Impairment Tests - Allocated and Unallocated Corporate Asset Assets - Case Study Example

Impairment tests –Corporate Asset Assets: Allocated and Unallocated Prepared by Executive Summary Given the difficult nature of the identification and valuation of intangible assets for impairment, the observation of the AABS 136 that a majority proportion of intangible assets continue to remain unreported in financial statements comes as no surprise. Impaired assets retained by the firm that is expected to contribute to operations and cash flows at reduced levels were not covered by AASB 136. The absence of both reporting guidelines and reliable market prices limited the recognition and disclosure of impairments of these long- lived assets; impairment provisions were subject to enormous management discretion. This report aims to understand different tests of impairment applied by ADG Global system, Woolworths ltd and Telstra Ltd, arguments in favor and against inclusion of impairment in the balance sheet, and explore different methods suggested for impairment test and valuation of such assets. The objective is to develop an insight into the issues surrounding this issue. Timely recognition of impairments may correct understated past depreciation or permit recognition of the effect of changes in markets or technology on operating assets. Higher frequency of impairment announcements and the absence of reporting guidelines resulted in diverse accounting practices that were not comparable across companies and inconsistently applied within firms over time. Table of contents Executive Summary 1 Table of contents 2 Introduction 3 Question 1 4 Question 1a 4 Question 1b 5 Question 1c 7 Question 2 9 Conclusion 10 Introduction When asset carrying value is higher than its value in-use the asset is said to be impaired. Accounting conservatism dictates that the asset value written down to its value-in use gives guidelines for asset impairment. However, it should be noted that asset impairment is still an allocation process, not a move toward valuation. That is, an asset impairment is recorded when managers` expectations of future benefits from the asset fall below carrying value. This yields an immediate write-off in a desire to better match future cost allocations with future benefits. In this paper, ADG Global system, Woolworths ltd and Telstra Ltd have been selected to analyze impairment tests required by AASB 136. ADG is responsible for arranging appropriate equipment for its buyers for Mining, Oiling and Gas supplies while keeping in view the requirements of the relevant industry, client’s budget and equipments efficiency, mobility, and durability. They were also awarded a privilege to be an exclusive Australia Distributors of a renowned name M-I SWACO for drilling equipments(ADG Global Supply) Woolworth is a big retail chain in Australia and New Zealand. It is the largest retail firm in both New Zealand and Australia in terms of sales and market capitalization. It is also the largest in food retailing in Australia and the second largest in providing the same in New Zealand. The company is the largest retailer in takeaway liquor and poker machine and hotel operator in Australia (Maguire 32). Telstra Corporation which is the largest telecommunications service provider in Australia has been chosen to examine application of asset impairment as per requirement of AASB 136. Question 1 Question 1a All the three companies have an accounting policy relating to Asset impairment that states that Assets are reviewed for impairment on an annual basis in conjunction with the preparation of the annual report or when a specific event indicates that the carrying value of an asset may not be recoverable. To assess the recoverability of the asset, future cash flows to be generated by the asset use in business before disposal is estimated (Ernst & Young, 2011). When the carrying amount exceeds the fair value, impairment loss is recognized in the income statement. When the carrying amount of the assets is greater than total value of undiscounted cash flows, impairment loss is recognized. Asset valuations should be challenged in considering whether amounts are recoverable and the bases of accounting are appropriate. ADG Global system revised asset impairment recognition to include projected undiscounted future cash flows of the mining activities. The company includes Impairment of Intercompany Receivables, Impairment of property, plant & Equipment and Impairment of Intangible assets. In preparation of annual report the company`s conclusions concerning future market conditions and the resulting impact on prices were not include in impairment. To determine the fair value of the Intercompany Receivables net assets, the company used the present value of future cash flows. The resulting fair value, which exceeded the offers received, was used to determine the amount of the write down. Telstra ltd has had reduced deferred tax liabilities in 2013 reflecting the fact that the impairment loss is not recognized for tax purposes until the property is disposed of. However, because they depreciate its fixed assets more quickly for tax purposes than for financial reporting, the impairment has the effect of reducing the difference between the tax bases and reporting basis of these assets. Thus, previously established deferred tax liabilities are reduced. The reduction in equity is the net effect of the impairment provision. This reduction increases in debt-to equity ratio and decreases reported book value per share. Woolworths ltd ratio used to evaluate fixed assets and depreciation policies are used to obtain the impaired write-down. During the year 2013, the company also identified impaired property and equipment at its stores, resulting in a pretax charge increase. This write down primarily relates to solid waste disposal assets. All these assets would require significant additional expenditures to receive the required operating permits from the appropriate environmental agencies. During the 2012/2013, the company identified more economical means, acceptable to such agencies, by which to dispose of its solid waste at these locations and concluded that the significant additional expenditures necessary to make the assets operational were not prudent, resulting in unusable assets. Question 1b In order to carry out Impairment test, the information needed to generate to determine whether a test is needed or not are Show that the asset has the ability to be impairment or show the previous impairment calculations. The useful life of the asset is another type of information that is required. AASB136 provides reporting guidelines for impairments which has divergent timing, measurement, and reporting practices. The use of undiscounted cash flows under AASB 136 reduces the probability of recognition of impairment and overstates asset values because of the failure to recognize the time value of money. It provides with guidelines to forecast impairment write-downs reducing management’s discretion as to timing. Substandard profitability, especially when persistent, is probably the surest sign of impaired assets. LIFO liquidations and changes in depreciation methods, estimated useful lives, and salvage values provide useful but very imprecise signals, segment data can help the analyst spot underperforming operations. The cash flow and tax implications of write-offs are also unclear spot underperforming operations. The cash flow and tax implications of write-offs are also unclear in some cases. Generally, impairments recognized for financial reporting are not deductible for tax purposes until the affected assets are disposed of. Recognition of the impairment, therefore, leads to a deferred tax asset not a current refund. Beneficial cash flow impacts may occur only in the future, when tax deductions are realized. Close attention to the income tax footnote should be helpful, but a complete understanding may require posing questions to management. Timely recognition of impairments may correct understated past depreciation or permit recognition of the effect of changes in markets or technology on operating assets. Higher frequency of impairment announcements and the absence of reporting guidelines resulted in diverse accounting practices that were not comparable across companies and inconsistently applied within firms over time. AASB 136 efforts to improve disclosures regarding “restructuring” provisions, has improved disclosure. Question 1c Purpose of impairment test: The main purpose of Impairment test is to determine the commercial viability value of the Intangible asset. ‘The recoverability test and loss measurement are based on assets grouped at the lowest level for which cash flows can be identified independently of cash flows of other asset groups’ (Ernst & Young, 2011). Like any expense impairment loss is recognized and recorded in income statement of a business for a continuing entity. Therefore, they are recognized in books while keeping in consideration the going concern aspect of the business as a unit; hence, should be able to continue in its operation at its current scale in the future AASB 136 the standard prohibits restoration of previous impairments. It requires disclosure of the amount of the loss, segments affected, events and circumstances surrounding the impairment, and how fair value was determined. With respect to impairments, there is a distinction between assets the firm has decided to dispose of and those it intends to keep and operate, albeit at reduced levels. The disposition decision severs the link between those assets and continuing operations, since the assets are no longer expected to contribute to the ongoing operations of the firm. AASB 136, reporting results of operations governs the financial reporting of the disposal or sale of a business segment; a related interpretation extends these rules to the disposition or sale of portions of a segment. The results of operations, net asset values, and gain or loss on sale or disposition of these assets are shown separately. Presence of intangible: AASB 136, accounting for the impairment of long-lived assets and for long-lived assets to be disposed of, established standards for the recognition and measurement of impairments. The standard requires the recognition of impairment when there is evidence that the carrying amount of an asset or a group of assets can no longer be recovered. Lack of recoverability may be signaled by one or more of the following indicators: A significant decrease in the market value, physical change, or use of the assets Adverse changes in the legal or business climate Significant cost overruns Current period operating or cash flow losses combined with a history of operating or cash flow losses and a forecast of a significant decline in the long-term profit-ability of the asset Steps in applying Impairment test: AASB 136 provides a two-step process. First is the recoverability test: impairment must be recognized when the carrying value of the assets exceeds the undiscounted expected future cash flows from their use and disposal. The second stage is loss measurement: the excess of the carrying amount over the fair value of the assets. When fair value cannot be determined, the discounted present value of future cash flows must be used. The recoverability test and loss measurement are based on assets grouped at the lowest level for which cash flows can be identified independently of cash flows of other asset groups. The impairment loss is reported pretax as a component of income from continuing operations. The standard prohibits restoration of previous impairments. It requires disclosure of the amount of the loss, segments affected, events and circumstances surrounding the impairment, and how fair value was determined. However, the need to evaluate recoverability periodically may result in the review of depreciation methods and estimates. Reported changes in these methods and estimates may precede a firm`s reluctant and delayed reporting of asset impairment. It is unclear whether, in practice, the new standard will reduce management discretion over the amount and timing of impairment announcements. Question 2 The statement is correct as the intangible given to the company runs for a period of five and should be treated so as it is the useful life of that asset. Once an intangible asset has been identified it useful life should be determined and their commercial viability using treated using AASB-136 guidelines on asset impairment and the analysis of projected income resulting from the deployment of the asset. How these can effectively bear on valuation and impairment of intangible assets such as customer relationships or expenses on brand development appears difficult to answer. Therefore, for following the AASB-136 guidelines, the first need is to restrict the definition of intangible assets and expense all costs incurred. They should be valued using fair value accounting according AASB 136, which seeks to determine a value for the asset that a buyer would pay. It allows the firm to choose between different methods for valuation. However, it restricts the choice of adopting fair value accounting only where an ‘active market’ exists for the asset like the case of at hand. Section 38.78 of AASB 136 provides a very narrow definition of ‘active market’, which effectively excludes most types of intangible assets. Because there is a ready and active market for real estate, most companies adopt this method for valuation of real estate property held by them. Those companies that do not adopt this method appear to do so because they believe this represents the liquidation value of the company’s assets and does not show high growth opportunities presented by the asset. Ranatunga (2002: 7) adds that there is an emerging market for intangibles but adds the rider that intangible assets are, “unique, tacit, and cannot be traded, especially when combined to create an organizational capability.” Another factor that could affect the choice of not using fair value accounting could be that this commits the firm to use this approach and AASB-116 does not allow reversion to historical cost. Ranatunga (2002) offers several options in determining the value of intangible assets, which are replacement cost, income projections, and market valuation. However, even these approaches do not lend themselves to determination of an accurate and reproducible valuation of intangible assets. For example, replacement cost, by the very nature of the term, assumes that a market exists from where one may buy an asset to replace an existing one. Therefore; it is evident that ascribing future income projections to a single intangible asset is fraught with danger of manipulation and creative accounting. Another method for valuation is to use the cost incurred in developing the intangible asset. Even this method does not provide a viable answer because costs and value created have very little link.. Conclusion Impairments recognized for financial reporting are not deductible for tax purposes until the affected assets are disposed of. Recognition of the impairment, therefore, leads to a deferred tax asset not a current refund. Beneficial cash flow impacts may occur only in the future, when tax deductions are realized. Close attention to the income tax footnote should be helpful, but a complete understanding may require posing questions to management. Reference List ADG Global Supply.About ADG Global Supply, (Online). Available at: (Accessed 28 April 2014) Ernst & Young, 2011. Financial reporting developments -Impairment or disposal of long-lived assets, (Online). Available at: < www.ey.com/.../vwluassetsdld/...impairment.../financialre>(Accessed 28 April, 2014) Maguire, Marion. Financial Statement Analysis. GRIN Verlag: Publisher, Amsterdam, Print. Ratnatunga, J. (2002): The Valuation of Capabilities: A New Direction for Management Accounting Research, Journal of Applied Management Accounting Research, 1(1), pp. 1-15. 1(1) Read More