Accounting Alert

This Accounting Alert is issued to provide an overview of Philippine Accounting Standards (PAS) 36, Impairment of Assets, to assist preparers of financial statements and those charged with the governance of reporting entities understand the requirements set out in PAS 36 and revisit some areas where confusion has been seen in practice.

Overview

The recoverable amount of an asset or a cash generating unit is the higher of its fair value lest costs of disposal (FVLCOD) and its value in use (VIU).  Estimating VIU involves estimating the future cash inflows and outflows to be derived from continuing to use the asset and from its ultimate disposal and applying the appropriate discount rate to those future cash flows.

Estimating the appropriate discount rate

The discount rate applied to the estimated cash flows should reflect the return that investors would require if they were to choose an investment that would generate cash flows of amounts, timing and risk profile equivalent to those the entity expects to derive from the asset. PAS  36 prescribes that management should apply a pre-tax discount rate(s) that reflects the current market assessment of both:

• the time value of money; and,
• the risks specific to the asset for which the future cash flowestimates have not been adjusted.

This rate may be estimated:

• from the rate implicit in current market transactions for similar assets, or,
• from the weighted average cost of capital (WACC) of a listed entity that has a single asset (or a portfolio of assets) similar in terms of service potential and risks to the asset under review.

In the event that neither of the above are available, the entity estimates the discount rate using surrogates.

Foreign currency issues

PAS 36 requires an entity to estimate future cash flows in the currency in which the cash flows will be generated and then discount the cash flows to present value using a discount rate appropriate for that currency. The entity then determines the VIU in its functional currency by translating the present value using the spot exchange rate at the date of the VIU calculation.

Exceptions to calculating both fair value less costs of disposal and value in use

Although recoverable amount is defined as the higher of the FVLCOD and VIU, PAS 36 makes it clear that it is not always necessary to determine both estimates. Below are the instances when an entity need only to calculate either FVLCOD or VIU:

• when either amount exceeds the asset’s carrying amount;
• when it is not possible to measure FVLCOD because there is no basis for making a reliable estimate of the price in accordance with PFRS 13, Fair Value Measurement;and,
• when there is no reason to believe that VIU materially exceeds FVLCOD.

Shortcuts for estimating FVLCOD or VIU

PAS 36 clarifies it is sometimes not necessary to perform the detailed computations for determining FVLCOD or VIU. Estimates, averages and/or computational shortcuts may be used when they provide reasonable approximations of the detailed computations for determining FVLCOD or VIU. PAS 36 also provides relief from calculating recoverable amount in some situations when an indicator has been identified or the annual impairment testing date has been reached.

See attached Accounting Alert for further details and illustrative examples.