Statement of Financial Accounting Standards No. 35: Its Impact and How Businesses Can Respond

Taiwan's Statement of Financial Accounting Standards no. 35 (SFAS 35) - "Accounting Treatment of Asset Impairment" - was issued on July 1, 2004. It will apply to all financial statements after the last day of the accounting year, December 31, 2005, and it may be applied ahead of time. Taiwan's regulations heretofore have specified when to recognize losses and required that monetary amounts be used when performing valuations of fixed assets, but the valuation method and the basis for the amount of the valuation were not clearly defined. SFAS 35 gives enterprises more precise definitions to follow.

Areas Requiring Attention in Testing for Asset Impairment

Beginning the first quarter of 2005 at the latest, where there is any indication that asset impairment might have occurred, exchange-listed and OTC-traded corporations must test to see if they need to recognize a loss from asset impairment in accordance with SFAS 35's provisions. In a departure from the past, the Statement provides that, in addition to a company itself, as long as there is any sign of impairment in its investment in a subsidiary, an invested company accounted for under the equity method, or a joint venture enterprise, it is also necessary to test for impairment, so the impact is rather wide-ranging. In the following, some of the important concepts in the Statement are set out for enterprises to consider:

1. Signs of impairment

When an enterprise tests for signs of asset impairment, various kinds of internal and external information must be considered. When it happens that the net book value of the enterprise's assets is greater than its total market value, this is a sign that the corporation's assets may have been impaired. That is to say, in terms of a company currently listed in the domestic stock market or traded over-the-counter, if the net value of its equity at the end of March 2004 is compared to its total market value, and the latter is lower than the former, then its assets may have suffered impairment. The company must assess whether it needs to recognize an asset impairment loss. In addition, on each succeeding balance sheet date it must ascertain whether or not the circumstance persists. If it does, then assets must be assessed to see whether or not recognition of impairment loss is required.

2. On assessing long-term equity investments in invested companies accounted for under the equity method

There are rules in the Statement on asset impairment of long-term equity investments valued using the equity method. The main points of those rules are as follows: (Enterprises should pay particular attention to testing, since some concepts differ quite markedly from the rules in previously issued statements)

• Enterprises must test for impairment of goodwill each year, regardless of whether there is any indication of impairment.
  For companies with goodwill in their book assets (generally speaking, these are most commonly seen among long-term equity investments accounted for by the equity method) SFAS 35 mandates that they test for impairment each year, whatever the amortization circumstances and regardless of whether or not there is any indication of impairment.
  
  
• When testing goodwill for impairment, it must be apportioned among cash-generating units.
  A buyer cannot identify on its own what Goodwill signifies, and it is recognized as an expenditure for future economic benefits from assets; it cannot generate cash flow independently of other assets or groups of assets, thus the goodwill acquired in a merger must be apportioned among cash-generating units, and impairment testing must be performed beginning from the date of acquisition. The cash flow of a so-called cash-generating unit - that is, the smallest identifiable group of assets capable of independently generating a cash flow - is largely independent of the cash flows of other assets or groups of assets.
  
  
• When goodwill is associated with a certain cash-generating unit, if there is an indication that asset impairment may have occurred, goodwill will be the first asset to have its impairment recognized.
  When there is an indication that there may be asset impairment in a cash-generating unit to which goodwill has been apportioned, the book value of that unit is compared to its recoverable amount, and impairment testing is carried out on it. If impairment is known to have occurred, the impairment must reduce the book value of the cash-generating unit's assets sequentially in accordance with (a) the goodwill already apportioned to the cash-generating unit, and; (b) assets other than goodwill in proportion to their book value.
  
  
• After goodwill impairment loss is recognized, should the cash-generating unit's recoverable amount increase, the loss already recognized may not be reversed.
  According to SFAS regulations, the goodwill an enterprise generates internally may not be recognized. After goodwill impairment losses occur, an increase in a cash-generating unit's recoverable amount may be an increase in internally generated goodwill. Therefore, it cannot be recognized.

• When an asset suffers impairment, a loss must be recognized. If the recoverable value of the asset later increases, then a loss already recognized is reversible, but under the condition that the book value of the asset after the reversal may not exceed the asset's book value before the impairment loss was recognized, less required provision for depreciation or amortization. As a result, even after recognizing an asset impairment loss, one must continue to retain such information as the asset's original cost and accumulated depreciation (depletion) in order to calculate the upper limit of the loss that can be reversed, if and when the impairment loss is reversed. After an asset impairment occurs, any new value acquired by the asset after the asset impairment loss was recognized must be apportioned on a reasonable basis over the remaining service life.
  
  
• When recognizing impairment of an asset that has already been revaluated, the impairment loss must first reduce capital reserve for unrealized increase in value upon revaluation (under shareholder equity). If the reserve is insufficient, a loss must be recognized in the income statement. Therefore, when reversing an impairment loss for a revaluated asset, the gain can only be recognized to the extent of the loss originally recognized in the income statement.