Dubai auditor professionals are challenged in handling cash-generating units (CGU) and impairment of assets. They must determine the recoverable amount of CGU/ assets. It can be quite simple, especially when the company audit team determines fair value. Auditors will need to calculate assets and CGU value in usage when there is no fair price.
Understanding Value in Use
IAS 36 defines value in use as the future value of cash flows that are derived from assets under review or CGU. To determine the present value, financial auditors should verify that cash flows and discount rates are not pre-tax.
Here’s the problem. Many Dubai companies look to the market for the right market rate that can help them in their value calculation. The market rates, especially for equity, are post-tax. What should auditors do?
Solution 1: Simple, but not precise
This is the first way to solve this problem.
Pre-tax rate = Post-tax Rate / (1-tax rate)
This technique is easy but should be leveraged occasionally. CGU or an asset that isn’t material to a Dubai company or variance in the discount rate don’t cause material errors in value.
This simple method can be used as your primary method. The timing of company tax payments will vary depending on the tax base (expenses or income) in most cases. Most Dubai, UAE companies pay taxes 12 months after they receive taxable revenues and expenses. This could result in a substantial difference in the real pre-tax.
Dubai-based audit firms and other entities need to remember that the pretax rate must take into account CGU’s/assets’ post-tax rate as well as the associated tax rate—also, the timing and value of future cash flows.
Solution 2: Top-Down Calculation
This method is a great choice if you have both a pre-tax market rate for your asset/CGU and a pre-tax cash flow projection. It’s actually the reverse, so I’ll attempt to draft it in three steps.
Calculate Post-Tax Cash Flows
We will use the post-tax rate to calculate the asset’s or CGU’s actual value. This inconsistency is not correct, as we have both pre-tax cash flows and post-tax rates. You should consider the following:
Calculate future tax payments using our cash flow projections for pre-tax payments. Keep doing this year after year. Take care. To make sure your calculations are accurate, consider all aspects of taxes, such as future tax deductions, tax losses, and temporary differences.
Do not multiply the tax base or tax rate. Instead, estimate tax payments as realistically and accurately as possible. Add future taxes to calculate pre-tax cash flows. This should be done annually. We now have post-tax cash flow.
Determine The Post-Tax Value Of Your Use
This is the point. The table includes post-tax cash flows and a post-tax discount. The present value is calculated by dividing the cash flows after tax.
Be consistent when calculating value. You will get the same answer. When calculating value using post-tax cash flow and post-tax values, internal auditors should use the exact same discount rate. Or, to put it another way:
Discounted Cash Flows After Tax
- Pre-tax cash flows are discounted with a pretax rate
- value in use
This logic leads to step 3
Determine The Pretax Rate By Combining The Value In Use With Pre-Tax Cash Flows
It is therefore a top-down calculation. It’s a simple matter of determining the current value of pretax cash flows relative to the use value. It is complicated because it requires a specific iteration technique. It is possible.
Pre-tax rates are unnecessary as we already have the post-tax value. If required by law, your pre-tax discount rate might need to be included in the notes to financial statements.
You may also like: Top differences between IAS 23 and US GAAP
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Theshani is a Senior auditor and has experience of 4+ years in providing audit assurance and advisory services to a wide range of industry clients. She continues to stay on top of ever-changing industry dynamics by continuously learning and developing expertise.