Intermediate Financial Accounting for Australian Securities and Investments Commission - Case Study Example

Name: Tutor: Title: Intermediate Financial Accounting ASIC Institution: Date: Table of Contents Contents Executive Summary In Australia, all the business firms are required to observe accounting standards that are set up by the Australian Securities and Investments Commission (ASIC). One of the most important accounting standards is on asset impairment that gives procedures that an organization may follow in ensuring that the organization’s assets are carried at a cost which is not more than its recoverable amount. The important components of asset impairment include good will allocation on cash generating units, impairment testing and key assumptions in impairment testing. The management of CCA (Coca Cola Amatil) at one time realized that its accounting procedures on asset impairment were not conforming to those of ASIC. The report below therefore compares the accounting standards required by ASIC and those followed by CCA, plus any potential gap and recommendations on filing up the gap. Introduction Asset impairment is defined as the sudden drop in the usability of a capital asset such as machinery, a vehicle or an entire factory. This drop could be caused by physical damage to that capital asset, the asset may become obsolete as improved technology is leading to better assets or it may be due to changes in the laws governing the usage of that asset. When an asset reaches this point of impairment, it should be written off. Generally, an asset is said to be impaired where its carrying amount is higher than its recoverable amount. In this case, the carrying amount is the value in which as asset is identified in the balance sheet after the accumulated depreciation and the accumulated impairment losses have been deducted. On the other hand, the recoverable amount is the excess of an asset’s fair value less cost to sell and its value in use. Fair value in this case refers to the value that can be obtained after an asset is sold in a lengthy transaction between two willing parties while the value in use is the present value, after discount, of the cash flow expected in future from continued use of an asset or its disposal after its (Corporations and Financial Services Committee, 2005). Accounting Standards According to ASIC on Asset Impairment Firms in Australia observe the accounting standards that have been set up by the Australian Securities and Investments Commission (ASIC) on various business issues including asset impairment. A review done by ASIC found out that some of the business firms do not follow the required standards while doing the impairment testing. Such firms also made use of cash flow information and discount rates that appeared unreasonable compared to the previous cash flows, market information and that firm’s future expectations (Stickney, Weil, Scipper, & Francis, 2009). On allocation of cash generating units, ASIC standards require that an asset should be attached to cash generating units at the least level to ensure that there is no use of cash flows from one group of assets in supporting the value of other assets. On goodwill, ASIC makes reference to AASB 136 (Australia Accounting Standards Board) which explains that goodwill acquired in an enterprise indicates a payment made by an acquirer expecting to get economic benefits in the future from assets that cannot be identified individually or recognized separately. According to AASB 136, goodwill should be allocated on two conditions. One is on a single cash generating unit where it is likely to relate the acquired goodwill to a particular cash generating unit. Secondly, on a group of cash generating units where various cash generating units are anticipated to profit from the synergies coming up from the goodwill obtained and also that the goodwill cannot be allocated to individual cash generating units on a non spontaneous basis. AASB further explains that in cases where goodwill relating to an income generating unit that it has not been allocated to, an impairment test should be done on that unit. This should be done by comparing its carrying amount, not considering any goodwill, with the unit’s recoverable amount. Therefore, if the carrying amount of the income generating unit includes an intangible asset which is ready for use or has an indefinite useful life and that it can be tested for impairment as part of the unit, then impairment test for this unit should be done annually. ASIC requirements on disclosures concerning impairment testing According to AASB 136 which ASIC makes reference to, there are required disclosures that an entity should make for each asset impairment loss that is realized or reversed for an individual asset, plus the goodwill and the cash generating unit. The first disclosure is the circumstances that prompted the realization or the reversal of the impairment loss. The amount of impairment loss that has been incurred should also be reported and for an individual asset, the type of an asset and the AASB reportable segment where the asset belongs. For a cash generating unit, some of the disclosures that should be made include a description of the features of the cash generating unit, the amount of impairment loss that has been realized or reversed and the method used in identifying the cash generating unit. Other important disclosures include the process used in calculating the asset’s recoverable amount and the values used in determining the recoverable amount (Australian Accounting Standards Board, 2007). ASIC requirements on calculating recoverable amounts Recoverable amount is defined as the excess of an asset’s fair value less cost to sell and its value in use. This amount is used in determining an asset’s impairment where the asset’s carrying amount is compared to its recoverable amount. In determining the recoverable amount of an asset, it is important to consider aspects such as an existing binding sale agreement where the price on that agreement less cost to sell is used. The other factor is availability of an active market for that particular asset where the market price less cost to sell is used. In this case, the market price is the current available bid price and if there is none available, the price used the latest transaction is used. Where an active market is not available, the best estimate of the selling price less cost to sell is used. The value in use is calculated considering aspects such as an estimated value of cash that the company expects from the asset in future, the expected variations in this value in different timings, the price with uncertainties intrinsic to the asset plus other issues such as liquidity Dagwell, Wines, & Lambert, 2008). ASIC requirements on disclosures concerning key assumptions According to ASIC, a firm should disclose the key assumptions made when calculating the recoverable amounts. This is especially on information concerning estimates made in measuring the recoverable amount of a cash generating unit where aspects such as goodwill is included in the asset’s carrying amount. For example, if the recoverable amount of that particular asset is calculated based on its fair value less cost to sell and that this value is not reached using the observable market price, the firm should therefore describe each of the assumption made when the management was determining the fair value less cost to sell. The key assumptions here are the ones which are most sensitive to the recoverable amount. Still on the key assumptions, ASIC requires that if there is a reasonable change in the key assumptions that the management has made in determining the recoverable amount that would result in a unit’s carrying amount being more than the recoverable amount, the firm should disclose the value attached to each key assumption and the level to which this value should change. Other requirements are on budgets and forecasts where they should not exceed a five-year period. If the budget has to go beyond five years, then the company should extrapolate from the earlier budgets. The discount rate to be considered in measuring the asset’s value in use should be calculated from its pre-tax rate which indicates the current market assessment with the value of money of that particular time and the risks that may be specific to that asset (ASIC, 2011). The current accounting practice of CCA Ltd The current accounting standards of CCA do not have many differences with the requirements of ASIC. CCA carries its impairment test by comparing the asset’s recoverable amount to its carrying amount. Recoverable amount is defined as the excess of fair value of cost to sell and the asset’s value in use. However, value in use is calculated using the discounted cash flow method of “relief from royalty” that covers a period of ten years with an appropriate residual value at the end of the ten years. This method makes use of estimated after tax royalty cash flow for a period of more than five years so as to reduce dependence on residual values and is based on business plans for three years prepared by the board of management. In CCA, impairment tests are also done based on the asset’s value in use. Apart from the value in use, CCA also calculates the asset’s fair value less cost to sell to ensure that value obtained from whichever method is in excess of carrying amount of the asset (CCA, 2010). Some of the key assumptions disclosed by CCA are on discount rates and forecasting growth rates among others. The discount rates used by the firm are determined as the average cost of capital after tax for the group in cash generating unit with adjustment of risks where necessary. CCA uses forecast growth rates to calculate residual value of the cash generating unit. For reasons of impairment testing, the values of real annual growth rates used are from nil to 2.0% since 2009. Regarding the goodwill, it is not amortized but its testing is done annually or more frequently if need be. Impairment is therefore calculated by assessing the recoverable amount of the cash generating unit for which the goodwill applies (CCA, 2010). Gap between the CCA’s current practice and the ASIC requirements CCA is not doing so badly in keeping up with the ASIC requirements on accounting standards concerning asset impairment. However, there are just a few issues that create a gap between the current practices of CCA and the ASIC requirements. One of the areas where there is a gap is on CCA’s method of calculating the value in use of the cash generating unit. ASIC requirements states that the value in use should be calculated from the pre tax rate that reflects the current market assessment and the currency value at that particular moment plus the associated risks to the asset. But on the contrary, CCA calculates the discount rates using the average cost of capital after tax for the group in cash generating unit with adjustment of risks where necessary. Still on the value in use, CCA calculates using the discounted cash flow for a period of fifteen years and considering the residual amount at the end of the same period whereas according to ASIC, it should be calculated at different timings considering the expected changes. The other difference between CCA operations and ASIC requirements is on budgets and cash flow forecasts where according to ASIC, the should only focus for a period of five years while CCA makes forecasts of more than five years. Recommended actions to satisfy the potential ASIC reviewers With the regular checks hat ASIC intends to be making on the accounting standards of entities,. It is very important or companies to keep updating their standards so that they will always meet the ASIC requirements. For example, the accounting board in CCA should go through their standards especially on asset impairment to ensure that they make corrections on the existing gaps. The most important issues regarding ASIC accounting standards are on identification of cash generating units, allocation of goodwill and the assumptions applied in impairment testing. To ensure that the company fulfils the above, it is important to have copies and always make reference to the AASB 136 (Australia Accounting Standards Board) and also keep a track of the changing ASIC requirements. References Australian Accounting Standards Board, 2007, Compiled Accounting Standards AASB 136: Impairment of Assets, AASB, Melbourne Australia. Australian Securities and Investments Commission (ASIC), 2011, Financial Reporting, retrieved on 13th September 2011 from http://www.asic.gov.au/asic/asic.nsf CCA, 2010, Annual Report, Sydney, Coca-Cola Amatil ltd. Corporations and Financial Services Committee, 2005, Australian Accounting Standards, Melbourne, Australian Government - Department of the Senate. Dagwell, R., Wines, G., & Lambert, C., 2008, Corporate Accounting in Australia, South Wales, UNSW Press. Stickney, C., Weil, R., Scipper, K., & Francis, J., 2009, Financial accounting: an introduction to concepts, methods, and uses, Cengage Learning, Boston. Read More