International Standards of Accounting (ISA) and International Financial Reporting Standards (IFRS) have documented internationally acceptable accounting standards that explain how certain accounting transactions should be treated in financial statements. In Australia, the Australian Accounting Standards Board (AASB) has the mandate of overseeing the implementation of the standards and making such changes necessary from time to time. Accounting Standard AASB 136, Impairment of Assets, was introduced on 15 Jul 2004 to offer guidelines on how organizations should be accounted for tangible non-current assets and intangible assets with finite useful lives; there have been amendments with the most recent on 1st January 2010 in the section (CCH, 2010).
AASB 136 requires that organizations should test their assets for impairment and make such adjustments in their books in accordance with the accounting standards. The provision clearly states that the amount should be carried out, as the values of tangible non-current assets and intangible assets with finite useful lives should not exceed what actually can be recovered, there is a challenge determining the right amount to be carried out in the books, the challenge is brought by the judgments that the accounting organization should make, and estimate assumptions associated with the practice. AASB 136 suggests that at each end of an accounting period, organizations should consider if there are any signs/indicators sufficient enough to support the need for impairment, in the event that the indicators are sufficient enough, then the company should go ahead and test the impairment by comparing the recoverable amount and the carrying amount in the books.
When an asset has been tested for an impairment successfully, the amount tested is recognized as an impairment loss and written down against its recoverable amount in the statement of comprehensive income; although the above accounting procedure cuts across the board, there are some slight changes in revalued assets. Revalued assets change the value of the asset is recognized directly in equity to the extent of the revaluation asset. Other treatments are as follows:
- write-downs of indefinite life intangible assets (including goodwill)
According to Accounting Standard AASB 136, the organizations that have goodwill and indefinite-lived intangible assets are compulsorily required to undertake an impairment test on those asset subjects to set out criteria. The standard provides that impairment can be conducted at any time during the accounting period, however, there should be consistency in the previous time of impairment in the same time for subsequent years. The above condition states that if a company has decided to do tests for impairment on 30th June of every year, then the same should apply across the board in subsequent years. Other than the mandatory annual impairment, Accounting Standard AASB 136 provides that impairment might happen on goodwill and other indefinite live intangible assets in the event that there are sufficient indicators to show that there is a need for a test.
Goodwill does not lead to the generation of income in an organization, however, its existence acts as a boost to other assets or groups of assets; the intangible asset contributes to the cash generation of multiple cash-generating units. The nature of goodwill limits it from being amortized but qualifies the asset for an impairment test annually, or there are some changes in the event that calls for a test for amortization. The amount that is charged in the comprehensive income statement after impairment is the amount that exceeds the recoverable amount after impairment. When calculating the impairment, the qualifying assets are arranged on the lowest level at which they can be separated and taking this level is related to the cash-generating units; in the event that the right approach has been made, the loss on impairment is accounted for the compressive income statement.
In a nutshell, Accounting Standard AASB 136 suggests that when accounting for write-downs of indefinite life intangible assets (including goodwill), the accounting company should evaluate the degree to which the assets can be recovered, then use its own judgments, assumptions, and estimations based on certain criteria on order to measure the impairment loss that provides the difference between the evaluated recoverable amount and the carrying values. Some of the assets that are affected by Accounting Standard AASB 136 include deferred charges, brand names, broadcasting licenses, goodwills and other intangible assets of this type. Changes in events can result in changes in the estimates made, and every time there is a loss that should be charged in the operations during the period that it is related to.
- Impairment testing
When testing the asset for impairment, the initial step is to measure the recoverable amount of the asset; according to international accounting standards, the recoverable amount that should be used for impairment that is higher than its fair value and less than the cost to sell (FVLCTS) and value in use (VIU). FVLCT is further defined as the present value of future cash flows expected from the asset; the above definition holds in recognition that assets generally do not generate incomes alone, but does so in the combination of other assets. The collaboration of groups of assets in deriving income brings out the issue of determining the proportion that can be attributed to one particular asset; the issue is solved by assuming that FVCTS is greater than its carrying amount, which calls for testing for impairment.
- including the identification of cash-generating units
According to ASSB 136 a cash generating unit (CGU) is “the smallest identifiable group of assets that generate cash inflows which are largely independent of the cash inflows from other assets or groups of assets” (Australian Accounting Standards Board, 2010). To identify the independent of A CGU, there are different factors should be taken into account. They include the product line, the operational area/district, how the policy of the transition regarding any continuing with or disposing the entity of assets, the organizational operations, and the business involved. The notion and the explanation offered by AASB is clear but problems always arise when trying to determine the lowest level of independent cash flow. In most instances, there is an issue determining the amount to attribute to a particular asset. The best method that managers are expected to use is their judgment considering the lowest aggregation of assets that generate largely independent cash flows (IAS 36.66). For an asset to quality to be an CGU, it must generate cash flow from its continued use, and depend on the input from other assets to generate the income.
“The allocation of goodwill to cash generating units and the use of unrealistic assumptions to calculate recoverable amounts (including discount rates and expected growth rates)” Australian Accounting Standards Board., 2010.
AASB 136 (paragraph 55) requires that projects made when impairing for VIU be discounted using a pre-tax that is a reflection of the time value for money. The rate should also be there to cater for any other foreseeable or unforeseeable financial risk that organization may faced. In the event that the risks had been accounted for elsewhere, the accounting firm should be keen on avoiding inclusion of the amount in their calculations to avoid any chances of double counting.
According to AASB 136(134), goodwill will be allocated to every cash generating unit (CGU) according to operating segment that the CGU relates to: on the other hand the CGU’s recoverable amount is calculated in five year terms management budgets that have projections of future cash flows and their respective growth rates. According to AASB 136(130)(e); (134)(c),(d)(iii),(iv), in the event that there are some management budgets exceeding five years, the cash flows are extrapolated using estimated growth rate which should not exceed the long-term average growth rate for the business.
- disclosures concerning impairment testing
Goodwill allocated to the CGU has been satisfactorily determined according to the provisions of AASB 136.E each segment will have its own goodwill allocating depending on the segment head and the assets therein.
The main assumptions is made when making impairments that similar organizations in different parts of the world have same business plan with the assuming business. An indication of need for impairment can be justified through this assumption only. The management budgets are expected to be true and attainable; in the case of change of any of the assumption, there will be similar changes in the computations (Dagwell, Graeme and Lambert, 2010).
The current accounting practice of CCA Ltd
The current accounting practice of CCA Ltd had the write downs of total indefinite life intangible assets and goodwill as less than one percent for a period of twelve months that ends on December 31st 2010; the disclosure is an assumption that the date of compulsory evaluation is on December 31st 2010. When the one percent had been compared with for twelve months period ending 30th June 2010, it was noted that the amount of impairment was greater that 6%; the basis that was used to determine the recoverable amount was not justified and there were high chances that the amount was based on unrealistic assumptions.
“Potential gap between the CCA’s current practice and the accounting standards requirements” Australian Accounting Standards Board., 2010
The main potential gap, which can be identified in the case, is how the realizable amount has been determined, it is also important to note that the company has opted to use cash flow methodology covering a 15 year period. Thus they are restricting their discounted rate to the growth rate of the company. The determined realizable amount can be a point of manipulation that can result in high or low profits that will affect the reported profits by the company.
When assessing the useful life of the intangible assets, the company considered the use of existing longevity of SPCA brands, such information or approach can hardly be supported by documentation to prove that the amounts used for the amortization are the right amounts (PwC, 2010).
Recommended actions to satisfy the potential ASIC reviewers
To ensure that CCA’s satisfy’s ASIC, the management should ensure that they align their accounting for intangible assets according to AASB 136; when complying with the section of accounting act, the management should be willing to make adjustments and give such disclosures that might be required by AASB 136.
Instead of basing the discounting rate on period of fifteen years, the company should use five years rolling budgets as it has been suggested; AASB require CGU’s recoverable amount to be calculated on five year terms management budgets that have projections of future cash flows and their respective growth rates. When determining the CGU, the management should consider product line, the operational area/district, how the transaction policies regarding any continuing with or disposing of the entity assets dictates, the organizational operations and the business involved. The period of impairment seems to be inconsistence and there is no support that there have been an indication of the need for impairments. In the future, the management should make consistent valuations as to comply with AASB 136 mandatory requirements. When making disclosures, the management should provide an account of how it identified issues with impairment testing and how they reached at particular cash generating units (Mills and Alan,2000).
If management feels like not being competent enough to handle impairment issues, it is advisable to have consultants who will be mandated with the task of setting appropriate frameworks for goodwill and indefinite life intangible assets disclosures. The consultants should also train management accountants how to handle the issue.
Australian Accounting Standards Board., 2010. AASB 136 Impairment of Assets. : Melbourne: Commonwealth of Australia.
CCH., 2010. Australian master accountants guide 2008/09. Melbourne: CCH Australia Limited.
Dagwell, R., Graeme W. and Lambert, C., 2010. Corporate Accounting in Australia. Melbourne: UNSW Press.
Mills, W. and Alan, D.,2000. Foundations of Accounting. New York: UNSW Press.
PwC., 2010. Understanding the accounting for impairment of assets. Web.