By Jose Garcia, partner at Kreston BSG, S.C. Mexico, member of the audit committee and member of Group Puebla of the Mexican Institute of Finance Executives (IMEF); and by Juan Espinosa, partner at Kreston BSG, S.C. Mexico, member of the control quality group of Kreston International Ltd. And VP of the National Technical Board of IMEF. From IAFEI October 2020 Quarterly Bulletin.

The COVID-19 outbreak has developed rapidly and worse than expected in 2020. Measures taken to contain the spread of the virus, including travel bans, quarantines, social distancing, and closures of nonessential services have triggered significant disruptions to business worldwide, resulting in an economic slowdown. Global stocks have also experienced great volatility and a significant weakening. Governments and central banks have responded with monetary and fiscal interventions to stabilize economic conditions and it is unknown what the long term impact on the business may be but for sure it will not be positive for most of the economic participants. If society and, as a consequence, businesses are exposed to COVID-19 for a longer period of time, it may result in prolonged negative results, pressure on the liquidity overall, jeopardizing of going concern assumptions and finally, in impairment of long-live assets as defined by the International Financial Reporting Standards (IFRS), specifically IAS 36 Impairment of Assets. The latter is addressed in this article.

Impairment basics and indicators

IAS 36 Requires tangible and intangible assets (with certain defined exceptions) to be carried at no more than their recoverable amount. To this end, the entities should test long-live acids for potential impairment when indicators of impairment exist or, at least, annually for goodwill and intangible assets with indefinite useful lives. The recoverable amount (RA) is defined as the higher of Fair Value less costs to sell (FV) and Value in Use (VU). the basic principle of impairment test is to compare the carrying amount (CA) with the RA; if the latter is lower than the CA, an impairment loss should be recognized in the books.

Indicators of impairment

As mentioned, if impairment indicators are observed, it is likely that the CAE of the assets may be impaired. Impairment indicators comprise both external and internal information, such as:

  • Change of market interest rates
  • significant adverse changes in the technological, market, economic or legal environment in which the entity operates
  • cash flow disruption or observed negative trend
  • material loss of clients and business segments volume
  • loss of purchase acquisition power from the markets in which the entity operates
  • disruption of commercial and production activities, including key suppliers
  • market capitalization being lower than net assets, for public entities
  • internal restructurings
  • evidence of obsolescence
  • physical damage to the asset
  • governmental adverse measures slowing the participation of economic parties.

As it can be observed, most of the aforementioned impairment indicators are nowadays observed and will prevail in the forthcoming months and or years, depending on the market, region, country , and of course, industry; therefore, question of impairment indicators existing is no longer under discussion and the entity should focus in determining the RA of long-live assets in view of the forthcoming 2020 year end closing.

Fair value less costs to sell – definition

Fair value less costs to sell (FV) is the amount obtainable from the sale of the assets in an arm’s length transaction between knowledgeable and willing parties, less the costs of disposal. The best evidence of the FV is a price in a binding sale agreement in an arm’s length transaction or the market price of the acid less the costs of disposal. If a market price is not available, if V can be determined using a discounted cash flow approach (DCF), always taking into consideration future events, market conditions, risks related thereto and other pertaining data.

Value in use – principle premises for its determination

Value in use represents the present value of the future expected cash flows to be generated from an asset or a cash generating unit (CGU) and comprises two basic elements:

a. Cash flow projections – estimation of the future cashflows that the entity expects from the normal utilization of the long-live assets and expectations on possible variations in the amount or timing of those future cashflows and should consider the following, but not limited to:

  1. Based on reasonable and supportable assumptions that represent management’s best estimate of the set of economic conditions that will exist over the remaining useful life of the asset;
  2. Based on the most recent financial budgets and forecasts approved by management – without including cash flows were outflows from future restructurings to which the entity is not yet committed to;
  3. not considering borrowing costs, income tax receipts or payments and capital expenditures that improve or enhance the asset’s performance;
  4. include overheads directly attributed or that can be allocated on a reasonable and consistent basis to the assets;
  5. Consider the amount of transaction costs if disposal is expected at the end of the assets useful life; and
  6. for periods beyond the periods covered by the most recent budgets and forecasts, the projections should be based on extrapolations using a steady or declining growth rate unless an increasing rate can be justified.

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