International Financial Reporting Standrads -Frequently asked questions (FAQ)

Calculation of Value in Use and Recognition of an Impairment Loss

Under IAS 36, value in use is defined as the present value of estimated future cash flows expected to arise from the continuing use of an asset and from its disposal at the end of its useful life. Estimating the value in use, involves the following steps: estimating the future cash inflows and outflows to be derived from continuing use of the asset and from its ultimate disposal; and
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applying the appropriate discount rate to these future cash flows.

Case background At the end of 20X0, enterprise T, a newly created company, acquires a production equipment for 3,000. The anticipated useful life of the production equipment is 15 years. It is depreciated using the straight-line method and no residual value is expected. T has no asset (but financial assets) other than the production equipment. At the end of 20X4, a new government is elected that passes legislation significantly, restricting exports of Ts main product. As a result, and for the foreseeable future, Ts production will be cut by 40%. Question 1:Should any impairment test be performed based on these facts? What is the cash-generating unit for any asset that needs to be tested for impairment? Question 2:In order to be able to determine the recoverable amount of the cashgenerating unit, what information should be made available by Enterprise T? Question 3:Calculate the value in use of the cash-generating unit using the information below.
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Schedule 1: cash flow forecasts for the next five years and growth rates for subsequent years The long-term average growth rate for the market to which the cash-generating unit is dedicated is 3% A pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the cash-generating unit is 15%.

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Schedule 1. Cash flow forecasts for the next five years and growth rates for subsequent years Year 20X5 (n=1) 20X6 20X7 20X8 20X9 20X10 20X11 20X12 20X13 20X14 20X15 20X16 20X17 20X18 20X19 4% -2% -6% -15% -25% -67% -67% -67% -67% -67% Long term growth rates Future cash flows 230 (1) 253 (1) 273 (1) 290 (1) 304 (1)

20X20 -67% (1) Based on managements best estimate of net cash flow projections (after the 40% cut).

Question 4:

Calculate any impairment loss and any consequences using the information below.

The net selling price of the cash-generating unit is estimated to be 1,000 At the end of 20X4, the tax base of the cash-generating unit is 1,100. Impairment losses are not deductible for tax purposes. The tax rate is 40%.

Solution
At the end of 20X0, enterprise T, a newly created company, acquires production equipment X for 3,000. The anticipated useful life of the production equipment is 15 years. It is depreciated using the straight-line method and no residual value is expected. T has no asset (but financial assets) other than the production equipment. At the end of 20X4, a new government is elected that passes legislation significantly, restricting exports of Ts main product. As a result, and for the foreseeable future, Ts production will be cut by 40%.

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Question 1:Should any impairment test be performed based on these facts? What is the cash-generating unit for any asset that needs to be tested for impairment?

The significant export restriction and the resulting production decrease will reduce the future revenues expected to be generated by the production equipment. It therefore requires T to estimate the recoverable amount of the production equipment. The cash-generating unit of the production equipment is T as whole since there is no other asset that generates cash inflows independent from the production equipment.
Question 2:In order to be able to determine the recoverable amount of the cash-generating unit, what information should be made available by Enterprise T?

To determine the value in use of the equipment, T needs: (a) to prepare cash flow forecasts derived from the most recent financial budgets/forecasts for the next coming years (in this case years 20X5-20X9), approved by management; (b) to estimate subsequent cash flows until the end of the useful life of the equipment (i.e., years 20X10-20X15) using steady or declining growth rates. These rates should not exceed the longterm average growth rate for the market to which the equipment is dedicated, unless a higher rate can be justified (which is not the case); (c) to select a discount rate, which represents a pre-tax rate that reflects current market assessments of the time value of money and the risks specific to the equipment.
Question 3: Calculate the value in use of the cash-generating unit using the information below.

Schedule 1: cash flow forecasts for the next five years and growth rates for subsequent years The long-term average growth rate for the market to which the cash-generating unit is dedicated is 3% A pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the cash-generating unit is 15%.

Schedule 1. Cash flow forecasts for the next five years and growth rates for subsequent years Year Long term growth rates Future cash flows

Present value factor at 15% discount rate (3) 0,86957 0,75614 0,65752 0,57175 0,49718 0,43233 0,37594

Discounted future cash flows 200 191 180 166 151 135 115

20X5 (n=1) 20X6 20X7 20X8 20X9 20X10 20X11

230 (1) 253 (1) 273 (1) 290 (1) 304 (1)

3%
-2%

313 (2) 307 (2)

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20X12 20X13 20X14

-6% -15% -25%

289 (2) 245 (2) 184 (2) 61 (2)

0,32690 0,28426 0,24719 0,21494

94 70 45 13 1,360

20X15
(1)

-67%

(2) (3)

Based on managements best estimate of net cash flow projections (after the 40% cut).

Based on an extrapolation from preceding year cash flow using declining growth rates. The present value factor is calculated as k = 1/(1+a)n, where a = discount rate and n = period of discount.

The value in use of the equipment is 1,360 (no ultimate cash flow since there is no residual value). Question 4: Calculate any impairment loss and any consequences using the information below.

The net selling price of the cash-generating unit is estimated to be 1,000 At the end of 20X4, the tax base of the cash-generating unit is 1,100. Impairment losses are not deductible for tax purposes. The tax rate is 40%.

The recoverable amount of the production equipment is 1,360: the higher of the net selling price of the production equipment (1,000) and its value in use (1,360). T compares the recoverable amount of the production equipment to its carrying amount (see Schedule 2). Schedule 2. Calculation of the impairment loss at the end of 20X4 Historical cost Accumulated depreciation (20X1-20X4) Carrying amount Recoverable amount Impairment loss Carrying amount after impairment loss 3,000 800 2,200 1,360 (840) 1,360

T recognizes an impairment loss of 840 immediately in the income statement. The recognition of the impairment loss on the production equipment reduces the taxable temporary difference related to it. The deferred tax liability is reduced accordingly.

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End of 20X4

Equipment before impairment loss 2,200 1,100 1,100 440

Impairment loss

Equipment after impairment loss 1,360 1,100 260 104

Carrying amount Tax base Taxable temporary difference Deferred tax liability (@ 40%)

(840) -(840) (336)

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