Insight required on Impairment.

[syedshiraz]

Hello everyone. I am an actuary. We have had some arguments recently with our auditors who insist on an impairment provision on our equity portfolio. I however do not agree to their logic, and believe that their education needs re-education. I believe they have yet to realize the concept behind impairment, and even though they are ever so keen to drag IAS 36 and IAS 39 in our argument, I do not find any clear indications as to a proper guidance to its determination but rather just crude judgement. Anyone willing to share their thoughts as to how they define impairment? Also, are there any established and working standards to fair value determination currently playing their role in pakistan or do all auditors stupidly realize market prices as fair value.

[Excel]

U may seek advice from KAMRAN ACA.
Hopefully he will clear ur problem.[)]

[irfan.mansoor]

You should refer to IAS 36 (Impairment of Assets)

Objective

To ensure that assets are carried at no more than their recoverable amount, and to define how recoverable amount is determined.

Scope

IAS 36 applies to all assets except [IAS 36.2]

inventories (see IAS 2)
assets arising from construction contracts (see IAS 11)
deferred tax assets (see IAS 12)
assets arising from employee benefits (see IAS 19)
financial assets (see IAS 39)
investment property carried at fair value (see IAS 40)
agricultural assets carried at fair value (see IAS 41)
insurance contract assets (see IFRS 4)
non-current assets held for sale (see IFRS 5)
Therefore, IAS 36 applies to (among other assets)

land
buildings
machinery and equipment
investment property carried at cost
intangible assets
goodwill
investments in subsidiaries, associates, and joint ventures carried at cost
assets carried at revalued amounts under IAS 16 and IAS 38
Key Definitions [IAS 36.6]

Impairment an asset is impaired when its carrying amount exceeds its recoverable amount

Carrying amount the amount at which an asset is recognised in the balance sheet after deducting accumulated depreciation and accumulated impairment losses

Recoverable amount the higher of an asset's fair value less costs to sell (sometimes called net selling price) and its value in use

Fair value the amount obtainable from the sale of an asset in an arm's length transaction between knowledgeable, willing parties

Value in use the discounted present value of the future cash flows expected to arise from

the continuing use of an asset, and from
its disposal at the end of its useful life
Identifying an Asset That May Be Impaired

At each balance sheet date, review all assets to look for any indication that an asset may be impaired (its carrying amount may be in excess of the greater of its net selling price and its value in use). IAS 36 has a list of external and internal indicators of impairment. If there is an indication that an asset may be impaired, then you must calculate the asset's recoverable amount. [IAS 36.9]

The recoverable amounts of the following types of intangible assets should be measured annually whether or not there is any indication that it may be impaired. In some cases, the most recent detailed calculation of recoverable amount made in a preceding period may be used in the impairment test for that asset in the current period [IAS 36.10]

an intangible asset with an indefinite useful life
an intangible asset not yet available for use
goodwill acquired in a business combination
Indications of Impairment [IAS 36.12]

External sources

market value declines
negative changes in technology, markets, economy, or laws
increases in market interest rates
company stock price is below book value
Internal sources
obsolescence or physical damage
asset is part of a restructuring or held for disposal
worse economic performance than expected
These lists are not intended to be exhaustive. [IAS 36.13] Further, an indication that an asset may be impaired may indicate that the asset's useful life, depreciation method, or residual value may need to be reviewed and adjusted. [IAS 36.17]

Determining Recoverable Amount

If fair value less costs to sell or value in use is more than carrying amount, it is not necessary to calculate the other amount. The asset is not impaired. [IAS 36.19]
If fair value less costs to sell cannot be determined, then recoverable amount is value in use. [IAS 36.20]
For assets to be disposed of, recoverable amount is fair value less costs to sell. [IAS 36.21]
Fair Value Less Costs to Sell

If there is a binding sale agreement, use the price under that agreement less costs of disposal. [IAS 36.25]
If there is an active market for that type of asset, use market price less costs of disposal. Market price means current bid price if available, otherwise the price in the most recent transaction. [IAS 36.26]
If there is no active market, use the best estimate of the asset's selling price less costs of disposal. [IAS 36.27]
Costs of disposal are the direct added costs only (not existing costs or overhead). [IAS 36.28]
Value in Use

The calculation of value in use should reflect the following elements [IAS 36.30]

an estimate of the future cash flows the entity expects to derive from the asset
expectations about possible variations in the amount or timing of those future cash flows
the time value of money, represented by the current market risk-free rate of interest
the price for bearing the uncertainty inherent in the asset
other factors, such as illiquidity, that market participants would reflect in pricing the future cash flows the entity expects to derive from the asset
Cash flow projections should be based on reasonable and supportable assumptions, the most recent budgets and forecasts, and extrapolation for periods beyond budgeted projections. [IAS 36.33] IAS 36 presumes that budgets and forecasts should not go beyond five years; for periods after five years, extrapolate from the earlier budgets. [IAS 36.35] Management should assess the reasonableness of its assumptions by examining the causes of differences between past cash flow projections and actual cash flows. [IAS 36.34]

Cash flow projections should relate to the asset in its current condition – future restructurings to which the entity is not committed and expenditures to improve or enhance the asset's performance should not be anticipated. [IAS 36.44]

Estimates of future cash flows should not include cash inflows or outflows from financing activities, or income tax receipts or payments. [IAS 36.50]

Discount Rate

In measuring value in use, the discount rate used should be the pre-tax rate that reflects current market assessments of the time value of money and the risks specific to the asset. [IAS 36.55]

The discount rate should not reflect risks for which future cash flows have been adjusted and should equal the rate of return that investors would require if they were to choose an investment that would generate cash flows equivalent to those expected from the asset. [IAS 36.56]

For impairment of an individual asset or portfolio of assets, the discount rate is the rate the entity would pay in a current market transaction to borrow money to buy that specific asset or portfolio.

If a market-determined asset-specific rate is not available, a surrogate must be used that reflects the time value of money over the asset's life as well as country risk, currency risk, price risk, and cash flow risk. The following would normally be considered [IAS 36.57]

the entity's own weighted average cost of capital;
the entity's incremental borrowing rate; and
other market borrowing rates.
Recognition of an Impairment Loss

An impairment loss should be recognised whenever recoverable amount is below carrying amount. [IAS 36.59]
The impairment loss is an expense in the income statement (unless it relates to a revalued asset where the value changes are recognised directly in equity). [IAS 36.60]
Adjust depreciation for future periods. [IAS 36.63]
Cash-Generating Units

Recoverable amount should be determined for the individual asset, if possible. [IAS 36.66]

If it is not possible to determine the recoverable amount (fair value less cost to sell and value in use) for the individual asset, then determine recoverable amount for the asset's cash-generating unit (CGU). [IAS 36.66] The CGU is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets. [IAS 36.6]

Impairment of Goodwill

Goodwill should be tested for impairment annually. [IAS 36.96]

To test for impairment, goodwill must be allocated to each of the acquirer's cash-generating units, or groups of cash-generating units, that are expected to benefit from the synergies of the combination, irrespective of whether other assets or liabilities of the acquiree are assigned to those units or groups of units. Each unit or group of units to which the goodwill is so allocated shall [IAS 36.80]

represent the lowest level within the entity at which the goodwill is monitored for internal management purposes; and
not be larger than an operating segment determined in accordance with IFRS 8 Operating Segments.
A cash-generating unit to which goodwill has been allocated shall be tested for impairment at least annually by comparing the carrying amount of the unit, including the goodwill, with the recoverable amount of the unit [IAS 36.90]

If the recoverable amount of the unit exceeds the carrying amount of the unit, the unit and the goodwill allocated to that unit is not impaired.
If the carrying amount of the unit exceeds the recoverable amount of the unit, the entity must recognise an impairment loss.
The impairment loss is allocated to reduce the carrying amount of the assets of the unit (group of units) in the following order [IAS 36.104]

first, reduce the carrying amount of any goodwill allocated to the cash-generating unit (group of units); and
then, reduce the carrying amounts of the other assets of the unit (group of units) pro rata on the basis.
The carrying amount of an asset should not be reduced below the highest of [IAS 36.105]

its fair value less costs to sell (if determinable),
its value in use (if determinable), and
zero.
If the preceding rule is applied, further allocation of the impairment loss is made pro rata to the other assets of the unit (group of units).
Reversal of an Impairment Loss

Same approach as for the identification of impaired assets assess at each balance sheet date whether there is an indication that an impairment loss may have decreased. If so, calculate recoverable amount. [IAS 36.110]
No reversal for unwinding of discount. [IAS 36.116]
The increased carrying amount due to reversal should not be more than what the depreciated historical cost would have been if the impairment had not been recognised. [IAS 36.117]
Reversal of an impairment loss is recognised as income in the income statement. [IAS 36.119]
Adjust depreciation for future periods. [IAS 36.121]
Reversal of an impairment loss for goodwill is prohibited. [IAS 36.124]
Disclosure

Disclosure by class of assets [IAS 36.126]

impairment losses recognised in profit or loss
impairment losses reversed in profit or loss
which line item(s) of the statement of comprehensive income
impairment losses on revalued assets recognised in other comprehensive income
impairment losses on revalued assets reversed in other comprehensive income
Disclosure by reportable segment [IAS 36.129]

impairment losses recognised
impairment losses reversed
Other disclosures

If an individual impairment loss (reversal) is material disclose [IAS 36.130]

events and circumstances resulting in the impairment loss
amount of the loss
individual asset nature and segment to which it relates
cash generating unit description, amount of impairment loss (reversal) by class of assets and segment
if recoverable amount is fair value less costs to sell, disclose the basis for determining fair value
if recoverable amount is value in use, disclose the discount rate
If impairment losses recognised (reversed) are material in aggregate to the financial statements as a whole, disclose [IAS 36.131]

main classes of assets affected
main events and circumstances
Disclose detailed information about the estimates used to measure recoverable amounts of cash generating units containing goodwill or intangible assets with indefinite useful lives. [IAS 36.134-35]

http//www.iasplus.com/standard/ias36.htm

[kamranACA]

@Shiraz sb

I request you to use decent language about other professions and the professionals if you really carry some knowledge thirst. This is itself a stupidity, if a professional of one field, for the sake of something of which he knows NOTHING and for the sake of his own understanding dilemma, calls the other professional a stupid. Certainly an engineer will not be telling a surgeon how to operate a heart. If he does, it would itself be a stupidity. So, please try to avoid it because it shows some personal grudge and incapacity to grasp the things professionally.

There are a wide ranged professional pronouncements on fair value concept that have been worldwide deliberated, discussed, accepted and approved AND on which brains from USA, Europe and other countries have worked for different phases over a long period. The development of IASs and IFRSs entails a whole process which you need to understand. Yes, disagreements do occur and are recorded properly, but, the thing that attains finality is the one which is approved with majority's global consensus after a greater deal of research.

Still, the work on Fair Value accounting has not been stopped and this process is going on globally, keeping in view the emerging dynamics of global markets, which possess a varying level of characteristics.

Further, such pronouncements, IASs, IFRSs, ISAs etc are followed by auditors in any country when its regulator statutorily or legally notifies them. Once notified, these become legally enforceable. These IAS-36 and 39 are not a piece of trash as you have expressed. These are legally enforced standards in Pakistan and any departure from these standards has to be questioned / pointed out. A thing that is worldwide accepted and then adopted by Pakistan and is legally enforced; how could it be ignored by the auditors? Yes, the regulator who enforces them can provide the exemptions / relaxations from such requirements, if it deems fit. Do the auditors have any personal issues with you or your entity or carry any malafied intentions? If yes, do raise this point with your board of directors or shareholders or as a last resort, contact ICAP or the SECP to get the issue resolved. If all of them are not listening to you (as your frustration speaks about it) then try to develop a habit of calling an apple as apple and factually understanding a stupid as stupid. )

The audit profession in Pakistan is the most regulated profession when listed companies and large scale entities come under question. Their work is always subject to review by regulators, their own professional body, international firms of which they carry the memberships (mind it; these international firms hail from the most advanced USA or Western countries) and Even by internal quality control reviewers under the requirements of ISQC-1. Specially the firms that use e-audit techniques, their work is uploaded on the cyberspace which always remains subject to review by their mother international firms. The adverse results of reviews carry irreparable impacts on the professional stature of the firms, if you can understand it properly. Had the thing you are pointing out been a stupidity, such stupidity must have been captured through so many of these deterrents. If it has not been captured, questioned, surfaced or highlighted, then this should make sense for you.

I hope you would try to understand above brief insights on the subject and would try to mind your own business of actuarial services instead of poking nose in the specialized audit job without having its knowledge and understanding. There are usually finance/accounts departments, audit committees, board of directors etc (and eventually the direct and indirect regulators) to take care of the issues regarding what auditors are doing and objecting. Let them do their job since they are the right people to do it. If you are really interested to know what is what, advice for you is to jump into this profession, undergo the whole process and then learn what is what. Theoretically no effort can make you a master through any shortcuts.

If you have any concrete question or logic, do come forward with it, and I am here to respond.

Regards,

[kamranACA]

I would again request the members of the forum to behave professionally in next discussions/posts (specially on this thread) so that the decorum can be maintained.

Regards,

[sohail kashif]

yea you are absolutely right kamran sb. the person who have not concept of IASs or IFRSs will not be engaged in the audit as is the case of sheraz sb.