CHARTERED ACCOUNTANTS ACADEMY

FINANCIAL ACCOUNTING & REPORTING DEPARTMENT

CERTIFICATE OF THEORY IN ACCOUNTING

IAS 36- IMPAIRMENTS

Contents
QUESTIONS ..............................................................................................................................2
DEMBELE PVT LTD ................................................................................................................2
GANDA DEMA LTD (GD).......................................................................................................9
QUESTIONS

DEMBELE PVT LTD

PART A (35 Marks)

Dembele Pvt Ltd, hereon referred to as “Dembele” is a reputable manufacturer of Brazilian

weaves and operates from its main factory situated in Willowvale. Its products are
distributed to the various salons and stores throughout the region. Dembele complies with
International Financial Reporting Standards and their year-end is 31 December.

Willowvale Factory Building

Dembele purchased its current factory building from an unnamed third party for $10 million
on 1 January 2009, the building had no roof (was incomplete) on the date of purchase. The
consideration was to be paid in two installments; the first one ($5 million) on 1 January 2009
and the second installment on 31 December 2009. The factory building’s floors with a
carrying amount of $ 1.3 million had to be removed as they were wooden and were replaced
with tiles at a cost of $1.8 million on 31 January 2009. In addition to this, $2 million was spent
on roofing the factory building. The roofing activities commenced on 15 January 2009 and
were completed on 28 February 2009. The roof was financed through an overdraft of $2
million from CBA bank approved on 1 January 2009 and ceased on 30 April 2009.

Architect and project manager’s fee of $50 000 were incurred on the roofing. The factory
building was brought into use on 1 March 2009. Dembele estimated that the total economic
life and the total useful life of the factory building to be 40 and 30 years respectively. The
residual value was estimated to be $1 million. Following the recent ‘Clean up Zimbabwe
Campaign’ the government required companies in the hair production industry to dismantle
their operations and relocate to a different designated area at the end of the useful life of
the asset. The fair value of the dismantling costs was estimated to be $420000.

For the 2009 and 2010 financial years, management re-assessed their estimates of the
economic life, useful life, residual value and costs of disposal, and no changes therein were
necessary.

On 1 January 2011, the recoverable amount of the factory building on that date was
determined as $9.5 million. At the same date, the company also re-assessed its estimate of
the economic life, the useful life, the residual value and the costs of disposal. The remaining
economic and useful life remained unchanged, but the residual value increased to $1.5
million. The estimated costs of disposal remained unchanged.

Acquisition of a fleet of delivery vehicles

During the 2009 financial year, Dembele decided to acquire its own fleet of delivery vehicles,
due to the increase in fees charged by the previous courier. Dembele intended to only use
the vehicles for 9 months and took out a put option to sell the vehicles to Mnandi Motors for
$9 million on 31 December 2009.

On 1 April 2009, Dembele purchased a new fleet of delivery vehicles at a total cost price of
$11.5 million. The Finance Manager is uncertain as to how the truck fleet should be classified
in the statement of financial position and seeks your advice in this regard.

Additional information
• Dembele uses the cost model as per IAS 16
• The interest rate chargeable on the overdraft facility was 12%
• Assume a nominal post-tax discount rate of 7.43% per annum.
• Ignore VAT and Tax

REQUIRED Marks
a) Provide all the necessary journal entries processed in the
accounting records of Dembele Pvt Ltd for the years ended 31
December 2009 and 31 December 2011 (27)
35
b) With regards to the acquisition of the fleet of delivery vehicles,
advise the Finance Manager on the appropriate classification of
the truck fleet in Dembele’s statement of financial position on 31
December 2009. (5)

c) Assume the Post tax discount rate was revised to 9.65% discuss
the impact of this on the Statement of Financial Position
(3)
Suggested solution
Part A

a)
Journal entries:

2009

Dr Factory Building (P/L) 10 000 000

(0.5)

Cr Bank (SFP)5 000 000

(0.5)
Cr Trade Payables (SFP)5 000 000
(0.5)

Initial recognition of purchase

Dr Trade Payables (SFP) 5 000 000

(0.5)

Cr Bank (SFP)5 000 000

(0.5)

Settlement of outstanding balance on Factory building (no need to take into account the
time value of money as the liability was settled within 12 months)

Dr Factory Building: New Floor (SFP) 1 800 000

(0.5)
Cr Factory building: Old Floor (SFP)1 300 000
(0.5)
Dr Loss on Derecognition (P&L) 1 300 000
(0.5)
Cr Bank (SFP)1 800 000
(0.5)
Derecognition of old floor and capitalization of new floor to the factory building

Dr Factory Building (SFP) 2 000 000

(0.5)
Cr Bank/Overdraft Facility (SFP) 2 000 000
(0.5)

Capitalisation of the roofing costs to the factory building

Dr Interest Expense (P/L) 80 000

(0.5)
Cr Bank/Interest payable 80 000
(0.5)

Period is less than a year therefore we don’t capitalize interest (4)

However, students who capitalized borrowing costs after apportioning were not penalised

Expensing of interest on overdraft

Dr Overdraft Liability (SFP) 2 000 000

(0.5)
Cr Bank (SFP) 2 000 000
(0.5)

Repayment of overdraft facility

Dr Factory Building (SFP) 50 000 (0.5)
Cr Bank (SFP)50 000
(0.5)

Capitalising of Architect’s fees

Dr Factory Building (SFP) 420 000 (0.5)

Cr Provision for Dismantling Costs (SFP)420 000
(0.5)

Capitalising of dismantling costs. There was no need to present value them as the PV was
the fair value

Dr Depreciation Expense (P/L) 332 500 (0.5)

Cr Acc Depreciation (SFP)332 500
(0.5)

Cost= 10000-1300+1800+2000+50+420=12970 therefore Depn = (12970-1000)/30*10/12

(4.5)

Recognition of depreciation for 2009

Dr Finance Costs (P/L) 35 000 (0.5)

Cr Provision for Dismantling (SFP)35 000
(0.5)

N= 30 I= 7.43/(1-0.2575) PV= 420 000 FV= Solve and find interest expense using calculator
(2)
10 months of interest so apportion 42000*10/12
Recognition of the increase in the provision
Dr Motor vehicles (Current Assets) (SFP) 11 500 000 (0.5)
Cr Bank (SFP)11 500 000
(0.5)

Acquisition of vehicles

Dr Bank (SFP) 9 000 000

Dr Loss on disposal (P&L) 2 500 000 (0.5)

Cr Motor Vehicles (SFP)11 500 000
(0.5)

Disposal of Motor vehicles

2010 ( Not required)

Dr Depreciation Expense (P/L) 399 000 (0)

Cr Acc Depreciation (SFP) 399 000 (0)

Recognition of depreciation for 2010

Dr Finance Costs (P/L) 45 500 (0)

Cr Provision for Dismantling (SFP) 45 500 (0)

(420000+35000)*10%
Recognition of the increase in the provision
2011

Carrying amount= 13000-332.5-399=12238.5 (1)

Recoverable amount= 9500 (0)
Impairment= 12200-9500= 2738.5 (1)

Dr Impairment Expense (P/L) 2 738 500 (0.5)

Cr Acc Impairment Loss (SFP)2 738 500
(0.5)

Recognition of the impairment on the factory building

Dr Depreciation Expense (P/L) 284024 (0.5)

Cr Acc Depreciation (SFP) 284024
(0.5)

= (9500-1500)/28years and 2 months (2.5)

Recognition of depreciation on the new carrying amount of the factory building. The residual
value has changed and the remaining useful life is 28 years and 2 months

Dr Finance Costs (P/L) 55 055 (0.5)

Cr Provision for Dismantling (SFP)55 055

(0.5)

(420000+35000+45500+50050)*10% (2)
Recognition of the increase in the provision

Presentation:
General (1)
 Using narrations (1)
(35.5)

GANDA DEMA LTD (GD)

Background
Ganda Dema Ltd (GD) GD is a large manufacturing concern, incorporated in Zimbabwe,
consisting of several separate divisions, each of which is operated as a profit centre.

As part of GD’s growth strategy, the company decided to enter the automobile industry.
The General Manufacturing and Expropriation Division (the Division) was established to
manufacture the 3-series Re-Hearsed, a low cost car that is highly standardized.

During the current financial year, ending 30 June 2011, the automobile industry was
particularly hard-hit by the worsening global recession. Signs of recovery in mid to late
2010 were short lived due to the emerging credit crisis in Greece and Portugal, as well as
worsening consumer confidence in the United States of America (USA) and European
Union (EU). The downgrading of the USA’s credit ratings form AAA to AA+ by the Bank of
Porsh De Maria only compounded existing problems.

Divisional Analysis
The following sales forecasts for the Division have been obtained from Mr. PT Muridzo CA
(Z), the Chief Financial Operator, and Mrs. BV Sibanda, the Group Financial Planner.
Please note that all amounts are quoted in US Dollars (USD), the functional currency of
GD.

Extract from the Divisional Profit Assessment Report

Assessment of impairment indicators

The following sales projection shows a temporary recovery in the number of units sold
in the first half of the 2010 financial year. Unfortunately, this trend did not continue into
the second half of 2010, being largely eroded by a low consumer confidence in the USA
and EU. A downward sales trend dominated 2011 with recovery in 2012 expected to be
slow. Units sold are projected to be only marginally above accounting break-even levels.
 Sales Over Time
40,000.00
35,000.00
30,000.00
Units Sold

25,000.00
20,000.00
15,000.00
10,000.00 Projected Sales (Units)
5,000.00 Break Even Level (Units)
-
Nov-10

Aug-14
Apr-11
Sep-11
Feb-12

Mar-14
Dec-12
May-13
Jun-10

Oct-13
Jan-10

Jul-12

Jan-15
Months

As a result of the above, it was concluded that an impairment test be performed on the
Division as the smallest identifiable group of assets and liabilities to which cash flows
could be reasonably allocated.

The following value in use calculation has been completed to determine the impairment
loss, if any, as at the end of the 2011 financial year.

Determination of the recoverable amount

Nominal Cash Flows Schedules

USD (thousands)
2011(A) 2012(B) 2013(B) 2014(B) 2015(B) Total
Sales 1,330 2,032 2,263 2,346 2,400 10,371
(6,741
Operating costs (865) (1,321) (1,471) (1,525) (1,560) )
Nominal Post Tax
Operating Profit before
Depreciation 466 711 792 821 840 3,630

(1,150
Depreciation (125) (125) (300) (300) (300) )
Depreciation Tax Shield 35 35 84 84 84 322
Net Effect of
Depreciation (90) (90) (216) (216) (216) (828)
Post Tax Asset
Enhancement (2,500) (2,500)
Post Tax Part Settlement
of Provision (450) (450)
 Net Flows (Post tax) 376 621 (1,924) 605 174 (148)

Net Present Value at 6% 354.25 552.87 (1,615.39) 479.30 130.02 (98.96)

Legend
A – actual results (unaudited)
B – projected results (unaudited)

Summary of Discount
Rates Pre -Tax
Firm - Level Weighted Average Cost of
Capital 12%
Division - Level Discount
Rate 16%
Money Market Rate 6%
Inflation Rate 7%

Please note that this table casts and cross casts. It may be assumed that it is
mathematically accurate.

The carrying value of the cash generating unit was USD5 500 000. The Accounts
Department has processed the following year-end journal entry:

Dr Cr

Details

(USD thousands)

Impairment Expense (5 500 – (-98.26)) 5 500

Accumulated Impairment (Statement of Financial 5 500

Position)

Impairment of PPE

Deferred Tax Asset (5 500 x 25.75%) 1 416

Tax Expense 1 416

Deferred tax at 25.75%

Recoverable Amount Determination: Additional Information

• Nominal post tax operating profit is expected to grow at 5% before tax after
2015. The client has not accounted for these terminal cash flows as it wants to
be prudent. The 5% projection is consistent with long term projections for the
automotive industry as a whole and may be assumed to be an appropriate
growth estimate.

• No reliable cash flow forecasts beyond 2015 are available.

• The asset enhancement that is expected on 1 July 2012 (i.e. during the 2013
financial year) is expected to account for 12% of the nominal post tax operating
profit in each period. This will remain constant over the life of the CGU. The
effects of the enhancement have been included in the cash flow summary
above. The asset enhancement may be assumed to take place at the start of the
2013 period. The change in depreciation and the depreciation tax shield is solely
the result of the additional capital expenditure.

• The post-tax provision settlement relates to expected warranty claims. The claim
would be retained by GD in the event of the Division being sold either piecemeal
or in aggregate.

• The tax rate is 25.75% and is expected to remain constant in perpetuity.

• If the CGU was sold ‘as is’ it would realize USD 2 500 000. Costs to sell would be
USD 245 000.

Summarized Proposed Action Plan Prepared by the Board:

GD, as a profit orientated entity, has identified ‘revenue’, ‘profit before tax’ and ‘return
on assets’ as its primary key performance indicators. Relative to the rest of the entity,
the decline in profitability of the Division is regarded as an isolated issue as it is largely a
result of the poor performance of the automotive industry as a whole. This is evidenced
by the fact that the Division is the only division of GD that has shown a loss for the
period under review and is projected to report an accounting loss for the 2012 financial
year.

Due to these factors, it has been discussed that the Division be ‘ring fenced’ as follows:

• The Division would be sold in a single transaction to ZED (Pvt) Ltd (ZED) at the
fair value of the respective net assets. All existing warranty provisions at the
date that the division is sold will be retained by the GD legal entity. In exchange,
 GD will take up a 100% stake in the Z-Class Preference Share Capital of ZED. The
preference shares will be valued at the fair value of the net assets transferred to
ZED such that no goodwill will result.

• A Memorandum of Understanding, prepared by GD, will establish the key

operating and distribution policies for the manufacture and sale of Re-Hearsed
vehicles (the operation) only.

• The Memorandum of Incorporation of ZED will be amended to provide that the

net proceeds of the manufacturing operations will be used only to service the Z-
Class preference dividends (8% of par-value). In the event that profits/cash flows
of the operation are inadequate to pay the preference shareholder’s claim, the
excess shall be accumulated for distribution in subsequent periods, subject to
the availability of future cash flows from the operation.

• Resolutions are passed at ZED by means of a simple majority of ordinary

shareholders although, in the event of a decision aimed at changing the terms of
the Memorandum of Understanding, the consent of the Z-Class Preference
Shareholders is required.

In the event of a decision that results in ZED it being classified as held for sale, all
preference shareholders shall have the right to convert their preference shares into
ordinary shares. Each ordinary share entitles the holder to one vote at a meeting of the
members. The effect of this would be that unanimous consent of both the ordinary and
Z-class preference shareholders would be required to classify ZED as held for sale.
REQUIRED Marks
A Prepare the correcting journal entry/(ies) that you consider necessary in 20
relation to the journal entries processed by the Accounts Department at the
end of the 2011 financial year. Support your journal entries with a cash flow
analysis/calculation. If you think that any cash flows should be excluded,
state this and briefly provide a reason.

• You need not deal with the allocation of the impairment/reversal of

impairment to the different classes of assets within the cash
generating unit.
• Ignore the proposed action plan for the purpose of this part of the
question.
• Ignore deferred tax for the purpose of this question
B Irrespective of your answer in the previous question, assume that the 5
Division was correctly impaired by US$5 500 000 and that US$200 000 of
this impairment was correctly allocated to goodwill that arose in a previous
business combination.

Discuss the deferred tax consequences resulting from the impairment of

goodwill, assuming that ZIMRA grants a s15 tax allowance related to
goodwill of 5% per annum of the cost of goodwill that arose on initial
recognition, not apportioned for time.

C Discuss with reasons, how the proposed action plan for the Division should 20
be recognised and measured in the separate financial statements of GD.
Your discussion should specifically address the following:

• Whether or not the Division would be classified as held for sale in

terms of IFRS 5 Non-current assets held for sale; and
• If it is possible that GD would retain control over the Division in
terms of IFRS 10 Consolidated financial statements.

You are not required to perform any calculations for this part of the
question and may ignore any current and deferred tax implications.
Suggested solution

Q7 - Solution
Part A

The impairment test is done at the end of the 2011 financial 1

year. Hence cash flows for 2012 onwards are relevant.

Nominal Cash
Flows
Schedules
USD'000
2011 2012 2013 2014 2015 Terminal Total
Value (2012
(2016) onwards)
Sales
1,330 2,032 2,263 2,346 2,400 9,041
Operating costs
(865) (1,321) (1,471) (1,525) (1,560) (5,877)
Nominal Post
Tax Operating 466 711 792 821 840 882 4,046
Profit - Given
(A)
Removal of 3
asset 466 711 697 723 739 776 3,646
enhancement
effect (Ax88%)

Depreciation -
ignored as not a - - - - - - - 1
cash flow
Depreciation tax
shield - ignored - - - - - - - 1
as we want pre
tax
Post Tax Asset
Enhancement - - - - - - - - 1
ignored as not
effected
Post Tax Part
Settlement of - - - - - - - 1
Provision -
ignored as
accounted for
under IAS 37
Net Flows Post 1
Tax (B) 466 711 697 723 739 776 3,646
Net Flows Pre
Tax (B/0.72) 647 988 968 1,004 1,027 1,078 3,646 3

Net Present
Value at 16% 646.53 851.53 719.43 642.94 567.02 5,412 8,193.37 4
Terminal Value 2
= 1078/(16%-
5%)x(1+16%)^-5

Summary of
Discount Rates
Pre Tax
Firm - Level 12%
Weighted
Average Cost of
Capital
Division - Level 16% 2
Discount Rate
Money Market 6%
Rate
Inflation Rate 7%

Recoverable 1
amount 8,193.37
Value in Use
8,193.37
Fair Value Less Cost to Sell 2
(if supported by an 2,255.00
explanation)

Carrying Value
5,500.00
Impairment Nil 1
needed

Hence reverse
the impairment
Dr Plant and 1
Equipment 5,500.00
Cr Profit and
Loss 5,500.00
Reversal of 1
impairment loss
Dr Tax Expense
1,416.25
Cr Deferred Tax 1
Asset 1,416.25
Reversal of 1
deferred tax
expense on
impairment
27

Available 27
Total Marks 20
Part B: Deferred Tax on Goodwill
The impairment of goodwill will result in a reduction of the carrying value of the asset
without a corresponding change to the tax base leading to a deductible temporary
difference 1
IAS 12 precludes the recognition of deferred tax resulting on the initial recognition of
goodwill (para 15a). 1

An impairment loss related to goodwill would usually be deemed to be a reversal of a

temporary difference on initial recognition for which deferred tax should not be provided.
1
To this end, it seems most appropriate to use 25.75% tax rate. Although goodwill is not
amortised, which may sometimes imply recovery through sale, this is overcome by virtue
of the fact that the inherent benefits represented by goodwill are, practically, recovered in
the CGU carrying out its operations (use). 2
Hence deferred tax on the impairment is raised at the appropriate tax rate (see para 21B).
1

This instance however is different. At initial recognition of the goodwill, the tax base
equalled the carrying amount due to the fact that full allowances are granted on the cost
of goodwill over 20 years. Therefore, any impairment raised related to goodwill is not a
reversal of a temporary difference on initial recognition and should attract deferred tax at
an appropriate tax rate (see para 21B). 2
In the event of a decision to classify the Division as held for sale, deferred tax would need
to be raised at 20% 1
Maximum 5
Solution Part C
Report format (Introduction, address and conclusion with signature) 2

Introduction
We need to account for a transaction in order to achieve a faithful presentation of the
underlying economic reality. In this case, although the Division appears to be classified as
held for sale, it seems that GC retains control over the Divisions and, in essence, that the
sale of the division to ZED is without substance. 2
This is substantiated by the fact that the preference shares have a value equal to the value
of the assets transferred (no goodwill results), an indicator of no change in exposure to
the underlying risk or variability inherent in the respective returns. 2

Does GC retain control over the division ?

In this case, the division's assets and liabilities are effectively ring fenced, with the net
proceeds used to service only the Z-Class preference share capital. 1
For this reason, we would need to assess if GC retains control over the specific assets and
liabilities of the division transferred to ZED, and not ZED in its entirely (IFRS 10, B76-B79)
1
In this instance, it seems that GC effectively retains control over the assets and liabilities of
the Division: 1
The exclusive involvement of GC in the design of the memorandum of understanding
implies that GC would have had the potential to establish power over the specified assets.
In essence, the memorandum of understanding sets up a type of autopilot mechanism
which implies that decisions about relevant activities were only needed at the inception of
the arrangement and made mainly by GC (IFRS 10, B51-53). 2

In particular, the memorandum of understanding establishes control over the operating

and distribution policies - relevant activities given that the operation is engaged in the
manufacture of motor vehicles. Hence we have a situation where GC has the ability to
direct those activities that would significantly affect the returns of the operation (IFRS 10,
B11 & B18-B19). 2
In addition, changes to the memorandum of incorporation would require the approval of
the preference shareholders. This means that GC has the right to direct relevant activities
at the time that decisions about changes to the status quo of the relevant activities are
made (IFRS 10, B11). 1

Alternatively, one may argue that ZED is, in effect, acting simply as an agent of GC given
that the memorandum of understanding would leave ZED with only limited discretion
concerning the management of the operation (IFRS 10, B58).
1

Although GC is not an ordinary shareholder of ZED, its preference shareholding entitles it

to 100% of the net proceeds from the operation, as the net proceeds are used only to
service the Z-class preference shares, implying an exposure or rights to returns associated
with the operation. 1

Further, that the preference dividends are based on the performance of the operation
implies that the underlying returns are variable. 1
The large exposure to these returns lends further weight to the argument that GC retains
control over the operations in the sense that it has exposure to significant risk and reward
and what is, in essence, residual ownership risk or interest (IFRS 10, B19). 1
It should be remembered that the rights of GC with respect to decisions to classify ZED as
held for sale are largely protective in nature and thus do not affect this assessment (IFRS
10, B26-B28) 1

Based on a collective assessment of the above facts, one would conclude that GC retains
control over the specific assets and liabilities of the division. 1
It may also be argued that the effect of the sale of the Division to ZED is thus tantamount
to a business combination under common control, which is outside the scope of IFRS 3
and IFRS 10, and which lends weight to the initial argument of the sale transaction lacking
commercial substance. 1

Decision to classify as held for sale: Requirements of IFRS 5

The Division would be classified as held for sale if it is recovered principally through sale
rather than use. 1
In light of the fact that the CGU in question is actually not impaired and has a substantially
positive recoverable amount, this may not seem to be the case 1
Considering whether or not the division is available for sale in its immediate condition and
if the sale is highly probable:
The Board seems committed to the plan to sell the asset. Although this may not be the
case if appraised of the revised value in use 2
A program to locate a buyer (ZED) seems to have been initiated with a draft proposal
prepared. 1

The net assets are to be transferred at fair value. 1

It is not clear if the sale will occur within one week. For example: the plan is only a draft
one; the consensus of the shareholders has not been obtained; it is not clear if the board
has been appraised of the revised recoverable amount. 2
For this reason, we cannot say that the plan would be approved 'as is' and not withdrawn
entirely or materially modified 1
Hence we cannot classify the division as held for sale 1
Even if the requirements to classify the Division as held for sale were otherwise met, the
sale of the Division to ZED is without substance given that GC retains control over the
division. 1
This conclusion is substantiated by the fact that the intention behind the sale of the
division to GC seems to be an effort to 'quarantine' the losses of the division. 1
For this reason, it would also not be appropriate to classify the arrangement as a lease in
terms of IFRIC 4 (SIC 27) as exposure to underlying risk and reward is virtually the same
both before and after the transaction. 1
Instead, it may be best to continue to account for the assets and liabilities of the division
in their own right and for any consideration received from ZED as a source of financing. 1

Classification of the assets as held for sale may thus amount to a departure from the
requirement to achieve fair presentation. It may be indicative of efforts to deliberately
misstate the earnings and net asset value of CG. 1
Such would call into question both the integrity and competency of the accounting staff;
the nature of the leadership function at GC and the commitment to sound corporate
governance in general. 1
A material departure from the requirements of IFRS could also lead to a departure from
the Companies Act, allegations of Fraud and sanctions imposed by ICAZ given that one of
the proponents of the plan of action is a CA(Z) 1

Other valid points 1

Students may go into detail on the ethics or risk inherent in making a decision based on an
incorrect value in use calculation. They may also ask why it is that two chartered
accountants would have made such blatant errors and pose the question of financial
misstatement/fraud. Marks to be awarded on an impression basis 1
Maximum 20