International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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flows and choosing a discount rate and often there is no agreed methodology to follow.
IAS 36 contains detailed and explicit 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 in
the process are:
• Step 1: Dividing the entity into CGUs (see 11.2 above);
• Step 2: Allocating goodwill to CGUs or CGU groups (see Chapter 20 at 8.1);
• Step 3: Identifying the carrying amount of CGU assets (see 11.4.1 below);
• Step 4: Estimating the future pre-tax cash flows of the CGU under review
(see 11.4.2 – 11.4.5 below);
• Step 5: Identifying an appropriate discount rate and discounting the future cash
flows (see Chapter 20 at 7.2 and below at 11.4.2.A);
• Step 6: Comparing carrying value with VIU (assuming FVLCD is lower than
carrying value) and recognising impairment losses (see Chapter 20 at 7.3).
11.4.1
Consistency in cash flows and book values attributed to the CGU
An essential requirement of impairment testing under IAS 36 is that the recoverable
amount of a CGU must be determined in the same way as for an individual asset and its
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carrying amount must be determined on a basis that is consistent with the way in which
its recoverable amount is determined. [IAS 36.74, 75].
The carrying amount of a CGU includes only those assets that can be attributed directly,
or allocated on a reasonable and consistent basis. These must be the assets that will
generate the future cash inflows used in determining the CGU’s VIU. It does not include
the carrying amount of any recognised liability, unless the recoverable amount of the
cash-generating unit cannot be determined without taking it into account.
For practical reasons the entity may determine the recoverable amount of a CGU after
taking into account assets and liabilities such as receivables or other financial assets,
trade payables, pensions and other provisions that are outside the scope of IAS 36 and
not part of the CGU. [IAS 36.79]. If the cash flows of a CGU are determined taking into
account these sorts of items, then it is essential that cash flows and assets and liabilities
within CGUs are prepared on a consistent basis.
Specific issues mining companies and oil and gas companies will need to consider are:
• environmental provisions and similar provisions and liabilities (see 11.4.1.A below);
and
• working capital such as trade debtors, trade payables and inventories (see
Chapter 20 at 4.1.3 for further discussion).
11.4.1.A
Environmental provisions and similar provisions and liabilities
IAS 36 requires the carrying amount of a liability to be excluded from the carrying
amount of a CGU unless the recoverable amount of the CGU cannot be determined
without consideration of that liability. [IAS 36.76, 78]. This typically applies when the
asset/CGU cannot be separated from the associated liability. See Chapter 20 at 4.1.1 for
further discussion of some of the practical challenges associated with this.
11.4.2
Projections of cash flows
IAS 36 requires that in calculating VIU an entity base its cash flow projection on the
most recent financial budgets/forecasts approved by management, excluding any
estimated future cash inflows or outflows expected to arise from future restructurings
or from improving or enhancing the asset’s performance. The assumptions used to
prepare the cash flows should be reasonable and supportable, which can best be
achieved by benchmarking against market data or performance against previous
budgets. These projections cannot cover a period in excess of five years, unless a longer
period can be justified. [IAS 36.33(b)]. Entities are permitted to use a longer period if they
are confident that their projections are reliable, based on past experience. [IAS 36.35].
In practice, most production or mining/field plans will cover a period of more than five
years and hence management will typically make financial forecasts for a corresponding
period. The use of such longer term forecasts may be appropriate where it is based on
proved and probable reserves and expected annual production rates. Assumptions as to
the level of reserves expected to be extracted should be consistent with the latest
estimates prepared by reserve engineers; annual production rates should be consistent
with those for a certain specified preceding period, e.g. five years; and price and cost
assumptions should be consistent with the final period of specific assumptions.
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11.4.2.A
Cash flows from mineral reserves and resources and the appropriate
discount rate
As discussed at 2.2 and 2.3 above, a significant amount of work is required before an
entity can conclude that its mineral resources should be classified as mineral reserves.
In practice, an entity may not have formally completed all of the detailed work that is
required in order to designate mineral resources as mineral reserves. IAS 36 requires
the cash flow projection used in calculating the VIU of assets to be based 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’.
[IAS 36.33(a)]. Therefore, while ordinarily the starting point for the calculation of VIU
would be based upon the mineral reserves recorded, it may sometimes be appropriate
under IAS 36 to take into account mineral resources that have not formally been
designated as mineral reserves. However an entity would need to adjust the discount
rate it uses in its VIU calculation for the additional risks associated with mineral
resources for which the future cash flow estimates have not been adjusted. [IAS 36.55]. If
the risks have been factored into the future cash flow estimates modelled, an entity
should be aware not to also adjust for this risk via the discount rate applied.
The requirements of IAS 36 for determining an appropriate discount rate are discussed
in detail in Chapter 20 at 7.2.
11.4.3
Commodity price assumptions
Forecasting commodity prices is never straightforward, because it is not usually possible
to know whether recent changes in commodity prices are a temporary aberration or the
beginning of a longer-term trend. Management usually takes a longer term approach to
estimates of commodity prices for internal management purposes but these are not
always consistent with the VIU requirements. Given the long life of most mines and oil
fields, an entity should not consider price levels only for the past three or four years.
Instead, it should consider historical price levels for longer periods and assess how these
prices are influenced by changes in underlying supply and demand levels.
For actively traded commodities, there are typically forward price curves available and
in such situations, these provide a reference point for forecast price assumptions.
The commodity assumptions need to match the profile of the life of the mine or oil field.
Spot prices and forward curve prices (where they are available as at the impairment
testing date) are
more relevant for shorter life mines and oil fields, while long-term price
assumptions are more relevant for longer life mines and oil fields. Forecast prices (where
available) should be used for the future periods covered by the VIU calculation. Where
the forward price curve does not extend far enough into the future, the price at the end
of the forward curve is generally held steady, or is often dropped to a longer term
average price (in real terms), where appropriate.
The future cash flows relating to the purchase or sale of commodities might be known
from forward purchase or sales contracts. Use of these contracted prices in place of the
spot price or forward curve price for the contracted volumes will generally be acceptable.
However, it is possible that some of these forward contracts might be accounted for as
derivatives contracts at fair value in accordance with IFRS 9, and therefore the related
assets or liabilities will be recognised in the statement of financial position. Such balances
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would be excluded from the IAS 36 impairment test. Given this, the cash flow projections
prepared for the purposes of the IAS 36 impairment test should exclude the pricing terms
associated with these forward contracts.
The commodity price is a key assumption in calculating the VIU of any mine or oil field.
Only in the context of impairment testing of goodwill and indefinite life intangible assets
does IAS 36 specifically require disclosure of:
(i) a description of each key assumption on which management has based its cash
flow projections for the period covered by the most recent budgets/forecasts. Key
assumptions are those to which the unit’s (group of units’) recoverable amount is
most sensitive; and
(ii) a description of management’s approach to determining the value(s) assigned to
each key assumption, whether those value(s) reflect past experience or, if
appropriate, are consistent with external sources of information, and, if not, how
and why they differ from past experience or external sources of information.
[IAS 36.134(d)(i)-(ii), 134(e)(i)-(ii)].
In practice, considerable differences may exist between entities in their estimates of
future commodity prices. Therefore, we recommend disclosure of the actual
commodity prices used in calculating the VIU of any mine or oil field that does not have
any goodwill or indefinite life intangibles allocated to it, even though this is not
specifically required by IAS 36 as these would generally be considered a significant
judgement or estimate and hence would require disclosure under IAS 1. [IAS 1.122, 125]. A
possible approach to such disclosures is illustrated in the following extract from the
financial statements of BP.
Extract 39.19: BP p.l.c. (2017)
Notes on financial statements [extract]
1.Significant accounting policies, judgements, estimates and assumptions [extract]
Impairment of property, plant and equipment, intangible assets, and goodwill [extract]
Significant judgements and estimates: recoverability of asset carrying values [extract]
Oil and gas prices
The long-term price assumptions used to determine recoverable amount based on fair value less costs of disposal from 2023
onwards are derived from $75 per barrel for Brent and $4/mmBtu for Henry Hub, both in 2015 prices, inflated for the remaining life of the asset (2016 $75 per barrel and $4/mmBtu, both in 2015 prices, from 2022 onwards). To determine recoverable
amount based on value in use, the price assumptions were inflated to 2023 but from 2023 onwards were not inflated.
For both value-in-use and fair value less costs of disposal impairment tests, the price assumptions used for the five-
year period to 2022 have been set such that there is a gradual transition from current market prices to the long-term
price assumptions as noted above, with the rate of increase reducing in the later years.
Oil prices have firmed somewhat in the wake of the extension of OPEC and non-OPEC production cuts and the
gradual adjustment in oil inventories from elevated levels. BP’s long-term assumption for oil prices is higher than
recent market prices reflecting the judgement that recent prices are not consistent with the market being able to
produce sufficient oil to meet global demand sustainably in the longer term.
US gas prices have been affected by short-term volatility in winter demand although remain relatively muted. BP’s
long-term price assumption for US gas is higher than recent market prices as US gas production is expected to grow
strongly, supported by increased exports of liquefied natural gas, absorbing the lowest cost resources and requiring
increased investment in infrastructure.
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The extract below illustrates a similar type of disclosure by Newcrest Mining from its
30 June 2017 financial statements, in this case as part of the key assumption disclosures
within its impairment disclosures.
Extract 39.20: Newcrest Mining Limited (2017)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS [extract]
FOR THE YEAR ENDED 30 JUNE 2017
12. IMPAIRMENT OF NON-FINANCIAL ASSETS [extract]
c) Key judgements, estimates and assumptions [extract]
The table below summarises the key assumptions used in the carrying value assessments as at 30 June 2017, and for
comparison also provides the equivalent assumptions used in 2016:
[extract]
2017 2016
Long
Long
term
term
Assumptions 2018 2019 2020
(2021+)
2017 2018 2019
(2020+)
Gold (US$ per
ounce)
$1,250 $1,250 $1,250 $1,250 $1,200 $1,255 $1,250 $1,250
Copper (US$
per
pound) $2.50 $2.60 $2.70 $3.00 $2.10 $2.30 $2.70 $3.00
Commodity prices and exchange rates estimation approach
Commodity price and foreign exchange rates are estimated with reference to external market forecasts and reviewed
at least annually. The rates applied have regard to observable market data including spot and forward values, and to
market analysis including equity analyst estimates.
Metal prices
Newcrest has maintained the long term US dollar gold and copper price estimates applied in 2016. Short term gold
and copper prices have been slightly adjusted from 2016, reflecting spot prices during the 2017 financial year and
Newcrest’s analysis of observable market forecasts for future periods.
11.4.4
Future capital expenditure
When determining VIU, although the standard permits an entity to take account of
cash outflows required to make an asset ready for use, i.e. those relating to assets
under construction, [IAS 36.42], it does not allow inclusion of cash outflows relating to
future enhancements of an asset’s performance or capacity to which an entity is not
committed. [IAS 36.44]. This may have a significant impact on relatively new assets and
on fields or mines that will be developed over time. Note that while enhancement
capital expenditure may not be recognised, routine or replacement capital
expenditure necessary to maintain the function or current performance of the asset
or assets in the CGU has to be included. Entities must therefore distinguish between
in practice but, for example, an anticipated increase in mineral reserves as a
consequence of incurring future capital expenditure may be an indicator that the
expenditure is enhancement expenditure.
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11.4.5
Foreign currency cash flows
An entity in the extractive industries will often sell its product in a currency that is
different from the one in which it incurs its production costs (e.g. silver production may
be sold in US dollars while production costs may be incurred in pesos). In such
situations, impairment testing and calculating VIU under IAS 36 require that the foreign
currency cash flows should first be estimated in the currency in which they will be
generated and then discounted using a discount rate appropriate for that currency. An
entity should translate the present value calculated in the foreign currency using the
spot exchange rate at the date of the VIU calculation. [IAS 36.54]. This is to avoid the
problems inherent in using forward exchange rates, which are based on differential
interest rates. Using such forward rates would result in double-counting the time value
of money, first in the discount rate and then in the forward rate. [IAS 36.BCZ49].
This requirement, however, is more complex than it may initially appear. Effectively, this
method requires an entity to perform separate impairment tests for cash flows generated
in different currencies, but make them consistent with one another so that the combined
effect is meaningful. This can be a difficult exercise to undertake. Many different factors
need to be considered, including relative inflation rates and relative interest rates, as well
as appropriate discount rates for the currencies in question. Because of this, the possibility
for error is significant, given this, it is important for entities to seek input from experienced
valuers who will be able to assist them in dealing with these challenges.
11.5 Calculation of FVLCD
FVLCD is 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, less the