When should impairment be assessed?
Like most non-current assets, consideration of impairment is an important part of holding onto exploration and evaluation assets. Such an asset should be assessed for impairment when- circumstances indicate that the carrying amount of the asset may exceed its recoverable amount.
Exploration assets must be impairment tested in a number of circumstances. These include:
- When the exploration period for which the entity has the right to explore in the area has expired, will expire soon or is not expected to be renewed.
- If expenditure on further exploration in the specific area is neither budgeted or planned.
- If commercially viable quantities have not been discovered and a decision has been made to discontinue further activities.
- If sufficient data exists to indicate the carrying amount of the asset is unlikely to recovered from the sale or development of the area.
Impairment testing must be performed as per AASB 136 Impairment of Assets. The testing is performed based on each area of interest to which an exploration and evaluation asset relates.
How should impairment testing be executed?
Impairment tests should be performed in accordance with AASB 136 Impairment of Assets.
Steps involved are as follows:
Step 1:
Allocate the assets to cash-generating units or groups of cash-generating units (CGUs).
Step 2:
Calculate the recoverable amount of the CGUs The recoverable amount is the higher of the CGU’s fair value less costs of disposal versus its value in use.
Fair value is a reliable estimate of the price at which an orderly transaction to sell the asset would take place between market participants.
Costs of disposal is the incremental costs directly attributable to the disposal of an asset or CGU, excluding finance costs and income tax expense. Example of such costs are legal costs, stamp duty and similar transaction taxes, costs of removing the asset, and the direct incremental costs to bring an asset into condition for its sale.
Value in use is determined by discounted future cash flow expected to derive from the asset.
Step 3:
Compare the recoverable amount to its carrying value (value in the book). Any shortfall will be treated as an impairment expense.
Difficulties in estimating the recoverable amount
There are many difficulties with calculating the recoverable amount for impairment testing. The challenges are different depending on what method of calculation has been used.
Difficulties of fair value less cost of disposal:
- It is not possible to measure fair value less cost of disposal when there is no active market for an identical asset.
- When there is no basis to make a reliable estimate of the price at which an orderly transaction to sell would take place.
Difficulties of value in use:
- Judgement in estimating the future cash flow from an asset.
- Possible variations in the amount or timing of those future cash flows.
- Difficulty in estimating the current market risk-free rate.
No matter the method to determine the recoverable amount, there is a level of professional judgement involved. Due to the unique nature of each exploration and evaluation asset (i.e., tenement), it is very hard to estimate its ‘fair value’ by making comparisons to another identical sold asset. Thus, practically, the recoverable amount is often determined using the ‘value in use’ discounting cash flow method.
For more information, contact your local William Buck Audit and Assurance specialist.
