Accounting Standards: Asset Impairment and Write-Down Risk Soars - Assignment Example

Asset impairment, write-down risk soars Abstract: The following project aims to bring to light the need for a process which outlines the evaluation of asset impairment and fair value assessment of tangible and intangible assets for any given commercial outfit at a particular given point in time especially now when investor trust needs to be restored in the market. It also aims to bring out the exact meaning of the term asset impairment, removing confusions with regards to the same. It will also seek to analyze the annual report of a company listed in the ASX and its compliance with the demands laid down in ASSB 136 for the 2008 and brings out the discrepancies that are apparent in what “should” be there in the accounting books and what “is” there. When the carrying amount of an asset exceeds its recoverable amount, the asset is said to have been impaired. Asset impairment has been defined by accounting standards as a method in which the total estimated profit that is to be created by capital asset over a given period of time a minimum of which is twenty years, is to be compared to its book value and an extraordinary gain or loss is shown depending on the difference between the two. In simple language impairment of asset occurs when the shown book value of an asset is a lot more than the actual value of the asset. This disparity between the two values can occur because of an unexpected or sudden decline in the service utility of an asset, such as a factory, property or vehicle. The reason for this can be physical damage to the asset, obsolescence due to technological innovation, or changes to the legal code. It is in fact required by standard accounting principles that long standing assets be marked for impairment. It also has to be noted that the a devaluation in the value of an asset due to impairment is recorded as a loss. If one has to analyze the basic purpose behind the adoption of AASB 136, there are a few factors that become clear. It lays down the procedures that a commercial organization needs to adopt in order to evaluate the carrying costs of its assets so as to ensure that they are valued in the books at no more than their resaleable value. AASB in simple terms requires a commercial unit to recognize its impairment losses and specifies exactly when it is a commercial entity has to reverse an impairment loss and also prescribes disclosures. It is important in this context to take a detailed look at what exactly it is that the AASB 16 says with reference to the impairment of assets. AASB 136 Impairment of Assets requires an entity to assess at each reporting date whether there is any indication that an asset is impaired and if such indication exists, the entity must estimate the recoverable amount. Impairment testing largely replicates the recoverable amount test in AASB1010 and AASB1041. However, the scope of impairment testing is wider in that it applies to all assets, rather than only non-current assets. Assessment of impairment according to ASSB 136 happens according to a few given standards. First and foremost, when there is an indication that an asset may be impaired, the asset’s recoverable amount must be calculated. Where an asset’s recoverable amount is less than that asset’s carrying amount, the carrying amount must be reduced to the recoverable amount of the asset and the reduction amount (impairment loss) shall be recognized as an expense unless the asset is carried at a revalued amount in accordance with AASB 116 Property, Plant and Equipment. In such an instance, the impairment loss is treated as a revaluation decrease in accordance with AASB 116. In the case of a CGU (cash generating unit), any impairment loss is allocated first to reduce the carrying amount of any goodwill allocated to the CGU and then to other assets of the CGU pro rata on the basis of the carrying amount of each asset in the CGU. Carrying amounts of individual assets within a CGU must not be reduced below fair value less costs to sell (if determinable), value in use (if determinable) or zero. For intangible assets with an indefinite useful life or not yet available for use, and for a CGU to which goodwill acquired in a business combination has been allocated, the recoverable amount shall be determined annually. There are many expectations from the new standards of asset impairment testing and the reasons for these are simple. The new standards are a lot more conservative, inflexible and to a certain extent even rigid. Markets are more likely to punish companies that try to avoid an impairment charge by using various accounting subterfuges. Such companies would be telling the world that their accounts cannot be trusted at all and that they are Satyams in the making. That would force the market to assume the worst and mark down even assets that are not actually impaired. These are supposed to help disclose the expectations related to future performances by the unit. It also helps outline the model and key assumptions to be held while running the unit, measure liabilities and fair value of assets and also to measure the fair value of the reporting unit. Given today’s’ economic turmoil and turbulence it becomes essential that companies disclose more information to the market in order to accurately assess company values. Outdated corporate reporting poses a serious threat to capital markets. The problems that are obvious in actually implementing the system however are first, the market doesn’t always react favorably to the information received about a given company at any given point in time. Moreover, companies’ managements assert that an internal system in the company doesn’t exist in order to disseminate information publicly to the market. What has to be accepted and hence justified in reference to the above mentioned article is that a fair assessment would, in the long run, accounting the fair value of all assets would bring benefits of increased share values, a lower cost of capital, access to new sources of capital, greater credibility for company management more long term investors and a greater following from analysts. While the attempt to actually fix the precise and fair-grounded value of assets can be daunting, if implemented correctly it can benefit shareholders and corporations alike In an article named, ‘Importance of Impairment Testing’ by Adrian Galis, published in December 2008, the author has said that the economic crisis that started in USA will spread to the rest of the world and from the perspective of a listed company with audited financial statements, an important way out of the crisis is to restore investor confidence. This can in fact, only be done through an accurate reflection of data in financial statements. He lays down very clearly in the article that “We should bear in mind that in hard times, most market participants expect losses from impairment.” It has been in fact categorically stated by many analysts that in case of an economic crisis like the present one, it is important that companies start thinking early about impairment, since many will be affected. Starting early is especially important for companies that have never been through this process. The extra time will be useful for understanding the key value drivers and setting up procedures properly. The company that the following report seeks to take into consideration with regards to its annual balance sheets for the year ended December 2008 is the GPT group. The GPT Group is basically made up of the General property Trust (Trust) and its controlled entities and GPT management holdings Limited Company and its controlled entities. If one was to look at the varied interests of the conglomerate it stands clear that the company has diversified interests in investing in income producing retail, office, industrial, business parks and seniors housing; development of Australian retail, commercial, industrial and business park properties property trust management; and hotel management among other things. The company is one of Australia's largest AREITs with total assets of $13.03bn on December 2008. GPT has three businesses, all of which are interlinked, each based on investment property, ownership, development and management. The company has assets spread over Australia, New Zealand, Europe and the USA. In its 2008 annual report, GPT Group said it has sold AUD 47 million worth of assets and has a further AUD 1.4 billion worth of non-core assets to be sold. With regard to completed sales, GPT said, "The sales, which will settle over the course of the next three months, will realize a total of AUD 47 million." GPT said it was continuing to market a number of non core assets with a total value of AUD 1.4 billion, including shopping centre Floreat Forum, the remainder of its Homemaker City Centers and its Hotel/Tourism portfolio of assets. "The group anticipates further progress on the sales program in the coming months," it said. GPT Group reported preliminary earnings results for the full year ended December 31, 2008. For the year, the company reported loss before interest, tax and depreciation of AUD 2,886.4 million compared EBITD of AUD 1,455.8 million a year ago. FY 2008 FY 2007 Realized operating income 468.8 605.1 Change in value of investment portfolio (non-cash) ($m) (2,152.1) 763.1 Goodwill impairment (non-cash) ($m) (121.8) ----- If one is to look at the figures that have been quoted from the group’s annual balance sheets, there are three things that instantly become clear. Recession has taken a toll on the group’s operating profits and shrunk them down considerably There has been a marked growth in the investment plans of the group in one year. There is a marked outlining of asset impairment and depreciation costs that probably was not there earlier. There is in fact a clear acceptance of the fact that A-IFRS losses which the document further goes on to state as being a total of 3.25 billion dollars. The document also outlines the causes for the losses being so manifest in the present fiscal document. 393.5 million net reduction in Australian core asset valuations $1,758.6 million net reduction in the value of non core investments $839 million mark to market of derivative positions. What is interesting to note is that there has been an attempt on the part of the GPT board to adhere to the guidelines laid down by AASB 132. The reasons for this are actually pretty clear as well. Being primarily a real estate company, GPT has felt the brunt of the sub prime crisis at its worst. The company has therefore been facing a liquidity crunch as the returns on investments have not been as great as was hoped. The real estate sector started the year on a boom but with the sub prime crisis and the collapse of banks, there has been enough economic turmoil in the past year to witness a major change in which the accounting reports were filed this year. Another reason for the probable clarity in some ways is to restore a semblance of investor confidence by providing a more acceptable outlet for the losses. GPT Group says the property trust is well advanced with an asset sale program, after reporting a $3.25 billion annual net loss amid challenging global operating conditions. The trust posted a net loss of $3.25 billion for calendar 2008, reflecting the effect of non-cash items, including asset revaluations and the mark to market of GPT's derivative positions. GPT acting managing director Michael O'Brien said 2008 had been a "very challenging year" as credit and real estate markets continued to deteriorate amid the global economic crisis. "Over the course of the year, economies and markets globally have deteriorated rapidly, credit markets have remained illiquid, further exacerbating market conditions," In conclusion it may be reiterated that the findings of the paper are very clear in the stand that they take. First, there is probably a need for greater regulation of adherence to accounting standards that have been set by accounting community and accounting laws like AASB 132. Second, despite being strict, time consuming and even rigid these laws definitely have their positive points and are in fact necessitated by the complex nature of the commercial world today in order to provide scope for better regulation and scrutiny. References: GPT Group, 2008 Annual report, accessed on April 4, 2009, Australian investment Review, accessed on April 4, 2009. Read More