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notes - value in use (VU).

NFV is the sales price of an asset in an arm’s length transaction less the costs of disposal.

VU is the present value (PV) of future cash flows expected to arise from the asset over its remaining life and from its disposal. In other words we are looking at the financial outcome of the two choices a company has with an asset:

keep it (VU), or sell it (NFV).

The higher is taken as it is assumed that the company will opt for the more beneficial outcome.

Example 1

A fixed asset was acquired in January 2008 for £200,000. Depreciation policy is 15% straight line with a nil estimated residual value. At 1 January 2011 the NFV of the asset is £95,000 and the value in use is estimated at £87,000.

Required: Calculate the amount of any impairment at 1 January 2011.

Solution NBV (carrying amount) of asset at 1.1.11 Cost £200,000 Less: depreciation 2008-10 (200,000 x 15% x 3 years) 90,000 NBV – 1.1.11 £110,000 Recoverable amount This is measured as the higher of NFV and VU (higher of £95,000 and £87,000) ie £95,000. As the recoverable amount is £95,000, there has been an impairment of £15,000 (carrying amount of £110,000 less £95,000). 5.4 REQUIREMENT FOR IMPAIRMENT REVIEWS

The directors of a company should assess at each balance sheet date whether there are indications of impairment. If there are, the recoverable amount should be calculated (para 9). Para 12 details some external and internal sources of information that might indicate an impairment eg falls in market values, changes in legislation, physical damage of an asset, operating losses, new competition. Para 10 has additional requirements for intangible assets and goodwill. A company should estimate the recoverable amount of the following assets at least annually even if there is no indication that the asset is impaired: (a) an intangible asset with an indefinite useful life; and

(b) an intangible asset not yet available for use.

In addition, goodwill acquired in a business combination should be tested for impairment annually.

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notes The following points should be noted in calculating the carrying amount of a CGU:

(i) includes only those assets that can be attributed directly, or allocated on a reasonable and consistent basis, to the CGU and that will generate the future cash flows. This will normally include tangible and intangible fixed assets and goodwill (see (iii) below);

(ii) exclude liabilities unless the recoverable amount cannot be determined without considering the liability eg if a CGU has an obligation to repair goods under warranty the NFV (and hence recoverable amount) will reflect this obligation as it is unlikely the CGU would be sold without transferring the liability at the same time. The liability should be included and the cash flows should reflect estimated repair costs under warranty. This will give consistency in the way carrying amount, NFV and VU are calculated.

(iii) goodwill should be allocated to individual CGUs if they benefit from synergies of the business combination. Section 5.9 deals with goodwill in more detail.

(iv) corporate assets (assets such as head office buildings, central computing facilities etc which serve more than one CGU) should be allocated to CGUs if possible. Refer to 5.9 where this is not possible.

Example 2

Jackson Ltd (Jackson) acquired 100% of the ordinary share capital of James Ltd (James) for £10 million on 1 January 2004. This figure included £960,000 for goodwill. Jackson is preparing group accounts for the year to 31 December 2010 and due to a decline in market conditions has decided to carry out an impairment review of the fixed assets and goodwill of James. James operates in two distinct business areas which are largely independent – one is services to the oil industry and the other is the operation of a rail franchise. The following assets have been attributed to these activities as follows: Oil Rail services franchise £’000 £’000 Fixed assets Tangible 10,000 6,900 Intangible - 1,200 10,000 8,100 All fixed assets are held at depreciated cost.

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notes The following items have still to be allocated: (a) head office property with a net book value of £3,200,000. It

is estimated that this can be split 60:40 between oil and rail. (b) goodwill – it is estimated that 75% of this relates to the rail

franchise and the remainder to oil.

The directors estimate that the rail franchise has a NFV of £7,500,000 and oil services a NFV of £9,600,000. The intangible asset in the rail franchise relates to the NBV of the operating license associated with the franchise. The following pre-tax cash flows have been estimated for each CGU: Oil Rail Year services franchise £’000 £’000 2011 3,000 4,200 2012 2,800 3,400 2013 2,800 3,400* 2014 4,800* * the rail franchise expires at the end of 2013 and the oil services division will be wound up in 2014. The pre-tax market rate of return for oil services is estimated at 15% and 20% for the rail franchise.

Required: (i) Calculate the total net assets for each CGU; (ii) Calculate the value in use for each CGU; (iii) Calculate the impairment (if any) for each CGU.

Note: The present value of £1 at the end of each year using a discount rate of 15% and 20% is as follows: End of year Amount at 15% Amount at 20%

£ £ 1 0.870 0.833 2 0.756 0.694 3 0.658 0.579 4 0.572 0.482

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notes Solution (i) Total net assets Oil Rail services franchise £000 £000 (ii) Calculation of value in use This is based on discounted cash flows. These can be calculated (to nearest

£000) as: Oil Rail services franchise £000 £000 9,315 7,828 Workings: Value in use Oil services Rail franchise Year Discount Cash PV Discount Cash PV factor flow factor flow (15%) (20%) £000 £000 £000 £000 2011 0.870 3,000 2,610 0.833 4,200 3,499 2012 0.756 2,800 2,117 0.694 3,400 2,360 2013 0.658 2,800 1,842 0.579 3,400 1,969 2014 0.572 4,800 2,746 ____ 9,315 7,828 (iii) Calculation of impairment Oil Rail services franchise £000 £000

You will now be able to achieve the second learning objective of this module.

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notes 5.7 ACCOUNTING FOR AN IMPAIRMENT LOSS

Loss for an individual asset (para 58 – 64) the asset should be written-down to recoverable amount if this is below the

carrying amount. the loss should be an expense in profit or loss, except when the asset has been

previously revalued. if the asset is carried at revalued amount the impairment loss should be treated

as a revaluation loss per IAS 16 or IAS 38, hence a debit to the revaluation reserve in the first instance with any excess loss taken to profit or loss

if the impaired asset has been revalued the impairment loss should be treated as a new revaluation. If the asset is at cost the impairment loss is additional depreciation.

after the impairment loss has been recognised depreciation is based on the adjusted carrying amount of the asset.

Loss for CGU (para 104 – 108) the loss should be allocated by writing-down assets in the CGU in the

following order: (a) first, any goodwill allocated to the CGU; (b) then, to other assets in the CGU pro-rata on carrying amount.

In carrying out (b) no individual assets in the CGU should be written-down below the highest of:

(a) its NFV (if determinable); (b) its VU (if determinable); and (c) zero.

Applying (a) and (b) means that no asset is written-down below a known value. In this case, the amount of loss not deducted from the carrying amount of the individual asset is spread pro rata over other assets in the unit. The other rules above relating to individual assets apply to a CGU eg loss to profit or loss/revaluation reserve.

Example 3

How would the impairment of the assets of James in example 2 be recorded as at 31 December 2010?

Solution There is no indication that any specific assets are impaired. The assets are held at cost therefore losses go to profit or loss. The write-down should be treated as additional depreciation. Oil services The impairment loss would first be allocated to the goodwill (£240,000) and

then to tangible fixed assets (remaining loss of £2,320,000). Each tangible fixed asset would be written-down by 19.46% (2,320/(10,000 + 1,920)).

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notes £000 £000 Rail franchise The impairment should first be allocated to goodwill, then to the other

assets. No distinction is made between intangible and tangible assets – the impairment loss is allocated proportionately.

Once goodwill has been written-off, the remaining impairment loss of £1,552,000 (£2,272,000 - £720,000) needs to be pro-rated between the remaining assets. NBV of remaining assets Rail £’000 Directly attributable - tangible 6,900 - intangible 1,200 Head office - tangible 1,280 9,380 The allocation of the loss is as follows: Working NBV % Loss allocated Tangible fixed assets 8,180 87.2 1,353 Intangible fixed assets 1,200 12.8 199 9,380 100.0 1,552

Example 4

Assume in the rail franchise of James it was known that the operating licence (the intangible asset) had a net fair value (NFV) of £1,100,000. As the licence does not itself generate cash flow it is not possible to calculate its VU. What effect would this have on the write-off of the impairment loss?

Solution The goodwill should still be written-off. The operating licence should not be written-down below the higher of NFV (£1.1m) and VU (not available) ie by a maximum of £100,000 (£1.2m - £1.1m). The remainder of the loss should be allocated to the remaining tangible fixed assets pro rata.

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notes Example 5

A CGU comprising a factory, plant and equipment etc and associated goodwill became impaired because its products became out of date and unattractive compared to those of competitors. The recoverable amount fell to £25m at 31 December 2006, resulting in an impairment loss of £15m, allocated as follows: Carrying amounts Carrying amounts before impairment after impairment based on HC

£m £m Goodwill 10 - Factory 12 10 Plant and machinery 18 15 Total 40 25 The impairment loss of £15m was recognised in profit or loss as the assets were at historic cost. By 31 December 2010 the entity had improved its product range substantially by adding new models and the recoverable amount of the CGU increased to £30m. The carrying amounts of the factory and plant and machinery at 31 December 2010 are as follows: Based on Had no impairment impairment values occurred £m £m Factory 9.0 10.8 Plant and machinery 12.0 14.4 The recoverable amount of the plant and machinery is estimated to be £13m. The recoverable amount of the factory is estimated to be £15m. Goodwill is estimated to be worth around £2m.

Required: Explain how the reversal of the impairment loss should be accounted for.

Solution

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