Question

Matt Holmes recently joined Klax Company as a staff accountant in the controller’s office. Klax Company provides warehousing services for companies in several European cities. The location in Koblenz, Germany, has not been performing well due to increased competition and the loss of several customers that have recently gone out of business. Matt’s department manager suspects that the plant and equipment may be impaired and wonders whether those assets should be written down. Given the company’s prior success, this issue has never arisen in the past, and Matt has been asked to conduct some research on this issue.

Instructions

Access the IFRS authoritative literature at the IASB website (http://eifrs.iasb.org/). (Click on the IFRS tab and then register for free eIFRS access if necessary.) When you have accessed the documents, you can use the search tool in your Internet browser to respond to the following questions. (Provide paragraph citations.)

1. What is the authoritative guidance for asset impairments? Briefly discuss the scope of the standard (i.e., explain the types of transactions to which the standard applies).
2. Give several examples of events that would cause an asset to be tested for impairment. Does it appear that Klax should perform an impairment test? Explain.
3. What is the best evidence of fair value? Describe alternate methods of estimating fair value.

Short answer

It does appear that Klax should perform an impairment test because the market value of the assets is most likely lower than the current carrying value.

Step-by-step solution

Meaning of Impairments

Impairment refersto a reduction of the market value of fixed or intangible assets, indicative of a reduction in the quantity, quality, or market value of an asset. The idea is that an asset should never be reported in a business's financial statements above the maximum amount that could be recouped through its sale.

(a) Explaining the authoritative guidance for asset impairments

IAS 36: Impairment of Assets is the definitive guide for asset impairments. This standard must be used to account for assets that have been impaired, except:

1. Inventories
2. Assets derived from construction projects
3. Deferred tax assets
4. Employee benefits-related assets
5. Financial assets that fall under the IFRS 9 Financial Instruments standard
6. Investment property valued at fair market value
7. Biological assets associated with agricultural activities that are valued at fair market value less selling expenses
8. IFRS 4 Insurance Contracts that include deferred acquisition costs and intangible assets stemming from an insurer's contractual rights under insurance contracts; and
9. IFRS 5 Non-current Assets Held for Sale and Discontinued Operations classifies non-current assets (or disposal groupings) as held for sale.

This Standard applies to financial assets classified as:

1. IAS 36; subsidiaries as specified in IFRS 10 Consolidated Financial Statements
2. IAS 28 Investments in Associates and Joint Ventures defines associates.
3. IFRS 11 Joint Arrangements defines joint ventures. Refer to IAS 39 for impairment of other financial assets.

(b) Elaborating several examples of events that would cause an asset to be tested for impairment

An entity must evaluate the following indicators when determining whether there is any indication that an asset may be impaired.

External sources of information

1. If there is a significant decrease in an asset's fair value as time progress or as it would normally decline, it is an indication that the asset may be impaired.
2. If an entity faces significant changes during a certain period or will face them very soon, in the technological, market, economic, or legal environments in which it operates, or in the markets where it sells its assets, it is also an indication that the entity’s assets may be impaired.
3. If interest rates and other market rates of return on investments rise, it increases the discount rate used in calculating an asset's value in use and reduces its recoverable amount.
4. In the case of an entity, carrying value is greater than market capitalization.

Internal sources of information

1. It is possible to provide evidence of asset obsolescence or deterioration.
2. When significant changes in which an asset is utilized or is likely to be used occur during a specified period, or is projected to occur in the near future, having an unfavorable effect on a company, it is an indication that the entity’s assets may be impaired. If an asset is idle, preparations to stop or reorganize the operation to which the asset belongs plans to dispose of the asset before the previously planned date, or reassessing the asset's useful life as finite rather than endless are examples of internal source information.
3. Internal reports give indications that an asset's economic performance is less than anticipated

Internal reporting evidence that an asset is potentially degraded includes the presence of:

1. A higher cash requirement than what was originally budgeted to acquire or maintain an asset.
2. Net cash flows or operating profits or losses are significantly lower than budgeted from an asset
3. Net operating losses of an asset when current period amounts are combined with budgeted amounts for the future.

(c) Explaining the best evidence of fair value and also describing the alternative methods of estimating fair value.

1. Different situations may result in the best proof of fair value (i.e. could be market value, revalued asset, etc.).
2. A direct additional cost of sale is the only difference between a fair value and its fair value fewer costs to selling.
3. Generally, recovery of revalued assets is close to or equal to their revalued amounts (i.e., fair value), as disposal costs are lower.
4. If the disposal expenses are not trivial, the revalued asset's fair value fewer costs to sell must be less than its fair value. As a result, if the revalued asset's value in use is less than its revalued amount, it will be impaired (i.e., fair value). In this scenario, a company uses this Standard to assess whether an asset is impaired once revaluation conditions are met.
5. Depending on how the fair value is determined, the revalued amount (i.e., fair value) may be more or less than the recoverable amount. As a consequence, an organization utilizes fair value to determine whether an asset is damaged after completing the revaluation standards.