Impairment of fixed assets and goodwill 1455
The income approach converts future amounts (e.g. cash flows or income and expenses)
to a single discounted amount. The fair value reflects current market expectations about
those future amounts. This will usually mean using a discounted cash flow technique or
one of the other techniques that fall into this classification (e.g. option pricing and multi-
period excess earnings methods). [IFRS 13.B10, B11].
See Chapter 14 for a further discussion of these valuation approaches.
The inputs used in these valuation techniques to measure the fair value of an asset have
a hierarchy. Those that are quoted prices in an active market for identical assets (Level
1) have the highest priority, followed by inputs, other than quoted prices, that are
observable (Level 2). The lowest priority inputs are those based on unobservable inputs
(Level 3). [IFRS 13.72]. The valuation techniques, referred to above, will use a combination
of inputs to determine the fair value of the asset.
An active market is a market in which transactions take place with sufficient frequency
and volume to provide pricing information on an ongoing basis. [IFRS 13 Appendix A].
Using the IFRS’s approach, most estimates of fair value for IAS 36 purposes will use
Level 2 inputs that are directly or indirectly observable and Level 3 inputs that are not
based on observable market data but reflect assumptions used by market participants,
including risk.
If Level 2 information is available then entities must take it into account in calculating
FVLCD because this is a relevant observable input, and cannot base their valuation only
on Level 3 information. Deutsche Telekom calculated the FVLCD of one of its CGUs
and took a third party transaction in the same sector and geographical area into account
in its valuation model. Although this transaction, shown in the following extract, long
pre-dates IFRS 13, the principles are the same as those that would be applied under
IFRS 13.
Extract 20.2: Deutsche Telekom AG (2007)
Notes to the consolidated income statement [extract]
16.
Depreciation, amortization and impairment losses [extract]
In the 2005 financial year, Deutsche Telekom recognized an impairment loss of EUR 1.9 billion at the T-Mobile UK
cash-generating unit. Telefónica announced its offer to acquire the UK group O2 at a price of 200 pence per share
(approximately GBP 17.7 billion) on October 31, 2005. When determining the fair value less costs to sell, the
purchase prices paid in comparable transactions must generally be given preference over internal DCF calculations.
The fair value of the cash-generating unit T-Mobile UK was derived from the Telefónica offer in accordance with a
valuation model based on multipliers.
IFRS 13 allows entities to use unobservable inputs, which can include the entity’s own
data, to calculate fair value, as long as the objectives (an exit price from the perspective
of a market participant) and assumptions about risk are met. [IFRS 13.87-89]. This means
that a discounted cash flow technique may be used if this is commonly used in that
industry to estimate fair value. Cash flows used when applying the model may only
reflect cash flows that market participants would take into account when assessing fair
value. This includes the type, e.g. future capital expenditure, as well as the estimated
amount of such cash flows. For example, an entity may wish to take into account cash
flows relating to future capital expenditure, which would not be permitted for a VIU
1456 Chapter 20
calculation (see 7.1.2 below). These cash flows can be included if, and only if, other
market participants would consider them when evaluating the asset. It is not permissible
to include assumptions about cash flows or benefits from the asset that would not be
available to or considered by a typical market participant.
The entity cannot ignore external evidence. It must use the best information that is
available to it and adjust its own data if ‘reasonably available information indicates that
other market participants would use different data or there is something particular to
the entity that is not available to other market participants such as an entity-specific
synergy’. An entity need not undertake exhaustive efforts to obtain information about
market participant assumptions. ‘However, an entity shall take into account all
information about market participant assumptions that is reasonably available.’
[IFRS 13.89]. This means using a relevant model, which requires consideration of industry
practice, for example, multiples based on occupancy, revenue and EBITDA might be
inputs in estimating the fair value of a hotel but the value of an oilfield would depend
on its reserves. The fair value of an oil field would include the costs that would be
incurred in accessing those reserves based on the costs a market participant expects to
incur instead of the entity’s own specific cost structure.
IAS 36 notes that sometimes it is not possible to obtain reliable evidence regarding the
assumptions and techniques that market participants would use (IAS 36 uses the phrase
‘no basis for making a reliable estimate’); if so, the recoverable amount of the asset must
be based on its VIU. [IAS 36.20]. Therefore, the IASB accepts that there are some
circumstances in which market conditions are such that it will not be possible to
calculate a reliable estimate of the price at which an orderly transaction to sell the asset
would take place under current market conditions. [IAS 36.20]. IFRS 13 includes guidance
for identifying transactions that are not orderly. [IFRS 13.B43]. These are discussed in
Chapter 14 at 8.2.
6.1.1
FVLCD and the unit of account
In determining FVLCD it is critical to determine the relevant unit of account
appropriately.
IFRS 13 does specify the unit of account to be used when measuring fair value in relation
to a reporting entity that holds a position in a single asset or liability that is traded in an
active market (including a position comprising a large number of identical assets or
liabilities, such as a holding of financial instruments). In this situation, IFRS 13 requires
an entity to measure the asset or liability based on the product of the quoted price for
the individual asset or liability and the quantity held (P×Q).
This requirement is generally accepted when the asset or liability being measured is a
financial instrument in the scope of IFRS 9. However, when an entity holds an
investment in a listed subsidiary, joint venture or associate, some believe the unit of
account is the entire holding and the fair value should include an adjustment (e.g. a
control premium) to reflect the value of the investor’s control, joint control or significant
influence over their investment as a whole.
Questions have also arisen as to how this requirement applies to cash-generating units
that are equivalent to listed investments. Some argue that, because IAS 36 requires certain
assets and liabilities to be excluded from a CGU, the unit of account is not identical to a
Impairment of fixed assets and goodwill 1457
listed subsidiary, joint venture or associate and an entity can include adjus
tments that are
consistent with the CGU as a whole. Some similarly argue that approach is appropriate
because, in group financial statements, an entity is accounting for the assets and liabilities
of consolidated entities, rather than the investment. However, others argue that if the
CGU is effectively the same as an entity’s investment in a listed subsidiary, joint venture
or associate, the requirement to use P×Q should apply.
IFRS 13 requires entities to select inputs that are consistent with the characteristics of the
asset or liability being measured and would be considered by market participants when
pricing the asset or liability. Apart from block discounts (which are specifically
prohibited), determining whether a premium or discount applies to a particular fair value
measurement requires judgement and depends on specific facts and circumstances.
The standard indicates that premiums or discounts should not be incorporated into fair
value measurements unless all of the following conditions are met:
• the application of the premium or discount reflects the characteristics of the asset
or liability being measured;
• market participants, acting in their economic best interest, would consider these
premiums or discounts when pricing the asset or liability; and
• the inclusion of the premium or discount is not inconsistent with the unit of
account in the IFRS that requires (or permits) the fair value measurement.
Therefore, when an entity holds an investment in a listed subsidiary, joint venture
or associate and if the unit of account is deemed to be the entire holding, it seems
to be appropriate to include, for example, a control premium when determining fair
value, provided that market participants would take this into consideration when
pricing the asset. If, however, the unit of account is deemed to be the individual
share of the listed subsidiary, joint venture or associate, the requirement to use P×Q
(without adjustment) to measure the fair value would override the requirements in
IFRS 13 that permit premiums or discounts to be included in certain circumstances.
In September 2014, in response to these questions regarding the unit of account for
an investment in a listed subsidiary, joint venture or associate, the IASB proposed
amendments to clarify that:
• The unit of account for investments in subsidiaries, joint ventures and associates
be the investment as a whole and not the individual financial instruments that
constitute the investment.
• For investments that are comprised of financial instruments for which a quoted
price in an active market is available, the requirement to use P×Q would take
precedence, irrespective of the unit of account. Therefore, for all such
investments, the fair value measurement would be the product of P×Q, even when
the reporting entity has an interest that gives it control, joint control or significant
influence over the investee.
• When testing CGUs for impairment, if those CGUs correspond to an entity whose
financial instruments are quoted in an active market, the fair value measurement
would be the product of P×Q.
1458 Chapter 20
Based on the feedback received on the proposed amendments, the Board decided that,
before further deliberating, additional research was required on this topic. In
January 2016 the Board decided to consider the findings from the 2014 Exposure draft
and subsequent research during the Post-implementation Review (PIR) of IFRS 13. In
May 2017 the Board issued the request for information in relation to the PIR of IFRS 13
with one section covering questions around prioritising Level 1 inputs or the unit
account. Until the IASB issues additional guidance, we expect that diversity in practice
will continue.
This issue is discussed in more detail in Chapter 14 at 5.1.1.
6.1.2
Depreciated replacement cost or current replacement cost as FVLCD
Cost approaches, e.g. depreciated replacement cost (DRC) or current replacement
cost, are one of the three valuation approaches that IFRS 13 considers to be
appropriate for establishing FVLCD. Yet, the Basis for Conclusions of IAS 36
indicates that DRC is not suitable:
‘Some argue that the replacement cost of an asset should be adopted as a ceiling
for its recoverable amount. They argue that the value of an asset to the business
would not exceed the amount that the enterprise would be willing to pay for the
asset at the balance sheet date.
‘IASC believed that replacement cost techniques are not appropriate to measuring
the recoverable amount of an asset. This is because replacement cost measures the
cost of an asset and not the future economic benefits recoverable from its use
and/or disposal.’ [IAS 36.BCZ28-BCZ29].
We do not consider that this means that FVLCD cannot be based on DRC. Rather,
this means that DRC can only be used if it meets the objective of IFRS 13 by being a
current exit price and not the cost of an asset. If the entity can demonstrate that the
price that would be received for the asset is based on the cost to a market participant
buyer to acquire or construct a substitute asset of comparable utility, adjusted for
obsolescence, then (and only then) is DRC an appropriate basis for FVLCD. See
Chapter 14 at 14.3.
7
DETERMINING VALUE IN USE (VIU)
IAS 36 defines VIU as the present value of the future cash flows expected to be
derived from an asset or CGU. IAS 36 requires the following elements to be reflected
in the VIU calculation:
(a) an estimate of the future cash flows the entity expects to derive from the asset;
(b) expectations about possible variations in the amount or timing of those future
cash flows;
(c) the time value of money, represented by the current market risk-free rate of interest;
(d) the price for bearing the uncertainty inherent in the asset; and
Impairment of fixed assets and goodwill 1459
(e) other factors, such as illiquidity that market participants would reflect in pricing
the future cash flows the entity expects to derive from the asset. [IAS 36.30].
The calculation requires the entity to estimate the future cash flows and discount them
at an appropriate rate. [IAS 36.31]. It also requires uncertainty as to the timing of cash flows
or the market’s assessment of risk in those assets ((b), (d) and (e) above) to be taken into
account either by adjusting the cash flows or the discount rate. [IAS 36.32]. The intention
is that the VIU should be the expected present value of those future cash flows.
If possible, recoverable amount is calculated for the individual asset. However, it will
frequently be necessary to calculate the VIU of the CGU of which the asset is a part.
[IAS 36.66]. This is because the single asset may not generate sufficiently independent cash
inflows, [IAS 36.67], as is often the case.
Goodwill cannot be tested by itself so it always has to be tested as part of a CGU or
group of CGUs (see 8 below).
Where a CGU is being reviewed for impairment, this will involve calculation of the VIU
of the CGU as a whole unless a reliable estimate of the CGU’s FVLCD can be made and
the resulting FVLCD is above the total carryi
ng amount of the CGU’s net assets.
VIU calculations at the level of the CGU will thus be required when no satisfactory
FVLCD is available or FVLCD is below the CGU’s carrying amount and:
• the CGU includes goodwill, indefinite lived intangibles or intangibles not yet
brought into use which must be tested annually for impairment;
• a CGU itself is suspected of being impaired; or
• intangible assets or other fixed assets are suspected of being impaired and
individual future cash flows cannot be identified for them.
The standard contains detailed requirements concerning the data to be assembled to
calculate VIU that can best be explained and set out as a series of steps. The steps also
contain a discussion of the practicalities and difficulties in determining the VIU of an
asset. The steps in the process are:
1:
Dividing the entity into CGUs (see 3 above).
2:
Allocating goodwill to CGUs or CGU groups (see 8.1 below).
3:
Identifying the carrying amount of CGU assets (see 4 above).
4:
Estimating the future pre-tax cash flows of the CGU under review (see 7.1 below).
5: Identifying an appropriate discount rate and discounting the future cash flows
(see 7.2 below).
6:
Comparing carrying value with VIU (assuming FVLCD is lower than carrying value)
and recognising impairment losses (if any) (see 11.1 and 11.2 below).
Although this process describes the determination of the VIU of a CGU, steps 3 to 6 are
the same as those that would be applied to an individual asset if it generated cash inflows
independently of other assets. Impairment of goodwill is discussed at 8 below.
1460 Chapter 20
7.1 Estimating
the
future pre-tax cash flows of the CGU under review
In order to calculate the VIU the entity needs to estimate the future cash flows that it
will derive from its use and consider possible variations in their amount or timing.
[IAS 36.30]. In estimating future cash flows the entity must:
(a) Base its cash flow projections on reasonable and supportable assumptions that
represent management’s best estimate of the range of economic conditions that
will exist over the remaining useful life of the asset. Greater weight must be given
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 287
