revise lecture 15
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Revise lecture 15. Impairment of assets. Recognition and measurement of an impairment Where there is an indication of impairment, an impairment review should be carried out: The recoverable amount should be calculated The asset should be written down to recoverable amount - PowerPoint PPT PresentationTRANSCRIPT
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Revise lecture 15
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Impairment of assets
Recognition and measurement of an impairment• Where there is an indication of impairment, an
impairment review should be carried out:1. The recoverable amount should be calculated2. The asset should be written down to
recoverable amount3. The impairment loss should be immediately
recognised in the income statement
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Impairment of assets
• The only exception to this is if the impairment reverses a previous gain taken to the revaluation reserve.
• In this case, the impairment will be taken first to the revaluation reserve until the revaluation gain is reversed and then to the income statement.
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Cash generating units (CGUs)
• What is a CGU?
When assessing the impairment of assets it will not always be possible to base the impairment review on individual assets.
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Cash generating units (CGUs)
• The value in use calculation will be impossible on a single asset because the asset does not generate distinguishable cash flows.
• In this case, the impairment calculation should be based on a CGU.
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Cash generating units (CGUs)
Definition of a CGU
A CGU is defined as the smallest identifiable group of assets which generates cash inflows independent of those of other assets
• Example: In a restaurant chain, the smallest group of assets
might be the assets within a single restaurant, but with a mining company, all the assets of the company might make up a single cash generating unit.
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• Provisions, contingent liabilities and assets (IAS 37)
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Provisions
The problem
• Until the issue of IAS 37 provisions, contingent liabilities and contingent assets, there was no accounting standard covering the general topic of provisions. This led to various problems.
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Provisions
• Provisions were often recognised as a result of an intention to make expenditure, rather than an obligation to do so.
• Several items could be aggregated into one large provision that was reported as an exceptional item (the ‘big bath’).
• Inadequate disclosure meant that in some cases it was difficult to ascertain the significance of the provisions and any movement in the year.
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Provisions
The historical problem of provisioning
• The making of provisions was an area of accounting abuse prior to the introduction of any relevant accounting standards.
• Users of financial statements found it very difficult to understand profit figures arrived at after the charging or releasing of provisions at management’s discretion.
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Provisions
A common example was on the appointment of a new management team to a business.
• On appointment the new management would set up large provisions for re-organisations (depressing profits), saying they were needed as a result of the actions of the previous management. Such depressed profits could therefore be blamed on that previous management team.
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Provisions
• One or more years later the new management would ‘discover’ that not all those provisions were necessary.
• So they would be written back (enhancing profits), probably without any disclosure.
• So the profits under new management would look impressive, when in reality they had been created by the release of provisions charged in an earlier period.
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Objective of IAS 37
The objective of IAS 37 provisions, contingent liabilities and contingent assets is to ensure that:
• Appropriate recognition criteria and measurement bases are applied to provisions, contingent liabilities and contingent assets
• Sufficient information is disclosed in the notes to the financial statements to enable users to understand their nature, timing and amount
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Provisions
What is a provision?
• A provision is a liability of uncertain timing or amount
• A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.
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Recognition of a provision A provision should be recognised when:
1. An entity has a present obligation (legal or constructive) as a result of a past event
2. It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation
3. A reliable estimate can be made of the amount of the obligation• If any of these conditions is not met, no provision may be
recognised
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Recognition
• An intention to make a payment is not enough on its own to justify a provision. There must be an actual obligation to make a payment.
• This is important in the accounting for repairs or refurbishments known to be required in future.
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Recognition - Example
If a property lease include a requirement that the premises are repainted every 5 years and the future cost is estimated Rs100,000. The lessee would probably prefer to spread this cost over 5 years, by charging Rs20000 against profits each year.
In this way there will be a provision of RS100,000 in 5 years time and profits have been equally affected each year.
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Recognition - Example
• IAS 37 does not permit this approach, because there is no obligation to incur this cost until the 5 years have elapsed.
• Over the first 4 years this is a future obligation which can be avoided by the simple means of selling the lease to someone else
• IAS 37 requires the full cost to be recognised in the 5th year, the lessee probably will not like the way profits are unaffected by this cost over 4 years but then suffer a major hit in the 5th.
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Obligations
A provision may be necessary as a result of:
• A legal or
• A constructive obligation
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Obligations
Legal obligations
A legal obligation is an obligation that derives from:
1. A contract2. Legislation3. Other operation of law
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Obligations
Constructive obligation
A constructive obligation is an obligation that derives from an entity’s actions where:
• By an established pattern of past practice, published policies or a sufficiently specific current statement, the entity has indicated to other parties that it will accept certain responsibilities
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Obligations
Constructive obligation
• As a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities
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Example
Question: A retail store has a policy of refunding
purchases by dissatisfied customers, even though it is under no legal obligation to do so. Its policy of making refunds is generally known.
Should a provision be made at the year end?
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Answer
• The policy is well known and creates a valid expectation.
• There is a constructive obligation.• It is probable some refunds will be made.• These can be measured using expected values.
Conclusion: A provision is required