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Critique Paper on Impairment of Assets

A critique paper on Impairment of long-lived assets by Sergey Komissarov, Joseph T. Kastantin, and Katherine Rick.
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  Impairment of Long-Lived Assets A Comparison under the ASC and IFRS Presented to the Accountancy Department De La Salle University In Partial Fulfillment of The Course Requirements in MODFIN2 K34 Co, Joshua Tan  A.   Phenomena Being Studied It is important for any firm to properly state their assets and liabilities so that they may  present proper information in their financial statements. Property, plant, and equipment are an important part of the financial position of an entity and makes up the bulk of their assets. Overstating these may result to overconfident decisions by the firm and misinterpretations from creditors and investors. Understating them on the other hand, may result in missed opportunities especially in terms of business decisions and investments. With that said it is indeed one of the most important aspects to account for properly. Depreciation is simple enough to properly allocate the depreciable amount of an asset over its useful life. Impairment on the other hand is a much more complicated matter. While depreciation poses a more systematic approach, impairment requires more of assessment and appraisal, and that is where difficulty may arise. An accounting paper done by Sergey Komissarov, Joseph T. Kastanin, and Katherine Rick, entitled “ Impairment of Long-Lived Assets ” , gives us an understanding of the differences between the Financial Accounting Standards Board‟s (FASB) Accounting Standards Codification‟s  (ASC) approach and the International Accounting Standards Board „s (IA SB) approach through its implementation of International Financial Reporting Standards (IFRS). The paper shows how these 2 approach the process of impairment and how large the disparities may be between companies that use one or the other. Particularly the paper looks at ASC topic 350 on property,  plant, and equipment and topic 350 on Intangible assets, and compares those to IFRS (IAS 16) on property, plant, and equipment, and IAS 38 on intangible assets . B.   Key Concepts Impairment by definition is a fall in the market value of an asset when its recoverable amount is lower than its carrying amount. This is to properly value the asset when there is evidence that its carrying value cannot be recoverable in full. It is important to note that assets should not be carried above its recoverable amount, following a conservative approach in accounting. Recoverable amount now, is defined as the net amount expected to be recovered from the net inflows and outflows of cash from the continued use of the asset and its subsequent disposal. The paper uses the term long-lived assets as the term for non-current assets, but they essentially mean the same thing. The paper clearly distinguishes between tangible and intangible assets, particularly putting emphasis on goodwill. Goodwill can be defined, as an intangible asset  that is not specifically identifiable, doesn‟t have a definite life, and it is part of the business and entity. Putting it in other words, goodwill is present in an entity due to the success of the company, so much so that its value is higher than its current carrying amount. As we learned in our modfin2 class, cash generating unit are the smallest identifiable group of assets that generate cash flows to the entity from continuing use. These groups may refer to departments, product lines, and the like. It is important to note here that these CGUs must be the smallest group identifiable and must be independent of cash flows form other groups. As part of determining the recoverable amount, we will run into the term, value in use, which is basically the present net worth of the asset calculated by taking the present value of its future net cash flows to the entity. C.   Analysis of Framework Based on what we learned from our modfin2 class, after initial measurement, a firm will choose either the cost model or the revaluation model as its accounting policy for subsequent measurement for property, plant and equipment. Revaluation model uses the fair value method at date of revaluation less any impairment loss and depreciation. By this method, the value of the asset can go way beyond its carrying amount, following the movements in fair value, and must  be done with sufficient regularity. The revalued amount must always be at the fair value appraised by professionals. If the fair value is not obtainable, then the revalued amount must be the depreciated replacement cost. We however will be talking more about the cost model where in the carrying amount should be compared to the recoverable amount and the difference when the recoverable amount is lower, shall be written off as impairment loss. The paper talks about how ASC and IFRS both provide the following: external and internal qualitative factors that determine impairment, treat impairment currently and prospectively, apply impairment equally to individual assets and groups and liabilities, testing for impairment at the lowest level of assets or liabilities, combination of goodwill and other non-identifiable assets, and require a certain level of disclosure for the impaired assets. So both ASC and IFRS agree as to how to address impairment. When talking about qualitative impairment factors, ASC and IFRS have similar characteristics. These are when: there is a significant decrease in the market price for the asset, a decrease in the productive utilization of the asset, a radical change in the legal environment of the asset, an increase in expected costs, continuous losses (negative cash flows), and greater than 50% probability that an asset will be prematurely disposed off. Both again agree on when  impairment should be recognized. The paper also mentions factors in terms of goodwill as follows: a subsidiary has recognized impairment, a business being disposed off that contains goodwill, a significant group of the reporting entity will be disposed off, an increase in input factors, a decrease in cash flows, a change in key personnel, a change in the market for the  product, and a change in macroeconomic factors. With that said, IFRS has 2 additional factors: when the entity issues dividends and the carrying amount in the consolidated statements exceeds those in the separate statements, and also when dividends are declared exceeding the total comprehensive income. Here we see that IFRS is a step ahead of ASC in that it recognizes an impairment of goodwill (as the paper mentioned, are in millions of dollars) in consolidated financial statements as well as dividend distribution. The main cut off however between the ASC and the IFRS, and where considerable disparities arise, is in the way they recognize if an asset is impaired or not. The ASC requires first that the asset undergo a recoverability test based on expected undiscounted cash flows from continual use of the asset and its eventual disposal. If there is evidence of impairment from the recoverability test, the firm then compares the fair value of its asset to the carrying amount; any excess of the carrying amount over the fair value is the impairment. When there is goodwill  present, ASC requires that the testing should be at the reporting-unit level up till one level below a segment. The ASC also prohibits the reversal of previously written off accounts. The authors observe that the ASC follows a certain 2-step approach in determining whether the asset is impaired or not. The first step is to compare between an entity‟s fair value and carrying amount including goodwill, being that if carrying value exceeds fair value there is impairment. The second step would be to compare the implied fair value of the goodwill with its carrying amount. Looking at the IFRS, goodwill the company deems itself to have must be allocated to all related cash generating units, and cannot be higher than the segment level. Instead of a recoverability test, the firm simply compares the carrying amount of the asset between the higher of its fair value and value in use. The impairment loss naturally being the difference, when carrying amount is higher than the recoverable amount. Thus the IFRS does not follow a 2-step approach like the ASC does. The IFRS also requires previous impairment to be reassessed at each reporting date to ensure that the impairment still holds, thereby allowing a recovery if it does not hold. The IFRS, however, does not permit the recovery of the impairment to go beyond the
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