Impairment Loss and Accounting Entries

Question: Discuss about the Impairment Loss and Accounting Entries. Answer: Introduction The accounting framework followed in Australia prescribes the accounting standard 136 (AASB 136) to deal with the accounting treatment of the impairment loss (AASB 136, 2007). The impairment loss has been defined as the amount worked out by deducting the recoverable amount from the carrying amount of the asset (Dagwell, Wines, and Lambert, 2011). In the context of this, an essay has been presented here describing the nature of impairment loss and the requirement for its discloser in the financial statements of an entity. This essay covers the discussion on the impairment loss from the accounting view point in the light of the Australian accounting standards. Nature of Impairment Loss The impairment loss is necessary to recognise to bring the assets at the value that would the entity fetch if the assets are sold in the market. The assets are initially recognised at cost in the books of accounts and then re-valued from time to time as per the prevailing market conditions. The accounting principle of prudence requires that the entity should immediately account for the foreseeable losses while the future gains should be ignored until their realisation is ensured (Mukherjee and Hanif, 2003). This implies that the assets should not be overstated and the liabilities should not be understated in the books of accounts of an entity. If there are conditions that indicate that the assets may be overstated, the entity should recognise the impairment loss immediately and bring the asset at the recoverable value (Mukherjee and Hanif, 2003). As per the provisions enunciated in the accounting standard 136, the impairment loss is recognized on all the assets except inventories, deferred tax assets, investment property dealt with as per AASB 140, and few other categories (AASB 136, 2007). This implies that the impairment loss is primarily recognized on the non-current assets such as plant and equipment, building, furniture, and intangibles. Further, it has been provided that the assets are to be considered individually for the computation of the impairment loss. However, where is impracticable to segregate the assets, the impairment loss is to be computed with reference to the entire unit, which is called the cash generating unit (CGU) (AASB 136, 2007). The computation of the impairment loss is made with reference to the carrying amount and the recoverable amount of the assets or CGU. The carrying amount is simply the value at which the assets have been shown in the books of accounts by the entity (Stickney et al., 2009). However, the computations are required for recoverable amount, which is computed with reference to the fair value and value in use of the assets or CGU. The recoverable amount is the higher of fair value less the expenses required to realize the asset and the value in use. Here the value in use is computed by discounting the future cash flows expected from the use of the asset or the CGU. The effectively the impairment loss could be computed as follows (Stickney et al., 2009): Impairment Loss= Carrying amount - [higher of fair value-expenses or value in use] The test for impairment is to be performed at each balance sheet date wherein the entity is required to collect and analyse the information from the internal as well as external sources (AASB 136, 2007). If the analysis of the information indicates that the recoverable amount of assets or CGU is less than the amount at which the assets are carried in the balance sheet, the impairment loss is provided for in the books and assets are restated at the recoverable amount. However, it may be noted here that the test for impairment in case of intangible assets is to be carried out at each balance sheet date disregarding the fact that there was not any indication for such test (AASB 136, 2007). In regard to recognition of the impairment loss, it has been observed that the same is to be charged to the profit and loss account unless there is existing revaluation reserve. If the revaluation reserve is available in respect of the asset which has been impaired, the impairment loss first is to be charged to the revaluation reserve and then the remaining to be charged to the profit and loss account (Ernst and Young LLP, 2015). Further, the carrying amount of the asset is reduced by the amount of impairment loss. Discloser Requirement in Case of Impairment Loss There are detailed discloser requirements in respect of the impairment loss to be followed by the entities in preparation and presentation of the financial statements. As per the provisions contained in the accounting standard, the entity is required to disclose the impairment loss in the profit and loss account as a separate line item (ICAA, 2012). Further, the entity shall also disclose the impairment loss in the notes to accounts pertaining to the impaired asset. The impairment loss is to be shown as a deduction from the carrying amount of the impaired asset. In addition to this, the entity is also required to disclose the events or circumstances which formed the basis for recognition of the impairment loss (AASB 136, 2007). Further, in respect of a cash generating unit, the entity shall disclose the description of all the assets identified as cash generating unit and the basis on which the assets were clubbed under the cash generating unit. Additionally, the impairment loss on cash generating unit is to be allocated on individual assets based on their carrying amount and to be disclosed in the notes to accounts. Apart from this, the entity is also required to disclose the basis used to compute the cash flows for computation of the value in use (AASB 136, 2007). Conclusion From the discussion, it may be articulated that the recognition of the impairment loss is a matter of financial prudence and thus, the entities should adhere to it. The nature of impairment loss, its measurement, and the discloser requirements have been discussed in this essay, which will help the entities in complying with the provisions of the accounting framework. Journal Entries for Impairment Loss Crossbow Ltd: Computation of Impairment Loss for Cash Generating Unit Amount ($) A Carrying Amount of Cash Generating Unit (Excluding Inventory) 1,500,000.00 B Recoverable Amount of Cash Generating Unit 1,420,000.00 C Impairment Loss (A-B) 80,000.00 Note: The inventories are not tested for impairment, hence excluded. The total impairment loss of $80,000 is to be allocated to the individual assets in proportion to their carrying amount. However, it should be noted that the impairment loss is first to be allocated to write of the goodwill and then the remaining amount is to be allocated to other assets in proportion to their carrying amount. Further, it is also to be noted that the impairment loss can not be allocated to the individual asset in excess of the difference of its individual carrying amount and the individual fair value net of selling expenses. In the light of these provisions, the allocation of impairment loss has been presented in the table given below: Allocation of the Impairment Loss to Individual Assets Assets Carrying Amount Impairment Loss Goodwill 40,000.00 40,000.00 Land (2/14.60)*40000 200,000.00 5,479.45 Brand 'Crossbow Shoes' (1.6/14.60)*40000 160,000.00 4,383.56 Shoe Factory (7/14.60)*40000 700,000.00 19,178.08 Machinery (4/14.60)*40000 400,000.00 10,958.90 Total 1,460,000.00 40,000.00 Journal Entry for Impairment Loss Description Debit ($) Credit ($) Impairment Loss 80,000.00 Goodwill 40,000.00 Accumulated impairment losses Land 5,479.45 Accumulated amortization and impairment losses brand 4,383.56 Accumulated depreciation and impairment losses Factory 19,178.08 Accumulated depreciation and impairment losses Machinery 10,958.90 References AASB 136. (2007). Impairment of Assets. [Online]. Available at: https://www.aasb.gov.au/admin/file/content105/c9/AASB136_07-04_COMPapr07_07-07.pdf [Accessed on: 20 September 2016]. Dagwell, R., Wines, G., and Lambert, C. 2011. Corporate accounting in Australia. Pearson Higher Education AU. Ernst and Young LLP. 2015. International GAAP 2016: generally accepted accounting principles under international financial reporting standards. John Wiley Sons. ICAA. 2012. Chartered accountants financial reporting handbook 2012, Google Ebook. John Wiley Sons. Mukherjee and Hanif. 2003. Financial accounting. Tata McGraw-Hill Education. Stickney, C.P., Weil, R.L., Schipper, K., and Francis, J. 2009. Financial accounting: an introduction to concepts, methods and uses. Cengage Learning.