The Measurement of the Amount of Impairment of Many Types of Assets - Term Paper Example

The Measurement of the Amount of Impairment of Many Types of Assets Introduction Judging impairment is a subjective financial activity. Financial managers are at will to determine the level of impairment of fixed assets. In the same context, accounting standard setting does require to compromise to strike agreement and it cannot protect itself from the direct threat of politicisation (Sutton, 1984; Brown and Tarca, 2001; Zeff, 2002).Financial managers use their personal financial understanding for the purpose of providing and determining a reasonable extent of asset impairment. For that financial activity, they are totally free to judge, determine and allocate their impairment estimation. The International Financial Reporting Standards, which are commonly known as IFRS, are unable to provide any guidance for the purpose of having an authorised and agreed way of judging and assigning the level of fixed assets impairment. After determining and issuing the International Accounting Standards number 36, in short IAS 36, the management of IFRS has become satisfied that they have successfully played and performed their job in the most positive way. Unfortunately, this level of contribution from the management of IFRS has only increased the use of subjectivity for the purpose of determining and assigning impairment for fixed assets. A huge amount of possible implications cannot be avoided. Many companies use this type of freedom to determine and allocate that level of impairment that may only support the interests of management at the cost of real owners-the shareholders. By determining the level of impairment for different types of assets, many companies become successful in engineering the type of financial statements that they want to show and declare in the public. Multiple impacts can be appeared on the financial statements. For example, for the statement of comprehensive income, the impact of impairment would be that it would show less net profit than it could have shown in case of no loss of impairment. Furthermore, this would directly and negatively show its effects on dividends of the company as well. Due to the occurrence of the impairment loss, the company is required to reduce the amount of profit. Consequently, less amount of dividend would be announced and given to the shareholders of the company. The shareholders could have given more dividends if the company had not shown the occurrence of the impairment loss. Additionally, if the amount of impairment is substantial and material, then undoubtedly, this would negatively impact on the valuation of the business of the company; aggregately, company may experience a reduced level of confidence by shareholders, individual and institutional investors as well. In the same context, the announcement of material impairment could impact on a share price of the company. And this impact would show its presence by forcing the share price to reduce its current level of price to the level of reduced amount. All in all, the use of subjectivity for the purpose of determining a particular amount of impairment has put a considerable amount of impact on the financial statements, share price, reduced amount of dividends, tax saving, and other short term and long term impacts. International Accounting Standard 36: Impairment of assets The main and fundamental aim of this standard is to ensure that the long term fixed assets are carried and incorporated into the financial statements at no more than their recoverable amount. Before going to further understand and analyse the concept and application of impairment, it is highly important to define and understand the meaning of assets which come directly under the ambit of impairment loss. International Accounting Standards Board has defined the concept of asset as “ an asset of an entity is (a) cash held by the entity; (b) a present right of the entity to cash; or (c) a present right, or other present privilege, of the entity to a resource that is capable of generating economic benefits to the entity, either directly or indirectly.” (IFRS, 2006) Goodwill and Impairment of goodwill Goodwill is considerably defined as the value linked to intangible assets as type of reputation, good contacts within the industry, well-experienced and well-trained workforce, favourable and attractive business location and some other unique characteristics of the company for which buying company would pay excess of the value of net assets shown in the balance sheet. Additionally, intangible assets are not easy to value in acquisition accounting. And this problem becomes severe where there has been a significant amount of manipulation in the previous accounting (Caldwell, 2006). For this understanding, Wyatt et al., (2001) provides one reason that intangible assets were inseparable from the firm’s underlying business model and operations. Also, Barth et al., (2001) highlights that prices of firms with high-intangible assets tend to be less informative. The complexity of intangible assets has been widely discussed and concluded that accounting for intangible assets is inevitably one of the most controversial and intractable issues in accounting (Wines and Ferguson, 1993; Jennings et al. 1996; Choi et al., 2000; Afferdson, 2001; Godfrey and Koh, 2001), Immeasurability and intangibility are the main features of goodwill (Seetharaman et al., 2006). Carlin (n.d.), explains that one of the major problems of contemporary financial reporting is the application of rigorous valuation and testing of impairment. Harper (2001) maintains that the new standard for measuring impairment of assets offers a clearer picture of goodwill to the users of financial statements. Also, many studies are conducted to measure and understand what motivates managers to revalue assets (Henderson and Goodwin, 1992; whittered and Chan, 1992) and what impact does revaluation announcement on share prices, future profitability of the firm (Emanuel, 1989; Easton et al., 1993; Aboody et al., 1999) Carrying value Carrying value is the amount at which an asset is recognised in the statement of financial position, normally and mostly called as balance sheet, after deducting any amount of accumulated depreciation or an amount of amortization and amount of accumulated impairment losses thereon. Measuring and recognizing an impairment loss If the recoverable amount of an asset is less than the values of its carrying amount, in this case, the carrying amount of the asset is required to be reduced to its extent of recoverable amount. Subsequently, that difference or reduction is recognized as an impairment loss. Now, the relevant standard has given and provided a certain way to account for this amount of impairment loss in the statement of comprehensive income. If the impaired asset is maintained by using another international accounting standard, for instance, IAS 16, Property, Plant and Equipment, and this impaired asset is carried at revalued amount. In this case, the impairment loss of a revalued asset must be decreased in accordance with the standards, methods and treatments provided and described by this standard; besides, it must be considered and treated as a revaluation decrease. In this case, this would not put any amount of impairment loss to the statement of comprehensive income. Causes and requirements of impairment assessment Each balance sheet date must observe an asset impairment assessment. This is required and recommended for the companies having the presence of long term fixed assets for the purpose of doing commercial business. It is always insisted to companies that even if there is neither indication nor any need, the process of impairment assessment must be determined and carried out. Some special focus and emphasis on the impairment assessment of certain long term assets is greatly prescribed and recommended for the companies. Besides, some external and internal situations may arise and may require a company to perform and carry out the process of asset impairment assessment. From the external side, it is possible that the market value of an asset may have declined and considerably reduced. Under this situation, the company is required to carry out the process of asset impairment assessment. For the purpose of determining and recognizing the amount of impairment, the company may be required to use and avail the services of a valuer. And this depends on the nature of the assets. There are many different types of fixed assets, each type of fixed asset has different and unique characteristics; some fixed or long term assets are very complex for the purpose of determining its market value and so on. Additionally, some fixed or long term assets are technical in nature and without the help and valuation of a related valuer, it would be difficult to determine the appropriate and relevant amount of impairment of the technical long term asset. Furthermore, any negative or adverse effects of changes in technology, law and relevant and related market in the economy may require a company to start and use an impairment test on a fixed asset. For instance, a company is manufacturing and selling different types of desktops. And in some days, a market observes that a new technological changes; and laptops are now more sold than the sale of desktops. The desktop selling company has no choice left but to start and use an asset impairment test on its assets. A change in the technology and change in the consumer demand have occurred. And the occurrence of this technological and demand change have left the desktop selling company to determine and recognise its long term fixed assets on its market value rather than the carrying value. For example, a new legislation requires a particular ban on a special type of car. That car manufacturing and selling company would have only one choice that is conduct the process of impairment test. Additionally, some internal causes may require the need of impairment assessment. For example, a long term fixed machine is physically damaged due to any reason. The first step for a company would be to determine the current market value of that machine. And subsequently, follow all the relevant and required steps to determine and recognise the impairment amount. Also, for instance, if a company purchased an asset with the expected production of 5000 units in a day; but, after its installation, that asset only produced 500 units in a day. This may require the company to conduct an impairment test for the purpose of determining the possible impairment in the asset. Recognition of impairment loss When a carrying amount of an asset is greater than its recoverable amount, in this case, the carrying amount is needed to be reduced to the extent of its recoverable amount. This reduction in the carrying amount of the asset is called as an impairment loss. Now there are two situations to account for the amount of impairment loss. If there is no revaluation account related with the impaired asset, in this case, the amount of impairment loss would be directly headed towards the statement of comprehensive income and this amount of impairment loss would be accounted for in it as an impairment loss. And this amount of impairment loss would decrease the amount of revenues in the statement of comprehensive income. Contrary to this, if the impaired asset has already a revaluation balance and revaluation account, in this case, the impairment loss would be channelized towards the revaluation account of the impaired asset where this amount of impairment loss would decrease the amount of revaluation. The companies have no choice but to be subjective for the purpose of determining impairment. If the companies are given any other way to measure and account for the impairment loss, and they are required to follow only that way to for the purpose of conducting impairment test, in that case, there would be a possibility of avoid using the tool of subjectivity. But, in the above mentioned and discussed different parameters for the purpose of measuring, recognizing the possible impairment loss of a fixed loss clearly highlighted that even the companies are at will to be subjective for the impairment loss, still they are required to follow and implement a set of procedures and standards. Without using and following these steps, companies cannot be able to measure the impairment of assets. Their level and use of subjectivity is not completely free; some basic situations that must be valid and reasonable; and must be there. Their presence of certain causes is highly required. It is this presence of certain causes that restrict companies to exploit the tool of asset impairment for any other objectives that may not be in favor of shareholders of the company. References 1. Aboody, D, Barth, ME, Kasznik, R1999, "Revaluation of fixed assets and future firm performance: evidence from the UK", Journal of Accounting and Economics, Vol. 26 pp.149-78. 2. Alferdson, K 2001, "Accounting for identifiable intangibles – an unfinished standard-setting task", Australian Accounting Review, Vol. 11 No.2, pp.12-22. 3. Barth, MF, Kasznik, R, McNichols, MF 2001, "Analysts coverage and intangible assets", Journal of Accounting Research, Vol. 39 pp.1-34. 4. Brown, P, Tarca, A 2001, “Politics, processes and the future of Australian Accounting Standards”, Abacus, Vol.37 No. 3, pp.267-96 5. Caldwell, A 2006, "IFRS 3's practical application", Accounting WEB. 6. Carlin, TM, “Asset impairment”, Managerial Finance, Vol. 36, Is. 9. 7. Choi, WW, Kwon, SS, Lobo, GJ 2000, "Market valuation of intangible assets", Journal of Business Research, Vol. 49 No.1, pp.35-45. 8. Emanuel, D 1989, "Asset revaluations and share price revisions", Journal of Business Finance & Accounting, No. Spring, pp.213-27 9. Easton, PD, Eddey, PH, Harris, TS 1993, "An investigation of revaluation of tangible long-lived assets", Journal of Accounting Research, (supplement), Vol. 31 pp.1-38. 10. Godfrey, J, Koh, P 2001, "The relevance to firm valuation of capitalizing intangible assets in total and by category", Australian Accounting Review, Vol. 11 No.2, pp.39-49 11. Jennings, R, Robinson, J, Thomson, RB, Duvall, L 1996, "The relation between accounting goodwill numbers and equity values",Journal of Business Finance & Accounting, Vol. 23 No.4, pp.513-33. 12. Harper, S 2001, “impairment test offers clearer picture of goodwill- a brief article”, available at: [www.findarticles.com/p/articles/mi_m0ICC/is_2_70/ai_80206023][Accessed on 25 February, 2011] 13. Henderson, S, Goodwin, J 1992, "The case against asset revaluations", Abacus, No.March, pp.75-87. 14. International Accounting Standards Board, definition of asset, available at: [http://www.ifrs.org/NR/rdonlyres/DBBADD47-0DFA-47C4-A624-B5991F1CB176/0/8_1455_0602sob04b.pdf] [Accessed on 25 February, 2011] 15. Sutton, TG 1984, "Lobbying of accounting standard-setting bodies in the UK and the USA: a Downsian analysis", Accounting, Organizations and Society, Vol. 9 No.1, pp.81-95 16. Zeff, S 2002, "Political lobbying on proposed standards: a challenge to the IASB", Accounting Horizons, Vol. 16 No.1, pp.43-54. 17. Seetharaman, A et al., 2006, Managing impairment of goodwill, Journal of Intellectual Capital, 7(3), 338-353.   18. Wines, GF, Ferguson, C 1993, "An empirical investigation of accounting methods for goodwill and identifiable intangible asset: 1985 to 1989", Abacus, Vol. 29 No.1, pp.90-125. 19. Whittered, G, Chan, YK 1992, "Asset revaluations and the mitigation of under investment", Abacus, No. March, pp.3-35. 20. Wyatt, A, Matolcsy, Z, Stokes, D 2001, "Capitalisation of intangibles – a review of current practice and the regulatory framework", Australian Accounting Review, Vol. 11 No.2, pp.22-39. Read More