Implication of Bangkok's floods to Company's financials

Earlier on, Thailand Finance Minister commented that the devastating floods in Bangkok could lower Thailand's Gross Domestic Products. The floods have caused damage to equipment in the flooded industril plant.

Your audit client may have a plants / factories located in the areas affected by the massive flood. In this instance, a proper check need to be performed to assess if the audit client's plants / factories are affected.

Assuming that the plants / factories are affected by the flood, the following procedures need to be performed, including (but not limited to):

- are the machineries and equipments been damaged in the flood. Should impairment been recorded given that the machineries and equipments are damaged?
- are there any going concern issue, given that the operations are likely to be stop?
- is your audit client able to produce financials on time for reporting?
- is there any penalty on contracts with customer if audit client is not able to deliver agreed items on time?
- is your audit client able to collect outstanding debts from customers who maybe affected as well?


A thorough understanding of the floods, and how will that affect the operations are required to determine the nature and extent of audit procedures to tackle the impact of floods.

#78 Goodwill written off

Company A acquired Company B in 2006. Net asset of Company B amounted to S$3mil, while Company A acquired the Company B with a purchase consideration of S$4mil. Management explained that the S$1mil excess ( which was subsequently considered as goodwill) is attributable to the goodwill paid to shareholder of Company B for existing customer base of Company B in computer hardware industry.

Year-over-year, Company B has shifted its focus to computer software industry. For the year ended 31 Dec 2008, Company B's ( which is a subsidiary of Company A) earning is at break-even stage. It has no more businesses in computer software, neither nor Company A.

What has happened to the goodwill Company A previously paid for ? Should it be written off even if Company B is not in loss-making position?

#74 Accounting entries to record impairment

Previously, we discussed about the objective of IAS 36- Impairment of Assets and all other related topics. We will proceed further on the accounting entries of impairment. Generally, upon recognition of impairment, the following entries should be passed:

Dr. Impairment Loss (Profit & Loss)
Cr. Provision for Dimunition in Value (Balance Sheet)

Provision for Dimunition in Value is a contra account to the existing asset account. For instance, the contra account of Stocks, in this case, is Provision for Stocks Obsolescence. The Provision for Dimunition in Value has properly disclosed the impact of impairment on the existing asset, that could be useful to financial statement users.

#70- Objective of IAS 36- Impairment of Assets

The objective of IAS 36 is to ensure that the Company's assets are carried at no more than their recoverable amount. An asset is carried at more than its recoverable amount if its carrying amount exceeds the amounts to be recovered through use or sales of the asset. If the carrying amount > recoverable amount, the asset have to be impaired.

IAS 36 is considered extremely for financial statement users. Let's illustrate a scenario where no Company does not apply IAS 36 appropriately.

Company ABC have recorded a few machineries in its accounting books for the year ended 31 Dec 2008. However, due to excessive usage of the machineries & improper maintenance, the machineries are at the end of its life cycle with approximately nil value. Company ABC is going to scrap off the machineries in one month time. However, in the book, the Machineries have a net book value of US$1million.

A few investors are in the process of taking over Company ABC. While reviewing the Company ABC's financial statement, they are more than happy to find out that the Company has US$1million worth of machineries on hand. As such, they are willing to pay another US$1million on top of the initial offer price!

If IAS 36 has been applied appropriately, the Company should have impaired the Machineries to its recoverable amount. Investors would not have paid another US$1mil for the end-of-life machineries. Hence, it is important to carry out proper impairment testing for significant assets on the Company's books.

#65 Impairment Testing

Auditing & Accounting experts foreseen that impairment testing on intangible assets, fixed assets, investments, assets, etc has to be assessed crtically in a detailed basis in the coming year, subsequent to the credit crunch.

The recession has driven the stock prices down, the value of the intangible assets sank accordingly. The recession acts as a trigerring points for the impairment testing.

Hence, the auditors should highlight to the clients that the impairment testings have to be performed earlier ( rather than sometimes near the audit), as the impairment testings required a lot of times. Rigid assessment by auditors are required, given the fact that financial statements users will be using the financial statements more cautiously.

#54 Credit Crunch- Implication of Impairment on Machinery

The economy is slowing down and hit heavily by the current credit crunch crisis. What would be the implication on our auditing?

Based on the prevailing research and information, manufacturing sector is likely to be affected severely. For instance, there might be cancelled sales orders. This would leave some of the machines or fixed assets of the Company become idle. Utilisation rate of the machinery is likely to drop tremendously.

The lower utilisation rate has implication on impairment of machinery, given that some of the machineries will be idle and not involved in generating cash flow to the Company. Non-cash generating unit is an indication on impairment. Because, return on asset ( i.e. machinery) is almost nil in idle condition.

#49- Impairment on Property

We received the following query from our reader:

".. other than an independent valuation, what other alternative method can we use to test for impairment on property.."

Before we proceed to answer the following question, let's assume that the property above relates to building, land or any other commercial related building employed by the Company in the course of doing ordinary busines..

To answer your question, if the property is involved in the ordinary course of business ( e.g. shophouse where a business do its trading), then the alternative method includes:
1) Discounted Cash Flow Analysis
2) Profitability forecast for the next 5 years
3) Obtained market price of the similar property in the area nearby

To elaborate on point 1 and 2 above, if the business is able to generate sufficient cash flow and be in profit position. The auditor can conclude that there is no indcation of impairment on the property. As the asset employed is sufficient to sustain the business operations of the Company, and hence no impairment.

Besides that, the auditor could obtained the last transation price of the similar property in nearby area to compare the market price to book value of the property, in order to assess the existence of indication of impairment.