Impairment Testing Of Goodwill And New Lease Accounting Standards: A Critical Analysis

Methodology of Impairment Testing for Goodwill

Impairment testing of goodwill has been done unless there is an indication of impairment and the carrying value of goodwill is done by deducting accumulated impairment. The allocations of goodwill that are acquired are done to the cash generating units for impairment testing. For the reporting date, 2015 Worley parsons limited has conducted an impairment testing of goodwill of amount $ 198.6 million in financial year 2016 and there was recognition of impairment of investment in associates of $ 12.1 million and the total amount of accumulated impairment was recorded at $ 200.2 million (Worleyparsons.com, 2018).

 The determination of impairment is done by assessing recoverable amount of cash generating unit of group that is related to goodwill. Group recognizes impairment loss whenever there is carrying amount of assets is more than their recoverable amount. The calculation of impairment testing is done by using projections of cash flow that is based on financial forecast of how the business will be performing consistently with external data and current and historical experience. Organization is required to make assumptions about any uncertain future events for estimating future cash flows (Worleyparsons.com, 2018). 

The total amount of accumulated impairment in year 2016 is recorded at $ 200.2 million. 

Yes, Worley parsons limited have recorded an impairment expenditure of $ 7.5 million during the financial year 2016 in its associate Cegertec (Worleyparsons.com, 2018).

Organization makes use of key assumptions such as risk weighted pre discount tax rate and growth rate beyond five years that is adjusted for risk in impairment testing for determining value in use. Estimate of value in use is sensitive to long-term growth rate achievement, forecast performance and discount rate. As part of impairment testing, group has performed sensitivity analysis for ensuring that tests that have been carried out are reasonable. An allowance for impairment has been established by the group through, which the estimated incurred loss expenses are represented in respect of trade and other receivables (Worleyparsons.com, 2018).

 Extent and subjectivity of estimates along with judgment involved in collecting information and inputs determines the accuracy of impairment testing. Impairment testing of Worley parsons limited has involved certain degree of subjectivity. However, management of organization has not acted opportunistically in determining resting of impairment.

 Analysis of annual report of Worley parsons limited depicts that process of impairment testing is quiet interesting. The method used for impairment testing by organization is presented in a way that it can be well understood by users. Company uses sensitivity analysis for determining the potential impacts of the risks associated with impairment testing ((Worleyparsons.com, 2018). There is segmented presentation of different concepts of impairment testing presented in the annual report.  

Fair Value Determination of Assets and Liabilities

Users of financial statement of group are able to get new insights in terms of performance of sensitivity analysis forming part of impairment testing. For the entire cash-generating unit, group performance sensitivity analysis on related inputs such as post discount rate, terminal growth rate and cash flow forecasting (Worleyparsons.com, 2018). Whether an organization requires the group determines impairment allowance by making proper judgments.

The determination of fair value of both non-financial liabilities and assets are done as per the disclosure and accounting policies of group. Notes to financial statements makes disclosures about assumptions used in determining fair value of specific assets and liabilities. From the analysis of annual report of the group, it is depicted that measurement of derivative financial instruments are done at fair value. Measurement and recognition of revenue is performed at fair value and group makes the amortization of fair value of rights over the performance period (Miller & Upton, 2014). It has been identified from annual report that the carrying amount of all cash-generating units is less than their combined fair value.

Former accounting standard is associated with several criticisms, as it did not provide users with clear picture of the financial position reporting entity. For similar transactions, there is different accounting due to application of different accounting models. Operating leases are not mandated to be disclosed under the balance sheet under existing standard. Therefore, the actual amount of liabilities of organization might be higher than liabilities represented on balance sheet (Sliwoski, 2017). Moreover, existing standard, there is loss of transparency as users find it difficulties in estimating total liabilities and assets pertaining to leases. Hence, former accounting standard does not reflect economic reality.

Former lease standard requires capital lease to be disclosed in the balance sheet while operating leases are not mandated to be disclosed. It is certainly possible there will be thousands of leased assets and liabilities that an organization might have and they are not disclosed on balance sheet and are not associated with financial metrics. However, total debts reported by organizations are disclosed in the balance sheet but this amount might be less than what are actual liabilities off balance sheets (Asyaeva et al., 2016). Therefore, the off balance sheet liabilities were up to 66 times more than debt reported in the balance sheet.

Controversies on the former lease accounting standard are associated with its complications in creating distinction between financing and operating. Investors using financial statements are not able to make decisions due to transparency and lack of absolute information. Either companies operating within airline industries are buying most of its fleet or they are leasing their most of aircraft fleets. It indicates the fact that financial positions of such companies are different. However, in actual scenario, there is similarity between these airline companies. This is a reason why there was no level playing field between airline companies. Issue of no level playing field between companies will be solved with the new lease standard (Brouwer et al., 2017).

Controversies Surrounding Old Lease Accounting Standards

New leasing standard that have been introduced is also subjected to several criticisms in relation to its costs and complexities of organizations. New standard is likely to make lessees’ balance sheet profile more leveraged and this will come with the consequence of increasing cost of borrowing by lessee. Organizations adapting to this standard will have increased cost of their reporting and complexities relating to small assets concerning lease. Moreover, management needs to have adequate information and the areas where they will have impact; hence, knowledge adequacy is the prerequisite of adopting lease standard. It might be required to make some alteration in their financial metrics and accounting process (Wong & Joshi, 2015). Some of the lenders makes an estimate about leased assets and liabilities, therefore, bringing on balance sheet is not regarded as apt.

The financial state of affairs of organizations will be reflected truly with the adoption of this new lease standard. Credit risks of lessee will be informed truly and this will help lenders in getting detailed information. Pricing risk of lenders will be better understood new standard will be well prepared for dealing with such standard. Organizations are required to conduct preliminary assessment for determining how accounting process relating to lease will be impacted by the standard. The categorization of lease into lease contract and service contracts is performed by following a detailed guidance incorporated under this standard (Bohusova & Svoboda, 2015). New lease standard will heavily affect the organization having leases. Investors are not required to make any rough estimates about amount of leased liabilities and assets and it will be presented by organization themselves (Dye et al., 2014). Therefore, there will be accuracy of information’s presented in the financial report and will facilitate informed decisions by investors.

References list:

Asyaeva, E. A., Chizhankova, I. V., Bondaletova, N. F., & Makushkin, S. A. (2016). Methods for assessing the credit risk of leasing assets. International Journal of Economics and Financial Issues, 6(1S).

Barone, E., Birt, J., & Moya, S. (2014). Lease accounting: a review of recent literature. Accounting in Europe, 11(1), 35-54.

Bohusova, H., & Svoboda, P. (2015). Possible Amendment to IFRS for SMEs due to New Approach to Operating Lease Reporting in Full IFRS: Effect on Financial Analysis Ratios in Air Cargo Transportation in the Czech Republic.

Bourjade, S., Huc, R., & Muller-Vibes, C. (2017). Leasing and profitability: Empirical evidence from the airline industry. Transportation Research Part A: Policy and Practice, 97, 30-46.

Brouwer, A., Hoogendoorn, M., & Naarding, E. (2015). Will the changes proposed to the conceptual framework’s definitions and recognition criteria provide a better basis for IASB standard setting?. Accounting and Business Research, 45(5), 547-571.

Dye, R. A., Glover, J. C., & Sunder, S. (2014). Financial engineering and the arms race between accounting standard setters and preparers. Accounting Horizons, 29(2), 265-295.

Miller, M. H., & Upton, C. W. (2014). LEASING, BUYING, HND THE COST OF CAPITAL SERVICES. Financial Decision Making Under Uncertainty, 95.

Sandblom, P., & Strandberg, A. (2015). The Value Relevance of the Proposed New Leasing Standard. An event study of the European Stock Markets’ Reaction to the proposed replacement of IAS17.

Sliwoski, L. J. (2017). Understanding the New Lease Accounting Guidance. Journal of Corporate Accounting & Finance, 28(4), 48-52.

Sliwoski, L. J. (2017). Understanding the New Lease Accounting Guidance. Journal of Corporate Accounting & Finance, 28(4), 48-52.

Wong, K., & Joshi, M. (2015). The impact of lease capitalisation on financial statements and key ratios: Evidence from Australia. Australasian Accounting Business & Finance Journal, 9(3), 27.

Worleyparsons.com. (2018).  Retrieved 16 January 2018, from https://www.worleyparsons.com/InvestorRelations/reports/Documents/00_WOR822_2016_Combined.pdf