Below are excerpts from ACRA’s just-released inaugural report on its key findings from reviews of companies’ financial statements. The full 17-page report can be viewed at the ACRA website and below is a case study involving circumstances which quite a few listed companies experience.
|Impairment loss not recognised for a significant or prolonged decline
Given the continuing economic uncertainties and market volatility globally, the quoted prices of some equity investments may have fallen below their acquisition costs for some time.
When faced with a potentially significant or prolonged decline in fair value below cost, directors should critically assess management’s basis for deferring the recognition of impairment loss in the income statement. A decline in line with the overall decline in the relevant markets does not mean that the investment is not impaired.
The impairment loss should not be reversed when the share price subsequently recovers. The decline should also be assessed based on the time period that has passed, and not based on whether the value will recover within the company’s investment horizon.
One listed company did not recognise impairment loss for its listed equity investment in the income statement, even though that investment’s quoted share price slipped more than 30 percent below its acquisition cost for more than three years. Although the quoted share price was trending upwards, the highest share price for the past year remained 37 percent below its acquisition cost.
The Group accounted for its equity interest in another listed company as an available-for-sale investment.
|Decrease in quoted share price below acquisition cost|
|At Sept 2010 (acquisition date)||--|
|At 31 Dec 2010||-7%|
|At 31 Dec 2011||-50%|
|At 31 Dec 2012||-44%|
|At 31 Dec 2013||-38%|
|Highest price between 1 Jan 2013 and 31 Dec 2013||-37%|
The Directors were of the view that the decline in fair value below cost was neither significant nor prolonged. This was because:
(a) there were no quantitative thresholds in the SFRS prescribing the extent when a decline was considered significant and the length of time when a decline was considered prolonged;
(b) given the business model of the investee, the Group required a longer time horizon to evaluate its investment in the investee; and
(c) the Group’s share of the investee’s net assets exceeded its cost of investment.
The Group disclosed that it had made a critical judgement that the decline in fair value below its cost was not significant or prolonged because of the short-term duration of the decline, the magnitude by which the fair value of the investment declined below cost and the positive financial health and short-term business outlook of the investee.
ACRA’s Analysis and Conclusion
The principle-based SFRS would typically not set quantitative thresholds. Therefore, directors should apply their judgement in deciding whether the decline is significant or prolonged. The judgement should be reasonable, able to withstand a third party’s scrutiny, and aligned with market practice.
Based on the Group’s circumstances, the decline in fair value below cost was in excess of 30 percent (i.e. significant). In addition, the decline in fair value below cost had persisted for more than three years (i.e. prolonged). At no time during the past three years had the share price exceeded the acquisition cost.
In fact, the highest share price during the past three years remained 25 percent below cost while the highest share price during the past one year was 37 percent below cost. It was irrelevant whether the Group expected to hold the investment for a longer time horizon, or that it had forecasted a recovery of the value during that investment horizon. The assessment of ‘prolonged’ should be based on the time period that has passed.
The fact that the net assets of the investee exceeded the Group’s cost of investment was also not pertinent given that this assessment must be performed using quoted share prices. Had the decline been considered significant or prolonged, the Group would have recorded an impairment loss, which would reduce its pretax profit in FY2013 by more than 30 percent. It was not sufficient to make only disclosures in this regard. Disclosure does not compensate for wrong accounting. (Technical reference: Paragraph 67 of SFRS 39 Financial Instruments: Recognition and Measurement)
Directors should critically assess management’s basis for the judgement made to ensure that it is not overly aggressive or is an outlier from the market practice. Where the management’s judgement appears to be out of the norm, directors should consider consulting independent parties or obtaining additional accounting advice to ensure that the management’s judgement is sound, able to withstand a third party’s scrutiny and aligned with market practice.