Impairment of Assets – AS – 28

By Mukesh M.Shah, Ahmedabad

Practising Valuers Association(India)

Continuing Education Programme At FUN POINT RESORTS,AHMEDABAD
Session on Valuation Practice 15th Aug. 2005

Impair – Damage, weaken.
Impairment is a noun of word Impair – meaning weakening phenomenon.

It is a novel & significant concept bringing transparency in large size limited companies – having annual turnover more than 50 crores.

 


The Indian Context :

The Impairment Standard is likely to create ripples and cause a deep and significant impact on the Indian industry. The real worth of many inefficient Indian enterprises is likely to be exposed by the standard.

The view that the standard is likely to have a significant impact on Indian enterprises is based on historical considerations. The ongoing recession. The inefficiencies in Indian enterprises caused by a highly protective economic policy in the past, bad labour laws, lack of incentives for M & A activities, unfavourable indirect tax structure, server decline in property prices in the latter half of the last decade, are condition that may result in server impairment of assets of Indian enterprises. Even mis – use of accounting practices such as charging low depreciation or huge capitalization of pre – operative expenses and interest incurred during the construction period, not compensated by future cash flows would render enterprise’s assets impaired.


An Indian shareholder would stick to his investment even if their market prices are on the decline, on the belief that some day the price would go up. A more sensible thing would be to sell the share, cut losses and make a profitable investment in some other share. An Indian entrepreneur like any other Indian shareholder or citizen is very emotionally attached to his business and assets, and would be very reluctant to dispose it off even if it is loss making. These Indian attitudes would mean that Impairment standards when applied to Indian enterprises may result in significant impairment provisions. The Impairment standard in India may force Indian entrepreneurs to think and act more objectively and run enterprises more efficiently or sell them to those who can run them more efficiently. Hopefully the Standard will encourage more M & A activity. That in my view would be a true success of the Impairment standard.

As already mentioned above, the Impairment Standard may cause a deep impact against the Indian psyche of retaining assets that are not profitable. There will be a lot more questions now at the AGMs relating to non – performing assets or businesses. It is understandable that the first reaction of the Indian industry will be that of resentment. However, the Indian industry should by now be aware that concealing impaired assets/businesses does not solve the problem, in fact it will only aggravate it. Shareholders who are the owners of the company need to know the reasons as to why the company intends to continue with an impaired asset/business.

Some management may argue that by disclosing impaired assets/businesses too soon, the opportunity of turning them around may be lost due to pressure from shareholders to dispose them off. However, in my view disclosure to shareholders is very important and that is the price one has to pay for being a significant or publicly held company. Further, if management is strongly convinced that they can turn around an impaired business/asset, then they should be able to convince the shareholders too.

A large number of companies that built capacities in excess of current requirement will be negatively impacted by the Standard, for example, the steel industry, fiber glass, textiles etc. These are generally capital – intensive companies. The standard is unlikely to have any significant impact on service companies, because most of them do not hold any significant assets. The standard would also adversely hit bad companies in an otherwise good sector, for example, a traditional engineering company with little value add, with huge facilities, high wage bill is a case for impairment. Conversely, a good company in a bad sector should not be negatively impacted. An old capital intensive company without significant carrying values attached to its assets, will not be significantly affected by the Standard.

Impairment losses will be normal expenses, therefore it will have impact like any other P & L item on distributable profits for dividend declaration, limits under Companies Acceptance of Deposits Rules, determination of sickness for BIFR purpose, EPS, eligibility to make investments, determination of profits for managerial remuneration, etc. Impairment losses and their reversals are exceptional items but not extra – ordinary items.