IFRS 16 And IAS 36: The impairment test of the use rights

The IFRS 16 first year of life has just ended and the first financial balances that incorporate the new assets produced by the application of this accounting principle, “the rights of use”, are in closure phase.

Therefore, the assessment of the recoverability of the value of these balance activities pursuant to the IAS 36 is the matter of these days. In fact, the right of use is normally inscribed in the balance sheet in the depreciated historic cost and this requests the necessity to periodically control, pursuant to the IAS 36, the recoverability of the activities object of detection as right of use.

It means that, in presence of impairment indicators, as they are defined by the IAS 36, every entity has to value if the accounting value to which Is inscribed the right of use is superior or not to the recoverable value (i.e. the highest between the value of use and the market value). Whether the accounting value is higher than the recoverable one, it would be necessary to evaluate the asset.

As far as the right of use is concerned, it is necessary to report that it is indissolubly linked to the passivity per leasing.  Such liability lease is qualifiable as a financial passivity, as can be deduced by the IFRS 16 dispositions that forecasts the classification of the relative reimbursements of the cash flows from financing activities pursuant to the dispositions of the paragraph 50.a) of the IAS 36 depending on which the relative cash flows must be excluded from the calculation of the value of use as are all the cash flows connected with the financial passivities. Therefore, in the calculation of the value of use, must be excluded the rent fees because they constitute the reimbursement of the financial passivity that must be excluded in the determination of the value of use.

As said above, if on one side the IFRS 16 in paragraph 33 explicitly establishes that the lessee must apply the dispositions of the IAS 36 to verify the recoverability of the detected right of use, on the other side, must be considered the undoubted peculiarities of the right of use that is not only an active contract tightly connected to its passivity per leasing, but that is not even able to produce autonomous cash flows.

It follows that because of the missed generation of autonomous cash flows, the right of use under analyzation must be aggregated to other units generators of cash flows, i.e. it must be configured as a “corporate asset” which recoverable value is connected to the totality of the cash generating units (CGU) that constitute the enterprise.

Such aggregation must occur depending on the capacities of the entity to attribute with a reasonable criterion the right of use to the smallest CGU to which can be aggregated the right of use.

For instance, if a company has rent a building in which are located its three operative divisions, if the company would be able to attribute with a reasonable criterion (for instance surfaces occupied at the condition that they will remain stable over time, that is not easy) to every division the right of use, it follows that the impairment test will be done at the level of single division, i.e. of single CGU.

Instead, whether this criterion does not subsist (something probable whether the surfaces are governed centrally and not by the single directions) then the reference CGU corresponds to the entity in its totality and therefore the impairment at test must be done at level of total entity.

In synthesis, the impairment mechanic determines the comparison between the accounting value (net book value) of the CGU comprehensive of the right of use inscription value with the cash flow actualized produced by the CGU without considering the disbursements forecast for the payment of the leasing fees.

Obviously, in this prospective, also the actualization rate to be adopted for the definition of the value of use must be coherently determined considering the effects coming from the adoption of the IFRS 16; particularly in a model of definition of the discount rate based on the weighted average cost of the capital (Weighted Average cost of capital-WACC) such effects take substance in an increase of the leverage that leads, on one side, to the increase of the “weight” of the component cost of the debt (generally less expensive than the equity one), and on the other side to  the increase of the  levered beta with consequent increase of the equity component’s cost. The combined effect is not easily predictable, therefore the increase of the leverage connected with the application of the IFRS 16 does not necessarily leads (as at first sight we could expect) to a reduction of a weighted medium cost of the capital.

At last a nod to the market value, to be used in the calculation of the recoverable value –whether higher – in alternative to the value of use. A possible way to evaluate it could be to estimate  – even with an adapt survey of a real estate advisor, that will necessarily state a market fee included in a reference range – the rent fee market value on the impairment test carrying out date (i.e. the balance sheet closure date) for a contract comparable with the one that has produced the right of use inscribed in the balance sheet. On the base of such fee should be determined the right of use expressed at market value to be compared with the accounting value. It must be said that such market value – on the base of the mentioned survey – will be expressed in a range, so that it would seem to be hazarded to limit us to compare the range medium value with the accounting value while, if the accounting value would be within the range, (even under its medium value) there may not be the conditions for a devaluation.

So the IFRS 16 has introduced a lot of news, with pervasive effects in the companies’ balance sheets, such as the verification of the recoverable value pursuant to the IAS 36. The balance sheets at the end of the 2019 represent the first proof of the coexistence of the IFRS 16 with the IAS 36.

Mr. Mario Vinzia


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