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The Australian Adoption Of International Accounting Standards
This paper addresses AASB 116, 102 & 136 equivalent to IAS 16, 2 & 36
A review by
Rodney Hyman FRICS LFAPI FPINZ FAMI
Introduction
On 1 January 2005 Australia adopted International Accounting Standards, renumbered them, removed most of the elements of choice by giving certain selections from the standards mandatory status and added some clauses to allow their application to not-for-profit entities.
The new aligned standards are a complete replacement for the Australian Accounting Standards and have been written in identical terms to the International Standards, but with two exceptions:
• In some cases the international standards allow for reporting entities to elect the method by which they treat some assets, but the Australian standard in almost every case has selected a single choice and made it mandatory.
• In some cases the AASB has added some clauses for the sake of clarity, but almost all these relate to the not for profit sector adoption which was not contemplated by the international standards.
The new standards adopt “Fair Value” for accounting purposes, but valuers should be aware that its definition does not accord with either:
• IVS 1 of the International Valuation Standards Committee definition of market value, as adopted by the Australian Property Institute
• The definition of Fair Value under AASB 1041.
The standard relating to the reporting of values for property, plant and equipment are incorporated in AASB 116 (which equates to IASB 16). Valuers should not assume that all of the rules governing their valuations under the new accounting standards are encapsulated within this standard as there are other standards which are relevant. It is particularly important for valuers to understand the boundaries of their responsibility in carrying out valuations for accounting purposes as there are rules that relate to the application of Fair Value which are generally the responsibility of the entity but which may benefit from the input of the experienced valuer.
AASB 116
Objective
[The] objective of the standard is to describe the accounting treatment for property, plant and equipment so that users of the financial reports can discern information about an entity’s investment in its property, plant and equipment and the changes in such investments. The principle issues in accounting for property, plant and equipment are the recognition of the assets, the determination of their carrying amounts and the depreciation of charges and impairment losses to be recognised in relation to them.
Scope
The scope of the standard is that it applies in accounting for all property, plant and equipment except where another standard requires or permits a different accounting treatment.
AASB 116 does not apply to:
(a) …
(b) Biological assets related to agricultural activity; or
(c) Mineral rights or mineral reserves such as oil, natural gas and similar non-re-generative resources
However, this standard applies to property, plant and equipment used to develop or maintain the assets…
Other standards may require recognition of an item of property, plant and equipment based on an approach different from that in this standard. For example, AASB 117 in respect to leases.
Definitions
The core definition incorporated in clause 6 is that for Fair Value which is defined as
…the amount for which an asset could be exchanged between knowledgeable, willing parties in an arms length transaction…
It is important to note that Fair Value is not necessarily market value as defined in both international standards and adopted by the Australian Property Institute, nor is it the same as Fair Value as currently defined in AASB 1041. Whilst the resulting value once calculated in accordance with the definition may be the same under all three definitions it is important for valuers to recognise that the definition of Fair Value under this standard is different and may lead to a different result if properly applied.
Similarly, recoverable amount has also been redefined and is now defined as the higher of an asset’s net selling price and its value in use.
Useful life is defined as:
(a) The period over which an asset is expected to be available for use by entity; or
(b) The number or similar units expected to be obtained from the asset by the entity
Useful life of an asset is thus determined by reference to the entity that owns it rather than to the class of assets to which it belongs. By example a truck owned by a long haul transport operator will have a different potential useful life than that owned by a single operator sub-contracting to carry out local haulage.
Recognition
This section of the standard relates to the definition of the asset and has particular relevance to spare parts and service equipment.
Clause 8
Spare parts and servicing equipment are usually carried as inventory… However, major spare parts and stand-by equipment qualify as property, plant and equipment when an entity expects to use them during more than one period. Similarly, if the spare parts and serving equipment can be used only in connection with an item of property, plant and equipment, they are accounted for property, plant and equipment.
In this Clause, the word “period” should be taken to mean an accounting period which is normally one year. The standard appears to be drawing a distinction between the purchase of spare parts which are generally current assets in the sense that they are likely to be traded in less than one year and those parts that are held for long term emergency purposes and therefore fall into the category of non-current assets.
Clause 9 goes on to state that standards do not prescribe the unit of measure for recognition. The standard states:
…Judgement is required in applying the recognition criteria to an entity’s specific circumstances. It may be appropriate to aggregate individually insignificant items, such as moulds, tools and dies and to apply the criteria to the aggregate value.
The issue of aggregation and the definition of the extent of an asset for reporting purposes will vary from company to company and it is possible that the same asset which is valued discretely in one company may only form part of an asset in another.
Elements of Cost
In Clauses 16 and 17, the standard describes the way that cost price is calculated when cost base is used as the measurement of value for reporting purposes. The elements of cost for this purpose gives the valuer a lead as to those components of cost that should be taken into account when determining cost for a depreciated replacement cost approach.
Clauses 16 and 17 provide as follows:
16. The cost of an item of property, plant and equipment comprises:
(a) Its purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates;
(b) Any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management; and
(c) The initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located, the obligation for which an entity incurs either when the item is acquired or as a consequence of having used the item during a particular period for purposes other than to produce inventories during that period.
17. Examples of directly attributable costs are:
(a) Costs of employee benefits (as defined in AASB 119 Employee Benefits) arising directly from the construction or acquisition of the item of property, plant and equipment;
(b) Costs of site preparation;
(c) Initial delivery and handling costs;
(d) Installation and assembly costs;
(e) Costs of testing whether the asset is functioning properly, after deducting the net proceeds from selling any items produced while bringing the asset to that location and condition (such as samples produced when testing equipment); and
(f) Professional fees
Clauses 19 - 22 demonstrate examples of cost that are not to be brought to account as part of the cost of an asset. For the reason that these costs are not relevant to cost based reporting for property, plant and machinery indicate that they probably should not be taken into account in determining current cost for the depreciated replacement cost approach. Examples and statements mentioned in these Clauses include:
- Costs of opening a new facility
- Costs of introducing a new product or service
- Costs of conducting business in a new location or with a new class of customer
- Administration or other general overhead costs
- Costs incurred after an asset has been brought to the stage where it is capable of operating in the manner intended but has yet to be brought into use (i.e., cost of the asset beyond the initial commissioning cost)
- Initial operating costs which are exampled with the words such as those incurred while demand for the items output builds up. One needs to consider whether this includes or excludes commissioning costs.
- Costs of relocating or reorganising part or all of an entity’s operations
- Costs that might be incurred in connection with the construction or development of an item of property, plant or equipment but are not necessary to bring the asset either to the location or into the condition necessary to be capable of operating.
Clause 22 is of assistance when assessing the value of self-constructed assets as it is stated that the cost is determined using the same principles as for an acquired asset.
Measurement of Cost
The Clauses under this heading further assist in the development of the cost model for the depreciated replacement cost approach.
Clause 23 begins by stating the cost of an item of property, plant and equipment is the cash price equivalent at the recognition date. If payment is deferred beyond normal credit terms, the difference between the cash price equivalent and the total payment is recognised as interest over the period of credit unless the AASB 123 allows an alternative treatment.
For valuers, the difficulty of Clause 23 is the way to treat the holding cost of the purchase of an asset that is delayed due to reasons beyond the control of the acquiring entity. An example might be an overseas manufactured asset which has special shipping requirements and which must wait for an appropriate type of vessel between the relevant ports before it can be transhipped. It is possible that a long period can elapse between the requirement for the payment for an asset and its eventual receipt at the site of the requiring entity, not to mention the holding cost during the installation and commissioning period.
Clause 23 appears to relate specifically to the cost of financing where financing is obtained externally and defers the requirement to pay for the asset through the payment of interest. The plant and machinery valuer’s concern is to treat payment as if it were by cash, but to recognise that on substantial input and sometimes locally manufactured purchases there may be financial holding costs that should be taken into account due to the long period of the contract fulfilment.
Measurement after Recognition
Clause 29 provides two alternatives by which an entity may record the carrying amount of its assets.
An entity shall chose either the cost model in paragraph 30 or the revaluation model in paragraph 31 as its accounting policy and shall apply that policy to an entire class of property, plant and equipment.
Clause 30 defines the cost model in this way:
After recognition as an asset, an item of property, plant or equipment shall be carried at its cost less any accumulated depreciation and any accumulated impairment losses.
Clause 31 provides a definition for the revaluation model as follows:
After recognition as an asset, an item of property, plant and equipment whose Fair Value can be measured reliably shall be carried at a re-valued amount being its Fair Value at the date of re-valuation less any subsequent accumulated depreciated and subsequent accumulated impairment losses. Re-valuation 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 reporting date.
The definition is expanded in Clause 32 in respect to items of plant and equipment to be usually their market value determined by appraisal.
In the event that market value cannot be determined by appraisal, then Clause 33 states:
If there is no market-based evidence of Fair Value because of the specialised nature of the item of property, plant and equipment and the items are 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.
It should be noted that depreciated replacement cost approach is not defined in the standard but depreciation is; the systematic allocation of the depreciable amount of an asset over its useful life. Valuers should be wary of applying the same methods of depreciation to all assets in all classes as the definition of Fair Value is:
The amount for which the asset could be exchanged between knowledgeable, willing parties in an arms length transaction.
And therefore depreciated replacement cost must be a surrogate for market value by appraisal (comparable sales approach): assets in different classes depreciate in different ways.
The General Valuation Concepts & Principles of the International Valuation Standards Committee at 9.2 provides that market value is predicated on the assumption that
…a prudent person would not pay more for a good or service than the cost of acquiring an equally satisfactory substitute good or service…
For the above reason valuers will need to resort to the use of a number of mathematically calculable depreciation formulae, including as required straight line, diminishing value, sum of the year’s digits, etc, and will need to recognise the capacity to accelerate and decelerate the diminishing value curve. Further, valuers will need to recognise that there are occasions when no mathematical curve will replicate a market place and that the curve may need to be constructed from some real life experiences. Valuers should be aware that it is also possible to combine the use of mathematically calculated depreciation formulae in order to replicate the market place during different periods in the lifetime of an asset.
In this latter regard, a computer demonstrates the point: A computer depreciates by a small margin as it is walked out of a showroom, then depreciates relatively slowly until the next generation of technology is released at which point its value falls very rapidly to a very low base from which its depreciation is again quite slow. This curve can be replicated by using a combination of an initial discount, straight line depreciation, a further discount and straight line depreciation again.
Clause 36 provides:
If an item of property, plant and equipment is re-valued, the entire class of property, plant and equipment to which that asset belongs shall be re-valued.
It should be noted that this clause is mandatory and valuers should take care to advise their clients appropriately where assets in a category are individually selected for re-valuation.
Depreciation
Clause 43 provides
Each part of an item of property, plant and equipment with a cost that is significant in relation to the total cost of the item shall be depreciated separately [and needs to be attributed individual values]
Clause 44 examples the meaning of this clause by way of an aircraft where the airframe, engines and so on all depreciate differently and thus should be carried in the accounts differently. For this reason, valuers should be aware to correlate their valuation with the company’s accounts in order to ensure that where component parts are depreciated separately that separate values are provided.
Clauses 56 and 57 provide detailed notes on how the future economic value of an asset is consumed by the entity throughout its life. These Clauses are well written:
56. The future economic benefits embodied in an asset are consumed by an entity principally through its use. However, other factors, such as technical or commercial obsolescence and wear and tear while an asset remains idle, often result in the diminution of the economic benefits that might have been obtained from the asset. Consequently, all the following factors are considered in determining the useful life of an asset:
(a) expected usage of the asset. Usage is assessed by reference to the asset’s expected capacity or physical output.
(b) expected physical wear and tear, which depends on operational factors such as the number of shifts for which the asset is to be used and the repair and maintenance programme, and the care and maintenance of the asset while idle.
(c) technical or commercial obsolescence arising from changes or improvements in production, or from a change in the market demand for the product or service output of the asset.
(d) legal or similar limits on the use of the asset, such as the expiry dates of related leases.
57. The useful life of an asset is defined in terms of the asset’s expected utility to the entity. The asset management policy of the entity may involve the disposal of assets after a specified time or after consumption of a specified proportion of the future economic benefits embodied in the asset. Therefore, the useful life of an asset may be shorter than its economic life. The estimation of the useful life of the asset is a matter of judgement based on the experience of the entity with similar assets.
Depreciation Method
Clause 60 of the standard formalises my earlier comments about the method of depreciation to be used.
Clause 60 provides
The depreciation method used shall reflect the pattern in which the assets future economic benefits are expected to be consumed by the entity.
In determining the depreciation method, valuers should have regard to three forms of obsolescence that might affect its value. A calculation may need to be made of functional, economical and/or physical obsolescence.
This rule, which is intended for entities using the cost approach for the recording of value is equally applicable for the valuers using a depreciated replacement cost approach to derive the surrogate for Fair Value.
Impairment
Clause 63 refers to AASB 136 in regard to impairment.
This standard is discussed more fully in its paper, but valuers should be aware that the carrying amount of an asset must have regard as to whether or not there is impairment loss. Responsibility for determining this loss lies with the entity but it is expected that valuers will assist the entity in determining impairment and if so its impact.
Disclosure
Clause 77 provides an obligation of the entity to make certain disclosures if items of property, plant and equipment are stated at re-valued amounts.
This Clause provides that the following shall be disclosed by the entity and therefore should be disclosed by the valuer to the entity:
77. If items of property, plant and equipment are stated at re-valued amounts, the following shall be disclosed:
(a) the effective date of the revaluation;
(b) …
(c) the methods and significant assumptions applied in estimating the items’ fair values;
(d) the extent to which the items’ fair values were determined directly by reference to observable prices in an active market or recent market transactions on arm’s length terms or were estimated using other valuation techniques;
(e) …
Helpful AUSTRALIAN GUIDANCE TO AASB116 which has subsequently been withdrawn
Fair Value
G1 provides a more detailed definition of Fair Value:
The Fair Value of an asset is the most probable price reasonably obtained in the market at the reporting date in keeping with the value definition … It is the best price reasonably obtained by the seller and the most advantageous price reasonably obtainable by the buyer.
G2 then expands the base definition by adding the presumption that:
… the entity is a going concern without any intention or need to liquidate.
G2 brings into play many of the normal qualifications to Market Value by stating:
It is assumed that the asset is exchanged after an adequate period of marketing to obtain its best price. The Fair Value of an asset is determined by reference to its highest and best use, that is, the most probable use of the asset that is physically possible, legally permissible, financially feasible, and which results in the highest value.
It should be noted that:
Where the most rational course of action is to hold the asset for sale, the revalued amount is net selling price…
G3 confirms what might be regarded as the usual approach to Market Value assessment by stating:
… the Fair Value is estimated by reference to the best available market evidence of the price for which the asset could be exchanged between knowledgeable willing parties in an arms length transaction. This evidence includes current market prices for assets that are similar in use, type and condition … and the price of the most recent transaction for the same or similar asset.
G4 provides before the possibility that a comparable sales approach may not be possible in the assessment of Fair Value and this is expanded in G5 which states:
Where Fair Value of an item of property, plant and equipment can not be reliably determined using market based evidence the asset’s Fair Value is measured at its market buying price and the best indicator of an asset’s market buying price is Depreciated Replacement Cost… Depreciated Replacement Cost is the current cost of an asset less, where applicable, accumulated depreciation calculated on the basis of such cost to reflect the already consumed or expired future economic benefits of the asset …
The treatment of spares for operating plant and equipment represents a new approach for valuers. A following statement of G9 and G10 and the first part of G11 is self explanatory.
These notes provide:
G9 Spares purchases specifically for a particular asset, or class of assets, and which would become redundant if that asset or class were retired or use of that asset or class were discontinued, are considered to form part of the historical cost of that asset or class. The depreciable amount of such spares is allocated over the useful life of the asset or class.
G10 Depreciable spares that can be used only in connection with a particular non-current asset do not have useful lives of their own. They are depreciated over the useful life of the related asset.
G11 Depreciable spares can be distinguished from spares held for sale or use in after sales.
Such spares held for sale or use in after sales and in like instances are specifically dealt with under AASB1002 Inventories.
There is an extensive appendix to AASB116 which provides further guidance in the application of the standard. There is particular guidance in the assessment of value of an intangible asset. It is important to note that:
There is a rebuttable presumption that the useful life of an intangible asset will not exceed 20 years from the date when the asset is available for use.
AASB102 INVENTORIES
The objective of [AASB102] is to prescribe the accounting treatment for inventories.
This standard applies to all inventories, except:
(a) Work in progress arising under construction contracts …;
(b) Financial instruments; and
(c) Biological assets ...
Inventories are described as assets:
6 (a) Held for sale in the ordinary course of business;
(b) In the course of production for such sale; or
(c) In the form of materials or supplies to be consumed in the production process or in the rendering of services.
Net Realisable Value is the estimated selling price in the ordinary course of business as the estimated costs of completion and the estimated costs necessary to make the sale.
Valuers may be called upon to assess the Net Realisable Value of inventories when entities are preparing their accounts and recognise that inventory is no longer saleable at normal prices. In this circumstance the inventory must be taken into account at Net Realisable Value.
The standard is generally logical from a valuer’s perspective with detailed discussion of the value to be attributed.
Clause 7 provides:
Net Realisable Value refers to the net amount that an entity expects to realise from the sale of inventory in the ordinary cause of business. Fair Value reflects the amount for which the same inventory could be exchanged between knowledgeable and willing buyers and sellers in the market place. The former is an entity-specific value; the latter is not. Net Realisable Value for inventories may not equal Fair Value less cost to sell.
Clause 8 then provides:
Inventories encompass goods purchased and held for resale including, for example, merchandise purchased by a retailer and held for resale, …. Inventories also encompass finished goods produced, or work-in-progress being produced, by the entity and include materials and supplies awaiting use in the production process. …
“Techniques for the Measurement of Cost”
The standard provides in clauses 21 and 22 techniques for the measurement of the costs of inventories. Whilst the information contained in these clauses is for the benefit of the entity rather than the valuer, the process described represent similar techniques to those that might be used by the valuer and are reassuring if a valuer is asked to assess the Net Realisable Value of an inventory.
Net Realisable Value
Clause 28 provides:
The cost of inventories may not be recoverable if those inventories are damaged, if they have become wholly or partially obsolete, or if their selling prices have declined. The costs of inventories may also not be recoverable if the estimated costs of completion or the estimated costs to be incurred to make the sale have increased. The practice of writing inventories down below cost to Net Realisable Value is consistent with the view that assets shall not be carried in excessive amounts expected to be realised from their sale or use.
Clause 29
Inventories are usually written down to Net Realisable Value item by item. In some circumstances, however, it may be appropriate to group similar or related items. This may be the case with items of inventory relating to the same product line who have similar purposes or end uses, … and can not be practically evaluated separately from items in that product line. It is not appropriate to write inventories down on the basis of a classification of inventory, for example, finished goods…
Clause 30
Estimates of Net Realisable Value are based on the most reliable evidence available at the time that the estimates are made, of the amount the inventories are expected to realise.
The thrust of the standard is overwhelming that the valuation is to be carried out from the perspective of the entity selling the inventory in the normal course of business. As such, valuers should contemplate the most likely method of sale by the entity, of the assets under discussion rather than the value of such inventory in a distressed situation or some other situation which is not applicable to the entity under discussion. This proposition is particularly reinforced in clause 31 which states estimates of Net Realisable Value also take into consideration the purpose for which the inventory is held.
Whilst the thrust of this clause relates to a level of inventory vis a vis the industry in which it operates it fits in with the general thrust of the standard that the inventory should be assessed as part of the property of the entity.
AASB136
AASB136 is titled “Impairment of Assets” with the stated objective:
To prescribe the procedures that an entity applies to ensure that its assets are carried at no more than their recoverable amount. An asset is carried at more than its recoverable amount if its carrying amount exceeds the amount to be recovered through use or sale of the asset. If this is the case the asset is described as impaired”
Thus if the value of an asset is impaired or in simple terms, shown in the books of the company at an amount greater than the recoverable amount, then the entity is required to recognise the deficiency in value which is called an impairment loss.
This Standard does not apply to inventories.
Clause 5 provides that the Standard does not apply to certain financial assets which are outside the scope of this paper. However,
… this standard applies to assets that are carried at re-valued amount (ie Fair Value) … such as the re-valuation model in AASB116 … Identifying whether a re-valued asset may be impaired depends on the basis used to determine Fair Value:
(a) If the asset’s Fair Value is its Market Value, the only difference between the asset’s Fair Value and its Fair Value less cost to sell is the direct incremental costs to dispose of the asset.
(i) if the disposal costs are negligible … it is unlikely that the re-valued asset is impaired and recoverable amount need not be estimated;
(ii) if the disposal costs are not negligible … the re-valued asset will be impaired if its value in use is less than its re-valued amount (ie Fair Value)
(b) If the asset’s Fair Value is determined on a basis other than its Market Value, its re-valued amount (ie Fair Value) maybe greater or lower than its recoverable amount. Hence, after the revaluation requirements have been applied, an entity applies this standard to determine whether the asset may be impaired.
In order to assist in the understanding of this standard there are a number of definitions of terminology, two of which are relevant to this paper:
The recoverable amount of an asset or a cash generating unit is the higher of its Fair Value less costs to sell and its value in use.
Value in use is the present value of the future cash flows expected to be derived from an asset or cash-generating unit.
The thrust of this standard places an obligation on entities to ensure that the value of their assets are not overstated in the entity’s accounts. By definition the obligation to ensure that assets are not impaired is an obligation of the entity. However it is possible that entities will seek the assistance of valuers to determine whether an asset is impaired and if the valuer has carried out a valuation for Fair Value and that valuation is at Market Value then accounting value will not be impaired.
There may be occasions however when Fair Value is not Market Value and thus the entity may seek a valuer’s assistance in determining whether the value derived in some other way exceeds the test laid down in this standard. For this reason valuers should be familiar with this standard and be able to assist their clients in applying the test and providing advice in respect to it.
Clause 12 of the standard provides that:
In assessing whether there is any indication that an asset maybe impaired, an entity shall consider, as a minimum, the following indications:
“External Sources of Information”
(a) … an asset’s Market Value has declined significantly …;
(b) Significant changes with an adverse effect on the entity have taken place … or will take place … in the technological, market, economic or legal environment in which the entity operates or in the market to which an asset is dedicated;
(c) Market interest rates or other market rates of return on investments have increased during the period and those increases are likely to affect the discount rate used in calculating an assets value in use and decrease the assets recoverable amount materially;
(d) The carrying amount of the net assets of the entity is more than its market capitalisation;
“Internal Sources of Information”
(e) Evidence is available of obsolescence or physical damage of an asset;
(f) Significant changes with an adverse affect on the entity have taken place … or are expected to take place … to the extent which or the manner in which an asset is used or is expected to be used. These changes include the asset becoming idle, plans to discontinue or restructure the operation …, plans to dispose of an asset before the previously expected date, and reassessing the useful life of an asset as finite rather than indefinite; and
(g) Evidence is available from internal reporting that the economic performance of an asset is, or will be worse than expected.
It is noted in the standard that the above list is not exhaustive
“Measuring Recoverable Amount’
Clause 18 provides that whilst recoverable amounts refers to an “asset” it could apply equally to an individual asset or a cash generating unit.
Clause 19 is very significant from a point of view of the valuer attempting to determine whether an asset is impaired as it says:
“It is not always necessary to determine both an asset’s Fair Value less cost to sell and its value in use. If either of these of amounts exceeds the asset’s carrying amount, the asset is not impaired and it is not necessary to estimate the other amount.”
Thus it would seem that valuation of an asset or group of assets has been carried out in order to determine Fair Value (less cost to sell) then prima facie there is no impairment as this is one of two amounts that define recoverable amount.
Clause 20 is very significant for the valuer attempting to assist in determining where there is impairment. This clause does not appear to apply to assets which might broadly be called plant and machinery but valuers should be aware of it. The relevant part states:
… sometimes it will not be possible to determine Fair Value less costs to sell because there is no basis for making a reliable estimate of the amount obtainable from the sale of the asset in an arm’s length transaction between knowledgeable and willing parties.
In this case, the entity may use the asset’s value in use as its recoverable amount.
In order to comply with the rules for determining impairment it might be necessary for the valuer to carry out the value in use calculation in order to determine the impairment, if any.
Clause 22 addresses for the first time the issue of determining recoverable amount on the basis of value in use where cash flows can not be attributed to an individual asset.
Clause 22 provides:
Recoverable amount is determined for an individual asset, unless the asset does not generate cash in flows that are largely independent of those from other assets or groups of assets.
If this is the case, recoverable amount is determined for the cash generating unit to which the asset belongs … unless either:
(a) The asset’s Fair Value less cost to sell is higher than its carrying amount or
(b) The asset’s value in use can be estimated to be close to its Fair Value less cost to sell and Fair Value less cost to sell can be determined.
Clause 27 adds to the background information required in determining Fair Value where it says that Fair Value less cost to sell:
… is based on the best information available to reflect the amount that an entity could obtain, at the reporting date from the disposal of an asset in an arms length transaction between knowledgeable, willing parties, after deducting the costs of disposal. In determining this amount, an entity considers the outcome of recent transactions for similar assets within the same industry. Fair Value less cost to sell does not reflect a forced sale unless management is compelled to sell immediately.
Unless there is an element of tautology in the statement within this clause then intent must be to ensure that a comparable sales approach is used as the preferable method of valuation where it is at all possible. Valuers should be wary of the reference to “recent sales” as the definition of what is recent will be particular to each case and it is possible in some industries that “recent sales” might have taken place as recently as some years prior.
For the first time the elements of a depreciated cash flow approach to valuation is laid out in a formal way for compliance. Clause 30 provides the following elements shall be reflected in the calculation of an asset’s value in use:
(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 ...;
(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
(e) Other factors such as illiquidity …
Clause 31 then goes onto refine the above:
Estimating the value in use of an asset involves the following steps:
(a) Estimating the future cash inflows and outflows to be derived from continuing use of the asset and from its ultimate disposal ;and
(b) Applying the appropriate discount rate to those future cash flows.
Valuers operating in the not-for-profit sector should be aware of special variation 32.1 which relates to the measurement of the future economic benefits of an asset of a not-full-profit entity and provides that they should be calculated by reference to a depreciated replacement cost. Depreciated replacement cost is then defined.
Clause 33 of the standard provides 3 elements of projections that the entity shall rely on. The valuer assisting in determining impairment should ensure that these projections are provided by the entity in writing and his report to the entity should clearly state that the calculations are based on the projections provided.
Clauses 34 to 44 provide a range of issues that on which the valuer may be asked to comment but which in most cases will be based on information provided by the entity. Valuers operating in this area should be certain to understand all of the clauses surrounding the discounted cash flow approach to valuation and where the assumptions relating to that have been derived.
Clause 44 to 57 provide detail for the method of treatment for future events in the context of determining the depreciated cash flow of the asset or group of assets.
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