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Ch07 sm loftus 2e
Financial Accounting II (ACCTING 2501)
The University of Adelaide
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Solutions manual to accompany Financial reporting nd 2 edition Loftus, Leo, Daniliuc, Boys, Luke, Ang and rnes Prepared Noel Boys John Wiley Sons Australia, Ltd 2018 Chapter 7: Impairment of assets Chapter 7: Impairment of assets Comprehension questions 1. What is an impairment test? It is a test to determine if an assets are overstated, that is, whether the carrying amount of the assets is greater than their recoverable amount. 2. Why is an impairment test considered necessary? To ensure that the reporting assets are not overstated. That is, assets are carried at no more than their recoverable amount. An balance sheet may overstate the assets, either because the fair values are lower than the carrying amounts, or because the estimates have resulted in an understatement of accumulated depreciation e. estimates of residual value, useful life, pattern of benefits. 3. When should an entity conduct an impairment test? At each reporting date, an entity must assess whether there is any indication of impairment. If such an indication exists, the entity shall estimate the recoverable amount of the asset 136 para 4. What are some external indicators of impairment? AASB 136 para 12: (a) significant decline in market value (b) significant changes in the technological, market, economic or legal environment in which the entity operates (c) increases in market interest rates (d) the carrying amount of the assets exceeds the market capitalisation. 5. What are some internal indicators of impairment? AASB 136 para 12: (a) evidence of obsolescence or physical damage (b) assets becoming idle, plans to discontinue operations, plans to dispose of assets (c) economic performance is worse than expected. 6. What is meant recoverable amount? Recoverable amount is the higher of an or fair value less costs of disposal and its value in use. John Wiley and Sons Australia Ltd, 2018 7 Chapter 7: Impairment of assets 12. How is goodwill tested for impairment? AASB 136 para 80: At the acquisition date, allocate the goodwill to each of the CGUs If goodwill cannot be allocated, treat it as a corporate asset Test goodwill annually for impairment, but note para 99 may allow use of a preceding information. 13. What is a corporate asset? AASB 138 defines a corporate asset as an asset other than goodwill that contributes to the future cash flows of both the CGU under review and other CGUs. Examples of corporate assets include headquarters, IT equipment or a research centre. The distinctive characteristic of a corporate asset is that it does not generate cash inflows independently of other assets or groups of assets, and its carrying amount cannot be fully attributed to a single CGU. 14. How are corporate assets tested for impairment? AASB 136 para 102: A corporate asset is one that cannot be fully attributable to a single CGU but, where possible, a portion of its carrying amount should be allocated to one or more CGUs. If it cannot be allocated on a reasonable and consistent basis, after testing the separate CGUs, identify the smallest group of CGUs that includes the CGU under review and to which the corporate asset can be allocated and test the group of CGUs for impairment. 15. When can an entity reverse past impairment losses? AASB 136 para 110: At each reporting date, an entity shall assess whether there is any indication that past impairment losses other than for goodwill may no longer exist or have decreased. If such an indication exists, the recoverable amount is determined. If the recoverable amount exceeds the carrying amount, reversal may occur, subject to the para 117 limitation i. the increased carrying amount attributable to the reversal shall not exceed the carrying amount that would have been determined had no impairment loss been recognised. John Wiley and Sons Australia Ltd, 2018 7 Solutions manual to accompany Financial reporting 2e Loftus et al. 16. What are the steps involved in reversing an impairment loss? 1. Test for indication that past losses may no longer exist or have decreased. Testing involves analysing external and internal sources of information as per para 2. If test is positive, determine the recoverable amount of the asset 3. If the recoverable amount is greater than the carrying amount, determine the carrying amount that would have been determined had no impairment loss been recognised in prior years. 4. Subject to the limit in 3. above, if testing an individual asset, write the asset up to its recoverable amount. If the asset is carried under the cost model, the reversal should be recognised as income in profit or loss. If the asset is carried under the revaluation model, the reversal should be treated as a revaluation increase. 5. If testing a CGU, allocate the reversal amount to the assets of the CGU except goodwill pro rata to carrying amounts, but ensuring that the carrying amounts of the assets are not increased above the lower of: Recoverable and Carrying amount had no impairment occurred 6. Adjust subsequent charges of assets John Wiley and Sons Australia Ltd, 2018 7 Solutions manual to accompany Financial reporting 2e Loftus et al. 1(a). BHP Billiton identified significant volatility and much weaker prices in the oil and gas industry. 1(b). In determining the recoverable amount of its onshore US assets, BHP Billiton: Decreased its medium to gas and short to oil price assumptions which would decrease their future cash flow forecasts. Increased its discount rate which would decrease the discounted future cash flows. Decreased its output projections based on decreasing the number of operational rigs from 7 to 5. 2. The impairment loss of billion decreased onshore US assets to billion. Therefore, the carrying amount of these assets was billion The impairment loss was approximately A write down of this magnitude would be considered significant. 3. An impairment loss decreases total assets and equity (either through profit or loss or other comprehensive income) while total liabilities are unchanged. Accordingly, gearing measured either total liabilities to total assets or total liabilities to total equity increases, therefore indicating a deterioration. John Wiley and Sons Australia Ltd, 2018 7 Chapter 7: Impairment of assets Case study 7 Determination of CGUs The Scenic City Council contracts out the bus routes in Scenic City to various subcontractors based on a tender arrangement. Some routes, such as the Express to City routes, are profitable, while others, such as those collecting schoolchildren from remote areas, are unprofitable. As a result, the council requires tenderers to take a package of routes, some profitable, some less so. The Saferide Bus Company has won the contract to operate its buses with a package of five separate routes, one of which operates at a significant loss. Specific buses are allocated the Saferide Bus Company to each route, and cash flows can be isolated to each route because drivers and takings are specific to each route. Required Write a report to the accountant of Saferide Bus Company which includes the following information. 1. An explanation of why impairment testing may require the use of CGUs, rather than being based on a single asset. 2. An explanation of the factors that should be considered in determining a CGU for Saferide Bus Company. 3. Your determination as to the identification of CGUs for Saferide Bus Company. John Wiley and Sons Australia Ltd, 2018 7 Chapter 7: Impairment of assets Case study 7 Goodwill Gu and Lev (2011) argue that the root cause of many goodwill is that the shares of the buyer are overpriced at the acquisition date. Figure 7 presents cumulative stock return against the 500 index from 2003. In 2005, eBay acquired the internet phone company Skype for billion. On 1 October 2007, it announced a massive goodwill of billion of the acquisition price) related to the Skype acquisition. Gu and Lev argue that the root cause of this behaviour is the incentives of managers of overvalued firms to acquire businesses, whether to exploit the overpricing for benefit or to justify and prolong the overpricing to maintain a facade of growth. Goodwill are accordingly an important business event signalling a flawed investment strategy. Required 1. Explain the circumstances under which goodwill is recognised and how any subsequent occurs. 2. Explain why a significant goodwill may signal a investment John Wiley and Sons Australia Ltd, 2018 7 Solutions manual to accompany Financial reporting 2e Loftus et al. Goodwill arises upon acquisition of a business combination. It is determined the excess of consideration over the fair value of net assets acquired. Goodwill is then allocated to each of the CGUs or groups of CGUs, expected to benefit from the synergies of the business combination. If a CGU is subsequently identified as impaired, the impairment loss is first allocated to the goodwill before being allocated to any of the other assets in the CGU. Once goodwill has been written off as impaired, it can never be reversed. Goodwill represents a premium paid the acquirer over and above the fair value of the net assets of a business. The more the acquirer pays, the greater the value placed on the goodwill acquired. Goodwill impairment is recognised when the recoverable amount of the business (i. the CGU) falls below the carrying amount. A significant goodwill may indicate that the acquirer has overestimated the future earning capacity of the business and that the acquirer paid too much when acquiring the business, hence a flawed investment strategy. John Wiley and Sons Australia Ltd, 2018 7 Solutions manual to accompany Financial reporting 2e Loftus et al. Case study 7 Impact of impairment losses On 28 August 2014, Qantas announced an annual statutory loss after tax of billion for the 12 months ended 30 June. This result included a massive billion of its international aircraft fleet. These losses were the largest in the history and were seen to represent of the biggest clearing of the decks in corporate (Bartholomeusz 2014). In the media release announcing the loss, Qantas CEO Alan Joyce was quoted: is no doubt numbers are yet he remained remarkably optimistic about the future, going on to say expect a rapid improvement in the financial performance and a return to Underlying PBT profit in the first half of (Qantas Group 2014). Required 1. Explain how such a massive impairment loss could be linked to any improved future performance. 2. Review the 2015 and 2016 annual reports of Qantas to determine if Alan optimism was justified. John Wiley and Sons Australia Ltd, 2018 7 Chapter 7: Impairment of assets 1. The recognition of an impairment loss decreases the carrying amount of assets which, in turn, will decrease the depreciation charge in future periods. In combination, the absence of the impairment loss and the lower depreciation expense in 2015 will result in significantly less expense recognised in profit or loss compared to 2014. Also, consider that the impairment losses decrease total assets and total equity in 2014. Profitability measured ROE (profit equity) and ROA (EBIT total assets) are likely to improve due to potentially higher numerators and lower denominators. 2. A review of the annual reports reveals the following line items from the Income Statement (note all figures are in millions): Revenue Depreciation and amortisation Impairment of CGU Fuel Profit or (loss) 2016 16,200 1,224 3,250 1,029 2015 15,816 1,096 3,937 560 2014 15,352 1,422 2,560 4,461 (2,843) In its 2015 Annual Report QANTAS boasted a turnaround in its underlying profit up from a loss of the previous year to (source: Note 4, p59 Qantas Annual Report 2015). While this change in underlying profit does not include the impact of the impairment loss in 2014, the figures above confirm the decrease in depreciation from 2014 to 2015 arising from the impairment loss reducing carrying amounts of depreciable assets. This decrease in expenses alone accounts for around of the turnaround. The line item disclosing the decreasing trend in fuel costs (in spite of the increase in revenue) is of interest given that one of assumptions in determining the 2014 impairment loss was anticipating future increases in fuel costs. John Wiley and Sons Australia Ltd, 2018 7 Chapter 7: Impairment of assets Exercise 7 Impairment of an individual asset On 1 April 2018 the construction of a fixed oil platform is completed and ready for use at a total cost of million. The useful life of the rig is linked to the exploration rights granted to the company. Due to the specific nature of the platform it is deemed to have no realisable value (other than minimal scrap value) at any stage throughout its life. All impairment tests are therefore based on estimations. On 30 June 2020 a rapid and significant decline in world oil prices has provided an indication that the asset may be impaired. On this date, the value in use is estimated to be million. On 30 June 2021 a major contract was cancelled after one of the customers was declared bankrupt. This led directors to believe the value in use of the rig was now million. Required Prepare the necessary journal entries to record adjustments for impairment on 30 June 2020 and 30 June 2021. (LO3 and LO4) 30 June 2020: DR Impairment loss Oil rig 41 CR Accumulated depreciation impairment losses Oil rig 41 Cost of with 25 year life Depreciation of p. Accumulated depreciation after years CA RA so Impairment of 30 June 2021: DR Impairment loss Oil rig 21 802 198 CR Accumulated depreciation impairment losses Oil rig CA at of with year life, Depreciation for year of and CA of RA of so Impairment of John Wiley and Sons Australia Ltd, 2018 21 802 198 7 Solutions manual to accompany Financial reporting 2e Loftus et al. Exercise 7 Impairment of an individual asset On 1 July 2020 an item of equipment is acquired at a cost of million. The asset is to be depreciated using the method on the basis of an estimated useful life of 15 years and a negligible residual value. On 30 June 2022 it is determined that the asset has a value in use of million and a fair value of million before costs of disposal of The remaining useful life of the asset is reassessed to be 8 years. On 30 June 2023 it is determined that the asset has a value in use of million and a fair value of million before costs of disposal of The remaining useful life of the asset is reassessed to be 5 years. Required Prepare the journal entries for any depreciation and impairment adjustments on the following dates. 1. 30 June 2020 2. 30 June 2022 3. 30 June 2023 (LO3 and LO4) 1. 30 June 2020: DR Depreciation Equipment 200 CR Accumulated depreciation impairment losses Equipment 15 200 DR Impairment loss Equipment 400 CR Accumulated depreciation impairment losses Equipment CA of less RA of 400 2. 30 June 2022: DR Depreciation Equipment 250 CR Accumulated depreciation impairment losses Equipment 8 250 DR Impairment loss Equipment 300 CR Accumulated depreciation impairment losses Equipment CA of less RA of 300 3. 30 June 2023: DR Depreciation Equipment 240 CR Accumulated depreciation impairment losses Equipment 5 John Wiley and Sons Australia Ltd, 2018 240 7 Solutions manual to accompany Financial reporting 2e Loftus et al. Exercise 7 Impairment loss of an individual asset incorporating revaluation model At 30 June 2020, an entity holds a block of land from which it generates revenue leasing it to agricultural enterprises. The land has a carrying amount of million. An independent market appraisal has valued the land at million but costs to dispose of the land are estimated at The value in use of land is determined to be million. Required 1. Determine the recoverable amount of the land. 2. Prepare the appropriate journal entry to record any impairment loss that should be recognised. Suppose now that this same block of land was carried under the revaluation model. 3. Prepare the journal entry to record any necessary adjustment assuming there had been no prior revaluations. 4. Prepare the journal entry to record any necessary adjustment assuming there had been a prior revaluation increase of 5. Prepare the journal entry to record any necessary adjustment assuming there had been a prior revaluation increase of (LO3 and LO4) 1. FV less cost of disposal less ViU RA 2. DR Impairment loss CR Accumulated impairment losses Land 170 3. DR Loss on revaluation CR Land 170 4. DR Revaluation surplus CR Land 170 5. DR Revaluation Surplus DR Loss on revaluation CR Land 120 50 John Wiley and Sons Australia Ltd, 2018 170 170 170 170 7 Chapter 7: Impairment of assets Exercise 7 Impairment loss and reversal of an individual asset On 30 June 2020, an item of machinery had a carrying amount of The cost at acquisition was at which time its estimated useful life was 10 years with no residual value. On 30 June 2020, the same item of machinery was assessed as having a recoverable amount of and a remaining useful life of 7 years. On 30 June 2023, the machinery was assessed as having a recoverable amount of and a remaining useful life of 3 years. All machinery is carried under the cost model. Required Show the journal entries for depreciation and any adjustments relating to impairment on each of the following dates. 1. 30 June 2020 2. 30 June 2023 3. 30 June 2024 (LO4 and LO6) John Wiley and Sons Australia Ltd, 2018 7
Ch07 sm loftus 2e
Course: Financial Accounting II (ACCTING 2501)
University: The University of Adelaide
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