Let’s return to the following fact pattern recently discussed by CPA Canada’s IFRS Discussion Group:
- Entity X recognizes a (right of use) asset for a building that it currently occupies as office space. The entity has occupied the building for seven years and has three years remaining on its original 10-year lease.
- Historically, this ROU asset has been tested for impairment as part of CGU 1 within Entity X since it was used by CGU 1 and did not generate largely independent cash inflows.
- During the COVID-19 pandemic, the office space is largely vacant as many employees are working from home. As a result, immediately prior to Entity X’s year end of December 31, 2020, the entity’s board, in conjunction with its management, made a final decision to permanently cease using this office space and has informed the affected staff. Entity X has the ability and expectation to be able to sublease the ROU asset after vacating the property for the remainder of the lease, but the lease for the ROU asset contains certain restrictions and limitations on the ability to sublease the space to a third party
- To facilitate the transition to other existing office spaces, Entity X will vacate the property two months after the final decision date. In accordance with paragraph 51 of IAS 16, Entity X reconsiders the ROU asset’s useful life and residual value and changes its deprecation period prospectively to depreciate the remaining ROU asset’s carrying value to nil over the remaining two-month period for which the space will continue to be used by CGU 1.
- Entity X considers its decision to cease use is an impairment indicator for the ROU asset on December 31, 2020, as it is considered an internal indicator of impairment under paragraph 12(f) of IAS 36.
- Assume that the recoverable amount of CGU 1 significantly exceeds its carrying amount and as such, no impairment is identified at the level of CGU 1.
As we covered previously, most group members thought the asset should be tested for impairment individually rather than as part of CGU 1. The group agreed that the restrictions and limitations on the sublease ability would be reflected in the impairment testing of the ROU asset, and specifically in measuring its fair value less costs of disposal, recalling that the fair value for a non-financial asset takes into account a market participant’s ability to generate economic benefits by using the asset in its highest and best use or by selling it to another market participant that would use the asset in its highest and best use. In practice this may involve some judgment as entities may be in the ongoing process of renegotiating such lease restrictions with their landlords – one group member thought it may be more workable to determine the fair value based on the contractual terms, and then consider from a market participant’s perspective whether the restrictions will be removed and how that would affect the assessment of fair value.
Of course, as with most fact patterns discussed by the group, small changes in the scenario might affect the conclusions reached. In this case, the group noted various factors that might make it more or less apparent whether the ROU asset should indeed be tested for impairment individually, such as:
- plans for ceasing use of the ROU asset have been finalized and the entity is committed to vacating the property (for example, it has announced its decision to the affected parties) versus expecting to vacate, but not yet committed to vacate the property;
- the period of use for the ROU asset by CGU 1 is more extended, rather than relatively short;
- the ROU asset is significant to the cash inflow generation of CGU 1;
- the period of any sublease relative to the period of use by Entity X before the property is vacated;
- the likelihood of subleasing the space (e.g. whether a signed sublease exists, rather than merely general expectations of market interest in the property, whether the entity has engaged real estate brokers to market the ROU asset for sublease, communicated to the landlord its the decision to cease own use and to sublease, and told employees about ceasing the use of the office space – these kinds of activities help to establish that the decision to cease using the space is substantive).
The final note, as it often is, was to emphasize the importance of an entity taking into consideration all relevant facts and circumstances and assessing the issue “holistically…in light of the current economic environment.” Of course, the pandemic has injected an extra dose of volatility and anxiety into some long-standing areas of accounting, and it’s appropriate that key areas of judgment be reexamined in that light. But more important in the long run, once covid-19 is over, is that the newly “holistic” mindset be maintained in grappling with the grey areas that will continue to exist, even if we don’t yet know what those might be…
The opinions expressed are solely those of the author