Identification and measurement of impairments under IAS 36 are 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.
Example – Building – assessing if the carrying amount is impaired. Under Canadian GAAP you assess the amount that is 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, then cash flows are expected for 50 years. If the estimated cash flow totals over the 50 years exceeds the Balance Sheet carrying value, then there is no impairment and you continue to amortize the building.
Note – the cash flow projections will be influenced by the anticipated cost of repairs in relation to construction quality, weather conditions, long-term refurbishing plans, interest rates, anticipated revenue streams, competitive factors in the real estate market etc
If however, 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 recognizing the impairment as a write down to the Income Statement. This is done by calculating the fair value of the asset, and 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 Value (market value) less selling costs or,
• Value in use – this is determined by the company’s use of the asset from the future value that you are going to get – 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.
Under IAS 36, there is impairment if the carrying value is less than the recoverable amount (the higher of the 2 valuation measurements as described above). It should be noted that because IFRS uses discounted cash flows, it is very likely that companies will have impairment under IAS 36 that they would not have had under Canadian GAAP 3063. This is because of the IFRS requirement to use discounted cash flows, as compared to undiscounted cash flows under Canadian GAAP. Discounted cash flows will always be less than undiscounted cash flows.
An example is an asset that has a carrying cost of $100 and generates cash flows of $10 year for the next 12 years. The undiscounted cash flows would be $120 (10 x $12), and under Canadian GAAP no impairment would be recognized.
However, if the cash flows are discounted at 10%, the net present value is about $68, which is less than the carrying amount of $100, and the impairment under IFRS would be $32.
As can be seen, if a company has assets with future cash flows of 20 or 30 or 40 years, it can have a significant impact, and will result in impairments under IFRS that would not have occurred under Canadian GAAP.
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. However, IFRS is concerned only with CASH INFLOWS, without regard to overhead sharing. On the other hand, Canadian GAAP looks at NET CASH FLOWS. For 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. 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 used for calculating the fair value.
Another point to remember is that under IFRS, impairments can be reversed, but not above carrying amount. Under Canadian GAAP, impairments cannot be reversed. 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.
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 CGA or other accounting professional for further guidance.
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