Week 3: Valencia Accounts & Assets Impairment (L3)
Part 1: Valencia Account Preparation
We will use Valencia’s trial balance to illustrate the preparation of its
published accounts SOCI, SoCE and SoFP.
Stepwise Approach:
■We will follow a progressive stepwise approach to the
preparation of published accounts:
▪ Step 1: Internal Income Statement from the trial balance data
▪ Step 2: Statement of Comprehensive Income (with costs analysed
by function).
▪ Step 3 (if required): Statement of changes in Equity
▪ Step 4: Statement of Financial Position
Part 2: Asset Impairment (IAS 36)
A true and fair view:
■Does the depreciated Historic Cost or revalued amount of a non-current
asset give a true and fair view?
■If the carrying amount of an asset is LARGER than the amount that
will be gained from using the asset or from selling it, then it is not
prudent to continue to carry it at the net book value.
When does Impairment occur?
Impairment occurs if the carrying amount of the asset is HIGHER than the
recoverable amount.
➢CARRYING AMOUNT: the depreciated value, i.e., cost or revaluation less
accumulated depreciation.
➢RECOVERABLE AMOUNT: the Higher of two values: (i) the Net Selling
Price and (ii) the Value in Use
An impairment loss is the amount by which the carrying amount
exceeds the recoverable amount.
What Might Signal Impairment?
External Indicators:
•Decline in market value of assets
•Adverse changes in the technological, market, economic or legal
environment
•Rising interest rates
Internal Indicators:
, •Evidence of asset obsolescence or damage
•Plans to discontinue the operation in which the asset is used
•Business reorganisation, loss of key staff
11
IAS 36 requires companies to test non-current assets for
impairment, if there is some indication that the asset might be
impaired.
How often should non-current assets be tested for impairment?
-For non-current assets that can be sold: they should be reviewed for
impairment only if the expected Net Selling Price deteriorates to below the
Carrying amount of the asset. The recoverable amount is then determined
as the highest between then Net Selling Price and the Value in Use
amount.
(Exception!) Two asset types for which the recoverable amount must
be determined every year:
▪Goodwill
▪Intangible assets which have an indefinite useful life or which
are not yet available for use
What is Value in Use (VIU)?
-VIU = It is the present value of expected future net cash flows from the
asset’s use in the business and its ultimate disposal.
Educated estimates (cash flows):
•Cash flows to be taken from formally approved budgets
•Cash flow growth rates over the long term should not exceed average
growth rate of economy.
•The Present Value Calculation requires a discount rate – market rate for
equally risky investments.
Accounting treatment for impairing single assets:
Impairment Example
• Asset Carrying Value at Sept 2020: £114,500
• Asset Scrap value at Sept 2023: £5,000
• So, asset would be depreciated until sold in 2023
• However, when preparing the financial statements for the year ended
September 2020, the financial director becomes aware that adverse
market conditions may affect the asset value in 2021. The possibility of
impairment exists.
• Estimated Net Selling Price Sept 2020: £70,000
Need to Calculate Value in Use
• Estimate net cash flows as:
o 2021 - £40,000
o 2022 - £55,000
o 2022 - £25,000 (including the scrap value)
• Choose a discount rate = 10%
Part 1: Valencia Account Preparation
We will use Valencia’s trial balance to illustrate the preparation of its
published accounts SOCI, SoCE and SoFP.
Stepwise Approach:
■We will follow a progressive stepwise approach to the
preparation of published accounts:
▪ Step 1: Internal Income Statement from the trial balance data
▪ Step 2: Statement of Comprehensive Income (with costs analysed
by function).
▪ Step 3 (if required): Statement of changes in Equity
▪ Step 4: Statement of Financial Position
Part 2: Asset Impairment (IAS 36)
A true and fair view:
■Does the depreciated Historic Cost or revalued amount of a non-current
asset give a true and fair view?
■If the carrying amount of an asset is LARGER than the amount that
will be gained from using the asset or from selling it, then it is not
prudent to continue to carry it at the net book value.
When does Impairment occur?
Impairment occurs if the carrying amount of the asset is HIGHER than the
recoverable amount.
➢CARRYING AMOUNT: the depreciated value, i.e., cost or revaluation less
accumulated depreciation.
➢RECOVERABLE AMOUNT: the Higher of two values: (i) the Net Selling
Price and (ii) the Value in Use
An impairment loss is the amount by which the carrying amount
exceeds the recoverable amount.
What Might Signal Impairment?
External Indicators:
•Decline in market value of assets
•Adverse changes in the technological, market, economic or legal
environment
•Rising interest rates
Internal Indicators:
, •Evidence of asset obsolescence or damage
•Plans to discontinue the operation in which the asset is used
•Business reorganisation, loss of key staff
11
IAS 36 requires companies to test non-current assets for
impairment, if there is some indication that the asset might be
impaired.
How often should non-current assets be tested for impairment?
-For non-current assets that can be sold: they should be reviewed for
impairment only if the expected Net Selling Price deteriorates to below the
Carrying amount of the asset. The recoverable amount is then determined
as the highest between then Net Selling Price and the Value in Use
amount.
(Exception!) Two asset types for which the recoverable amount must
be determined every year:
▪Goodwill
▪Intangible assets which have an indefinite useful life or which
are not yet available for use
What is Value in Use (VIU)?
-VIU = It is the present value of expected future net cash flows from the
asset’s use in the business and its ultimate disposal.
Educated estimates (cash flows):
•Cash flows to be taken from formally approved budgets
•Cash flow growth rates over the long term should not exceed average
growth rate of economy.
•The Present Value Calculation requires a discount rate – market rate for
equally risky investments.
Accounting treatment for impairing single assets:
Impairment Example
• Asset Carrying Value at Sept 2020: £114,500
• Asset Scrap value at Sept 2023: £5,000
• So, asset would be depreciated until sold in 2023
• However, when preparing the financial statements for the year ended
September 2020, the financial director becomes aware that adverse
market conditions may affect the asset value in 2021. The possibility of
impairment exists.
• Estimated Net Selling Price Sept 2020: £70,000
Need to Calculate Value in Use
• Estimate net cash flows as:
o 2021 - £40,000
o 2022 - £55,000
o 2022 - £25,000 (including the scrap value)
• Choose a discount rate = 10%
