Asset Impairment - Common Pitfalls You Need to Know
Posted 04 May 17 by Shane Cross
Ever since the Global Financial Crisis occurred, and more recently with the commodity prices diving, asset values have been the focus of regulators and standard setters throughout the world. ASIC has recently released guidance which spells out the various areas for preparers to focus upon based on their financial reporting surveillance program. ASIC Commissioner John Price said “As in previous reporting periods, directors and auditors should focus on values of assets… ASIC continues to see companies use unrealistic assumptions in testing the value of assets…” Within this release, Asset Values is considered to be the number one focus area for ASIC when reviewing companies.
In the last 6 months there have been numerous examples of companies writing down their assets (tangible or intangible) by millions of dollars in the following reporting period after ASIC had selected them for review and raised concerns in relation to the value of these assets. For further details relating to these go to the ASIC website, http://asic.gov.au/about-asic/media-centre/ and go to the section ‘Media Releases’.
In light of this, we would like to highlight to preparers of financial reports some of the common pitfalls that we have seen and experienced and that they need to avoid when preforming an asset impairment test.
Identifying Cash Generating Units (CGUs)
When preparers have performed impairment testing, they have only included reference to the specific asset and have not included other assets integral to the generation of cash inflows (e.g. debtors, creditors, inventories). Such assets should be tested for impairment together with the smallest group of assets that generate cash inflows independently from other parts of the business.
Pre-tax vs Post-tax Discount Rates
Under Australian Accounting Standard AASB 136 you are required to use a pre-tax discount rate, however, a number of preparers have obtained the post-tax discount rate and not converted this to a pre-tax basis. We have also found that when the post-tax discount rates have been utilised that the cash flows used within the model have been on a pre-tax basis and therefore not being consistently applied.
Adequate Consideration of Capital Expenditure
In considering the cash outflows preparers have often either overlooked the ongoing capital expenditure and working capital required to achieve the forecasts or have incorrectly included cash outflows that have improved or enhanced the asset’s performance. Preparers are allowed to include capital expenditure where it is necessary to maintain the level of economic benefits expected to arise from the asset in its current condition.
Risk Adjusted Discount Rates
Preparers need to be aware that CGUs and/or individual assets may have different risk profiles to their overall parent entity. These could be different due to a different jurisdiction or industry that they are operating within. In these instances, the asset or CGU may have a different required rate of return and therefore discount rate.
- Some other pitfalls that need to be considered are:
- Integrity of your model
- Considering impact of foreign currencies
- Ensure that all disclosures of key assumptions and possible alternative outcomes are made
- Compare results with other approaches (sanity check)
As this continues to be the current focus of regulators, and with current dynamic global economy, preparers need to work collaboratively with their auditors from the beginning of the process to ensure that it runs smoothly with no last minute surprises.