ACCM4200 Financial Accounting and Reporting For Impairment

Can you please explain the following before I meet with the operations managers: 
•The difference between depreciation, impairment and revaluation losses?
•What impact these charges will have on profitability? 
•Why the changes are required for depreciation, impairment and revaluation? 
•What disclosures are necessary for these changes? 
•How we could otherwise report on performance without upsetting the managers? 

Answer:

Clarification of issues –

• Difference between revaluation losses, impairment and depreciation

Depreciation – in accounting, depreciation is termed as reduction of the fixed asset’s cost in systematic manner until the asset’s value becomes negligible or zero. It allows a percentage of assets cost to revenue that is generated by the fixed asset (Del Giudice, Manganelli and De Paola 2016).

Impairment – impairment is associated with the long term asset that has its market value lower than its carrying value. If the future cash flows of the asset are lower as compared to the carrying amount the company shall report impairment loss for the asset.

Revaluation loss – revaluation is used for adjusting the fixed asset’s book value to the current market value. Once the asset is revalued it shall be carried at the fair value reduced by accumulated depreciation and impairment loss, if any. Asset can be revalued only if the fair value of the asset can be calculated reliably (Kulikova, Gubaidullina and Elsukova 2016).

Impact of the charges on profitability

Depreciation – the depreciation expenses has direct impact on profit stated under the income statement. With increase in amount of depreciation, amount of net profit goes down. However, as it is not cash expenses it does not have any impact on company’s cash flow statement (Zuca 2013).

Impairment – amount of impairment loss is recorded under income statement in same section where the operating expenses are recorded. Impairment loss eventually reduced the amount of profit reported in the income statement. However, it does not have any immediate impact on the cash balance of the company.

Revaluation loss – when the revaluation leads to reduction of the value of the asset that is when the revaluation loss takes place, the loss amount is reported in the income statement which in turn reduces the profit (Kulikova, Gubaidullina and Elsukova 2016).

• Changes required for revaluation losses, impairment and depreciation

Depreciation – changes are required for depreciation due to the below mentioned reasons –

• Retaining fund for the purpose of replacement – business assets require replacement after expiration of service. If the asset is used in production on continuous basis, it wears out. Physical deterioration for any asset takes place due to strain, erosion, fiction and movement. If depreciation is not provided during the asset’s life it will be difficult for the business to replace the asset due to unavailability of funds. Therefore, it is required to make necessary provision to create funds for replacing the asset.
• Reducing the tax liability – as depreciation is deductible expense under tax it is allowed to be deducted from profit. Therefore, the company will avail the advantages from depreciation charge to profit and reduce its tax liability (Goodwin et al. 2016).
• Ascertaining the asset’s true value – balance sheet shall to state true and fair value of the company’s business state. If the company does not provide any depreciation on its assets, the assets will be shown at historical cost that will not state the true status of business.

Impairment – it is expected that the financial report shall provide meaningful and useful information to the investors and various other users of financial statements so that they are informed and confident while making decisions associated with investment. Non-financial assets generally represent the significant part of the company’s assets. Its value has direct impact on company’s financial performance as well as financial position. Therefore, the assets those are impaired shall be presented in the financial statement at its true value (Bond, Govendir and Wells 2016).

Revaluation loss – it is required to provide for revaluation loss to state the asset at its fair market value that has been depreciated since its purchase. As time passed, value of some assets gets reduced and therefore the actual value of the asset differs with the balance sheet value. Further, asset’s value has direct impact on company’s financial performance as well as financial position. Therefore, the assets those are impaired shall be presented in the financial statement at its true value.

• Disclosure requirement

Depreciation – As per AASB 116 on depreciation the financial statement shall disclose the following with regard to depreciation –

• Measurement base used to determine the carrying amount of asset
• Method of depreciation used
• Useful life of the asset
• Carrying amount of the asset and accumulated depreciation at opening as well as at closing of the period.
• Reconciliation of the asset’s carrying amount at opening as well as at closing with details of additions, acquisition from business combinations, depreciation, impairment or revaluation loss, exchange difference and other changes (gov.au2018).

Impairment – As per AASB 136 on impairment the financial statement shall disclose the following with regard to impairment –

• Amount of the impairment loss recorded under income statement for which the impairment losses are recognized
• Reversal of impairment loss amount recognized in the loss or profit under income statement for which the impairment losses are reversed
• Circumstances and events that led to recognition or reversal of impairment loss
• Amount of impairment loss recognized or reversed
• Nature of the asset, for individual asset (gov.au 2018)

Revaluation loss - As per AAS 38 on revaluation of non-current asset the financial statement shall disclose the following with regard to revaluation loss –

• If the fair value method is used to measure the value of non-current asset, financial statement shall disclose the method used to determine the fair value. Further it shall disclose whether revalued carrying amount of the asset is determined with independent valuation.
• Financial statement shall disclose balance of asset revaluation reserve account along with the restrictions, if any on distribution of balance to the owners (Choi et al. 2013).
• The financial statement shall further disclose the details of disposals, additions, acquisitions through operations or acquisitions
• Other way of reporting

The business can report on the performance through providing provision for depreciation, impairment and revaluation loss rather than reporting it as loss in the income statement. Provision will not reduce the profit immediately and when the amount of loss will be recognized the amount will be charged from provision. In this way, the managers will not get upset.

Based on the above discussion it is recommended that the accountant shall follow AASB 116 while providing depreciation on the assets. The managers shall understand the fact that particular care for maintenance of the machines cannot protect the machines against depreciation. Further, for testing the assets for impairment the accountant must follow the requirement of AASB 136 on impairment. 

Reference

Aasb.gov.au. 2018. [online] Available at: https://www.aasb.gov.au/admin/file/content105/c9/AASB136_07-04_COMPjun09_01-10.pdf [Accessed 28 Aug. 2018].

Aasb.gov.au. 2018. [online] Available at: https://www.aasb.gov.au/admin/file/content105/c9/AASB116_08-15_COMPoct15_01-18.pdf [Accessed 28 Aug. 2018].

Bond, D., Govendir, B. and Wells, P., 2016. An evaluation of asset impairment decisions by Australian firms and whether this was impacted by AASB 136.

Choi, T.H., Pae, J., Park, S. and Song, Y., 2013. Asset revaluations: motives and choice of items to revalue. Asia-Pacific Journal of Accounting & Economics, 20(2), pp.144-171.

Del Giudice, V., Manganelli, B. and De Paola, P., 2016, July. Depreciation methods for firm’s assets. In International Conference on Computational Science and Its Applications(pp. 214-227). Springer, Cham.

Goodwin, J., Atilgan, Y., Simsir, S.A. and Ahmed, K., 2016. Investor reaction to accounting misstatements under IFRS: Australian evidence.

Kulikova, L.I., Gubaidullina, A.R. and Elsukova, T.V., 2016. Disclosure of the risks of the organization influencing decision making by users of financial reporting. International Business Management, 10(22), pp.5280-5285.

Zuca, M.R., 2013. The Accounting Treatment Of Asset Depreciation And The Impact On Result. Annals of the University of Petrosani Economics, 13(2).