Identification of a CGU (Impairment Loss Assessment)

Illustration 1

Retail store chain

Background

Store X belongs to a retail store chain M. X makes all its retail purchases through M’s purchasing centre. Pricing, marketing, advertising and human resources policies (except for hiring X’s cashiers and sales staff) are decided by M. M also owns five other stores in the same city as X (although in different neighbourhoods) and 20 other stores in other cities. All stores are managed in the same way as X. X and four other stores were purchased five years ago and goodwill was recognised.

What is the cash-generating unit for X (X’s cash-generating unit)?

Analysis

In identifying X’s cash-generating unit, an entity considers whether, for example:

(a) internal management reporting is organised to measure performance on a store-by­store basis; and

(b) the business is run on a store-by-store profit basis or on a region/city basis.

All M’s stores are in different neighbourhoods and probably have different customer bases. So, although X is managed at a corporate level, X generates cash inflows that are largely independent of those of M’s other stores. Therefore, it is likely that X is a cash-generating unit.

If X’s cash-generating unit represents the lowest level within M at which the goodwill is monitored for internal management purposes, M applies to that cash-generating unit the impairment test. If information about the carrying amount of goodwill is not available and monitored for internal management purposes at the level of X’s cash-generating unit, M applies to that cash-generating unit the impairment test.

Illustration 2

Plant for an intermediate step in a production process

Background

A significant raw material used for plant Y’s final production is an intermediate product bought from plant X of the same entity. X’s products are sold to Y at a transfer price that passes all margins to X. Eighty per cent of Y’s final production is sold to customers outside of the entity.

60% of X’s final production is sold to Y and the remaining 40 per cent is sold to customers outside of the entity.

For each of the following cases, what are the cash-generating units for X and Y?

Case 1: X could sell the products it sells to Y in an active market. Internal transfer prices are higher than market prices.

Case 2: There is no active market for the products X sells to Y.

Analysis

Case 1

X could sell its products in an active market and, so, generate cash inflows that would be largely independent of the cash inflows from Y. Therefore, it is likely that X is a separate cash-generating unit, although part of its production is used by Y.

It is likely that Y is also a separate cash-generating unit. Y sells 80 per cent of its products to customers outside of the entity. Therefore, its cash inflows can be regarded as largely independent.

Internal transfer prices do not reflect market prices for X’s output. Therefore, in determining value in use of both X and Y, the entity adjusts financial budgets/forecasts to reflect management’s best estimate of future prices that could be achieved in arm’s length transactions for those of X’s products that are used internally.

Case 2

It is likely that the recoverable amount of each plant cannot be assessed independently of the recoverable amount of the other plant because:

(a) the majority of X’s production is used internally and could not be sold in an active market. So, cash inflows of X depend on demand for Y’s products. Therefore, X cannot be considered to generate cash inflows that are largely independent of those of Y.

(b) the two plants are managed together.

As a consequence, it is likely that X and Y together are the smallest group of assets that generates cash inflows that are largely independent

Illustration 3

Single product entity

Entity M produces a single product and owns plants A, B and C. Each plant is located in a different continent. A produces a component that is assembled in either B or C. The combined capacity of B and C is not fully utilised. M’s products are sold worldwide from either B or C. For example, B’s production can be sold in C’s continent if the products can be delivered faster from B than from C. Utilisation levels of B and C depend on the allocation of sales between the two sites.

For each of the following cases, what are the cash-generating units for A, B and C?

Case 1: There is an active market for A’s products.

Case 2: There is no active market for A’s products.

Analysis

Case 1

It is likely that A is a separate cash-generating unit because there is an active market for its products.

Although there is an active market for the products assembled by B and C, cash inflows for B and C depend on the allocation of production across the two sites. It is unlikely that the future cash inflows for B and C can be determined individually. Therefore, it is likely that B and C together are the smallest identifiable group of assets that generates cash inflows that are largely independent.

In determining the value in use of A and B plus C, M adjusts financial budgets/forecasts to reflect its best estimate of future prices that could be achieved in arm’s length transactions for A’s products.

Case 2

It is likely that the recoverable amount of each plant cannot be assessed independently because:

(a) there is no active market for A’s products. Therefore, A’s cash inflows depend on sales of the final product by B and C.

(b) although there is an active market for the products assembled by B and C, cash inflowsfor B and C depend on the allocation of production across the two sites. It is unlikely that the future cash inflows for B and C can be determined individually.

As a consequence, it is likely that A, B and C together (ieM as a whole) are the smallest identifiable group of assets that generates cash inflows that are largely independent.

Illustration 4

Magazine titles

Background

A publisher owns 150 magazine titles of which 70 were purchased and 80 were self-created. The price paid for a purchased magazine title is recognised as an intangible asset. The costs of creating magazine titles and maintaining the existing titles are recognised as an expense when incurred. Cash inflows from direct sales and advertising are identifiable for each magazine title. Titles are managed by customer segments. The level of advertising income for a magazine title depends on the range of titles in the customer segment to which the magazine title relates. Management has a policy to abandon old titles before the end of their economic lives and replace them immediately with new titles for the same customer segment.

What is the cash-generating unit for an individual magazine title?

Analysis

It is likely that the recoverable amount of an individual magazine title can be assessed. Even though the level of advertising income for a title is influenced, to a certain extent, by the other titles in the customer segment, cash inflows from direct sales and advertising are identifiable for each title. In addition, although titles are managed by customer segments, decisions to abandon titles are made on an individual title basis.

Therefore, it is likely that individual magazine titles generate cash inflows that are largely independent of each other and that each magazine title is a separate cash-generating unit.

Illustration 5

Building half-rented to others and half-occupied for own use

Background

M is a manufacturing company. It owns a headquarters building that used to be fully occupied for internal use. After down-sizing, half of the building is now used internally and half rented to third parties. The lease agreement with the tenant is for five years.

What is the cash-generating unit of the building?

Analysis

The primary purpose of the building is to serve as a corporate asset, supporting M’s manufacturing activities. Therefore, the building as a whole cannot be considered to generate cash inflows that are largely independent of the cash inflows from the entity as a whole. So, it is likely that the cash-generating unit for the building is M as a whole.

The building is not held as an investment. Therefore, it would not be appropriate to determine the value in use of the building based on projections of future market related rents.

IFRIC 12: Service Concession Arrangements

IFRIC 12 Features of Service Concession Arrangements

The grantor is a public sector entity, including a governmental body, or a private sector entity to which the responsibility for the service has been devolved. • The operator is responsible for at least some of the management of the infrastructure and related services and does not merely act as an agent on behalf of the grantor. • The contract sets the initial prices to be levied by the operator and regulates price revisions over the period of the service arrangement. • The operator is obliged to hand over the infrastructure to the grantor in a specified condition at the end of the period of the arrangement, for little or no incremental consideration irrespective of which party initially financed it.

Included in the scope of the IFRIC may include: • provision of transport services; • construction and operation of waste treatment plants; • provision of public airport services; • construction and maintenance of hospitals; • generation of renewable energy; • production of electricity; and • construction and operation of public transport systems, schools, prisons, etc.

For existence of a public service obligation, the services offered do not have to be made available to all members of the public. Instead, the services need to be available to benefit members of the public. For example, prisons only accommodate those individuals required to be incarcerated by law, and cannot be accessed by members of the public seeking accommodation. However, prisons would still be considered to provide services to the public

The Interpretation applies to public-to-private service concession arrangements if:

(a) the grantor controls or regulates what services the operator must provide with the infrastructure, to whom it must provide them, and at what price; and (b) the grantor controls - through ownership, beneficial entitlement or otherwise - any significant residual interest in the infrastructure at the end of the term of the arrangement

Whether the grantor controls the price is important in evaluating whether the criterion in (a) is satisfied. The application guidance in IFRIC 12 states that “for the purpose of condition [IFRIC 12:5](a), the grantor does not need to have complete control of the price: it is sufficient for the price to be regulated by the grantor, contract or regulator, for example by a capping mechanism.”

If the agreement requires review or approval of pricing by the grantor that would generally be sufficient for the agreement to meet the IFRIC 12:5(a) requirement. Such reviews or approvals of pricing should not be disregarded unless there is sufficient evidence supporting an assertion that a review or approval of pricing is non-substantive.

If an agreement contained a cap but the cap is set such that it would only ever take effect in very remote circumstances then the grantor would not be considered to have control over the price, e.g. stating in the contract that a road toll must not exceed CU1000, when the anticipated toll is CU2.

Such a price capping mechanism would generally be considered non-substantive and the arrangement would be outside the scope of IFRIC 12

Example: Concession with unregulated prices and congestion payment

Company A is granted a concession for the construction and operation of a toll road for 40 years. The price Company A is able to charge users is set by the grantor for years 1-3 of the arrangement. From the fourth year of operation of the toll road, Company A is able to charge users at a price it considers appropriate, based on its own strategy and business perspectives. However, the concession arrangement provides for a mechanism known as a “Congestion Payment” whereby Company A will pay certain amounts to the grantor if there is congestion (i.e., traffic jams) in the use of the complementary public infrastructure (i.e., nearby roads).

The grantor exercises absolute control over the pricing for an insignificant period of time in the context of the service concession arrangement as a whole. The congestion payment mechanism would need to be analysed to determine if it is substantive. If this mechanism is included in the contract solely to avoid excessively high prices, it may not be substantive because the operator has the freedom to charge what it wants within a reasonable range. The only limitation is that the operator cannot charge a price the market would not bear and in doing so create congestion on other roads. If the mechanism is considered non-substantive, the arrangement would fall outside the scope of IFRIC 12

Significant Residual Interests

When considering whether a significant residual interest exists for purposes of determining whether the criterion in IFRIC 12:5(b) is satisfied, the residual value should be estimated as the infrastructure's current value as if it was of the age and condition expected as at the end of the contract. An asset which will only be able to be sold for scrap value is unlikely to have a significant residual value at the end of the contract. Conversely, a building with a 50 year useful life that is only used in a service concession arrangement for 20 years is likely to have a significant residual value at the end of the arrangement. If a building with a significant residual value is retained by the operator, the arrangement would be outside the scope of IFRIC 12.

IFRIC 12 does not address the circumstance in which the grantor provides an indemnification to the operator in respect of the residual value of the assets at the end of the arrangement. When such an indemnification is provided, the facts and circumstances relating to the arrangement will need to be analysed to determine whether the arrangement is within the scope of the Interpretation.

Under the terms of a service concession arrangement, an operator may be required to replace parts of an item of infrastructure, for example the top layer of a road or the roof of a building. In these types of arrangements, the item of infrastructure is considered as a whole for the purpose of determining whether the grantor controls any significant residual interest. Thus, condition IFRIC 12:5(b) would be met for the whole of the infrastructure, including the part that is replaced, if the grantor controls any significant residual interest in the final replacement of that part.

Furthermore, an arrangement where the infrastructure is used for its entire useful life ('whole of life assets') would be within the scope of IFRIC 12 provided condition IFRIC 12:5(a) is met. This is the case irrespective of which party controls any remaining insignificant residual interest.

Infrastructure used in a concession arrangement for its entire useful life

The term of a concession arrangement for the construction and operation of a solar thermal plant is 30 years, which coincides with the estimated useful life of the plant. The fact that the infrastructure is not controlled by the grantor at the end of the concession arrangement does not automatically lead to a conclusion that the concession arrangement is outside the scope of IFRIC 12. When the term of a concession arrangement is equal to the useful life of the infrastructure, the arrangement is within the scope of IFRIC 12, provided that the grantor controls or regulates what services the operator must provide with the infrastructure, to whom it must provide them, and at what price

Indefinite term of the concession arrangement

Certain arrangements allow the operator to renew the license arrangement indefinitely without significant costs. In those cases, a careful analysis of all the facts and circumstances is necessary in order to establish whether, at a point of possible renewal, there will be significant residual interest.

Where there may be significant residual interest in the infrastructure, it is necessary to determine who controls that residual interest. If the terms of the arrangement are such that the grantor controls the residual interest in the infrastructure if the operator chooses not to renew the license, the arrangement would fall within the scope of IFRIC 12. In contrast, if the grantor does not control the significant residual interest in the infrastructure if the operator decides not to renew the arrangement, the arrangement would not meet the criterion in paragraph 5(b) and so would be excluded from the scope of IFRIC 12

Application of IFRIC 12 when residual interest is returned to grantor at fair value

An entity (the operator) has entered into a service concession arrangement in which it will construct a bridge and operate that bridge for 30 years. It cannot sell the bridge to a third party unless the government (the grantor) agrees to the sale. At the end of the arrangement, the grantor is required to repurchase the bridge for its fair value at the end of the term of the arrangement. The bridge has an estimated useful economic life of 50 years. Does the grantor control the residual interest in the infrastructure at the end of the term of the arrangement in accordance with IFRIC 12:5(b)?

Yes. IFRIC 12:5 states, in part, 'This Interpretation applies to public-to-private service concession arrangements if … the grantor controls - through ownership, beneficial entitlement or otherwise - any significant residual interest in the infrastructure at the end of the term of the arrangement.'

IFRIC 12:AG4 states, in part, 'For the purposes of condition (b) [of IFRIC 12:5 outlined above], the grantor's control over any significant residual interest should both restrict the operator's practical ability to sell or pledge the infrastructure and give the grantor a continuing right of use throughout the period of the arrangement.' In this scenario, the operator would not be able readily to sell or pledge the infrastructure even though it may be able to sell or pledge its economic interest in the residual value of the infrastructure.

IFRIC 12 applies a control approach. Accordingly, the grantor has a continuing right of use of the infrastructure asset at the end of the term of the arrangement and therefore controls the use of the bridge throughout its economic life. This is the case even though the grantor has to pay fair value for the asset at the end of the term of the arrangement.

Would the grantor control the residual interest in the infrastructure at the end of the term of the arrangement if the grantor has the option to purchase the bridge (at an amount equal to its fair value) rather than an obligation to repurchase?

Yes. In the circumstances described, the condition in IFRIC 12:5(b) “together identify when the infrastructure ... is controlled by the grantor for the whole of its economic life” is met due to the existence of the purchase option at the end of the term of the arrangement; the grantor has the power to purchase the bridge or to allow the operator to retain it for its continued use and/or disposal.

Due to the existence of the purchase option held by the grantor, the operator is unable readily to sell or pledge the infrastructure even though it may be able to sell or pledge its economic interest in the residual value of the bridge.

IFRS 15: Defining a customer

IFRS 15: Definition of a customer

Put simply, a customer is the party that purchases an entity’s goods or services. In many transactions, a customer is easily identifiable. However, where transactions involve multiple parties, it may be less clear which counterparties are customers of the selling company. For some arrangements, multiple parties could all be considered customers of the seller. However, for other arrangements, only some of the parties involved are considered as customers. Identification of performance obligations in a contract can also have a significant effect on the determination of which party is the entity’s customer.

Example — Identification of a customer

Co X provides internet-based advertising services to companies. As part of those services, X purchases banner-space on various websites from a selection of publishers. For certain contracts, X provides a sophisticated service of matching the ad placement with the pre-identified criteria of the advertising party (i.e., the customer). Additionally, X pre-purchases the banner-space from the publishers before it finds advertisers for that space. Assume that X appropriately concludes it is acting as the principal in these contracts. Accordingly, X identifies that its customer is the advertiser to whom it is providing services.

In other contracts, X simply matches advertisers with the publishers in its portfolio, but does not provide any sophisticated ad-targeting services or purchase the advertising space. Assume that X appropriately concludes it is acting as the agent in these contracts. Therefore, X identifies that its customer is the publisher to whom it is providing services.

Collaborative Arrangements

In several transactions, a counterparty may not always be a ‘customer’ of the entity. Instead, the counterparty may be a collaborator or partner that shares in the risks and benefits of developing a product to be marketed. For example, an arrangement wherein one party is responsible to perform research and development, while another party is responsible for marketing/commercialisation activities would not result into a vendor-customer relationship. Such agreements are common in the pharmaceutical, bio-technology, oil and gas, real estate and health care industries.

However, depending on the facts and circumstances, these arrangements may also contain a vendor-customer relationship component. Such contracts can still be within the scope of IFRS 15, at least partially, if the collaborator or partner meets the definition of a customer for some, or all, aspects of the arrangement.

The parties to such arrangements need to consider all of the facts and circumstances to determine whether a vendor-customer relationship exists that is subject to the standard.

Interaction with other standards

Revenue from transactions or events that do not arise from a contract with a customer is not in the scope of IFRS 15 and should continue to be recognised in accordance with the other standards. Such transactions may include dividends, non-exchange transactions such as donations or contributions and change in the fair value of biological assets and the inventory of broker-traders.

Entities may also enter into transactions that are partially within the scope of IFRS 15 and partially within the scope of other standards, say, revenue transactions with an embedded lease or an embedded derivative. If the other standards specifies how to separate and/or initially measure one or more parts of the contract, then an entity will first apply the separation and/or measurement requirements in those standards. If the other standard does not specify how to separate and/or initially measure one or more parts of the contract, then the entity will apply IFRS 15 to separate and/or initially measure the part (or parts) of the contract