Earnings Management And Asset of Impairment - MyAssignmenthelp.com

Question: Discuss about the Earnings ManagementAndAsset of Impairment. Answer: The main objective of this report is to focus on the impairment criteria and assumptions used by Bradken Limited for conducting the impairment tests on the assets. The report will also focus on the impairment testing procedures used by the company and the subjectivity involved in the procedure. To comment on these the annual report of the company for the year ended 30th June 2016. Bradken Limited is the leading manufacturer in the world for various capital and consumables products for the global market and delivers wide range of fabricated and cast products through four divisions focussed in the market divisions and independent branded business that includes transport and mining, processing of mineral, fixed plant, services related to cast metal and engineered products (Bradken.com 2018). The company uses their wide experience for developing the innovative products for freight rail, mining, steel making, power generation, transport, gas and oil, cement and various other industries. An impaired asset is the asset of the company having the market value that is less than the carrying value of the asset. Assets that are likely to get impaired are the tangible fixed assets like plant, property, equipment and the intangible assets like accounts receivable and goodwill (Amiraslani, Iatridis and Pope 2013). After adjusting the carrying value of the impaired asset the loss is recorded in the income statement of the company. After writing off impairment, asset will have a reduced carrying cost as the adjustments will be recognized as loss and will reduce the value of the asset. Assets tested for impairment As per the annual report of the company for the year ended 30th June 2016, the company tested the following assets for impairment Goodwill and intangible assets of are not amortised, however, it is tested for impairment annually of frequently that is more than once in a year if changes in the circumstances or any events indicates that it may be impaired and it is carried in financial statement at cost reduced by accumulated losses on account of impairment (Rennekamp, Rupar and Seybert 2014). Other assets like plant, equipment and property, inventories are tested for impairment when there is an indication that the carrying amount of the asset may not be recoverable. Impairment test procedure Apart from the intangible assets and goodwill, other assets are tested for impairment when the indication is there that the carrying amount of the asset may not be recoverable. However for intangible assets and goodwill that are not amortised are tested for impairment annually of frequently that is more than once in a year if changes in the circumstances or any events indicates that it may be impaired. Further, the goodwill is allocated to cash generating unit for carrying out the impairment testing (Cotter 2012). The non-financial assets except the goodwill that suffered the impairment are analysed for the possible reversal of the impairment at the each date of reporting. For impairment assessment the assets are grouped at lowest levels of separately recognisable cash inflows and are widely independent of cash inflows from the other assets or the group of the assets that is the cash generating units. Impairment expenditures The company recorded impairment expenses for the year ended 30th June 2016 as follows Intangible assets and goodwill during the period the company recorded total impairment amounting to $ 64.1 million on intangible assets and goodwill, out of which $ 49 million was recorded against goodwill, $ 12.8 million were recorded against the customers list and $ 2.3 million were recorded against the licenses. Plant, property and equipment - during the period the company recorded total impairment amounting to $ 163.2 million for fixed assets, out of which $ 108 million was recorded against transport and mining, $ 4.4 million were recorded against mineral processing division and $ 50.8 million were recorded against the segments of engineered products. Assumptions and estimates used by the company for conducting impairment test Bradken Limited makes various assumptions and estimates as they are concerned regarding the future. The outcomes of the accounting estimates by definition will be equal to the associated actual outcomes (Andrews 2012). The assumptions and estimates that have considerable risks that it can lead to material adjustments to the assets carrying value within next accounting year are discussed and disclosed through the notes to accounts where these kinds of judgements are required. Owing to the continuous adverse condition of the market and continuous downturn of the market for the assessment of recoverable amount for goodwill and the other intangible assets of the companys cash generating units was conducted (Ramanna and Watts 2012). The recoverable amount of CGU is computed on the basis of the calculation of value-in-use. Further, these calculations use the projections of cash flows on the basis of the financial forecast that is prepared by the management for last 5 years. For calculation of value-in-use the key assumptions are as follows Discount rates Growth rates using the extrapolate flows of cash beyond the period of forecast EBITDA/Sales margin Subjectivity involved in the process of impairment testing As per IAS 36 on Impairment of assets it is perceived that it is the atypical standard in IFRS and it demands the subjective interpretation and its can be adaptable with regard to the managerial requirements and it does not limit the creative accounting. It was found from the annual report of Bradken Limited that there involved considerable subjectivity while the management carrying out the process for impairment test as the management had the opportunity of exploiting their discretion and may carried out the goodwill impairment test opportunistically (Amiraslani, Iatridis and Pope 2013). This can be proved with help of the fact that goodwill allocation to the CGU and computation of recoverable amount when no availability of active prices are there for goodwill is subject to the fact of discretion. Confusing and difficult part of impairment Based on the analysis, it is recognized that the difficult and confusing part of impairment is that the indication of impairment. Through, the indications depend on the internal as well as external signal that the asset may be impaired; the frequency of conducting the test for intangible assets and goodwill is entirely depends on the managements discretion. Therefore, chances are there that the management will carry out the test opportunistically while there is a downturn in the value. New insights regarding conducting the impairment Impairment loss is the difference between the carrying amount of the asset and the recoverable amount of the asset. The recoverable amount considered as higher among the value-in use and the fair value of the asset reduced by disposal cost. Fair value is determined through the sales agreement or the value of the asset in active market under which the asset is traded or the availability of best information to reveal the amount at which the company can sell the asset. Further, the value in use in accordance with IAS 36 is the present value of future cash flows that is expected to be received from the CGU or the asset. Fair value measurement As per IFRS 13 fair value is determined through value of the asset in active market under which the asset is traded sales agreement availability of best information to reveal the amount at which the company can sell the asset Reason why the former accounting standards does not reflect the economic reality Nearly 1 out of 2 companies that use US GAAP or IFRS are affected by the changes in accounting. As per the current status, companies under US GAAP or IFRS have commitments and leased assets amounting to almost 3.3 trillion, out of which 85% are not reported in the balance sheet as they are treated as operating leases (Ifrs.org 2018). For compensating this, the investors generally include the estimates that are inconsistent, inaccurate and incomparable computations. Therefore, it is stated that the former accounting standards does not reflect the true economic reality. Mismatch in lease liability and reported debts As per the previous accounting standards, most of the companies reported 85% of their leases recognised the amount under operating leases and did not presented those under the balance sheet. Though the operating leases were not recorded under balance sheet, actually they created real liabilities (Lee and Hooy 2012). Therefore, during the period of financial crisis few major retail companies went bankrupt as they could not adjust the updated economic reality quickly. Further, they had considerable amount of commitments with regard to the long-term operating leases while their balance sheets were deceptively lean. Therefore, lease liabilities were 66 times more than the debt of balance sheet. Reasons why the Chairperson of IASB is in the view that under the previous accounting standard no level playing field was there among some airline entities The former systems of accounting for lease results into lack of comparability. The airline industries accounts most of their leases as operating leases and do not record it under the balance sheet. Therefore, an airline company that leases almost all their aircraft fleet seems very dissimilar from their competitor who purchase almost all their aircraft fleets even though in reality the financial obligations of both type of airline companies are very similar. Therefore, level playing field does not exist among these airline companies. With the introduction of new standard all the leases will accounted as assets and the lessees will account is as liability (Fit, Moya and Orgaz 2013). Therefore, it is expected that the problem will be resolved. Reasons why the Chairperson is in the view that the new standard will not be popular with everyone The changes in the standard will are expected to have impact on almost half of the listed companies and are not expected to be popular with all the companies. The reason behind this is that the changes are always controversial and can lead to warning effects with regard to adverse economic circumstances and costs associated with the system changes. Further, the companies must be ready to accept the considerable changes in income statement as well as the balance sheet due the changes in the new standard (Marshall 2016). Moreover, the changes may have bigger commercial impacts. For instance, various contractual arrangements and banking covenants tied with the financial statements of the company like profit targets for arranging the bonus payment to the employees or debt to equity ratio may required to get revised prior to implementation of the new standard. Further, all the departments of the business have to understand the impact of changes that includes the finance, IT, treasury, hum an resource, asset procurement and investor relation department. All these reasons will lead to unpopularity of the new accounting standard. Possibilities that the new visibility with regard to all the leases will result into better informed decision for investment As per the former accounting standard as most of the companies were treating the operating leases as off balance sheet items the users of financial statement or investors do not have entire picture of companys financial position and therefore they were not able to compare the companies that leases assets with the companies that buy assets (Jennings and Marques 2012). However, the new standard is expected to update the IFRS 16 and it is expected that it will widely outweigh the costs which in turn will result into better informed decisions for investment and will reflect the lease versus buy decisions in better way by the management. Reference Amiraslani, H., Iatridis, G.E. and Pope, P.F., 2013. Accounting for asset impairment.London: Cass Business School. Amiraslani, H., Iatridis, G.E. and Pope, P.F., 2013.Accounting for asset impairment: a test for IFRS compliance across Europe. Centre for Financial Analysis and Reporting Research (CeFARR). Andrews, R., 2012. Fair Value, earnings management and asset impairment: The impact of a change in the regulatory environment.Procedia Economics and Finance,2, pp.16-25. Bradken.com., 2018. Bradken. [online] Available at: https://bradken.com/ [Accessed 4 Jan. 2018]. Cotter, D., 2012.Advanced financial reporting: A complete guide to IFRS. Financial Times/Prentice Hall. Fit, M.., Moya, S. and Orgaz, N., 2013. Considering the effects of operating lease capitalization on key financial ratios.Spanish Journal of Finance and Accounting/Revista Espaola de Financiacin y Contabilidad,42(159), pp.341-369. Ifrs.org., 2018. IFRS. [online] Available at: https://www.ifrs.org/ [Accessed 4 Jan. 2018]. Jennings, R. and Marques, A., 2012. Amortized cost for operating lease assets.Accounting Horizons,27(1), pp.51-74. Lee, C.H. and Hooy, C.W., 2012. Determinants of systematic financial risk exposures of airlines in North America, Europe and Asia.Journal of Air Transport Management,24, pp.31-35. Marshall, D., 2016.Accounting: What the numbers mean. McGraw-Hill Higher Education. Ramanna, K. and Watts, R.L., 2012. Evidence on the use of unverifiable estimates in required goodwill impairment.Review of Accounting Studies,17(4), pp.749-780. Rennekamp, K., Rupar, K.K. and Seybert, N., 2014. Impaired judgment: The effects of asset impairment reversibility and cognitive dissonance on future investment.The Accounting Review,90(2), pp.739-759.