COMMON ERRORS IN ACCOUNTING FOR IMPAIRMENT – PART 1
Despite the accounting standards being very clear on a particular accounting treatment, preparers regularly ignore the clear instructions in the standard, resulting in their financial statements being potentially materially misstated.
Perhaps the most common situation where this occurs for Tier 1 and Tier 2 entities is testing for impairment and the application of NZ IAS 36 Impairment of Assets (or the equivalent standards for public benefit entities - PBE IPSAS 21 Impairment of Non-Cash-Generating Assets and PBE IPSAS 26 Impairment of Cash-Generating Assets). (Note, the requirements for PBE IPSAS 21 and PBE IPSAS 26 are similar to those of NZ IAS 36, and thus have not been separately addressed in this article.)
While estimating an asset’s recoverable amount requires a great degree of judgement and estimation, in a number of cases there are a set of very clear rules, which are commonly overlooked. These include:
- Not testing for impairment when the standard clearly requires it
- Not testing for impairment at the correct ‘unit of account’
- Not including the correct assets in the impairment test:
- Basic errors in determining recoverable amount Basic errors in determining ‘value in use’
- Basic errors in determining ‘fair value less cost of disposal’.
This month we will discuss the first error, i.e. not testing for impairment when the standard clearly requires it. We will discuss the remaining errors in future editions of Accounting Alert.
Basic requirement of NZ IAS 36
The basic requirement of NZ IAS 36 is very simple.
Not testing for impairment, when the standard clearly requires it
There are five basic situations where NZ IAS 36 requires an asset to be tested for impairment:
- The asset is goodwill
- The asset is an intangible asset with an indefinite useful life
- The asset is an intangible asset not yet available for use
- There are external indicators that an impairment trigger has taken place
- There are internal indicators that an impairment trigger has taken place.
Testing goodwill for impairment
NZ IAS 36 clearly says:
A common error is to assume that goodwill acquired during the current financial year is not subject to an impairment test. This is not true. All goodwill is subject to impairment testing, even if it arose as a result of a business combination during the current year.
Testing an intangible asset with an indefinite useful life for impairment
NZ IAS 36 also clearly says:
Therefore entities with intangible assets that they have determined to have indefinite useful lives, and are not amortising, must perform an impairment test on these brands, mastheads, licences, etc.
Testing an intangible asset not yet available for use
Note that this requirement also applies to entities capitalising development costs under NZ IAS 38 Intangible Assets. It also raises the question of whether development of a mine is a tangible or intangible asset, remembering that at the point in time when an exploration and evaluation asset transfers to the development phase, it must be tested for impairment under NZ IFRS 6 Exploration for and Evaluation of Mineral Resources.
There are external indicators that an impairment trigger has taken place
At each reporting date (this includes the half-year if half-year financial statements are produced), an entity is required to assess whether there is any indication of impairment. This includes goodwill and indefinite life intangibles.
The above non-exhaustive list raises a number of conditions where, if one of the events listed above has occurred, an impairment test must take place. This is in addition to the usual annual impairment testing of goodwill.
If your net assets are greater than your market capitalisation, you must test for impairment.
You can also see from NZ IAS 36, paragraph 12(b) requirements above, that an external indicator of impairment is ‘significant changes with an adverse effect on the entity have taken place during the period, or will take place in the near future, in the technological, market, economic or legal environment in which the entity operates or in the market to which an asset is dedicated.’ This requires you to perform impairment tests in advance of actually being impacted by new technology or new legislation, and arguably, impairment write- downs should occur at least a year in advance of operating losses.
There are internal indicators that an impairment trigger has taken place
NZ IAS 36, paragraph 12 goes on to list the following internal indicators of impairment:
These requirements highlight the importance of tying internal budget information into impairment testing assessments and calculations. Failing to do so may result in errors occurring, for example, if you have no impairment write-downs but you have internal budgets showing that:
- The asset is not as profitable as budgeted
- The asset has cost more to construct than was budgeted, or
- The asset has taken longer to construct or get into production than budgeted.
Again, preparers must realise that impairment testing is required to consider planned future events such as disposals, reorganisations, etc. If there are plans to close a facility early, or to undertake a major refurbishment of that facility, an impairment test must be performed.
It must also be recognised that this list is not exhaustive.
In next month’s Accounting Alert we will look at the common error of not testing for impairment at the correct ‘unit of account’.
For more on the above, please contact your local BDO representative.