Fixed assets - WIRC · PDF fileScope, objective and definition AS 10 Fixed Tangible assets...
Transcript of Fixed assets - WIRC · PDF fileScope, objective and definition AS 10 Fixed Tangible assets...
Scope, objective and definition
AS 10
Fixed
� Tangible assets (for Intangibles – refer to AS 26)
� Held for production or supply of goods or services and
not for sale in the normal course of business
� Thus fixed assets include those held for rental to others
or those held for administrative purposes
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Other related accounting standards
Fixed assets Depreciation (AS 6)
Borrowing costs (AS 16)
Government grants (AS 12)
Leases (AS 19)
Impairment (AS 28)
Intangible assets (AS 26)
Scope, objective and definition
AS 10 does not deal with items
to which special considerations
apply
Forests, plantations and similar
regenerative natural resources
Wasting assets including mineral
rights and similar non-regenerative
resources
Expenditure on real estate
(Continued)
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development
Livestock
Except
Fixed assets used to develop or
maintain these activities
but
separable from those activities
Recognition
Fixed asset should be recognised as an asset when:
� Asset is brought to its working condition for its intended use i.e. ready for
commercial production
Initially, measure at cost
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May be appropriate to
� Aggregate insignificant items and apply criteria to aggregate value
� Expense an item of fixed asset if the amount is not material
� Allocate expenditure to material component parts of a fixed asset if
– parts are separable and
– useful lives for each component can be estimated and are different
Components of cost
Purchase price
(including import duties and non-refundable purchase taxes or levies)
- any trade discounts or rebates deducted
+ any directly attributable costs
+ borrowing costs as per AS 16
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+ borrowing costs as per AS 16
+/- exchange differences (para 46 A of AS 11)
= Cost of fixed asset� Site preparation
� Initial delivery and handling cost
� Installation cost
� Professional fee
Other expenses
Administration and other general overhead costs not included
unless
Such expenses are specifically attributable
� to construction of a project or
� to acquisition of fixed asset or
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� to acquisition of fixed asset or
� bringing it to its working condition
Start-up, test runs and similar pre-production costs
� Included only till asset is ready for commercial production
� Not included if incurred after commercial production even if the plant will be
taken over after satisfactory completion of guarantee period
Expenditure during period of delayed commercial production
Self constructed fixed assets
Same principles as stated earlier
� Direct costs
� Costs attributable to construction which can be allocated
to the asset
� Internal profits are eliminated
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Cost
Can the following costs be capitalised?
� Administrative, selling and general overheads which cannot
be attributed to making the asset ready for use
� Clearly identified abnormal costs including those of
inefficiencies
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� Expenditure on training the staff to operate the asset
Impact of withdrawal of Guidance Note on Expenditure incurred during pre-construction period
Cost
The cost may change subsequently due to:
� Changes in duties
� Other similar factors
� Exchange fluctuations
� Price adjustments
(Continued)
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� Price adjustments
Component accounting - Paragraph 8.3 states ‘the accounting for an item of fixed asset may
be improved if the total expenditure thereon is allocated to its component parts, provided they are in practice separable, and estimates are made of the useful lives of these components’ – recommendatory
provision’.
Cost of fixed asset acquired in exchange of another asset
Fair value of the consideration given or
Fair value of asset acquired (whichever is more clearly evident)
Cost of fixed asset acquired
OR
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asset acquired in exchange of another asset
Net book value of the asset given up
OR
Adjust for any balancing payment or receipt of cash/other consideration
Subsequent expenditure
Add to book value only if it increases the future benefits from the existing asset beyond its previously assessed standard of performance
� extends useful life
� increases capacity
� substantially improves output quality
Subsequent expenditure
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� substantially improves output quality
� substantially reduces operating costs
� Capitalise to existing asset if of capital nature and an integral part of existing asset
� Capitalise separately if separate identity and capable of being used after existing asset is disposed of
Addition / extension
Special cases – machinery spares
Implication of non-inclusion of ASI 2 (machinery spares) in notified standards
Relevant guidance under notified standards
� Para 4 - AS 2, Inventories
� Para 8.2 - AS 10, Accounting for Fixed Assets
“Inventories do not include machinery spares
which can be used only in connection with an
item of fixed asset and whose use is expected
to be irregular; such machinery spares are
accounted for in accordance with Accounting
Standard (AS) 10, Accounting for Fixed
Assets.”
“Machinery spares are usually charged to the
profit and loss statement as and when
consumed. However, if such spares can be used
only in connection with an item of fixed asset
and their use is expected to be irregular, it may
be appropriate to allocate the total cost on a
systematic basis over a period not exceeding the
useful life of the principal item.”
The principles of ASI 2 were consistent with the above but were prescriptive
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Special cases – machinery spares
Impact of non-inclusion
� Machinery spares which can be used only in connection with an item of fixed
asset and whose use is expected to be irregular cannot be included as
inventories in view of specific exclusion in paragraph 4 of AS 2
� As per paragraph 8.2 of AS 10, “it may be appropriate” to capitalise such
spares to be depreciated over a period not exceeding the useful life of the
principal item
(Continued)
– Conceptually preferred treatment of such spares is capitalisation
– Was made mandatory by ASI 2
– Permissive wording of AS 10 viewed with non-inclusion of ASI 2
� Company has a CHOICE of expensing such spares when FIRST PUT TO USE
� Pending use, shown SEPARATELY as current assets other than inventories
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Special cases – machinery spares
If a company changes its treatment of aforesaid machinery spares pursuant to notified standards
� Constitutes a change in accounting policy
� Should be applied to all such spares, irrespective of their date of acquisition
(Continued)
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Special cases
Disclose:
Hire purchase
Recorded at their cash value
� If not available then calculate assuming
appropriate rate of interest
� Appropriate disclosure that enterprise does
not have full ownership
»Disclose:
Joint assets
� Enterprise’s share in such asset
� Proportion of original costs
� Accumulated depreciation
� Written down value
Group pro rata costs of such assets with fully
owned assets with appropriate disclosure
OR
»
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Special cases
� Where several fixed assets are purchased for a consolidated price
Separate fixed asset in its own right
Stand-by and servicing
equipment »
(Continued)
� Where several fixed assets are purchased for a consolidated price
Apportion consideration to various assets on fair basis determined by
competent valuers
� Goodwill
Record only when some consideration in money or money’s worth has been
paid for it
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Subsequent measurement
Allowed alternative Benchmark treatment
Revaluation
Depreciation of
revalued amount
over useful life
Depreciation of cost
over useful life
Historical cost
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Revaluation
� Revalue atleast all asset of the same class
– If not, select assets on a systematic basis (and disclose the basis)
� Revaluation increase credited to owner’s interest (revaluation reserve)
– unless the asset was previously revalued downward and the related
charge was made to expense » take to profit and loss account
–
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– any accumulated depreciation should not be credited to profit and loss
account
� Revaluation decrease charged to expense
– unless the asset was previously revalued upward and the related credit
was made to revaluation surplus » charge against earlier increase
Net book value after revaluation should not exceed recoverable value (see AS 28)
Depreciation
�
Dealt with in AS 6, Depreciation accounting
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� Fixed asset is subject to systematic allocation of cost minus residual value to expense (freehold land excluded) over its useful life
� Periodically review:
– useful life
– depreciation method
Impairment
Assess at each balance sheet date indications of impaired fixed assets
Yes
Carrying value
Recognise impairment loss* as an
expense immediatelyvalue
Lower of
Written
down valueRecoverable
amount
Net realisable value Value in use
Higher of
� unless carried at revalued
amount (treated as revaluation
decrease as long as it does not
exceed amount held in
revaluation reserve)
� use “new” carrying amount to
calculate future depreciation
* Refer to AS 28 on how to compute impairment loss
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Retirements and disposals
�Eliminate items of fixed assets on disposal
If retired from active use and held for disposal
� State at the lower of net book value or net realisable value
� Loss recognised immediately in profit and loss account
� Shown separately in financial statements
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� Shown separately in financial statements
�Difference between carrying amount and net disposal proceeds recognised as income or expense
For re-valued assets:
� Loss to the extent of unutilised revaluation reserve is charged to that account
� Balance of revaluation reserve is transferred to general reserve
Disclosure
Distinction, as far as possible, has been made between expenditure upon:
� Goodwill
� Land
– Freehold
– Leasehold
� Buildings
� Railway sidings
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� Railway sidings
� Plant and machinery
� Furniture and fittings
� Development of property
� Patents, trade marks and designs
� Livestock
� Vehicles
� Others (specify)
Disclosure
� Accounting policy
− any other movements − original cost
� A reconciliation of gross and net book values of each class of fixed assets at
the beginning and end of period showing:
(Continued)
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− revaluations
− impairment losses
− reversal of impairment losses
− depreciation, for the year and
accumulated
− additions
− disposals
− acquisitions (through business
combinations etc)
Disclosure
� The amount of expenditures on account of fixed asset in the course of
construction or acquisition
� Existence and amounts of restrictions on title to assets
� Fixed assets pledged as securities for liabilities
� Capital commitments
� Reduced/increased figures
(Continued)
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� Reduced/increased figures
� Date of reduction/increase
� The method to compute revalued amounts
� Nature of any indices used
� The year of any appraisal made
� Whether independent valuer was involved
� The revaluation surplus, including movement
� The amount of reduction/increase for the five subsequent years
If re-valued amounts:
Illustrative issues
Is this correct?
� Fixed assets, individually costing less than Rs. 5,000 and written off fully in the
year of acquisition are not entered in the Fixed Asset Register
� Fixed assets are excluded from the Fixed Asset Register as soon as they are
depreciated to their residual value. No other record of such fully depreciated
assets is maintained
1.
The surplus arising on revaluation of land and buildings has been credited to the profit
and loss account to the extent of depreciation charged thereon in previous years. It is
argued that to this extent, depreciation need not have been charged in those years
2.
The building account has been debited with the cost of land on which the building
stands and depreciation has been provided thereon3.
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Illustrative issues
� Historical cost of the asset: Rs. 1,00,000
� Revalued cost (after three years): Rs. 1,50,000
� Book value at the time of revaluation: Rs. 70,000 (Depreciation = SLM 10%)
� Asset sold for: Rs. 1,40,000
� Book value at the time of sale: Rs. 94,000
� Management wants to credit Rs. 1,26,000 as profit from sale by transferring Rs.
5.
(Continued)
� Management wants to credit Rs. 1,26,000 as profit from sale by transferring Rs.
80,000 from revaluation reserve
Is this correct?
On the basis of a report of valuers showing that the book value of the
enterprise is much lower than their market value, the difference has been
accounted for as goodwill. Is this correct?
6.
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Illustrative issues
Deferred revenue expenditure
Paragraph 9.2 of AS 10
However, expenditure incurred during this (‘construction) period is also sometimes treated as
deferred revenue expenditure to be amortised over a period not exceeding 3 to 5 years after
the commencement of commercial production.
Paragraphs 55(a) and 56 of AS 26
Expenditure on an intangible item should be recognised as an expense when it is incurred
7.
(Continued)
Expenditure on an intangible item should be recognised as an expense when it is incurred
unless: (a) it forms part of the cost of an intangible asset that meets the recognition criteria
(see paragraphs 19-54).
EAC Opinion – Query 10 – Volume XXIII
The expenditure incurred between the date the project is ready to commence commercial
production and the date at which the commercial production actually begins cannot be treated
as deferred revenue expenditure pursuant to the requirements of paragraphs 55 and 56, since
such an expenditure does not create an intangible asset, and, therefore, will have to be
expensed.
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Non - Applicability of Standard
� Forests, plantations and similar regenerative natural resources
� Wasting assets including expenditure on the exploration for and extraction of
minerals, oils, natural gas and similar non-regenerative resources;
� Expenditure on research and development;
� Goodwill and other intangible assets; � Goodwill and other intangible assets;
� Livestock.
� This standard also does not apply to land unless it has a limited useful life for
the enterprise.
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Meaning of depreciation
� Depreciation is a measure of the wearing out, consumption or other loss of
value of a depreciable asset arising from use, effluxion of time or
obsolescence through technology and market changes. Depreciation is
allocated so as to charge a fair proportion of the depreciable amount in each
accounting period during the expected useful life of the asset. Depreciation
includes amortization of assets whose useful life is pre-determined.
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Meaning of depreciable asset
Depreciable assets are assets which
� are expected to be used during more than one accounting period; and
� have a limited useful life; and
� are held by an enterprise for use in the production or supply of goods and
services, for rental to others, or for administrative purposes and not for the services, for rental to others, or for administrative purposes and not for the
purpose of sale in the ordinary course of business.
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Meaning of useful life of depreciable asset
Useful life is either
(i) the period over which a depreciable asset is expected to be used by the
enterprise; or
(ii) the number of production or similar units expected to be obtained from the
use of the asset by the enterprise.
Factors to be considered
1. Pre-determined by legal or contractual limits
2. Directly governed by extraction or consumption
3. Dependent on the extent of use and physical deterioration
4. Obsolescence etc.
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Methods of Depreciation
Straight Line Method(SLM)
Written Down Method(WDV)
Basis of selection of most appropriate method are:
1.Type of asset
2. the nature of the use of such asset
3. circumstances prevailing in the business
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Straight Line Method (SLM)
� Depreciation =
Original Cost – Estimated Scrap Value
------------------------------------------------------------
Estimated useful life
1. Original Cost: Cost of acquisition, installation and commissioning as well as 1. Original Cost: Cost of acquisition, installation and commissioning as well as
for additions to or improvement thereof
2. Scrap Value: Estimated residual value of asset at the end of useful life.
(Generally assumed as ‘Nil’).
3. As explained in earlier slide
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Written Down Method (WDV)
� Under this method depreciation is calculated on the reduced balance of the
fixed asset. Reduced balance is calculated by deducting accumulated
depreciation from the original cost or revalued amount.
� The statute governing an enterprise may provide the basis for computation of
the depreciation. For example, the Companies Act, 2013 lays down the rates
of depreciation in respect of various assets.
� Depreciation for the year = WDV * Rate
1. WDV : Original cost – Accumulated depreciation
2. Rate : Prescribed by the governing statue
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Change in Depreciation Method
� Required by statute
� Required by accounting standard
Conditions
� Management judgment
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Effect of Change in Depreciation Method
Recalculation of depreciation from the date of put to use to the date of
Change of method
Actual Depreciation Charged till date – Depreciation should be charged
Surplus Deficiency
Should be adjusted in the statement of profit & loss in the year in which the
Method of depreciation Is changed.
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Change in Useful Life
� In case of useful life of the depreciable asset then it is necessary to charge
the depreciation on the basis of remaining useful life of the asset as per the
re-estimated useful life. The change should be given effect prospectively.
� What would be the treatment in the event of remaining useful life of an asset
being increased as compared to the original estimate.
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being increased as compared to the original estimate.
� Can there be an scenario where the method of depreciation changes and
there is also a change in the estimate of remaining useful life?
Capitalization of Foreign Exchange Loss/Gain
� Where the historical cost of a depreciable asset has undergone a change due
to increase or decrease in long term liability on account of exchange
fluctuations, the depreciation on the revised unamortized depreciable amount
should be provided prospectively over the useful life of the asset.
� At point in time do you recognize and capitalize exchange differences (where
an enterprise elects to apply paragraph 46A of AS 11 – whether monthly,
quarterly, half-yearly or annually?quarterly, half-yearly or annually?
� Practical difficulty in maintaining trail of exchange differences which were
capitalised at the respective period-end and depreciating such differences at
a rate which is different from the rate being applied to the base cost originally
capitalised.
� Whether the fixed asset accounting is in an ERP environment or is it done on
MS Excel sheets, practical difficulties in maintaining audit trail.
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Revaluation and depreciation
� In case of revaluation of depreciable asset, the depreciation charge should be
based on the revalued amount.
Revaluation
Upward Downward
Depreciation will be charged onrevalued amount of asset and anequal amount will be transferredfrom revaluation reserve to profit
& loss account.
Depreciation will be charged onrevalued amount of asset.
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Disclosures
The following information should be disclosed in the financial statements :
� the historical cost or other amount substituted for historical cost of each class
of depreciable assets;
� total depreciation for the period for each class of assets; and
� the related accumulated depreciation.� the related accumulated depreciation.
� depreciation methods used; and
� depreciation rates or the useful lives of the assets, if they are different from
the principal rates specified in the statute governing the enterprise.
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Capitalised
� Borrowing costs directly attributable to acquisition, construction or production
of a qualifying asset to be capitalised as part of cost of that asset. Borrowing
costs capitalised as part of cost of qualifying asset when probable that they
will result in future economic benefits to enterprise and costs measured
reliably
AS 16 – Recognition
� Amount of borrowing costs eligible for capitalisation to be determined in
accordance with Statement.
Charged Off
� Other borrowing costs recognised as expenses in period incurred.
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� Concept of qualifying assets – whether land can be a qualifying asset? What
if an enterprise has borrowings to set up a power project and a portion of
such borrowings are used to acquire land (on which a power plant will be
constructed)? Should such interest be capitalised to land?
� Practical challenges in allocating interest cost to different components of
qualifying assets which take a long gestation period to construct, for e.g. a
period of 3-5 years, how would one allocate interest to different classes of
AS 16 – Qualifying assets
period of 3-5 years, how would one allocate interest to different classes of
assets which got constructed at different points of time during the period of
construction?
� Whether a period less than 1 year can be considered – what about interest on
loans taken by a company for opening retail outlets which usually take 6-9
months to construct.
44
� Where funds borrowed generally and used for obtaining a qualifying asset,
borrowing costs eligible for capitalisation to be determined by applying a
capitalisation rate to expenditure on that asset.
� Capitalisation rate should be weighted average of borrowing cost applicable
to borrowings outstanding during the period other than borrowings specifically
for obtaining a qualifying asset.
AS 16 – Borrowing costs eligible for capitalisation
� Amount of borrowing costs capitalised during a period not to exceed
borrowing costs incurred during period.
� Borrowing costs for the period where there is cessation of construction
activity? How about costs where such cessation is necessary and incidental
to such construction.
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� When carrying amount or expected ultimate cost of qualifying asset exceeds
recoverable amount or net realisable value, carrying amount written down/off
in accordance with other Accounting Standards.
� In certain circumstances, amount of write down/off is written back in
accordance with those other Accounting Standards.
As 16 – Excess of carrying amount of qualifying asset over
recoverable amount
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Applicability
� Mandatory in nature for all enterprises
� Notified by Central Government w.e.f. accounting periods commencing on or
after 7 December 2006
What is the purpose of the Standard?
� To set forth criteria for recognition, measurement and disclosures about� To set forth criteria for recognition, measurement and disclosures about
intangible assets
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Effect on other standards
� From the date of the Standard becoming mandatory:
− AS 8 (R & D) to stand withdrawn fully
− AS 6, Depreciation Accounting, to stand superseded with respect to the
amortisation of intangible assets
− Paragraphs 16.3 to 16.7, 37 and 38 of AS 10, which deal with expenditure− Paragraphs 16.3 to 16.7, 37 and 38 of AS 10, which deal with expenditure
on patents and know-how, to stand withdrawn
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Exclusions from scope of standard
� Standard does not apply to –
– Intangible assets covered by another Accounting Standard
– Financial assets
– Mineral rights and expenditure on exploration, development or extraction
of minerals, oil, natural gas and similar non-regenerative resourcesof minerals, oil, natural gas and similar non-regenerative resources
– Intangible assets arising in insurance enterprises from contracts with
policyholders
– Expenditure in respect of termination benefits
– Discount or premium relating to borrowings and ancillary costs incurred in
connection with arrangement of borrowings, share issue expenses and
discount allowed on issue of shares
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What is an ‘Intangible Asset’
� ‘Intangible asset’ is “an identifiable non-monetary asset, without physical
substance, held for use in the production or supply of goods or services, for
rental to others, or for administrative purposes”
� An asset is a resource controlled by an enterprise from which future
economic benefits are expected to flow to the enterprise
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Identifiability
� Clearly distinguished from goodwill
� Enterprise can rent/sell/exchange/distribute future benefits
� Asset is identifiable even if it generates future benefits in combination with
other assets
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Control
� Power to obtain future benefits
� Also can restrict access of others to those benefits
� Normally stems from legal rights
� In absence of legal rights, more difficult to demonstrate control
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Composite assets
� Intangible assets contained in or on a physical substance, e.g. software
contained on a CD, motion picture contained on celluloid film
� Assets incorporating both intangible and tangible elements e.g, computer
hardware containing also the operating system as well as applications
software
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What qualifies as intangible asset
� AS 26 applies to expenditure on advertising, training, start-up, research and
development activities, rights under licensing agreements (for items such as
motion picture films, video recordings, plays, manuscripts)
� AS 26 also covers intangible resources such as scientific or technical
knowledge, design and implementation of new processes or systems,
expenditure on prototypes, licences, intellectual property, market knowledge
and trademarks (including brand names and publishing titles). Common and trademarks (including brand names and publishing titles). Common
examples of items encompassed by these broad headings are computer
software, patents, copyrights, motion picture films, customer lists, mortgage
servicing rights, fishing licences, import quotas, franchises, customer or
supplier relationships, customer loyalty, market share and marketing rights
� Not all the items described above will meet the definition of an intangible
asset
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Recognition of intangible assets
� An intangible asset to be recognised if,
– it is probable that the future economic benefits that are attributable to the
asset will flow to the enterprise; and
– the cost of the asset can be measured reliably.
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Recognition of intangible assets
� An intangible asset should be measured initially at cost. After initial
recognition, an intangible asset should be carried at its cost less any
accumulated amortisation and any accumulated impairment losses.
� Per AS 10 (para 15.3) - where several assets are purchased for a
consolidated price, the consideration is apportioned to the various assets on
a fair basis as determined by competent valuers (eg. Assets/business
purchase on ‘Slump’ basis)purchase on ‘Slump’ basis)
� As per AS 26 (para 27), an intangible asset acquired in an amalgamation in
the nature of purchase is accounted for in accordance with Accounting
Standard 14
� Indian GAAP does not permit Revaluation of Intangibles; under IFRS,
intangibles which have an active market (eg. Emission allowance) may be
revalued to fair value; US GAAP does not permit revaluation of intangibles.
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Cost of an intangible asset
� Acquired in exchange for shares or other securities of the reporting enterprise
- cost is asset’s fair value, or fair value of securities issued, whichever is more
clearly evident.
� Acquired in exchange for another asset - apply AS 10
� Acquired by way of government grants - apply AS 12
� Acquired in an amalgamation in the nature of purchase
– Record at existing carrying amount or
– Allocate consideration based on fair values at amalgamation date.
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Internally generated assets
� Internally generated goodwill not to be recognised as an asset
� Internally generated brands, mastheads, publishing titles, customer lists, etc.
not to be recognised as intangible assets
� For other internally generated assets, generation of asset to be classified into:
– Research phase– Research phase
– Development phase
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Research phase
� Examples of research phase activities
– Activities aimed at obtaining new knowledge
– Search for, evaluation and final selection of, applications of research
findings or other knowledge
– Search for alternatives for materials, devices, products, processes,
systems or servicessystems or services
– Formulation, design, evaluation and final selection of possible alternatives
for new or improved materials, devices, products, processes, systems or
services
� Research phase costs to be expensed in all cases
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Development phase
Examples of development phase activities:
� Design, construction and testing of pre-production or pre-use prototypes and
models
� Design of tools, jigs, moulds and dies involving new technology
� Design, construction and operation of a pilot plant that is not of a scale� Design, construction and operation of a pilot plant that is not of a scale
economically feasible for commercial production
� Design, construction and testing of a chosen alternative for new or improved
materials, devices, products, processes, systems or services
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Development phase
� An intangible asset should be recognised if enterprise can demonstrate thefollowing:
– Technical feasibility of completing the asset
– Its intention to complete the asset and use/sell it
– Its ability to use or sell the intangible asset
– How the asset will generate probable future economic benefits
(Continued)
– How the asset will generate probable future economic benefits
– Availability of adequate technical, financial and other resources to complete the
development and to use or sell the intangible asset and
– its ability to measure the expenditure attributable to the intangible asset during its
development reliably
� Cost of internally generated intangible asset comprises expenditure incurredfrom the time when it first meets the recognition criteria
64
Exclusions from cost of internally generated intangible assets
� Selling, administrative, other general overheads unless they can be directly
attributed to making the asset ready for use
� Clearly identified inefficiencies and initial operating losses incurred before an
asset achieves planned performance
� Expenditure on training the staff to operate the asset
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Recognition as expense
� Expenditure on an intangible item to be expensed when incurredunless:
– it forms part of the cost of an intangible asset that meets the recognition
criteria or
– the item is acquired in an amalgamation in the nature of purchase and
cannot be recognised as an intangible asset. In this case, the expenditurecannot be recognised as an intangible asset. In this case, the expenditure
(included in the cost of acquisition) should form part of goodwill/capital
reserve
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Examples of expenditure to be expensed
� Expenditure on research
� Start-up costs other than
– Expenditure which can be capitalised as per AS 10
– Share/debenture issue expenses
– Discount on shares/debentures (Preliminary expenses other than the – Discount on shares/debentures (Preliminary expenses other than the
above are to be expensed)
� Expenditure on training activities
� Expenditure on advertising/promotional activities
� Expenditure on relocation/re-organisation
� Expenditure initially recognised as expense in previous annual/interim
financial reports cannot later be recognised as part of cost of an intangible
asset
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Subsequent expenditure
� To be expensed unless -
– it is probable that the expenditure will result in future economic benefits in
excess of its originally assessed standard of performance and
– the expenditure can be measured and attributed to the asset reliably
� Only rarely will subsequent expenditure be added to the cost of the � Only rarely will subsequent expenditure be added to the cost of the intangible asset
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Amortisation
� Depreciable amount to be amortised over useful life
� Amortisation should commence when the asset is available for use
� Requirements concerning amortisation method, useful life and depreciable
amount are significantly at variance from those of AS 6
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Amortisation method
� Should reflect the pattern in which the asset's economic benefits are
consumed
� If that pattern cannot be determined reliably, straight-line method should be
used
� There will rarely, if ever, be persuasive evidence to support an amortisation
method that results in a lower amount of accumulated amortisation thanmethod that results in a lower amount of accumulated amortisation than
under straight-line method
� Eg. Extractive industry - Costs incurred to gain access to mineral reserves
are capitalised and amortised over the life of the quarry, which is based on
the estimated tonnes of raw materials to be extracted from the reserves
Eg. Pharma - Intangible assets comprise patents, trademarks, designs and
licenses and computer software which are stated at cost less accumulated
amortization (determined on a straight line basis) and impairment losses, if
any
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Useful life
� Rebuttable presumption that the useful life of an intangible asset will not
exceed ten years. Reasons for taking useful life exceeding ten years to be
disclosed highlighting the factors that played a significant role in determining
useful life
� Computer software and many other intangible assets are susceptible to
technological obsolescence and their useful life is thus likely to be short
� If control is achieved through legal rights granted for limited period, useful life
not to exceed the period of the legal rights unless:
– the legal rights are renewable and
– renewal is virtually certain
71
Useful life
� Eg. Consumer goods - For various brands acquired by the Company,
estimated useful life has been determined ranging between 20 to 25 years.
The Company believes this based on number of factors including the
competitive environment, market share, brand history, product life cycles,
operating plan, no restrictions on title and the macroeconomic environment of
the countries in which the brands operate. Accordingly, such intangible assets
are being amortised over the determined useful life.are being amortised over the determined useful life.
72
� Computer software and many other intangible assets are susceptible totechnological obsolescence and their useful life is thus likely to be short
– Eg. Mfg co. Expenditure on computer software is amortised on straight line method
over the period of expected benefit not exceeding five years
� If control is achieved through legal rights granted for limited period, useful lifenot to exceed the period of the legal rights unless:
(Continued)Useful life
– the legal rights are renewable and renewal is virtually certain
Eg. Mfg co. - Licenses for Technical know-how have been amortised on a straight line
basis over the License term of forty two months
Eg. Telecom - Bandwidth / Fibre taken on Indefeasible Right of Use (IRU) is amortised
over twenty years being the agreement period
� Under International GAAP (IFRS/US GAAP), Intangibles can also have indefiniteuseful life (eg Brands)
73
Residual value
� In determining depreciable amount, residual value should be assumed to be
zero unless:
– there is a commitment by a third party to purchase the asset at the end of
its useful life or
– there is an active market for the asset and:
� residual value can be determined by reference to that market and� residual value can be determined by reference to that market and
� it is probable that such a market will exist at the end of the asset's useful life
74
Review of amortisation period/method
� Amortisation period to be reviewed at least at each financial year end and to
be changed if expected useful life is significantly different from previous
estimates, the amortisation period should be changed accordingly
� Amortisation method to be similarly changed if there has been a significant
change in expected pattern of economic benefits
� Both are changes in accounting estimates� Both are changes in accounting estimates
75
Impairment losses
� Recoverable amount of following assets to be determined at least at each
financial year end even if there is no indication of impairment:
– intangible assets not yet available for use
– intangible assets being amortised over a period exceeding ten years from the date
when they became available for use
– Intangible assets with indefinite useful life (under International GAAP)– Intangible assets with indefinite useful life (under International GAAP)
76
Derecognition
� Asset to be derecognised on disposal or when no future economic benefits
are expected from its use and subsequent disposal.
77
Transitional provisions
� Assess remaining useful life (as per standard) of each intangible item on the
date of initial application of standard (say 3 years in the case of Asset A and 4
years in the case of Asset B and 6 years for Asset C)
� Determine remaining amortisation period as per books of account (say 4
years for each)
� In case of Assets B and C write off net book value in 4 years� In case of Assets B and C write off net book value in 4 years
� In case of Asset A, increase accumulated amortisation so that it can be
written off in 3 years. Increase to be adjusted against opening revenue
reserves
78
Transitional provisions - another example
� Amortisation period 10 years, 6 years have elapsed
� Remaining life as per AS 26 is 3 years. Hence total life as per AS 26 is
9 years. Hence amortisation for each year would be 100/9 or Rs 67 should
have been written off. Adjust Rs 7 against opening reserve
79
Case study on intangible assets
� Facts
During the year ended 31 March X3, Company A purchased intellectual
property rights (IPR) in the Product X, a treasury management product, from
Company B for use by its Banking group. The aggregate consideration paid
for the IPR is Rs. 5 crores. Management estimates the useful life of the IPR
as two years
� Analysis of the case
Applicability of AS 26 – Intangible assets to the above case
− In accordance with the definition of intangible assets in para 6 of AS 26 on
Intangible Assets, the IPR above constitutes an identifiable non-monetary
asset without physical substance, held for use in the supply of the services
to others. Further, intellectual property is explicitly included in examples of
intangible resources in Para 7 of the standard.
80
Case study on intangible assets
� Recognition and initial measurement of the asset
− The facts above represent a case of separate acquisition. Accordingly
the consideration paid to Company B for the acquisition of the IPR has
been used for recording the asset in the books.
� Amortisation
− Management of Company A believes that the economic benefits
(Continued)
− Management of Company A believes that the economic benefits
embodied in the IPR shall be received over a period of two year which
represent the best estimate of the useful life of the IPR. Further, this
estimate does not exceed the period of the legal rights. In accordance
with Para 63, amortisation has commenced from the date when asset is
available for use to Company A. The amortisation is performed in
accordance with Para 72 using the straight-line method over the
estimated useful life
81
Case study on accounting for software development
Stage Examples Accounting treatment
Preliminary stage
� Strategic decision to
allocate resources
� Determination of
performance requirements
� Payroll costs
� Administration costs –
eg. traveling, rent,
communications
� Recognised as expense
as incurred
� Reason – enterprises
cannot demonstrate performance requirements
� Exploration of alternative
performance requirements
� Determination of
technology
� Appointment of consultant
for development/
installation of software
communications
� External consultants
� Purchase of software
� Cost of external
software services
cannot demonstrate
that an asset exists
from which future
economic benefits are
probable
82
Case study on accounting for software development
Stage Examples Accounting treatment
Development stage
� Software including program design
� Coding of computer software
� Same as above –
Costs not considered for capitalisation
� Selling, administration and
� Recognised as assets, if & only if:
� Technical feasibility has been achieved
� Enterprise has intention to
(Continued)
� Beta testing (initial testing)
� Testing of function, feature and technical performance of product design
� Selling, administration and other general overhead expenditure
� Clearly defined ineffectiveness and initial operating losses before software achieves planned performance
� Staff training costs
� Enterprise has intention to complete software project and use it for intended purpose
� Enterprise has ability to use the software
� Software will generate future economic benefits
� Availability of adequate technical, financial and other resources to complete development and use software
– Expenditure can be measured
83
� Costs incurred subsequent to development of software shall becapitalised if
− probable that future economic benefits are in excess of originally
assessed standards of performances
− expenditure can be reliably measured and attributed to software
development
Case study on accounting for software development(Continued)
development
� Amortisation period
− 3 to 5 years or if useful life is a shorter period or software is susceptible to
technological obsolescence. Testing for impairment to be carried out
annually
84
IPR – Definition
As per World Trade Organisation
Intellectual Property Rights (IPR) are the rights given to persons over the creations of their minds. They
usually give the creator an exclusive right over the use of his/her creation for a certain period of time
I Copyright and rights related to copyright
� The rights of authors of literary and artistic works (such as books and other writings, musical
compositions, paintings, sculpture, computer programs and films) are protected by copyright, for a
minimum period of 50 years after the death of the author
� Also protected through copyright and related (sometimes referred to as “neighbouring”) rights are the� Also protected through copyright and related (sometimes referred to as “neighbouring”) rights are the
rights of performers (e.g. actors, singers and musicians), producers of phonograms (sound recordings)
and broadcasting organizations. The main social purpose of protection of copyright and related rights
is to encourage and reward creative work
II Industrial property
� One area can be characterized as the protection of distinctive signs, in particular trademarks (which
distinguish the goods or services of one undertaking from those of other undertakings) and
geographical indications (which identify a good as originating in a place where a given characteristic of
the good is essentially attributable to its geographical origin)
� Other types of industrial property are protected primarily to stimulate innovation, design and the
creation of technology. In this category fall inventions (protected by patents), industrial designs and
trade secrets
85
As per Development Commissioner - Micro, Small and Medium Enterprises
Intellectual Property Rights (IPR) are legal rights, which result from intellectual activity in
industrial, scientific, literary & artistic fields. These rights safeguard creators and other
producers of intellectual goods & services by granting them certain time-limited rights to
control their use. Protected IP rights like other property can be a matter of trade, which
can be owned, sold or bought
Types of IPR
(Continued)IPR – Definition
a. Patents
b. Trademarks/ Brands
c. Copyrights and related rights
d. Geographical Indications
e. Industrial Designs
f. Trade Secrets
g. Layout Design for Integrated Circuits
h. Protection of New Plant Variety
86
IPR accounting – relevance and challenges
� As corporations around the world are awakening to the revenue-generating
potential of intangible assets, the issue of accounting for intellectual property
gains importance
� Varying accounting practices are prevalent resulting in differing Balance
sheets and Profit and loss accounts
� Due to absence of organised and transparent markets, and subjectivity
involved, there are difficulties in determining value of IPRsinvolved, there are difficulties in determining value of IPRs
� Accounting rules are evolving to enhance reporting/disclosures of IPR
� Differences between economic framework of accounting and legal framework
lead to disparity between what Companies show in the balance sheet and
own. Therefore, not all IPR are recognised as intangible assets in accounting
and some intangible assets considered as IP are not recognised as IPR by
law
� Is IP Report a need of the hour (in case of internally generated IPs)??
87
IPR recorded on the balance sheets….
� Pepsi has perpetual brands of USD 4,839 million representing 6% of its total
assets
� Walt Disney has copyrights and trademarks aggregating USD 4,273 million
representing 6% of its total assets
� Microsoft has technology based and marketing related intangibles of USD
3,083 million representing 2% of its total assets3,083 million representing 2% of its total assets
� Coca Cola has perpetual trademarks of USD 6,527 million representing 8% of
its total assets
� Google has patents and developed technology of USD 5,987 million
representing 6% of its total assets
88
Applicability of accounting literature for IPR
� Under Indian GAAP, accounting for IPR is guided by:
- Accounting Standard 26 ‘Intangible Assets’
- Accounting Standard 10 ‘Fixed assets’ –
• As per AS 10, assets are grouped into various categories, such as
land, buildings, plant and machinery, vehicles, furniture and fittings,
goodwill, patents, trade marks and designsgoodwill, patents, trade marks and designs
� Accounting Standard 14 ‘Accounting for Amalgamations’
� Typical industries with IPRs
- Technology - Microsoft, IBM, Google, Wipro
- Pharma - Ranbaxy, Pfizer
- Media and Entertainment – Time Warner, Walt Disney
- Manufacturing - Pepsi, Coca Cola, Nokia
89
Impairment losses
� Recoverable amount of following assets to be determined at least ateach financial year end even if there is no indication of impairment:
– intangible assets not yet available for use
– intangible assets being amortised over a period exceeding ten years from
the date when they became available for use
– Intangible assets with indefinite useful life (under International GAAP)– Intangible assets with indefinite useful life (under International GAAP)
90
Derecognition
� Asset to be derecognised
– on disposal or
– when no future economic benefits are expected from its use and
subsequent disposal
91
Again a new
You areBeautifulWith this dress
What is Impairment?(Continued)
Married since 7 months
Again a newdress ?
Married since 7 years
How much ?
Married since 7 days
98
w.e.f April 1, 2004
� Listed & in process of listing
� Turnover > 500 Mn
w.e.f April 1, 2005All Enterprises
Applicability
Excludes
Inventory
Financial Assets
Construction
contracts
Deferred Tax Asset
99
Recoverable
amount is greater
of:
Impairment Loss = Carrying Amount - Recoverable Amount
Impairment Concept
Net Selling Price (NSP)
determined by either of:
Binding Sale
Bid price in
Active Market
Best Estimate
Value in Use: NPV of
Cash Flows
Number
of Years
Discount
Rate
100
Impairment
Indications exist
No
Impairment
Review
Identify Asset
No Yes
Impairment Concept (Continued)
Review
Determine Recoverable
Amount
If indeterminate,
identify Cash-
Generating Unit
(CGU)
101
� A land is rented as a parking space as a result of which there is impairment.
However the land owner argues that an impairment provision is not required
since the land will soon be converted into a bowling alley, a highly profitable
business. Is that argument acceptable for not making an impairment
provision?
Case # 1 – Recoverability / Fair value
− Recoverability Test – Continuing use of asset
− Not a Fair Value Test – Market place assumption
− Future change – Not yet committed
102
70% of the Printing Press – New Plant has been completed. Due to some
financial problems further work came to a halt since the past one year. Is
impairment required to be provided on capital work-in-progress?
� Yes, Impairment is required.
Case # 2 – Impairment - CWIP
� Existing Carrying Amount is without expected future cash outflows
� Value in use to include future cash outflows before use/sale
103
� The Roller coaster in a theme park is damaged and is to be repaired
� This ride generates independent cash inflows
� The ride’s NSP (which is negligible) < Carrying Amount
� Value in use can be estimated
� The smallest identifiable CGU is the Theme park ? Or the ride? The Theme park taken
as a whole is not impaired
Case # 3A – Identification of CGU
as a whole is not impaired
� Assume no commitment to sell & replace the machine
� What is impaired?
� Recoverable Amount – Can be estimated for machine as well as the Theme Park
� However, Theme Park is not impaired
Only reassess depreciation method/period for machine
105
� Now assume, a commitment to sell and replace the machine
� Also, Cash flows from continuing use to be negligible
� What is impaired?
Case # 3B – Identification of CGU
� Machine
� Recoverable Amount – Can be estimated for machine
− Commitment to sell the machine &
− NSP > Value in Use
� Hence, no consideration to CGU
106
Admin++= Roller Coaster Ferry Wheel
How to arrive at Carrying Amount of CGU?
Admin+
Allocable Assets
-
Liabilities on Disposal
+
Assets Under CGU
= Roller Coaster Ferry Wheel
107
� While doing cash projection of following CGU that has assets with different remaining useful lives, how is the maximum period, up to which the cash flows should be projected is determined?
� Identify Primary asset of the CGU
� The Primary Asset is Rides, since
− Availability of Rides determines possibility of cash generation of the CGU
− No need of other assets unless entity has exciting Rides
Case # 4 – Useful life of CGU
− No need of other assets unless entity has exciting Rides
� Cannot be the asset not being amortized e.g. Land
Assets Balance Life Carrying Amt.
Sets 8 100 Mn
Building 6 20 Mn
Rides 10 85 Mn
Furniture 12 50 Mn
Computer 3 2 Mn
108
Admin Roller Coaster Ferry Wheel
Level at which Impairment required...
NilImpairment
60 MnNPV of rentals
50 MnCarrying Amount
Admin Roller Coaster Ferry Wheel
20 MnImpairment
230 MnNPV of Business Income
200 MnCarrying Amount of Others
50 MnCarrying Amount of Admin
109
Goodwill allocated, if any
Other assets: Pro-rata
Allocation of Impairment Loss on CGU
Ensure, Carrying Amount = Recoverable Amount
Else, balance Loss to be allocated to other assets
Other assets: Pro-rata
110
External Sources
Market Value ↓
Adverse External Env
Internal Sources
Physical Damage
Indicators
Adverse External Env
↑ Market ROI
Book Value > Mkt. Cap.
Poor Economic performance
Adv chg in Asset use
Formally estimate Recoverable Amount
111
Apply Bottom-Up test, if allocable
How is Impairment determined for Goodwill and
Corporate Asset?
Else, apply both Bottom-Up & Top-Down Tests
112
Application of Top-Down Test
(Rs in Mn) Goodwill Total
Carrying Amount 250 100 20 370
Impairment Loss for A under
Bottom up test
(20) - - (20)
Carrying Amount after loss 230 100 20 350
Recoverable Amount 340
Impairment Loss - Top Down (10)
113
Accounting Treatment
� Initial Losses to be adjusted against opening revenue reserves
� The Loss should be recognised as
− Revaluation decrease if asset was revalued earlier, else
− Expense in P&L
� After recognition, revise depreciation charge� After recognition, revise depreciation charge
� Recognise liability if, Loss > Carrying Amount
114
Treatment of Reversals
� Annually identify if Loss recognised earlier no longer exists
� Reversal if change in Cash Flow or Discount rate
� Carrying Amount <= original amortised Carrying Amount
� The Reversal should be recognised as
− Revaluation Increase if asset was revalued earlier, else
− Income in P&L
115
Disclosure requirements
� For each class of assets and reportable Segment, seperately
− Loss / Reversals recognised in P&L Account
− Loss / Reversals recognised against Revaluation Reserves
116
If material to the financial statements as a whole:
Relevant events and circumstances
Nature of asset / CGU
Disclosure requirements (Continued)
Nature of asset / CGU
Reportable Segment
Reasons for change, current and former CGU
Measurement of Recoverable Amount
117
Im p a irm e n t
In d ic a tio n s e x is t
N oIm p a irm e n t
R e v ie w
Id e n tify A s s e t
D e te rm in eR e c o ve ra b le A m o u n t
R e c o ve ra b leA m o u n t is g re a te r
o f:
N o
Y e s
If U n d e te rm in e d , id e n tifyC a s h -G e n e ra tin g U n it
V e r ify
Summary
N e t S e llin g P ric ed e te rm in e d b y
e ith e r o f:
B in d in gS a le
B id p ric e in
A c tiveM a rk e t
B e s tE s tim a te
V a lu e in U s e :N P V o f C F
C a rry in g A m o u n t >R e c o ve ra b le A m o u n t
N oIm p a irm e n t
P ro v is io n
Im p a irm e n t L o s s =C a rry in g A m o u n t - N e t
R e c o ve ra b le A m o u n t
T o b e fo llo w e d u p b yA n n u a l Im p a irm e n t
R e v ie w
N o
Y e s
N u m b e r o f
Y e a rs
D is c o u n tR a te
118
� Financial forecasts for maximum 5 years
� Steady / declining growth rate for extrapolating
� Do not consider
− Financial activities, receivables, payables and provisions
− Income tax receipts and payments
Cash Flows
− Income tax receipts and payments
− Non-committal future restructuring
− Proposed capital expenditure
� Foreign currency cash flows discounted at a rate appropriate to such currency. NPV to
be translated using the exchange rate at balance sheet date
� Cash Flow & Discount rate must reflect consistent assumptions about Inflation
120
� A pre-tax rate that reflects current time value of money and asset specific
risks
� Ignore risks for which future Cash Flows have been adjusted
� Rate of return that investors would expect from similar asset
� Weighted Average Cost of Capital (WACC) of a listed entity with similar
Discount Rate
� Weighted Average Cost of Capital (WACC) of a listed entity with similar
service potential and risks
� If benchmark not available, then consider entity’s own WACC or incremental
borrowing rate adjusted for:
− asset-specific risks
− country risks
− currency risks
121