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IAS 36 Nokulunga
IAS 36 Nokulunga
IAS 36 Nokulunga
First and foremost, praises and thanks to the God, the Almighty, for His shoIrs of blessings
throughout my research work to complete the research successfully.
I would also like to show my gratitude to Mr. Ibster Gobvu, Academic Manager, Transcollege for
sharing his pearls of wisdom with me during this research, and I also thank 3 “anonymous” revieIrs
for their insights into this research work. Any errors are my own and should not tarnish the
reputations of these esteemed persons.
Finally, my thanks go to all my family members who have supported me to complete the research
work directly or indirectly.
i
Abstract
Background and Discussion: IAS 36 seems to be a challenging area. Assessment of whether an
asset has declined in value may be highly subjective and impairments may look like a failure
and the management can therefore have incentives to report in a certain way. If the values of
assets are overestimated, impairment losses can be avoided, and the result is affected.
Purpose: The purpose of this thesis was to investigate the perceived strengths and Weakness of
IAS 36.
Methodology: Data collection was collected using a qualitative method from secondary sources.
Conclusions: Several studies have suggested that the adoption of IAS 36 enhances the quality of
financial reports, in turn improving their reliability and usefulness.
However, as noted, IAS 36 requires managers to make frequent assumptions on issues such as cash
flow projection periods, growth rates, discount rates, and events and circumstances leading to an
impairment loss. These assumptions are usually unverifiable and subjective and can thus hide
earnings management. However, the calculation of recoverable amounts may also be affected by
difficulties in estimating the abovementioned variables. In addition, testing goodwill for
impairment requires not only the application of detailed financial modeling, but also results in a
heavy compliance burden as firms reporting subject to IFRS are called upon to provide insight into
the assumptions used, benchmarks referred to and processes used in the formation of a judgment
on the value of the most vexed of all intangible assets.
Further research: The following area would be interesting for further research:
− Investigate why IASB has not changed or simplified IAS 36 in a higher extent and how
the regulation can be improved
Keywords: Impairment, Impairment test, Impairment loss, IFRS, IAS 36, Fixed asset,
Assessment, Recoverable amount, Value in use, Discount rate, Cash flows, Fair value, CGU
ii
Abbreviations
CGU – Cash Generating Unit
FRSC - Financial Reporting Standards Committee
HKFRS - Hong Kong Financial Reporting Standards
IAS – International Accounting Standard
IAS 36 – International Accounting Standard, Impairment of Assets
IASB – International Accounting Standard Board
IFRS – International Financial Reporting Standards
SQAB - Standards and Quality Accountability Board
iii
Table of contents
Chapter 1: IAS 36: Impairment of assets…………………………………………. 1
Chapter 2: Literature review………………………………………………………. 11
Chapter 3: Research methodology………………………………………………… 14
Chapter 4: Findings and evidence from Canada…………………………………... 16
Chapter 5: Findings and evidence from Singapore………………………………. 29
Chapter 6: Findings and evidence from Hong Kong……………………………… 39
Chapter 7: Summary and conclusion……………………………………………….. 48
References………………………………………………………………………….. 63
iv
LIST OF TABLES
LIST OF FIGURES
LIST OF ILLUSTRATIONS
6.1 Illustrative disclosures for goodwill……………………………………………… 42
v
CHAPTER 1
1.1 Introduction
During the 1990s a new generation of accounting standards on the impairment of fixed assets
appeared in leading market economies. The pioneer was the US standard SFAS 121, Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of , issued in
1995. It was succeeded in 1998 by IAS 36, Impairment of Assets, of the International Accounting
Standards Committee, and by the British standard FRS11, Impairment of Fixed Assets and
Goodwill. SFAS 121 was substituted in 2001 by SFAS 144,Accounting for the Impairment or
Disposal of Long-Lived Assets, and IAS 36 was materially revised in 2004. In many respects the
three standards have the same system for measuring impairments, although not for assessing
whether there is one. One common feature is the obligation, in certain circumstances, to measure
the asset, or group of assets, by the present value of the cash flows that it will generate. There is
one striking difference, though. The British and international standards, which are identical in most
respects, require that cash flows for the computation of present value exclude cash flows related
1.2.1 Relevance
The fundamental quality requirement is that of relevance, meaning that the information should
have relevance for decision making such as to buy, keep or sell a stock. The information should
also be relevant so it can be used in forecasting. For it to be useful for predictive purposes there is
a minimum requirement that the information should be presented in an understandable way and
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include topical figures and issues. Tightly associated with the primary requirement for relevance
of information are the secondary characteristics reliability and comparability (Smith, 2006).
1.2.2 Comparability
Comparability as a qualitative characteristic has two sides. Comparability on the one hand is about
the comparability in between firms and on the other hand it is concerned with the comparability of
one firm but over time. Comparability in between firms has the fundamental reason to make it
possible to compare firms with the use of ratios, say a profitability ratio between three firms and
see which of them is the most profitable. In principal every event, asset or liability of the same
kind should be reported identically in all firms (Smith, 2006).
1.2.3 Reliability
With the reader in mind a financial statement must provide information that is reliable. A financial
statement has achieved reliability if it “is free from material error and bias and can be depended
on by users to represent faithfully that which it either purports to represent or could reasonably be
expected to represent” (IFRS, 2009). A key to achieve reliability is to keep the information neutral.
Neutral means that the information is not influenced or directed to achieve any predetermined
result or outcome, so called “cosmetic” treatment to make the firm appear better than it is (Smith,
2006).
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1.4 Methodology
This research revieId studies on an impairment IAS 36 published in the 2004-2018 period. 2004
represents the year when an impairment-only approach was first issued by the IASB under the new
International Financial Reporting Standard (IFRS) 3 Business Combinations and the revised
International Accounting Standard (IAS) 36 Impairment of Assets.
The necessary data was collected from companies’ annual reports, which I accessed directly from
the companies’ official Ibsites. I also made use of previous published researches on the impairment
area.
In a second step, I excluded editorials, book reviews, comments, replies, and papers that do not
apply an empirical research design from the sample. The third step involved assessment of the
quality of the studies. I selected only refereed papers from academic journals rated in quality
rankings to provide a measure of high quality as commonly understood in management
research(Tranfield et al., 2003).
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1.5.1 Studies of determinants associated with goodwill recognition, impairment, and
disclosure
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1.6 Limitations
The research is confined to answering the questions of what the positive and negative international
critique of IAS 36. It relies largely on published sources and annual company reports.
1.7 Conclusion
The chapter started by giving a background on impairment of assets. It also looked at the choice
of the research topic, research methodology and literature review. It ended with the limitations of
the research project.
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CHAPTER 2
In March 2004, IFRS 3 Business Combinations changed the accounting requirements for goodwill
and introduced an impairment-only model with no annual amortisation. This standard replaced the
previous amortisation-based model required by IAS 22 Business Combinations.
In January 2008, the IASB issued a revised version of IFRS 3. Although some potentially
significant differences remained, the publication of IFRS 3 led to a higher degree of convergence
between IFRS and US GAAP in the accounting for business combinations.
In June 2015, the IASB published its report and feedback statement on its PIR of IFRS 3. The
report identified that many respondents thought that the impairment test was complex, time-
consuming and expensive and involved significant judgement. In addition, investors identified
shortcomings in the information provided to them (e.g. timing of impairments)
To address these concerns, the IASB added a research project to its agenda that considers how to
address the following three areas of focus:
(a) Whether changes should be made to the existing impairment test for goodwill and other
non-current, non-financial assets;
1
Agenda Paper 4, p11
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(b) Subsequent accounting for goodwill (including the relative merits of an impairment-
only approach and an amortisation and impairment approach); and
(c) The extent to which other intangible assets should be separated from goodwill.
Except for goodwill and certain intangible assets for which an annual impairment test is required,
entities are required to conduct impairment tests where there is an indication of impairment of an
asset, and the test may be conducted for a 'cash-generating unit' where an asset does not generate
cash inflows that are largely independent of those from other assets.
IAS 36 was reissued in March 2004 and applies to goodwill and intangible assets acquired in
business combinations for which the agreement date is on or after 31 March 2004, and for all other
assets prospectively from the beginning of the first annual period beginning on or after 31 March
2004.i
2
www.iasplus.com/en/standards/ias/ias36
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March 2004, and for all other assets
prospectively from the beginning of the
first annual period beginning on or after
31 March 2004
22 May 2008 Amended by Annual Improvements to Effective for annual periods beginning on
IFRSs 2007 (disclosure of estimates or after 1 January 2009
used to determine a recoverable
amount)
16 April 2009 Amended by Annual Improvements to Effective for annual periods beginning on
IFRSs 2009 (units of accounting for or after 1 January 2010
goodwill impairment testing using
segments under IFRS 8 before
aggregation)
29 May 2013 Amended by Recoverable Amount Effective for annual periods beginning on
Disclosures for Non-Financial or after 1 January 2014
Assets (clarification of disclosures
required)
2.3.2 Scope
IAS 36 applies to all assets except: [IAS 36.2]
− Inventories (IAS 2)
− Assets arising from construction contracts (IAS 11)
− Deferred tax assets (IAS 12)
− Assets arising from employee benefits (IAS 19)
− Financial assets (IAS 39)
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− Investment property carried at fair value (IAS 40)
− Agricultural assets carried at fair value (IAS 41)
− Insurance contract assets (IFRS 4)
− Non-current assets held for sale (IFRS 5)
− Therefore, IAS 36 applies to (among other assets):
− Land buildings
− Machinery and equipment
− Investment property carried at cost
− Intangible assets
− Goodwill
− Investments in subsidiaries, associates, and joint ventures carried at cost
− Assets carried at revalued amounts under IAS 16 and IAS 38
2.3.3.1Carrying amount: the amount at which an asset is recognised in the balance sheet
after deducting accumulated depreciation and accumulated impairment losses
2.3.3.2Recoverable amount: the higher of an asset's fair value less costs of disposal*
(sometimes called net selling price) and its value in use
2.3.3.3Fair value: the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the measurement date (see
IFRS 13 Fair Value Measurement)
2.3.3.4 Value in use: the present value of the future cash flows expected to be derived from
an asset or cash-generating unit
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2.3.4 Identifying an asset that may be impaired
At the end of each reporting period, an entity is required to assess whether there is any indication
that an asset may be impaired (i.e. its carrying amount may be higher than its recoverable amount).
IAS 36 has a list of external and internal indicators of impairment. If there is an indication that an
asset may be impaired, then the asset's recoverable amount must be calculated. [IAS 36.9]
2.3.5.1External sources:
− Market value declines
− Negative changes in technology, markets, economy, or laws
− Increases in market interest rates
− Net assets of the company higher than market capitalisation
2.3.5.2Internal sources:
− Obsolescence or physical damage
− Asset is idle, part of a restructuring or held for disposal
− Worse economic performance than expected
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2.3.8 Value in use
The calculation of value in use should reflect the following elements: [IAS 36.30]
− An estimate of the future cash flows the entity
− Expects to derive from the asset expectations about possible variations in the amount or
timing of those future cash flows
− The time value of money, represented by the current market risk-free rate of interest
− The price for bearing the uncertainty inherent in the asset
− Other factors, such as illiquidity, that market participants would reflect in pricing the future
cash flows the entity expects to derive from the asset
− Cash flow projections should be based on reasonable and supportable assumptions, the
most recent budgets and forecasts, and extrapolation for periods beyond budgeted
projections.
− Cash flow projections should relate to the asset in its current condition – future
restructurings to which the entity is not committed and expenditures to improve or enhance
the asset's performance should not be anticipated. [IAS 36.44]
− Estimates of future cash flows should not include cash inflows or outflows from financing
activities, or income tax receipts or payments. [IAS 36.50]
For impairment of an individual asset or portfolio of assets, the discount rate is the rate the entity
would pay in a current market transaction to borrow money to buy that specific asset or portfolio.
If a market-determined asset-specific rate is not available, a surrogate must be used that reflects
the time value of money over the asset's life as Ill as country risk, currency risk, price risk, and
cash flow risk. The following would normally be considered: [IAS 36.57]
− The entity's own Weighted average cost of capital
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− The entity's incremental borrowing rate
− Other market borrowing rates
Represent the lowest level within the entity at which the goodwill is monitored for internal
management purposes; and not be larger than an operating segment determined in accordance with
IFRS 8 operating segments
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A cash-generating unit to which goodwill has been allocated shall be tested for impairment at least
annually by comparing the carrying amount of the unit, including the goodwill, with the
recoverable amount of the unit: [IAS 36.90]
If the recoverable amount of the unit exceeds the carrying amount of the unit, the unit and the
goodwill allocated to that unit is not impaired
If the carrying amount of the unit exceeds the recoverable amount of the unit, the entity must
recognise an impairment loss.
The impairment loss is allocated to reduce the carrying amount of the assets of the unit (group of
units) in the following order: [IAS 36.104]
First, reduce the carrying amount of any goodwill allocated to the cash-generating unit (group of
units); and then, reduce the carrying amounts of the other assets of the unit (group of units) pro
rata on the basis.
The carrying amount of an asset should not be reduced below the highest of: [IAS 36.105]
Its fair value less costs of disposal (if measurable)
Its value in use (if measurable)
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2.3.14 Disclosure
Disclosure by class of assets: [IAS 36.126]
− Impairment losses recognised in profit or loss
− Impairment losses reversed in profit or loss which line item(s) of the statement of
comprehensive income
− Impairment losses on revalued assets recognised in other comprehensive income
− Impairment losses on revalued assets reversed in other comprehensive income
− Disclosure by reportable segment: [IAS 36.129]
− Impairment losses recognised
− Impairment losses reversed
− Other disclosures:
− If an individual impairment loss (reversal) is material disclose: [IAS 36.130]
− Events and circumstances resulting in the impairment loss
− Amount of the loss or reversal
− individual asset: nature and segment to which it relates
− Cash generating unit: description, amount of impairment loss (reversal) by class of assets
and segment
2.4 Conclusion
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CHAPTER 3
The CCDG was replaced by the Accounting Standards Council (ASC) as of 1 November 2007.
The ASC was established by the Accounting Standards Act, passed in Parliament on 27 August
2007. In addition to prescribing accounting standards for companies, the ASC will also prescribe
accounting standards for charities, co-operative societies, and societies. The Singapore
Government believes that “creation of the ASC is a positive step towards ensuring consistency in
accounting standards, facilitating comparison of financial statements between different entities and
enhancing the credibility and transparency of financial reporting”.4
3.2.1 Objective
According to the Accounting Standards Council the objective of this Standard is to “prescribe the
procedures that an entity applies to ensure that its assets are carried at no more than their
recoverable amount.”5
3
https://www.iasplus.com/en/jurisdictions/asia/singapore
4
https://www.iasplus.com/en/jurisdictions/asia/singapore
5
SFRS(I) 1-36 Impairment of Assets, p6
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3.2.2 Scope
The Standard is applied in accounting for “the impairment of all assets, other than: inventories,
deferred tax asset, assets arising from employee benefits, financial assets, investment property that
is measured at fair value, biological assets related to agricultural activity, deferred acquisition
costs, and intangible assets, arising from an insurer’s contractual rights under insurance contracts,
and non-current assets (or disposal groups) classified as held for sale”6
The standard however, does not apply to “ inventories, assets arising from construction contracts,
deferred tax assets, assets arising from employee benefits, or assets classified as held for sale (or
included in a disposal group that is classified as held for sale) because existing SFRS(I)s applicable
to these assets contain requirements for recognising and measuring these assets”7
In addition, this standard does not apply to “financial assets within the scope of SFRS(I) 9,
investment property measured at fair value within the scope of SFRS(I) 1-40, or biological assets
related to agricultural activity measured at fair value less costs to sell within the scope of SFRS(I)
1- 41.”8
6
SFRS(I) 1-36 Impairment of Assets, p6
7
SFRS(I) 1-36 Impairment of Assets, p6
8
SFRS(I) 1-36 Impairment of Assets, p6
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3.2.5 Measuring the recoverable amount of an intangible asset with an indefinite
useful life
Paragraph 10 requires an intangible asset with an indefinite useful life to be tested for impairment
annually by comparing its carrying amount with its recoverable amount, irrespective of whether
there is any indication that it may be impaired. However, the most recent detailed calculation of
such an asset’s recoverable amount made in a preceding period may be used in the impairment test
for that asset in the current period.
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3.2.9 Recognising and measuring an impairment loss
Paragraphs 59–64 of SFRS(I) 1-36 set out the requirements for recognising and measuring
impairment losses for an individual asset other than goodwill. Furthermore, recognising and
measuring impairment losses for cash-generating units and goodwill are dealt with in paragraphs
65–108
Example9
A mining entity owns a private railway to support its mining activities. The private railway could
be sold only for scrap value and it does not generate cash inflows that are largely independent
of the cash inflows from the other assets of the mine.
It is not possible to estimate the recoverable amount of the private railway because its value in
use cannot be determined and is probably different from scrap value. Therefore, the entity
estimates the recoverable amount of the cash-generating unit to which the private railway
belongs, ie the mine.
Paragraph 6 of SFRS(I) 1-36 defines an asset’s cash-generating unit is the smallest group of assets
that includes the asset and generates cash inflows that are largely independent of the cash inflows
from other assets or groups of assets. Identification of an asset’s cash-generating unit involves
9
SFRS(I) 1-36 Impairment of Assets(n.d.)., p17
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judgement. If recoverable amount cannot be determined for an individual asset, an entity identifies
the lowest aggregation of assets that generate largely independent cash inflows.
Example 10
A bus company provides services under contract with a municipality that requires minimum
service on each of five separate routes. Assets devoted to each route and the cash flows from
each route can be identified separately. One of the routes operates at a significant loss.
Because the entity does not have the option to curtail any one bus route, the lowest level of
identifiable cash inflows that are largely independent of the cash inflows from other assets or
groups of assets is the cash inflows generated by the five routes together. The cash-generating
unit for each route is the bus company.
Example 12
A company operates a mine in a country where legislation requires that the owner must restore
the site on completion of its mining operations. The cost of restoration includes the replacement
of the overburden, which must be removed before mining operations commence. A provision
for the costs to replace the overburden was recognised as soon as the overburden was removed.
The amount provided was recognised as part of the cost of the mine and is being depreciated
10
SFRS(I) 1-36 Impairment of Assets, p18
11
SFRS(I) 1-36 Impairment of Assets, Paragraph 75, p19
12
SFRS(I) 1-36 Impairment of Assets, p19
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over the mine’s useful life. The carrying amount of the provision for restoration costs is CU500,
(a) which is equal to the present value of the restoration costs.
3.2.10.3 Goodwill
Paragraph 80 of SFRS(I) 1-36 states that for the purpose of impairment testing, goodwill acquired
in a business combination shall, from the acquisition date, be allocated to each of the acquirer’s
cash-generating units, or groups of cash-generating units, that is expected to benefit from the
synergies of the combination, irrespective of whether other assets or liabilities of the acquiree are
assigned to those units or groups of units.
If goodwill has been allocated to a cash-generating unit and the entity disposes of an operation
within that unit, the goodwill associated with the operation disposed of shall be included in the
carrying amount of the operation when determining the gain or loss on disposal; and measured on
the basis of the relative values of the operation disposed of and the portion of the cash-generating
unit retained, unless the entity can demonstrate that some other method better reflects the goodwill
associated with the operation disposed of.
Example 13
An entity sells for CU100 an operation that was part of a cash-generating unit to which goodwill
has been allocated. The goodwill allocated to the unit cannot be identified or associated with an
asset group at a level lower than that unit, except arbitrarily. The recoverable amount of the
portion of the cash-generating unit retained is CU300.
Because the goodwill allocated to the cash-generating unit cannot be non-arbitrarily identified
or associated with an asset group at a level lower than that unit, the goodwill associated with the
operation disposed of is measured based on the relative values of the operation disposed of and
the portion of the unit retained. Therefore, 25 per cent of the goodwill allocated to the cash-
generating unit is included in the carrying amount of the operation that is sold.
13
SFRS(I) 1-36 Impairment of Assets, p21
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However, according to paragraph 87, if an entity reorganises its reporting structure in a way that
changes the composition of one or more cash-generating units to which goodwill has been
allocated, the goodwill shall be reallocated to the units affected. This reallocation shall be
performed using a relative value approach like that used when an entity disposes of an operation
within a cash-generating unit, unless the entity can demonstrate that some other method better
reflects the goodwill associated with the reorganised units.
Example 14
Goodwill had previously been allocated to cash-generating unit A. The goodwill allocated to A
cannot be identified or associated with an asset group at a level lower than A, except arbitrarily.
A is to be divided and integrated into three other cash-generating units, B, C and D.
Because the goodwill allocated to A cannot be non-arbitrarily identified or associated with an
asset group at a level lower than A, it is reallocated to units B, C and D based on the relative
values of the three portions of A before those portions are integrated with B, C and D.
14
SFRS(I) 1-36 Impairment of Assets, p22
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Example15
A machine has suffered physical damage but is still working, although not as Ill as before it was
damaged. The machine’s fair value less costs of disposal is less than its carrying amount. The
machine does not generate independent cash inflows. The smallest identifiable group of assets
that includes the machine and generates cash inflows that are largely independent of the cash
inflows from other assets is the production line to which the machine belongs. The recoverable
amount of the production line shows that the production line taken is not impaired.
The recoverable amount of the machine alone cannot be estimated because the machine’s value
in use: (a) may differ from its fair value less costs of disposal; and (b) can be determined only
for the cash-generating unit to which the machine belongs (the production line).
The production line is not impaired. Therefore, no impairment loss is recognised for the
machine. Nevertheless, the entity may need to reassess the depreciation period or the
depreciation method for the machine. Perhaps a shorter depreciation period or a faster
depreciation method is required to reflect the expected remaining useful life of the machine or
the pattern in which economic benefits are expected to be consumed by the entity.
The machine’s value in use can be estimated to be close to its fair value less costs of disposal.
Therefore, the recoverable amount of the machine can be determined, and no consideration is
given to the cash-generating unit to which the machine belongs (i.e. the production line).
15
SFRS(I) 1-36 Impairment of Assets, p25
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Because the machine’s fair value less costs of disposal is less than its carrying amount, an
impairment loss is recognised for the machine.
3.2.14 Disclosure
According to paragraph 126 an entity shall disclose the following for each class of assets the
amount of impairment losses recognised in profit or loss during the period and the line item(s) of
the statement of comprehensive income in which those impairment losses are included. In addition,
the amount of reversals of impairment losses recognised in profit or loss during the period and the
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line item(s) of the statement of comprehensive income in which those impairment losses are
reversed. More so the amount of impairment losses on revalued assets recognised in other
comprehensive income during the period. Furthermore, the amount of reversals of impairment
losses on revalued assets recognised in other comprehensive income during the period.
Accounting Standards are developed by the Accounting Standards Board of Japan (ASBJ) and are
designated as Japanese GAAP by the Financial Services Agency of Japan.
The ASBJ develops Accounting Standards in accordance with the “Rules on the Due Process for
the Development of Japanese GAAP and Japan’s Modified International Standards” (hereinafter
referred to as the “Due Process Rules”) set out by the Financial Accounting Standards Foundation
(FASF).
When the Standards Advisory Council advises the ASBJ on either the topics or their priorities, the
ASBJ generally respects such advice. In some cases, the ASBJ may request the Standards Advisory
Council to discuss a potential agenda item. In cases of emergency, the ASBJ may decide to put an
item on its agenda without the consultation of the Standards Advisory Council.
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3.3.3 Standards Issued by the ASBJ
The types of Accounting Standards issued by the ASBJ after following the Due Process Rules can
be classified as follows:
Practical Solutions: Tentative treatment for areas where Accounting Standards do not exist and
practical treatment for areas where there is urgent need for guidance
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As a result, if the carrying value value of an asset exceeds its
is higher than the undiscounted recoverable amount.
cash flows, the carrying value is
considered to be not recoverable.
Recoverable amount is the
higher of (i) fair value less
An impairment loss is then
costs to sell and (ii) value in
recognised for the difference
use ( the present value of
between the carrying value and
the amount of the discounted
future cash flows derived from
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goodwill relates, at a generally
higher level. Each unit or group of units to
which the goodwill is
If the carrying amount of allocated shall:
goodwill can be allocated to
asset groups of the related Represent the lowest level
business based on some within the entity at which the
reasonable criteria, goodwill is monitored for
recognition of an impairment internal management
loss can be judged after the purposes.
goodwill has been allocated to
each asset group. Not be larger than an
operating segment as defined
by paragraph 5 of IFRS 8
operating Segments before
aggregation.
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Smyce: IFRS-JGAAP comparison16
Practical evidence of determination of recoverable amount: Figure 4.1 is an extract from the
financial statements of EFT Solutions for the 2017 financial year. The extract shows how EFT
Solutions determines recoverable amount.
Figure 4.1: Extract from the notes to the2017 financial statements of EFT Solutions
16
https://www.eyjapan.jp/services/assurance/ifrs/issue/ifrs-others/other/pdf/ifrs-jgaap-comparison-v20-E.pdf.
Accessed 29/03/2019
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useful life of the asset. However, in FVLCD calculations, an entity is required to use assumptions
that market participants would use when pricing the asset or liability, if market participants act in
their economic best interest.
Practical evidence on the value in use: Both the theoretical and the empirical material show that
value in use is often applied by companies, which is a challenging area due to its subjectivity and
estimation about the future. This process consists of several steps, which together shall reflect the
value of the asset to the company.
IAS 36 aims to define procedures to guarantee that assets are not registered at a higher book value
than the value that can be recovered through use or sale. If evidence exists of impaired assets in
the future, the entity should apply the test to check the possible loss and, if identified, the
devaluation should be recognized through the constitution of an allowance for impairment losses
Figure 4.2 shows the notes in the financial statements of VTech Holdings Limited regarding the
determination of value in use.
Figure 4.2: Extract from the notes to the2017 financial statements of VTech Limited
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3.4.3 Determining a CGUs
Requirements of IAS 36: The CGU 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. [IAS
36.6]
Perceived Weakness of IAS 36: When a company has clarified that strong indications occur and
thus conduct an impairment test; difficulties arise in the assessment of which asset or assets that
should be included. IAS 36 states that a CGU shall be defined on the lowest possible level.
(Anderson & Inzel 2014, p. 33)
Perceived Weakness of IAS 36: The determination of CGUs, which is the smallest group of
assets that generate independent cash flows (IAS 36:6), is according to Marton (2012) another
challenging area within IAS 36. According the Managerial Finance issue of 2010, “If CGUs are
determined at a higher level than necessary, impairments can be avoided. This can simply be
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explained by combining a profitable asset with an unprofitable asset, and then the CGU will not
be a subject to impairment.”17
17
Managerial Finance 2010b p.8
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3.5 Analysis of the strengths and Weakness of IAS 36
3.5.1 Disclosure and compliance
Strengths of IAS 36:
Many users think that information required by IAS 36 Impairment of Assets is useful. Useful
disclosures include discount rates used, long-term growth rates, profit and capital expenditure
assumptions and sensitivities.
IAS 36 therefore, improves the accuracy of the information disclosed. The application of IAS 36
affects the quality and reliability of the information advertised. Impairment application improves
the credibility of accounting information and provides information that is more credible and
reliable for decision-making process. To be useful, accounting information needs to be reliable.
Many participants think that the impairment test is complex, time-consuming and expensive and
involves significant judgements. The main challenges identified are the following:
(a) Determining the cash flows from the cash generating unit to which the goodwill
has been allocated, the discount factor to be applied and the terminal value (growth
rate) of the cash flows can be very judgmental. Cash flows projections must be
prepared specifically for the purpose of impairment testing, as management
projections are not based on an ‘as is’ status, but also include management best
estimates of future cash flows derived from new investments and products.
(c) The allocation of goodwill to cash generating units (CGUs) for impairment testing.
Goodwill is allocated to the CGUs that are expected to benefit from the synergies
of the combination, which can be judgmental and difficult to apply in practice. After
the initial allocation, the carrying value of the goodwill is tested for impairment as
part of the respective GCUs, which might be merged or restructured in subsequent
- 32 -
years to a degree that they have little or no similarities to the originally acquired
business. Furthermore, the impairment test is performed based on the most recent
approved budgets, which over time can be substantially different from the business
plans at the acquisition date.
It is not clear what represents ‘the lowest level within the entity at which the goodwill is monitored
for internal management purposes’, as set out in paragraph 80 of IAS 36.
Practical difficulties related to the testing of a CGU for impairment when part of the recoverable
amount is attributable to non-controlling interest (NCI). If an entity is measuring NCI at its
proportionate share of net assets, this needs to be reflected in the impairment calculation. This
becomes more complicated when there have been transactions with NCI holders after the business
acquisition date, or if there is a group of CGUs to which goodwill is attributed that is partly
measured at fair value and partly on a proportionate basis.
The requirement to use a pre-tax discount rate when equity returns are always post-tax (meaning
there are not observable market inputs for a pre-tax cost of equity). Practically, this means that the
test is usually conducted on a post-tax basis with an additional iteration performed simply to derive
a pre-tax discount rate.
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Relevant academic evidence includes the following:
Petersen and Plenborg (2010) investigated compliance with IAS 36 for companies listed on the
Copenhagen Stock Exchange. They found some inconsistencies in application relating to defining
cash generating units and estimating recoverable amounts.
Kvaal (2007) noted complexity relating to the use of pre-tax discount rates in measuring an asset’s
recoverable amount under IAS 36. He recommended the use of company-specific after-tax cash
flows for value in use calculations, with deferred taxes considered in the impairment review.
Research based on archival data has generated mixed results as regards the decision usefulness of
financial information related to goodwill and impairment. With regard to goodwill at acquisition,
a study by Shalev (2009), based on US data, finds that preparers seek to avoid transparency in their
financial reporting when the acquisition premium is to a higher extent allocated to goodwill and
argues that this is consistent with a behaviour where acquirers downplay ‘bad news’ for investors
by trying to hide overstatement of goodwill in the purchase price allocation in order to avoid
amortisation. In a more recent study, Shalev et al. (2013) find that CEOs whose compensation
packages rely more on earnings-based components are more likely to over-allocate the purchase
price to goodwill.
About goodwill impairment tests, a review paper by Barone et al. (2015), reports that major
standard setters, i.e. FASB and IASB, support the impairment-only approach because impairment
test provides users of financial reports with a measure of goodwill that reflects firms’ underlying
economic value and investment opportunities.
3.5.2 Goodwill
Strengths of IAS 36:
Some users think that the information provided by the impairment test of goodwill is useful,
because it has confirmative value. However, they admit that impairment losses are often
recognised too late (ie they do not have predictive value).
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Weakness of IAS 36:
“(a) the high number of judgements and assumptions make the goodwill impairment testing a
complex and time-consuming exercise;
(b) it is not clear that the benefits of mandatory annual impairment testing outweigh the related
costs;
(c) the value relevance of impairment testing is in confirming instead of predicting value, and that
goodwill impairment charges do not act as a major signaling event for the market.”
According to the Research Group’s report titled “Should goodwill still not be amortised?
Accounting and disclosure for goodwill” (2014), also found that “although IAS 36 requires an
annual goodwill impairment test and a one-step impairment test, it still allows discretion in making
a number of choices in relation to impairment.”19
The surveys conducted by OIC-EFRAG, the ASBJ’s survey in 2014 also raised the following
shortcomings of IAS 36:
“(a) the impairment-only approach leaves significant room for managerial discretion,
interpretation, judgment and bias and in fact it may result in the entity failing to recognise an
incurred impairment loss; and
(b) the financial crisis has shown that an improvement of the current standard may be necessary.
Specifically, many respondents stated that the IASB should investigate whether the impairment
test could be improved to ensure that entities use robust and reliable assumptions so that
impairment losses are recognised on a timely basis.”20
18
Who cares about goodwill impairment? Available at:
http://www.kpmg.com/CN/en/IssuesAndInsights/ArticlesPublications/Documents/Who-cares-aboutgoodwill-
impairment-O-201904.pdf
19
Research Group, “Should goodwill still not be amortised? Accounting and disclosure for goodwill”, pp33 -34
20
Ibid
- 35 -
The allocation of goodwill to cash generating units (CGUs) for impairment testing. Goodwill is
allocated to the CGUs that are expected to benefit from the synergies of the combination, which
can be judgmental and difficult to apply in practice. After the initial allocation, the carrying value
of the goodwill is tested for impairment as part of the respective GCUs, which might be merged
or restructured in subsequent years to a degree that they have little or no similarities to the
originally acquired business. Furthermore, the impairment test is performed based on the most
recent approved budgets, which over time can be substantially different from the business plansat
the acquisition date.
The Global Preparers Forum (2017) states that “the identification of CGUs requires significant
judgment, as specifically acknowledged by IAS 36. Managers, however, can exploit discretion
such that reports of impairment charges are avoided, resulting in an overstatement of assets in
financial statements.”22
21
Ibid
22
Global Preparers forum
- 36 -
Practical difficulties related to the testing of a CGU for impairment when part of the recoverable
amount is attributable to non-controlling interest (NCI). If an entity is measuring NCI at its
proportionate share of net assets, this needs to be reflected in the impairment calculation. This
becomes more complicated when there have been transactions with NCI holders after the business
acquisition date, or if there is a group of CGUs to which goodwill is attributed that is partly
measured at fair value and partly on a proportionate basis.
Suggested improvements:
Anderson and Inzel (2014) state that both the “theoretical and the empirical material show that
value in use is often applied by companies, which is a challenging area due to its subjectivity and
estimation about the future.”
IAS 36 states that the discount rate shall be a pre-tax rate; despite that, companies usually apply a
post-tax rate. Paragraph 55 of IAS 36 requires that an entity must use a pre-tax discount rate to
discount pre-tax cash flows so there is consistency between the discount rate and the cash flows.
Paragraph 94 of the Basis for Conclusions of IAS 36 states that, conceptually discounting post-tax
cash flows at a post-tax discount rate or discounting pre-tax cash flows at a pre-tax discount rate
should give the same results.
According to the findings of the Research Group “A significant area of judgement in the
calculation of the VIU is the determination of the discount rate. This could be understood as an
indirect equivalence between pre-tax and post-tax discount rates. However, if the expected future
cash flows are not evenly distributed over the period, the equivalence may not occur.
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In addition, the Research Group (2014) states that” IAS 36 is not explicit as to how to estimate a
pre-tax discount rate, and implicitly suggests using an iterative process in certain cases (see
paragraphs 56, 57 and BCZ85). VIU could be estimated starting from a post-tax calculation to
arrive at an equivalent result through an iterative process.”23
The requirement to use a pre-tax discount rate when equity returns are always post-tax (meaning
there are not observable market inputs for a pre-tax cost of equity). Practically, this means that the
test is usually conducted on a post-tax basis with an additional iteration performed simply to derive
a pre-tax discount rate.
Andersson & Inzel (2014) observe that “it is not important how many companies use a post-tax rate, but
important is the fact that a post-tax rate occurs in practice, which shows that there is a gap between the
regulation and the application of IAS 36.”
The Research Group (2014) reports that “size and composition of CGUs impacts the recognition
and measurement of impairment losses”. However, according to the Research Group “IAS 36
offers limited guidance in identifying them. If a CGU is too broad, it may result in non-recognition
of impairment because the gains of some units may offset the losses of another unit within the
same CGU.”
23
The Research Group, ‘ Should Goodwill Still not Be Amortised? Accounting and Disclosure For Goodwill, (2014,
p.37)
- 38 -
It is not clear what represents ‘the lowest level within the entity at which the goodwill is monitored
for internal management purposes’, as set out in paragraph 80 of IAS 36.
The Research Group (2014) states that “the method applied to determine the recoverable amount
should reflect the expected manner of recovery, and if the entity intends to recover the value by
operating the unit, the recoverable amount should only be based on VIU.”
According to the Netherlands Authority for the Financial Markets (2012) the “full application of
the provisions of IAS 36.134(f) gives investors a good understanding of the factors involved in the
determination of the recoverable amount of a cash-generating unit and the decision as to whether
recognition of an impairment loss is necessary or not.”24
The Global Preparers Forum (2017) noted that “IAS 36 helps preparers and users to deal with the
problems of the historical cost principle. IAS 36 thus improves the quality of accounting
information by giving a clear picture of the companies’ positions. By applying impairment loss
financial reports become clearer, more accurate, describe reality, and provide relevant information
24
The Netherlands Authority for the Financial Markets 2012
- 39 -
which indicates an increase in credibility to satisfy the users’ needs and wants by improving the
information content and reporting, if the valuation of fair value relies on objective measurements.
Impairment presents equitable treatment and fairness for all parties, thus promoting public trust in
the company. It locates the financial position of the company accurately and objectively. Any small
piece of information may affect the users’ decisions either positively or negatively, or even amend
them. This information should be displayed for various user groups of financial information.”25
Value in use should reflect risk and uncertainty to the extent that these would be reflected in the
price of an arm’s length transaction. Risk may be reflected by adjusting either the cash flows or
the discount rate, but not both. Determining an appropriate discount rate that reflects current
market assessments and the appropriate risks will often be difficult and will require consideration
and input from financial management, line management and, perhaps, valuation professionals.
Input from these parties will also be required to formulate assumptions regarding growth rates used
to project cash flows until the end of the asset’s useful life, which will also require significant
judgment to formulate.27
25
Global Preparers Forum 2017
26
Ibid
27
Ibid
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testing, as management projections are not based on an ‘as is’ status, but also include management
best estimates of future cash flows derived from new investments and products.
4.5 Conclusion
The chapter illustrated that the debate about impairment of assets (IAS 36) is full of arguments
that are in support and against the standard. This research has managed to highlight the
controversies surrounding the IAS 36 standard. According to the positive and negative
international critiques of IAS 36 the concept of impairment of assets, it is obvious and clear that
this concept is far from being perfect.
There are a number of areas for possible improvements of IAS 36 in order to reduce the operational
challenges. This applies to calculation of VIU and its relationship with fair value as well as the
determination of the discount rate.
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CHAPTER 5
5.1 Introduction
In this chapter, I draw my conclusions based upon the discussion in the analysis. The conclusion
will provide an answer to the research problem. Suggestions for further research are also provided
in areas related to the thesis subject.
5.2.3 Providing better and timely information about goodwill and impairment to
investors
28
Agenda ref 18D, p5
29
Agenda ref 18D, p5
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In addition, the IASB feels that this approach “moderately contributes to achieving the
simplification objective”. However, it also notes that the approach “detracts from achieving the
effectiveness objective and providing better and timely information.”30
The IASB explains that for example, if goodwill impairment exists at the lower level at which the
goodwill is monitored, “that impairment might not be recognised if a unit that contains goodwill
is aggregated with other units that contain sufficient headroom to offset the impairment loss.”32
The IASB also believes that this approach moderately “contributes to achieving the simplification
objective but significantly detracts from achieving the effectiveness objective and providing better
and timely information”33
5.3.3 Removing restrictions on cash flow projections used in calculating value in use
The IASB does not believe this will make impairment testing more effective. However, it believes
it “might mitigate some possible concerns about the costs of applying the updated headroom
approach; and enhances the relevance of the disclosure of headroom.”34
30
Agenda ref 18D, p5
31
Paragraphs B24–B28 of Appendix B of Agenda Paper 18E
32
Paragraphs B24–B28 of Appendix B of Agenda Paper 18E
33
Agenda ref 18D, p6
34
Agenda ref 18D, p4
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5.3.4 A single method as the sole basis for determining recoverable amount
The IASB argues that this approach might not significantly simplify impairment testing “because
an entity does not need to calculate both value in use and fair value less costs of disposal of a cash-
generating unit in all situations. It needs to do this only when calculating one of these amounts has
shown that there may be an impairment.”35
The IASB, similarly, this approach might not in itself make impairment testing more effective.
However, “it might mitigate some possible concerns about the costs of applying the updated
headroom approach.”36
According to the IASB this approach “might also improve the information provided to investors.
For example, if value in use is used as the sole basis for measuring recoverable amount, some
investors may find value in use more useful than fair value less costs of disposal because value in
use reflects the way an entity expects to use the asset”.37
This approach according to the IASB will “significantly contribute to providing better and timely
information and moderately contributes to achieving the effectiveness objective but imposes undue
costs that significantly outweigh the benefits.”39
35
Agenda ref 18D, p4
36
Agenda ref 18D, p4
37
Agenda ref 18D, p5
38
Paragraphs B1–B15 of Appendix B of Agenda Paper 18F
39
Paragraphs B1–B15 of Appendix B of Agenda Paper 18F
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5.4 Recommendations for improving the application of IAS 36
Goodwill and Impairment research project considered improving the application of IAS 36 by:
Simplifying the test without making it less robust; and/or making the test more effective at timely
recognition of impairments of goodwill? The board considers improving the application of IAS 36
by “amending the calculation of value in use of an asset (or a cash-generating unit) by removing
the requirement to exclude from the calculation of value in use those cash flows that would result
from a future restructuring or from a future enhancement”40
In addition, considered “making impairment testing of goodwill more effective by using the
unrecognized headroom of a cash-generating unit (or groups of units) as an additional input in the
impairment testing of goodwill”41
The other recommendation that the board considered was “removing the explicit requirement to
use pre-tax inputs in calculating value in use, and to disclose pre-tax discount rates used. Instead,
an entity would be required to use internally consistent assumptions about cash flows and discount
rates, and to disclose the discount rate(s) actually used.”42
According to the board, the calculation of the value in use can also be simplified by” the prohibiting
including estimated cash flows from uncommitted future restructuring; and improving or
enhancing the asset’s performance.”44
40
Goodwill and Impairment research project, p4
41
Goodwill and Impairment research project, p4
42
Goodwill and Impairment research project, p4
43
Agenda ref 18D, p9
44
Agenda ref 18D, p9
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5.4.2 Using headroom approach
The IASB believes that using the headroom approach will “significantly contributes to achieving
the effectiveness objective and providing better and timely information while imposing some
costs.”45
In addition, the board is of the view that “using single method for determining recoverable amount
and removing the prohibition on cash flows used in calculating value in use might to some extent
mitigate the costs of applying the updated headroom approach by resolving the concern that the
current measurement basis of IAS 36 does not produce a single point estimate of recoverable
amount”.46
According to the board to remove the shielding effect from internally generated goodwill, “the
updated headroom approach would introduce the amount of unrecognised headroom as an
additional input into the impairment testing model.”47
45
Agenda ref 18D, p10
46
Agenda ref 18D, p10
47
Goodwill and Impairment research project, p10
48
Goodwill and Impairment research project, p10
- 46 -
5.4.4 Inputs and methods for estimating the recoverable amount of CGUs
5.6 Conclusions
According to my results full compliance with IAS 36, paragraph 134 has yet to be achieved. This
raises several questions regarding the actual efficiency of the standard. What is an acceptable
compliance level according to the standard setters, and do they reckon that full compliance will be
achieved one day or are they satisfied with a slightly lower compliance level?
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