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In: Accounting

QUESTION THREE The objective of IAS 36 Impairment of assets is to prescribe the procedures that...

QUESTION THREE
The objective of IAS 36 Impairment of assets is to prescribe the procedures that an entity applies to ensure that its assets are not impaired. Telepath acquired an item of plant at a cost of K800,000 on 1 January 2017 that is used to produce and package pharmaceutical pills. The plant had an estimated residual value of K50,000 and an estimated life of five years, neither of which has changed. Telepath uses straight-line depreciation. On 31 December 2019, Telepath was informed by a major customer (who buys products produced by the plant) that it would no longer be placing orders with Telepath. Even before this information was known, Telepath had been having difficulty finding work for this plant. It now estimates that net cash inflows earned from the plant for the next three years will be:
K
year ended: 31 December 2020 220,000
31 December 2021 180,000
31 December 2022 170,000
On 31 December 2022, the plant is still expected to be sold for its estimated realisable value. Telepath has confirmed that there is no market in which to sell the plant at 31 December 2019. Telepath’s cost of capital is 10% and the following values should be used:
K
value of K1 at: end of year 1 0.91
end of year 2 0.83
end of year 3 0.75
Required:
(a) Explain what is meant by assets that may form a cash generating unit and how an impairment review should be done for a cash generating unit. [5 Marks]
(b) Calculate and explain the carrying amounts of the assets above at 31 December 2019 after applying any impairment losses. Calculations should be to the nearest 1,000. [10 Marks]
[TOTAL: 15 Marks]

Solutions

Expert Solution

a) A cash generating unit is the smallest identifiable group of assets that generates cash inflows from continuing use that are largely independent of the cash inflows from other assets or group of assets.

The carrying amount of cash generating unit should not be reduced below the highest of the following :

a. Net Selling Price
b. Value in Use

To test for impairment, goodwill must be allocated to each of the acquirer's cash-generating units, or groups of cash-generating units, that are expected to benefit from the synergies of the combination, irrespective of whether other assets or liabilities of the acquiree are assigned to those units or groups of units.

A cash-generating unit to which goodwill has been allocated shall be tested for impairment at least annually by comparing the carrying amount of the unit, including the goodwill, with the recoverable amount of the unit:

  • If the recoverable amount of the unit exceeds the carrying amount of the unit, the unit and the goodwill allocated to that unit is not impaired
  • If the carrying amount of the unit exceeds the recoverable amount of the unit, the entity must recognise an impairment loss.

The impairment loss is allocated to reduce the carrying amount of the assets of the unit (group of units) in the following order:

  • first, reduce the carrying amount of any goodwill allocated to the cash-generating unit (group of units); and
  • then, reduce the carrying amounts of the other assets of the unit (group of units) pro rata on the basis.

b) Loss of a major customer will adversely affect the operating capacity of the asset and such incident would trigger impairment review.

Impairment Loss = Lower of carrying amount and recoverable amount

Carrying amount = value of the asset less accumulated depreciation

Recoverable amount = Higher of net selling price or value in use

Step 1: Computation of carrying amount as at 31/03/2019 :

Carrying amount = value of the asset less accumulated depreciation

Particulars Amount in $
Cost 800,000
Less : Accumulated depreciation for 2 years 300,000
Carrying amount at 31/3/2019 500,000

Period Depreciation = (800000-50000) / 5 years = 150000

Therefore, accumulated depreciation = $150000*2 = $300000

Step 2 : Calculation of value in use :

Year Net cashflows Cost of capital discounting factor Value in use(to the nearest 1000) in $
31/3/2020 220,000 0.91 200000
31/3/2021 180,000 0.83 149000
31/3/2022 170,000 0.75 128000
31/3/2022 50,000 0.75 38000
515000

Impairment loss = Lower of the following :

   a) Carrying amount = $500000

   b) Recoverable amount = value in use = $515000

Therefore, Impairment loss = $500000

Explanation as to the carrying amount of the plant :

At March 31st 2019, the lower of recoverable amount and carrying amount is $500000. Hence the new carrying amount will be $500,000 which is same as the carrying amount at the review date. In such situation the plant has not been impaired by the incident and should still be recognized at $500000.


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