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ERNAKULAM BRANCH OF SIRC OF ICAIERNAKULAM BRANCH OF SIRC OF ICAI

Chain Seminar on Accounting StandardsChain Seminar on Accounting Standards

Impairment of AssetsImpairment of AssetsASAS--2828

an asset is IMPAIRED

when the carrying amount of the asset exceeds its

recoverable amount


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Objective of the ASObjective of the AS To ensure that no asset is carried above its

recoverable amount

To prescribe procedures for recognition and reversalof impairment loss

To prescribe disclosures for impairment

To bring Indian accounting in line with IAS-36

US GAAP (SFAS 144)


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Mandatory forMandatory forLevel I Enterprise:

Listed companies (existing/ proposed)

Banks / Insurance/Financial Institutions

Turnover exceeding Rs 50 cr

Borrowings exceeding Rs 10 cr (any time)Holding/subsidiary of above

1st April 2004

Level II Enterprise (SMC):

Turnover between Rs 40 lakhs- Rs 50 cr

Borrowings between Rs 1 cr-Rs 10 cr

1st April 2006

Level III Enterprise

All Other enterprises

1st April 2008


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Steps in Applying ASSteps in Applying AS--2828


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Step 1Step 1

Identify

Assets (or)

Cash Generating Units (CGU)

for assessing impairment


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AssetsAssets Applies to ALL assets,except those covered by

AS 2 -inventories

AS 7 construction contracts

AS 13 financial assets / investments AS 22 deferred tax assets

Covers

Fixed assets AS 10 /AS-6

Intangible assets AS 26

EACH ASSET SHOULD BE IDENTIFIEDBASED ON ITS INDEPENDENT CAPABILITYTO GENERATE CASH FLOW


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How can each asset be capable ofHow can each asset be capable of

independently generating cash flowsindependently generating cash flows

when in reality all or many assets functionwhen in reality all or many assets function

together as a unit ?together as a unit ?

Answer

Identify group of assets as

CASH GENERATING UNITS (CGU)


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Cash Generating Unit (CGU)Cash Generating Unit (CGU)

Is

the smallest identifiable group of assets that generates cash inflows from continuing

use that are largely independent of the

cash inflows from other assets or groups of

assets.


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Features of a CGUFeatures of a CGU

Smallest group of assets which can independentlygenerate cash flows from external parties

Will include assets directly identifiable to CGU

Will require allocation of common assets

(corporate assets) and goodwill (if accounted) Will include group of assets which produce

intermediary/captive outputs-if such outputs havean active market

CGUs may have to be aggregated if incapable ofbeing acquired / disposed independently

Identification should be consistent from period toperiod changes should be disclosed


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CASE STUDY OIL REFINERY Many refining products-HSD /MS/ Av.Fuel/ Kerosene/ LSHS/ Bitumen

etc-wide variation in prices and margins

Manufacturing upto an advanced stage is from same manufacturingstream since input is Crude and marketing channels are through OMCs

Also manufacturers Petro-chemical products from different processes,marketing channels of which are different from refining products

Also has a Captive Power Plant and aD

rum Manufacturing Plant theoutputs of which are fully used internally. But Power & Drums also havean active market.

RESULT-CGUs Whole refinery could be treated as One CGU-since cash flows of each

refining product are not largely independent of the other

Petrochemical division can be a separate CGU based on separate cashflows

The Captive Power Plant & Drum Manufacturing Unit may have to betreated as separate CGUs, even if actually there is no separate Cash Flowfrom the same now-since active markets exist


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CASE STUDY UNIVERSITY CANTEEN

CONTRACTOR

Contract for running ten college canteens will be

awarded only together by the university

Cash flows from each college canteen is separately

ascertainable Eight are profitable, two loss making

RESULT-CGUs

All ten canteens will constitute only one CGU-even

though cash flows are determinable-each cannot be

disposed of separately


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CASE STUDY MAGAZINE PUBLISHER

Owns many publications: Some are own created and some purchased

Each publication can be sold/discarded separately

Cash flows including ad revenue can be separately

ascertained

RESULT-CGUs

Each publication can be a separate CGU since cash

flows are distinct and each can be disposedseparately


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Step 2Step 2

Assess whether thereare any indications of

Impairment


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External IndicationsExternal Indications Significant decline in market value of asset

Adverse changes in external operating

environment-technology/market/legal/economic

Increase in interest rates in market or ROI will push up discount factor and reduce

present value Carrying amount of assets exceeds market

capitalisation


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Internal IndicationsInternal Indications Evidence of obsolesce / physical damage

Manner of use of assets has / will change

adversely eg: proposed discontinuation/disposal etc

Evidence from internal reports-economic

performance will be worse than expected Substantial future cash outflows will be

required for continuing future operations


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DecisionsDecisions

If no indications exist No need to make aformal estimate of recoverable amount

If indications exist -Recoverable Amount must beestimated and matched with Carrying Costs

Indications may also require that effective life and

depreciation charge as per AS 6 may have to bereviewed/adjusted

Assessment must be done annually (on B/S date)


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Step 3Step 3

AssessCarrying Cost


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Carrying CostCarrying Cost Amount at which asset is carried in Balance Sheet

Historical Cost (or)

Revalued Amount Less:Accumulated depreciation/amortisation

Less: Impairment Losses

Liability which is required to be taken over as part of an

asset must be adjusted in carrying cost


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Carrying Cost of A CGUCarrying Cost of A CGU

Include Assets attributed directly to the CGU

Assets Allocated - on a reasonable basis

Including Corporate Assets (and)Goodwill (if accounted)

Methods of allocation prescribed bottom up /

top down

Exclude (usually)

Liabilities relating to the assets


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Step 4Step 4

AssessRecoverable Amount


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Recoverable AmountRecoverable Amount Higher of

NET SELLING PRICE

(or)

VALUE IN USE


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SubSub--Step 1 in Assessing RAStep 1 in Assessing RA

Assess

Net Selling Price


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Net Selling PriceNet Selling Price

Arms length price obtainable on Sale of Asset /CGU (not a forced sale)

Based on Binding sale agreements (or)

Active market prices (or)

Best estimates based on available information

Recent industry transactions for similar assets

Add: Liability taken over by buyer if any

Less: Cost ofDisposal of Asset/CGU (other than

finance costs & tax thereon)

Valuation by independent expert (Chartered

Valuer etc ) cannot be used-EAC Opinion


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Decision based on NSPDecision based on NSP

If NSP is more than carrying cost NO

impairment loss

Need not formally assess- Value in Use

If NSP is less than carrying cost Value in

Use must be assessed


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SubSub--Step 2 in Assessing RAStep 2 in Assessing RA

Assess

Value In Use


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Value in UseValue in Use Value in use is the present value of

estimated future cash flows expected to

arise from the continuing use of an asset

and from its disposal at the end of its useful

life,(or a reasonable estimate thereof).

Relaxation for SMC- reasonable estimate


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Value In Use (VIU)Value In Use (VIU)

Present value of

Estimated future cash flowsarising from the Asset/CGU

(+)

Residual value at the end of itslife


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Estimating VIUEstimating VIU

Involves:

Estimating future net cash flows fromcontinuous use of asset over effective life

Cash Inflows

Cash Outflows

Estimating future net cash flows from use-end disposal of asset

Applying appropriate discount factor to thecash flows


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Future Cash FlowsFuture Cash Flows--IncludeInclude

Cash flows from continuous use of asset/CGU

Net off - projected cash outflows to generate

above cash inflows

Net cash flows-in/out for disposal of asset at end

of its life

Foreign currency cash flows at AS 11 values


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Future Cash FlowsFuture Cash Flows--ExcludeExclude

Cash flows from financing activities

Tax receipts / payments

Cash flows from

uncommitted future restructuring

capital expenditure that will improve / enhance assetsperformance over original assessments


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Estimating future cash flowsEstimating future cash flows

Reasonable and supportable assumptions

Recently approved budgets/forecasts

usually upto five years, unless justified

Cash flow projections beyond the above

extrapolated for future years

using a steady / declining growth rate, unlessjustified

growth rate should not exceed long term growthrate for product/industries/country(ies) in whichthe enterprise operates


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Discount RateDiscount Rate Discount rate should be based on:

Pre-tax rate

Current market assessment of time value ofmoney based on nature of the Asset/CGU

Rate that an investor would require if theywere to choose an investment which willgenerate identical cash flows as the asset/CGU

Market borrowing rates Enterprise weighted average of capital or

incremental borrowing rate

Enterprise risks country/currency/price/cash

flow risk to be considered


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Relaxation for SMCRelaxation for SMC

SMC can choose to measure VIU on a

reasonable estimate basis-without using

present value techniques

Exemption from disclosing discount rate if

not applied for VIU


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NET SELLING PRICE (A) 400000

ALUE IN USE(B)Year Cash Flows iscount CF

@6%

1 110000 0.943396 103774

2 100000 0.889996 890003 90000 0.839619 75566

4 80000 0.792094 63367

5 70000 0.747258 52308

Residual 50000 0.747258 37363

421378

RECO ERABLE AMOUNT 421378

VALUE IN USE


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FindingsFindings

If RA is more than carrying cost

No IL

If RA is less than carrying cost

Recognise IL


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Step 5Step 5

RecognisingImpairment Loss


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IMPAIRMENT LOSSIMPAIRMENT LOSS

CARRYING AMOUNT

(-) RECOVERABLE AMOUNT


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CARRYING COST 600000

NET SELLING PRICE (A) 400000

VALUE IN USE(B)

Year Cash Flows Discount DCF

@6%

1 110000 0.943396 103774

2 100000 0.889996 890003 90000 0.839619 75566

4 80000 0.792094 63367

5 70000 0.747258 52308

Residual 50000 0.747258 37363

421378

RECOVERABLE AMOUNT 421378

IMPAIRMENT LOSS 178622

VALUE IN USE


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Accounting of ILAccounting of IL

Write off to Profit & Loss Account

Revalued assets-IL equal to revaluation

reserve balance shall be set off first

Transitional IL on date of application of

AS-28 to be charged to Reserves

Carrying cost of assets should be reduced

Future charges of depreciation must be

based on revised carrying cost over balance

life


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Accounting of ILAccounting of IL--CGUCGU

First adjust against goodwill (if any) Balance to other assets (including corporate

assets) on pro-rata -based on carrying costs

of each asset

After such allocation, carrying amount of

each asset in CGU should not be less than

its individual net selling price/value in use /

zero If any balance loss remains unallocated

based on above, an impairment liability

should be created


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Case Study-IL for CGU

Carrying amount of a plant X is Rs 10 lakhs

NSP is Rs 8 lakhs Independent cash flows from X are not identifiable

X is classified as part of a CGU Y

Carrying amount of CGU Y is Rs 50 lakhs

NSP of Y is Rs 45 lakhs VIU of Y is Rs 60 lakhs

Result

There is no IL for CGU Y since VIU is more than

carrying amount Even though NSP of plant X is less than carrying-since

VIU of X cannot be assessed NO IL FOR PLANT X

Need to assess higher depreciation charge for Plant X


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Step 6Step 6

Reassess ImpairmentEach Year


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Reversal of Impairment LossReversal of Impairment Loss On each balance sheet an assessment of IL must be

made-additional IL must be recognised

If IL earlier charged no longer exists-the amount

earlier recognised should be reversed as income/ to

revaluation reserve as done originally

After reversal-carrying cost should not exceed the

carrying cost (less depreciation) that would have

originally resulted, but for recognition of IL

In case of CGU Reversal must be made to carrying value of assets first

Balance if any (relatable to goodwill) should not normally be

reversed (AS-26 restriction)


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Step 7Step 7

Making disclosures


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Description of CGU(s) adopted

Changes in identification of CGU comparedto previous estimate of CGU

Events and circumstances leading to IL

Recoverable amount-whether NSP or VIU

Basis of NSP or VIU(discount rate) Amount of IL

Debited to P & L A/c

Reversed to P & L A/c

Set off against revaluation reserve

Credited to revaluation reserve

IL for each AS-17 segment


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Some Legal ImplicationsSome Legal Implications

Companies ActNo formal Schedule VI disclosure for IL

Income Tax Allowability of IL for 115JB computation has to

be tested

IL will create a Deferred Tax Asset


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ConclusionConclusion

AS-28 challenges for the Assurance Function

1. Correct classification of CGUs

2. Fair approximation of NSP

3. Even reasonable accuracy of the longterm future estimations of the

management


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THANK YOUTHANK YOU

..

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