On December 2, 2009, I was a speaker at an IFRS conference in Toronto, Canada, organized by Acumen Information Services. There were 3 areas that I discussed, all of which seem to be attracting a lot of discussion on IFRS forums, on my web-site blogs, and when I’m talking to people;
• IAS 16 – Property, Plant & Equipment – Revaluation Model and Cost Model.
• IAS 36 – Impairment of Long-Lived Assets, which is tied to Property, Plant and Equipment.
• IAS 40 – Investment Property
The first two topics are relevant to almost every company. Investment Property may not apply to every company, but it does there is a fair value choice associated with it that is important to understand.
In this blog, I am summarizing the discussion on IAS 36 – Impairment of Long-Lived Assets.
IAS 36 – Impairment of Long-Lived Assets
Identification and measurement of impairments under IAS 36 is significantly different than Canadian GAAP 3063 – Impairment of Long Lived Assets.
First of all, let’s take a quick refresher on the requirements under Canadian GAAP, which has a 2 step approach to identifying impairments. The first step is assessing the “recoverable” amounts using undiscounted cash flows.
So for example, you have a Building, and need to determine if the carrying amount is impaired.
Under Canadian GAAP you look at the amount on the Balance Sheet, and compare that to the undiscounted cash flows that are expected to be received from the building. If you expect the building to have a life of 50 years and the estimated cash flow totals over the 50 years exceeds the Balance Sheet carrying value, then there is no impairment, and your work is done.
However, if the undiscounted cash flows are less than the carrying value of the asset, there is impairment.
Under Canadian GAAP, you then go to the second step, which involves determining the Fair value, comparing it to the Carrying value, and recognizing the difference as impairment, and expensing the amount to the Income Statement. This is done by calculating the fair value of the asset.
The difference between the carrying amount of the asset and the recoverable is recognized as impairment and written off on the Income Statement.
Under IAS 36, there is a one step process, where you take the carrying amount and compare it to the “recoverable” amount.
The recoverable amount is the higher of 2 amounts:
• Fair less selling costs or,
• Value in use
So, with IFRS, essentially you are going directly to calculating the Fair Value or Value in Use.
First, let’s talk about Fair Value.
Here are some extracts from IAS 36…
The best evidence of an asset’s fair value less selling costs is a price in a binding sale agreement in an arm’s length transaction, adjusted for incremental costs that would be directly attributable to the disposal of the asset.
If there is no binding sale agreement but an asset is traded in an active market, fair value less costs to sell is the asset’s market price less the costs of disposal. The appropriate market price is usually the current bid price.
When current bid prices are unavailable, the price of the most recent transaction may provide a basis from which to estimate fair value less costs to sell.
Now, let’s talk about “Value in Use” – Value in Use is determined by the company’s use of the asset, from the future value that you are going to get from its use. It is the expected cash flows from the asset on a DISCOUNTED basis. If the present value of the future cash flows is less than the carrying amount, then there is impairment under IFRS.
Although Fair Value and Value in Use are both included as part of IAS 36, I think the standards seem to encourage companies to use Fair Value in its calculation of the recoverable amount. Fair Value is more likely to be supported by market data.
So, in terms of calculating impairment – under IAS 36, there is impairment if the carrying value is less than the recoverable amount, which is the higher of the 2 valuation measurements as described above.
Identifying at what level to do the impairment testing is the key. Under IFRS, it is the CASH GENERATING UNIT, which is somewhat similar to the ASSET GROUP under Canadian GAAP.
IFRS is concerned only with CASH INFLOWS, without regard to overhead sharing. On the other hand, Canadian GAAP looks at NET CASH FLOWS. And, as mentioned previously, under IFRS the cash flows are discounted, whereas under Canadian GAAP, they are not discounted.
IAS 36 paragraphs 55 through 57 have some fairly granular information pertaining to the discount rate calculation. I briefly mention the risk free rate and the specific rate applicable to the asset. Once again, there are a lot of details in IAS 36, and I would encourage people to read the IAS standards. I think the standards are actually very well written, and easy for accountants to understand.
I thought it would be helpful to provide an illustration of Impairments to Fixed Assets by way of a simple example.
Suppose there are 4 retail stores in a company that are being supported by a shared warehouse and head office. Each of the retail stores has independent cash inflows.
Under Canadian GAAP, the relevant statistic would be the net cash flows resulting from the retail stores combined with the supporting operations – in other words, the NET CASH FLOWS.
However, under IFRS, only the CASH INFLOWS for each independent retail store would be relevant in calculating the future cash flows. So, unlike Canadian GAAP, you exclude the shared head quarter and warehousing costs. These cash inflows would then be discounted at the appropriate rate to determine the net present value, or fair value.
The key point is that with IFRS, you must review the facts, and determine lowest level at which a group of assets can generate independent cash INFLOWS, and these cash flows must be discounted when calculating the fair value.
In this simple example, all 4 of the retail stores have PP&E with a carrying cost of $100 each for a total of $400. The estimated cash inflows vary for each store, but in total they are $425. Using a discount rate of 10%, the recoverable amount is calculated to be $386.
Since the recoverable amount of $386 is less than the carrying amount of $400, under IFRS there would be an asset impairment of $13, which would be expensed to the Income Statement. Under Canadian GAAP if the Net Cash Flows are $425 or some amount above $400, impairment would not exist. So this highlights one of the key differences between IFRS and Canadian GAAP.
Another point to remember is that under IFRS, impairments can be reversed, but not above carrying amount. Under Canadian GAAP, impairments cannot be reversed – period!
The result is that under IFRS, there may be greater volatility in net income, as companies reverse previously recorded asset impairments. However, the theory is that in reversing asset impairment, it more accurately portrays the financial position of the company.
Once again, one of the key differences is that IFRS uses discounted cash flows. As a result, it is possible that companies will have impairment under IAS 36 that they would not have had under Canadian GAAP 3063.
The companies that I have talked to are looking at this area very closely, so that they understand the potential impacts in this area.
I hope this helps. This is one of a series of blogs that is meant to convey information relating to Canada’s transition from Canadian GAAP to IFRS.
For further information, please refer to the ongoing series of IFRS blogs on the Edelkoort Smethurst Schein CPA’s LLP web-site and please remember to contact your accounting professional for further guidance.
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