In: Accounting
Briefly write about the procedure for impairment of intangible assets with suitable examples.
Impairment occurs when an intangible asset is deemed less valuable than is stated on the balance sheet after amortization
Intangible assets which have a finite useful life such as copy rights, patents, etc. are tested for impairment when there is indication that they might be impaired
Indicators of impairment include legal restrictions, business restructuring, development of new technology, economic changes, etc
Under US GAAP, impairment test for intangible assets with finite useful life is the same as that for a tangible fixed asset: (a) comparing the carrying value with the sum of undiscounted cash flows and (b) where the carrying value exceeds the sum of undiscounted cash flows, recognizing any excess of carrying value over the fair value of the asset as the impairment loss. Under IFRS, comparison is made between the carrying amount of the asset and the higher of fair value (less cost to sell) and value in use and any excess is recognized as impairment
Selai Telecom is mobile telecom operator that purchase a 4G license for $200 million in 2014 which is valid for a 10-year period for a small annual fee. The company expected that the license will generate revenues of $50 million per year for the next 8 years. However, after the first year of operations, the market reception of the new technology is not very encouraging, and the company is forced to revise its estimate of annual cash flows down to $30 million per annum.
During the first year, the license amortization expense would be $25 million ($200 million divided by 8). The license’s carrying value at the end of first year works out to $175 million. The sum of undiscounted cash flows which the license will bring in future is $150 million ($30 million multiplied by 5). Because the carrying value is higher than the sum of sum of undiscounted cash flows, the license is impaired. The second step of the test requires the company to work out the license’s fair value. Since the license is not transferrable, the fair value must be estimated based on the present value of future cash flows. If the appropriate discount rate is 10%, the fair value of the license works out to $113.72 million. The impairment loss in this case equals $61.28 million i.e. the amount by which the carrying value, which is $175 million, exceeds the fair value, i.e. $113.72 million
The impairment loss would be recognized using the following journal entry:
Impairment loss |
$61.28 million |
|
Accumulated impairment loss |
$61.28 million |