Asset Impairment and Valuation

This assignment delves into the concept of asset impairment and its calculation. It outlines the key elements like recoverable value, value in use, and fair value less cost of disposal. The document explains how to determine each of these values, taking into account factors such as discount rates, cash flow estimations, and market conditions. The importance of transparent disclosure regarding assumptions used in the calculations is also highlighted.

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By student name
Professor
University
Date: 18 August 2017.
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Contents
Introduction...…………………………………………………………………………………………….......3
Concepts of recoverable value, value in use and the fair value………..........……………………………..
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Conclusion.....…………………………………………………………….....…………………………………6
Refrences.....……………………………………………………………….......................................7
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Introduction – Impairment
IAS 36 deals with the impairment of both the tangible and the intangible assets. As per the IAS,
an asset should not be arried in the books at more than the recoverable value., i.e., the higher of the
value in use or the fair value of the asset less cost of disposal of the asset. The company needs to check
for the potential impairment in the value of the asset if the conditions exist for the same. Goodwill and
other intangible assets with indefinite lives should be assessed annually for impairment. The need for
impairment arises because the assets needs to be reported only to the extent they actually exist in
reality. (Buchanan, et al., 2017) In case the single asset is not being able to generate revenue, then the
smallest possible group of asset or the class of asset which would be able to generate the revenue
independently would be analysed for impairment. Once the impairment is done, the same needs to be
extensively disclosed in the financials disclosures with the test and the loss recorded. Further
impairment loss already recognised in the previous period may be required to be reversed if the
estimated for determining the recoverable value change. The indicators which are used for the
assessment of impairment are classified into 2 categories, namely internal and external factors. IAS 36 is
applicable on the plant and machinery, land and building, furniture and fixture, intangible assets,
goodwill and investment in other companies or subsidiaries. However, IAS 36 does not applies to
deferred tax assets, assets which arise from employement benefits, inventories, assets out of
construction contracts, agricultural assets, financial assets, and non current assets being held for sale.
(kabir, et al., 2017)
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Concepts of recoverable value, value in use and the fair value
A company needs to check on periodically whether the indicators for impairment of assets exist or not.
In case the indicators do exists, then the recoverable amount needs to be calculated for comparison
with the carrying value. External indicators includes changing taste, fashion, preferences and
technology, increase in the market interest rates, net assets of the company being carried at more than
the market capitalization or decline in the market value. Internal factors which may be attributable to
the impairment can be asset is lying idle or there is greater obsolescence on the asset or the economic
benefit that can be derived from the asset is low or the carrying amount to be invested in the investee
or subsidiary company is lower than income earned by such company. The list is just an illustrative list
and is not exhaustive. (Das, 2017)
The recoverable value of the asset is higher of the value in use of the asset or the fair value of the asset
less cost of disposal. To calculate the impairment, asset’s recoverable amount needs to be compared
with the carrying value of the asset, differential being recognised as impairment loss. Depending on the
circumstances the recoverable value may have to be calculated for a single asset or a group or class of
assets called “cash generating unit”. (Goldmann, 2016)
Value in use may be defned as the present value of future cash flows expected to be generated out of
the asset or a CGU using a rate of interest. This maily includes 2 variables:
1. Cash Flow Projections: the expected cash flows that can be earned from the asset or the CGU
has to be estimated, the time lag or the timings of the cash flows. The projections should be
realistic and based on relevant supportings and reasonable assumptions by the management, it
should be based the figures in the latest financial statements or budgets or forecasts. (Fay &
Negangard, 2017) Also, there cash flows should be exclusive of any major capital expenditure or
overhaul cost that the company may be planning to invest in the near future. In case the time
range to be used is high, extrapolation should be used beyond 5 years as per the AS.
2. The 2nd most important input is the rate of discount. The rate used should be pre tax discount
rate as per the current market conditions and should account for risk on the asset, it should also
include the uncertainity element on cash flow from the asset and also the illiquidity factor. IT
should be the rate which the investors would be expecting when they make an investment in
the project or the rate at which the company would have borrowed the funds from the market
to buy that particular asset. (Mahapatra, et al., 2017)
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Besides all the above considerations, the company should compare the forecast with the previous
year’s estimations or forecast and in case they find there is an overstatement or understatement,
the same should be immediately adjusted in the cash flows. All in all, the cash flows should be the
weighted average of all the possible outcomes. (J, 2016)
Lastly the fair value of the asset is the amount that can be obtained by the sale of asset at the arm’s
length price to a knowledgeable and willing party, less the cost of dispoing the same. (Meroño-Cerdán,
et al., 2017) The fair value can be determined in accordance with IFRS 13 or the price which would have
been there in the binding sale agreement or the price the asset would have fetched if traded in the
active market or in the absence of both the above information, the amount which the entity could
extract based on the best information available. In case none of the above information is available, the
fair value can ve determined using the discounted cash flow technique. The cost of disposal should
include all the transaction cost and other direct cost attributable to its disposal.
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Conclusion
We saw how the recoverable value, the value in use and the fair value less cost of disposal
needs to be calculated and what all factors needs to be taken into consideration. However, in case the
fair value cannot be ascertained in the absence of information, the value in use becomes the
recoverable value and same needs to be compared with the carrying value of the asset. All the
important assumptions on the discount rate, methodology of estimating the cash flows, the amount of
impairment loss and the amount of depreciation to be adjusted in future needs to be disclosed in the
financials statements.
References
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Buchanan, B., Cao, C., Liljeblom, E. & Weihrich, S., 2017. Taxation and Dividend Policy: The Muting Effect
of Agency Issues and Shareholder Conflicts. Journal of Corporate Finance, Volume 42, pp. 179-197.
Das, P., 2017. Financing Pattern and Utilization of Fixed Assets - A Study. Asian Journal of Social Science
Studies, 2(2), pp. 10-17.
Fay, R. & Negangard, E., 2017. Manual journal entry testing : Data analytics and the risk of fraud. Journal
of Accounting Education, Volume 38, pp. 37-49.
Goldmann, K., 2016. Financial Liquidity and Profitability Management in Practice of Polish Business.
Financial Environment and Business Development, Volume 4, pp. 103-112.
J, G., 2016. Principles of Australian Contract Law. Australia: Lexis Nexis.
kabir, H., Rahman, A. & Su, L., 2017. The Association between Goodwill Impairment Loss and Goodwill
Impairment Test-Related Disclosures in Australia. 8th Conference on Financial Markets and Corporate
Governance (FMCG) 2017, pp. 1-32.
Mahapatra, S., Levental, S. & Narasimhan, R., 2017. Market price uncertainty, risk aversion and
procurement: Combining contracts and open market sourcing alternatives. International Journal of
Production Economics, pp. 34-51.
Meroño-Cerdán, A., Lopez-Nicolas, C. & Molina-Castillo, F., 2017. Risk aversion, innovation and
performance in family firms. Economics of Innovation and new technology, pp. 1-15.
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