Chp. 12

When to test for impairment IFRS goodwill

IFRS requires an impairment test for goodwill at least annually. The firm can perform the fair value measurement for each unit at any time during the fiscal year, as long as it uses the measurement date consistently from year to year. A firm can also use different measurement dates for different units. IFRS indicates conditions under which a firm may waive the annual goodwill impairment test and instead utilize the prior year's test. In general, these conditions ensure that the makeup of the cash-generating unit has not changed substantially and that the prior test for impairment resulted in a considerable margin between the recoverable amount of the cash-generating unit and the carrying value of the cash-generating unit.

focus of chapter:

(2 departures from historical cost accounting: 1. impairments 2. Long-term operating assets held for sale Appendix discusses revaluations under IFRS, which occur when a company reports a long-term asset at its fair value, rather than its historical cost. With both impairments and revaluations, the economic value of a long-term asset differs from its depreciated historical cost (carrying value)

Two-step impairment Test

2 steps: 1. Assess recoverability 2. Compare the carrying value to fair value, if required (referred to as the "fair value" test)

Accounting for Impairments: Indefinite-Life Intangible Assets

Asset Grouping: US GAAP stipulates that firms combine indefinite-life intangibles into an asset grouping if they are operated as a single asset and thus are not separable from each other. When to Test for Impairment: (2 options) 1. Assess qualitative factors annually to determine whether it is necessary to perform the quantitative impairment test. Indefinite-life intangibles are tested annually, as opposed to when indicators exists, because they are not amortized and thus are more likely to be overstated. If it is "more likely than not" that the asset is impaired, the firm then proceeds to calculate the fair value. Qualitative factors could include changes in technology and the marketplace such as consumers preferring touch-screen phones, changes in economic factors such as interest rate changes the affect present-value calculations, or an adverse legal ruling restricting a company's activities. 2. Perform an annual impairment test with the same indicators in Exhibit 12.1

Asset Grouping IFRS

Asset grouping is similar under US GAAP and IFRS, although there may be some differences in practice. If a firm cannot estimate the recoverable amount of the individual asset, then it groups assets. Under IFRS, the asset group is called a cash-generating unit (CGU), which is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets.

Measurement Subsequent to Impairment *

Similar to accounting for impairment losses on PPE and finite-life intangible assets, US GAAP does not permit subsequent reversals of impairment losses. After the write-down, the firm reports the asset at its revised carrying value.

Accounting for Impairments: PPE & Finite-Life Intangible Assets

The accounting procedures for the determination of impairment are identical for property, plant and equipment and finite-life intangible assets

One-Step Impairment Test

The fair-value test determines the impairment loss for an indefinite-life intangible asset as the amount by which the carrying value of the asset exceeds the fair value of the asset. There is no recoverability test based on future undiscounted cash flows for indefinite-life intangible assets. Many indefinite-life intangible assets easily meet the recoverability test because their cash flows extend many years into the future.

Categories and Steps Associated with the Impairment of Long-term Operating Assets

The method of accounting for the impairment of long-term operating assets depends upon the type of asset. - Property, plant, and equipment and finite-life intangible assets - Indefinite-life intangible assets - Goodwill The key steps related to accounting for impairments of long-term operating assets include the following: - Asset grouping - When to test for impairment - Impairment test - Measurement subsequent to impairment

Measurement Subsequent to Impairment GW

US GAAP does not permit subsequent reversals of goodwill impairment losses. After the write-down, the firm reports goodwill at its revised carrying value.

Accounting for Impairments: PPE, Finite-Life Intangible Assets and Indefinite-Life Intangible Assets: IFRS

Unlike US GAAP, IFRS impairment testing is similar for all types of long-lived assets other than goodwill.

Impairment indicators

1. A significant decrease in the market price of a long-lived asset (asset group) 2. A significant adverse change in the extent or manner in which a long-lived asset (asset group) is being used or in its physical condition. 3. A significant adverse change in legal factors or in the business climate that could affect the value of a long-lived asset (asset group), including an adverse action or assessment by a regulator 4. An accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of a long-lived asset (asset group) 5. A current-period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with the use of a long-lived asset (asset group) 6. A current expectation that, more likely than not (>50%), a long-lived asset (asset group) will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. The term more likely than not refers to a level of likelihood that is more than 50%. Firms develop their own impairment indicators based on the guidelines above

Measurement Subsequent to Impairment

After a write-down, conditions could change and the asset's future cash-flow generating ability could recover. In this case, the asset's fair value may be higher than its carrying value after the impairment. However, once an impairment loss is taken, US GAAP does not permit subsequent reversals of write-downs for long-term operating assets held for use in operations. The revised carrying value after the write-down becomes the new cost for subsequent depreciation and amortization.

Required Disclosures of Long-term operating Assets Held for Disposal

Companies must disclose the following items when classifying assets as held for sale: 1. The description of the facts and circumstances that led to the expected disposal as well as the expected manner and timing of the disposal. 2. The carrying values of the major classes of assets and liabilities included as part of the disposal group (reported either on the face of the financial statements or in the note disclosures) 3. The gain or loss included in net income due to a write-down or write-up (reported either on the face of the income statement or in the note disclosures) 4. The segment, if applicable, that includes the disposal group.

Long-term Operating Assets Held for Sale or Disposal

The accounting for assets held for sale or disposal under US GAAP and IFRS is substantially converged. The concepts and judgements that underlie the accounting treatment of assets held for sale are the same as those involved in the accounting treatment of impairments for long-term operating assets.

An asset is no longer an asset when...

it no longer provides a future economic benefit.

When a long-term operating asset's future economic value is impaired, the firm:

1. Recognizes the decline in value as a loss on the income statement in the period that it determines the impairment occurred 2. Reduces the the asset's carrying value on the balance sheet because its economic value has declined. The impairment loss is a noncash expense that has no impact on the statement of cash flows.

When to test for impairment

After identifying the asset group, the firm then determines if impairment testing is required. If impairment testing is required, it then performs a two-step test to determine if there is an impairment. If there is an impairment, the firm then computes the amount of the loss. Firms conduct an impairment test whenever events and circumstances referred to as impairment indicators indicate than an asset may be impaired.

Asset Grouping GW

Firms associate goodwill with the group of net assets in the reporting unit (RU), which is an operating segment or one level below an operating segment. The codification defines an operating segment as a component of a public entity with the following three characteristics: 1. It engages in business activities from which it may earn revenues and incur expenses 2. The entity's chief decision maker regularly reviews the performance of the segment 3. The segment's discrete financial information is available.

IFRS uses a one-step impairment test that has 2 parts

Part 1: Determine the asset's recoverable amount Part 2. Compare the asset's recoverable amount to its carrying value The asset's recoverable amount is the greater of 1. The asset's estimated fair value less costs to sell, or 2. It's value in use, the present value of the future cash flows the firm expects to derive from an asset Firms then compare the recoverable amount to the carrying value of the assets. 1. If the recoverable amount is less than the carrying value of the asset, then the entity is required to measure the impairment loss. 2. If the recoverable amount is greater than the carrying value of the asset, then there is no impairment loss Under IFRS, the impairment loss is simply the difference between the recoverable amount and the carrying value of the asset The journal entry to record the impairment loss is the same format under both US GAAP and IFRS. When recording the impairment loss, the firm eliminates the balance in the accumulated depreciation or accumulated amortization account, and then reduces the asset account. The asset account will reflect its recoverable amount (which is the higher of fair value less costs to sell or value in use) After recognizing this impairment, the firm carries the asset at its recoverable amount with no accumulated depreciation or amortization. The recoverable amount becomes the new cost of the asset as if it were just acquired.

When to test for impairment IFRS

Under IFRS, firms must review the impairment indicators every year to determine whether an impairment test is needed. Similar to US GAAP, a company assesses whether the indicators exist by considering both external factors (such as market interest rates, economic environment, technological breakthrough, or a decline in market capitalization) and internal factors (such as the evidence of obsolescence and restructuring activities in the entity). Additionally, IFRS requires an annual test for indefinite-life intangibles even in the absence of indicators. For indefinite-life intangible assets, the existence of impairment indicators can prompt more frequent testing. Impairment tests are more frequent for indefinite-life intangible assets because they are not amortized, and there is more risk that firms will overvalue them than with PPE or finite-life intangibles, which firms carry at net book value.

The accounting method for reversing impairment losses (sales subsequently increase and future cash flow predictions are positive)

depends on whether a company uses IFRS or US GAAP

Impairment

occurs when an asset's total future cash-generating ability falls below its carrying value.

Impairment test IFRS goodwill

IFRS uses a one-step impairment test that has two parts to assess goodwill impairment. Part 1 - Determine the recoverable amount of the CGU, Part 2 - Compare the recoverable amount of the CGU to the carrying value of the CGU including goodwill The recoverable amount of the cash-generating unit is the greater of the fair value (less selling costs) of the CGU or the value in use of the cash-generating unit. The firm reports an impairment loss when the recoverable amount of the cash-generating units is less than the carrying value of the cash-generating unit, including goodwill. If the impairment loss is greater than the amount of reported goodwill, the firm first reduces goodwill and then prorates the remaining loss to the unit's other assets based on their carrying value. Under IFRS, if the impairment loss is greater than the carrying value (book value) of goodwill, the firm reduces the value of other assets on a prorated basis

Assess recoverability

If the impairment indicators suggest an impairment of a long-term operating asset, the firm assess the asset's recoverability. In general, the recoverability of an asset refers to the firm's ability to recover the asset's carrying value based on the sum of the undiscounted cash flows from the use and disposal of the asset. 1. If the sum of the undiscounted future cash flows is less than the carrying value of the asset, then the asset is impaired and the company must measure the impairment loss. 2. If the sum of the undiscounted future cash flows is greater than the carrying value of the asset, then the asset is not impaired.

Required disclosures for Asset impairments

Impaired Asset Disclosure Requirements: A firm recognizing an impairment loss on its financial statements should disclose: 1. The asset or asset group the was impaired 2. The events and circumstances that led to the recognition of the impairment (based on the impairment indicators) 3. The amount of the impairment loss in the notes to the financial statements (if the firm does not separately disclose this amount on the income statement) 4, The method or methods used to estimate the fair value of the asset

Accounting for Impairments: Goodwill

Impairment testing for goodwill is significantly different from the impairment tests we have discussed thus far. Goodwill is a unique asset that is not separable from the entity as a whole. Because a firm cannot separate goodwill from a specific set of net assets, it cannot associate goodwill with as specific stream of cash flows, as we did for tangible fixed assets and other intangible assets that have value in use.

Measurement Subsequent to Impairment IFRS

In contrast to US GAAP, IFRS allows firms to reverse impairment loss write-downs on property, plant, and equipment as well as finite-life intangible assets. If the asset's future cash generating ability improves and its fair value increases, IFRS views the fair value as relevant and reliable information. There are 2 important constraints: 1. The amount of the write-up (reversal) is limited to the amount of the original impairment loss. The reversal cannot exceed the original impairment loss. 2. The reversal cannot result in a company reporting a value that is higher than what it would be reporting if the asset had never been impaired. Firms report a reversal of an impairment loss in income.

When to test for impairment GW

Because goodwill is not subject to amortization and has an uncertain value, US GAAP allows companies either to: 1. Make a qualitative evaluation annually to determine whether it is more likely than not that a reporting unit's goodwill is impaired. If it is more likely than not that the goodwill is impaired, then a firm must conduct a quantitative assessment of impairment. 2. Conduct a quantitative test for the impairment of goodwill at least annually

Accounting for Impairments: Goodwill under IFRS

IFRS associates goodwill with a cash-generating unit (CGU), which is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets. After identifying the cash-generating unit, the firm determines the amount of any goodwill impairment.

Impaired Asset Disclosure Requirements: IFRS

IFRS disclosure requirements are identical to US GAAP with one exception. IFRS also requires disclosure of whether the recoverable amount was fair value less costs to sell or value in use. Because IFRS allows recoveries of impairment losses, it requires the following additional disclosures by segment: 1. The events and circumstances that led to the recognition of the impairment loss reversal 2. The amount of any impairment loss reversal in income or other comprehensive income 3. The amount of any impairment loss the firm reported in other comprehensive income for assets that it has previously revalued

Determine any impairment loss

When the asset's carrying value is greater than its fair value, a company reports an impairment loss, calculated as the carrying value less the fair value. (Carrying value - fair value) The asset's fair value is the amount the asset holder will receive from the sale of an asset in a current transaction between willing parties. Because the definition of fair value is based on selling an asset, it is often called an exit price. Quoted prices in active markets are the best evidence of fair value. If market prices are not available (which is frequently the case), then accountants base fair-value estimates on the best information available or use valuation techniques such as market comparable, review of recent transactions, and discounted cash flow valuation. In the absence of market prices, we use discounted future cash flows in this chapter. When recording the impairment loss, the firm eliminates the balance in the accumulated depreciation (or accumulated amortization) account and reduces the asset amount. Specifically, it recognizes the impairment loss by: 1. Debiting the loss 2. Debiting the accumulated deprecation or accumulated amortization for its entire balance. 3. Crediting the asset account for the sum of the loss and the accumulated depreciation or accumulated amortization. These steps ensure that the asset's carrying value reflects its fair value. That is. after recognizing the impairment, the firm carrie the asset at its fair value with no accumulated depreciation or amortization. There is a new basis of accounting as if the asset were just acquired.

Recording Long-term operating assets held for sale or disposal

A company selling or disposing of an asset measures the asset the lower of cost (carrying value) or net realizable value (fair value less selling costs). If a write-down is necessary, then the loss is equal to the difference between the carrying value of the asset and its fair value net of selling costs. If a company writes down the asset in one period and still holds the asset in the next period, then the company can report an increase in value in the subsequent period if the fair value net of selling costs has increased. However, because the asset is held at the lower of cost or fair value less selling costs, the write-up could never result in a carrying value greater than the carrying value of the asset before the write-down or impairment. Companies do not depreciate or amortize long-term operating assets while holding them for sale or disposal because they are reporting them at the lower of cost or fair value less selling costs. Companies report the asset as a separate line item on the balance sheet, if material in amount

Two-Step Impairment Test

After identifying the reporting unit, there are two steps to determine the amount of any goodwill impairment: 1. Assess recoverability 2. Compare goodwill's carrying value to its implied fair value To assess recoverability, the firm compares the fair value of a reporting unit (which includes any goodwill) to the carrying value of the reporting unit, including goodwill. The fair value of the reporting unit is the valuation of the entity as if the company were to be sold in a business combination. If the carrying value is higher than the fair value of the reporting unit, goodwill may be impaired requiring that the firm compare the goodwill;s carrying value to its implied fair value. Otherwise, no impairment is indicated. The impairment loss is the difference between the implied fair value of goodwill and its carrying value. Specifically, the firm compares the fair value of the reporting unit (including goodwill) to the appraisal (fair) value of its net assets (excluding goodwill). The difference, or residual, is the implied fair value of goodwill. If the carrying value of the goodwill is greater than the implied fair value, the impairment loss is the difference between the carrying value and the implied fair value. Impairment loss is limited to the carrying value of goodwill

Asset Grouping

Before testing assets for impairment, a firm must determine whether to assess them as individual assets or in asset groups. An asset grouping is the lowest level of identifiable and independent cash flows. If cash flows are identifiable and independent for an individual asset such as a delivery truck, the firm can test the delivery truck for impairment. Alternatively, if the delivery truck is part of a fleet of the store's delivery trucks, the delivery fleet could be considered an asset group. The rationale is that the cash flows from an individual truck are dependent on the cash flows from the other trucks in the fleet.