3.10_impairment_of_non-financial_assets_(insights_into_ifrs)

3.10 Impairment of non-financial assets (IAS 36, IFRIC 10) OVERVIEW OF CURRENTLY EFFECTIVE REQUIREMENTS CURRENTLY EFFECTIVE REQUIREMENTS This publication reflects IFRSs in issue at 1 August 2011. The currently effective requirements cover annual periods beginning on 1 January 2011. The requirements related to this topic are derived mainly from IAS 36 Impairment of Assets and IFRIC 10 Interim Financial Reporting and Impairment. FORTHCOMING REQUIREMENTS AND FUTURE DEVELOPMENTS When a currently effective requirement will be changed by a new requirement that is issued but is not yet effective, it is marked with a # as a forthcoming requirement and the impact of the change is explained in the accompanying boxed text. The forthcoming requirements related to this topic are derived from the following. When a significant change to the currently effective or forthcoming requirements is expected, it is marked with an * as an area that may be subject to future developments and a brief outline of the relevant project(s) is given in 3.10.680. 3.10.10 STEPS IN IMPAIRMENT TESTING 3.10.10.10 There are certain key definitions in IAS 36 that are used in this chapter. Here we give a general description as an aid to understanding the concepts in IAS 36 as the chapter progresses.   3.10.20 SCOPE 3.10.20.10 IAS 36 covers the impairment of all non-financial assets except for investment property that is measured at fair value (see 3.4); inventories (see 3.8); biological assets that are measured at fair value less estimated costs to sell (see 3.9); deferred tax assets (see 3.13); assets arising from construction contracts (see 4.2.230); assets arising from employee benefits (see 4.4); non-current assets (or disposal groups) classified as held for sale (see 5.4.20); and deferred acquisition costs and intangible assets arising from an insurer's contractual rights under insurance contracts (see 5.10). The standard does not cover financial assets (see 7.6) other than investments in subsidiaries, jointly controlled entities and associates. [IAS 36.2-5] 3.10.20.20 The above assets are excluded from the scope of IAS 36 because other standards deal with their measurement. However, that does not mean that the assets are ignored entirely in the impairment testing process (see 3.10.360-370). [IAS 36.3] 3.10.20.30 There is no scope exemption for assets that are not ready for use or sale, e.g. a building under construction (see 3.10.250.60). 3.10.30 KEY DEFINITIONS AND OBJECTIVE 3.10.30.10 There are certain key definitions in IAS 36 that are used in this chapter. Here we give a general description as an aid to understanding the concepts in IAS 36 as the chapter progresses. 3.10.30.20 A cash-generating unit (CGU) is the smallest group of assets that generates cash inflows from continuing use that are largely independent of the cash inflows of other assets or groups thereof. In our experience, in most cases impairment testing is performed at the CGU level, i.e. assets are tested in groups rather than on a stand-alone basis. CGUs are discussed in 3.10.60. [IAS 36.6] 3.10.30.30 In testing for impairment, the carrying amount of an asset or CGU is compared to its recoverable amount, which is the higher of the asset's or CGU's fair value less costs to sell and value in use. [IAS 36.6] 3.10.30.40 Fair value less costs to sell is the amount obtainable from the sale of an asset or CGU in an arm's length transaction between knowledgeable, willing parties, less the costs of disposal. In general, the definition of fair value is no different from how the term is used in other IFRSs and generally there is no special guidance in IAS 36 on the determination of fair value; however, there are certain restrictions on the method that can be used to determine fair value in the context of IAS 36 (see 3.10.190). [IAS 36.6] 3.10.30.50 Value in use is the present value of the future cash flows expected to be derived from an asset or CGU. Value in use is a valuation concept that is specific to IAS 36 and not used in other IFRSs. It combines entity-specific estimates of future cash flows (from continuing use and eventual disposal of the asset or CGU) with a market participant-based discount rate. IAS 36 includes detailed rule-based requirements on the determination of value in use (see 3.10.220-350). [IAS 36.6] 3.10.30.60 Corporate assets are assets other than goodwill that contribute to the future cash flows of both the CGU under review and other CGUs. IAS 36 includes specific requirements on how to test corporate assets for impairment because they benefit multiple CGUs. See 3.10.150 and 170 for a discussion of the general requirements related to corporate assets and 3.10.500 for application issues. [IAS 36.6] 3.10.40 IDENTIFYING THE LEVEL AT WHICH ASSETS ARE TESTED FOR IMPAIRMENT 3.10.50 Individual assets 3.10.50.10 Whenever possible IAS 36 is applied to the individual asset. However, a single asset generally is not tested for impairment on a stand-alone basis when it generates cash inflows only in combination with other assets as part of a larger CGU. There are exceptions to this basic rule, which are explored in 3.10.120.80-110. [IAS 36.22, 66, 67] 3.10.50.20 In our experience, most single assets do not qualify to be tested alone, which means that most assets are tested for impairment in CGUs (see 3.10.120.60-100). An example of a single asset that might be tested individually is an investment property measured under the cost model (see 3.4.180). 3.10.60 Cash-generating units 3.10.60.10 Assets are grouped together into the smallest group of assets that generates cash inflows from continuing use that are largely independent of the cash inflows of other assets or groups thereof, e.g. a plant or division of a larger entity. Such a group is known as a CGU. A CGU is identified consistently from period to period for the same asset or types of assets, unless a change is justified. [IAS 36.68] 3.10.60.20 The identification of CGUs requires judgement and can be one of the most difficult areas of impairment accounting. While the key test is the identification of independent cash inflows, IAS 36 also refers to other factors such as the manner in which management monitors operations and makes decisions about continuing or disposing of assets and/or operations. In our view, these additional factors are intended to assist in identifying parts of the business that have independent cash inflows, and are not alternative tests. [IAS 36.68, 69] 3.10.70 Independent cash inflows 3.10.70.10 In determining whether a group of assets is a CGU, in our view emphasis is placed on independent cash inflows, rather than net cash flows; therefore, cash outflows in themselves are not relevant. For example, an individual store location with largely independent sales is a CGU. The fact that the store may share infrastructure, human resources, marketing and other operating expenses with other stores is not relevant in making this determination. [IU 03-07] 3.10.70.20 In identifying groups of assets that have independent cash inflows, in our view two considerations, neither of which is likely to be determinative in isolation, are particularly useful in the analysis. 3.10.70.30 IAS 36 clarifies that if an active market exists for the output from a group of assets, then that group of assets is a separate CGU, even if the output is sold only to other units of the same entity. This is because that group of assets could generate independent cash inflows. [IAS 36.70, 71] 3.10.70.40 This clarification is particularly relevant for vertically integrated businesses, in which one unit produces a product and transfers it to another unit within the same reporting entity for further processing or sale. In this case, it is likely that each unit will be a separate CGU regardless of how the business is run. [IAS 36.IE5-IE10] 3.10.70.50 CGUs are not constrained by country borders and a single CGU might cover different countries and functional currencies (see 2.7.30). 3.10.75 Revenue separation 3.10.75.10 Revenue separation is likely to be the key consideration in businesses that operate a large number of smaller businesses, e.g. retail outlets, or that sell bundled products or have a large amount of referred business. In 3.10.75.20-60 we consider some examples. 3.10.75.20 Company R operates retail outlets in a number of cities within a country; the retail outlets are supplied via regional distribution centres. The customer base of one outlet is separate from the customer bases of other outlets, i.e. their cash inflows are independent. Therefore, R concludes that each retail outlet is a separate CGU. The regional distribution centres may be corporate assets (see 3.10.90). [IAS 36.IE1-IE4] 3.10.75.30 Company M is a multinational with manufacturing operations split between two countries and sales offices in a number of countries around the world. Engines are manufactured in Country X and parts are manufactured in Country Y. Almost all customers that buy an engine also buy original spare parts through the same sales office; customers do not buy parts unless they have also purchased an engine. Products and pricing are controlled by head office, and the price of an engine takes into account the almost inevitable subsequent sale of parts and maintenance services, i.e. the engine often is sold at a discounted price. In this example, M concludes that it has a single CGU for the following reasons: 3.10.75.40 The analysis in the above example may be more complex if M has a series of product lines, each with its own engine series and related spare parts. 3.10.75.50 Company U is a utility company that caters to the residential customers in a particular region. It offers a 'value-pack' to its customers, which is a bundle of two products: gas and electricity. Although customers can elect to purchase the elements of the package separately, 75 percent of customers choose the value-pack. Accordingly, U concludes that its business as a whole comprises a single CGU since the cash inflows of each operation are not generated largely independently. 3.10.75.60 Changing the facts of this example, only 45 percent of customers choose the value-pack. In this case, U concludes that it has two CGUs: gas and electric. 3.10.80 Asset separation 3.10.80.10 Asset separation is likely to be the key consideration in businesses that use a single asset base to generate different revenue streams, e.g. telecoms that use a single network to deliver services. In 3.10.80.20-50 we consider some examples. 3.10.80.20 Company T is a telecommunications company that offers fibre-to-the-premise services with the 'last mile' (i.e. the connection from the exchange or the cabinet to the customer's residence) being either copper or fibre. Both services are provided from a single fibre network, the backbone, which is the core operating asset. In this example, T concludes that its business is a single CGU because its core operating asset, the network, services all customers. Although the cash inflows can be separated to the customer level, the asset cannot be separated between the two types of customers (copper vs fibre) except on an arbitrary basis. 3.10.80.30 Company T operates in the transportation industry and was recently awarded a licence by the government to provide bus services throughout Country X, based on minimum service levels. T charges a separate fare for each passenger on each bus route and therefore is able to measure revenues by route; however, T does not have discretion to choose the areas in which it will operate because the contract requires it to supply the entire country with bus services. In this example, T concludes that all of the assets dedicated to the contract form a single CGU because it does not have the ability to make decisions about the allocation of assets at a lower level. Although the cash inflows can be separated by route, the terms of the licence agreement require the assets to be operated as part of a single network such that the routes do not generate independent revenue streams. This conclusion is reached even if cash inflows are capable of being determined at a lower level, e.g. for each region or route, because T is not able to close an unprofitable route under the terms of the contract. [IAS 36.68] 3.10.80.40 Changing the facts of this example, the terms of the licence do not prescribe minimum service levels for the country overall, i.e. the licence allows T to withdraw bus services from routes that are unprofitable. T manages its fleet of buses by region; the buses are similar and are used interchangeably in a particular region. On the basis that revenue separation is possible, in this example T concludes that each region is a separate CGU because its core assets are managed at this level even if each route has a separate customer base. 3.10.80.50 In our view, the conclusion in this example would not change even if T theoretically could interchange the buses used in different regions. This is because IAS 36 emphasises the way in which a business actually is run and not how it could be run. [IAS 36.69] 3.10.85 Review of CGU determination 3.10.85.10 IAS 36 requires that a CGU be identified consistently from period to period unless a change is justified. In our view, this requirement indicates that the application of the standard is not intended to result in a different outcome each year if there has been no significant change in the business; instead, an entity should look for significant trends over time. [IAS 36.72] 3.10.85.20 Continuing the example of utility company U in 3.10.75.50, between 2007 and 2010 approximately 75 percent of customers chose the value-pack and U concluded that its business as a whole comprised a single CGU. In 2011 that percentage drops to 55 percent even though U's product offering has remained the same. In this example, we would not expect U to change the basis of identifying its CGUs in 2011 in the absence of a clear reason for the change, e.g. a sustained change in customer preferences because of new technology or products offered by competitors. However, a change in CGU determination may be appropriate if the trend continues in 2012 even if the reason for the trend cannot be identified specifically. 3.10.90 Corporate assets 3.10.90.10 By definition (see 3.10.30.60), corporate assets contribute to the future cash inflows of two or more CGUs, without generating their own cash inflows that are largely independent. Therefore, a corporate asset is not tested for impairment as an individual asset on a stand-alone basis unless management has decided to dispose of the asset (see 3.10.50). Instead, IAS 36 includes specific requirements about how a corporate asset is tested for impairment as part of the testing of CGUs. See 3.10.150 for a discussion of the general requirements related to corporate assets and 3.10.500 for application issues. [IAS 36.100, 101] 3.10.90.20 IAS 36 notes that examples of corporate assets include headquarter buildings, computer equipment and research centres. Other examples of corporate assets might be a warehouse shared by several retail units, or plant and machinery shared by production lines. In practice such assets sometimes are referred to as 'shared' rather than 'corporate' assets, but they fall under the definition of a corporate asset in IAS 36 if they contribute to the cash flows of more than one CGU. [IAS 36.100] 3.10.95 Asset separation vs corporate assets 3.10.95.10 In 3.10.80 we refer to the core operating assets of a business being used collectively to generate revenue. This could be seen as similar to a corporate asset that contributes to the future cash inflows of two or more CGUs (see 3.10.90.10). Therefore, a question arises as to why corporate assets do not result in CGUs being identified at a higher level. Such a conclusion would result in a different analysis of CGUs and may result in a different impairment outcome. 3.10.95.20 Making the distinction between core operating assets and corporate assets requires judgement and a careful analysis of the facts and circumstances. In our view, the core operating assets are the key to revenue generation within the business, whereas corporate assets are peripheral to the generation of revenue. Returning to the example of telecommunications company T in 3.10.80.20, the backbone network is the core operating asset because it drives the amount of revenue earned; however, T's headquarters relate to the administration of the business as a whole and are classified as a corporate asset. 3.10.100 Goodwill 3.10.100.10 Similar to corporate assets, goodwill does not generate cash inflows independently of other assets or groups of assets and therefore is not tested for impairment separately. Instead, IAS 36 includes specific requirements about how goodwill is tested for impairment as part of the testing of CGUs. See 3.10.160 and 3.10.170 for a discussion of the general requirements related to goodwill and 3.10.450 for a discussion of application issues. 3.10.110 DETERMINING WHEN TO TEST FOR IMPAIRMENT 3.10.110.10 Impairment testing is required: 3.10.110.20 The annual impairment test is required in addition to any impairment tests performed by the entity as a result of a triggering event. [IAS 36.10] 3.10.120 Indicator-based impairment testing 3.10.120.10 An entity assesses at each reporting date whether there is an indication, based on either internal or external sources of information, that an asset or a CGU may be impaired. [IAS 36.9] 3.10.120.20 The following are examples of internal indications of impairment that are considered in assessing whether indicator-based impairment testing is necessary: 3.10.120.30 The following are examples of external indications of impairment that are considered in assessing whether indicator-based impairment testing is necessary: 3.10.120.40 In our view, if the price paid to acquire non-controlling interests is less than the carrying amount of those interests in the consolidated financial statements, then this might be an indication that certain assets of the subsidiary are impaired. In such cases, we believe that the entity should consider whether any of the underlying assets are impaired prior to accounting for the change in ownership interests. 3.10.120.50 The examples in 3.10.120.20-40 are indications of possible impairment that are considered in assessing whether impairment testing is required; they do not automatically lead to mandatory impairment testing. For example, an entity assesses whether the magnitude or effect of a change in interest rates or the gap between its net assets and market capitalisation requires the determination of recoverable amounts. [IAS 36.12, 16] 3.10.120.60 The nature of the indication of impairment and the nature of the asset determines the level at which impairment testing is carried out. For example, Company C's business comprises three CGUs, X, Y and Z. CGUs X and Y are profitable, but a downturn in the market for the product sold by CGU Z has resulted in operating losses for that CGU, which management concludes is an indication of possible impairment. Accordingly, C tests CGU Z for impairment, but does not test CGUs X and Y unless such testing is required because of the allocation of corporate assets (see 3.10.150) and/or goodwill (see 3.10.160). 3.10.120.70 In another example, Company B is a listed multinational with various manufacturing operations. While all CGUs that make up the company continue to be profitable despite downward pressure on margins, the company's market capitalisation has fallen significantly below the carrying amount of B's recognised net assets. B is not able to identify a specific area of operations that is the driver for the fall in market capitalisation, and ac