Scenario
Let's look at the following example (this is extracted directly from the example in paragraph 78 of IAS 36):
"A company operates a mine in a country where legislation requires that the owner must restore the site on completion of its mining operations. The cost of restoration includes the replacement of the overburden, which must be removed before mining operations commence. A provision for the costs to replace the overburden was recognised as soon as the overburden was removed. The amount provided was recognised as part of the cost of the mine and is being depreciated over the mine’s useful life. The carrying amount of the provision for restoration costs is CU500, which is equal to
the present value of the restoration costs.
The entity is testing the mine for impairment. The cash‑generating unit for the mine is the mine as a whole. The entity has received various offers to buy the mine at a price of around CU800. This price reflects the fact that the buyer will assume the obligation to restore the overburden. Disposal costs for the mine are negligible. The value in use of the mine is approximately CU1,200, excluding restoration costs. The carrying amount of the mine is CU1,000."
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| A picture of a mine. |
To summarise,
Carrying amount (CA) of the mine = CU1,000
CA of the provision for restoration costs = CU500
Fair value less cost of disposal (FVLCOD) of the mine = CU800
Value in use (VIU) of the mine (excluding restoration costs) = CU1,200
To understand how to solve this issue, we will need to understand some rules in IAS 36. After you understand the rule, then you can come back to this case again.
Back to Basic
According to IAS 36, impairment happens when the CA exceeds recoverable amount (RA). RA is the higher of VIU and FVLCOD.
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| Image from IFRS box. |
FVLCOD means the price that would be received to sell an asset in an orderly transaction between market participants (refer to IFRS 13) minus the incremental costs directly attributable to the disposal of an asset or cash-generating unit.
Cash-generating unit (CGU) is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets.
Rules in Measuring Fair Value Less Costs of Disposal
IAS 36 also mentions that when we measure the cost of disposal in FVLCOD, we should not include in costs that have been recognised as liabilities. Refer to below (paragraph 28 of IAS 36):
"Costs of disposal, other than those that have been recognised as liabilities, are deducted in measuring fair value less costs of disposal."For example, if we have already recognised a provision for dismantling or restoration cost, we need not minus such dismantling or restoration cost when we calculate FVLCOD. The reason is to prevent double counting as the liability has already been recognised in the financial statements.
Rules in Measuring Value In Use
IAS 36 also mentions that in the measurement of VIU, we do not include the cash outflows relating to obligations that have been recognised as liabilities. Refer to below (paragraph 43(b) of IAS 36):
"To avoid double‑counting, estimates of future cash flows do not include cash outflows that relate to obligations that have been recognised as liabilities (for example, payables, pensions or provisions)."This is basically the same rule for measuring FVLCOD. If we have already recognised a provision for dismantling or restoration cost, we need not minus such dismantling or restoration cost when we calculate VIU.
Reasons for The Rules of Not Minus Costs That Have Been Recognised as Liabilities
We can see that for both the rules in measuring FVLCOD and VIU, we do not minus costs or cash outflows that have been recognised as liabilities.
To understand the logic behind this rule, we need to understand what does it mean by "cost / cash outflows that have been recognised as liabilities".
A good example would be provision for dismantling cost. Such provision is recognised as liability in the financial statements. It will also be capitalised as part of the asset (e.g. PPE). Subsequently, the asset value (together with the capitalised dismantling cost) will be depreciated and it will be charged to SOPL.
In other words, we can say that the provision for dismantling cost will ultimately be charged to SOPL as expense. This makes profit figure to be lower.
For impairment loss, generally we charge impairment loss to SOPL. This also reduces profit.
Consider the following:
If we minus the cost of dismantling when we calculate FVLCOD and VIU, it will cause the FVLCOD and VIU to be lower. This will increase impairment loss and profit will be reduced (e.g. if CA is 100 and VIU is 80, impairment is 20. However, if VIU is lowered to 60, impairment will be increased to 40 and profit will be reduced).
Therefore, if we have already recognised provision for dismantling cost, our profit would have been reduced by the dismantling cost. If we minus cost of dismantling again in FVLCOD and VIU, this makes impairment loss amount to be larger, and hence profit will be reduced by the cost of dismantling again.
In other words, we would have double counted the impact on dismantling in our profit (i.e. it is charged to SOPL twice). Hence, to prevent such double counting, the rule is that we are not to minus such cost or cash outflows in FVLCOD and VIU.
Exception to the Above Rules
There is an exception to the rules mentioned above. This happen if a buyer wishes to buy over the asset together with the associated liability. Consider the following case:
Let say we have an asset with fair value of $1,000 and a buyer want to buy this asset from us. However, this asset comes with a liability to dismantle it at the end of the useful life. Let's say this liability is having the present value of $200.
(Note: We have also recognised a provision for dismantling cost in our financial statements.)
Logically, the buyer will not offer us $1,000 to buy the asset from us. The buyer may offer $800 only because the buyer will need to pay for the future dismantling cost.
(Note: when deciding the offer price, the buyer will deduct dismantling cost and give us the net offer price of $800.)
FVLCOD is thus $800. However, this figure is derived after the buyer deducts dismantling cost. Notice that this FVLCOD of $800 is not consistent with the measurement rule as explained above.
According to the rule as mentioned above, we are not supposed to minus dismantling cost from FVLCOD if we have already recognised a provision.
IAS 36 acknowledges this issue, and this was mentioned in paragraph 78:
"It may be necessary to consider some recognised liabilities to determine the recoverable amount of a cash‑generating unit. This may occur if the disposal of a cash‑generating unit would require the buyer to assume the liability. In this case, the fair value less costs of disposal (or the estimated cash flow from ultimate disposal) of the cash‑generating unit is the price to sell the assets of the cash‑generating unit and the liability together, less the costs of disposal. To perform a meaningful comparison between the carrying amount of the cash‑generating unit and its recoverable amount, the carrying amount of the liability is deducted in determining both the cash‑generating unit’s value in use and its carrying amount."In short, because the FVLCOD of $800 is derived after minus the dismantling cost, therefore when we perform impairment testing, we should also minus dismantling cost when we calculate the carrying amount as well as the value in use.
Application to the Scenario
After you understand the exception to the rule, you can now go back and read the case at the beginning of this post again.
As a recap:
CA of the mine = CU1,000
CA of the provision for restoration costs = CU500
FVLCOD of the mine = CU800
VIU of the mine (excluding restoration costs) = CU1,200
In this case, the FVLCOD of CU800 is a net offer price by the buyer (meaning the buyer has already deducted the restoration cost in arriving at CU800).
As such, to achieve apple with apple comparison, we need to minus the provision for restoration cost when we calculate carrying amount and VIU:
CA = CU1,000 - CU500 = CU500
VIU = CU1,200 - CU500 = CU700
FVLCOD = CU800 (Note: buyer already minus dismantling cost)
RA = CU800 (higher of VIU and FVLCOD)
In this case, there is no impairment because the CA is less than RA.
Refer to the following for the explanation by IAS 36:
"The cash‑generating unit’s fair value less costs of disposal is CU800. This amount considers restoration costs that have already been provided for. As a consequence, the value in use for the cash‑generating unit is determined after consideration of the restoration costs and is estimated to be CU700 (CU1,200 less CU500). The carrying amount of the cash‑generating unit is CU500, which is the carrying amount of the mine (CU1,000) less the carrying amount of the provision for restoration costs (CU500). Therefore, the recoverable amount of the cash‑generating unit exceeds its carrying amount."
Conclusion
In conclusion, whenever we make comparison, it is important to compare apple with apple. The illustration above demonstrate the importance of comparing apple with apple.
