LECTURE NOTES ON WASTING ASSETS

The Revaluation Model

• The asset is carried at a revalued amount, being its fair value at the date of the revaluation less any subsequent
accumulated depreciation and subsequent accumulated impairment losses.
• If an item is revalued, the entire class of assets to which that asset belongs should be revalued.

How to determine fair value?

• Land and buildings - usually determined from market-based evidence by appraisal that is normally undertaken
by professionally qualified valuers.
• Items of plant and equipment - usually determined by appraisal.
• If there is no market-based evidence of fair value because of the specialized nature of the item of PPE and the
item is rarely sold, except as part of a continuing business, an entity may need to estimate fair value using an
income or a depreciated replacement cost approach.

How often should assets be revalued?

• Revaluations shall be made with sufficient regularity to ensure that the carrying amount does not differ materially
from that which would be determined using fair value at the end of the reporting period.
• The frequency of revaluations depends upon the changes in fair values of the items of PPE being revalued.
• When the fair value of a revalued asset differs materially from its carrying amount, a further revaluation is
required.
• Some items of PPE experience significant and volatile changes in fair value, thus necessitating annual
revaluation.
• Such frequent revaluations are unnecessary for items of PPE with only insignificant changes in fair value.
Instead, it may be necessary to revalue the item only every three or five years.

Accounting for Revaluation Increase

Not previously impaired:

• Recognized in OCI and accumulated in equity under the heading of revaluation surplus

Previously impaired:

• Reversal of impairment loss recognized in P/L

• Excess recognized in OCI

Accounting for Revaluation Decrease

Not previously revalued:

• Recognized in P/L as revaluation loss

Previously revalued:

• Recognized in OCI to the extent of any credit balance existing in the revaluation surplus in respect of that asset

• Excess recognized in P/L

Realized Revaluation Surplus

• May be transferred directly to retained earnings, or

• It may be left in equity under the heading revaluation surplus.

The transfer to retained earnings should not be made through profit or loss

IMPAIRMENT
Key Definitions

Impairment: An asset is impaired when its carrying amount exceeds its recoverable amount.

Carrying amount: the amount at which an asset is recognized in the statement of financial position after deducting
accumulated depreciation and accumulated impairment losses

Recoverable amount: The higher of an asset's fair value less costs of disposal and its value in use:

Fair value: the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date.

Costs of disposal: Incremental costs directly attributable to the disposal of an asset or cash-generating unit, excluding
finance costs and income tax expense.

Value in use: the present value of the future cash flows expected to be derived from an asset or cash-generating
unit.

Identifying an Asset That May Be Impaired

An entity shall assess at the end of each reporting period whether there is any indication that an asset may be
impaired. If any such indication exists, the entity shall estimate the recoverable amount of the asset.
Indications of Impairment

External sources:
• market value declines
• negative changes in technology, markets, economy, or laws
• increases in market interest rates
• company stock price is below book value
Internal sources:
• obsolescence or physical damage
• asset is part of a restructuring or held for disposal
• worse economic performance than expected
These lists are not intended to be exhaustive. Also, must consider materiality. Further, an indication that an asset
may be impaired may indicate that the asset's useful life, depreciation method, or residual value may need to be
reviewed and adjusted.

Determining Recoverable Amount

• If fair value less costs of disposal or value in use is more than carrying amount, it is not necessary to calculate
the other amount. The asset is not impaired.

• If fair value less costs of disposal cannot be determined, then recoverable amount is value in use.

• For assets to be disposed of, recoverable amount is fair value less costs of disposal.
Fair Value Less Costs of Disposal

• Refer to PFRS 13 in determining fair value.

• Examples of such costs of disposal are legal costs, stamp duty and similar transaction taxes, costs of removing
the asset, and direct incremental costs to bring an asset into condition for its sale.

• However, termination benefits (as defined in IAS 19) and costs associated with reducing or reorganizing a
business following the disposal of an asset are not direct incremental costs to dispose of the asset.

Value in Use

The calculation of value in use should reflect the following elements:

• an estimate of the future cash flows the entity expects to derive from the asset in an arm's length transaction;

• expectations about possible variations in the amount or timing of those future cash flows;

• the time value of money, represented by the current market risk-free rate of interest;

• the price for bearing the uncertainty inherent in the asset; and

• other factors, such as illiquidity, that market participants would reflect in pricing the future cash flows the entity
expects to derive from the asset.

Cash flow projections should be based on reasonable and supportable assumptions, the most recent budgets and
forecasts, and extrapolation for periods beyond budgeted projections. PAS 36 presumes that budgets and forecasts
should not go beyond five years; for periods after five years, extrapolate from the earlier budgets. Management
should assess the reasonableness of its assumptions by examining the causes of differences between past cash flow
projections and actual cash flows.

Cash flow projections should relate to the asset in its current condition – future restructurings to which the entity is
not committed and expenditures to improve or enhance the asset's performance should not be anticipated.

Estimates of future cash flows should not include cash inflows or outflows from financing activities, or income tax
receipts or payments.

Discount Rate

In measuring value in use, the discount rate used should be the pre-tax rate that reflects current market assessments
of the time value of money and the risks specific to the asset.

The discount rate should not reflect risks for which future cash flows have been adjusted and should equal the rate
of return that investors would require if they were to choose an investment that would generate cash flows equivalent
to those expected from the asset.
For impairment of an individual asset or portfolio of assets, the discount rate is the rate the company would pay in a
current market transaction to borrow money to buy that specific asset or portfolio.

If a market-determined asset-specific rate is not available, a surrogate must be used that reflects the time value of
money over the asset's life as well as country risk, currency risk, price risk, and cash flow risk. The following would
normally be considered:
• the entity’s own weighted average cost of capital;
• the enterprise's incremental borrowing rate; and
• other market borrowing rates.
Recognition of an Impairment Loss

• An impairment loss should be recognized whenever recoverable amount is below carrying amount.

• An impairment loss on a non-revalued asset is recognised in profit or loss.

• An impairment loss on a revalued asset is recognised in other comprehensive income to the extent that the
impairment loss does not exceed the amount in the revaluation surplus for that same asset.

• When the amount estimated for an impairment loss is greater than the carrying amount of the asset to which it
relates, an entity shall recognise a liability if, and only if, that is required by another Standard.

• Adjust depreciation for future periods.

Cash-Generating Units

If it is not possible to determine the recoverable amount for the individual asset, then determine recoverable amount
for the asset's cash-generating unit (CGU). The CGU is the smallest identifiable group of assets:
• that generates cash inflows from continuing use, and
• that are largely independent of the cash inflows from other assets or groups of assets.
The impairment loss is allocated to reduce the carrying amount of the assets of the unit (group of units) in the
following order:
• first, reduce the carrying amount of any goodwill allocated to the cash-generating unit (group of units); and
• then, reduce the carrying amounts of the other assets of the unit (group of units) pro rata on the basis of the
carrying amount of each asset in the unit (group of units).

The carrying amount of an asset should not be reduced below the highest of:
• its fair value less costs of disposal (if determinable);
• its value in use (if determinable); and
• zero.
If the preceding rule is applied, further allocation of the impairment loss is made pro rata to the other assets of the
unit (group of units).

Reversal of an Impairment Loss

• Same approach as for the identification of impaired assets: assess at the end of each period whether there is an
indication that an impairment loss may have decreased. If so, calculate recoverable amount.

• No reversal for unwinding of discount.

• The increased carrying amount due to reversal should not be more than what the depreciated historical cost
would have been if the impairment had not been recognized.

• Reversal of an impairment loss on a non-revalued asset is recognized in profit or loss.

• Reversal of an impairment loss on a revalued asset is recognised in other comprehensive income and increases
the revaluation surplus for that asset. However, to the extent that an impairment loss on the same revalued
asset was previously recognised in profit or loss, a reversal of that impairment loss is also recognised in profit
or loss.

• Adjust depreciation for future periods.

Impairment of Goodwill

Goodwill should be tested for impairment annually.

To test for impairment, goodwill must be allocated to each of the acquirer's cash-generating units, or groups of cash-
generating units, that are expected to benefit from the synergies of the combination, irrespective of whether other
assets or liabilities of the acquiree are assigned to those units or groups of units. Each unit or group of units to which
the goodwill is so allocated shall:
• represent the lowest level within the entity at which the goodwill is monitored for internal management purposes;
and
• not be larger than an operating segment determined in accordance with PFRS 8.
A cash-generating unit to which goodwill has been allocated shall be tested for impairment at least annually by
comparing the carrying amount of the unit, including the goodwill, with the recoverable amount of the unit:
• If the recoverable amount of the unit exceeds the carrying amount of the unit, the unit and the goodwill allocated
to that unit is not impaired.
• If the carrying amount of the unit exceeds the recoverable amount of the unit, the entity must recognize an
impairment loss.

The impairment loss is allocated to reduce the carrying amount of the assets of the unit (group of units) in the
following order:
• first, reduce the carrying amount of any goodwill allocated to the cash-generating unit (group of units); and
• then, reduce the carrying amounts of the other assets of the unit (group of units) pro rata on the basis of the
carrying amount of each asset in the unit (group of units).

The carrying amount of an asset should not be reduced below the highest of:
• its fair value less costs of disposal (if determinable);
• its value in use (if determinable); and
• zero.
If the preceding rule is applied, further allocation of the impairment loss is made pro rata to the other assets of the
unit (group of units).

Reversal of an Impairment Loss

Reversal of an impairment loss for goodwill is prohibited.

PROBLEMS
Use the following information for next two questions.

Tyke Corporation has the following information on January 1, 2015 relating to its land and building.

Land P 20,000,000
Building 450,000,000
Accumulated depreciation 75,000,000

There were no additions or disposals during 2015. Depreciation is computed using straight line method over 15
years for building. On June 30, 2015, the land and building were revalued as follows:

Depreciated
Replacement cost replacement cost
Land P 35,000,000 P 35,000,000
Building 600,000,000 480,000,000

1. The depreciation expense for the year 2015 is

2. The revaluation surplus as of December 31, 2015 is

Use the following information for next two questions.

Tycoon Corporation acquired a building on January 1, 2011 at a cost of P50,000,000. The building has an estimated
life of 10 years and residual value of P5,000,000. The building was revalued on January 1, 2015 and the revaluation
revealed replacement cost of P80,000,000, residual value of P2,000,000 and revised total life of 12 years.

3. The carrying amount of building as of December 31, 2015 is

4. The revaluation surplus as of December 31, 2015 is

Use the following information for the next three questions.

On December 31, 2014, the statement of financial position of Twitter Corporation showed the following property and
equipment after charging depreciation:

Building P3,000,000
Accumulated depreciation (1,000,000) P2,000,000
Equipment 1,200,000
Accumulated depreciation (400,000) 800,000

The company has adopted the revaluation model for the valuation of property and equipment. This has resulted in
the recognition in prior periods of an asset revaluation surplus for the building of P140,000. The company does not
make a transfer to retained earnings in respect of realized revaluation surplus.

On December 31, 2014, an independent valuer assessed the fair value of the building to be P1,600,000 and the
equipment to be P900,000. The building and equipment had remaining useful lives of 25 years and 4 years,
respectively, as of that date.

5. The net amount to be recognized in comprehensive income for 2014 related to the revaluation of property and
equipment is

6. The revaluation surplus as of December 31, 2015 is

7. The carrying amount of property and equipment as of December 31, 2015 is

8. Twinkle Corporation has one division that performs machining operations on parts that are sold to contractors.
A group of machines have an aggregate cost and accumulated depreciation on December 31, 2015 as follows:

Machinery P90,000,000
Accumulated depreciation 30,000,000

The machines have an average remaining life of 4 years. The fair value less costs of disposal of this group of
machines in an active market is determined to be P45,000,000. The financial forecast for this group of machines
reveals the following cash inflows and cash outflows for the next four years:

Cash inflows Cash outflows Net

2016 30,000,000 12,000,000 18,000,000
2017 32,000,000 17,000,000 15,000,000
2018 26,000,000 14,000,000 12,000,000
2019 16,000,000 6,000,000 10,000,000

Compute for the impairment loss in 2015 assuming that the appropriate discount rate is 8%.
9. On January 1, 2011, the Twine Corporation purchased a machine with a useful life of 12 years for P650,000.
The machine is carried at P400,000 at December 31, 2015 before recording any impairment loss. Late in 2015,
because of increasing competition in the industry, the company believes that its asset may be impaired and will
have a remaining useful life of 5 years, over which it estimates the asset will produce total cash inflows of
P1,000,000 and will incur total cash outflows of P825,000. The cash flows are independent of the company's
other activities and will occur evenly each year. The company is not able to determine the fair value based on
a current selling price of the machinery. The appropriate risk-free interest rate is 10%. The impairment loss to
be recognized in 2015 profit or loss is

10. Autobots Bottling purchased for P800,000 a trademark for a very successful soft drink it markets under the name
OK!. The trademark was determined to have an indefinite life. A competitor recently introduced a product that
is in direct competition with the OK! product, thus suggesting the need for an impairment test. Data gathered
by Autobots suggests that the useful life of the trademark is still indefinite, but the cash flows expected to be
generated by the trademark have been reduced either to P30,000 per year (with a probability of 80%) or to
P60,000 per year (with 20% probability). The appropriate risk-free interest rate is 5%. The appropriate risk-
adjusted interest rate is 10%.

The loss on impairment of trademark is

11. On January 1, 2013, Bunny Inc. purchased a patent with a cost P1,160,000, a useful life of 5 years. The company
uses straight-line depreciation. At December 31, 2014, the company determines that impairment indicators are
present. The fair value less cost to sell the patent is estimated to be P540,000. The patent's value-in-use is
estimated to be P565,000. The asset's remaining useful life is estimated to be 2 years.

The company's 2015 income statement will report amortization expense for the patent of

12. An entity has an oil platform in the sea. The entity has to decommission the platform at the end of its useful
life, and a provision was set up at the commencement of production. The carrying amount of the provision is
P8 million. The entity has received an offer of P20 million (selling costs P1 million) for the rights to the oil
platform, which reflects the fact that the owners have to decommission it at the end of its useful life. The value-
in-use of the oil platform is P26 million ignoring decommissioning costs. The current carrying amount of the oil
platform is P28 million. How much should be recognized as impairment loss?

13. On July 1, 2015, Hansel, Inc. acquired Grettel Company in a business combination. As a result of the
combination, the following amounts of goodwill were recorded for each of the three reporting units of the acquired
company:

Retailing P300,000
Service 200,000
Financing 400,000

Near the end of 2015 a new major competitor entered the company’s market and Hansel was concerned that
this might cause a significant decrease in the value of goodwill. Accordingly, Hansel computed the implied value
of the goodwill for the three major reporting units at December 31, 2015 as follows:

Retailing P250,000
Service 100,000
Financing 600,000

Determine the amount of goodwill impairment that should be recorded by Hansel at December 31, 2015.

14. At reporting date, the carrying amount of a cash-generating unit was considered to be have been impaired by
P1,000,000. The unit included the following assets: Land P3,000,000; Building P2,000,000; Goodwill P500,000.
The fair value of land is reliably determined to be P2,800,000. The carrying amount of building after impairment
loss is

15. Jenus owns a company called Klassic Kars. Extracts from Jenus' consolidated statement of financial position
relating to Klassic Kars are:

Goodwill P 80,000,000
Franchise costs 50,000,000
Restored vehicles (at cost) 90,000,000
Plant 100,000,000
Other net assets 50,000,000
P370,000,000

An impairment review at December 31, 2015 has estimated that the value of Klassic Kars as a going concern is
only P240 million. The franchise agreement contains a 'sell back’ clause, which allows Klassic Kars to relinquish
the franchise and gain a repayment of P30 million from the franchisor. The restored vehicles have an estimated
realizable value of P115 million.

How much is the carrying amount of Plant after impairment loss is recognized?

16. Twig Company reported an impairment loss of P4,000,000 in its income statement for the year 2014. This loss
was related to an equipment which was acquired on January 1, 2013 with cost of P25,000,000, useful life of 10
years and no residual value. On December 31, 2014 statement of financial position, Twig reported this asset at
P16,000,000 which is the recoverable amount on such date. On December 31, 2015, Twig determined that the
recoverable amount of its impaired asset had increased to P19,000,000. The straight line method is used in
recording depreciation of this asset.

Compute the amount of gain on impairment recovery to be recognized in 2015 profit or loss.
17. Protoss Corporation acquired a patent right on July 1, 2012 for P250,000. The remaining a legal life on the date
of purchase is 15 years. However, due to rapidly changing technology, management estimates that the
remaining useful life on July 1, 2012 is only 5 years.

At January 1, 2013, management is uncertain that the process can actually be made economically feasible, and
decides to write down the patent to an estimated recoverable amount of P75,000. Amortization will be taken
over 3 years from that point.

On January 1, 2015, having perfected the related production process, the entity adopts the revaluation model
to measure the patent. The patent now has a fair value of P300,000. Furthermore, the estimated remaining
useful life is now believed to be 5 years.

How much can be recognized as gain on impairment recovery in 2015 profit or loss?

Use the following information for the next two questions:

One of the cash-generating units of Tweak Corporation is that associated with the manufacture of wine barrels. At
31 December 2014, Tweak Corporation believed, based on an analysis of economic indicators, that the assets of the
unit were impaired. The carrying amounts the assets of the unit at 31 December 2014 were:

Buildings, net
(Depreciated at P60,000 per annum) P240,000
Machinery, net
(Depreciated at P45,000 per annum) 180,000
Goodwill 15,000
Inventory 80,000
Receivables, net
(Allow. for doubtful debts of P5,000) 35,000
Cash 20,000
Total P570,000

Tweak Corporation determined the value in use of the unit to be P535,000. The receivables were considered to be
collectible, except those considered doubtful.

During 2015, Tweak Corporation increased the depreciation charge on buildings to P65,000 per annum, and to
P50,000 per annum for factory machinery. The inventory on hand at 31 December 2014 was sold by the end of
2015. At 31 December 2015, Tweak Corporation, due to a return in the market to the use of traditional barrels for
wines and an increase in wine production, assessed the recoverable amount of the cash-generating unit to be P20,000
greater than the carrying amount of the unit.

18. How much is the carrying amount of buildings at 31 December 2014 after allocating impairment loss?

19. How much is the carrying amount of factory machinery at 31 December 2015 after the reversal of impairment
loss?