Business Impairment Loss Business Accounting Scenarios

Question: Describe about the Business Impairment Loss for Business Accounting Scenarios. Answer: The International Accounting Standard (IAS) 36 on Impairment of Assets deals with accounting for those long lived assets whose market value has diminished significantly and hence the value of the same needs to be revised in the balance sheet of the company. The standard similar to the same spelt out by the Australian Accounting Standard Board (AASB) is AASB 136, Impairment of Assets under section 334 of the Corporations Act 2001. The main aim for the introduction of this standard was to ensure that the value of the assets reflected in the balance sheet of a company is not more than the amount that is recoverable on selling the asset. In such a situation the asset is classified as impaired and the amount by which an asset gets impaired is known as an impairment loss. As per the said standard it not only details about the accounting of impairment loss but also describes the scenarios when such losses are to be reversed and the disclosure requirements too. Broadly speaking assets such as intangible assets like goodwill, tangible assets like plant and machinery, land and buildings, motor vehicles, computer etc fall under the purview of impairment. However impairment of an asset is arrived at after assessing the situations which point out towards impairment and the calculations which help to arrive at the amount by which such impairment is to be done. There exist some exceptions to the said rule wherein certain category of assets do not fall under the purview of the said standard. They are inventories, construction contracts, deferred tax assets, investment and the biological assets which are valued at fair value and assets which are held to be disposed off. All these are covered by separate standards (Australian Accounting Standards Board, 2009). Certain terms are very crucial to understand before impairment of an asset is calculated. They are as under: CARRYING AMOUNT: The amount at which an asset reflects in the balance sheet of a company after accounting for the accumulated depreciation and the impairment loss / reversal of the asset. CASH GENERATING UNIT (CGU): The smallest cluster of assets of a company that enable generation of adequate cash flows to the company. The cash flows that a CGU generates is separate and easily identifiable from the other CGUs of the company (Hamilton et al. 2011). IMPAIRMENT LOSS: The difference between the carrying mount of the asset or a CGU in the balance sheet of an entity and the actual amount that can be recovered from that asset or CGU is termed as impairment loss. RECOVERABLE AMOUNT: The fair value of an asset or the CGU or the value in use of the same whichever is higher is termed as recoverable amount. VALUE IN USE: Net present value of the future cash flows that is expected to be earned from the particular asset or CGU (Kpmg.com, 2010). Before impairment of an asset or a CGU as a whole it is very important to understand whether situations prompting impairment exists or not. Various factors enable determination of the same. They are external as well as internal to the entity. The external factors are: Considerable diminution in the market value of the asset or the CGU due to normal wear and tear or the time lapse. The market capitalisation amount is far less than the amount at which the assets of a company are being carried in the balance sheet. The discounting rate used to find the value in use of the assets have increased due to an increase in the market interest rate will lead to reduction of the recoverable amount of the asset or the CGU. Uncertain legal, economic or political environment or a significant technological change which entails the asset to become obsolescent. The internal factors are as under: If the asset has suffered any significant damage or breakage which has led to reduction of the value of the asset significantly. Situations which denote that the companys performance has reduced considerably. In case of major acquisitions, carrying amount of the assets is greater than the carrying amount of the investees assets, contribute to the impairment (ey.com, 2014). Apart from the same it is very significant to note that IAS 36 and AASB 136 both detail about situations which entails to reversal of such impairment as well. The said situation is applicable to all assets except goodwill. A reversal will take place only if there is a situation which points out towards the fact that there is a change in the estimate of the amount of the asset and the same is expected to be more than the present carrying amount. However the reversal can take place only to the extent of the depreciated historical cost of the asset that would have been had the asset not been impaired. The impairment loss/ (reversal) both are recorded in the income statement of an entity and the immediate effect is felt on the balance sheet of the firm. The standard requires certain disclosures to be made regarding the impairment of assets. They are enumerated as under: For each class of asset or CGU the entity must disclose the following: The impairment loss or reversal amount that is reflected in the income statement of the firm as well as the line item(s) of the statement of comprehensive income. The impairment loss or reversal amount in case of any revalued assets that is recognized in the other comprehensive income (Albrecht, et.al. 2011). In case of segmental reporting done by an organization, the amount of impairment loss or reversal captured in the profit and loss account or in the other comprehensive income statement should be disclosed. Apart from the above the organizations who have impaired an asset or reversed the past impairment of any asset or a CGU shall also disclose the following: The factors (both external and internal) which led to the impairment of an asset or a CGU The amount by which the asset is impaired or impairment is reversed. The assets nature and in case of segmental reporting doen by an entity then the particular segment to which the impaired asset belongs should also be disclosed. The method by which the recoverable amount of an asset has been arrived at i.e. whether it is arrived by using the value in use method or the fair value less selling expenses method (Kvaal, 2005). Thus on a concluding note, it s very clear that the provisions spelt out by IAS36 and AASB 136 with regards impairment is similar. The impairment test is of utmost importance to enable determination of the quality of the financials of an entity. It has an effect on the health of the company, its stock prices as well as the liquidity position of the entity in case it goes for liquidation. References: Kpmg.com, (2010), Impairment Testing, Available at https://www.kpmg.com/AL/en/IssuesAndInsights/ArticlesPublications/Factsheet/Advisory/Documents/Impairment%20testing.pdf (Accessed 15th September 2016) Australian Accounting Standards Board, (2009), Impairment of Assets- AASB 136, Available at https://www.aasb.gov.au/admin/file/content105/c9/AASB136_07-04_COMPjun09_01-10.pdf (Accessed 15th September 2016) Albrecht, S., Stice, E., Stice, J., Swain, M. (2011).Accounting: Concepts and applications(11th ed.). Mason: South-Western ey.com, (2014), Impairment Accounting the basics of IAS 36 , Impairment of Assets, Available at https://www.ey.com/Publication/vwLUAssets/Impairment_accounting_the_basics_of_IAS_36_Impairment_of_Assets/$FILE/Impairment_accounting_IAS_36.pdf (Accessed 15th September 2016) Hamilton, K., Hyland, B., Dodd, J.L., (2011), Impairment : IASB-FASB Comparison, Drake Management Review, vol.1, no. 1, pp. 55-67 Kvaal, E., (2005), Topics in Accounting for Impairment of fixed assets, A dissertation submitted to Bi Norwegian School of Management for the degree of Dr. Oecon, Available at https://brage.bibsys.no/xmlui/bitstream/handle/11250/94340/05-03-kvaal.pdf?sequence=1 (Accessed 15th September 2016)