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