1

Revise lecture 15

2

Impairment of assets

Recognition and measurement of an impairment• Where there is an indication of impairment, an

impairment review should be carried out:1. The recoverable amount should be calculated2. The asset should be written down to

recoverable amount3. The impairment loss should be immediately

recognised in the income statement

3

Impairment of assets

• The only exception to this is if the impairment reverses a previous gain taken to the revaluation reserve.

• In this case, the impairment will be taken first to the revaluation reserve until the revaluation gain is reversed and then to the income statement.

4

Cash generating units (CGUs)

• What is a CGU?

When assessing the impairment of assets it will not always be possible to base the impairment review on individual assets.

5

Cash generating units (CGUs)

• The value in use calculation will be impossible on a single asset because the asset does not generate distinguishable cash flows.

• In this case, the impairment calculation should be based on a CGU.

6

Cash generating units (CGUs)

Definition of a CGU

A CGU is defined as the smallest identifiable group of assets which generates cash inflows independent of those of other assets

• Example: In a restaurant chain, the smallest group of assets

might be the assets within a single restaurant, but with a mining company, all the assets of the company might make up a single cash generating unit.

7

• Provisions, contingent liabilities and assets (IAS 37)

8

Provisions

The problem

• Until the issue of IAS 37 provisions, contingent liabilities and contingent assets, there was no accounting standard covering the general topic of provisions. This led to various problems.

9

Provisions

• Provisions were often recognised as a result of an intention to make expenditure, rather than an obligation to do so.

• Several items could be aggregated into one large provision that was reported as an exceptional item (the ‘big bath’).

• Inadequate disclosure meant that in some cases it was difficult to ascertain the significance of the provisions and any movement in the year.

10

Provisions

The historical problem of provisioning

• The making of provisions was an area of accounting abuse prior to the introduction of any relevant accounting standards.

• Users of financial statements found it very difficult to understand profit figures arrived at after the charging or releasing of provisions at management’s discretion.

11

Provisions

A common example was on the appointment of a new management team to a business.

• On appointment the new management would set up large provisions for re-organisations (depressing profits), saying they were needed as a result of the actions of the previous management. Such depressed profits could therefore be blamed on that previous management team.

12

Provisions

• One or more years later the new management would ‘discover’ that not all those provisions were necessary.

• So they would be written back (enhancing profits), probably without any disclosure.

• So the profits under new management would look impressive, when in reality they had been created by the release of provisions charged in an earlier period.

13

Objective of IAS 37

The objective of IAS 37 provisions, contingent liabilities and contingent assets is to ensure that:

• Appropriate recognition criteria and measurement bases are applied to provisions, contingent liabilities and contingent assets

• Sufficient information is disclosed in the notes to the financial statements to enable users to understand their nature, timing and amount

14

Provisions

What is a provision?

• A provision is a liability of uncertain timing or amount

• A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.

15

Recognition of a provision A provision should be recognised when:

1. An entity has a present obligation (legal or constructive) as a result of a past event

2. It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation

3. A reliable estimate can be made of the amount of the obligation• If any of these conditions is not met, no provision may be

recognised

16

Recognition

• An intention to make a payment is not enough on its own to justify a provision. There must be an actual obligation to make a payment.

• This is important in the accounting for repairs or refurbishments known to be required in future.

17

Recognition - Example

If a property lease include a requirement that the premises are repainted every 5 years and the future cost is estimated Rs100,000. The lessee would probably prefer to spread this cost over 5 years, by charging Rs20000 against profits each year.

In this way there will be a provision of RS100,000 in 5 years time and profits have been equally affected each year.

18

Recognition - Example

• IAS 37 does not permit this approach, because there is no obligation to incur this cost until the 5 years have elapsed.

• Over the first 4 years this is a future obligation which can be avoided by the simple means of selling the lease to someone else

• IAS 37 requires the full cost to be recognised in the 5th year, the lessee probably will not like the way profits are unaffected by this cost over 4 years but then suffer a major hit in the 5th.

19

Obligations

A provision may be necessary as a result of:

• A legal or

• A constructive obligation

20

Obligations

Legal obligations

A legal obligation is an obligation that derives from:

1. A contract2. Legislation3. Other operation of law

21

Obligations

Constructive obligation

A constructive obligation is an obligation that derives from an entity’s actions where:

• By an established pattern of past practice, published policies or a sufficiently specific current statement, the entity has indicated to other parties that it will accept certain responsibilities

22

Obligations

Constructive obligation

• As a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities

23

Example

Question: A retail store has a policy of refunding

purchases by dissatisfied customers, even though it is under no legal obligation to do so. Its policy of making refunds is generally known.

Should a provision be made at the year end?

24

Answer

• The policy is well known and creates a valid expectation.

• There is a constructive obligation.• It is probable some refunds will be made.• These can be measured using expected values.

Conclusion: A provision is required