Question

Cure Limited prepares its financial statements to 31 December each year. The company is involved in the pharmaceuticals industry and its operations are divided into two cash generating units, ‘EU’ and ‘Non EU’. Two issues need to be resolved before the financial statements for the year ended 31 December 2018 can be finalised.

Issue 1:

The following information is available in relation to the two cash generating units.

	EU	Non EU
	£’000	£’000
Goodwill	-	4,800
Other intangible assets	6,000	1,200
Property	9,600	25,600
Plant and equipment	13,200	5,600
Carrying value at 31 December 2018	28,800	37,200
Fair value less costs of disposal at 31 December 2018	30,000	16,800
Future net cash inflows:
2019	4,800	4,800
2020	3,600	5,200
2021	10,800	6,400
2022	6,000	6,000
2023	6,400	3,600
2024	7,200	7,200
Discount rate appropriate for the activities of the cash generating units	10%	12%

Requirement

Calculate whether an impairment loss arises for either of the two cash generating units, ‘EU’ and ‘Non EU’and Allocate any impairment loss arising in accordance with IAS 36 Impairment of Assets.

Issue 2:

On 1 January 2017, Cure Limited entered into a contract to have a new distribution depot built at a cost of £15,000,000. In order to finance the cost of the contract, Cure Limited borrowed £15,000,000 on 1 January 2017 at an interest rate of 6% per annum. The borrowings were drawn down in full on 1 January 2017.

While the depot was expected to be completed by 31 March 2018, it was delayed as a result of a strike by workers during the period 1 November 2017 to 28 February 2018. During the period of the strike, no building work was undertaken. Cure Limited invested available funds from 1 November 2017 to 28 February 2018, earning interest income of £24,000. The depot was completed on 31 May 2018 and the loan was repaid on 30 June 2018.

Requirement                                                                                                                           

Calculate and explain how this transaction should be accounted for by Cure Limited in accordance with extant international accounting standards.

Answer 1

1. IAS 36 defines impairment loss as an impairment loss is the amount by which the carrying amount of an asset or a cash-generating unit exceeds its recoverable amount. The recoverable amount of an asset or a cash-generating unit is the higher of its fair value less costs to sell and its value in use.

In the case of EU Segment. fair value less cost of disposal is higher than carrying amount and hence, no impairment loss is required to be recored.

For non-EU segment, value in use needs to be computed which is as follows:

Year	Cash flow	PV factor @ 12%	NPV
2019	4,800.00	0.89	4,285.71
2020	5,200.00	0.80	4,145.41
2021	6,400.00	0.71	4,555.39
2022	6,000.00	0.64	3,813.11
2023	3,600.00	0.57	2,042.74
2024	7,200.00	0.51	3,647.74
	Total		22,490.11

Recoverable amount of Non-EU segment is 22,490 considering value in use is higher than fair value less cost which is 16,800.

Impairment loss for Non-EU segment is :

Carrying amount		37,200
Recoverable amount		22,490
Impairment loss		14,710

2, IAS 23 defines a qualifying asset as an asset that necessarily takes a substantial period of time to get ready for its intended use or sale. Standard provides that an entity shall capitalise borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset as part of the cost of that asset. An entity shall recognise other borrowing costs as an expense in the period in which it incurs them. The borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset are those borrowing costs that would have been avoided if the expenditure on the qualifying asset had not been made.

An entity shall begin capitalising borrowing costs as part of the cost of a qualifying asset on the commencement date. The commencement date for capitalisation is the date when the entity first meets all of the following conditions: (a) it incurs expenditures for the asset; (b) it incurs borrowing costs; and (c) it undertakes activities that are necessary to prepare the asset for its intended use or sale. In determining the amount of borrowing costs eligible for capitalisation during a period, any investment income earned on such funds is deducted from the borrowing costs incurred.

Standard also provides that an entity shall suspend capitalisation of borrowing costs during extended periods in which it suspends active development of a qualifying asset.

An entity shall cease capitalising borrowing costs when substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete.

Working on capitalisation is as follows-

Capitalisation of cost working as follows-
Cost incurred	15,000,000
Interest cost from 1 Jan 2017 to 1 Nov 2017	752,055
Interest cost from 1 March 2018 to 31 May 2018	226,849
Total cost to be capitalised	15,978,904

In the given case construction was suspended between 1 Nov 2017 to 28 Feb 2018 for which interest cost shall not be capitalised. Further, construction ceased on 31 May 2018. Hence, any cost incurred after 31 May 2018 shall not be capitalised.