ACC711: ADVANCED ACCOUNTING PRACTICE & REPORTING II

Tutorial 3: Revaluation & impairment testing of non-current asset

1. What is an impairment test?
An impairment test is a test to determine if any entity’s assets are overstated, that is, whether
the carrying amount of the asset is greater than their recoverable amount.

2. Why an impairment test is considered necessary?

An impairment test is considered necessary to ensure that the reporting entity’s assets are not
overstated. That is, entity’s assets are carried at no more than their recoverable amount. An
entity’s balance sheet may overstate the assets, either because the assets’ fair values are
lower than the carrying amounts, or because the accountant’s estimates have resulted in an
understatement of accumulated depreciation e.g. estimates of residual value, useful life,
pattern of benefits.

3. When should an entity conduct an impairment test?

According to paragraph 9 of AASB 136/IAS 36, at each reporting date, an entity must assess
whether there is any indication of impairment. If such an indication exists, the entity shall
estimate the recoverable amount of the asset.

4. What are some external indicators of impairment?

According to paragraph 12 of AASB 136/IAS 36, some examples of external indicators of
impairment are:
a) Significant decline in market value
b) Significant changes in the technological, market, economic or legal environment in which
the entity operates
c) Increases in market interest rates
d) The carrying amount of the entity’s assets exceeds the entity’s market capitalization.

5. What are some internal indicators of impairment?

According to paragraph 12 of AASB 136/IAS 36, some examples of internal indicators of
impairment are:
a) Evidence of obsolescence or physical damage
b) Assets becoming idle, plans to discontinue operations, plans to dispose of assets
c) Economic performance is worse than expected.

6. How is an impairment loss calculated in relation to a single asset accounted for?

AASB 136 paragraph 60

Under the cost model:

 Recognize the impairment loss immediately in profit or loss.
 Write down the asset to its recoverable amount – if the asset is depreciable, increase
accumulated depreciation.

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 Under the revaluation model: the impairment loss is treated the same as for a revaluation
decrease, taking into account any past revaluation increases.

7. What are the limits to which an asset can be written down in relation to impairment losses?
An asset must be reduced to its recoverable amount.

8. What is a cash generating unit?

The smallest identifiable group of assets that generates cash inflows largely independent of
the cash flows from other assets or groups of assets.

9. How are corporate assets tested for impairment losses?

According to AASB 136 Paragraph 102:
 A corporate asset is one that cannot be fully attributable to a single CGU but, where
possible, a portion of its carrying amount should be allocated to one or more CGUs.

 If it cannot be allocated on a reasonable and consistent basis, after testing the separate
CGUs, identify the smallest group of CGUs that includes the CGU under review and to
which the corporate asset can be allocated and tested the group of CGUs for impairment.

10. When can an entity reverse past impairment losses?

AASB 136 Paragraph 110:
At each reporting date, an entity shall assess whether there is any indication that past
impairment losses – other than for goodwill – may no longer exist or have decreased. If
such an indication exists, the recoverable amount is determined. If the recoverable
amount exceeds the carrying amount, reversal may occur, subject to the paragraph 117
limitation i.e. the increased carrying amount attributable to the reversal shall not exceed
the carrying amount that would have been determined had no impairment loss been
recognized.

11. What effect will an asset revaluation have on subsequent period’s profit?
If an upward asset revaluation has been undertaken for a depreciable asset, then depreciation
in subsequent periods will increase, as the depreciation will be based on the higher revalued
amount (which becomes the new ‘carrying amount’). Profit on sale of the asset, before the
completion of its useful life, will be lower.

For example, to show how a revaluation can reduce any profit recorded on the ultimate sale
of an asset, assume that a reporting entity has land recorded at a cost of $100,000 and then
elects to revalue it to $300,000. The difference of $200,000 will be transferred to the
revaluation surplus account, and is not treated as part of the period’s profits (although the
increase will be included as part of ‘other comprehensive income’). If in a subsequent period
the entity sells the asset at a price of $350,000, then it will record a profit on sale of $50,000
which will be included in profit or loss. Had it not revalued the land it would have recorded a
profit on sale of $250,000. While the related revaluation surplus balance of $200,000 will

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 need to be transferred to retained earnings when the revalued asset is ultimately sold, this
transfer will be directly to retained earnings and will not go via profit or loss. Hence the
transfer will not impact reported profits in the year of transfer.

In summing up, upward asset revaluations will have an effect of decreasing profits in
subsequent periods, either through increased depreciation and/or through decreased gains on
sale.

12. When should a revaluation increment be credited to the statement of comprehensive income?
A revaluation increment will always go to the statement of profit or loss and other
comprehensive income, but it might be included either as part of profit or loss, or as part of
‘other comprehensive income’. A revaluation increment should be credited to the statement
of comprehensive income as part of profit or loss when it reverses a previous devaluation to a
particular class of assets. (The initial revaluation decrement would have been treated as an
expense.), otherwise the increment goes to a revaluation surplus (and the increase in the
revaluation surplus would be shown as part of ‘other comprehensive income’ in the statement
of comprehensive income). As paragraph 39 of AASB 116 states in relation to property, plant
and equipment:

If an asset’s carrying amount is increased as a result of a revaluation, the increase shall

be recognized in other comprehensive income and accumulated in equity under the
heading of revaluation surplus. However, the increase shall be recognized in profit or
loss to the extent that it reverses a revaluation decrease of the same asset previously
recognized in profit or loss.

13. If an item of PPE is measured at cost, but the recoverable amount of the asset is determined
to be less than cost, what action must be taken?
It should be understood that within AASB 116 reporting entities have a choice between the
‘cost model’ and the ‘revaluation model’. A similar choice is available for intangible assets
pursuant to AASB 138 (although there is a prohibition on the revaluation of many intangible
assets).

If the revaluation model is adopted then AASB 116 requires that after recognition as an asset,
an item of property, plant and equipment whose fair value can be measured reliably shall be
carried at a revalued amount, being its fair value at the date of the revaluation less any
subsequent accumulated depreciation and subsequent accumulated impairment losses.
Revaluations 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.

If the cost model is adopted then after recognition as an asset, an item of property, plant and
equipment shall be carried at its cost less any accumulated depreciation and any accumulated
impairment losses. An impairment loss is the amount by which the carrying amount of an

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 asset exceeds its recoverable amount. Determination of recoverable amount can often be
based on a great deal of professional judgment.

AASB 116 requires that where property, plant and equipment are valued at cost, the carrying
amount of the asset is not to exceed the recoverable amount. If the recoverable amount
(which is defined as the higher of an asset’s fair value less costs of disposal and its value in
use) is less than the carrying amount then an impairment loss must be recognised. An
impairment loss is defined in AASB 116 as the amount by which the carrying amount of an
asset exceeds its recoverable amount.

14. An item of depreciable machinery is acquired on 1 July 2011 for $120,000. It is expected to
have a useful life of 10 years and a zero residual value. On 1 July 2015, it is decided to
revalue the asset to its fair value of $110,000.

Provide journal entries to account for the revaluation.

The revaluation takes place four years after acquisition, therefore, assuming the straight-line
method of depreciation is used, the accumulated depreciation at revaluation date would be
equal to $120,000 × 10% × 4 = $48 000. The carrying amount before the revaluation would
be $72,000.

1 July 2015
Dr Accumulated Depreciation $48,000
Cr Machinery $48,000

Dr Machinery $38,000
Cr Revaluation Surplus $38,000
($110,000 – $72,000 = $38,000)

15. An asset having a cost of $100,000 and accumulated depreciation of $20,000, is revalued
to $120,000 at the beginning of the year. Depreciation for the year is based on the revalued
amount and the remaining useful life of eight years. Shareholder’s equity. Before adjusting
for above revaluation and subsequent depreciation, is as follows:

$
Share Capital 300,000
Revaluation surplus 45,000
Capital profit reserve 85,000
Retained earnings 70,000
500,000

Required:
Prepare journal entries to reflect the revaluation of the assets and the subsequent depreciation
of the revalued assets. Which of the equity accounts would be affected directly or indirectly
by the revaluation?

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 The entry at the beginning of the year for the revaluation would be
Dr Accumulated depreciation $20,000
Cr Assets $20,000

Dr Assets $40,000
Cr Revaluation surplus – OCT (other comprehensive income) $40,000
(Asset revaluation surplus ($100,000 – $20,000 = $80,000
$120,000 - $80,000 = $40,000)

The entry at the end of the year would be:

Dr Depreciation expense $15,000
Cr Accumulated Depreciation ($120,000/8) $15,000

16. Arrow Ltd acquired a machine for $250,000 on 1 July 2013. It depreciated the asset at 10%
p.a. on a straight-line basis. On 30 June 2015, Arrow Ltd conducted an impairment test on
the asset. It determined that the asset could be sold to other entities for $154,000 with costs
of disposal of $2,000. Management expect to use the machine for the next four years with
expected cash flows from use of the machine being:
2016 $80,000
2017 60,000
2018 50,000
2019 40,000
The rate of return expected by the market on this machine is 8%.

Required
Assess whether the machine is impaired. If necessary, provide the appropriate journal
entry to recognise any impairment loss.

CA of machine at 30 June 2015 = $200,000 [$250,000 ($250,000/10 × 2 years)]

FV less costs of disposal = $152,000 [$154,000 – $2,000]

Value in use = $194,600 calculated as follows:

[($80,000 × 0.9259) + ($60,000 × 0.8573) + ($50,000 × 0.7938) + ($40,000 × 0.7350)]

RA = $194,600 [higher of these two]

RA < CA so asset is impaired by $5,400

DR Depreciation - Machine $5,400

CR Accumulated depreciation & impairment losses - Machine $5,400

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17. Cash-generating unit
Bow Ltd reported the following assets in its statement of financial position at 30 June 2015.
Plant $800,000
Accumulated Depreciation ($240,000)
Land $300,000
Patent $240,000
Office Equipment $620,000
Accumulated depreciation ($340,000)
Inventory $220,000
Cash and Cash equivalents $180,000
$1,780,000

The recoverable amount of the entity was calculated to be $1,660,000. The fair value less
costs of disposal of the land was $280,913.

Required
Prepare the journal entry for any impairment loss at 30 June 2015.
Carrying amount of assets = $1,780,000
Recoverable amount = $1,660,000
Impairment loss = $120,000

Assuming the inventory is carried at the lower of cost and net realizable value, the allocation
of the impairment loss will not involve both cash and inventory.

The allocation of the impairment loss is as follows.

Carrying Proportion Allocation Net Carrying
Amount of Loss Amount
Plant $560,000 56/138 $48,696 $511,304
Land $300,000 30/138 $26,087 $273,913
Patent $240,000 24/138 $20,870 $219,130
Office Equipment $280,000 28/138 $24,347 $255,653
$1,380,000 $120,000

If the fair value less costs of disposal of the land is $280,913, then the land cannot be written
down to an amount below that figure. Hence, the maximum impairment loss allocable to land
is $19,087. The extra $7,000 must be allocated to the other assets.
$280,913 – $273,913 = $7,000

Carrying Proportion Allocation Net Carrying

Amount of Loss Amount
Plant $511,304 511,304/986,087 $3,630 $507,674
Patent $219,130 219,130/986,087 $1,555 $217,575
Office Equipment $255,653 255,653/986,087 $1,815 $253,838
$986,087 $7,000

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 The journal entry to record the impairment loss is.
Dr Impairment Loss $120,000
Cr Accumulated depreciation and impairment losses – Plant ($48,696 + $3,630) $52,326
Cr Land ($300,000 – $280,913) $19,087
Cr Accumulated amortisation and impairment losses – Patent ($20,870 + $1,555) $22,425
Cr Accumulated depreciation and impairment losses – Office equipment ($24,347 + $1,815) $26,162
(Allocation of impairment loss)

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