Gyamfi Ltd (Gyamfi) is an international company with a presence in Ghana providing spare parts for the automotive industry. It operates in many different jurisdictions with different currencies. During 2020, Gyamfi experienced financial difficulties partly due to the COVID- 19 pandemic marked by a decline in revenue, a reorganisation and restructuring of the business and as a result reported a loss for the year. An impairment test of goodwill was performed, but no impairment was recognised. Gyamfi applied one discount rate for all cash flows for all cash-generating units (CGUs), regardless of the currency in which the cash flows would be generated. The discount rate used was the weighted average cost of capital (WACC), and Gyamfi used the 10-year government bond rate at its jurisdiction as the risk-free rate in this calculation.
Furthermore, Gyamfi built its model using a forecast denominated in the parent company’s functional currency. Gyamfi felt that any other approach would require a level of detail that was unrealistic and impracticable. Gyamfi argued that the different CGUs represented different risk profiles in the short term. Still, there was no basis for claiming that their risk profiles were different over a longer business cycle.
Gyamfi has tested for the impairment of its non-current assets. It was decided that a building located overseas was impaired due to flooding in the area. The building was acquired on 1 April 2020 at 25 million dinars when the exchange rate was 2 dinars to the Ghana Cedi. The building is carried at cost. On 31 March 2021, the building’s recoverable amount was deemed 17·5 million dinars. The exchange rate at 31 March 2021 was 2·5 dinars to the Ghana Cedi. Buildings are depreciated over 25 years. The tax base and carrying amounts of the non-current assets before the impairment write-down were identical. The impairment of the non-current assets is not allowable for tax purposes. Gyamfi has not made any impairment or deferred tax adjustment for the above. Gyamfi expects to make profits for the foreseeable future and assume the tax rate is 25%. No other deferred tax effects must be taken into account other than on the above non-current assets.
Required:
i) Evaluate the acceptability of the above accounting practices under IAS 36: Impairment of Assets. (6 marks)
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- The discount rate used by Gyamfi Ltd has not been calculated in accordance with the requirements of IAS 36 Impairment of Assets. According to IAS 36, the future cash flows are estimated in the currency in which they will be generated and then discounted using a discount rate appropriate for that currency. IAS 36 requires the present value to be translated using the spot exchange rate at the date of the value in use calculation.
- Furthermore, the currency in which the estimated cash flows are denominated affects many of the inputs to the WACC calculation, including the risk-free interest rate.
Gyamfi Ltd has used the 10-year government bond rate for its jurisdiction as the risk-free rate in the calculation of the discount rate. As government bond rates differ between countries due to different expectations about future inflation, value in use could be calculated incorrectly due to the disparity between the expected inflation reflected in the estimated cash flows and the risk-free rate. - According to IAS 36, the discount rate should reflect the risks specific to the asset. Accordingly, one discount rate for all the CGUs does not represent the risk profile of each CGU. The discount rate generally should be determined using the WACC of the CGU or of the company of which the CGU is currently part. Using a company’s WACC for all CGUs is appropriate only if the specific risks associated with the specific CGUs do not diverge materially from the remainder of the group. In the case of Gyamfi Ltd, this is not apparent.
(Three points well explained @ 2 marks each = 6 marks)
ii) Recommend the accounting treatment of the above transaction to the directors of Gyamfi for the year ended 31 March 2021, including financial statements extracts in accordance with relevant International Financial Reporting Standards. (5 marks)
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A number of IASs are required to answer this question, which include the knowledge of IAS 16, IAS 36, IAS 12 and IAS 21
- Carrying amount of building at 31 March 2021 GH¢ (25 – 1 depreciation) million, i.e. 24 million dinars/2 = GH¢12 million. (0.5 mark)
- Recoverable amount of building at 31 March 2021 (17.5 million dinars/2.5 ) = GH¢7 million. (0.5 mark)
- Impairment loss to profit or loss = GH¢5 million (GH¢12 million – GH¢7 million) (0.5 mark)
- The tax base and carrying amount of the non-current assets are the same before the impairment charge. After the impairment charge, there will be a difference of GH¢ 5 million. This will create a deferred tax asset of GH¢5 million x 25%, = GH¢1·25 million.
As Gyamfi Ltd expects to make profits for the foreseeable future, this can be recognised in the financial statements. (1.5 marks)
Statement of profit or loss for the year ended 31/3/2021 extract
. GH¢ million
Impairment of building (5)
Depreciation of building (25 dinnars/25 yrs = 1dinnar/2 (0.5)
. (1 mark)
Statement of financial position extracts as at 31/3/2021
Non-current assets:
Deferred tax assets 1.25
Building (12 – 5) 7
. (1 mark)