- INTRODUCTION
There is a long-standing principle in financial accounting that an asset should not be shown at more than its recoverable amount in the financial statements. If the carrying value of the asset is greater than its recoverable amount, the asset is said to be impaired. This requires action to be taken to bring the value of the asset down to its recoverable amount.
IAS 36 Impairment of Assets outlines how the recoverable amount of the asset is calculated, and also the necessary action required by the entity in the event of an impairment loss arising. It also covers situations where an impairment should be reversed as well as the disclosures that are necessary.
IAS 36 applies to accounting for impairment of all asses, with the exception of:
- Inventories
- Investment property measured at fair value Biological assets
- Non-current assets held for resale (IFRS 5)
- Construction contracts
- Deferred tax assets
- Financial assets covered by IAS 39
- Assets arising from employee benefits
Impairment is the sudden reduction in the value of a non-current asset (or cash generating unit) over and above the normal wear and tear or reduction in value caused by depreciation. It arises because something happens to the asset itself and / or the environment in which it operates.
With the exception of intangible assets with indefinite lives and goodwill (which must be tested for impairment annually), a formal estimate of an asset’s recoverable amount is not required annually unless there is an indication that the asset may be impaired. The indicators of impairment may be of an external or internal nature. Examples of these indicators would be:
External Indicators:
- Market value of asset has fallen, more than expected
- Technological, market, economic, legal change
- Changes in interest rates (which may impact on the calculation of the asset’s Value in Use)
Internal Indicators
- Evidence of obsolescence or physical damage
- Changes in the way an asset is to be used e.g. asset will become idle
- Evidence from internal reporting that indicates that the economic performance of an asset is, or will be, worse than expected
Furthermore, evidence from internal reporting which may suggest impairment of an asset has occurred may derive from:
- Cash budgets for the operation and maintenance of the asset are significantly higher than expected.
- Actual cash flows are worse than expected
- A significant fall in budgeted cash flows or operating profit
- Operating losses.
If the asset is impaired and its value in the accounts is written down to its recoverable amount, it is important to remember that the depreciation charge in respect of that asset should also be reviewed and adjusted accordingly (for example, the remaining useful economic life may now be much shorter).
Impairment Loss
The amount by which the carrying amount of the asset (or cash-generating unit) exceeds its recoverable amount
Carrying amount
The amount at which the asset is recognised in the Statement of Financial Position after deducting accumulated depreciation / amortisation and any accumulated impairment losses
Recoverable amount
The HIGHER of an asset’s:
• Fair value less costs to sell; and
• Value In Use
Fair vale less costs to sell
The amount obtainable from the sale of an asset in an arm’s length transaction between knowledgeable and willing parties, less the costs of disposal
Costs of Disposal
The incremental costs directly attributable to the disposal of an asset. Examples include legal costs, costs of bring the asset into the condition necessary for its sale and the costs relating to the removal of a sitting tenant (in the case of a building) but they exclude finance costs and income tax
Value in use
The Present Value of the future cash flows expected to be derived from using an asset, including its eventual disposal
The fair value less costs to sell should be determined by the best judgement of management. The best evidence of this value would be a binding sale agreement, adjusted for incremental costs of disposal. If there is no binding sale agreement, but an active market exists, then the fair value less costs to sell will be the assets market price less the costs of disposal. The price should be the current bid price or the price of the most recent transaction. Failing either of these indicators being present, the fair value less costs to sell should be based on the best information available to reflect what would be received between willing parties at arm’s length. (It should not be based on a forced sale or fire sale).
The Value In Use (VIU) is arrived at by estimating the future cash inflows and outflows from the use of the asset (including its ultimate disposal, but excluding tax and interest) and discounting them to their present value.
The discount rate should be the rate of return that the market would expect from an equally risky investment. It should exclude the effects of any risk for which the cash flows have been adjusted and it should be calculated on a pre-tax basis.
When estimating the future cash flows, an entity should base is projections on reasonable and supportable assumptions that represent management’s best estimate of the economic conditions that will exist over the remaining useful life of the asset. The projections should cover a maximum period of five years (unless a longer period can be justified) and should not include the costs of future restructurings.
- RECOGNITION OF IMPAIRMENT LOSSES IN THE FINANCIAL STATEMENTS
An impairment loss is normally charged immediately in the Income Statement / Statement of Comprehensive Income, to the same heading as the related depreciation (i.e. cost of sales, administration or distribution).
That is:
Debit Income Statement
Credit Asset Account
with the amount of the impairment loss
But, if the asset has previously been revalued upwards, the impairment should be treated as a revaluation decrease (and shown in “Other Comprehensive Income”). That is, the loss is first set against any revaluation surplus for that asset until the surplus relating to that asset has been exhausted. Then, any excess is recognised as an expense in the Income Statement.
After adjusting for the impairment loss, the new carrying amount is written off over the remaining useful life of the asset.
Any related deferred tax assets or liabilities are determined under IAS 12 by comparing the revised carrying value of the asset with its tax base.
- CASH GENERATING UNITS
In some instances, it may not be possible to determine the recoverable amount of particular assets. For example, a production line in a factory may be made up of a number of different machines, with the output of Machine 1 becoming the input of Machine 2 and so on. Therefore, revenues are earned by the production line as a whole, rather than a single asset. This means that the Value In Use must be calculated for groups of assets rather than for individual assets. Likewise, any subsequent impairment review must be in respect of this group of assets.
Another example would be the case of a private railway servicing the mining activities of an organisation. If the railway’s exclusive purpose is to support the mine and it does not generate independent cash flows from those of the mine, then when conducting an impairment review, the entire assets of the mining activities, including the railway, must be considered. The railways Value In Use cannot be separately identified and its fair value less costs to sell might merely be its scrap value.
These groups of assets are called “Cash Generating Units” (CGUs) and can be defined as segments of the business whose income streams are largely independent of each other. In reality, they are likely to represent the strategic business units for monitoring the performance of the business. It could also include a subsidiary or associate within a corporate group structure.
The identification of a CGU involves judgement and should be the lowest identifiable group of assets that generate largely independent cash flows from continuing use. Only cash inflows from external parties should be considered. If an active market exists for the asset’s (or group of assets) output, then they should be identified as a CGU, even if some of the output is used internally.
If this is the situation, management’s best estimate of future market prices should be used in determining the Value In Use of:
- The CGU, when estimating the future cash inflows relating to internal uses; and
- Other CGUs of the entity, when estimating future cash flows that relate to internal use of the output.
CGUs should be identified consistently from period to period unless a change is justified.
Allocating assets to Cash Generating Units
The recoverable amount of a CGU is the higher of its fair value less costs to sell and its Value In Use. The carrying amount should be determined consistently with the way the recoverable amount is determined.
The net assets of the business that can be attributed directly or allocated on a reasonable and consistent basis (including capitalised goodwill, but excluding tax balances and interest bearing debt) are allocated to cash-generating units. However, there are two areas of concern:
- Corporate Assets:
These are assets that are used by several cash-generating units (e.g. a head office building or an R&D facility). They do not generate their own cash inflows, so cannot be considered CGUs in their own right.
- Goodwill
This does not generate cash flows independently of other assets and often relates to a whole business.
It may be possible to allocate corporate assets and/or goodwill over other cash-generating units on a reasonable basis. It is important to remember that when a CGU has been allocated goodwill, that CGU must be subjected to an impairment review at least annually.
If no reasonable allocation of corporate assets or goodwill is possible, then the entity should:
- Compare the carrying amount of the CGU (excluding the corporate asset) to its recoverable amount and recognise any impairment loss accordingly
- Identify the smallest CGU to which a portion of the corporate asset can be allocated on a reasonable and consistent basis and
- Compare the carrying amount of the larger CGU, including a portion of the corporate asset, to its recoverable amount and recognise any impairment loss.If goodwill is calculated using the proportion of net assets method, the Non-controlling interest (NCI) share of goodwill is not reflected in the group accounts. Therefore, any comparison between the carrying value of the CGU (including goodwill) and its recoverable amount will not be on a like for like basis.
In order to address this problem, goodwill must be grossed up to include goodwill attributable to the NCI, prior to conducting the impairment review. This grossed up goodwill is called “total notional goodwill”.
Once any impairment loss is determined, it should be allocated firstly to the total notional goodwill and then to the CGUs assets on a pro rata basis. As only the parent’s share of goodwill is recognised in the group accounts, only the parent’s share of the impairment loss should be recognised.
On the other hand, if the full method of valuing NCI is used, the goodwill in the group Statement of Financial Position represents full goodwill. Thus, together with the rest of the CGU, it can be compared to the recoverable amount of the CGU on a like for like basis.
On the examples above:
- BKLB used the full goodwill method
- TMP owns 100% of PFR, so there is no grossing up of notional goodwill for the amount attributable to the NCI
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- REVERSAL OF IMPAIRMENT LOSSES
The calculation of impairment losses is based on predictions of what may happen in the future. However, because actual events may turn out to be more favourable that originally predicted, it may be the case that the impairment loss accounted for in the past may now no longer be appropriate (or significantly lower than anticipated).
If this is the case, the recoverable amount is recalculated and the previous write-down is reversed. The procedure to be followed, in respect of an individual asset is as follows:
- Assets that have been subject to impairment should be reviewed at each reporting period to determine whether there are indications that the impairment has reversed.
- A reversal of an impairment loss is recognised as income in profit or loss immediately. If the original impairment was charged against a revaluation surplus, it is now recognised as “Other Comprehensive Income” and credited to the revaluation reserve.
- However, after the reversal, the new carrying amount of the asset must not exceed the carrying amount that would have existed if no impairment loss has been recognised in previous years (i.e. its depreciated historical cost)
- The future depreciation charge after the reversal should be adjusted to reflect the revised carrying amount, i.e.
Revised carrying amount – residual value
Remaining useful life
An impairment loss recognised for goodwill cannot be subsequently reversed. This is because IAS 38 Intangible Assets expressly forbids the recognition of internally generated goodwill.
Reversal of an impairment loss for a CGU
If the reversal relates to a CGU, the reversal is allocated to assets, other than goodwill, on a pro rata basis. The carrying amount of an asset should not be increased above the lower of:
- Its recoverable amount (if determinable); and
- The carrying amount that would have been determined (net of amortisation or depreciation) had no impairment loss been recognised for the asset in prior periods.
The amount of the reversal of the impairment loss that would otherwise have been allocated to the asset is allocated pro rata to the other assets of the CGU, except for goodwill.
As mentioned earlier, impairment losses relating to goodwill can never be reversed. The reason for this is that once purchased goodwill has become impaired, any subsequent increase in its recoverable amount is likely to be an increase in internally generated goodwill, rather than a reversal of the impairment loss for the original purchased goodwill. Under IAS 38, internally generated goodwill cannot be recognised.
- DISCLOSURES
Extensive disclosures are required by IAS 36 Impairments. The most salient disclosures are:
- Losses recognised during the period, and where charged in Income Statement / Statement of Comprehensive Income
- Reversals recognised during the period, and where credited in Income Statement / Statement of Comprehensive Income
- For each material loss or reversal in the period:
- The amount of loss or reversal and the events causing it
- The nature of the asset (or CGU) and its reportable segment
- Whether the recoverable amount is the fair value less costs to sell or Value In Use
- Basis used to determine the fair value less costs to sell
- The discount rate used to determine the Value In Use
