3 Explain the accounting issues related to asset impairment.

- Lower of cost or NRV for inventories does not apply for PPE , because it is difficult
to arrive at a fair value for PPE
3.1 Recognizing impairment
- When the carrying amount of an asset is not recoverable either through using it or
by selling it, a company records a write-off referred to as an impairment
- Impairment occurs when the CA of an asset exceeds its recoverable amount
+ Recoverable amount of an asset is the higher of its fair value less cost to sell (at
the asset could be sold for after deducting costs of disposal) or value in use (Present
value of the future cash flows expected to flow from the use of the asset)
+ If CA>Recoverable amout =>
Impairment loss = carrying amount – recoverable amount
+ If CA<=Recoverable amount => No impairment is recorded
+ Impairment loss is charged immediately to Profit or loss (Income Statement)
Dr Impairment expense (P&L) X
Cr Acc depreciation (SOFP) X
- Accounting for impairment is an example of prudence being applied in financial
accounting as it ensures that assets are not overstated. Determining whether an assets
has been impaired and calculating the recoverable amount of the asset are areas in
which the accountant must apply judgement.
- Indicators of an impairment: decline in the asset’s cash-generating ability
through use or sale
External indicators Internal indicators
- A fall in the asset’s market - Evidence of obsolescence or
value that is more than is expected as physical damage
a result of passage of time or normal - Adverse changes in the use to
use which the asset is put
- A significant change in the - Evidence from internal reports
technological, market, legal or that the economic performance of an
economic environment of the asset is, or, will be, worse than
business in which the assets are expected
employed
- The carrying amount of the
entity’s net assets being more than its
market capitalisation
 - Conclusion: process
Step 1: If impairment indicators are present, then an impairment test must be
conducted.
Step 2: Impairment test
o Calculate the recoverable the higher of its fair value less cost to sell or value
in use
o If the recoverable amount < the asset's carrying amount = asset is considered
impaired => calculating impairment loss
o If the recoverable amount >= the asset's carrying amount = no impairment has
occurred
Examples:
*No impairment:
Assume that Cruz SA performs an impairment test for its equipment. The carrying
amount of Cruz's equipment is €200,000, its fair value less costs to sell is €180,000,
and its value-in-use is €205,000. In this case, the value-in-use of Cruz's equipment is
higher than its carrying amount of €200,000. As a result, there is no impairment
*Impairment:
Assume the same information for Cruz SA above except that the value-in-use of
Cruz's equipment is €175,000 rather than €205,000. Cruz measures the impairment
loss as the difference between the carrying amount of €200,000 and the higher of
fair value less costs to sell (€180,000) or value-in-use (€175,000). Cruz therefore
uses the fair value less cost of disposal to record an impairment loss of €20,000
(€200,000 − €180,000).
Cruz makes the following entry to record the impairment loss.
Dr Loss on Impairment 20,000
Cr Accumulated Depreciation—Equipment 20,000
The Loss on Impairment is reported in the income statement in the “Other income
and expense” section. The company then either credits Equipment or Accumulated
Depreciation—Equipment to reduce the carrying amount of the equipment for the
impairment
3.2. Impairment illustration: additional examples
EX1: 31/12/2020, Hanoi compy has an equipment cost 26,000,000 VND, Acc dep =
12,000,000, useful life = 4 years, RV = 2,000,000. Other information:
- CA= 26,000,000 – 12,000,000=14,000,000
- Straight-line depreciation. Dep/year is recorded
- Recoverable amount = 11,000,000
- Remaining useful life =2 years
=> CA > Recoverable amount => impairment loss => record on 31/12/2020
Dr Loss on impairment 3000
Cr Acc dep – equipment 3000
Hanoi continues to use straight-line depreciation and makes the following journal entry to
record depreciation for 2021:
Dr Depreciation Expense (VND11,000,000/2) 5,500,000
Cr Accumulated Depreciation—Equipment 5,500,000
EX2: At the end of 2019, Verma Company tests a machine for impairment, CA= $200,000,
useful life = 5 years.
Because of the unique nature of the machine, there is little market-related information on
which to base a recoverable amount based on fair value. As a result, Verma determines the
machine's recoverable amount should be based on value-in-use. To determine value-in-use,
Verma develops an estimate of future cash flows based on internal company cash budgets
Verma uses a discount rate=8%, future cash flows = $40,000 each year for five years, RV =
$10,000 at the end of the five years. It is assumed that all cash flows occur at the end of the
year.
Present value of 5 annual payments of $40,000 (Present value of an annuity-consatnt
cashflow for a number of years)($40,000 × 3.99271, discount table 6.4 in chap 6) =
$159,708.40 (1)
Present value of residual value of $10,000 ($10,000 × .68058, Table 6.1) = 6,805.80 (2)
=> Value-in-use related to machine = (1) + (2)= $166,514.20
=> CA > Value in use => impairment loss = 200,000 -166,514.20 =33,485.80
The company therefore records an impairment loss at December 31, 2019, as follows.
Dr Loss on Impairment 33,485.80
Cr Accumulated Depreciation—Machinery 33,485.80
3.3. Reversal of impairment loss
When recoverable amnount > CA => no impairment loss => impairment loss be reversed
EX: To illustrate, assume that Tan Group purchases equipment on January 1, 2019, for
HK$300,000, with a useful life = 3 years and no residual value.
Depreciation for 3 years:
At December 31, 2019, Tan determines it has an impairment loss of $20,000 and therefore
makes the following entry.
Dr Loss on Impairment 20,000
Cr Accumulated Depreciation—Equipment 20,000
 CA on 31/12/2019 = 200,000-20,000=180,000

At the end of 2020, Tan determines that the recoverable amount of the equipment is HK$
96,000, which is greater than its carrying amount of $90,000.
 Tan reverses the previously recognized impairment loss with the following entry.
Dr Accumulated Depreciation—Equipment 6,000
Cr Recovery of Impairment Loss 6,000
The recovery of the impairment loss is reported in the “Other income and expense” section
of the income statement. The carrying amount of Tan's equipment is now $96,000 ($90,000
+ $6,000) at December 31, 2020
***If recovery > $10,000 results in Tan carrying the asset at a value above its historical
cost => not permitted
3.4. Cash-Generating units
When the single asset generates cash flows only in combination with other assets.
=> companies should identify the smallest group of assets that can be identified that
generates cash flows independently of the cash flows from other assets. Such a group is
called a cash-generating unit (CGU).
For example, Santos SpA is reviewing its plant assets for indicators of impairment.
However, it is finding that identifying cash flows for individual assets is very cumbersome
and inaccurate because the cash flows related to a group of assets are interdependent. This
situation can arise if Santos has one operating unit (machining division) that manufactures
products that are transferred to another Santos business unit (packing division), which then
markets the products to end customers. Because the cash flows to the assets in the
machining division are dependent on the cash flows in the packing division, Santos should
evaluate both divisions together as a cash-generating unit in its impairment assessments.
3.5 Impairment of Assets to Be Disposed Of
(What happens if a company intends to dispose of the impaired asset, instead of holding it
for use?)
- Assets held for disposal are like inventory; companies should report them at the
lower-of-cost-or-net realizable value.
- Not depreciate or amortize assets held for disposal during the period it holds them.
- Can write up or down an asset held for disposal in future periods, as long as the
carrying value after the write-up never exceeds the carrying amount of the asset
before the impairment.
- Companies should report losses or gains related to these impaired assets as part of
operating income in “Other income and expense.”

4. Depletion
Depletion is the process of allocating the cost of natural resources
Natural resources, often called wasting assets, include petroleum, minerals, and timber. o
two categories: (1) biological assets such as timberlands, and (2) mineral resources such as
oil, gas, and mineral mining
They have two main features:
- complete removal (consumption) of the asset, and
- replacement of the asset only by an act of nature.
4.1 Establishing a Depletion Base
Computation of the depletion base involves properly accounting for three types of
expenditures:
- Pre-exploratory costs.
- Exploratory and evaluation costs.
- Development costs.
1. Pre-exploratory cost: are costs incurred before the company has obtained the legal
rights to explore a specific area.
EX: seismic testing fee of possible oil-drilling sites before incurring any substantial
exploration costs (phí kiểm tra địa chấn của các địa điểm có thể khoan dầu trước khi phát
sinh bất kỳ chi phí thăm dò đáng kể nào.)
 propecting cost => considered are expense incurred
2. Exploratory and evaluation costs – E&E cost (Phí thăm dò và đánh giá)
EX:
• Acquisition of rights to explore.
• Topographical (địa hình), geological (địa chất), geochemical (địa hóa), and geophysical
(địa vật lý) studies.
• Exploratory drilling.
• Sampling.
• Activities in relation to evaluating the technical feasibility and commercial viability of
extracting a mineral resource
How capitalized? (2 ways)
- Full-cost concept (full capitalization)
- Successful-efforts concept
EX: assume that Royal Dutch Shell is exploring for oil and determines that the area of
exploration has oil reserves  drills a well to determine the amount of the reserves.
Unfortunately, the well drilled results in a dry hole; that is, no reserves are found.
Shell then drills more wells and finds some oil reserves, but some others are dry holes.
 Those who hold the full-cost concept (full capitalization) argue that the cost of
drilling a dry hole is a cost needed to find the commercially profitable wells.
 Others believe that companies should capitalize only the costs of the successful
wells. This is the successful-efforts concept. Its proponents believe that the only
relevant measure for a project is the cost directly related to that project, and that
companies should report any remaining costs as period charges.
3. Development costs
- Once technical feasibility and commercial viability of production are demonstrated, E&E
assets are reclassified as development costs
- Two parts:
(1) Tangible equipment costs = not the depletion base: transportation and other
heavy equipment needed to extract the resource and get it ready for market
Because companies can move the heavy equipment from one extracting site to
another, companies do not normally include tangible equipment costs in the depletion base
=> separate depreciation charges to allocate the costs of such equipment
*some tangible assets (e.g., a drilling rig foundation) cannot be moved. Companies
depreciate these assets over their useful life or the life of the resource, whichever is shorter.
(2) Intangible development costs = depletion base: drilling costs, tunnels, shafts, and
wells
- Restoration cost = depletion base: incur to restore property to its natural state after
extraction has occurred
4.2 Write-off of Resource Cost
(How to allocate the cost of mineral resource to acc period?)
- Compute depletion on units-of-production method (activity approach)

EX: 1,000 acres of land to mine for silver

Lease cost = 50,000
Related exploration cost = 100,000
Intangible development cost = 850,000
 Total cost related to mine = 1,000,000
Estimated the mine = 100,000 onces of silver => compute the depletion cost?
- Depletion cost per unit = 1,000,000/100,000=10 per ounce
- If in first year, extract 25,000 ounces => depletion cost = 10x25,000=250,000
 Record:
Dr Inventory 250,000
Cr Acc Depletion/Mineral resources asset 250,000
4.3 Estimating Recoverable Reserves
- Company need to change the estimate of recoverablr reserves because they have new
information or because more sophisticated production process are available
- The same as accounting for changes in estimates for the useful lives of plant and
equipment
=> revise the depletion rate on a prospective basis
4.4 Liquidating Dividends -dividends greater than the amount of accumulated net income.

Công ty sở hữu 1 tài sản lớn duy nhất (vd như đất khai thác,..), mà từ đó dự định sẽ khai
thác tài nguyên khoáng sản. Nếu công ty không có ý định mua thêm đất, công ty có thể dần
dần phân phối cho các cổ đông khoản đầu tư vốn của họ bằng cách trả Liquidating
dividend (cổ tức thanh lý)= Dividends > Accumulated net income
EX: A comany has RE=1,650,000
Acc depletion on mineral properties = 2,100,000
Share premium = 5,435,493
Comany declare a dividend $3/share on 1,000,000 shares => total dividend = 3,000,000
 Because dividend>RE => company may pay liquidating dividend
Record:
Dr RE 1,650,000
Dr Share Premium-Ordinary 1,350,000
Cr Cash 3,000,000
 Company must inform shareholders that the £3 dividend per share represents a £1.65
(£1,650,000 ÷ 1,000,000 shares) per share return on investment and a £1.35
(£1,350,000 ÷ 1,000,000 shares) per share liquidating dividend.
4.5 Presentation on the Financial Statements
Companies should disclose the following related to E&E expenditures.
1. The accounting policies for exploration and evaluation expenditures, including the
recognition of E&E assets.
2. The amounts of assets, liabilities, income and expense, and operating cash flow
arising from the exploration for and evaluation of mineral resources
6. Presentation and analysis
6.1 Presentation of PPE and Mineral Resources
- disclose the basis of valuation—usually historical cost—for property, plant,
equipment, and mineral resources + pledges, liens, and other commitments related to
these assets
Công ty nên tiết lộ cơ sở định giá – thường là historical cost- cho PPE và tài nguyên
khoáng sản + các khoản cầm cố, thế chấp và các cam kết khác liên quan
- not offset any liability against these assets => report in liabilities section
- segregate PPE not currently employed as producing assets in the business from
assets used in operations
- When depreciation -> use Cr Acc dep account
- When depletion -> use Cr Acc depletion account /credit mineral resource account
directly
6.2 Analysis of PPE
- Asset turnover =Net asset/Average total assets: How efficiently a company uses its
assets to generate sales
 - Profit margin on sales = Net income/Net sales : answer the question of how
profitably a company uses its assets
- Return on assets (ROA) = Profit margin on sales x Asset turnover
=Net income/Average Total Assets
 ascertain how profitably the company used assets during that period of time
EX: the following data from Siemens Group's (DEU) 2016 annual report.

- Asset Turnover=Net Sales/Average Total Assets

=79.644/[(125.717+120.348)/2]=0.65
- Profit Margin on Sales=Net Income/Net Sales =5,584/79,644=7.0%
- Return on Assets=Profit Margin on Sales×Asset Turnover = 7.0%×0.65=4.5%
- Return on Assets=Net IncomeAverage Total Asset
=5,584/[(125,717+120,348)/2]=4.5%