The Measurement Of The Amount Of Impairment Of Many Types Of Assets Accounting Essay

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The aim of this essay is to discuss , the measurement of the amount of impairment of many types of assets in companies reporting. This essay is structured as follows. In the first section, this essay will attempt to study methodology of an impairment in accordance with IAS 36. An asset is described as impaired and IAS 36 requires it to be recorded as an impairment loss when the asset's carrying amount exceeds its recoverable amount.

In the second part, this essay will attempt to bring to light on the problems and limitations of the impairment testing particularly it will show some subjective points of the IAS36 and how they can be manipulated . Finally, the last section will summarize the main topics discussed in the main body.

The main thing in any information - its significance.

Piles of numbers, if they do not lead to solutions -

pointless expenditure of energy and resources.

(Y. V. Sokolov)

Main Body

IAS 36 defines the procedures that the company uses to account for its assets at a value not exceeding their recoverable amount. Asset is carried at a value in excess of its recoverable account if its carrying amount exceeds the quantity that will be recovered through use or sale of this asset. In this case the asset is considered impaired and the amount of the impairment requires recognition of the loss.

Standard applies to the integration of the following assets:

land, buildings, machinery and equipment;

investment property, which is estimated to cost;

intangible assets;


investments in subsidiaries, associates and jointly controlled companies

valued at historical cost;

Assets that are recorded at revalued amounts under (IAS 16) and (IAS 38).

Standard does not apply to the account of the following assets:

reserves (IAS 2 );

assets arising from construction contracts (IAS 11);

deferred tax assets (IAS 12);

assets arising from employee benefits (IAS 19);

financial assets (IAS 39);

investment property, which is measured at fair value (IAS 40);

assets related to agricultural activity measured at fair

value (IAS 41);

Assets that arose out of insurance contracts (IAS 4);

assets held for sale (IAS 5).

Identifying an asset that may be impaired

At each balance sheet date, all assets are tested for impairment (book value

asset may be higher than the selling price or value of the asset). (IAS) 36

contains a list of external and internal signs of impairment. If there are

impairment is necessary to determine the recoverable amount of an asset.

In respect of the following types of intangible assets recoverable amount is determined annually, regardless of impairment:

intangible assets with indefinite useful lives;

intangible assets that are not available for use;

Goodwill arising on acquisition of companies.

In measuring whether there is any sign that an assets may be impaired an entity should consider , as a minimum, the following indications:

External evidence of impairment

decline in market value;

adverse changes in the technological, market, economic and legal conditions;

increase in market interest rates;

price shares below net asset value of the company.

The internal evidence of impairment

moral or physical obsolescence;

asset involved in the restructuring process, whether subject to retirement;

economic indicators for the reporting period, worse than expected

This list is not exhaustive. Further signs of impairment may indicate that it should revise the useful life of the asset method of depreciation or resale value.

Assessing the recoverable amount

IAS 36 defines recoverable amount as the highest value of the "fair value less cost to sell sales "and "operational value" of an asset or cash-generating unit.

If the asset's fair value less costs to sell or the value of its use exceeds the carrying value of the asset, the recoverable amount asset is not calculated. Asset is not impaired. However if the asset's fair value less costs to sell can not be defined, then the asset's recoverable amount is the value of its use. For assets subject to disposal, the recoverable amount is the fair value less costs to sell.

The fair value less costs to sell

If there is agreement on the sale of an asset, company should use the price specified in the agreement less costs of disposal. Current and overhead costs are not included in the cost of disposal of an asset. If there is an active market for the asset, company should use a market value of the asset less disposal costs. Under the market price understand the current bid price, if available, otherwise company must apply the most recent transaction price. If an active market for the asset is missing, organization should use the most optimal price of an asset (best estimate), less costs of disposal.

Value in Use

The calculation of the value of the asset shall include the following elements:

assessment of future cash flows, which the organization expects to receive from asset;

expectations regarding possible changes in the amount and timing of these cash flows;

time value of money provided by the current market risk-free rate per cent;

allowance for the uncertainty inherent in the asset;

Other factors such as illiquidity, reflected market participants

establishing the value of future cash flows, which the organization

expects to receive from the asset.

Cash flow planning should be based on reasonable and justified assumptions, the latest budgets and forecasts, and extrapolated for periods that do not refer to the period of the budget. IAS36 admits that the budgets and forecasts not compiled for a period exceeding 5 years. To calculate cash flows for the period more than 5 years, projections and estimates are extrapolated from earlier budgets and forecasts. Guide must evaluate the reasonableness of these assumptions, checking reasons for the differences between past projected cash flows and actual cash flows.

Discount rate

Main points of discount rate are that it should be pre-tax rate that replicates existing market estimations of the time value of money and risk specific to the asset. It should not mirror risk to which prospect cash flows estimates have been adjusted.

Recognition of an impairment loss.

An impairment loss should be recognized only if the recoverable asset value is less than its book value. Loss on impairment of assets is recorded as an expense in the profit and loss account (if the asset is carried at a revaluated amount, which reflects changes directly in equity). Recognition of an impairment loss is an adjustment of future depreciation deductions.


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The recoverable amount should be determined for each individual asset, if possible. If it is impossible to determine the recoverable amount for each individual asset, then

determine the recoverable amount of the cash-generating unit. Cash Generating Unit - is the smallest identifiable group of assets that cause cash flow and it is largely independent from the cash inflows from other assets or groups of assets. CGU should first considered intangible assets such as goodwill, than tangible assets such as corporate assets.

Goodwill is positive difference of cost of acquisition and fair value of net tangible assets. According to IFRS 3 it must use accusation method in every combination. Cash Generating unit to which goodwill has been allocated shall be tested for impairment at least once a year by comparing the carrying value of cash-generating unit including goodwill with its recoverable amount: If the recoverable amount of cash-generating unit exceeds the book value, then generating unit and the goodwill related to this one, do not depreciate. However if the carrying value of cash-generating unit exceeds its recoverable amount, the company should recognize an impairment loss.

Subjectivity of the measurement of the amount of impairment of many types of assets. Listen

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Concerning the subjectivity of the process and the variables used in the valuation process, no reliable measures can be derived from the test (Schultze, 2005: 279).

Important subjectivity of the Impairment testing is that different approaches are used to determine fair value of an asset such as available market price, price of similar assets, present value techniques and other valuation methods. Therefore users of financial information should think that market values are not always clear. As the result fair value estimations are founded on subjective decision.

As it was discussed above, the test for impairment of long-term assets is based on

IAS 36. At the first stage of impairment testing, the largest of the estimates is determined for each object of long-term assets 1) Value in use, defined as the present value of future cash flows generated by the asset for its intended use, or 2) net sales price, defined as the difference between the possible sale price and the estimated costs to sell. Obviously, the goodwill does not generate independent from other assets cash flow, so the value of its use can't be determined. Also, goodwill cannot be sold because of its inseparable from the group. Therefore, goodwill's impairment testing is in the area of subjective decisions and assessments.

Goodwill's impairment test requires complete accepting of methodology for valuing assets and liabilities. A quoted market price, that is available only in the active market, should be used for the measurement as the best proof of fair value. Bens (2006) declares that fair values are not readily accessible for many of the reporting units to which goodwill was assigned; managers use a confident amount of discretion when applying the impairment test. Applying the model of fair value for assets and liabilities, which are not actively traded, make accounting reports more subjective. If quoted market prices are not available, estimations of fair value should be supported by the best available information, taking into account prices for similar assets and liabilities and using suitable valuation techniques, such as the present value, matrix pricing, option adjusted spread model, option-pricing models and fundamental analysis (Lander and Reinstein, 2003: 228). Managers using IAS36 accounting impairment test make a momentous amount of subjective decisions when they prepare accounting information to shareholders. The lack of market-based assessments is likely to increase uncertainty and this reduces the efficiency of information (Dunse et al., 2004: 241) Also the estimation of fair value involves the organization to making a number of suppositions and estimations, such as future earnings, future revenues and probability of outcomes this situation may lead to possible earnings manipulations. (Sevin and Schroeder 2005: 48)

The measurement of the amount of impairment of many types of assets abounds in subjective decisions. The way on estimating fair values for assets and liabilities additionally improve the possibility of creative accounting. In spite of the fact that some researchers argue that the main result of application of the IAS36 is to provide users of financial statements with better information, the stated problems concerning Impairment testing should be taken into consideration. One of major reason why the new standard was applied was to improve the information content concerning the goodwill write-offs. At this point it is worth to think does IAS36 really provide with better information about goodwill or is a new opportunity of creative accounting.


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IAS 36 Impairment of Assets "is applied to a large number of assets recognized in the balance sheet. The main objective of this standard is to provide a realistic assessment of the assets in the financial statements through recognition of impairment losses. This standard was made to make financial reports of organizations more transparent for shareholders. However the measurement of the amount of impairment of many types of assets has a lot of subjectivity. The assignment totally supportive with Sevin and Schroeder that those limitations of the IAS36 are not able to prevent possible earnings manipulation by the manager. Uncertainty of this standard can reduce the efficiency of the financial reports. New IAS 36 is not perfect and there are many opportunities for creative accounting. Thus, in the development of IAS it seems to be appropriate to change not only the International Financial Reporting Standards, but also the very principles of preparation of financial statements.