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IMPAIRMENT OF ASSETS

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PART A: Reversal of Impairment loss on Goodwill:

Goodwill is an Intangible asset which originates when an existing business is purchased. Goodwill is the future economic benefit and contributes for the higher cash flows. It is important to note that goodwill is not independent of the related assets and cash flow is generated with use of other assets. As per the definition above, self generated goodwill is not allowed to be shown in accounts as asset. With introduction of IFRS and other new accounting standards now, goodwill is not allowed to be amortized per year; rather same has to be tested for impairment for each reporting period.

There is a special accounting standard which governs the Impairment of assets. Standard seeks to ensure that value of assets in the books does not exceed their recoverable amount.   When the carrying amount in books is more than the recoverable amount, the asset is called as impaired. The excess of carrying amount over the recoverable amount is booked as loss in accounts.

Recoverable amount is higher of Asset/CGU’s fair value reduced by the cost of selling or the value in use. The value in use is generally computed based on the fund generating capacity of the asset. The estimated future funds are discounted to get the value in use. (Elliott, J. A., and W. H. Shaw, 1988) Generally, a single asset may not be able to generate the cash flows for business. In such case, Impairment loss to be computed based on Cash generating unit. Method of computing the carrying amount of CGU shall be same as method of computing the recoverable amount. 

For identification of assets for impairment, organizations have to identify whether there are any indication for any assets to be impaired. Exercise has to be done for each reporting year. The indications may be internal or external such as decrease market value of assets, unfavorable changes in market or other environmental factors. Internal factors are any damage to asset or low expected economic benefits of asset. (McKaig, Thomas 2011)

However, there are some specified assets which need to be tested for impairment regardless of indication for any changes in recoverable amount. These assets specifically include Goodwill and Intangible assets with an indefinite useful life. 

Goodwill has special treatment where it is not to be amortized but to be mandatorily assessed for impairment for each reporting year (AbuGhazaleh 2011). The reason for same is that amortization is the systematic allocation over the useful life of assets. It is technically not possible to check the life of goodwill and the ratio of proposed benefit it will provide. On other hand, the impairment provides for the actual realizable value of goodwill during each reporting period. Another reason in favor of amortization is different rate of amortization will be charged by different entities based on the assessment of useful life and expected benefits from goodwill. (Jarva, H., 2009) The difference of approaches regarding this can be used to manipulate the profits for the year and thus can give incorrect picture of company affairs to user of financial statement. The entity considering the higher useful life or benefits for the longer period will be reflecting better profits in comparison to entity considering the shorter period.

Looking again into the Impairment standard, entities has to not only assess the indication for impairment but also for the impairment reversal. Any indicators indicating decrease in impairment loss which was booked in the past years have to be assessed. Also, It may be possible that such loss does not exist.  If there are indications available for reversal, then such assets shall be revalued again and value of asset to be increased by the impairment reversed subject to conditions. For reversal of impairment loss, it is mandatory that there has been changes in estimates which determine the assets recoverable value when the asset was last impaired.

Exception to the impairment reversal: The concept of Impairment reversal is applicable to all the assets. However, the exception to the rule of Impairment reversal is Goodwill. No reversal of impairment loss can be made for Goodwill. (Dinh, Tami & Kang 2017). Accounting standard specifically mentions ‘Other than Goodwill’ for assessment of indications for reversal as well as for reversing the impairment loss.

The possible reason for non reversal of impairment loss on Goodwill originates from the basic definition and recognition principal of goodwill in accounting. In accounting, goodwill is generated when any existing business is purchased. (Nikolai, Loren A 2010) This is the amount which is paid in excess of net value of assets and liabilities as this will help the business to generate additional cash flows along with other assets. The important points in above lines are – To record on purchase of business.

For any intangible asset to be recorded in the books of accounts, they have to meet with the criteria for definition and recognition of intangible assets. Defination part says that Identifiable non monetary assets without the physical substance. Recognition requires that there shall be some economic benefits to business on account of same and these benefits can be reliable measured. Another requirement for recognition is the reliable measurement of the cost of assets. Internally generated goodwill fulfills the definition part as goodwill is non monetary asset and does not have any physical substance. However, it fails to fulfill the recognition criteria in the standard. The cost of self generated goodwill cannot be measured reliably and this makes it different from other intangible assets. Thus, self generated or in house goodwill cannot be recorded in books on account of recognition failure.

Any increase in value of goodwill will be on account of impairment loss reversal and not on account of purchase of any business. Thus, the goodwill generated out of reversal in the impairment loss of the previous period will be the internally generated goodwill and not an acquired or purchased goodwill.

As internally generated goodwill is not allowed to be recognized in the books of accounts as an asset. Hence, no increase in value of goodwill can be recorded on account of reversal of impairment loss.

From above discussion, it is evident the reversal of impairment loss is not allowed on goodwill as goodwill is only allowed to be shown in books when this generates out of purchase of business. Any self generated goodwill does not fulfill the definition of intangible asset and thus cannot be recorded in the books.   

PART- B: Computation of Impairment loss and related Journal Entries:

Fine China Division is recognized as CGU by the Gali Ltd. The total value of assets as provided in table below of $1007700.          

Impairment loss is difference of carrying amount from the value in use.

Impairment loss is to be allocated between the remaining assets in ratio of their book value except the inventories. Reduced value of land shall not be less than the Fair value reduced by cost of sales of $651252. (AASB 136).  

Allocation can be seen in table below:

Journal Entry: The Journal Entry for the case will be to recognize the loss on account of impairment and to reduce the value of assets in ratio of loss allocated.

References:

  • AbuGhazaleh, N. M., O. M. Al-Hares, and C. Roberts, 2011, Accounting Discretion in Goodwill Impairments: UK Evidence, Journal of International Financial Management & Accounting 22, 165-204
  • Jarva, H., 2009, Do Firms Manage Fair Value Estimates? An Examination of SFAS 142 Goodwill Impairments, Journal of Business Finance & Accounting 36, 1059-1086., 2014
  • Elliott, J. A., and W. H. Shaw, 1988, Write-Offs As Accounting Procedures to Manage Perceptions, Journal of Accounting Research 26, 91-119.
  • Dinh, Tami & Kang, Helen & Morris, Richard & Schultze, Wolfgang. (2017). Evolution of Intangible Asset Accounting
  • AASB 136 https://www.aasb.gov.au/admin/file/content102/c3/AASB136_07-04_ERDRjun10_07-09.pdf
  • McKaig, Thomas. "Understanding Impairment Accounting: What It Is and When It Is Used". qfinance.com. Bloomsbury Information Ltd. Archived from the original on October 28, 2011. Retrieved November 6, 2011.
  • Nikolai, Loren A.; Bazley, John D; Jones, Jefferson P. (2010). Intermediate accounting (11th ed.). Australia: South-Western/Cengage Learning. p. 532. ISBN 978-0-324-65913-9.
  • Kieso, Donald; Weygandt, Jerry; Warfield, Terry; Young, Nicola; Wiecek, Irene (2010). Intermediate accounting

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