The Impairment of Assets from the Viewpoint of Transfield Services - Case Study Example

Table of Contents Table of Contents 2 Executive Summary 3 What are the principal business activities of Transfield Services Ltd? 4 Did Transfield Services undertake impairment tests and report impairment charges in the year ended 30 June 2009? Comment on the magnitude and frequency of its impairment between 2007 and 2009. 5 What do you think are the main reasons for the impairment charges incurred in 2009? 6 Which assets were subject to impairment charges in the 2009 annual report? Was Transfield application of impairment consistent with AASB 136 Impairment of Assets? 7 Transfield has discussed the implications of the impairment charge in 2009 on the company. Do you agree or not? Justify your view. 8 To what extent do you believe impairment contribute to reliability and relevance of financial reporting? 9 Bibliography 11 Executive Summary Impairment of Assets is the sudden loss I the value of an asset over and above the systematic recognition of the loss of the asset’s value through depreciation. Once the asset is revalued then the higher of the recoverable amount or the carrying value is carried forward in the books of accounts. Recoverable value is the amount which can be recovered from the asset due to the changed conditions. Carrying value is the actual value which is recorded in the books of accounts to date. Impairment of assets is the recording of the loss in value of assets, this loss is known as impairment loss. In this paper we look at impairment of assets from the view point of Transfield Services. The report starts with an introduction about Transfield Services and the business they are in. then it goes on to analyze the impairments done in 2009 wand 2007 and provides a brief explanation of the differences in the same. A detail analysis about the impairments done in the year ending 2009 has alson been provided alongwith the reasons for the sudden increase in the amount of impairment loss, a comment on the methods of impairment followed by Transfield Services and its sync with the AASB 136 standards. The report ends with a view on Impairment of Assets as a whole. What are the principal business activities of Transfield Services Ltd? Transfield Services Limited provides various services to key industries in the Resources and Industrial, Infrastructure Services and Property and Facilities Management sectors. (Transfield Services (Australia) Pty Limited, 2008) It provides maintenance, and asset and project management services globally. (Transfield Services (Australia) Pty Limited, 2008) The key business activities of Transfield Services Limited are classified under the following heads: Asset Management Providing a range of structured business processes together with skilled management to help clients achieve maximum value from their existing assets. (Transfield Services (Australia) Pty Limited, 2008) Project Management Undertaking of significant maintenance, shutdown, turnaround and engineering projects to optimize clients capital expenditure and achieve goals efficiently within budget. (Transfield Services (Australia) Pty Limited, 2008) TWS Best Practices Network Providing information to clients regarding the best practices followed in the industry as well as outside it to instill a culture of continuous improvements in the client. (Transfield Services (Australia) Pty Limited, 2008) Customer Service Providing customer service systems through mentoring and coaching to impede successful business relationships. (Transfield Services (Australia) Pty Limited, 2008) Quality Management System Providing Operations Systems Manual (OSM) to monitor issues relating to health, safety, environment, quality and risk to effectively manage and control HSE risks within the workplace. (Transfield Services (Australia) Pty Limited, 2008) Risk Management System Conducting strategic and operational risk assessments providing comprehensive set of reports to identify and assist in the management of risk. (Transfield Services (Australia) Pty Limited, 2008) Continuous Improvement System Business Information Services Did Transfield Services undertake impairment tests and report impairment charges in the year ended 30 June 2009? Comment on the magnitude and frequency of its impairment between 2007 and 2009. Yes, Transfield Services did undertake impairment tests and report impairment charges in the year ended 30 June, 2009. Transfield services announced an impairment charge of $ 148.4 million (post-tax) on the North American Facilities Management subsidiary USM. (Transfield Services Limited, 2009) This estimation is done by first calculating the assets carrying amount and then recoverable amount. The amount by which the recoverable amount exceeds the carrying amount is recorded as the impairment loss. (Transfield Services Limited, 2009) Impairment between 2007 and 2009 has a huge difference. The frequency of impairment is the same whereas the magnitude has increased radically from 2007 to 2009. Earlier in 2007 impairment testing on assets was done annually though there was provision to do the impairment testing on intangible assets like goodwill any number of times. (Transfield Services Limited, 2007) The same has been followed in 2009. (Transfield Services Limited, 2007) The impairment loss has increased many a times from 2007 to 2009 in value. The accumulated impairment and amortization for non-current items for the year ended June 2007 was $ 40 million (Transfield Services Limited, 2007) whereas the same for the year ended June 2009 was $ 246 million (Transfield Services Limited, 2009). The total of depreciation, amortization and impairment for the year ended 2007 was $ 46 million (Transfield Services Limited, 2007), the same for the year ended 2009 was $ 247 million (Transfield Services Limited, 2009). This sudden increase in such expenses raises serious questions about the profitability of the organization though the board is assured that it is a temporary phase which has no affect on the liquidity position and will get over soon (Transfield Services Limited, 2009). What do you think are the main reasons for the impairment charges incurred in 2009? The major impairment charge on Transfield services was of $ 148.4 million (post-tax) on the North American Facilities Management subsidiary USM (Transfield Services Limited, 2009). The management attributes this loss to the deteriorating economic conditions and higher risk premiums which are specific to USM. This led to the under achievement of the growth and cash flow targets anticipated in the acquisition pricing models. (Transfield Services Limited, 2009) The major reasons for this event are discussed briefly under the following heads: US meltdown and financial crisis: During the FY 2009, US underwent a major financial crisis commonly known as the sub-prime crisis. This led to a slowdown in infrastructure development along with a cut down in the costs of infrastructure maintenance. Such a major disaster was not foreseen and thus the provisions of which were not included in the projections of cash flows and growth for USM. This led to a decrease in the recoverable value of the assets of USM over their lifetime and therefore a loss due to impairment. So in order to calculate the loss due to impairment Transfield conducted an impairment test under which the future eight year period cash flows were extrapolated based on the two year actual operating results and two year forecasted results. A declining growth rate was assumed to arrive at a long term growth rate of 3 percent which did not exceed the growth rate of the industry or the economy as a whole. This forecast gave them the carrying value and as well as the recoverable amount which helped in calculating the impairment loss. (Transfield Services Limited, 2009) Non-payment by clients: Another major contributor to impairment losses is the clients’ failure to pay. This is a common phenomenon and is anticipated in every organization beforehand. However in the case of Transfield Services the impairment losses under the trade receivables are more commonly due to dispute resolutions rather than non-payment. Disputes happen due to differentiation in the terms and conditions of the clients and the firm itself. This value was calculated each year and the provision for it was placed in the financial statements of the company. (Transfield Services Limited, 2009) Which assets were subject to impairment charges in the 2009 annual report? Was Transfield application of impairment consistent with AASB 136 Impairment of Assets? Transfield had a huge impairment charge in the year ended 2009. This charge was divided mostly between two assets:- Intangible Assets Goodwill - $ 171.7 million (pre-tax) (Transfield Services Limited, 2009) Tangible Assets Trade Receivables - $ 4.8 million (pre-tax) (Transfield Services Limited, 2009) AASB 136 states the following guidelines with respect to impairment of assets: (Government of Western Australia Department of Trasury and Finance, 2009) Annual assessment is required for impairment. Recoverable amount should be measured if there is an indication of impairment. Recoverable amount is to be calculated as the higher of fair value less selling costs and present value of future cash flows where cash flows are to be discounted using the market rates. If the carrying amount is higher than the recoverable amount then the asset should be written down to the recoverable amount, i.e., an impairment loss should be shown. It also states that if any asset shows any sign of impairment then the assets recoverable amount should be calculated and compared with that of the carrying value. Any asset (other than goodwill) which has undergone impairment previously should be assessed at every reporting date for reversal. Transfield Services follows the guidelines mentioned in the AASB 136 completely. As mentioned in the annual report Transfield Services has provisions for annual assessment. Once assessment is done it calculates the values as instructed by the AAASB 136 guidelines. Reversal assessment for non-financial assets other than goodwill is done at every reporting date by the company. If the asset’s recoverable amount is less than the carrying value than the same is brought down to the recoverable amount and the impairment loss is reflected in the income and loss statement under impairment expenses. (Transfield Services Limited, 2009) Transfield has discussed the implications of the impairment charge in 2009 on the company. Do you agree or not? Justify your view. Transfield Services has discussed the implications of the impairment charge in 2009 on the company very briefly. The company said that the impairment has no effect on the dividend payout as well as complying with its debt covenants. (Transfield Services Limited, 2009) Other implications have not been discussed in the report which are quite significant. Therefore I do not completely agree with Transfield and would like to bring forward the following points: Net Profit: Due to the impairment loss in USM Transfield Services has recorded a net loss in its books. This is not a good sign for the future even though they have a positive cash flow. A loss even on books is highly undesirable by the stakeholders of the company as it forms up negative EPS and P/E ratio. Share Price: Negative profit also hits the market price of the company’s shares. They also start declining as people start to lose confidence in the company. It reflects the image of inefficient operational activities of the company. However, Transfield Services has tried to control the share prices by giving out dividends as dividends give hope for a better future. Credit Ratings: Negative profits also have an adverse impact on the credit rating of the company. The credit rating agencies might consider the loss as a bad sign and so the ratings might drop as well. Loans and Interest rate: The financial institutions giving out loans to the company also gets cautious and might increase the interest rates once the credit rating drops. This leads to an increase in interest rate expenditure and thus cutting down of profits and cash flows in the future. Loss of Business: Future clients may also find the company unattractive as they feel that the company is risky and they may have to suffer losses. All these factors might affect the company adversely in the long run. For instance it is very difficult to get a higher credit rating as it requires years of consistency but one mistake downgrades a company immediately. These factors have not been addressed by the board in the annual report. They must have been addressed along with a strategy of how will they overcome such situations and also how are they planning to avoid such a loss in the future. To what extent do you believe impairment contribute to reliability and relevance of financial reporting? Impairment in simple terms as I understood means recording of assets at their net realizable value. This type of recording will prevent a firm from anticipating profits from an asset which might not be able to give that in reality. It also reduces the fear of loss in books in future when the asset is sold as it has already been recorded at its recoverable value. Some of the basic contributions of impairment towards reliability and relevance of financial reporting are: Recording of true profits: Impairment enables the recording of assets at their net recoverable value. This is the value which can be earned from the asset and thus true information is given out regarding the profit earning capability of the organization. This benefits all the stakeholders of the company as they will now know the true standing of the company and so take decisions well informed then before. This will also help the company as they will no exact status of the trust which the stakeholders have in the company and thus work accordingly; better information about the company to the financiers will bring in attractive interest rates for the company. Better future: Impairment also helps to achieve a better future. Once an asset has been impaired the returns arising from it is anticipated to be low. Now, any rise in the profits from that asset will act as an added bonus for the company. Further any loss in the future which may happen has already been provided for, thus better planning and worthwhile results are more real. Better Risk Management: Impairment also helps in putting up a better risk management system in place. The policy of impairment enables revaluing assets to check the change in the recoverable value and carrying value due to the change in the business conditions. This gives us an idea about the extent of losses due to certain factors and thus a better risk management system could be put in place in order to face such situations. However, impairment also has its drawbacks. The showing and deducting of impairment from the Income and loss sheet might lead to a negative profit on the books as in the case of Transfield Services for 2009 (Transfield Services Limited, 2009). In such a case though there is positive cash flow, shareholders and other stakeholders might give more importance to profitability and thus lose confidence in the company. They might not understand that the loss was due to revaluation and that it has no impact on the cash flows and other liquidity aspects of the business. This might prove to be a great setback for the company as people might try to pull their stakes out. So, on one hand impairment helps to increase reliability and relevance of the financial statements while on the other they increase the chance of letting out two much information which may hit back adversely on the company. Bibliography Government of Western Australia Department of Trasury and Finance. (2009). Department of Treasury and Finance. Retrieved January 3, 2010, from Department of Treasury and Finance: http://www.dtf.wa.gov.au/cms/index.aspx Transfield Services (Australia) Pty Limited. (2008). Asset Management | Transfield Services. Retrieved January 3, 2010, from Transfield Services: http://www.transfieldservices.com/page/Client_Support_Services/Asset_Management Transfield Services (Australia) Pty Limited. (2008). Customer Service | Transfield Services. Retrieved January 3, 2010, from Transfield Services: http://www.transfieldservices.com/page/Client_Support_Services/Customer_Service Transfield Services (Australia) Pty Limited. (2008). Overview|Transfield Services. Retrieved January 3, 2010, from Transfield Services Website: http://www.transfieldservices.com/page/Industry_Sectors/Overview/ Transfield Services (Australia) Pty Limited. (2008). Project Management | Transfield Services. Retrieved January 3, 2010, from Transfield Services: http://www.transfieldservices.com/page/Client_Support_Services/Project_Management Transfield Services (Australia) Pty Limited. (2008). Quality Management System | Transfield Services. Retrieved Jaunary 3, 2010, from Transfield Services: http://www.transfieldservices.com/page/Client_Support_Services/Quality_Management_System Transfield Services (Australia) Pty Limited. (2008). Risk Management System | Transfield Services. Retrieved January 3, 2010, from Transfield Services: http://www.transfieldservices.com/page/Client_Support_Services/Risk_Management_System Transfield Services (Australia) Pty Limited. (2008). TWS Best Practices Network | Transfield Services. Retrieved January 3, 2010, from Transfield Services: http://www.transfieldservices.com/page/Client_Support_Services/TWS_Best_Practices_Network Transfield Services Limited. (2007). Transfield Services Limited Annual Report 2007. Australia: Transfield Services. Transfield Services Limited. (2009). Transfield Services Limited Annual Report 2009. Australia: Transfiled Services. Read More