Cash-Generating Units (CGU's) - Definition

Practical guidelines

• When should impairment tests be updated after a first impairment loss?
• A threshold should be defined to determine when future impairment tests are to be performed. We must avoid situations where an impairment loss is followed by a reversal, which in turn is followed by a new impairment loss.
• The discount rate to be applied also has a business and a country component.
• Internal transfer prices for impairment tests of CGU’s should be based on market prices (arm’s length transactions)

IFRS definition of a cash-generating unit (CGU)

• How to identify CGU's?

(IAS 36, par 6)

The smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets.

(IAS 36, par 69)

Cash inflows are inflows of cash and cash equivalents received from parties external to the entity. In identifying whether cash inflows from an asset (or group of assets) are largely independent of the cash inflows from other assets (or groups of assets), an entity considers various factors including how management monitors the entity’s operations (such as by product lines, businesses, individual locations, districts or regional areas) or how management makes decisions about continuing or disposing of the entity’s assets and operations.

=> the CGU is defined in relation with  the independence of the cash inflows from parties external to the CGU.

Approach: Start with detailed assets and stop aggregating them when reaching the smallest group of assets that generates independent cash flows.

Evaluation of the independence criteria

• First indication of cash flow independence: existence of an "active market"

(IAS 36, par 70)

If an active market exists for the output produced by an asset or group of assets, that asset or group of assets shall be identified as a cash-generating unit, even if some or all of the output is used internally. If the cash inflows generated by any asset or cash-generating unit are affected by internal transfer pricing, an entity shall use management’s best estimate of future price(s) that could be achieved in arm’s length transactions in estimating:

(a)   the future cash inflows used to determine the asset’s or cash-generating unit’s value in use; and

(b)   the future cash outflows used to determine the value in use of any other assets or cash-generating units that are affected by the internal transfer pricing.

(IAS 36, par 71)

Even if part or all of the output produced by an asset or a group of assets is used by other units of the entity (for example, products at an intermediate stage of a production process), this asset or group of assets forms a separate cash-generating unit if the entity could sell the output on an active market. (…) 

=> The existence of an « active market » is a prevailing factor in the definition of a CGU.

Examples:

• Second indication of cash flow independence: a CGU must correspond to an operation management unit at the lowest level ("smallest group of assets")

(IAS 36, par 69) as stated above

Example: PVC Europe:

• a customer can be supplied from several plants,
• production capacities and logistics management are shared.

=> Cash inflows from the various PVC plants in Europe are interdependent and we have one single CGU.

• Corporate Assets (IAS 36, par 100-103)

Certain assets, the so-called “corporate” assets, such as headquarters building, R&D installations and goodwill cannot be allocated to one or several CGU’s on a reasonable and consistent basis. 

The distinctive characteristics of corporate assets are that they do not generate cash inflows independently of other assets or groups of assets and their carrying amount cannot be fully attributed to the CGU under review.

If there is an indication that a corporate asset may be impaired, recoverable amount is determined for the CGU or group of CGU’s to which the corporate asset belongs, and is compared with the carrying amount of this CGU or group of CGU’s.

Case 1 – Portion of the corporate asset that can be allocated to a CGU or group of CGU’s

Compare the carrying amount of the CGU or group of CGU’s including the portion of the carrying amount of the corporate asset that can be allocated, with its recoverable amount. Recognize impairment loss if any.

Case 2 – Portion of the corporate asset that cannot be allocated to a CGU

The impairment test is carried out in a 2-step approach:

Step 1

Identify the smallest group of CGU’s to which a portion of the corporate asset can be allocated.

Test each of these CGU’s (excluding “corporate” assets) for impairment and recognize an impairment loss if necessary.

Step 2

Compare the carrying amount of that group of CGU’s, including the portion of the carrying amount of the corporate asset allocated to that group, with the recoverable amount of the group.

Any impairment loss is allocated to reduce the carrying amount of the assets in the following order:

• • first, to reduce the carrying amount of any goodwill allocated to the CGU or group CGU’s; and
  • then, to the other assets of the CGU or group of CGU’s pro rata on the basis of the carrying amount of each asset in the CGU or group of CGU’s.

In allocating an impairment loss, an entity shall not reduce the carrying amount of an asset below the highest of:

• • its fair value less costs to sell (if determinable);
  • its value in use (if determinable); and
  • zero.

The amount of the impairment loss that would otherwise have been allocated to the asset is allocated pro rata to the other assets of the CGU or group of CGU’s.
Example: if, among the assets that should be impaired, there is a brand new asset, this brand new asset should not be impaired.

In practice, impairment losses may be recorded at central level through shadow companies to avoid a difference between IFRS and local accounts and to simplify administrative procedures. The adjustment to depreciation and amortization expenses would also be recorded in a shadow company based on an average residual useful life of the installations.

• Agents and distributors operating for several CGU's

Solvay Chemicals International (company 00005) sells Solvay European chemical products throughout the world. Product flow managers choose the origin of a given product so as to optimize costs taking into account factors such as cost price, transportation costs, maintenance programs, etc.
A choice is necessary whenever there are several production sites making the same products.

The products are sold through a network of local internal or external agents (the commission is based on net sales) or to distributors e.g. Solvay Chemicals Inc. (04290) in the USA, Solvay do Brasil (05685), Nippon Solvay (00360) and Solvay Shanghai (05876) to name but a few. Some of them have inventories for certain products. These distributors can be identified as they generally hold no or very few tangible assets and essentially have working capital only. They cannot be tested for impairment at the level of the individual CGU’s as they generally encompass several divisions and even SBUs. Moreover, such internal distributors are unlikely to make losses unless the margin between transfer prices and market prices does not allow them to cover their operating costs.

In addition, Solvay Chemicals International also sells to non-consolidated companies that serve as distributors in certain countries such as Solvay Vostok (05785) in Russia and Solvay Alexandria trading in Egypt (06059). As these companies are not consolidated, they are not directly involved in an impairment test except through the investment of their respective parent companies.

• What should invested capital include for an impairment test?

For an impairment test, the invested capital should include the following components:

• Carrying value of fixed assets, and
• Working capital, because the net present value of the cash flows includes working capital variations.

Example of CGU’s for the Soda ash Business

EMEA and NAM are considered as separate markets for Soda Ash and have different industrial processes:

• In Europe Solvay produces synthetic soda ash only. European glass manufacturers do not buy natural soda ash. Europe in general (outside of Solvay) imports almost no natural soda ash.
• In the USA Solvay produces natural soda ash (based on trona as raw material), which is sold in the USA and to Asia and Mercosur.

Solvay Alexandria Sodium Carbonate (06046) is grouped together with Europe for several reasons:

• Due to geographical proximity, the plant could deliver European markets
• Low capacity, which does not cover Egyptian needs (no export)
• Devnya in Bulgaria exports soda ash to Egypt.