asset

A34. In accordance with AS 22, Accounting for Taxes on Income , the enterprise recognises the deferred tax asset subject to the consideration of prudence as set out in AS 22.

Illustration 4 - Reversal of an Impairment Loss

Use the data for enterprise T as presented in Illustration 2, with supplementary information as provided in this illustration. In this illustration tax effects are ignored.

Background

A35. In 20X6, the government is still in office in Country A, but the business situation is improving. The effects of the export laws on T’s production are proving to be less drastic than initially expected by management. As a result, management estimates that production will increase by 30%. This favourable change requires T to re-estimate the recoverable amount of the net assets of the Country A operations (see paragraphs 94-95 of this Standard). The cash- generating unit for the net assets of the Country A operations is still the Country A operations.

A36. Calculations similar to those in Illustration 2 show that the recoverable amount of the Country A cash-generating unit is now Rs. 1,710 lakhs.

Reversal of Impairment Loss

A37. T compares the recoverable amount and the net carrying amount of the Country A cash-generating unit.

Schedule 1. Calculation of the carrying amount of the Country A cash- generating unit at the end of 20X6 (Amount in Rs. lakhs)

Identifiable

Goodwill

assets

Total

End of 20X4 (Example 2)

Historical cost

1,000

2,000

3,000

Accumulated depreciation/ amortisation (4 years)

(1)

The value in use of the plane exceeds what its carrying amount would have been at depreciated historical cost. Therefore, the reversal is limited to an amount that does not result in the carrying amount of the plane exceeding depreciated historical cost.

Schedule 5. Summary of the carrying amount of the plane (Amount in Rs. lakhs)

Year

Depreciated historical cost

Recoverable amount

Adjusted depreciation charge

Impairment loss

Carrying amount after impairment

20X0

1,500.00

1,211.28

(288.72)

1,211.28

20X1

1,350.00

n.c.

(121.13)

1,090.15

20X2

1,200.00

n.c.

(121.13)

969.02

20X3

1,050.00

n.c.

(121.13)

847.89

20X4

900.00

(121.13)

renewal

250.00

1,150.00

1,220.72

(121.13)

173.24

1,150.00

20X5

958.33

n.c.

(191.67)

958.33

n.c. = not calculated as there is no indication that the impairment loss may have increased/decreased.

Illustration 7 - Application of the ‘Bottom-Up’ and ‘Top- Down’ Tests to Goodwill

In this illustration, tax effects are ignored.

A58. At the end of 20X0, enterprise M acquired 100% of enterprise Z for Rs. 3,000 lakhs. Z has 3 cash-generating units A, B and C with net fair values of Rs. 1,200 lakhs, Rs. 800 lakhs and Rs. 400 lakhs respectively. M recognises goodwill of Rs. 600 lakhs (Rs. 3,000 lakhs less Rs. 2,400 lakhs) that relates to Z.

A59. At the end of 20X4, A makes significant losses. Its recoverable amount is estimated to be Rs. 1,350 lakhs. Carrying amounts are detailed below.

Schedule 1. Carrying amounts at the end of 20X4 (Amount in Rs. lakhs)

End of 20X4

Goodwill

Total

Net carrying amount

1,300

1,200

800

120

3,420

A - Goodwill Can be Allocated on a Reasonable and Consistent Basis

A60. At the date of acquisition of Z, the net fair values of A, B and C are considered a reasonable basis for a pro-rata allocation of the goodwill to A, B and C.

Schedule 2. Allocation of goodwill at the end of 20X4

Total

End of 20X0

Net fair values

1,200

800

400

2,400

Pro-rata

50%

33%

17%

100%

End of 20X4

Net carrying amount

1300

1200

800

3300

Allocation of goodwill

120

(using the pro-rata above)

Net carrying amount (after allocation of goodwill)

1360

1240

820

3420

A61. In accordance with the ‘bottom-up’ test in paragraph 78(a) of this Standard, M compares A’s recoverable amount to its carrying amount after the allocation of the carrying amount of goodwill.

Schedule 3. Application of ‘bottom-up’ test (Amount in Rs. lakhs)

End of 20X4

Carrying amount after allocation of goodwill (Schedule 2)

1,360

Recoverable amount

1,350

Impairment loss

A62. M recognises an impairment loss of Rs. 10 lakhs for A. The impairment loss is fully allocated to the goodwill in accordance with paragraph 87 of this Standard.

B - Goodwill Cannot Be Allocated on a Reasonable and Consistent Basis

A63. There is no reasonable way to allocate the goodwill that arose on the acquisition of Z to A, B and C. At the end of 20X4, Z’s recoverable amount is estimated to be Rs. 3,400 lakhs.

A64. At the end of 20X4, M first applies the ‘bottom-up’ test in accordance with paragraph 78(a) of this Standard. It compares A’s recoverable amount to its carrying amount excluding the goodwill.

Schedule 4. Application of ‘bottom-up’ test (Amount in Rs. lakhs)

End of 20X4

Carrying amount

1,300

Recoverable amount

1,350

Impairment loss

A65. Therefore, no impairment loss is recognised for A as a result of the 'bottom-up' test .

A66. Since the goodwill could not be allocated on a reasonable and consistent basis to A, M also performs a ‘top-down’ test in accordance with paragraph 78(b) of this Standard. It compares the carrying amount of Z as a whole to its recoverable amount (Z as a whole is the smallest cash-generating unit that includes A and to which goodwill can be allocated on a reasonable and consistent basis).

Schedule 5. Application of the ‘top-down’ test (Amount in Rs. lakhs)

End of 20X4

Goodwill

Carrying amount

1,300

1,200

800

120

3,420

Impairment loss arising from the 'bottom-up' test

Carrying amount after the 'bottom-up' test

1,300

1,200

800

120

3,420

Recoverable amount

3,400

Impairment loss arising from 'top-down' test

A67. Therefore, M recognises an impairment loss of Rs. 20 lakhs that it allocates fully to goodwill in accordance with paragraph 87 of this Standard.

Illustration 8 - Allocation of Corporate Assets

In this illustration tax effects are ignored.

Background

A68. Enterprise M has three cash-generating units: A, B and C. There are adverse changes in the technological environment in which M operates. Therefore, M conducts impairment tests of each of its cash-generating units. At the end of 20X0, the carrying amounts of A, B and C are Rs. 100 lakhs, Rs. 150 lakhs and Rs. 200 lakhs respectively.

A69. The operations are conducted from a headquarter. The carrying amount of the headquarter assets is Rs. 200 lakhs: a headquarter building of Rs. 150 lakhs and a research centre of Rs. 50 lakhs. The relative carrying amounts of the cash-generating units are a reasonable indication of the proportion of the head-quarter building devoted to each cash-generating unit. The carrying amount of the research centre cannot be allocated on a reasonable basis to the individual cash-generating units.

A70. The remaining estimated useful life of cash-generating unit A is 10 years. The remaining useful lives of B, C and the headquarter assets are 20 years. The headquarter assets are depreciated on a straight-line basis.

A71. There is no basis on which to calculate a net selling price for each cash- generating unit. Therefore, the recoverable amount of each cash- generating unit is based on its value in use. Value in use is calculated using a pre-tax discount rate of 15%.

Identification of Corporate Assets

A72. In accordance with paragraph 85 of this Standard, M first identifies all the corporate assets that relate to the individual cash-generating units under review. The corporate assets are the headquarter building and the research centre.

A73. M then decides how to deal with each of the corporate assets:

(a)

the carrying amount of the headquarter building can be allocated on a reasonable and consistent basis to the cash-generating units under review. Therefore, only a ‘bottom-up’ test is necessary; and

(b)

the carrying amount of the research centre cannot be allocated on a reasonable and consistent basis to the individual cash- generating units under review. Therefore, a ‘top-down’ test will be applied in addition to the ‘bottom-up’ test.

Allocation of Corporate Assets

A74. The carrying amount of the headquarter building is allocated to the carrying amount of each individual cash-generating unit. A weighted allocation basis is used because the estimated remaining useful life of A’s cash- generating unit is 10 years, whereas the estimated remaining useful lives of B and C’s cash-generating units are 20 years.

Schedule 1. Calculation of a weighted allocation of the carrying amount of the headquarter building (Amount in Rs. lakhs)

End of 20X0

Total

Carrying amount

100

150

200

450

Useful life

10 years

20 years

Weighting based on useful life

Carrying amount after weighting

100

300

400

800

Pro-rata allocation of the building

12.5%