Sample chapter

A Student’s Guide toGroup Accounts

A Student’s guide to group accounts – second edition by Tom Clendon A free sample chapter

About the book

The book starts out assuming no knowledge of group accounts and takes you through all the various consolidation problems, starting with a 100% directly owned subsidiary

and building all the way to complex group structures and the translation of foreign subsidiaries.

With plenty of exercises to practice, the use of relevant diagrams, colour, examples and humour bring this potentially dry subject to life. And it is written in plain English!

Each chapter sets out what is new, explains the issue in both words and numbers through worked examples, contains practice questions, a mind map, a further expla-nation in double entry (if you like that sort of thing) and also a technical corner where

further tricky little sub plots are explored!

This student focused book is essential for students studying for their degrees, MBA programs and professional examinations including ACCA, CIMA and ICAEW.

The book can be purchased direct from www.kaplanpublishing.co.uk, or from your local stockist. You can find your nearest stockist on the Kaplan Publishing website.

About the author

Tom Clendon trained with KPMG and qualified as a certified accountant in 1989. He has many years’ experience in preparing students for their professional examinations.

In 2009 he received Tutor of the Year award from PQ magazine. He runs a very popular face book page – tom clendon lecturer.

A little sincerity is a dangerous thing, and a great deal of it absolutely fatal

Impairment review of goodwill

It is always a silly thing to give advice, but to give good advice is fatal.

chapter 7

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What's new?

Goodwill is subject to an annual impairment review, and where it has been impaired must be written down. In the examples that we have looked at to date the goodwill that has arisen at acquisition has either not been impaired and so remained intact at the reporting date or the question has clearly stated the amount of the impairment loss. We have also seen that where NCI at acquisition is measured at fair value then goodwill is in full and so the impairment loss is then split between the parent's profits (w5) and the NCI (w4). Further we have also seen that where the NCI at acquisition is measured on a proportionate basis then goodwill is attributable to the parent only and so the impairment loss is wholly charged against the parent's profits (w5).

Well now is the time to understand how to measure the impairment loss! First we shall explore the general principles of impairment, before considering the impairment of full goodwill and then the impairment of goodwill when it is only attributable to the parent.

Impairment of an asset

An asset is impaired when its carrying value exceeds its recoverable amount. The impairment loss is therefore calculated using the following proforma:

This is the net book valu e i. e. the f igure the asset is currently recorded at in the accounts.

Impairment review This is the estimate of how much cash the company thinks it will get from the asset.

Carrying value X

less Recoverable amount (X)

Impairment loss X

This loss must be recognised, and the asset written down to the recoverable amount. Prudent!

For example if the carrying amount of an asset was $100, but only $80 could be recovered from the asset then the impairment loss is $20.

Impairment review $

Carrying value 100

less Recoverable amount (80)

Impairment loss 20

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Please bear in mind that if the recoverable amount exceeds the carrying value then the impairment review results in no impairment loss. We do not record impairment gains!

There are no accounting choices or accounting policy decisions to be made in respect of impairment. The impairment loss must be recorded and the asset written down to its recoverable amount.

Impairment of goodwill

When goodwill is subject to an impairment review it is necessary to do this at the level of a cash-generating unit. A cash-generating unit is a collection of assets and liabilities that generate an independent stream of cash. This is because goodwill is inseparable from the net assets of the subsidiary. That it is to say the subsidiary is the cash-generating unit so the net assets and the goodwill together are considered as the carrying value to be compared to the recoverable amount.

In all our examples the impairment loss arising from the impairment review will be used to write down the goodwill. Strictly though, if the cash-generating unit has another asset that is specifically damaged or otherwise impaired then the impairment loss would first be allocated to that asset. If the impairment loss exceeded the goodwill then the remaining balance of the loss will be allocated against the other assets on a pro-rata basis.

Impairment of goodwill when calculated in full

Where the NCI has been calculated at fair value i.e. there is goodwill in full, the impairment loss will be split between the parent and the NCI in the proportion that they normally share profits and losses. In the context of a group statement of financial position this will mean the parent’s share of the impairment loss will reduce the group retained earnings in w5 and the impairment loss attributable to the NCI will reduce the NCI in w4.

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Example

Four years ago Oman made an acquisition of 80% of the shares in Muscat when its retained earnings were $50m. Below are the summarised statements of financial position of the two companies.

Oman Muscat

$m $m

Non-current assets

Tangible 100 100

Investment in Muscat 175

Current assets

Inventory 140 200

Receivables 160 100

Cash at bank 125 200

700 600

Ordinary shares ($1) 160 050

Retained earnings 240 100

Equity 400 150

Non-current liabilities 100 250

Current liabilities 200 200

700 600

Additional information

1 At the date of acquisition the fair values of Muscat's assets were equal to their carrying amounts.

2 Oman has a policy of accounting for any NCI at acquisition at fair value. The fair value of the NCI at the acquisition date was $25m. No goodwill had previously been impaired. Muscat is regarded as a cash-generating unit with a $230m recoverable amount at the year-end.

Required

Prepare the consolidated statement of financial position of Oman.

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The first two workings are routine.

W1 Group structure

OmanParent's interest 80%

NCI 20%

The subsidiary was acquired four years ago

Muscat

W2 Net assets of the subsidiary

At acquisition At year-end

$m $m

Share capital 50 50

Retained earnings 50 100

100 150

$50m

The post-acquisition profits of the subsidiary are $50m ($150m - $100m) and these will be shared as normal between the parent and the NCI.

W3 Goodwill

$m

FV of the parent's investment 175

FV of the NCI at acquisition 25

Less the FV of the subsidiary's net assets at acquisition (100)

Goodwill at acquisition 100

Less impairment loss (20)

Goodwill at reporting date 80

The impairment loss of $20m has come from the next working - the impairment review of Muscat the cash-generating unit.

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The impairment review of goodwill is conducted by aggregating the net assets at the year-end with the goodwill arising to form the cash generating unit that we can then compare with the recoverable amount.

Impairment review of Muscat

$m $m

Carrying value

Net assets of the subsidiary at year-end 150

Goodwill 100

250

Recoverable amount (230)

Impairment loss 20

This impairment loss is used to reduce the asset of goodwill. As NCI at acquisition is at fair valu e so goodwill is in fu ll and the impairment loss is split between the parent and the NCI in the normal proportions.

To the extent that the carrying value of $250m exceeds the recoverable amount of $230m this reveals an impairment loss of $20m.

W4 NCI

$m

Fair value of the NCI at acquisition 25

Plus the NCI% of the post-acquisition profits w2 (20% x 50) 10

Less the NCI% of the impairment loss w3 (20% x 20) (4)

31

W5 Group retained earnings

$m

Parent's profits 240

Plus the parent’s % of the post-acquisition profits w2 (80% x 50) 40

Less the parent’s % of the goodwill impairment loss w3

(80% x 20) (16)

264

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Oman group statement of financial position

$m

Non-current assets

Goodwill w3 post impairment 80

Tangible assets (100 + 100) 200

Current assets

Inventory (140 + 200) 340

Receivables (160 + 100) 260

Cash at bank (125 + 200) 325

1,205

Ordinary shares ($1) parent only 160

Retained earnings w5 264

NCI w4 31

Equity 455

Non-current liabilities (100 + 250) 350

Current liabilities (200 + 200) 400

1,205

Impairment of goodwill when calculated on a proportionate basis

When goodwill has been calculated on a proportionate basis, for the purposes of conducting the impairment review it is necessary to crudely gross up goodwill proportionally so that in the impairment review goodwill will include an unrecognised notional goodwill attributable to the NCI.

This is because the recoverable amount will relate to the whole cash-generating unit, so it is argued some of this must relate to the unrecognised notional goodwill attributable to the NCI.

Any impairment loss that arises is first allocated against the total of recognised and unrecognised goodwill in the normal proportions that the parent and NCI share profits and losses.

Any amounts written off against the notional goodwill will not affect the consolidated financial statements. Any amounts written off against the recognised goodwill will be attributable to the parent only, without affecting the NCI.

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If the total amount of impairment loss exceeds the amount allocated against recognised and notional goodwill, the excess will be allocated against the other assets on a pro-rata basis. This further loss will be shared between the parent and the NCI in the normal proportion that they share profits and losses.

Example

At the year-end an impairment review is being conducted on the 80% owned subsidiary David Leigh. At the date of the impairment review the carrying value of the subsidiary’s net assets were $600m and the goodwill $80m (based on NCI at acquisition being a proportion of net assets) and the recoverable amount of the subsidiary $640m.

Required

Determine the outcome of the impairment review.

In conducting the impairment review of proportionate goodwill it is first necessary to gross it up.

Proportionate goodwill Grossed up Goodwill including the notional unrecognised NCI of $20m

$80m x 100/80 = $100m

Now for the purposes of the impairment review, the goodwill will be $100m and together with the net assets of $600m forms the carrying value of the cash-generating unit - the subsidiary.

Impairment review

Carrying value $m $m

Net assets of subsidiary at year-end 600

Goodwill-recognised and notional 100

700

Recoverable amount (640)

Impairment loss on the gross goodwill 60

Impairment loss on the goodwill attributable to the parent (80% x 60) 48

This is the impairment loss that is actually recorded

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The impairment loss of $60m is less than the recognised and notional goodwill of $100m, so only goodwill has been impaired. The parent's share of the impairment loss (80% x $60m) $48m is recognised in group retained earnings (w5) thus reducing the proportionate goodwill that has been recognised from $80m by $48m to $32m. The NCI (w4) is not charged with any of this impairment loss, after all the goodwill that is being impaired is wholly attributable to the parent. There is no actual recording of either the notional unrecognised goodwill of $20m nor of its impairment.

$m

Goodwill attributable to the parent at acquisition 80

Less impairment loss (80% x 60) (48)

Goodwill at the reporting date 32

This impairment loss is wholly charged against group retained earnings w5

If the impairment loss had been say $110m i.e. $10m more than recognised and notional goodwill of $100m, then in addition to writing off all of the recognised goodwill there would have been a further actual impairment loss of $10m to recognise. This would relate to other assets of the subsidiary and be charged between the parent's profits (w5) and the NCI (w4) in the ratio of 80/20 being the proportion that profits and losses are shared.

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Mind Map

Goodwill together with the net assets of the subsidiary form a cash-generating unit

When NCI at acquisition is a

proportion of net assets so goodwill

is attributable to the parent only

Annual impairment review of goodwill

is required

Impairment losses on the goodwill attributable

to the parent only are wholly charged against retained earnings w5

Impairment losses on full goodwill are charged against retained earnings

w5 and NCI w4

When NCI at acquisition is at fair value so there is full

goodwill

In the impairment review process goodwill attributable to the

parent is notionally grossed up but only the parent's share of the impairment loss on gross goodwill is actually recorded

An impairment loss arises when the

carrying value of the cash-generating

unit exceeds the recoverable amount

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Double entry

The recording of impairment losses when NCI at acquisition is at fair value so goodwill is in full can be thought of in double entry terms.

Let us consider the recording of the impairment loss of $20m on the full goodwill of Muscat, the 80% subsidiary.

The impairment loss reduces the asset of full goodwill in the top half of the group statement of financial position and it also reduces the equity (split between the retained earnings and the NCI).

To record the impairment loss is to recognise an expense that will decrease equity, i.e. the retained earnings and also the NCI. To reduce equity is a DR.

To record the impairment loss is to write down an asset. To reduce an asset is a CR.

$m $m

DR Retained earnings (w5) 16

DR NCI (w4) 04

CR Goodwill (w3) 20

The recording of impairment losses when NCI at acquisition is measured as a proportion of net assets so that goodwill is attributable to the parent only can be thought of in double entry terms.

The notional grossing up of the goodwill attributable to the parent purely for the purposes of the impairment review is not a double entry as this notional goodwill is unrecognised and unrecorded. The actual impairment loss on the goodwill attributable to the parent was $48m.

To record the impairment loss is to recognise an expense that will decrease equity, in this case the whole loss is charged against the retained earnings. To make equity go down is a DR.

To record the impairment loss is to write off the asset of goodwill. To reduce an asset is a CR.

$m $m

DR Retained earnings (w5) 48

CR Goodwill (w3) 48

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Technical corner

Determining the recoverable amount

There are two ways of recovering cash from an asset or collection of net assets (cash-generating unit).

One way of recovering cash from an asset is to sell it. The measurement of the recoverable amount can therefore be the fair value less costs to sell i.e. sale proceeds less any costs necessary to achieve the sale.

The other way of recovering cash from an asset is to keep and use the asset so that it generates a cash flow in the future. This second way is termed the “value in use”. When measuring the future cash flows it will be necessary to discount the figures to a present value.

The recoverable amount is the higher of the net sale proceeds and the value in use. It is the higher because that is what the standard1 says – but actually also to reflect the common sense that losses will always try to be minimised.

For example if an asset could be sold for $230m net of selling costs, but has a value in use of $150m, the recoverable amount will be $230m (the higher) as the sensible decision will be to sell the asset. But if the asset could be sold for $125m net of selling costs and has a value in use of $200m, then the asset will be kept, making the recoverable amount $200m. The recoverable amount will always be the higher of the two figures on offer.

The measurement of the recoverable amount is of course subjective since the sale proceeds are an estimate as indeed are the future cash flows in the value in use calculation.

1 IAS36 Impairment of Assets

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Question Singapore

The following information relates to Singapore a 60% subsidiary.

Net assets at

acquisition

Net assets at year-end

Fair value of the NCI at

acquisition

Parent's investment

Recoverable amount at year-end

$m $m $m $m $m

500 600 250 800 1,000

Required

(i) Assuming that NCI at acquisition is measured at fair value and so that goodwill is full, determine the goodwill that will be recognised in the group statement of financial position at the reporting date i.e. after the impairment review.

(ii) Assuming that the NCI at acquisition is measured as a proportion of net assets so that goodwill is attributable to the parent only, determine the goodwill that will be recognised in the group statement of financial position at the reporting date i.e. after the impairment review.

where the goodwill is attributable to the parent only, when doing the impairment review the goodwill will have to be notionally grossed up