KPMG anticipates a high degree of difficulty associated with the interpretation and practical application of the CGU concept. For example, an electricity retailer that has acquired the business of a competing retailer and then integrated it into its current business would be likely to be regarded as having two CGUs. Over time, however, as the businesses are integrated, such CGUs may become increasingly difficult to identify. Management and the board may focus on customer groups to obtain economies of scale synergies and allocation of acquisition asset carrying amounts is likely to be subjective.

Intangible assets

IAS 38 Intangible Assets requires acquired intangible assets to be recognised at their costs of acquisition. However, internally generated intangible assets other than goodwill can only be recognised when a strict series of tests is met. Internally generated goodwill must not be recognised as an asset. An acquired or recognised internally generated intangible asset can only be remeasured to fair value if there is an active market for the asset.

The introduction of IAS 36 into Australia will require all companies to review their intangible assets. Many internally generated assets will have to be written-off and most assets that can remain will need to be written down to original cost.

One change to AGAAP arising from IAS 38 is that intangible assets with indefinite useful lives will no longer be amortised. Instead of amortisation, every year the company will have to test the asset for impairment and reconsider whether its useful life remains indefinite.

For many utility companies, this will be a welcome reinstatement of an old industry practice. Some three years ago, ASIC's surveillance program focussed heavily on companies that were not amortising intangibles, or that were amortising over very long useful lives. At that time, many utility companies commenced amortisation or reduced the assessment of useful lives of their licences as a response to regulatory pressure.

Financial instruments

IAS 39 Financial Instruments: Recognition and Measurement contains requirements for the recognition and measurement of all financial instruments other than assets and liabilities arising from leases, assets and liabilities arising from employee benefit plans, interests in insurance contracts, own equity instruments, certain guarantees and contingent consideration in business combinations.

IAS 39 represents a significant change in the way Australian power and utility companies must measure and recognise financial assets, liabilities and derivatives. The standard will significantly impact power and utility companies with investments, borrowings and trading activities, including companies utilising derivatives to manage risk.

Specific changes to AGAAP that will be required by IAS 39:

* all financial assets and liabilities are to be recorded on the face of the balance sheet, with all derivatives, including those embedded in other financial instruments, recorded at fair value;

* there are specific requirements for recognising cash flow hedges, including maintaining sufficient documentation to prove that a hedge is effective at inception and at each reporting date. This includes satisfying the 80-125% hedge effectiveness test;

* changes in fair values of non-hedge derivatives must be included in the

* income statement;

* changes in cash flow hedges and hedges of a net investment in a foreign entity are deferred in equity until the hedged event occurs. However, any hedge ineffectiveness must be recognised in the income statement immediately. If the transaction is no longer expected to occur, the amount previously deferred to equity is recycled to the income statement; and

* embedded derivatives are generally accounted for separately from the underlying contract.

Particular impacts for utility companies include:

* a detailed assessment of the derivatives commonly embedded in gas and electricity supply contracts will be required to determine whether these derivatives should be accounted for separately from the host contract;

* energy participants will need to consider application of the 'normal purchase and sale exemption' that is available under IAS to their contractual arrangements when determining what qualifies as a derivative and what does not;

* electricity retailers who hedge their electricity demands and generators who undertake capacity hedges will need to be cognisant of the more stringent rules applying to hedge accounting; and

* although AGAAP requires the debt and equity components of compound financial instruments to be recognised separately, IAS 32 Financial Instruments: Presentation and Disclosure may require instruments classified as equity under AGAAP to be reclassified as debt. The consequential impact on the balance sheet, associated ratios, and possibly credit ratings need to be managed carefully.

For example, reset convertible securities have been a popular funding mechanism for utility companies in recent times. These securities, have reset dates on which a range of terms such as the conversion discount and ratios and dividend dates may be altered. Given that they typically have no set maturity date and can usually only be converted into equity, historically they have often met the equity test. Under IAS 32, they are likely to be reclassified to debt.