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.