Chapter 11 – Impairment of assets

REVIEW QUESTIONS

2. Why is an impairment test considered necessary?

An entity’s balance sheet may overstate the assets, either because the assets’ fair values are
lower than the carrying amounts, or because the accountant’s estimates are wrong eg the
calculation of depreciation requires estimates of residual value, useful life, pattern of benefits.

3. When should an entity conduct an impairment test?

At each reporting date, an entity must assess whether there is any indication of impairment. If
such an indication exists, the entity shall estimate the recoverable amount of the asset [AASB
136 para 9]

6. What is meant by recoverable amount?

Recoverable amount is the higher of an asset’s value in use and fair value less costs of disposal.

7. How is an impairment loss calculated in relation to a single asset accounted for?

AASB 136 para 60

Under cost model:
- Recognise loss immediately in profit or loss
- Write down asset – if depreciable, increase accumulated depreciation and impairment
losses account
Under revaluation model: as for a revaluation decrease under that model, the effect being
dependent on whether there have been past revaluation increments.

8. What are the limits to which an asset can be written down in relation to impairment
losses?

An asset must be reduced to its recoverable amount.

9. What is a cash generating unit?

The smallest identifiable group of assets that generates cash inflows largely independent of the
cash flows from other assets or groups of assets.
10. How are impairment losses accounted for in relation to cash generating units?

AASB 136 para 104:

- Reduce the carrying amount of any goodwill allocated to the CGU
- Allocate any balance of loss to the other assets of the CGU pro rata on the basis of their
carrying amounts
11. Are there limits in adjusting assets within a cash generating unit when impairment losses
occur?

AASB 136 para 105:

- An entity shall not reduce the carrying amount of the asset in a CGU below the highest
of:
- Its fair value less costs of disposal;
- Its value in use; and
- Zero.

12. How is goodwill tested for impairment?

AASB 136 para 80:

- Allocate the goodwill to each of the acquirer’s CGUs if possible
- If it cannot be allocated, treat as a corporate asset
- Test goodwill annually, but note para 99 may allow use of a preceding period’s
information.

CASE STUDY QUESTIONS

Case Study 1 Cash – generating units

1. Define a CGU

A cash-generating unit is the smallest identifiable group of assets that generates cash flows that are
largely independent of the cash inflows from other assets or groups of assets.

2. Explain why impairment testing requires the use of CGUs

The impairment test requires a comparison of the recoverable amount of an asset with the higher of
the asset’s value in use and fair value less costs of disposal.
Value in use requires:
- an estimate of the future cash flows the entity expects to derive from the asset
- expectations about variety in timing of cash flows
- the price for bearing the uncertainty inherent in the asset
These cash flows are based upon data such as financial budgets and forecasts.

For some assets, there are no cash flows that are generated independently from those of other assets
e.g. the milking machines or the machines used to separate cream from milk etc do not generate
independent cash flows. The eventual cash flows come from the sale of the milk products. These
machines could be sold separately, giving a fair value less costs of disposal. However, as management
have decided to use the machines rather than sell them, management have made the decision that the
value in use is greater than the value via sale.

3. Explain the factors that the accountant should consider in determining the CGUs for Fresh
Milk Ltd

Cash flows must be independent of other cash flows

A CGU must be the lowest aggregation of assets independently generating cash flows.
Factors include (see paras 69-71 of AASB 136):
- how management monitors the entity’s operations: such as product lines, businesses,
individual locations, districts or regional areas. How does management break down Fresh
Milk Ltd – by factory? By dairy district? By product?
 - how management makes decisions about continuing or disposing of the entity’s assets and
operations. If management wanted to sell off part of the business but still keep a viable
business remaining, how could the business be broken down into parts that could be sold off?
- the existence of an active market for the output produced even if some or all of the output is
used internally. In this case, the milk produced is not sold to the public or other entities but is
used to make further milk products. However, as there is an active market for milk, the milk
production section is potentially a separate CGU. This is because the assets in that section
could generate cash flows independently of the rest of the entity. Internal transfer prices
should not be used to determine recoverable amount unless these reflect the best estimate of
prices that could be achieved in arm’s length transactions.

PRACTICE QUESTIONS

QUESTION 11.1
TAMBO LTD

If recoverable amount is $510 000, then there is an impairment loss of $30 000.
Assuming the inventory is carried at the lower of costs and net realisable value, the allocation of the
impairment loss is as follows:

Carrying Proportion Allocation Net Carrying

Amount of Loss Amount

Factory $210 000 21/48 13 125 196 875

Land 150 000 15/48 9 375 140 625
Equipment 120 000 12/48 7 500 112 500
$480 000 30 000

(a) If the fair value less costs of disposal of the land is $140 000, then the journal entry to record
the impairment loss is:

Impairment loss Dr 30 000

Accumulated depreciation and
impairment losses –factory Cr 13 125
Land Cr 9 375
Accumulated depreciation and
impairment losses –equipment Cr 7 500
(Allocation of impairment loss)

(b) If the fair value less costs of disposal of the land is $145 000, then the land cannot be written
down to an amount below that figure. Hence the maximum impairment loss allocable to land is
$5 000. The extra $4 375 must be allocated to the other assets.

Carrying Proportion Allocation Net Carrying

Amount of Loss Amount

Factory $196 875 196 875/309 375 2 784 194 091

Equipment 112 500 112 500/309 375 1 591 110 909
$309 375 4 375
The journal entry to record the impairment loss is:

Impairment loss Dr 30 000

Accumulated depreciation and
impairment losses –factory Cr 15 909
Land Cr 5 000
Accumulated depreciation and
impairment losses –equipment Cr 9 091
(Allocation of impairment loss)

QUESTION 11.2
NARRABRI LTD

The carrying amount of the assets of the Toy Train Division is $500 000. If the recoverable amount is
$423 000, then there is an impairment loss of $77 000.

The impairment loss is firstly used to write off the goodwill - $50 000. The balance of the loss - $27
000 – is allocated across the other assets, except for inventory assuming it is recorded at the lower of
cost and net realisable value:

Carrying Proportion Allocation Net Carrying

Amount of Loss Amount

Factory 250 000 5/6 22 500 227 500

Brand 50 000 1/6 4 500 45 500
300 000 27 000

The journal entry to record the impairment loss is:

Impairment loss Dr 77 000

Goodwill Cr 50 000
Accumulated depreciation and
impairment losses –factory Cr 22 500
Accumulated amortisation and
impairment losses –brand Cr 4 500
(Allocation of impairment loss)

QUESTION 11.7
MILES LTD

Jericho Jackson
Plant $850 825
Patent 240 0
Inventory 54 75
Receivables 75 82
Goodwill 25 20
1 244 1 002
Recoverable amount 1 044 990
Impairment loss (200) (12)
In relation to Jackson, write goodwill down by $12:

Impairment loss Dr 12
Accumulated impairment losses
- goodwill Cr 12

In relation to Jericho, reduce goodwill by $25 and allocate the remaining $175 impairment loss to
applicable assets:

Carrying Proportion Allocation Net Carrying

Amount of Excess Amount
Plant 850 85/109 136 714
Patent 240 24/109 39 201
1 090 175

As the patent has a fair value less costs of disposal of $220, only $20 of the impairment loss can be
allocated to it, so the plant must be reduced by a further $19, to $695.

The journal entry to record the impairment loss at 31 December 2013 is:

Impairment loss Dr 200

Goodwill Cr 25
Accumulated depreciation and
impairment losses – plant Cr 155
Accumulated impairment losses – patent Cr 20
(Allocation of impairment loss)

At 31 December 2014, the plant and patent are recorded as follows:

Plant $1 500
Accumulated depreciation and
impairment losses 1 155 [650 +155 +350]
345

Patent $240
Accumulated impairment losses 20
220

At 31 December 2014:

In relation to Jackson, there can be no reversal of the prior goodwill impairment.

In relation to Jericho, the plant would have had the following carrying amount if the impairment loss
had not occurred:

Plant $1 500
Accumulated depreciation and
impairment losses 950 [650 + 300]
550
Hence, the maximum reversal of impairment in relation to plant is $205 (ie $550 - $345). The
maximum reversal for the patent is $20.

As the recoverable amount for the unit’s assets exceed the carrying amount by $180, the whole of this
amount can be allocated on a pro rata basis as a reversal of impairment losses:

Carrying Proportion Allocation Net Carrying

Amount of Excess Amount

Plant 345 345/565 110 235

Patent 220 220/565 70 150
565 180

As the patent can only be reversed to the extent of $20, then $160 can be allocated to plant, this being
less than the maximum of $205.

The entry for the reversal of the impairment loss is:

Accumulated depreciation and

impairment losses – plant Dr 160
Accumulated impairment losses – patent Dr 20
Income: reversal of impairment loss Cr 180
(Reversal of impairment loss)