How Impairment Testing and Off-Balance Sheet Liabilities Affect the Essay

How Impairment Testing and Off-Balance Sheet Liabilities Affect the Reliability of Financial Statements - Essay Example When an instrument is not traded in an active market there is great uncertainty about the ultimate amount that can be realized from the instrument in a transaction between knowledgeable willing parties in an arms length transaction (Eipstein and Jermacowicz 2007). In July 2002, the European Union issued a regulation requiring all EU-listed companies to prepare their year-end accounting standards in compliance with IFRS as from December 31st 2005. Following the recent wave of accounting scandals at Enron, Tyco International and WorldCom, as well as the greater concern for off-balance sheet liabilities, the IFRS has issued a number of standards (IAS 32 Financial Instruments Disclosure and Presentation, IAS 39 , IFRS 7 Financial Instruments Disclosures, and IAS 17 Leases) to help reduce bright lines that enable companies to use off-balance sheet financing. In this paper the developments in respect of convergence between national and international accounting standards since 1st January 2005 to present day will be discussed. The impact that off-balance sheet financing and impairment testing may have upon the reliability of financial statements will also be discussed. In the light of all these, the next section argues in respect to the theme of thi s paper. 1.1.1 How impairment testing and off balance sheet Liabilities affect the Reliability of Financial Statements IAS 36 requires companies to test assets for impairment. Basically, the standard requires that tangible assets should be tested for impairment when there is an indication that an asset might be impaired. (Epstein and Jermacowicz, 2007). However, intangible assets having an indefinite useful life must be tested annually for impairment. The impairment test is required to be applied to a cash generating unit, that is, the smallest group of assets for which the entity has identifiable cash flows. During an impairment test, the carrying amount of an asset or group of assets in the cash generating unit is compared with the fair value or value in use (value in use is calculated as the present value of the cash flows expected to be generated from using the asset). The higher of value in use and fair value is taken and compared with the carrying amount and an impairment loss is recognized if the carrying amount is higher than the higher of fair value and value in use. (Epstein and Jermacowiz, 2007). IAS 36 also requires a company to determine at each reporting date whether there are conditions that would indicate that impairment may have occurred and further provides a set of indicators of potential impairment some of which include (Epstein and Jermacowiz, 2007: p. 247): Market value declines for specific assets or cash generating u