Question

a) Telescope acquired an item of plant at a cost of $800 000 on 1 April 2017 that is used to produce and package pharmaceutical pills. The plant had an estimated residual value of $50 000and an estimated life of 5 years, neither of which has changed. Telescope uses straight line depreciation. On 31 March 2019, Telescope was informed by a major customer (who buys products produced by the plant) that it would not be placing orders with Telescope. Even before this information was known, Telescope had been having dilliculty finding work for this plant. It now estimates that the net cash inflows earned from the plant for the next 3 years will be: $ 000 Year ended: 31 March 2020 220 31 March 2021 180 31 March 2022 170 On 31 March 2022. the plant is still expected to be sold for its estimated realizable value. Telescope has confirmed that there is no market, in which to sell the plant at 31 March 2022. Telescope's cost of capital is 10% and the following values should be used: 0.91 Value of Si at: End of year 1 End of year 2 0.83 End of year 3 0.75 b) Telescope owned a 100% subsidiary, Tillia that is treated as a cash generating unit. On 31 March 2019, there was an industrial accident (a gas explosion) that caused damage to some of Tillia's plant. The assets of Tillia immediately before the accident were: $000 Goodwill 1 800 Patent 1 200 Factory building 4 000 Plant 3 500 Receivables and cash 1 500 12 000 As a result of the accident, the recoverable amount of Tillia is $6,7m The explosion destroyed to the point of no further use) an item of plant that had a carrying amount of $500 000. Tillia has an open offer from a competitor of $1m for its patent. The receivable and cash are already stated at their fair value less costs to sell (net realizable value). Required: a) Calculate the carrying amounts of the assets in a) and b) above at 31 March 2019 after applying any impairment losses. (11) b) Explain what is meant by an impairment review. Your answer should include assets that that may form a cash generating unit. (4)

Answer 1

Impairment loss

1. Statement showing calculation of Impairment loss:-

For calculating impairment loss first we need to calculate the carrying amount of the asset as on 31^st march, 2019 as under :

On 1^st April, 2017, cost of plant = $800000

Residual value = $50000

Life of asset = 5 years

Therefore depreciation for 2 years on straight line method

=              cost of plant – residual value

                                    Life of asset                            *2 years

=              $800000 - $50000

                        5 years                             *2 years

= $300000

Therefore carrying amount for the year 31^st march, 2019

= Cost of the asset – Depreciation for 2 years

= $800000 - $300000

= $500000

Calculation of recoverable amount of the asset:-

Recoverable amount = fair value less cost to sell or value in use whichever is higher

Calculation of value in use :

Year	Cash flow in $000 (a)	Present value factor @10% (b)	Present value cash flow in $000 (a*b)
31st march, 2020	220	.91	200.2
31st march, 2021	180	.83	149.4
31st march, 2022	170	.75	127.5
		Total	477.1

Therefore recoverable amount = $477.1 (In $000), as fair value less cost to sell is not given in the question.

An impairment loss happens when the value of a fixed asset abruptly falls below its carrying cost. Basically, that means if the value of an asset decreases so much that the recoverable amount is less than the carrying cost, you can write off the difference.

Therefore as the carrying amount of asset is more than the recoverable amount of the asset the entity must reduce the carrying amount of the asset to its recoverable amount, and recognise an impairment loss.

Therefore Impairment loss = Carrying amount – Recoverable amount

                                                 = $500000 - $477100

                                                   = $22900

Note : Carrying amount of asset after applying the Imapirment loss is

                  $500000 - $22900

                   = $477100

2. Calculation of Impairment loss of a Cash generating unit:

Calculation of carrying amount:

Account title	Amount ($000)
Goodwill	1800
Patent	1200
Factory Building	4000
Plant	3500
Receivables & cash	1500
Total	12000

Therefore carrying amount of tillia is $120 m

Recoverable amount of Tillia as given in question is $67m

As the recoverable amount of the CGU is lower than the carrying amount of the CGU, an impairment loss shall be recognised. The amount of Impairment loss

= Carrying amount of Tillia – Recoverable amount of Tillia

= $12m - $6.7m

= $5.3m

Therefore Impairment loss of Tillia is $5.3m.

Note : The carrying amount of Tillia after Impairment loss is as follows:

• This impairment loss shall reduce the carrying amount of any goodwill allocated to the CGU, first . The total amount of $1.8m on the goodwill account is therefore removed.
• The remaining amount of the impairment loss of $3.5m (calculated as the total impairment loss of $5.3m less the amount of $1.8m recognised against goodwill) shall then be allocated to the other assets of the CGU, pro rata on the basis of the carrying amount of each asset in the CGU. The total carrying amounts of the remaining assets being the patent, factory building, plant , receivables & cash equals $10200($000) ($1200 + $4000 + $3500 + $1500). The impairment loss of $3.5m, allocated pro rata on the basis of the carrying amounts of the assets mentioned, is calculate as follows:

Patent
($3.5m/ $10.2 * $1.2m) = $0.41m

Factory Building
($3.5m/ $10.2* $4m) =         $1.37m

Plant
($3.5m/ $10.2 * $3.5m) =          $1.2m

Receivables & Cash
($3.5m/ $10.2* $1.5m) =          $0.51m

Therefore carrying amount after impairment as follows:

Patent = $1.2m - $0.41m =    $0.79m

Factory Building = $4m – $1.37m = $2.63m

Plant = $3.5m - $1.2m = $2.3m

Receivables & Cash = $1.5m - $0.51m = $0.99m

Answer to part (b) of question:

An impairment review compares the carrying amount of an asset with its recoverable amount, where recoverable amount is the higher of net realisable value and value in use.

Net realisable value is the amount for which an asset can be disposed of, less any direct selling costs. Direct selling costs include legal costs and the costs of removing a sitting tenant but they do not include reorganisation costs eg redundancy costs linked to the sale of a property.

Value in use as the present value of the future cash flows from the asset's continued use. However, it adds that, where a fixed asset is not held for the purpose of generating cash flows, an alternative measure of its service potential may be more relevant.

The accounting treatment of an impairment loss of a cash generating unit is as follows:

• Determine the carrying amount of the cash-generating unit;
• Determine the higher of the fair value less costs to sell and the value in use ;
• Calculate the impairment loss if the recoverable amount is less than the carrying amount;
• Recognise the impairment loss, first against any goodwill and then pro rata on the basis of the carrying amount of each asset in the CGU; and
• Assess the “limits” in the Standard – the carrying amount of any individual asset in the CGU shall not be reduced to below its fair value less cost to sell.

Example

A SME company, with a reporting date of 30 June, packs organic fruit for exportation to Europe.

Assume that the company obtained a fruit packing factory in terms of a business combination. The individual assets of the fruit packing factory cannot generate cash flows independently. Any goodwill calculated at the date of the business combination is allocated, in total, to the fruit packing factory (CGU).

The following information relates to the net assets of the fruit packing factory:

	Carrying amount at the reporting date $
Factory building at carrying amount	2 415 385
Machines at carrying amount	1 419 000
Goodwill as a result of the accounting for the business combination at cost	200 000
Total assets in the CGU	4 534 385

Assume that the value in use of the fruit packing factory (CGU) at the reporting date amounted to $4000000 and on the same date the fair value less costs to sell of the fruit packing factory amounted to $3800000.

It is only for the factory building that forms part of the fruit packing factory, for which there is an active market and its fair value less costs to sell amounts to $2000000.

The journal entry (excluding taxation) in the records of the company at the reporting date to account for the impairment loss relating to the fruit packing factory is as follows:

Account	Calculation and explanation	Debit$	Credit$
Impairment loss (P/L)	a)	534 385
Goodwill (SFP)	b)		200 000
Accumulated depreciation of the factory building (SFP)	c)		210 638
Acc. Dep machines (SFP)	c)		123 747

Calculations and explanations

• a.) If, as in this example, the recoverable amount of the CGU is lower than the carrying amount of the CGU, an impairment loss shall be recognised. The amount of the impairment loss is $534385 and is calculated as the recoverable amount $4000000 (higher of the fair value less costs to sell and its value in use) less the carrying amount of $4534385. The impairment loss shall be recognised immediately in profit or loss as no assets were previously revalued in this example.
• b.) This impairment loss shall reduce the carrying amount of any goodwill allocated to the CGU. The total amount of $200000 on the goodwill account is therefore removed.
• c.) The remaining amount of the impairment loss of $334385 (calculated as the total impairment loss of $534385 less the amount of $200000 recognised against goodwill) shall then be allocated to the other assets of the CGU, pro rata on the basis of the carrying amount of each asset in the CGU. The total carrying amounts of the remaining assets being the factory building and the machines equals $3834385 ($2415385 + $1419000). The impairment loss of $334385, allocated pro rata on the basis of the carrying amounts of the assets mentioned, is calculate as follows:

Factory building
($334 385/ $3 834 385 x $2 415 385) $210 638

Machines
($334 385/ $3 834 385 x $1 419 000) $123 747