Impairment Testing and Annual Report of PHOTON GROUP LIMITED

The company we selected is PHOTON GROUP LIMITED its name changed to ENERO GROUP in the year 2012. The company is basically involved in the providing integrated communication and marketing services in Australia, US and UK. The company is listed in Australian stock exchange. The company’s major services are advertising, communication planning, events management and direct marketing.

We analysed the annual report of the company of the year 2016 and we found that the company’s assets that has undergone impairment test are goodwill allocated to the CGU and its trade receivables.

The company conducted the impairment test by reviewing the carrying amounts of the Goodwill and trade receivables at each reporting date. This is done to review as if there is any indication of the impairment. If there is any such indication then the recoverable amount of the asset is estimated. As the goodwill and other intangible assets are not amortised over the useful life that is the only reason to do impairment testing on these assets to know as if there is change in the carrying amount of these assets (Annual Report, 2016).

The impairment expenditure recorded by the company is $ 249000. The impairment expenditure is recorded in the income statement by the company.

The assumptions used by the company for the impairment of assets are:

Discount Rate:

The Group’s discount rates are based on the pre-tax weighted average cost of capital (WACC).

Projected Cash Flows:

The projected cash flows are estimated on the basis of the current financial year results adjusted for the expectations of the future trading performance. Projected cash flows can differ from the actual cash flows (Dagwell, Wines & Ambert, 2015).

The growth rate taken by the company is the compounded average growth rate of 2.4% that has been applied to estimate the projected future cash flows of the company or CGU. This growth rate is based on the industry growth rates and historical growth rates.

The CGU’s recoverable amount is based on the value in use which is calculated by using the pre-tax cash flow projections which are based on 2017 financial budget. The cash flows are estimated by using the growth rate of 2.40%. The cash flow projections are based on the gross margins which were expected to be same throughout the year.

The company did the impairment test and recorded the impairment loss in its income statement. At the time of calculating the impairment loss the company contended that if the recoverable amount of CGU will be less than the carrying amount the impairment loss will be first allocated to the goodwill and then to any other asset of the CGU. The impairment loss recognised on the goodwill will be transferred to the income statement directly and not to be reversed in the subsequent financial years.

Assumptions Used in Impairment Testing

The impairment loss recognised on the part of account receivables in previous years was deducted from the amount that needs to be recorded in the balance sheet. The company also reviews the non-financial assets other than goodwill at each reporting date for the purpose of estimating the amount of impairment.

Fair value measurement is the price which we receive when we sale or transfer any asset. Fair value measurement technique is totally market based and the entity based measurements have no role to play in it. The company’s cash forecast are based on the 5 years projected cash flows.

As we see in the present case, the IASB’s chairperson contends that the lease standard that was used before does not present the economic realty. The reason behind this is that in the current accounting standard more than 85% of the leases are operating lease and are not being reported in the balance sheet of the company. During the financial crises it becomes difficult for the industries like retail industries to identify the real liabilities as in the current accounting standard leases are recorded as an off balance sheet item (Maynard, 2017). The companies are free to categorise its leases as operating leases and operating leases are not represented in the balance sheet because of that investors find it difficult to compare and contrast the economic conditions of the separate entities. This lead to faulty presentation of the financial statements of the company which misleads the investors and affect the decision making process. This will affect the concept of true and fair presentation of financial statements. That is the only reason behind the chairpersons’ contention that the former lease standards do not reflect the economic reality of the companies.

In the old standard, the leases which are likely to be in the nature of purchase are recorded as finance lease and finance leases are recorded in the company’s balance sheet. The leases which are not considered as finance lease are recorded as operating lease. Operating lease does not form part of the balance sheet of the company and are recorded as an off balance sheet items (Robinson, Henry, Pirie and Broihahn, 2015). Operating leases forms a part of an off balance sheet item as per the former accounting standard of lease. In this case we found the fact that the lease liabilities which are reported off balance sheet are 66 times more than the reported debt amount. This reason for this big difference is the reporting requirements of the accounting standards. As per the accounting standard companies are not required to present their operating leases in the statement of financial position and this lead to false presentation of the financial position of the company. The information about the leases of the company is not presented in the financial statements of the company that will impact the decisions of the stakeholders and investors of the company. There is also a drawback attached with the non-reporting of the lease liability as theses lease liabilities can be traded in any manner as and when required. The reporting of the lease as an off balance sheet item also helps the company in keeping their debt equity ratio low.

Fair Value Measurement for Asset Evaluation

In the present case, the chairperson of the company argued that the ‘level playing field’ between the airlines companies is not there in respect of their reporting formats. The airlines entities which are following the old lease standard may report the fleet as an operating lease liability the other entities may represent it as finance lease. In the old lease standard the operating lease liability is reported as an off balance sheet item. The competitor companies may be considering the lease of fleet as finance lease as there is no defined criterion for the classification of the lease (Kusano, Sakuma and Tsunogaya, 2015). Finance lease is recorded in the financial statements of the company. The competitor company which takes the fleet on the lease and purchases criterion will consider the lease as finance lease and finance lease is reported in the balance sheet of the company. There are contrary things available in the former accounting standard for the reporting of the lease as the investors who are analysing two companies they will become confused regarding the leased assets as may be some companies are taking finance lease and other are taking operating lease. Some are reporting lease in the financial statements and some are reporting lease as an off balance sheet item. There need to be harmony in the criterion to be followed by the company or the reporting requirements of the standard s to make the presentation of financial statements comparable. That is only reason behind the chairpersons statement that lease standard does not provide same level of comparison between two companies.

The new accounting stand for lease will majorly impact the airline industry, retail and shipping sector as the leased assets are more in these sectors.  The chairperson also contended that the new accounting standard will majorly affect the listed companies and will have low impact on the unlisted companies. The reason behind this may be the reporting requirements between these two segments. International Accounting Standard Board (IASB) has established a new accounting standard for the accounting of leases that is (International Financial Reporting Standard) IFRS 16. This new accounting standard will replace the existing IAS 17 and will be effective from 2019 (Kieso, Weygandt and Warfield, 2010). This new accounting standard will change the reporting requirements of the lease as per this standard the lease will be recorded in the financial statements and further the classification of lease cannot be made in operating and finance lease. The next impact of the new accounting standard will be on the assets and liabilities of the company and this will impact the key financial ratios as the formulas for ratio analysis will be changed after implementing this IFRS 1 (Buchman, Harris and Liu, 2016). The debt equity ratio of the companies may increase after the implementation of the new IFRS.

The implementation of new accounting standard will bring significant changes in the accounting of lease. The companies will be able to present its financial statements in a true and fair manner after the compliance with the new accounting standard. The investors will be better off after the implantation of the new accounting standard as they will be able to make comparisons between the companies without any point of confusion. The evaluation of the financial statements will be accurate and comparable that will ease out the decision making process (Öztürk and Serçemeli, 2016). The new format will be based on the single lease accounting model which will remove the classification of lease as off balance sheet and on balance sheet item. The lease reporting will be in the financial statements of the company as an on balance sheet item which will make the financial statements comparable and present the true and fair view of financial statements. The IFRS 16 will help in the better allocation of the capital and will positively impact the economic growth of the company (You, 2017).

References:

Annual Report, 2016. Enero Group Ltd, Accessed on 03-02-2018, from < https://www.enero.com/shareholder-centre/annual-reports>.

Buchman, T., Harris, P. and Liu, M., 2016. GAAP vs. IFRS Treatment of Leases and the Impact on Financial Ratios.

Dagwell, R., Wines, G. & Ambert, C, 2015. Corporate Accounting in Australia, Pearson Higher education.

Kieso, D.E., Weygandt, J.J. and Warfield, T.D., 2010. Intermediate accounting: IFRS edition (Vol. 2). John Wiley & Sons.

Kusano, M., Sakuma, Y. and Tsunogaya, N., 2015. Economic impacts of capitalization of operating leases: Evidence from Japan. CORPORATE OWNERSHIP & CONTROL, p.838.

Maynard, J., 2017. Financial Accounting, Reporting, and Analysis. Oxford University Press.

Öztürk, M. and Serçemeli, M., 2016. Impact of New Standard” IFRS 16 Leases” on Statement of Financial Position and Key Ratios: A Case Study on an Airline Company in Turkey. Business and Economics Research Journal, 7(4), p.143.

Robinson, T.R., Henry, E., Pirie, W.L. and Broihahn, M.A., 2015. International financial statement analysis. John Wiley & Sons.

You, J., 2017. The Impact of IFRS 16 Lease on Financial Statement of Airline Companies (Doctoral dissertation, Auckland University of Technology).