South Africa’s economy suffered two consecutive quarters of negative economic performance, technically the country is in a recession. This is bad news for all of us, but for accountants of SMEs the picture may even be worse. This economic decline could be an indicator that an entity’s assets may be impaired. Section 27 Impairment of assets of the IFRS for SMEs, which require that an entity shall assess at each reporting date whether there is any indicators of impairment, could become very relevant.
If any indication of impairment exists (as is probably the case in the current economic climate), an entity shall estimate the recoverable amount of its asset (for example: its property, plant and equipment) affected by the economic downturn. The operation of most SMEs is arguably structured in such a way that an individual non-current asset is not necessary producing cash flows on its own, but are rather working together with other assets to produce cash flows to the entity. If the recoverable amount of the individual asset cannot be estimated, the recoverable amount of the cash-generating unit (CGU) to which the asset belongs, shall be estimated (para. 8). An impairment shall be recognised for a CGU if the recoverable amount of the unit is less than the carrying amount of the unit (para. 21). The recoverable amount is defined as the higher of the fair value less costs to sell and the value in use, which basically means the net cash flow from using or selling it. The following example will explain the recognising and measuring of an impairment loss for a CGU.
In short, the accounting treatment of an impairment loss, is as follows:
- Determine the carrying amount of the cash-generating unit;
- Determine the higher of the fair value less costs to sell and the value in use ;
- Calculate the impairment loss if the recoverable amount is less than the carrying amount;
- Recognise the impairment loss, first against any goodwill and then pro rata on the basis of the carrying amount of each asset in the CGU; and
- Assess the “limits” in the Standard – the carrying amount of any individual asset in the CGU shall not be reduced to below its fair value less cost to sell.
A SME company, with a reporting date of 30 June, packs organic fruit for exportation to Europe.
Assume that the company obtained a fruit packing factory in terms of a business combination. The individual assets of the fruit packing factory cannot generate cash flows independently. Any goodwill calculated at the date of the business combination is allocated, in total, to the fruit packing factory (CGU).
The following information relates to the net assets of the fruit packing factory:
|Carrying amount at the reporting date
|Factory building at carrying amount||2 415 385|
|Machines at carrying amount||1 419 000|
|Goodwill as a result of the accounting for the business combination at cost||200 000|
|Total assets in the CGU||4 534 385|
Assume that the value in use of the fruit packing factory (CGU) at the reporting date amounted to R4 000 000 and on the same date the fair value less costs to sell of the fruit packing factory amounted to R3 800 000.
It is only for the factory building that forms part of the fruit packing factory, for which there is an active market and its fair value less costs to sell amounts to R2 000000.
The journal entry (excluding taxation) in the records of the company at the reporting date to account for the impairment loss relating to the fruit packing factory is as follows:
|Calculation and explanation||Debit Rand||Credit
|Impairment loss (P/L)||a)||534 385|
|Goodwill (SFP)||b)||200 000|
|Accumulated depreciation of the factory building (SFP)||c)||210 638|
|Acc. Dep machines (SFP)||c)||123 747|
Calculations and explanations
- a.) If, as in this example, the recoverable amount of the CGU is lower than the carrying amount of the CGU, an impairment loss shall be recognised (para. 21). The amount of the impairment loss is R534 385 and is calculated as the recoverable amount R4 000 000 (higher of the fair value less costs to sell and its value in use (para. 11)) less the carrying amount of R4 534 385. The impairment loss shall be recognised immediately in profit or loss (para. 6) as no assets were previously revalued in this example.
- b.) This impairment loss shall reduce the carrying amount of any goodwill allocated to the CGU, first (para. 21(a)). The total amount of R200 000 on the goodwill account is therefore removed.
- c.) The remaining amount of the impairment loss of R334 385 (calculated as the total impairment loss of R534 385 less the amount of R200 000 recognised against goodwill) shall then be allocated to the other assets of the CGU, pro rata on the basis of the carrying amount of each asset in the CGU (para. 21(b)). The total carrying amounts of the remaining assets being the factory building and the machines equals R3 834 385 (R2 415 385 + R1 419 000). The impairment loss of R334 385, allocated pro rata on the basis of the carrying amounts of the assets mentioned, is calculate as follows:
(R334 385/ R3 834 385 x R2 415 385) R210 638
(R334 385/ R3 834 385 x R1 419 000) R123 747
However, after having the first few steps in the recognition of the impairment loss on the CGU, one need to assess the “limits” in the Standard. The carrying amount of any individual asset in the CGU shall not be reduced to below its fair value less cost to sell (para. 22 (b)). The fair value less costs to sell is, in our example, only available for the factory building. The new carrying amount of the factory building after the impairment loss has been recognised is, R2 204 747 (R2 415 385 – R210 638) which means that the new carrying amount of the factory building is not below the fair value less costs to sell of R2 000 000 and now further re-allocation of the impairment loss is necessary.
This article briefly discussed and illustrated the accounting treatment of an impairment loss on a CGU of an entity. Entities applying the IFRS for SMEs and their accountants, should carefully consider the relevance and impact of impairment losses on the financial statements as the current economic downturn in South Africa, may very well serve as an indicator of an impairment of the assets of typical small and medium-sized business in South Africa.
Elsje Raubenheimer CA(SA) is a Senior lecturer in Financial Accounting, School of Accountancy at the University of the Free State