Question

Matt Holmes recently joined Klax Company as a staff accountant in the controller’s office. Klax Company provides warehousing services for companies in several European cities.

The location in Koblenz, Germany, has not been performing well due to increased competition and the loss of several customers that have recently gone out of business. Matt’s department manager suspects that the plant and equipment may be impaired and wonders whether those assets should be written down. Given the company’s prior success, this issue has never arisen in the past, and Matt has been asked to con- duct some research on this issue.

Instructions

Access the IFRS authoritative literature at the IASB website (http://eifrs.iasb.org/) or any other websites (i.e., kasb.or.kr). When you have accessed the documents, you can use the search tool in your Internet browser to respond to the following questions. (Provide paragraph citations.)

(a) What is the authoritative guidance for asset impairments? Briefly discuss the scope of the standard (i.e., explain the types of transactions to which the standard applies).

(b) Give several examples of events that would cause an asset to be tested for impairment. Does it appear that Klax should perform an impairment test? Explain.

(c) What is the best evidence of fair value? Describe alternate methods of estimating fair value.

Answer 1

(a)        The authoritative guidance for asset impairments is IAS 36: Impairment of Assets. This Standard shall be applied in accounting for the impair­ment of all assets, other than:

a.         inventories;

b.         assets arising from construction contracts;

c.         deferred tax assets;

d.         assets arising from employee benefits;

e.         financial assets that are within the scope of IAS 39 Financial Instruments: Recognition and Measurement;

f.          investment property that is measured at fair value;

g.         biological assets related to agricultural activity that are measured at fair value less costs to sell;

h.         deferred acquisition costs, and intangible assets, arising from an insurer’s contractual rights under insurance contracts within the scope of IFRS 4 Insurance Contracts; and

i.          non-current assets (or disposal groups) classified as held for sale in accordance with IFRS 5 Non-current Assets Held for Sale and Discontinued Operations (para. 2).

This Standard applies to financial assets classified as:

a.         subsidiaries, as defined in IAS 27 Consolidated and Separate Financial Statements;

b.         associates, as defined in IAS 28 Investments in Associates; and

c.         joint ventures, as defined in IAS 31 Interests in Joint Ventures. For impairment of other financial assets, refer to IAS 39 (para. 4).

(b)        In assessing whether there is any indication that an asset may be impaired, an entity shall consider, as a minimum, the following indications. (para. 12):

External sources of information

a.         during the period, an asset’s market value has declined signifi­cantly more than would be expected as a result of the passage of time or normal use.

b.         significant changes with an adverse effect on the entity have taken place during the period, or will take place in the near future, in the technological, market, economic or legal environment in which the entity operates or in the market to which an asset is dedicated.

c.         market interest rates or other market rates of return on investments have increased during the period, and those increases are likely to affect the discount rate used in calculating an asset’s value in use and decrease the asset’s recoverable amount materially.

d.         the carrying amount of the net assets of the entity is more than its market capitalisation.

Internal sources of information

e.         evidence is available of obsolescence or physical damage of an asset.

f.          significant changes with an adverse effect on the entity have taken place during the period, or are expected to take place in the near future, in the extent to which, or manner in which, an asset is used or is expected to be used. These changes include the asset becoming idle, plans to discontinue or restructure the operation to which an asset belongs, plans to dispose of an asset before the previously expected date, and reassessing the useful life of an asset as finite rather than indefinite.

g.         evidence is available from internal reporting that indicates that the economic performance of an asset is, or will be, worse than expected.

Dividend from a subsidiary, jointly controlled entity or associate

h.         for an investment in a subsidiary, jointly controlled entity or associate, the investor recognizes a dividend from the investment and evidence is available that:

(i)         the carrying amount of the investment in the separate financial statements exceeds the carrying amounts in the consolidated financial statements of the investee’s net assets, including associated goodwill; or

(ii)        the dividend exceeds the total comprehensive income of the subsidiary, jointly controlled entity or associate in the period the dividend is declared.

The list in paragraph 12 is not exhaustive. An entity may identify other indications that an asset may be impaired and these would also require the entity to determine the asset’s recoverable amount or, in the case of goodwill, perform an impairment test in accordance with paragraphs 80–99 (para. 13).

Evidence from internal reporting that indicates that an asset may be impaired includes the existence of:

a.         cash flows for acquiring the asset, or subsequent cash needs for operating or maintaining it, that are significantly higher than those originally budgeted;

b.         actual net cash flows or operating profit or loss flowing from the asset that are significantly worse than those budgeted;

c.         a significant decline in budgeted net cash flows or operating profit, or a significant increase in budgeted loss, flowing from the asset; or

d.         operating losses or net cash outflows for the asset, when current period amounts are aggregated with budgeted amounts for the future. (para. 14)

Yes, it does appear that Klax should perform an impairment test because market value of assets are most likely lower than current carrying value.

(c)        Different situations may lead to best evidence of fair value (i.e. could be market value, revalued asset, etc.).

a.         if the asset’s fair value is its market value, the only difference between the asset’s fair value and its fair value less costs to sell is the direct incremental costs to dispose of the asset:

(i)         if the disposal costs are negligible, the recoverable amount of the revalued asset is necessarily close to, or greater than, its revalued amount (i.e., fair value). In this case, after the revaluation requirements have been applied, it is unlikely that the revalued asset is impaired and recoverable amount need not be estimated.

(ii)        if the disposal costs are not negligible, the fair value less costs to sell of the revalued asset is necessarily less than its fair value. Therefore, the revalued asset will be impaired if its value in use is less than its revalued amount (i.e., fair value). In this case, after the revaluation requirements have been applied, an entity applies this Standard to determine whether the asset may be impaired.

b.         if the asset’s fair value is determined on a basis other than its market value, its revalued amount (i.e., fair value) may be greater or lower than its recoverable amount. Hence, after the revaluation requirements have been applied, an entity applies this Standard to determine whether the asset may be impaired (para. 5)