ACCT13-303 Advanced Financial Accounting

Impairment of Assets (inc. Intangibles)

Question: Do managers time the recognition of asset impairments?

Answer: Maybe! If managers have profit target-based bonuses.



Objective
The aim of the assignment is for students to investigate a contemporary reporting issue and apply the
theories from the subject to interpret current reporting practice and reporting options.
Empirical Analysis and Report [25 Marks].

Introduction
This project explores the reporting of asset impairment (including intangibles) by Australian listed
companies. Considering the impairment of assets is required as part of the reporting process but this
is arguable more complex for intangible assets. The profession and regulators have grappled with
accounting for intangible assets including goodwill and the subsequent amortization and impairment
for many years with reporting requirements changing periodically. The issue of timing of impairment
recognition and the judgements in the process especially for value in use (VIU) computations and
identifying cash generating unit (CGU) leave impairment of assets generally, and intangibles more
specifically, being open to opportunistic behaviour by management. Or are management being
informative about asset values?

The project is motivated by three factors:
(1) Impairment of asset is constantly flagged as an area of focused inquiry in ASIC’s annual review
of financial reports;
(2) A current financial reporting issue is the impact of COVID-19 and post-COVID economic shocks
on the impairment of assets during the 2020 through 2022 financial reporting periods; and
(3) The future impact of current impairments on performance metrics and remuneration.

(1) ASIC & Company Reporting of Impairment of Assets

ASIC announces every year via media release the financial reporting issues they will focus on for that
year and for some time has identified “recoverability of the carrying amounts of assets such as
goodwill, other intangibles and property, plant and equipment” as an area they will review in company
filed financial reports.i Despite these warnings ASIC continually finds impairment issues. Figure 1
providers an example detailing ASIC’s findings on the 2019 financial reports.ii


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Figure 1: ASIC Review of 31 December 2019 Financial Reports

(2) Impact of COVID-19

COVID-19 is an example of a large and unusual impairment event firms need to consider in their
financial reporting. ASIC’s annual media release on 15 December 2020 specifically flagged the impact
of COVID-19 as an ongoing impairment factor that it expects firms to consider.iii This warning reflected
ASIC’s review of filed 2020 annual reports that found some firms deficient in their reporting despite
ASIC’s prompting earlier in 2020 to pay attention to impairment and COVID-19 in particular. Figure 2
documents ASICs overarching comments.iv




2. Asset values and impairment testing
ASIC continues to identify concerns about assessments of the recoverability of the carrying values of assets, including
goodwill, exploration and evaluation expenditure, and property, plant and equipment.
Findings include:
• Reasonableness of cash flows and assumptions: There continue to be cases where the cash flows and
assumptions used by entities to determine recoverable amounts are not reasonable or supportable in light of
historical cash flows, economic and market conditions, and funding costs.

In particular:
o assumptions derived from external sources were not assessed for consistency and relevance, and
o the entity’s forecast cash flows did not appear reasonable and had exceeded actual cash flow for a
number of reporting periods.
• Determining the carrying amount of cash generating units: Some entities appear to have:
o identified cash generating units (CGUs) at too high a level despite cash inflows being largely
independent, resulting in cash flows from one asset or part of the business being incorrectly used to
support the carrying values of other assets
o not included all assets that generate the cash inflows in the carrying amount of a CGU, such as
inventories and trade receivables and tax balances, and/or
o incorrectly deducted liabilities from the carrying amount of a CGU.
• Use of fair value: ASIC still sees entities using discounted cash flow techniques to estimate fair value where
the calculations are dependent on a large number of management inputs. Where it is not possible to reliably
estimate the value that would be received to sell an asset in an orderly transaction between market
participants, the entity may need to use the asset’s value in use as its recoverable amount.
• Impairment indicators: Some entities are not paying sufficient attention to impairment indicators, including
significant adverse changes in market conditions, and reported net assets exceeding market capitalisation.
• Disclosures: ASIC continues to find a number of entities not making necessary disclosure of:
o sources of estimation uncertainty
o key assumptions, including discount rates and growth rates
o sensitivity analysis
o instances where a reasonably foreseeable change in one or more assumptions could lead to
impairment, and/or
o for fair values, the valuation techniques and inputs used.
These disclosures are important to inform investors and other users of financial reports given the estimation uncertainty
associated with many asset valuations. They enable users to make their own assessments about an entity’s carrying
values and risk of impairment.”

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Figure 2: ASIC Comments on 2020 COVID-19 Impairment Reporting



ASIC’s comments arising from their review of 31 December 2020 financial statements as
related to impairment are outlined in Figure 3.v

Figure 3: Extract of Attachment to 21-135 ASIC review of 31 December 2020 financial reports



Go to the ASIC website https://asic.gov.au/about-asic/news-centre/find-a-media-release/2021-
releases/21-354mr-asic-review-of-30-june-2021-financial-reports/ and see the comments ASIC made
regarding the 2021 financial reports. Note the comment re post-COVID that “The findings of [2021
review] emphasise that directors and auditors should continue to focus on impairment of assets,
particularly as some businesses may be adversely affected in a post-COVID environment or by
continuing pandemic impacts in overseas markets.”


(3) Future remuneration impact of impairments
This last issue we can only speculate on at this time as we need to see 2023 onwards reporting
periods. But technically if firms become unimpaired then that can reverse the prior impairments. The
question is will they? We can, however, think about the potential effects if the assets are unimpaired
and think about the incentives for management to potentially not reverse the 2020/2021 impairments.




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Empirical Issues with Impairment

Your Audit Committee have asked you as the accountant to investigate impairment practices of other
companies. The Audit Committee are preparing recommendations for the Board of Directors and
therefore seek to understand the impairment practices of other companies so they can benchmark
best reporting practice and ensure they minimize the risk of an ASIC investigation. Furthermore, the
Board seek to avoid ASIC requiring the company to adjust the accounts after an investigation and the
negative PR associated with a restatement.

There are several key issues with impairing assets that the Board and Audit Committee you need to
investigate and report back about including:

• What firms and industries are reporting larger and more frequent impairments?
• Do other firms regularly impair assets including goodwill and intangibles?
• When firm’s impair assets what method do they use, how do they derive the relevant inputs,
and what disclosures are made?
• How did firms deal with COVID-19 and how did the method and or disclosures change in the
2020-2022 financial reports?
• Have firms reversed COVID-19 related impairment losses or are they considering potential
reversal of impairments post-COVID-19?
• What remuneration incentives are provided to management and how might remuneration
impact the timing and judgments around impairments in 2020, 2021 and potentially 2022?
• Do the impairment requirements outlined in IAS 36 and related disclosures increase the
decision usefulness of the financial statements?

These issues are outlined in more detail in the following pages which also document the
assessment requirements.


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REQUIREMENTS TOTAL MARKS 100 (Reweighted to 35)

Overview/Objective
You are to prepare a report for the Audit Committee outlining your findings from investigating
the impairment practices of an Australian listed entity, its industry, and two comparison firms.

You will focus your analysis on the Australian listed entity chosen by you – focus on firms with
significant impairments in 2020-2021. In analysing the issues outlined in the assessment you should
incorporate industry and two other firms as comparison firms into your analysis. Furthermore, your
report and analysis should also incorporate relevant empirical research, the conceptual framework,
accounting standards, and accounting theories.

Requirements
1) Collect Annual Reports and Data for your entity and two comparison firms:
a) Obtain the annual report for the past 5 years from DatAnalysis
(https://bond.libguides.com/az.php?q=datanalysis ).
b) Download the financial data from DatAnalysis – this will give you the basic P&L, BS and
the “Revenue Expense” tab will have some detailed line items including impairments (the
“Revenue Expense” tab is normally only for 3-4 years while financials will be 10 years).

2) Set up a table using the downloaded financial data and annual reports to document
total impairments by your entity and the two comparison firms.
The table should include relevant information, for example: which assets/asset classes were
impaired, assets before impairment, % impaired, impairment expense as a % of EBIT before
impairment. Your table might include the following lines (or be more than one table).
Comment on the magnitude and nature of the assets impaired by the firm. The table below is
a draft exemplar – you can modify as needed.

Item 2018 2019 2020 2021 2022
Asset – PPE
Impairment PP&E
% PP&E Impaired
Asset – Intangibles B4
Impairment of Intangibles
% Intangibles Impaired
Etc
Impairment other assets
Total Impairment Expense
EBIT (B4 impairment charge)
Impairment % EBIT

3) For each major asset class impaired, document how your entity arrived at the impairment
expense. What method and what key inputs? How does this compare with the two
comparison firms? Summarise the major disclosures rather than cut and paste (you could snip
to an appendix) but be sure to reference back to the relevant page in the annual report.
4) Analyse the impact of COVID-19/post COVID on impairment reporting:
a) How did the reporting of impairment change in 2020 through 2022 in response to COVID-
19/post COVID?
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b) Do the financial statements provide sufficient decision useful information? If not
identify any areas where the disclosure is deficient. Use prior years as a base. How
does your entity’s practices compare with industry and two comparison firms?
c) Is there any discussion or evidence that your entity or the two comparison firms are
considering reversal of impairments (either in the past or potentially in the future
post- COVID-19)?
5) Are there any incentives for management to bias impairments in 2020 or 2021 (either
overly aggressive or to under-write off)? How might those incentives impact the
recognition of impairment reversals post COVID-19?
a) To address this look at your entity’s remuneration policy for short- and long-term
remuneration. Which elements of remuneration rely on some form of “profit” measure
and/or some form of “asset” measure in the performance metrics as these are potentially
impacted by impairment expense and reduced (impaired) assets? (HINT: many firms use
return on invested capital (ROIC) where the numerator is an adjusted firm determined
profit measure and the denominator is an adjusted net asset number – see remuneration
report and other footnotes to the accounts).
b) How does the impairment decision (the numbers) impact the disclosed
remuneration calculation – think about 2020, 2021 and future years.
c) What incentives do the remuneration contracts (terms and conditions) provide
management in relation to recognising (timing), magnitude (biasing estimates),
and booking future reversal of impairments? Relate to theory and research.
6) Based on the evidence you collect what do you conclude about impairment of intangibles
in 2020 through 2022? Do the current disclosures and requirements of IAS 136 (i) improve
the decision usefulness of financial reports and (ii) assist users analyse the stewardship of
management?
7) Based on your report, are there any issues you think regulators might want to consider?


When working on this empirical assignment remember the old accounting saying that:
“What counts is what gets counted”


References and Sources

i See for example 19-341MR Financial reporting focuses for 31 December 2019, https://asic.gov.au/about-asic/news-
centre/find-a-media-release/2019-releases/19-341mr-financial-reporting-focuses-for-31-december-2019/
ii See https://asic.gov.au/about-asic/news-centre/find-a-media-release/2020-releases/20-173mr-asic-review-of-31-
december-2019-financial-reports/
iii See 20-325MR ASIC highlights focus areas for 31 December 2020 financial reports under COVID-19 conditions |
ASIC - Australian Securities and Investments Commission
iv See 20-329MR ASIC review of 30 June 2020 financial reports | ASIC - Australian Securities and Investments
Commission
V See https://asic.gov.au/about-asic/news-centre/find-a-media-release/2021-releases/21-135mr-asic-review-of-31-
december-2020-financial-reports/