Identifying Cash-Generating Units By Audit Firm In Dubai Per IAS 36

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IDENTIFYING CASH-GENERATING UNITS BY AUDIT FIRM IN DUBAI PER IAS 36

 This article describes how to identify cash-generating units (CGUs). We cover how audit firms in Dubai &

UAE assign assets and assign goodwill. An impairment review’s results can be significantly affected by identifying CGUs. However, identifying CGUs requires judgment. It is also possible that the CGUs determined by an entity may change as its operations change, or the way it conducts them may change.  In an impairment review, the CGU has two primary responsibilities. They include: •

The amount recoverable for assets that cannot be determined individually

•

Corporate acquisitions and goodwill are assessed for impairment

 Dubai company audit professionals perform impairment testing on goodwill and corporate assets. They

must allocate to a CGU or group of CGUs.

OPERATIONS OVER LEGAL STRUCTURES 

To identify CGUs, financial audit experts need to identify the smallest identifiable group of assets that generates independent mainly cash flows. Identifying CGUs at the lowest level is crucial to minimize the likelihood of masking impairments of specific assets or groups by high-performing assets. An entity in Dubai & UAE identifies a CGU by asking two questions:

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How independent are the cash flows from a group of assets?

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Is the output being sold on the market?

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Are there independent cash inflows from a group of assets?

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Identifying CGUs is as simple as separating the entity into distinct parts. A CGU gets its definition from cash inflows, so the division process should primarily focus on an entity’s sources of revenue and how assets are employed to generate its revenue. It will be necessary for management to consider how it monitors the entity’s operation through audit services (such as product line, business, location, district, or region) or how it makes decisions about continuing or disposing of its assets and operations.

OPERATIONS OVER LEGAL STRUCTURES

 In some cases, a Dubai entity’s management and design may not match its legal structure. The CGU

might be an entity like a company, division, product line, geography, or physical location such as a hotel or retail store. This section explains how the lowest aggregation of assets generates independent cash inflows in different circumstances.

CGU IDENTIFICATION: LOWEST LEVEL OF LARGELY INDEPENDENT CASH FLOWS  Under a contract with a municipality, a bus company in Dubai provides services on five different routes

with minimum service requirements. Cash flows can be identified separately from assets devoted to each route. An unprofitable route is determined.

AN EXAMPLE OF IDENTIFYING THE CGU IS A CHAIN OF SUPERMARKETS 

Entity A owns and operates ten supermarkets in a major city (City B), each located in a different suburb. The supermarkets in City B purchase their inventory from Entity A’s purchasing center. Entity A decides on prices, marketing, advertising, and human resource policies (except for hiring local staff at each supermarket). Also, entity A is responsible for 50 supermarkets located in other major cities across the country.

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Is a CGU permitted to combine more than one store location? This question was given to the IFRS Interpretations Committee (IFRIC). In addition to shared infrastructures, marketing and pricing policies, and human resources.

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According to the IFRIC, IAS 36 identifies CGUs primarily based on independent cash inflows rather than independent net cash flows, meaning outflows such as shared infrastructure and marketing costs are not considered. The IFRIC decided not to take this item on the agenda in March 2007, stating that it would be more of application guidance than additional guidance beyond that given already in IAS 36 on cash inflows being primarily independent.

DOES THE OUTPUT HAVE AN ACTIVE MARKET?  Management and their audit team need to consider if an active market is available for an output when it

has identified a group of assets that produce an outcome but do not generate largely independent cash inflows.  Suppose the Dubai entity can sell an asset (or group of assets) on an active market. In that case, the asset

(or group of assets) represents a CGU even if other entity units use one or more parts of the output.

Generally speaking, the cash inflows of an asset would be largely independent of cash inflows from other assets.

PRACTICAL INSIGHT: BUSINESSES THAT ARE VERTICALLY INTEGRATED AND A MARKET FOR THEIR PRODUCTS  Vertically integrated businesses often have this problem. Some assets do not generate independently

generated cash flows because their output is used internally rather than sold externally. Suppose the Dubai entity can sell the output on an active market. In that case, an asset (or group of assets) forms a separate CGU even if other Dubai entity units use part of or all of the output.  The Fair Value Measurement requirement in IFRS 13 defines an active market in which transactions occur

sufficiently frequently and in sufficient volume to provide pricing information on an ongoing basis.

Commodities like oil and gold can be considered active markets.

IDENTIFYING THE CGU FOR THE OUTPUT – IDENTIFYING AN ACTIVE MARKET 

Enterprise X manufactures only one product in Dubai (widgets) and has three production facilities. These plants are in different geographical regions. A widget component is produced at plant one and then assembled in either plant two or plant three before being sold worldwide from either plant. There is no additional capacity in either plant.

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Availability depends on how orders are shared between two locations for order fulfillment:

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The component of plant 1 has an active market.

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There is no active market for plant 1’s component in scenario 2.

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In estimating an entity’s cash inflows via an asset or CGU where internal transfer pricing would be applicable, a financial audit best estimates of future prices that could be achieved through a deal at arm’s length is used:

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Value in use (VIU) is determined using future cash inflows.

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ViU is determined by using the cash outflows that will occur in the future for any other assets or CGUs that will be affected by internal transfer pricing.

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Unless the group of assets generates substantially independent cash inflows and there are active markets for its output, the group is not a CGU. To identify the CGU, the Dubai internal auditors must combine these assets with others contributing to the same revenue stream.

UNITS WITH CASH-GENERATING POTENTIAL THAT HAVE CHANGED

 If necessary, CGUs for the same asset or asset type are consistently identified from period to period.

Dubai companies should disclose additional information if a change in CGUs is justified

CHANGING THE STRUCTURE OF THE CGU BASED ON CERTAIN TRIGGERS  A change in CGUs would not be justified by the examples provided by IAS 36. In general, such a change

would only be appropriate if the entity’s operations have changed – for example, by engaging in different revenue-generating activities or utilizing assets differently. The typical reasons for a change might be as follows: •

Combinations and divestitures of businesses

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Organizational restructuring

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Product or service introductions or withdrawals.

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Exit from or entry into new markets.

CHANGING STRUCTURE OF CGU OVER TIME

 It is not always driven by one specific event that justifies a change in CGU structure. The Dubai firm might

start allocating orders to its different production facilities or use assets more efficiently to generate revenue. CGU changes are justified when cash flows produce independent cash flows, even when this cannot be attributed directly to an event. It may be practical to consider when management began changing how they review or assess CGUs.

WHAT WE CAN DO

 We hope that you find this article helpful in understanding IAS 36. Don’t hesitate to get in touch with

Audit Firms In Dubai for any questions you have.