Accounting Alerts

Insights into PAS 36 - Other impairment issues

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

PAS 36, Impairment of Assets, is a Standard that has been on issue for many years. However, some areas of the Standard are complex and therefore can be challenging to apply in practice, and therefore many entities struggle when determining whether or not their assets should be impaired.

This article considers some regularly encountered application issues when applying PAS 36, which are:

  • Deferred tax and goodwill problem
  • Non-controlling interests
  • Equity accounting, and
  • The interaction between PAS 36 and other PFRS

Deferred tax and goodwill problem

This refers to a well-known application issue that sometimes arises in testing goodwill for impairment. In some business combinations, goodwill arises mainly or solely as a consequence of deferred tax liabilities (DTLs). DTLs are recognized (and increase goodwill) when the acquisition date fair value of identifiable assets exceeds their tax base. The effect of deferred tax on goodwill is relevant to most business combinations but can be particularly significant for acquisitions involving:

  • properties acquired in a corporate shell for which the tax base is driven by the historical amount paid by the shell entity; and, 
  • intangible assets that are recorded at fair value by the acquirer but were not recognized by the acquired entity (and therefore have a tax base of zero).

Non-controlling interests

Non-controlling interests (NCI) are equity instruments of the acquiree not held directly or indirectly by the acquirer and arise when a parent holds less than 100% of the equity of a subsidiary. PFRS 3 includes an accounting policy option to initially measure NCI at either:

  • fair value; or,
  • the proportionate interest in the acquiree’s recognized identifiable net assets.

When the fair value model is used, 100% of the goodwill in the acquiree is effectively recognized (both the acquirer’s and the NCI’s share) in the statement of financial position. This is sometimes described as the ‘full goodwill’ method. In this case, when the entity performs its impairment review, there is no ‘mismatch’. This is because VIU and FVLCOD are estimated based on 100% of the asset or CGU under review and its related cash flows.

In practice, however, an acquirer more often measures NCI at the proportionate interest in the acquiree’s recognized identifiable net assets. In this case, only the acquirer’s interest in the goodwill is recognized (‘partial goodwill’ method). Therefore, without an adjustment, the carrying value of the CGU is understated because recoverable amount is based on 100% of the cash flows but the carrying value does not include all the goodwill that contributes to those cash flows).

If an impairment loss then arises, this must be allocated between the amount relating to the parent’s recognized goodwill and the NCI share. Only the impairment loss relating to the goodwill that is allocated to the parent is recognized as a goodwill impairment loss.

Equity accounting

The requirements of PAS 36 apply to subsidiaries, associates and joint ventures accounted for under the cost method in the parent’s separate financial statements and to investments accounted for using the equity method in accordance with PAS 28, Investments in Associates and Joint Ventures.

Interaction between PAS 36 and other PFRS Standards

PAS 36 and PAS 34, Interim Financial Reporting

PAS 36 calls for an assessment ‘at the end of each reporting period’ for any indication that an asset may be impaired. For entities that prepare half-yearly or quarterly financial statements in accordance with PAS 34, the assessment will be more frequent than for entities that prepare only annual financial statements.

PAS 34 requires an entity to apply the same accounting policies in its interim financial statements as are applied in its annual financial statements.

PAS 34 also states the frequency of an entity’s reporting (annual, half-yearly, or quarterly) should not affect the measurement of its annual results. However, the frequency of reporting can in fact affect annual results when an entity recognizes an impairment loss on goodwill in an interim period. This loss cannot be reversed even if conditions change at the end of the annual period and indicate that the impairment loss would have been reduced or avoided (had the entity only reported annually).

IFRIC 10, Interim Financial Reporting and Impairment, effectively confirms that the prohibition on reversing goodwill impairment in PAS 36 overrides the statement in PAS 34.

See attached Accounting Alert for further details and illustrative examples.