ERNAKULAM BRANCH OF SIRC OF ICAI

Chain Seminar on Accounting Standards

Impairment of Assets
AS-28

“an asset is IMPAIRED

when the carrying amount of the asset exceeds its
recoverable amount”
 Objective of the AS
 To ensure that no “asset” is carried above it’s
recoverable amount
 To prescribe procedures for recognition and reversal
of impairment loss
 To prescribe disclosures for impairment

 To bring Indian accounting in line with

– IAS-36
– US GAAP (SFAS 144)
 Mandatory for
Level I Enterprise: 1st April 2004
Listed companies (existing/ proposed)
Banks / Insurance/Financial Institutions
Turnover exceeding Rs 50 cr
Borrowings exceeding Rs 10 cr (any time)
Holding/subsidiary of above
Level II Enterprise (SMC): 1st April 2006
Turnover between Rs 40 lakhs- Rs 50 cr
Borrowings between Rs 1 cr-Rs 10 cr
Level III Enterprise 1st April 2008
All Other enterprises
Steps in Applying AS-28
Step 1
Identify
Assets (or)
Cash Generating Units (CGU)
for assessing impairment
 Assets
 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 IDENTIFIED

BASED ON IT’S INDEPENDENT CAPABILITY
TO GENERATE CASH FLOW”
 How can each asset be capable of
independently generating cash flows
when in reality all or many assets function
together as a unit ?

Answer
Identify group of assets as
CASH GENERATING UNITS (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.
 Features of a CGU
 Smallest group of assets which can independently
generate 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 have
an active market
 CGUs may have to be aggregated – if incapable of
being acquired / disposed independently
 Identification should be consistent from period to
period – changes should be disclosed
 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 manufacturing
stream 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 a Drum Manufacturing Plant the
outputs of which are fully used internally. But Power & Drums also have
an “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 cash
flows
– The Captive Power Plant & Drum Manufacturing Unit may have to be
treated as separate CGUs, even if actually there is no separate Cash Flow
from the same now-since active markets exist
 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
 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 disposed
separately
Step 2

Assess whether there

are any indications of
Impairment
 External 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
 Internal 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
 Decisions
 If no indications exist – No need to make a
formal estimate of recoverable amount

 If indications exist -Recoverable Amount must be

estimated and matched with Carrying Costs

 Indications may also require that effective life and

depreciation charge as per AS 6 may have to be
reviewed/adjusted

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

Step 3

Assess
Carrying Cost
 Carrying 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
 Carrying 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
Step 4

Assess
Recoverable Amount
 Recoverable Amount
 Higher of

NET SELLING PRICE

(or)
VALUE IN USE
Sub-Step 1 in Assessing RA

Assess
Net Selling Price
 Net 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 of Disposal of Asset/CGU (other than
finance costs & tax thereon)

 Valuation by independent expert (Chartered Valuer

etc ) cannot be used-EAC Opinion
 Decision 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
Sub-Step 2 in Assessing RA

Assess
Value In Use
 Value 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”

 Value In Use (VIU)

Present value of
Estimated future cash flows
arising from the Asset/CGU
(+)
 Residual value at the end of it’s
life
 Estimating VIU
Involves:
 Estimating future net cash flows from
continuous 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 the
cash flows
 Future Cash Flows-Include

 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 it’s life
 Foreign currency cash flows – at AS 11 values
 Future Cash Flows-Exclude

 Cash flows from financing activities

 Tax receipts / payments
 Cash flows from
– uncommitted future restructuring
– capital expenditure that will improve / enhance assets
performance over original assessments
Estimating 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, unless
justified
– growth rate should not exceed long term growth
rate for product/industries/country(ies) in which
the enterprise operates
 Discount Rate
 Discount rate should be based on:
– Pre-tax rate
– Current market assessment of time value of
money based on nature of the Asset/CGU
 Rate that an investor would require if they

were to choose an investment which will

generate 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
 Relaxation 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
NET SELLING PRICE (A) 400000

VALUE IN USE(B)
Year Cash Flows Discount DCF
@6%
1 110000 0.943396 103774
2 100000 0.889996 89000
3 90000 0.839619 75566
4 80000 0.792094 63367
5 70000 0.747258 52308
Residual 50000 0.747258 37363
VALUE IN USE 421378

RECOVERABLE AMOUNT 421378

 Findings
 If
RA is more than carrying cost –
No IL

 IfRA is less than carrying cost –

Recognise IL
Step 5

Recognising
Impairment Loss
IMPAIRMENT LOSS

 CARRYING AMOUNT
(-)
 RECOVERABLE AMOUNT
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 89000
3 90000 0.839619 75566
4 80000 0.792094 63367
5 70000 0.747258 52308
Residual 50000 0.747258 37363
VALUE IN USE 421378

RECOVERABLE AMOUNT 421378

IMPAIRMENT LOSS 178622

 Accounting 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
 Accounting of IL-CGU
 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
it’s individual net selling price/value in use /
zero
 If any balance loss remains unallocated
based on above, an impairment liability
should be created
 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
Step 6

Reassess Impairment
Each Year
 Reversal 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)
Step 7

Making disclosures
 Description of CGU(s) adopted
 Changes in identification of CGU compared
to 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
 Some Legal Implications
 Companies Act
– No 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
 Conclusion

AS-28 challenges for the Assurance Function

1. Correct classification of CGUs

2. Fair approximation of NSP
3. Even reasonable accuracy of the long
term future estimations of the
management
THANK YOU