Accounting Alert

This Accounting Alert is issued to provide an overview of Philippine Accounting Standard (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 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 future cash inflows and outflows

The starting point for estimating future cash flows is the most recent financial budget or forecast approved by management that typically needs to be both adjusted and extrapolated. PAS 36 specifically requires that these budgets/forecasts are adjusted to:

• exclude any estimated future cash inflows/outflows expected to arise from future restructuring or improving or enhancing the asset’s performance,
• exclude cash inflows or outflows from financing activities or income tax receipts/payments,
• include cost for day-to-day servicing, future directly attributable overheads and cash flows necessary to maintain the level of economic benefits expected to arise from the asset in its current condition,
• cover a maximum period of five years (unless a longer period can be justified). Cash flow projections needed beyond the period covered must be estimated by extrapolating the budget/forecast projections using a steady or declining growth rate for subsequent years (unless an increasing rate can be justified), and,
• incorporate net cash flows, if any, to be received (or paid) for the disposal of the asset at the end of its useful life.

This list of adjustments is not exhaustive. The specific adjustments required in each case will naturally vary depending upon the basis of the budgets or projections used as a starting point and the nature of expected cash flows.

Reflect reasonable and supportable assumptions

It is an overarching principle of the VIU estimate that assumptions should be ‘reasonable and supportable’. PAS 36 includes a requirement under which management should compare past projections with actual cash flows to ensure the assumptions on which current projections are based are consistent with past actual outcomes.

PAS 36 requires consideration of whether the budget/forecast information used as the basis for the cash flow estimates reflects reasonable and supportable assumptions and management’s best estimate of the set of economic conditions that will exist over the remaining useful life of the asset.

See attached Accounting Alert for further details and illustrative examples.