The global economic slowdown is having an adverse impact on many
businesses, often resulting in lower cash flows. Lower cash flows
increase the likelihood that asset carrying amounts may be
"impaired" in terms of AASB 136 "Impairment of
Assets" ("the Standard").
An asset or cash generating unit ("CGU") is impaired
when its carrying amount is greater than its "recoverable
amount". Recoverable amount is the higher of an asset's
fair value less cost to sell and its "value in use"
("VIU"), a discounted cash flow determination. An entity
must test goodwill and certain other intangible assets for
ASIC has highlighted asset impairment as one of its focus areas
when it undertakes its review of 30 June 2009 financial
reports. Entities should ensure that impairment calculations are
robust and support its position in terms of the requirements of the
Standard. The following practical tips may assist in calculating
the recoverable amount of assets and CGUs:
How do discount rates compare with those used in
previous periods? Should discount rates differ between different
The discount rate should reflect the risk profile that market
participants would apply in pricing the expected future cash flows.
While government bond rates have fallen recently, it does not
automatically follow that the required rate of return of an asset
has also fallen. It is necessary to consider specific risk
adjustments to compensate for current market conditions which have
generally deteriorated since the last balance date.
The weighted average cost of capital ("WACC") of an
entity is often used as a starting point in calculating an
asset's discount rate. However, entity WACC should be adjusted
to reflect a market assessment of an asset's specific risks,
where appropriate. Discount rates would differ for assets with
differing risk profiles.
Should a pre-tax or post-tax discount rate be
The discount rate is usually a post-tax rate by default where
WACC is used as a starting point. Care should be taken that a
post-tax discount rate is only applied to post-tax cash flows.
Similarly, a pre-tax discount rate should only be applied to
pre-tax cash flows.
Even where a post-tax discount rate has been used, a pre-tax
discount rate requires disclosure in the financial statements. A
pre-tax discount rate can be determined by an iterative computation
so that the VIU determined using pre-tax cash flows and a pre-tax
discount rate equals the VIU determined using post-tax cash flows
and a post-tax discount rate. Because of the differences in the
timing of tax payments, a post-tax discount rate may not be a
pre-tax discount rate multiplied by the tax-rate.
Do cash flow projections reflect current market
conditions and the requirements of the Standard?
The assumptions used to project cash flows must be reasonable
and supportable. Greater weight should be given to external
evidence, such as industry research, broker analysis, economic
forecasts, etc. The global economic slowdown is likely to
negatively impact cash flows, with an immediate and potentially
cumulative effect on the recoverable amount.
The Standard requires estimated future cash flows to reflect the
asset in its current condition. An entity should exclude the impact
of plans to improve, enhance or restructure a particular asset
unless an entity has committed to the restructuring.
Cash flow projections should be based on budgets / forecasts
approved by management covering a maximum period of 5 years. Cash
flow projections beyond the period covered by management's
budgets / forecasts should be based on a steady or declining rate
of growth, not exceeding the long-term average growth rate of the
product, industry, country or market.
Has the reasonableness and sensitivity of the
discounted cash flow calculation been tested?
Useful tests may include:
Comparing the aggregate recoverable amount for all assets to
the market capitalisation (where listed) or entity value implied by
recent share transactions, adjusted for net debt.
Comparing the earnings multiple implied by the recoverable
amount (i.e. recoverable amount divided by estimated future
earnings) with prospective market multiples for the entity (where
listed), comparable quoted companies and comparable transactions,
Performing a sensitivity analysis on key or highly subjective
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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The purchase price of an operating business is usually attributable to net tangible assets and intangible assets, such as customer relationships or a brand name. Intangible assets may comprise a sizable portion of the total assets acquired.
The new standard AASB 15 will provide a single source of accounting requirements for all contracts with customers.
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