Historical context and recoverable amount
Audit Practice Bulletin 2 of 2010, dated 30 November 2010, follows an excerpt in the July 2010 fourth Practice Monitoring Programme public report. Economic deterioration can reduce asset cash flows and require impairment testing. Goodwill and indefinite-life intangibles require annual testing; other assets may show new impairment indicators. The source defines recoverable amount as the higher of fair value less costs to sell and value in use, using the historical FRS 36 terminology. Management must revisit sales volumes/prices, wages, raw-material costs and macroeconomic, currency, financing and country risks rather than recycle previous forecasts.
Identify the smallest appropriate cash-generating unit
A CGU is the smallest asset group with largely independent cash inflows, considering how management monitors products, operations or locations and makes continuation/disposal decisions. A legal entity is not automatically one CGU. Combining manufacturing and investment activities can let investment income hide impairment in loss-making manufacturing assets. Critically evaluate and document groupings, challenge aggregation at an excessively high level, and consider consistency with FRS 108 operating-segment determination.
Start-up subsidiaries need corroborated assessment
Pre-operating costs and initial losses can reduce a new subsidiary’s net tangible assets below investment cost. Inquiry of management alone is insufficient. Obtain and review operational plans, compare actual progress with those plans, and assess whether the investment is impaired. Also consider impairment of the loss-making subsidiary’s underlying net assets and the consequent effect on consolidated statements. Start-up status does not automatically justify dismissing impairment indicators.
Test underlying assets before relying on net tangible assets
FRS 36.12 requires consideration of external and internal indicators. If net tangible asset value is used as the only screen, justify why other indicators do not require a detailed review. First assess whether the subsidiary’s property, plant and equipment or receivables from loss-making or insolvent fellow subsidiaries need write-downs. Otherwise an overstated net-asset measure can support an incorrect conclusion about impairment of the parent’s investment.
Cash flows rather than an unexplained profit proxy
Value in use reflects future cash from continued use and eventual disposal. The bulletin observed use of profit before tax as an initial proxy and requires the basis to be evaluated and documented, particularly the effect of non-cash items. Its paragraph 15 contains an awkward statement about cash flows not closely approximating profit; that wording should not be treated as a general rule authorising an unrepresentative profit measure. Reconcile the proxy to relevant cash flows and include future capital expenditure necessary to support forecast revenue growth.
Use matching goodwill and ownership comparisons
For a subsidiary identified as a CGU, compare the recoverable amount with the unit’s net assets plus allocated goodwill, not with goodwill alone. The source describes grossing up goodwill for a non-wholly-owned CGU to include the non-controlling interest before comparing the whole unit; its cited Appendix C4 applied from periods beginning 1 July 2009, replacing paragraph 92. Separately, when assessing the parent’s investment in a partly owned subsidiary against investment cost, use discounted subsidiary cash flows corresponding to the parent’s effective equity interest. These are different comparison bases.
Challenge forecasts and apply sensitivity analysis
Check omitted capital expenditure and disposal cash flows, present-value discounting, revenue/profit/terminal growth assumptions, consistency between expense and revenue growth, and the discount rate. Experienced senior auditors should lead the challenge. Ask how market conditions, volume, pricing and costs were incorporated; whether historical margins remain realistic; the headroom in debt covenants; and adjustments for counterparty, credit, liquidity and market risks. Stress-test volume, price and cost changes. The source uses sales declines of 10–15% or more as plausible scenarios during uncertainty, not a compulsory uniform stress percentage.
Experts and consistent current plans
An expert may cross-check value in use by comparing its implied earnings multiples with market multiples for the entity, comparable quoted companies and available comparable transactions. Evaluate and document the expert’s competence and objectivity under revised SSA 620. Use the latest business plan reflecting downturn effects and check agreement with budgets presented to senior management and the board. An expert’s calculation or a management plan is not a substitute for the auditor’s own assessment of assumptions and evidence.
Support discount rates and avoid arbitrary haircuts
Discount future cash to present value and assess rates in light of market risk, government rates, lending rates and cost of capital. An unadjusted borrowing rate may omit asset-specific timing, country, currency or price risks. Document evaluation under FRS 36.55–57. ACRA also rejected an arbitrary unsupported reduction of calculated value in use for general uncertainty: address particular assumptions and stress-test growth, gross margin and discount rate instead of applying an unexplained haircut.
Reversals and the bulletin’s professional status
For assets other than goodwill, FRS 36.114 requires reversal when relevant recoverable-amount estimates change, including the measurement basis, amount/timing of cash flows, discount rates or fair-value-less-selling-cost components. Improved conditions may therefore require reassessing previous losses with the same rigour as initial recognition. Apply paragraphs 117 and 122 when determining asset and CGU reversal amounts. The bulletin supplements standards and inspection criteria; it is not an ACRA rule and does not replace governing professional requirements.
Official source
This article independently explains the substantive contents of the official PDF, including the relevant conditions, procedures and annexes. The linked document remains the authoritative source for its original wording, and later changes should be checked separately.
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