Reduction of Assets Value by Way of Impairment - Research Paper Example

Running head: Reduction of Assets Value by Way of Impairment Name: University: Course: Tutor: Date of Submission: Contents Contents 1 Abstract 2 Abstract The main aim of this paper is to investigate quoted Australian companies which reduced the value of their assets in 2008 and 2009 by way of impairment. In addition, the research will endeavour to find out the reasons given for the impairment as well as what comments did the auditors make in relation to the asset impairment. Further, the research paper will analyse the results obtained by these companies to find out if the results obtained from the procedure actually support the American study of impairment by Ross Watts. The literature review will analyse what asset impairment is as well as it will discuss prior researches which have been done in relation to asset impairment according to Australian Accounting Standards Board (AASB).Methodology will cover the research method used in data collection and finally discussion part will analyse quoted Australian companies which reduced the value of their assets in 2008 and 2009 by way of impairment. 1.0 Introduction Asset impairment is an accounting practice of valuing assets mainly to determine if the cost of carrying them is more than the value that they are providing to the business. Asset impairment has over the years become a famous accounting practice within companies especially for complex assets such as warehousing locations, departments or properties. Asset impairment has become a wide spread phenomena in accounting practice hence it’s usually perceived as a wider strategy of treating value loss as business deductions (Stickney, Weil & Francis, 2009, pp.56-70). In any accounting period assets are susceptible to impairment (decline) of their value and this may be caused by several factors such as poor management, new competition and technological innovations. Since asset impairment has become a common practice among accountant most of them usually assess factors such as market changes or changes in the prime lending interest rate to clearly understand and see if these changes have any effect on the asset value. Assets impairment today is being used by many companies primarily to provide investors with a way to evaluate corporate management as well as decision making track record (Nikolai, Bazley & Jones P,2009,pp.12-30). 2.0 Problem Statement Today professional accountants within companies are using asset impairment as way of evaluating how assets affect the bottom line as well as the company’s total profits. This kind of accounting practice has become common in many organizations because it helps business leaders to benefit from an optimized annual tax return at the same time recover the cost of doing business in any given year. With prior knowledge on what asset impairment is, this research paper investigates quoted Australian companies which reduced the value of their assets in 2008 and 2009 by way of impairment, reasons given for the impairment as well as what comments did the auditors make in relation to the asset impairment. In addition, the research will find out if the results obtained by these companies support the American study of impairment by Ross Watts. 3.0 Research Objectives The main objective of this paper is to paper investigate quoted Australian companies which reduced the value of their assets in 2008 and 2009 by way of impairment. Additionally, the research paper will find out what comments were made by the auditors regarding asset impairment and if the results obtained support American study of impairment by Ross Watts. 4.0 Literature Review As a fundamental principle in the course of accounting, assets especially non-current assets need not to be recorded at a value that is in excess. There is therefore the need for the specification of an amount against which the carrying amount of an asset should be weighed to find out whether the amount is excessive or satisfactory. This amount is referred to as the recoverable amount. For this reason, the Australian Accounting Standards Board (AASB) came up with a prescription to see to it that no asset is carried at an amount that is greater than the recoverable amount. The recoverable amount in this sense refers to that amount that the company will be able to recoup by either using or selling the asset or both (McEwen,2009,pp.80-100,. The procedure identified by the Australian Accounting Standards Board is recorded as AASB 136. In the spirit of the standard if an asset’s carrying amount is larger the same asset’s recoverable amount, then the asset is construed to have expired. In that circumstance therefore it is required that the excess amount should be recognized and this amount will be referred to as the impairment loss. Further, the standard provides an understanding on when the impairment loss should be recognized by the entity. Recognition of the impairment loss in effect results to the reduction of the asset’s carrying value (CCH Editors, 2008: 631). According to the standard an entity need to carry out an assessment of all of its assets to identify whether there is an indication that any of them may have been impaired. If in any case there is an indication of impairment of the asset then the recoverable amount of the asset should be determined and then compared to the carrying amount to determine whether the amount is excessive or not. If the case of the asset supports an excessive carrying amount, then the asset need to be written down by way of recognizing of a loss due to impairment. The standard also provides a number of indications of impairment that emanate both from within and without the company (Dagwell, Wines and Lambert, 2008: 176). 4.1 Indicators of Impairment Loss 4.1.1 External Indicators The entity which is in the process of assessing whether impairment has occurred or not will consider several indications provided in the standard. As indicated above the indications might stem from inside the business and also from outside the business. Externally, the market value for the asset might have significantly declined during the financial period in question more than anticipated. It would also be as a result of very significant changes that are of an adverse effect on the business that occurred during the period are expected to occur in the near future. These changes might be related to the technological, economic, the market or the legal environment in which the business is operating. Changes in the interest rate s on the market and other investment rates of return could also have an adverse effect on the rate of discounting that is normally used to calculate the value of the assets. Finally the external market capitalisation of the company or business could be less than the net value of the assets in terms of their carrying amount (Australian Accounting Standards Board, 2009). 4.1.2 Internal Indicators Information about asset impairment is also gotten from inside the business from the analysis of the different events that occurred during the period under consideration. Firstly there could be proof of obsolescence of some of the assets in the business or a significant physical smash up to the assets in the entity. Further there could have been significant changes during the period or are anticipated in the near future and the changes could be of an adverse effect on the value of the assets. These changes could be affecting the functioning of the assets or the manner in which the assets are expected to be used. It could be that the asset would become idle due to the plans to discontinue a unit of operation in the business or there is a plan to restructure the business which could render the asset redundant in the company or there could be an adverse reassessment of the useful life of the asset. There is also the possibility that there could be an indication that the economic performance of the asset is actually worse or expected to be worse than anticipated by the managers. Finally the indication could be with respect to an investment made in a subsidiary, joint venture or an associate and a dividend has been received from the investee company. Where the dividend received is more than the aggregate comprehensive income of the investee company in the period of dividend declaration, there is an indication of impairment of the asset value (Australian Accounting Standards Board, 2009). 5.0 Methodology 5.1 Research design The research survey used Systematic sampling to collect data and only quoted Australian companies which reduced the value of their assets in 2008 and 2009 by way of impairment were selected for the research. 5.2 Target Sample The sample comprised of quoted Australian companies which reduced the value of their assets in 2008 and 2009 by way of impairment. The companies chosen for the research comprised of; OM Holdings Limited, Jameson Resources Limited, Pacific Brands Limited and AED Oil Limited 5.3 Data collection method The data collected for the research was through surveys and interviews, in which various managers of Quoted Australian companies were interviewed to find out if they really used impairment method to reduce the value of their assets in the year 2008 and 2009. 6.0 Discussion 6.1 Impairment of Assets by Australian Quoted Companies In the years 2008 and 2009 several Australian companies that are quoted reduced the value of their assets by way of impairment. It is worth to note that the impairment of assets’ value by the quoted companies cut across different industries and sectors of the Australian economy. This is of course based on different conditions as provided and applicable to the specific company. This is because of the nature of the world economy towards the end of the fiscal year 2008 and the beginning of 2009. The economy was hit hard and there was a serious depression on the major world economies. The Australian economy was not an exception hence several companies were forced to use Asset Impairment. The quoted companies which used assets impairment comprises of; 6.1.1 OM Holdings Limited OM Holdings Limited is one of the listed public companies on the Stock Exchange for Australia which fundamentally deals in trading with metals. It is also involved in both harnessing and distribution of products from manganese ore and also in the processing of the ores to different products that are intermediate. In the recent past the company also started operating mining activities for commercial purposes. The company did recognise impairment loss (OM Holdings Limited, 2008). 6.1.2 Jameson Resources Limited Jameson Resources Limited which deals in coal projects also reduced its assets value by way of impairment. The company identifies, acquires and develops coal projects that are strategic as its core activity. It is also listed on the Australian Stock Exchange (Jameson Resources Limited, 2009). 6.1.3 Pacific Brands Limited Pacific Brands Limited which deals in the production of household products and clothing also reduced its asset value by way of impairment (Pacific Brands Limited, 2009). The company use Asset impairment primarily to determine if the cost of carrying the assets was more than the value that assets were providing to the business 6.1.4 AED Oil Limited Finally AED Oil Limited which deals in oil products also reduced its assets value by over 50 million Pounds by way of impairment. There quite a number of reasons for the companies to reduce the value of their assets as outlined in the ensuing section (AED Oil Limited, 2009). 6.2 Reasons for Impairment There are diversified reasons as to why the companies recorded an impairment loss on their assets. The AED Oil Limited Group brought to an end its production activities. Also there was a contract referred to as the FPSO Charter Contract that was closed on July 4th 2009. Following these events the group wrote down all the costs related to the infrastructure used for production purposes and also examined the remaining value for impairment. Of course the residual value was transferred to the deferred costs of exploration, evaluation and development. The economic conditions that were in place as at the end of 2008 and the beginning of 2009 also activated the impairment. Generally oil prices and the prices of other commodities experienced a sharp fall which also impacted the performance of the company negatively. It was also within the expectation of the company that the performance of the Puffin North East plant will be low(Gerard,2009,pp.67-78). A combination of these facts resulted to the company recognising an impairment loss which was computed using the fair value less the selling costs and the discounted cash flow analysis methodology. Therefore it can be concluded that the reason behind the recognition of the impairment by the company was due to the changes within the company’s operation whereby its production unit was terminated, uncertainty in the economic conditions and the future expectation of low performance of the company’s plant (AED Oil, 2010: 52). Pacific Brands Limited recognised an impairment loss of 174.8 million Pounds. This difference between the carrying amount and the fair value of the assets was allocated to intangible assets including goodwill and brand names. The loss was determined through the examination of the Outwear and Sport unit which is the major Cash Generation Unit of the company. This unit had underperformed during the year and there was uncertainty with regard to its future performance. The market for the Underwear and Sports products is expected to underperform during the subsequent years therefore impacting negatively the returns and cash flows expected and estimated respectively through the use of the unit (Pacific Brands Limited, 2009). OM Holdings Limited and its subsidiaries also recorded an impairment of its financial assets. Normally the group has identified several events that constitute the objective evidence of impairment. This include; where a debtor to the company is experiencing financial difficulty that is very significant, where the debtor has breached the contract, where it is probable that the debtor will be bankrupt or will undergo a financial reorganisation. An adverse change in the market, technological environment, legal and economic environment in which the company operates is also an indication of impairment (OM Holdings Limited, 2008). The same reasons applied for Jameson Resources Limited coupled with the uncertain conditions in the market due to the global financial crisis (Jameson Resources Limited, 2009). 6.3 Auditors’ Comments on the Reasons The companies were audited by different auditors. The Pacific Brands Limited was audited by KPMG (Pacific Brands Limited, 2009), OM Holdings Limited was audited by Foo Kon Tan Grant Thomton LLP accountants, AED Oil Limited was audited by Ernst & Young (AED Oil Limited, 2009) while Jameson Resources Limited was audited by HLB Mann Judd (Jameson Resources Limited, 2009). In all the cases the auditors’ reports were unqualified. This means that the auditors were in agreement with the reasons for the recognition of the impairment loss by the companies. The auditors also agreed with the measurement of the impairment loss by the companies. 6.4 American Study of Impairment by Ross Watts The United States distinguish non-current assets into three distinct classes for purposes of determining and measuring impairment loss. These categories include; long-lived assets other than intangible assets, intangible assets and goodwill. Similarly according to the American study impairment loss is the difference between the carrying amount of the assets and the recoverable amount. According to the American Study of impairment loss, there are several indicators of an impairment loss. These indicators culminate to the reasons for recognizing the impairment loss. Where the market price for the asset has significantly decreases there is an indication of an impairment loss which should be recognised by the entity (Gerard, 2009). Also where there is a significant change of adverse nature in the extent to which the asset is currently or is expected to be used; there is an indication of impairment loss. Legal factors in the legal environment in which the company operates may also adversely affect the usability of the asset and therefore providing an indication of an impairment loss. Furthermore, where there are excess costs of acquisition or construction of an asset that have been accumulated than expected there is an indication of impairment loss. In addition an impairment loss is indicated where the current projection or forecast shows a continued trend of losses associated with the asset. Finally where the asset is expected to be disposed through a sell transaction or in any other way before the end of its useful life previously estimated there is an indication of an impairment loss (Nikolai, Bazley and Jones, 2009: 513). 6.5 Comparison of the Reasons with the American Study The reasons provided by the American study and the reasons given by the companies listed on the Australia Stock Exchange are similar to a large extent. The major reason in both cases for the recognition of an impairment loss is when the carrying amount of an asset as recorded in the books of accounts of the company is less than what can be recovered from the use of the company or disposal amount or both (Gerard,2009,pp.67-78). The carrying amount is therefore required to be compared with the recoverable amount and an observation is made whether there is an impairment loss or not. The indicators of impairment loss emanate from both the internal operations of the entity and the external environment of the entity. The events occurring within the entity are very significant in affecting the recoverable amount of the asset. Where there is the possibility of underperformance of the asset either in the current period or in the future there are high changes that the recoverable amount of the asset from its use would be less than its carrying amount. Therefore an impairment loss should be determined and recognised (Gerard, 2009, pp.67-78). The economic environment in which the entity is operating determines the market value of the asset and therefore if it is unfavourable, then there is a possibility that the entity’s assets will fetch fewer amounts than the carrying amount. Also the legal environment of the entity also has the potential to negatively impact the value of an asset. Therefore both the external and internal environment of an entity will provide indicators of impairment loss as shown by both the American study and the Australian listed companies (McEwen, 2009: 79). 7.0 Recommendations and Conclusion Keen examination of both the American study and the reasons provided by the companies listed on the Australian Stock Exchange shows that companies need to constantly assess their assets to determine any discrepancies that may exist between the carrying amount and the recoverable amount of their assets. There are several indicators of impairment loss both from inside an entity and outside the entity (Dangwell, Wines & Lambert, 2008, pp.25-45). Companies should therefore be very keen on the dynamisms that occur both in the internal and external environment of the entity. Where there are events either within the entity or outside the entity that point to the fact that there is a possibility that the assets’ value has been impaired, the entity should determine the recoverable amount of the assets and compare it to the carrying amount. If the recoverable amount is less than the carrying amount, an impairment loss should be recognised and reported in the financial statements or reports. This amount is the difference between the two amounts (Dangwell, Wines & Lambert, 2008, pp.25-45).Despite the mere fact that many companies have adopted asset impairment as an accounting practice including Australian companies there will be numerous challenges arising. References AED Oil Limited, (2009), Annual Financial Report Year Ended 30 June 2009. Australian Accounting Standards Board, (2009), Compiled AASB Standard AASB136, Australian Accounting Standards Board, Melbourne. CCH Editors, (2008), Australian Master Accountants Guide 2008/2009, McPherson’s Printing Group, Australia. Dangwell R, Wines G. & Lambert C., (2008), Corporate Accounting in Australia, 4th Edition, The University of New South Wales Limited, Sydney,pp.25-45 Gerard M., (2009), Fair Value Accounting Fraud: New Global Risks and Detection Techniques, John Wiley & Sons Inc., New Jersey,pp.67-78 Jameson Resources Limited, (2009), Annual Report for the Year Ended 30th June, 2009. McEwen A., (2009), Transparency in Financial Reporting: A Comparison between IFRS and US GAAP, Harriman House Limited, Hampshire,pp.80-100 Nikolai A., Bazley D. & Jones P., (2009), Intermediate Accounting, Cengage Learning, Mason,pp.12-30 OM Holdings Limited, (2008), Audited Financial Statements for the Year Ended 31st December 2008. Pacific Brands Limited, (2009), Pacific Brands 1H11 for the Year Ended 31st December 2009. Stickney, C P.,Weil, R L & Francis, J (2009).Financial accounting:an introduction to concepts, methods and uses.Chicago:Cengage Learning,pp.56-70 Read More