Most organisations are being impacted by the coronavirus (COVID-19) pandemic, either directly or indirectly, and the increased economic uncertainty and risks may have significant financial reporting implications.
Many organisations are having to consider the carrying amount of their non-financial assets given the shutdown of businesses, idle assets and the general downturn in markets resulting from the COVID-19 outbreak. Impairment of non-financial assets is a complex area generally and requires much judgement and estimation, the complexity of which is only exacerbated during this time of economic uncertainty.
Disruptions to business operations and increased economic uncertainty may trigger the need to perform impairment testing.
Actions for management to take now
- Consider whether there are any indicators of impairment for the entity’s CGUs or assets that are tested on a stand-alone basis.
- Consider whether cash flow forecasts which reflect the entity’s expectations about the duration and severity of shutdowns and speed of recovery are consistent with external information available at reporting date.
- Consider whether discount rates have been updated to reflect the current risk environment.
- Consider consistency with assumptions used in other cash flow projections such as the going concern basis.
Common financial reporting questions
- Are assets which are no longer used included in a CGU for impairment testing?
- When corporate assets, for example leased space, are no longer used how are they tested for impairment?
- What should an organisation consider when recognising deferred tax assets this reporting period?
- When should I do my impairment testing?
- Does a detailed impairment analysis need to be undertaken when an organisation’s market capitalisation falls below its net assets?
- If market capitalisation is an indicator, is management required to assess the recoverable amount for all cash generating units (CGUs)?
- What are examples of potential indicators of impairment?
- How is cash flow uncertainty risk factored into recoverable amount assessments?
- When is it appropriate to use a most likely vs a probability weighted cash flow approach to determining recoverable amounts?
- Can an external valuation with a valuation uncertainty disclaimer arising from COVID-19 be relied on for impairment testing?
- Are recoverable amount cash flows updated for events which occur post period end?
- Are more impairment-related disclosures expected due to COVID-19?
- I have temporarily ceased my operations, should depreciation continue to be recognised on idle assets?
Are assets which are no longer used included in a CGU for impairment testing?
A CGU includes assets that generate cash inflows from their continuing use. An asset which is no longer used would not be included in a CGU and instead is tested for impairment separately as an individual asset. For example, where a department store closes one floor of its store, as the floor is considered a separate asset and it is no longer being used, it would be assessed for impairment as an individual asset and not included in the CGU with the rest of the store.
In contrast, assets that are used less efficiently due to social distancing requirements (e.g. an office floor used at 70% capacity), would continue to be included in their normal CGU for impairment testing.
When corporate assets, for example leased space, are no longer used how are they tested for impairment?
Corporate assets are assets that relate to more than one CGU. For impairment testing, corporate assets are either allocated across related CGUs or included in an impairment test applied to the collection of CGUs they support.
For example, a chain of retail stores may be supported by a rented head office with two floors. The retailer can benefit from each floor separately and the floors are not highly dependent on nor inter-related with each other. Each office floor would be considered a separate lease, and therefore separate corporate assets.
When one of the office floors stops being used it no longer relates to any CGUs. Therefore the right of use asset for the floor no longer used would not be treated as a corporate asset for impairment testing purposes but tested for impairment separately as an individual asset.
What should an organisation consider when recognising deferred tax assets this reporting period?
Deferred tax assets (DTAs) are recognised to the extent that it is probable that future taxable profits will be available – either through the availability of qualifying deferred tax liabilities (DTLs) or other future taxable profits and tax planning opportunities.
In the current circumstances, a company’s projections of future taxable profits may be affected by:
- changes in forecast cash flows
- changes in a company’s tax strategies
- substantively enacted changes to the income tax law introduced as part of a government’s measures in response to COVID-19
- changes in a company’s plans to repatriate or distribute profits of a subsidiary (which may result in an increase in DTLs).
Some of these changes may reduce future taxable profits or change their timing, while others may potentially increase them.
When preparing projections of future taxable profits for the purposes of assessing the recoverability of deferred tax assets, organisations need to reflect expectations at the reporting date and use assumptions that are consistent with those used for other recoverability assessments.
When should I do my impairment testing?
The assessment of whether there is an indicator, and any associated impairment testing is performed at the end of the reporting period. In practice however, it is common that organisations do this analysis prior to year-end.
However, where conditions change between the date of the impairment analysis and year-end, organisations may have to re-perform their impairment assessment considering this new information. Given the volatility in market conditions, organisations may want to reconsider the timing of their impairment assessments or plan for a process of updating the impairment analysis closer to the end of the reporting period.
Does a detailed impairment analysis need to be undertaken when an organisation’s market capitalisation falls below its net assets?
Market capitalisation falling below net assets is an indicator of impairment under AASB 136 Impairment of Assets. However, this sole indicator does not automatically lead to mandatory impairment testing. An organisation should consider the magnitude of the deficiency and whether there are other impairment indicators.
If market capitalisation is an indicator, is management required to assess the recoverable amount for all cash generating units (CGUs)?
Market capitalisation is an indicator of the value of an organisation as a whole, as opposed to separate cash generating units (CGUs). As a result, when this indicator is triggered, an entity will apply judgement to determine whether it needs to undertake a detailed impairment assessment for all CGUs or only a subset that might have had other impairment indicators triggered.
What are examples of potential indicators of impairment?
Declining margins and profitability, temporary shutdowns, proposed restructurings and requesting staff to take unpaid leave, could be indicators of underutilised assets and therefore potentially indicators of impairment. In addition, many of the non-going concern indicators discussed in the going concern topic would also be considered indicators that would trigger impairment assessments.
How is cash flow uncertainty risk factored into recoverable amount assessments?
Cash flow uncertainty should be factored into recoverable amount models determined on a discounted cash flow basis. These uncertainties can be factored into either the cash flows or the discount rate. The two approaches used in practice include:
- modelling one set of “Most likely” cash flows, discounted at a discount rate that is adjusted for cash flow uncertainty risk
- probability weighting multiple likely cash flow scenarios, discounted at discount rates that exclude cash flow uncertainty risk (also known as the Expected cash flow approach).
When is it appropriate to use a most likely vs a probability weighted cash flow approach to determining recoverable amounts?
Organisations should identify where the key areas of uncertainty are in their cash flow models, and what the reasonably possible changes in those cash flows could be.
Where an organisation finds it challenging to determine a single “most likely” set of cash flows, it may be appropriate to use a probability weighted approach to capture the greater uncertainty of the potential future cash flow scenarios.
If however an organisation is able to develop a clearer view of their most likely future cash flows, or considers the upside and downside cash flow scenarios to be equally likely, then a single most likely cash flow approach with adjustments to the discount rate for cash flow uncertainty risk may be a reasonable approach.
Can an external valuation with a valuation uncertainty disclaimer arising from COVID-19 be relied on for impairment testing?
If a disclaimer is included in a valuation report, organisations need to understand the purpose of that disclaimer and whether and how risk associated with COVID-19 has been reflected in the valuation. For example, has uncertainty associated with COVID-19 been reflected in the valuation and the disclaimer is to draw attention to the effects of COVID-19 being uncertain, or have uncertainties associated with COVID-19 not been reflected in the valuation.
Cash flow uncertainty risk is required to be adjusted for in both fair value less cost of disposal and value in use valuations. Where uncertainty risk associated with COVID-19 has not been reflected in the valuation, adjustments will be required to rely on the valuation for impairment testing.
Are recoverable amount cash flows updated for events which occur post period end?
It depends on whether the events that occur post balance date are adjusting or non-adjusting events. To determine whether an event is an adjusting event, organisations should consider whether revised assumptions arising from this post balance date event could be reasonably expected to be made as at period end.
For example, if in mid-July 2021 a government restriction requiring the closure of football stadiums to fans is lifted, an organisation considers whether any information was available at 30 June 2021 to indicate the likely removal of that restriction in or around mid-July.
The following factors could indicate cash flows should be adjusted to reflect the lifting of restrictions in mid-July:
- the government announced in June that they expect to lift the restrictions in mid-July if certain targets were met; and
- management’s best estimate based on publicly available information at 30 June was that these targets would be met.
There may be significant judgment involved in assessing whether information existed at period end supporting the specific event being reasonably expected at year end.
Where the amounts in the financial statements are not adjusted, material non-adjusting subsequent events are disclosed, including the nature of such events and where possible an estimate of their financial effect, or a statement that such an estimate cannot be made.
Are more impairment related disclosures expected due to COVID-19?
Yes. It is expected that the level of disclosure on judgments and estimates be increased as a result of the additional uncertainty associated with the impact of COVID-19.
Detailed disclosures on judgments and estimates relating to impairment assessments are required where:
- there is an impairment recognised;
- an impairment test has been mandatorily performed due to the existence of goodwill or an indefinite life asset; or
- there is a significant risk of a material adjustment to the carrying amounts of assets.
Disclosures may include details of key scenarios modelled and assumptions made, approach used to reflect cash flow risk uncertainty, sensitivity of the carrying amount of assets to assumptions and external sources of information used.
I have temporarily ceased my operations, should depreciation continue to be recognised on idle assets?
Depreciation of an asset commences when the asset is available for use, and ends at the earlier of the asset being classified as held for sale (applying AASB 5 Non-Current Assets Held for Sale and Discontinued Operations) or being written off.
Depreciation does not cease when an asset becomes idle or is retired from active use unless the asset is fully depreciated. However, if a usage method of depreciation has always been applied, such as units of production, the depreciation charge can be zero while there is no production.