Accounting Issues In A Downturn April 2010

ACCOUNTING ISSUES IN A DOWNTURN

APRIL 2010

PRESENTED BY:

Deirdre KielyCPA, ACCA

Irish/UK GAAP

Seminar Contents FRS15 Tangible Fixed Assets FRS 10 Goodwill and

Intangible Assets FRS 11 Impairment of Fixed

Assets & Goodwill SSAP 19 Accounting for

Investment Properties SSAP 21 Accounting for

Leases & Hire Purchase Contracts

TRUE AND FAIR VIEW

Section 3 Companies Act, 1986 – Overriding principle

FRS 15Tangible Fixed Assets

FRS 15 Tangible Fixed Assets

Replaced SSAP 12

Sets out the principles for: initial measurement valuation and depreciation

of tangible fixed assets excl. Investment Property

FRS 15 Tangible Fixed Assets (contd)

Initial Measurement

At cost:

Cost comprises of purchase price (less discounts/rebates) and any costs directly attributable to bringing the asset into working condition for intended use.


Valuation

Revaluations - optional If adopted do not need to apply to all classes of

tangible assets but must revalue all assets in a class

If adopted must perform full valuation every 5 years and interim valuation year 3.

Interim valuations years 1,2 and 4 if material change in value


Valuation

Revaluation gains go to the STRGL Reversal of revaluation gains go to the STRGL until

the revaluation reserve is depleted and thereafter to the P&L

Disclosure requirements


Depreciation

Subjective test – estimated useful economic life Period over which the asset will be consumed by

the entity If no depreciation is charged e.g. Hotel, assess for

impairment annually Don’t depreciate land


Depreciation

Useful economic life should be reviewed at each balance sheet date and revised if expectations are significantly different to the original estimate.

Change in an estimate is not a change in accounting policy

Depreciate the carrying amount of the asset over the revised useful economic life


Website Development Cost

Significant costs incurred on website development Planning costs, infrastructure development costs,

design and content costs Capital or expense? UITF Abstract 29 provides direction on this



Is it an enduring asset and are there reasonable grounds for supporting that future economic benefits in excess of the cost will be generated by the website?

Revenues direct from website: Orders placed via the Website Amounts paid by subscribers to gain access Selling advertising space



If it is an enduring asset capitalise, if not, expense Generally expense websites used only for

Advertising or promoting the entities own products or services

Tangible asset v Intangible asset?


Impairment of Tangible Assets

Where there is an indication of impairment must perform an impairment review

Impairment reviews – FRS 11

FRS 10Goodwill and Intangible Assets

FRS 10 Goodwill andIntangible Assets

Replaced/ significant change from SSAP 22 Goodwill and Intangible assets Objective is to ensure Goodwill and Intangibles are

charged to P&L over the periods in which they are depleted

FRS 10 Goodwill andIntangible Assets (contd)

Goodwill

Purchased Goodwill = Price paid less the sum of a fair value of its assets and liabilities

Positive Goodwill and Negative Goodwill – both in the balance sheet

Capitalise Purchased Goodwill Do not capitalise internally generated Goodwill


Intangible Assets Trademarks, Patents, Copyrights, Licences,

Franchises, Intellectual Property Excludes: Oil and Gas exploration and R&D Capitalise at cost if acquired separate to the

business If acquired as part of a business capitalise

» Separate to goodwill if value can be reliably measured» As part of goodwill if value cannot be reliably measured

Internally generated – capitalize if ascertainable market value


Amortisation Goodwill/Intangible assets amortized over useful

economic life ‘UEL’ UEL – rebuttable presumption of not greater than

20 years Review the UEL at the balance sheet date and

revise if necessary


Impairment First review performed at the end of first full

financial year following initial recognition but refer to the indicators of impairment under FRS 11 which may result in an earlier review

Thereafter review annually and impair if carrying value not recoverable in full

Impair in accordance with FRS 11

FRS 11Impairment of Fixed Assets and Goodwill

FRS 11 Impairment of FixedAssets and Goodwill

Applies to all categories of fixed assets, intangible assets and goodwill but excludes Investment Properties

Assets carried at not more that recoverable amount Most likely impaired –

Property/Goodwill/Investments Must perform impairment review if there is some

indication that impairment has occurred

FRS 11 Impairment of FixedAssets and Goodwill (contd)

Examples of indications of impairment:» The current economic climate » Evidence of obsolescence or physical damage

to the fixed asset» Adverse change in either the business or the

market in which the fixed asset or goodwill is involved

» Significant reorganisation» A major loss of key employees» Significant increase in market interest rates


Impairment Review Comparison between carrying value of the assets in the balance sheet with the recoverable amount


Definitions

Recoverable amount is the higher of net realisable value ‘NRV’ and value in use ‘VIU’.

NRV = amount the asset can be sold for (at arms length in normal conditions) less selling costs/taxation (OMV)

If the asset fails the NRV test perform the VIU test


Definitions

VIU = present value of future cash flows

Prepare cashflows for the smallest income generating unit which can be;

Individual asset orGroups of assets orThe whole factory


Value in use test

Apply a discount rate to the cashflows of the income generating unit to determine present value

Discount rate: Market rate for similar assets Weighted average cost of capital of a comparable listed

company Weighted average cost of capital of the entity under

review - incremental borrowing rate


Example

XYZ Limited car dealership

ABC Limited manufacturing company


Must take tax into account

When comparing NRV and VIU must take tax into account. If NRV is €100 and deferred tax of €30 and VIU is €110 with deferred tax of €45 recoverable amount is based on NRV.


Impairment Loss

Recognise in the profit and loss account Previously revalued asset – loss to STRGL until

back to historical cost and then to P&L Assignment of loss in a single income generating

unit:» First to Goodwill» Next to Intangible assets» Pro rata to all fixed assets


Impairment Loss

Exceptional Item on P&L Disclosures in the financial statements Review remaining useful life and depreciate over

revised remaining useful life


Reversal of Impairment Loss

Example:Land impaired on refusal of planning permission however if planning permission refusal is reversed may be appropriate to reverse the impairment

Can reverse goodwill impairment however exercise with caution (IAS 36 prohibits reversal)


Application

Vodafone – 27% of equity value was impaired RBS - Impairment of £32.6bn mainly goodwill HSBC - $10.6bn impairment of goodwill Rio Tinto - $8.0bn mainly goodwill

SSAP 19 Accounting for Investment Properties

SSAP 19 Accounting for Investment Properties Old accounting standard introduced in the early

1980’s. Amended in 1994 when FRS3 introduced the

STRGL. Investment Property is Land & Buildings where:

» All construction & development work complete» Properties are held for investment purposes or rental

Excludes Properties:» Held for consumption in the business operations» Occupied by group companies» Held on a lease with unexpired term of less than 20 yrs

SSAP 19 Accounting for Investment Properties (contd) Investment properties are not depreciated. Valued in the balance sheet at open market value

‘OMV’ Investment properties must be valued annually. Difficult to determine OMV in current environment. No requirement for valuer to be qualified or

independent – can be valued by a director. May cause difficulties for auditors!

Disclose valuers name, qualification, whether internal or external and basis of valuation.

Listed companies must value annually by a qualified valuer who can be internal or external. Valued at least every five years by an external valuer. SSAP19 no longer applies to listed entities since the adoption of IFRS in 2005.

SSAP 19 Accounting for Investment Properties (contd)


Movements in the value of Investment Properties should be taken to the ‘STRGL’.

If expected to be permanent the deficit goes to the profit and loss account and not the STRGL.

Companies Act requires a charge to P&L only in respect of write downs expected to be permanent.

What’s the different is between temporary and permanent.

Impair on an individual asset basis i.e. do not comingle the assets


Stock of trading properties to investment properties UITF Abstract 5

» Timing - when management decide» Transfer at lower of cost and NRV» Any diminution in value charge to P&L account» Apply SSAP 19 rules once transferred

SSAP 21 Accounting for Leases and Hire Purchase Contracts

SSAP 21 Accounting for Leasesand Hire Purchase Contracts

SSAP21 was introduced in 1984 and amended in 1997.

Deals with accounting treatment of Leases and Hire Purchase agreements.

Leases are classified into:» Finance Leases and» Operating Leases

SSAP 21 Accounting for Leasesand Hire Purchase Contracts (contd) Finance Lease

» Risks and rewards of ownership, except legal title, are transferred to the lessee

» Asset is capitalized and obligation to make future payments recognised as a liability

» HP agreements normally accounted for in a similar way

SSAP 21 Accounting for Leasesand Hire Purchase Contracts (contd)

Operating Lease

» Risks and rewards of ownership remain with the lessor

» Annual rental costs are charged to the P&L account


Operating Lease Incentives

» Initial period - Rent free period» Initial period - Reduced rent» Up-front cash payment» Contribute to relocation costs etc



» SSAP 21 does not deal with accounting treatment for lease incentives

» Recognise lease rentals on a straight line basis over the lease term even if not paid on that basis



UITF Abstract 28» Recognise the incentives as a reduction of rental

expense » Allocate the benefit over the shorter of the lease

term and a period ending on a date from which market rents will be payable


EXAMPLE - Operating Lease Incentive

XYZ Limited entered into a 21 year property lease in October 2004 at an annual rent of €100,000. It had a ‘break option’ clause on the 5th anniversary i.e. October 2009 exercisable by the tenant. In September 2009 the landlord and tenant entered into an agreement that ‘in consideration of the tenant not exercising the break option the landlord granted the tenant a rent free allowance of €93,750’. This reduction was to be accommodated by reducing the monthly rent by €4,166.67 per month for 22 months from 1 October 2009 to 1 July 2011 and by €2,083.38 for 1 August 2011.

There is no further break option in the lease so from the date of this new agreement there are 16 years left to expire.

UITF 28 provides that ‘the benefit should be allocated over the shorter of the lease term and a period ending on a date which it is expected that the prevailing market rental will be payable.


ANSWER - Operating Lease Incentive

The incentive of €93,750 should be allocated over 23 months at €4,076.08 per month as the rent will revert to €100,000 per annum on the 1 September 2011. It is assumed that will be market rent at that time.

Thank you

Deirdre Kiely [email protected] 01 418 2088

mailto:[email protected]

Accounting Issues In A Downturn April 2010

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