- 20 Marks
Question
Evo Plc acquired a cash-generating unit (CGU) several years ago. The directors of Evo Plc were concerned that the value of the CGU had declined because of a reduction in sales due to new competitors entering the market. At February 28, 2021, the carrying amounts of the assets in the CGU before any impairment testing were:
| Asset | Carrying Amount (N’m) |
|---|---|
| Goodwill | 3 |
| Property, Plant and Equipment | 10 |
| Other Assets | 19 |
| Total | 32 |
The fair values of the property, plant, and equipment and the other assets at February 28, 2021, were N10 million and N17 million, respectively, and their costs to sell were N100,000 and N300,000, respectively. The CGU’s cash flow forecasts for the next five years are as follows:
| Date (Year Ended) | Pre-tax Cash Flow (N’m) | Post-tax Cash Flow (N’m) |
|---|---|---|
| 28 February 2022 | 8 | 5 |
| 28 February 2023 | 7 | 5 |
| 28 February 2024 | 5 | 3 |
| 28 February 2025 | 3 | 1.5 |
| 28 February 2026 | 13 | 10 |
The pre-tax discount rate for the CGU is 8%, and the post-tax discount rate is 6%. Evo Plc has no plan to expand the capacity of the CGU and believes that a reorganisation would bring cost savings, but as yet, no plan has been approved. The directors of Evo Plc need advice as to whether the CGU’s value is impaired.
The following extract from a table of present value factors has been provided:
| Year | Discount Rate 6% | Discount Rate 8% |
|---|---|---|
| 1 | 0.9434 | 0.9259 |
| 2 | 0.8900 | 0.8573 |
| 3 | 0.8396 | 0.7938 |
| 4 | 0.7921 | 0.7350 |
| 5 | 0.7473 | 0.6806 |
Required:
a. How is impairment loss determined and accounted for by a business entity? (6 Marks)
b. Advise the directors of Evo Plc on:
i. Whether the CGU’s value is impaired. (7 Marks)
ii. How the transactions above should be treated in its financial statements in accordance with the provisions of IAS 36 – Impairment of Assets. (7 Marks)
(Total 20 Marks)
Answer
a. The Determination and Treatment of Impairment Loss
Impairment loss is the amount by which the carrying amount of an asset (or a cash-generating unit, CGU) exceeds its recoverable amount. The stages involved in accounting for an impairment loss are as follows:
- Establishing Indicators of Impairment
An impairment review is required when there is evidence or an indication that an impairment may occur. Indicators include:- External factors: Market changes, unexpected decline in asset’s market value, significant changes in technology, etc.
- Internal factors: Deterioration in the asset’s condition, evidence of reduced usage, and lower-than-expected performance.
- Assessing the Recoverable Amount
If impairment is indicated, the recoverable amount is calculated as the higher of fair value less costs to sell and value in use. Value in use is the present value of future cash flows the asset will generate. - Writing Down the Affected Assets
Impairment loss is recognized by debiting the statement of profit or loss and crediting the asset account, reducing the asset’s carrying amount to its recoverable amount.
b. i. Determination of CGU Impairment
To determine if Evo Plc’s CGU is impaired, we calculate the recoverable amount, which is the higher of fair value less costs to sell and value in use:
- Fair Value Less Costs to Sell Calculation:
Asset Fair Value (N’m) Cost to Sell (N’m) Fair Value Less Cost to Sell (N’m) Property, Plant & Equipment 10 0.1 9.9 Other Assets 17 0.3 16.7 Total 26.6 - Value in Use Calculation (Discount Rate 6%):
Year Cash Flow (N’m) Discount Factor Present Value (N’m) 1 5 0.9434 4.717 2 5 0.8900 4.450 3 3 0.8396 2.518 4 1.5 0.7921 1.188 5 10 0.7473 7.473 Total 20.346
The recoverable amount is therefore N26.6 million (the higher of fair value less costs to sell and value in use).
- Impairment Calculation:
Carrying amount of CGU = N32 million
Recoverable amount = N26.6 million
Impairment = N32 million – N26.6 million = N5.4 million
Thus, an impairment loss of N5.4 million should be recognized.
b. ii. Financial Statement Treatment of Impairment (IAS 36)
The impairment loss of N5.4 million should be recognized immediately in the statement of profit or loss, reducing the carrying amount of the assets in the CGU. The journal entry is as follows:
| Debit | Credit | Amount (N’m) |
|---|---|---|
| Statement of Profit or Loss | Property, Plant & Equipment | 5.4 |
This entry reflects the impairment loss on the CGU, reducing both the profit and total assets in Evo Plc’s financial statements in compliance with IAS 36.
- Tags: Cash-Generating Unit, Fair Value, Financial Reporting, Impairment, Value in Use
- Level: Level 3
- Topic: Impairment of Assets (IAS 36)
- Series: NOV 2022
- Uploader: Dotse