Characteristics Of Impairment Testing Of Assets Essay

Question:

Discuss about the Characteristics of Impairment Testing of Assets.

Answer:

Introduction

Companies ought to conduct an impairment testing to discover the actual value of the fixed and intangible asset. Some assets are prone to depreciation, amortization, obsolescence, wear and tear and so forth. This must be incorporating the assets to make sure that their carrying amounts are less than their recoverable amounts. This report has two parts. Part A discusses the objective of impairment testing, the impact of goodwill on impairment testing and the necessary steps that should be taken by the management of Longreach Ltd to conduct an impairment test. Part B, on the other hand, performs an impairment test on Crossbow Ltd.

According to AASB 136 Impairment of Assets, assets should be carried at their carrying amounts, which should not be higher than the recoverable amount (Andri?, Miji?, and Jak?i?, 2011, pp.101-116). The importance of an impairment test is to ensure that assets are recorded at carrying amounts, which should be less than the recoverable amounts (Chunguang, 2006, pp.345-357). AASB 136 paragraph 6 states that the carrying amounts of an intangible or fixed asset are the amount, which are recognized after lessing the amortization, depreciation, and any losses on impairment. Assets that may be impaired include goodwill, property, plant and equipment, patent and any other intangible assets. However, other assets are excluded from impairment (Devalle, and Rizzato, 2012, p. 87). These assets include stock, employee benefit assets, financial assets, investments, and biological assets, available for sale assets, deferred acquisition assets, insurance contracts assets and so forth.

The existence of goodwill will affect the impairment test since goodwill will require an annual impairment test in agreement with AASB 136 paragraph 10(b) (Fang-fei, D.I.N.G., 2008, pp.789-811). This international accounting standard requires that goodwill acquired in a company should be apportioned to each cash generating unit and regularly tested for impairment whenever one cash-generating unit is sold. To impair goodwill, one debits the goodwill impairment account and credits the accumulated impairment of goodwill with the impairment amount (Francesco, 2016, pp.315-362). The next step is debiting the profit and loss account and crediting the impairment of goodwill account with the impairment loss. Several factors would indicate that an asset is impaired. First, an asset would be impaired if its value at market has reduced significantly more than it’s budgeted value. It would also be reduced if the market, legal, technological, or economic environment in which the company operates has changed significantly, if the return on investment has increased, or if the carrying amount of the asset is more than its market capitalization (Gallery, 2009, pp.337-339). An asset may also be tested for impairment due to internal indicators. These include evidence of obsolescence, significant changes in the use of an asset, and so forth.

For the management of Longreach Ltd to conduct an impairment test, they must follow some basic steps. First, the administration ought to calculate the recoverable value (Kuzmina, I., and Kozlovska, I., 2012, pp.56-65). It is calculated by taking the higher of the fair value of a fixed or intangible asset minus costs to sell that asset. This can also be calculated by taking the present value of the estimated future cash flows required from the assets. The next step is comparing the carrying amount to the recoverable amount. If it exceeds the recoverable amount, then there is need to impair the asset. Finally, one records the impairment loss in the books of accounts by recording a debit entry to the impairment account of asset and recording a credit entry to the accumulated impairment on an asset. Then, one debits the profit and loss account with the impairment loss and credits the impairment account of an asset with the impairment loss amount.

Crossbow Ltd as at 30 June 2015 had a land of $ 200,000, stock products amounting to $ 180,000, and the brand ‘Crossbow Shoes' that had a value of $ 160,000 as at 30 June 2015. In addition, the firm had a shoe factory at the value of $ 700,000, machinery for manufacturing shoes amounting to $ 400,000 and goodwill of $ 40,000. The sum carrying value of Crossbow Ltd's assets at the balance sheet date was $ 1,680,000 (Lhaopadchan, 2010, pp.120-130). Due to competition, Crossbow Ltd had to assess its impairment position. Various factors indicated that there was a probable impairment loss. Its recoverable amount as at 30 June 2015 was $1 420 000 while the fair value of the land less disposal price was $171 000. Below are the journal entries for the impairment loss of Crossbow Ltd.

Particulars

Dr.

Cr.

Impairment account on land

$ 29,000.00

Accumulated impairment on land

$ 29,000.00

To record impairment loss on land

Profit and loss account

$ 29,000.00

Impairment account on land

$ 29,000.00

To close the impairment loss account on land to the P & L A/c

Impairment account on assets ($ 260,000-29,000)

$ 231,000.00

Accumulated impairment on assets

$ 231,000.00

To record impairment loss on assets less the impairment loss on land

Profit and loss account

$ 231,000.00

Impairment account on assets

$ 231,000.00

To close the impairment loss account on assets to the P & L A/c

Calculation of the impairment loss on land

However, this impairment loss on assets includes the impairment loss on land, which means that we have to deduct the impairment loss on land from the impairment loss on assets to prevent consequences on double impairment as shown below.

Conclusion

As seen in the report of Long reach Ltd, goodwill is likely to affect the impairment test. The management, therefore, has to conduct an impairment test regularly to determine the carrying value of goodwill. This can be seen from the journal entries of Crossbow Ltd. Since the corporation has both an impairment loss on land and overall assets, an impairment test should be conducted on the two. Crossbow Ltd has an impairment loss of $ 29,000 on land and $ 231,000 on the assets. These amounts should be debited on the profit and loss account as an expense to the business.

References

Andri?, M., Miji?, K. and Jak?i?, D., 2011. Financial Reporting and Characteristics of Impairment of Assets in the Republic of Serbia According To IAS/IFRS and National Regulation. Economic Annals, 56(189), pp.101-116. Retrieved on 5th January 2017.

Chunguang, Z., 2006. Asset Impairments and Earnings Management [J].Accounting Research, 3(003), pp.345-357. Retrieved on 5th January 2017.

Devalle, A. and Rizzato, F., 2012, January. The quality of mandatory disclosure: the impairment of goodwill. An empirical analysis of European listed companies. In International Conference on Accounting and Finance (AT). Proceedings (p. 87). Global Science and Technology Forum. Retrieved on 5th January 2017.

Fang-Fei, D.I.N.G., 2008. Empirical Research on Non-current Assets Impairment Influenced by New Chinese Accounting Standards [J]. The Theory and Practice of Finance and Economics, 1(015), pp.789-811. Retrieved on 5th January 2017.

Francesco, C., 2016. Impairment of Assets. Accounting Research, 3(003), pp.315-362. Retrieved on 5th January 2017.

Gallery, G., 2009. Discount Rates in Disarray: Evidence on Flawed Goodwill Impairment Testing. Australian Accounting Review, 19(4), pp.337-339. Retrieved on 5th January 2017.

Kuzmina, I. and Kozlovska, I., 2012. Accounting measurement of long-lived assets: A case of impairment practice. Journal of Business Management, 5, pp.56-65. Retrieved on 5th January 2017.

Lhaopadchan, S., 2010. Fair value accounting and intangible assets: Goodwill impairment and managerial choice. Journal of Financial Regulation and Compliance, 18(2), pp.120-130. Retrieved on 5th January 2017.

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