Question

A parent company has deemed its wholly owned subsidiary a cash-generating unit. The parent has determined that an impairment loss has occurred as the recoverable amount of the subsidiary is less than its carrying value.

1. Explain how the recoverable amount is determined.
   
2. Explain how this impairment loss should be allocated.

Answer 1

(a)

A Cash-generating Unit (CGU) is the smallest group of assets that is identified and generates independent cash inflows from other assets or groups of assets.

The recoverable amount is determined as the higher of –

· Fair value less costs to sales, or

· Value in use.

Value in use:

The future cash flows which are expected to derive from the asset or CGU, the present value of such cash flows is called the value-in-use.

There are two ways to calculate the value in use:-

1. Cash Flow Projections: - An estimation is made to identify the future cash flows taking in view the variations in the amount over the time.

2. Discount Rate: - The projections of the cash flows are made by taking into account the time value of money, i.e. a pre-tax discount rate.

Fair Value less costs to less:

This is the amount that is earned from the sale of the asset in a normal business transaction, less the costs incurred in disposal of that asset.

(b) In the given case, the carrying amount of the subsidiary is greater than the recoverable amount, impairment loss should be recognized.

The impairment loss should be allocated in the following manner: -

· If the goodwill is allocated to the CGU, or the group of CGUs, then it is firstly allocated to the goodwill, to the extent of the carrying amount of the goodwill.

· Then, the remaining amount of the impairment loss (if any), is allocated proportionately to the other assets of the CGU, based on their carrying amount.

The carrying amount of an asset in the CGU is not reduced below, the higher of:-

· the recoverable amount of the individual assets, or

· Zero.

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