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Accounting Standard (AS) 28 Notes

Accounting Standard (AS) 28: Impairment of Assets

An asset is impaired if its carrying amount exceeds the amount to be recovered through use or sale of the asset and given the situation the standard requires the enterprise to recognize an impairment loss i.e. the amount by which the carrying amount of an asset exceeds its recoverable amount.

Impairment loss is a normal expense and thus will have impact on distributable profit and other provisions of the company’s act and applicable enactment (Acceptance of Deposit Rules, BIFR etc)

Impairment loss may be discussed in the following areas:

1) Impairment loss on a specific asset;

2) Impairment loss for a cash generating unit;

3) Impairment loss for discontinuing operation.

Impairment Loss = Carrying amount of the Asset – Recoverable amount.

Carrying amount is the amount at which asset is shown in the Balance Sheet.

Recoverable amount of an asset is higher of:

  • Net selling price
  • Value in use

Net Selling Price= Expected realizable value of an asset – cost of disposal

Net Selling price can be obtained from:

  • Active market for the asset
  • Binding sale agreement
  • Best estimate based on information

Value in Use= Present value of estimated future cash flow arising from the use of asset + residual value at the end of its useful life.

Present value is calculated by applying discount rate to future cash flows.

Estimated cash flows includes :

  • Cash inflows from continuing use of the asset
  • Projected cash outflows to generate cash inflows from continuing use of the asset
  • Net cash flows if any to be received( or paid) for the disposal of the asset at the end of its useful life.

Estimated cash flows excludes:

  • Cash flows from financing activities
  • Payment /refund of income tax

Discount rate: It is the cost of capital to be applied to calculate the present value of estimated cash flows and is based on the following factors:

  • Pre-tax rate
  • Current market assessment of time value of money after considering specific risk of the asset.
  • Enterprises weighted average cost of capital or incremental financial cost.
  • The current rate of inflation is also considered.

AS-28 does not apply to:

  • inventories (as per AS 2);
  • construction contract assets ( as per AS 7);
  • deferred tax assets (as per AS 22);
  • investments covered by AS-13 and financial instruments, because other AS provide for recognizing and measuring these assets.

Assessment for impairment of assets needs to be made at the B/S date: as to any indication in this context based on external or internal source of information.

External sources:

  • Market value changes with passage of time or normal use (typewriter on invention of computer)
  • Adverse effect in the light of technological, market, economic, or legal environment in which the enterprise operates.
  • Change in market rate of interest or returns on investment affect the discount rates used to assess an assets value in use (if the effect is not a short-term phenomenon).
  • Carrying amount of the net asset, exceeds its market capitalization (determined by future growth, profitability, threat of new products/entrants etc).

Internal sources:

  • Obsolescence /physical damage is evident.
  • Indication obtained internally that economic performance of an asset has worsened or likely to worse than expected.
  • Continuous cash loss may indicate that one or more of the business division is impaired.

Assessment for impairment should be made on individual asset basis, except when:

(i) The asset value in use cannot be estimated to be close to the net se1ling price i.e. future cash flow from continuing use of the asset cannot be estimated to be negligible or there is no plan to dispose of the assets in near future.

(ii) The asset does not generate cash inflows from continuing use that are largely independent of those from other assets.

In the exceptional case as above, the value in use/recoverable amount can be determined with regard assets cash generating units (generate cash inflows from outside the reporting enterprise and independent of cash inflows from other assets / group of assets.

Impairment Loss to a cash generating unit :

Cash generating unit (CGU): The smallest group of an asset for which cash flows can be determined independently.

Even if the cash flows can determined independently, aggregation of cash generating units becomes necessary in some situations.

To determine impairment loss of a CGU, we have to follow ‘bottom up’ or ‘top down’ test.

Impairment Loss for discontinuing operation :

In this type of situation, the impairment loss shall depend on the way the discontinuing operation is disposed off:

(a) substantially in its entirety;

(b) as piecemeal sales;

(c) by abandonment.

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