Identification of cash-generating units – internally-used products
Example A – Plant for an Intermediate Step in a Production Process
A significant raw material used for plant Y’s final production is an intermediate product bought from plant X of the same entity. X’s products are sold to Y at a transfer price that passes all margins to X. 60 per cent of X’s final production is sold to Y and the remaining 40 per cent is sold to customers outside of the entity. Y sells 80 per cent of its products to customers outside of the entity
If X can sell its products in an active market and generate cash inflows that are largely independent of the cash inflows from Y, it is likely that X is a CGU even though part of its production is used by Y. Therefore, its cash inflows can be regarded as being largely independent. It is likely that Y is also a separate CGU. However, internal transfer prices do not reflect market prices for X’s output. Therefore, in determining value in use of both X and Y, the entity adjusts financial budgets/forecasts to reflect management’s best estimate of future prices that could be achieved in arm’s length transactions for those of X’s products that are used internally.
If, on the other hand, there is no active market, it is likely that the recoverable amount of each plant cannot be assessed independently of the recoverable amount of the other plant. The majority of X’s production is used internally and could not be sold in an active market. Cash inflows of X depend on demand for Y’s products. Therefore, X cannot be considered to generate cash inflows that are largely independent of those of Y. In addition, the two plants are managed together. As a consequence, it is likely that X and Y together are the smallest group of assets that generates cash inflows that are largely independent. [IAS 36.IE5-10].
Example B – ‘Market’ for intermediate product not relevant to identification of a separate CGU
A vertically integrated operation located in Australia produces an intermediate product that is fully used internally to manufacture the end product. There is no active market for the intermediate product in Australia. The entity has only one other competitor in Australia, which is also vertically integrated and, likewise, uses the intermediate product internally. Both entities are, and have always been, very profitable when looking at their vertically integrated manufacturing processes to the end-stage product.
There is an active market for the intermediate product in China, but the prices at which the product can be sold are so low that a company based in Australia whose sole activity is to sell the intermediate product into China would never be profitable and a company would never set up manufacturing operations in Australia in order to sell into China.
Each of the Australian companies will occasionally sell small surpluses of their intermediate products into the active market in China, rather than make that product available to their competitor in Australia.
The existence of an active market for the intermediate product in China might suggest that the operations involved in it should be treated as a separate CGU. However, the mere existence of an active market somewhere in the world does not mean that the asset or CGU could realistically generate cash inflows independently from the rest of the business by selling on that active market. If such sales are a genuine incidental activity (i.e. if it is genuinely a case of obtaining some proceeds from excess product that would otherwise be scrapped), it may be appropriate not to regard that market as an active market for the intermediate product for IAS 36 purposes.
If the market is not regarded as an active market for IAS 36 purposes, the assets/operations involved in producing the intermediate product will not be treated as a separate CGU.