Lecture 4

Business Combination, and

Impairment of Asset

Lili DAI
 Topic 1
Business Combination

(AASB 3, Chapter 12)

 Business Combination

What is business combination under AASB 3?

A transaction or other event in which an acquirer obtains control of one or

more businesses.

There are different forms of business combination.

o A acquires assets and liabilities from B.

o A acquires a group of assets and liabilities from B.

o A and B merged together form C.

 Business Combination

Accounting for business combination - Four key steps

FVINA = Identifiable assets - Liabilities

Recognition of identifiable
Identify the acquirer
assets, liabilities, and NCI

Determine the acquisition date Recognition of goodwill or gain

Goodwill = (Consideration + NCI + Previous Equity) FVINA

Gain on bargain purchase = FVINA (Consideration + NCI + Previous Equity)
 Business Combination

More on Step 3 Including contingent liabilities (two types)

Possible Real
obligations liabilities

To be confirmed by
Cannot be reliably
future events not
measured
within control

Ignored if probability < 50%, Recognised, because reliability is

otherwise recorded. satisfied via business combination.
 Business Combination

More on Step 3 - Including Intangible assets

Trademark Customer list

Composition

Software Franchise agreement

FV of an intangible reflects market expectations about the probability of future

economic benefits flowing to the entity.
 Business Combination

More on Step 4 - Consideration transferred

Consideration includes
o Cash

o Non-monetary assets

o Equity instruments

o Liabilities undertaken

o Contingent consideration

Consideration measured to FV as of the acquisition date,

or to CA if assets or liabilities remain within the combined entity.
 Business Combination

More on Step 4 Goodwill

Goodwill = Consideration transferred FVINA acquired

An asset representing the future economic benefits arising from other assets
acquired in a business combination that are not individually identified and
separately recognised. - AASB 3

This Core Goodwill defined by AASB 3 includes:

o Going-concern goodwill

o Combination goodwill

Initial measurement at costs. Subsequent measurement for impairment tests

(Next - Topic 2).
 Business Combination

An Example
A Ltd acquired all the assets and liabilities of B Ltd on 1 Jan 2016 with
consideration including

Cash of $400,000, half paid on 1 Jan 2016 and half on 1 Jan 2017 (r=10%).

100,000 shares with price=$1.5.

Cost of issuing the shares was $1,000.

Guarantee payment for decrease in share price. A expected 25% chance that
price will fall to $1.4 until March 2016, and 75% $1.5.

Supply of patent to B valued at $60,000.

Legal and associated costs = $5,000.

 Business Combination

An Example
B Ltds assets and liabilities acquired by A Ltd are as follows:
CA FV
Plant & equipment 360,000 367,000
Land 260,000 257,000
Inventory 24,000 30,000
Accounts receivable 18,000 16,000
Accounts payable (35,000) (35,000)
Bank overdraft (55,000) (55,000)
Net assets 572,000 580,000

B has unrecorded contingent liability of $10,000 with probability>50%.

 Business Combination

An Example

Cash Payable now 200,000

Deferred ($200,000 / (1+10%) ) 181,818
Shares 100,000 x $1.50 150,000
Guarantee 100,000 x ($1.50-$1.40) x 25% 2,500

Patent 60,000
Cost of acquisition 594,318
 Business Combination

An Example

FVINA = FV of recorded net assets Contingent liability

= 580,000 - 10,000

= 570,000

Goodwill = Cost of acquisition FVINA

= 594,318 - 570,000

= 24,318
 Business Combination

Dr Plant & equipment 367,000

Dr Land 257,000
Dr Inventory 30,000
Dr A/C Receivable (net) 16,000
Dr Goodwill 24,318
Cr A/C Payable 35,000
Cr Bank o/draft 55,000
Cr Provision for contingency 10,000
Cr Cash 200,000
Cr Deferred consideration payable 181,818
Cr Share capital 150,000
Cr Provision for loss in value of shares 2,500
Cr Gain on sale of patent 60,000
Dr Legal fee expenses 5,000
Dr Share capital 1,000
Cr Cash 6,000
To be Continued with
Impairment of Asset
 Topic 2
Impairment of Asset

(AASB 136, Chapter 13)

 Impairment of Asset

Some examples:

Aurizon facing full-year loss amid writedowns

Rail freight company Aurizon Holdings .. declaring it will write down the value of its
bulk freight business will log $80 million of extra costs and impairments due to
transformation costs.
- July 26, 2017, The Australian

SkyCity flags $95m Darwin casino impairment

SkyCity blamed the writedown of goodwill on competitive pressures following the

Northern Territory governments unexpected decision to remove the cap on gambling
machines in December 2014.
- July 26, 2017, The Australian
Impairment of Asset

SkyCity

Aurizon
 Impairment of Asset

What does AASB 136 require?

Assets should be tested for impairment when there is an indication or evidence of

impairment.

CA > RA Impairment loss

RA is the higher of (1) Value in Use (VIU) and (2) FV less Cost of Sell.

Following assets must be tested annually:

Intangibles with indefinite useful lives.

Intangibles not yet available for use.

Goodwill acquired in a business combination.

 Impairment of Asset

What are the indicators of impairment under AASB 136?

Internal Indicators External Indicators

Obsolescence or physical damage Decline in market value

Change in asset use Adverse changes in market

Economic performance worse than expected Increases in interest rates

 Impairment of Asset

How to calculate value in use (VIU)?

It is the present value of future cash flows (inflows and outflows) expected to be
derived from an asset or cash-generating unit.

1) Managements best estimates.

2) Greater weight shall be given to external evidence.

3) Exclude future cash flows arising from future reconditioning.

Managements best estimates Based on a steady or declining growth rate, unless CF of disposal
included

Y0 Y5 Y15
 Impairment of Asset

Let us see some examples

 Impairment of Asset

Case 1: Impairment test for individual asset

An asset has book value of $120, accumulated depreciation of $20, and
recoverable amount of $90.

Under cost model

Record the impairment loss:

Dr Impairment loss (P/L) 10 [(120-20) 90]
Cr Accum. depn and impairment losses 10

Accum. depn account is rename as Accum. depn and impairment losses.

The balance of Accum. depn and impairment losses is $30 ($20 + $10).
 Impairment of Asset

Case 1: Impairment test for individual asset

An asset has book value of $120, accumulated depreciation of $20, and
recoverable amount of $90.

Under revaluation model

Write off the book value to carrying amount:

Dr Accum. depn 20
Cr Asset 20

Record the impairment loss:

Dr Impairment loss (P/L) 10 [(120-20) 90]
Cr Accum. impairment losses 10
 Impairment of Asset

Case 1: Impairment test for individual asset

An asset has book value of $120, accumulated depreciation of $20, and
recoverable amount of $90. Assume that previous increase was $10.

Under revaluation model

Write off the book value to carrying amount:

Dr Accum. depn 20
Cr Asset 20

Reverse previous increase through impairment loss:

Dr Asset revaluation surplus (OCI) 7
Dr Deferred tax liability 3
Cr Asset 10
 Impairment of Asset

Cash-generating unit (CGU) to be discussed before Examples 2-4

Why shall we consider CGU?

o When it is not possible to determine the RA for an individual

asset

CGU is the smallest group of assets generating independent cash

flow.

Loss is allocated to each asset in the CGU on a pro-rata basis.

 Impairment of Asset

Case 2: Impairment test for CGU excluding GW

A identified an impairment loss of $12,000 on one CGU, which

consists of assets:

o Buildings, CA = 500,000, RA = 497,000

o Equipment, CA = 300,000

o Land, CA = 250,000

o Fittings, CA = 150,000
 Impairment of Asset

Case 2: Impairment test for CGU excluding GW

CA Pro-rata Impairment loss allocated Adjusted CA

Buildings 500,000 5/12 5,000 495,000
Equipment 300,000 3/12 3,000 297,000
Land 250,000 2.5/12 2,500 247,500
Fittings 150,000 1.5/12 1,500 148,500
1,200,000 12,000

Any problem with this allocation?

 Impairment of Asset

Case 2: Impairment test for CGU excluding GW

CA Pro-rata Impairment loss allocated Adjusted CA
Buildings 500,000 5/12 5,000 495,000
Equipment 300,000 3/12 3,000 297,000
Land 250,000 2.5/12 2,500 247,500
Fittings 150,000 1.5/12 1,500 148,500
1,200,000 12,000

Total impairment
Adjusted CA Pro-rata Impairment loss allocated
loss allocated
Buildings 3,000
Equipment 297,000 297/693 857 3,857
Land 247,500 247.5/693 714 3,214
Fittings 148,500 148.5/693 429 1,929
693,000 2,000 12,000
 Impairment of Asset

Case 2: Impairment test for CGU excluding GW

- An alternative approach

CA Pro-rata Impairment loss allocated Adjusted CA

Buildings 500,000 3,000 497,000
Remaining impairment loss to be allocated = 12,000 - 3,000 = 9,000
Equipment 300,000 3/7 3,857 296,143
Land 250,000 2.5/7 3,214 246,786
Fittings 150,000 1.5/7 1,929 148,071
700,000 9,000
 Impairment of Asset

Case 3: Impairment test for CGU including GW

A identified an impairment loss of $300,000 on one CGU, which

consists of assets:

o Buildings, CA = 500,000

o Equipment, CA = 300,000

o Land, CA = 250,000

o Goodwill, CA = 150,000
 Impairment of Asset

Case 3: Impairment test for CGU including GW

Goodwill can be tested for impairment only at the CGU level.

Apply the impairment loss firstly to goodwill, and allocate the remaining part to
other assets in CGU on a pro-rata basis.

CA Pro-rata Impairment loss allocated Adjusted CA

Goodwill 150,000 150,000 -
Remaining impairment loss to be allocated = 300,000 - 150,000 = 150,000
Buildings 500,000 5/10.5 71,429 428,571
Equipment 300,000 3/10.5 42,857 257,143
Land 250,000 2.5/10.5 35,714 214,286
1,050,000 150,000
 Impairment of Asset

Case 4: Reversal of an impairment loss

Recall the indicators of impairment Can they be reversed?

Internal Indicators External Indicators

Obsolescence or physical damage Decline in market value

Change in asset use Adverse changes in market

Economic performance worse than expected Increases in interest rates

 Impairment of Asset

Case 4: Reversal of an impairment loss Basic example

An asset has book value of $120, accumulated depreciation of $20, and
recoverable amount of $90 in 2016. In 2017, the new RA = $100.

Under both cost and revaluation models

In 2016, record the impairment loss:

Dr Impairment loss (P/L) 10 [(120-20) 90]
Cr Accum. (depn and) impairment losses 10

In 2017, record the reversal of impairment loss:

Dr Accum. (depn and) impairment losses 10
Cr Income - impairment loss reversal (P/L) 10
 Impairment of Asset

Case 4: Reversal of an impairment loss RA > value if no impairment

An asset has book value of $120, accumulated depreciation of $20, and
recoverable amount of $90 in 2016. In 2017, the new RA = $105.

Under both cost and revaluation models

In 2016, record the impairment loss:

Dr Impairment loss (P/L) 10 [(120-20) 90]
Cr Accum. (depn and) impairment losses 10

In 2017, record the reversal of impairment loss:

Dr Accum. (depn and) impairment losses 10 (15)
Cr Income - impairment loss reversal (P/L) 10
 Impairment of Asset

Case 4: Reversal of an impairment loss Reversal of reversal

An asset has book value of $120, accumulated depreciation of $20, and
recoverable amount of $90 in 2016. Assume that previous increase was
$10 in 2015. Now in 2017, the new RA = $100.
Under revaluation model
In 2016, reverse previous increase through impairment loss:
Dr Asset revaluation surplus (OCI) 7
Dr Deferred tax liability 3
Cr Asset 10
In 2017, record the reversal of impairment loss:
Dr Asset 10
Cr Deferred tax liability 3
Cr Asset revaluation surplus (OCI) 7
 Impairment of Asset

Case 4: Reversal of an impairment loss - CGU

CA Pro-rata Impairment loss allocated Adjusted CA

Goodwill 150,000 150,000 -
Remaining impairment loss to be allocated = 300,000 - 150,000 = 150,000
Buildings 500,000 5/10.5 71,429 428,571
Equipment 300,000 3/10.5 42,857 257,143
Land 250,000 2.5/10.5 35,714 214,286
1,050,000 150,000

Assume that there is an increase in the RA of CGU value of 150,000.

 Impairment of Asset

Case 4: Reversal of an impairment loss - CGU

CA Pro-rata Impairment loss allocated Adjusted CA
Goodwill 150,000 150,000 -
Remaining impairment loss to be allocated = 300,000 - 150,000 = 150,000
Buildings 500,000 5/10.5 71,429 428,571
Equipment 300,000 3/10.5 42,857 257,143
Land 250,000 2.5/10.5 35,714 214,286
1,050,000 150,000 900,000

CA Pro-rata Reversal of IL allocated Adjusted CA

Goodwill - - -
Buildings 428,571 428.6/900 71,429 500,000
Equipment 257,143 257.1/900 42,857 300,000
Land 214,286 214.3/900 35,714 250,000
900,000 150,000 1,050,000
Next Lecture

Consolidation:
controlled entities &
wholly owned
subsidiaries

By Chuan Yu