Expert Advisory Committee
ICAI-Expert Advisory Committee
Options:

Query No. 23

 

Subject:

Identification of Cash Generating Units of a petroleum company. 1

 

A. Facts of the Case

 

1. A public sector company has registered a turnover of Rs. 56,333 crore and post-tax profit of Rs. 1,904 crore for the year ending 31st March, 2004. The company is in the business of refining and marketing of petroleum products. The company’s business operations are spread across the country and has an asset base of Rs. 11,387 crore (gross block). The company has been consistently declaring healthy profits year after year since its inception and has been rewarding the shareholders with dividend payouts and bonus shares from time to time. The querist has submitted information with regard to the financial performance of the company and its growth as well as information regarding growth in production and marketing volumes.

 

 

2. Books of account of the company are subjected to audit by both the statutory auditors and the Comptroller and Auditor General of India (C&AG). According to the querist, accounting policies of the company, as disclosed in the notes to accounts, are in conformity with the accounting standards/guidelines issued by the Institute of Chartered Accountants of India (ICAI).

 

 

3. The querist has stated that Accounting Standard (AS) 28, ‘Impairment of Assets’, issued by the ICAI, has come into force with effect from 1st April, 2004. In the view of the querist, AS 28 envisages that assets are carried at no more than their recoverable amount. The Standard states that cash inflows from continuing use are inflows of cash and cash equivalents received from parties outside the reporting enterprise. The querist has stated that cash inflows to the company occur only on a final sale. There are no other intermediary stages involved leading to generation of cash inflows though intermediary distribution of assets is involved.

 

 

4. The querist has further mentioned that AS 28 defines a cash generating unit (CGU) as follows:

 

"A cash generating unit is the smallest identifiable group of assets that generates cash inflows from continuing use that are largely independent of the cash inflows from other assets or groups of assets."

 

In the view of the querist, the CGUs could be (a) product lines, (b) businesses, (c) individual locations, (d) districts or regional areas, (e) a reportable segment etc. According to the querist, the Standard guides to a conclusion that in case the operations of the enterprise are monitored on the above lines, CGUs may have to follow that pattern. Thus, what constitutes a CGU needs to be judged by the company.

 

 

5. According to the querist, the business environment in which the company functions is such that all assets of the entire company are inter- related/linked and no one group of assets can generate independent cash flows. Over the years, the company has built assets spreading across the length and breadth of the company for distribution of its products as part of supply chain management. Each asset is so much dependent on the other that no one group of assets can generate cash flows on its own. Further, when Accounting Standard (AS) 17, ‘Segment Reporting’, was made mandatory by the ICAI, the oil industry to which the company belongs had collectively opined that there are no reportable segments. The querist has informed that the auditors of the oil industry have also agreed with this opinion and hence, AS 17 is not applicable to the company. Therefore, in the view of the querist, the pertinent question is when revenues cannot be segmented, can the underlying assets generating these revenues be segmented?

 

 

6. The querist has further informed that in the light of the following points, the company is of the view that the smallest identifiable group of assets capable of generating independent cash inflows from continuous use can only be the entire company:

 

(i) A refinery does not sell all its products at the refinery gate by itself. The querist has mentioned that as per AS 28, for an ‘active market’ to exist, three of the conditions are paramount, one of which is that willing buyer can normally be found at any time. According to the company, this condition is not met because at the refinery gate, the entire production cannot be sold/evacuated. As refineries are meant for production of petroleum products to be supplied throughout the country through marketing network, they do not have enough storing capacity to store its products beyond a very limited period and, therefore, depend upon marketing the same. Thus, it can be said, in the view of the company, that refineries cannot independently generate cash inflows.

 

(ii) Before the product reaches the outlets from refineries, it passes through terminals, depots and pipelines meant for distribution, storage and transportation. Thus, pipelines cannot function independently unless the refinery pumps the product through these pipelines and marketing terminals make arrangement to receive them. Similarly, terminals/depots cannot load the product to these retail outlets unless refinery sends the product to them and similarly, retail outlets cannot sell the products unless they receive it from the depots/terminals.

 

(iii) Further, clustering the assets for the purpose of defining a CGU is not possible as the logistics would often undergo change periodically, even within a year.

 

(iv) Since terminals of the company are not involved exclusively in the sale of products as substantial quantities of products are transferred either on inter-state or within the state to its branches, cash inflows for these terminals cannot be worked out even notionally. Further, the useful life of different assets in the supply chain varies.

 

7. At present, there is no indication of potential impairment since none of the indicators mentioned in paragraphs 8-10 of AS 28 (whether external or internal) is present in the company or in the industry to which the company belongs or in the environment in which the company operates. Further, it would not be possible for the company to project the future scenario as the industry is not independent of the global oil economics.

 

8. In view of the above, having defined the whole of the company as one CGU, and after considering its track record of past growth/profitability, the cash inflows work out to be positive at the time of ascertaining the impairment and thus, its assets are not impaired. The company is, therefore, of the view that a disclosure by way of a suitable note in its notes to accounts would meet the requirement.

 

B . Query

 

9. The querist has sought the opinion of the Expert Advisory Committee on whether the above view of the company is correct.

 

C. Points considered by the Committee

 

10. The Committee notes the following definitions of ‘cash generating unit’, ‘corporate assets’ and ‘active market’ provided in paragraph 4 of AS 28:

"A cash generating unit is the smallest identifiable group of assets that generates cash inflows from continuing use that are largely independent of the cash inflows from other assets or groups of assets."

 

"Corporate assets are assets other than goodwill that contribute to the future cash flows of both the cash generating unit under review and other cash generating units."

"An active market is a market where all the following conditions exist :

 

(a) the items traded within the market are homogeneous;

 

(b) willing buyers and sellers can normally be found at any time; and

 

(c) prices are available to the public."

 

11. The Committee further notes paragraphs 64 to 69 of AS 28, which contain requirements and provide guidance for identification of cash generating units (CGUs), as follows:

"64. If there is any indication that an asset may be impaired, the recoverable amount should be estimated for the individual asset. If it is not possible to estimate the recoverable amount of the individual asset, an enterprise should determine the recoverable amount of the cash-generating unit to which the asset belongs (the asset’s cash-generating unit).

 

65. The recoverable amount of an individual asset cannot be determined if:

(a) the asset’s value in use cannot be estimated to be close to its net selling price (for example, when the future cash flows from continuing use of the asset cannot be estimated to be negligible); and

(b) the asset does not generate cash inflows from continuing use that are largely independent of those from other assets. In such cases, value in use and, therefore, recoverable amount, can be determined only for the asset’s cash-generating unit.

66. As defined in paragraph 4, an asset’s cash-generating unit is the smallest group of assets that includes the asset and that generates cash inflows from continuing use that are largely independent of the cash inflows from other assets or groups of assets. Identification of an asset’s cash-generating unit involves judgement. If recoverable amount cannot be determined for an individual asset, an enterprise identifies the lowest aggregation of assets that generate largely independent cash inflows from continuing use.

 

67. Cash inflows from continuing use are inflows of cash and cash equivalents received from parties outside the reporting enterprise. 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 enterprise considers various factors including how management monitors the enterprise’s operations (such as by product lines, businesses, individual locations, districts or regional areas or in some other way) or how management makes decisions about continuing or disposing of the enterprise’s assets and operations. Example 1 in the Appendix gives examples of identification of a cash-generating unit.

 

68. If an active market exists for the output produced by an asset or a group of assets, this asset or group of assets should be identified as a separate cash-generating unit, even if some or all of the output is used internally. If this is the case, management’s best estimate of future market prices for the output should be used:

 

(a) in determining the value in use of this cash-generating unit, when estimating the future cash inflows that relate to the internal use of the output; and

 

(b) in determining the value in use of other cash- generating units of the reporting enterprise, when estimating the future cash outflows that relate to the internal use of the output.

 

69. Even if part or all of the output produced by an asset or a group of assets is used by other units of the reporting enterprise (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 enterprise could sell this output in an active market. This is because this asset or group of assets could generate cash inflows from continuing use that would be largely independent of the cash inflows from other assets or groups of assets. In using information based on financial budgets/forecasts that relates to such a cash-generating unit, an enterprise adjusts this information if internal transfer prices do not reflect management’s best estimate of future market prices for the cash-generating unit’s output."

12. On the basis of the above, the Committee is of the view that as stated in paragraph 64 of AS 28, the company should first determine whether there are certain individual assets that may be impaired in the light of indicators stated in paragraph 8 of AS 28. For example, an asset might be damaged beyond repair or might have outlived its utility [paragraph 8(e) of AS 28]. Thereafter, or in case it is not possible to identify individual assets for impairment, the CGUs need to be identified. Identification of CGUs in a large organisation requires intensive detailed exercise involving consideration of various factors, including those illustrated in AS 28, so as to meet the definition of the ‘cash generating unit’ reproduced in paragraph 10 above. As stated in paragraph 66 of AS 28 reproduced above, ‘identification of an asset’s cash-generating unit involves judgement’ to be exercised by the management and the auditors on the basis of the aforesaid exercise and, therefore, depends on consideration of various factors.

 

13. In respect of various views expressed by the querist in the ‘Facts of the Case’, the Committee wishes to state as below:

(i) The Committee is of the view that it is not necessary that if the revenues of an enterprise cannot be segmented, its assets also cannot be segmented. Thus, it is possible to have more than one CGU in an enterprise which does not provide segment information as per Accounting Standard (AS) 17, ‘Segment Reporting’. The Committee is, however, of the view that this can be one of the factors in deciding a CGU. (The Committee has not addressed the aspect of applicability of AS 17 to the company as it has not been raised by the querist).

 

(ii) The Committee does not agree with the querist that the mere fact that the entire production of a refinery cannot be sold at the refinery gate, it fails the test of ‘willing buyers can normally be found at any time’, which forms one of the parts of the definition of ‘active market’ as per AS 28, reproduced in paragraph 10 above. The definition does not stipulate the place at which the buyers should be available, viz., the refinery gate. In the view of the Committee, this test is satisfied, e.g., for a refinery as a separate CGU from other refineries of the same enterprise, if buyers are available at any time through the common distribution channels of the enterprise, particularly if the products of the refineries can be sold independently in the sense that if the production of one refinery is stopped, the products of the other refinery can be sold.

 

(iii) The pipelines, terminals, depots, etc., which cannot function independently of refineries may be covered by the definition of ‘corporate assets’ to be identified with the related CGUs, if any, in the manner explained in paragraph 83 to 85 of AS 28.

 

(iv) It is the factor of independence of cash inflows which determines the CGUs in an enterprise rather than the physical clustering of assets for CGUs as it appears to be implied in paragraph 6(iii) of the ‘Facts of the Case’.

 

(v) Paragraphs 8 to 10 of AS 28 related to assessment of indications of impairment are to be applied to each CGU once the same have been identified, rather than the enterprise as a whole unless the enterprise itself constitutes a CGU.

 

(vi) Even in a highly profitable enterprise some assets may be impaired.

14. The Committee is further of the view that the management and the auditors should consider various other factors in deciding CGUs including the following:

(i) If the enterprise has more than one refinery, different refineries can be considered as separate CGUs, even if they have a common distribution system, unless the production of one refinery is dependent on the products of the other refinery. Assets used in distribution channels can be considered as corporate assets as discussed in paragraph 13(iii) above.

 

(ii) Even within a refinery, there can be more than one CGU, e.g., where there is more than one product line, provided they meet the definition of CGU as per AS 28.

D. Opinion

 

15. On the basis of the above, the Committee is of the opinion that to conclude that there is only one CGU, viz., the company itself on the basis of the facts furnished by the querist would not be appropriate. As suggested in the above paragraphs, the company should carry out an intensive detailed study to identify individual assets as well as CGUs that may be impaired based on various factors.

 

1 Opinion finalised by the Committee on 27.12.2004