Ramesh Ruben Louis explains how to approach impairment of non-cash-generating assets held by public-sector entities
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This article was first published in the June 2016 Malaysia edition of Accounting and Business magazine.
The treatment for impairment of assets for public-sector bodies is different from that for profit-oriented entities, largely due to its use in the ordinary course of providing services to the public rather than in generating commercial returns. The relevant accounting standard in the Malaysian Public Sector Accounting Standards (MPSAS) framework is MPSAS 21, Impairment of Non-Cash-Generating Assets.
Scope and applicability
In essence, MPSAS 21 is similar to IPSAS 21, the equivalent standard from the International Public Sector Accounting Standards Board. It applies to all public-sector entities except Government Business Enterprises (GBEs), which apply Malaysian Financial Reporting Standards.
There are a number of circumstances in which public-sector entities may hold assets with the primary objective of generating a commercial return, although the majority of assets are not held for that purpose. A public-sector asset can generate cashflows although it is primarily held for service-delivery purposes. For example, a waste treatment plant is operated to ensure the safe treatment of medical waste generated by state-owned hospitals, but it may also treat a small amount of medical waste generated by other private hospitals on a commercial basis. The treatment of medical waste from the private hospitals is incidental to the activities of the plant, and the assets that generate cashflows cannot be distinguished from the non-cash-generating assets.
In other instances, an asset may generate cashflows and also be used for non-cash-generating purposes. For example, a public hospital has 30 wards, 25 of which are used for fee-paying patients on a commercial basis, while the others are used for non-fee-paying patients. Patients from both wards jointly use the operating facilities of the hospital. The extent to which the asset is held with the objective of providing a commercial return needs to be considered to determine whether the entity should apply the provisions of MPSAS 21 or those of MPSAS 26, Impairment of Cash-Generating Assets. If, as in this example, the non-cash-generating component is an insignificant component of the arrangement as a whole, the entity applies MPSAS 26 rather than MPSAS 21.
It is important to note that in circumstances where it is not clear whether the purpose of the operations is for cash-generating or non-cash-generating activities, the entity will have to apply judgement to determine which standard to apply for impairment. The judgement will most likely be based on the significance of the cashflow. In addition, Paragraph 73A of MPSAS 21 requires an entity to disclose the criteria used in making such judgement.
A non-cash-generating asset is impaired when the carrying amount of the asset exceeds its recoverable service amount. The key indications that an impairment loss may have occurred are as follows:
a) cessation, or near cessation, of the demand or need for services provided by the asset;
b) significant long-term changes having an adverse effect on the entity, which includes external factors such as technological or government policies and internal factors such as assets becoming idle, the discontinuance of operations or the restructuring of same;
c) physical damage of an asset;
d) the halting of the construction of the asset before it is complete or in a usable condition;
e) significantly inferior service performance of an asset than expected.
If any of these indications are present, an entity is required to make a formal estimate of recoverable service amount. This is to determine if any impairment loss needs to be recognised to reduce the carrying amount of the asset.
Measuring the recoverable service amount
The most distinct difference in impairment of non-cash-generating assets compared to cash-generating assets is the measurement of the recoverable service amount. It is the higher of an asset’s fair value less costs to sell, and its value in use. The asset’s fair value less costs to sell is the price in a binding sale agreement in an arm’s length transaction, adjusted for incremental costs attributable to the disposal of the asset.
Value in use
The standard defines the value in use of a non-cash-generating asset as the present value of the asset’s remaining service potential. The present value of the remaining service potential of the asset is determined using one of these three approaches:
i. Depreciated replacement cost approach. The depreciated replacement cost is determined by comparing the cost of an equivalent new asset (with similar or identical service potential) – known as the replacement cost, which is depreciated – with the carrying amount of the existing asset.
ii. Restoration cost approach Under this approach, the current (or new) cost of replacing the impaired asset (which is depreciated to reflect the remaining service potential) is compared against the carrying amount of the existing asset, less restoration costs that would be incurred to restore the asset to an economic condition if there was no impairment.
iii. Service units approach
This approach is usually used for assets under circumstances where an existing asset has a more reduced economic use than previously anticipated. The impairment loss is determined by comparing the carrying amount of the existing asset against the higher of the asset’s fair value (based on the reduced economic use) and the adjusted depreciated replacement cost (similar to approach (i) above, but adjusted for the reduced economic use).
Swipe to view table
|A||Historical cost, 1997||10,000,000|
|Accumulated depreciation, 2003 (A × 6 ÷ 50)||(1,200,000)|
|B||Carrying amount, 2003||8,800,000|
|C||Replacement cost of a storage facility of similar capacity||4,200,000|
(C × 6 ÷ 50)
|D||Recoverable service amount||3,696,000|
|Impairment loss (B - D)||5,104,000|
i. Example: in 1997, the district of Kajang constructed a primary school at a cost of RM10m. The estimated useful life of the school was 50 years. In 2003, the school closed due to very low enrolment as a result of a shift in the population away from the area. The school underwent conversion for use as a storage warehouse, and the school district had no expectation that the building would be reopened for use as a school. The current replacement cost for a warehouse with the same storage capacity as the school is RM4.2m.
Ramesh Ruben Louis is a professional trainer and consultant in audit and assurance, risk management and corporate governance, corporate finance and public practice advisory.
ii. Example: in 1984, the city of Georgetown built an office building at a cost of RM50m. The building was expected to provide service for 40 years. In 2003, after 19 years of use, fire caused severe structural problems. Due to safety reasons, the office building was closed, and structural repairs costing RM35.5m were made to restore the office building to a usable condition. The replacement cost of a new office building was RM100m.
Swipe to view table
|A||Acquisition cost, 1984||50,000,000|
|Accumulated depreciation, 2003 (A × 19 ÷ 40)||(23,750,000)|
|B||Carrying amount, 2003||26,250,000|
|C||Replacement cost (of a new building)||100,000,000|
|Accumulated depreciation (C × 19 ÷ 40)||(47,500,000)|
|D||Depreciated replacement cost (undamaged)||52,500,000|
|Less restoration cost||(35,500,000)|
|Recoverable service amount||17,000,000|
|Impairment loss (B-E)||9,250,000|
iii. Example: in 1988, Kuala Lumpur (KL) City Hall constructed a 20-storey office building for use by the council in downtown KL at the cost of RM80m. The building was expected to have a useful life of 40 years. In 2003, occupational health and safety regulations required that the top four storeys of high-rise buildings be left unoccupied for the foreseeable future. The building had a fair value less costs to sell of RM45m in 2003 after the regulations came into force. The current replacement cost of a similar 20-storey building was RM85m. Impairment was indicated because the extent of use of the office building had changed from 20 floors to 16 floors as a result of the new regulations.
Swipe to view table
|A||Acquisition cost, 1988||80,000,000|
Accumulated depreciation, 2003
(A × 15 ÷ 40)
|B||Carrying amount, 2003||50,000,000|
|C||Replacement cost (20-storey building)||85,000,000|
|Accumulated depreciation (C × 15 ÷ 40)||(31,875,000)|
|D||Depreciated replacement cost before
adjustment for remaining service units
|E||Value in use of the building after the
regulation came into force (D × 16 ÷ 20)
|F||Fair value less costs to sell of the
building after regulation came into force
|G||Recoverable service amount
(higher of E and F)
|Impairment loss (B - G)||5,000,000|