Case study 1

1. Define a CGU

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

2. Explain why impairment testing requires the use of CGUs

The impairment test requires a comparison of the recoverable amount of an asset with the higher of the assets value in
use and fair value less costs to sell.
Value in use requires:
- an estimate of the future cash flows the entity expects to derive from the asset
- expectations about variety in timing of cash flows
- the price for bearing the uncertainty inherent in the asset
These cash flows are based upon data such as financial budgets and forecasts.

For some assets, there are no cash flows that are generated independently from those of other assets e.g. the milking
machines or the machines used to separate cream from milk etc do not generate independent cash flows. The eventual
cash flows come from the sale of the milk products. These machines could be sold separately, giving a fair value less
costs to sell. However, as management have decided to use the machines rather than sell them, management have
made the decision that the value in use is greater than the value via sale.

(iii) Explain the factors used in selecting a CGUs for an entity

Cash flows must be independent of other cash flows
A CGU must be the lowest aggregation of assets independently generating cash flows.
Factors include (see paras 69-71 of AASB 136):
- how management monitors the entitys operations: such as product lines, businesses, individual locations,
districts or regional areas. How does management break down Fresh Milk Ltd by factory? By dairy district?
By product?
- how management makes decisions about continuing or disposing of the entitys assets and operations. If
management wanted to sell off part of the business but still keep a viable business remaining, how could the
business be broken down into parts that could be sold off?
- the existence of an active market for the output produced even if some or all of the output is used internally. In
this case, the milk produced is not sold to the public or other entities but is used to make further milk products.
However, as there is an active market for milk, the milk production section is potentially a separate CGU. This
is because the assets in that section could generate cash flows independently of the rest of the entity. Internal
transfer prices should not be used to determine recoverable amount unless these reflect the best estimate of
prices that could be achieved in arms length transactions.