An amendment to IAS 36 has clarified that a cash-generating unit cannot be larger than an operating segment before aggregation. Graham Holt explains
This article was first published in the March 2012 UK edition of Accounting and Business magazine.
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The basic principle of impairment is that an asset may not be carried on the statement of financial position above its recoverable amount, which is the higher of the asset's fair value less costs to sell and its value in use. An asset's carrying value is compared with its recoverable amount and the asset is impaired when the former exceeds the latter. Any impairment is then allocated to the asset, with the impairment loss recognised in profit or loss.
All assets subject to the impairment review are tested for impairment where there is an indication that the asset may be impaired, although certain assets such as goodwill and indefinite-lived intangible assets are tested for impairment annually even if there is no impairment indicator.
The recoverable amount is calculated at the individual asset level. However, an asset seldom generates cashflows independently of other assets, and most assets are tested for impairment in groups of assets described as cash-generating units (CGUs). A cash-generating unit is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets.
Goodwill acquired in a business combination is allocated to the acquirer's CGUs that are expected to benefit from the business combination. However, the largest group of CGUs permitted for goodwill impairment testing is the lowest level of operating segment. Under IAS 36, Impairment of Assets, impairment testing of goodwill must be performed at a level no larger than an operating segment as defined in IFRS 8,Operating Segments.
However, complexity is created because IFRS 8 allows operating segments to be aggregated into a higher-level reportable operating segment if certain criteria are met. IAS 36 was not clear as to whether the highest level of aggregation of CGUs for goodwill allocation and impairment testing purposes was to be no larger than an operating segment before or after this aggregation.
To deal with this lack of clarity, the International Accounting Standards Board (IASB) has issued an amendment to IAS 36 to clarify that a CGU cannot be larger than an operating segment before aggregation. Entities should ensure their CGUs are aligned with their operating segments.
The recoverable amount of a CGU is the same as for an individual asset. The carrying amount of a CGU consists of assets directly and exclusively attributable to the CGU and an allocation of assets that are indirectly attributable on a reasonable and consistent basis to the CGU, including corporate assets and goodwill. Where goodwill has been allocated to a CGU and the entity disposes of an operation within that CGU, the goodwill attributable to the operation disposed of is included in the carrying amount of the operation when calculating the profit or loss on disposal.
Similarly, an entity might reorganise its business and change the composition of one or more CGUs to which goodwill has been allocated. In such situations, the goodwill attributable to operations that are moved between CGUs is calculated on the basis of the relative fair values of those operations and the remainder of the CGUs from which the operations are transferred. Liabilities that relate to the financing of the CGU are not allocated to determine the carrying amount of the CGU as the related cashflows will be excluded from the impairment calculations.
An impairment charge calculated for a CGU should be allocated to the CGU's individual assets - first of all to goodwill allocated to the CGU, and then to the other assets of the CGU on a pro rata basis according to the carrying amount of each asset in the CGU.
In allocating the impairment loss to a CGU the carrying amount of each asset within the CGU should not be reduced below the highest of:
a) fair value less costs to sell;
b) value in use;
Any unallocated impairment should be reallocated to the CGU's other assets, subject to the same limits. This could result in a process that continues until the impairment loss is fully allocated or until each of the CGU's assets have been reduced to the highest of each asset's fair value less costs to sell, value in use and zero. The recognition of impairment loss should not, however, result in recognition of a liability, unless it meets the definition of a liability under another IFRS.
IFRS 3, Business Combinations, brings in new requirements for the allocation of impairment losses when dealing with goodwill. An entity that acquires a partial interest in a subsidiary can choose on an acquisition-by-acquisition basis how to measure the non-controlling interest (NCI). It can be measured at the NCI's proportionate share of the fair value of the subsidiary's identifiable net assets at the date of acquisition or at the fair value of the NCI at the acquisition date.
An entity's choice of method will affect the amount of goodwill that will be recognised in the consolidated financial statements. Under the partial goodwill method, only the holding company's share of the goodwill is recognised; under the full goodwill method, goodwill includes both the holding company's and the NCI's share of the goodwill in the subsidiary.
Management should consider the measurement method's impact on their impairment test when choosing how to measure an NCI under IFRS 3. Entities will need to keep records of each component of their goodwill balances.
Any CGU containing goodwill is tested for impairment annually. However, the way that entities choose to measure their goodwill and NCI affects the nature of the test and the amount of impairment loss recognised. Under the partial method, a notional gross-up of the entity's goodwill balance is required to ensure the carrying value of the CGU includes any goodwill attributable to the NCI.
The grossed up amount is compared to the recoverable amount of the CGU and an impairment loss calculated. Only the holding company's share of the impairment loss is recognised in profit or loss. This requirement is not new and entities will already be grossing up goodwill from partial business combinations in impairment tests. Under the full goodwill method, there is no grossing up required because the goodwill figure already captures the goodwill that is attributable to the NCI.
An entity acquires 60 per cent of a subsidiary, which is a CGU. At the year-end, the carrying amount of the subsidiary's identifiable net assets is GBP 30m; the recoverable amount of the CGU is GBP 43m. Goodwill is GBP 12m using the partial method or GBP 18m under the full goodwill method. This table this shows the impairment test under the partial goodwill method.
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Partial goodwill method
|Identifiable net assets||$30m|
|Goodwill grossed up ($12m x 100/60)||$20m|
|Total carrying amount of CGU||$50m|
|Less: recoverable amount||$43m|
This table shows the impairment test under the full goodwill method:
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Full goodwill method
|Identifiable net assets||£30m|
|Total carrying amount of CGU||$48m|
|Less: recoverable amount||$43m|
Under the partial goodwill method only the holding company's share of the impairment loss is recognised in profit or loss because only the holding company's goodwill share is recognised. This is 60% of GBP 7m, or GBP 4.2m.
Using the full goodwill method, the impairment loss charged to profit or loss is higher for an entity that elects to adopt the fair value method. There will almost always be a difference in the impairment figure calculated under the two methods. Under the full goodwill method, the impairment loss is recognised in full.
There are requirements for allocating goodwill impairment losses between the holding company and the NCI. Where the subsidiary with the NCI represents a CGU for goodwill impairment-testing purposes, the allocation of the loss is done on the same basis as the allocation of profit. Under the full goodwill method, the full impairment loss of GBP 5m is charged against the goodwill/the net assets and in profit or loss, 40 per cent is allocated to the NCI (GBP 2m) and 60 per cent (GBP 3m) to the holding company.
The allocation of impairment losses between the holding company and the NCI can become more complex if the subsidiary is not a CGU itself but part of a larger CGU for impairment testing purposes. The full goodwill method introduces some complexities in impairment testing in this scenario and management should consider the impact on impairment tests when choosing goodwill method.
Difficulties may well occur where entities have a CGU that has goodwill from several sources. Examples will be subsidiaries acquired before IFRS 3 was revised that apply the partial goodwill method, subsidiaries acquired after IFRS 3 was revised that apply the full goodwill method, and entities that have goodwill from 100 per cent-owned subsidiaries.
In the above example let's assume that the subsidiary (A) that has been acquired is part of a larger CGU that includes another subsidiary (B) that is 100%-owned by the holding company. Assume that goodwill of GBP 27m arose on the acquisition of the wholly owned subsidiary.
The carrying amount of the identifiable net assets of the combined CGU (A plus B) is GBP 50m and the recoverable amount of the combined CGU is GBP 80m. If the full goodwill method is used, the results are as shown in the Impairment Problems table below:
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|Identifiable net assets||$50m|
|Goodwill ($18m + $27m)||$45m|
|Total value of CGU||$95m|
|Less recoverable amount||$80m|
Under IAS 36, impairment losses are allocated first to goodwill and then to the identifiable assets on a pro rata basis. All the impairment loss in the example relates to goodwill and is allocated to the two subsidiaries that form the CGU.
The loss will be allocated based on their relative carrying amounts of goodwill. The loss will be allocated 40/60, based on the goodwill values of GBP 18m and GBP 27m respectively.
Thus the goodwill of wholly owned subsidiary B will be charged with a GBP 9m impairment loss and that of partially owned subsidiary A with a GBP 6m impairment loss. B's impairment loss will be charged entirely to the profit or loss of the holding company whereas A's will be split on the profit-sharing basis (60/40) between the holding company and the NCI - GBP 3.6m and GBP 2.4m respectively.
This example does not reflect all of the complexities that might well occur in practice. Under IFRS 3, impairment losses have to be allocated between each component of the goodwill in the CGU, which will mean detailed tracking of each component of goodwill.
Graham Holt is an examiner for ACCA and associate dean of the accounting and finance division at Manchester Metropolitan University Business School.