IAS 36 Impairment of Assets ensures that an asset is not carried at more than the amount recoverable through use or sale. If the carrying amount is higher than that recoverable amount, the asset is impaired and the difference is recognised as a loss.
When is an impairment test required?
At each reporting date, an entity assesses whether there is any indication that an asset may be impaired. If there is, it estimates the recoverable amount. Some assets must be tested at least annually, regardless of indicators:
- Goodwill acquired in a business combination
- Intangible assets with an indefinite useful life
- Intangible assets not yet available for use
Indicators include external signals (a significant fall in an asset's market value, adverse changes in the technological, market, economic or legal environment, higher market interest rates, a market capitalisation below the carrying amount of net assets) and internal ones (evidence of obsolescence or physical damage, asset idle or being restructured, or economic performance worse than expected).
Recoverable amount
Recoverable amount is the higher of:
- Fair value less costs of disposal, measured under IFRS 13, less the incremental costs of selling; and
- Value in use, the present value of the future cash flows expected from continuing use and eventual disposal.
If either amount exceeds the carrying amount, the asset is not impaired and the other need not be calculated.
Measuring value in use
- Cash flows are based on reasonable and supportable assumptions and the most recent approved budgets and forecasts, which normally cover a maximum of five years unless a longer period can be justified.
- Cash flows exclude financing and income tax cash flows, and exclude uncommitted restructurings and future enhancements to the asset's performance.
- The discount rate is a pre-tax rate reflecting current market assessments of the time value of money and the risks specific to the asset, to the extent not already reflected in the cash flows.
Cash-generating units
Many assets do not generate cash inflows independently. Where the recoverable amount of an individual asset cannot be determined, it is determined for the cash-generating unit (CGU): the smallest identifiable group of assets that generates cash inflows largely independent of other assets or groups. Goodwill is allocated to the CGU, or group of CGUs, expected to benefit from the synergies of the combination, and that level cannot be larger than an operating segment under IFRS 8. Corporate assets are allocated to CGUs on a reasonable and consistent basis.
Recognising and allocating the loss
An impairment loss is recognised in profit or loss (or against a revaluation surplus for assets carried at revalued amounts). For a CGU, the loss is allocated in this order:
- First, to reduce the carrying amount of any goodwill allocated to the CGU
- Then, to the other assets of the CGU pro rata to their carrying amounts, but not reducing any asset below the highest of its fair value less costs of disposal, its value in use, and zero
A simple worked example
A CGU has a carrying amount of 1,000, which includes goodwill of 200. Its recoverable amount (the higher of value in use and fair value less costs of disposal) is 850.
- Impairment loss = 1,000 − 850 = 150
- The loss is allocated first to goodwill: goodwill falls from 200 to 50, and no loss is allocated to the other assets.
Had the recoverable amount been 700, the loss of 300 would eliminate the goodwill (200) and the remaining 100 would be allocated pro rata to the other assets, subject to the floor described above.
Reversals
For assets other than goodwill, an impairment loss is reversed if there has been a change in the estimates used to determine the recoverable amount since the last loss was recognised. The reversal is capped so that the carrying amount does not exceed what it would have been, net of depreciation, had no impairment been recognised. An impairment loss on goodwill is never reversed.
Where this typically goes wrong
- Not performing the annual goodwill test, or testing at a level above the CGU group allowed by the standard
- Using a post-tax discount rate, or a rate that double-counts risks already in the cash flows
- Including cash flows from uncommitted restructurings or future capital expenditure that enhances performance
- Forecasts that are more optimistic than the budgets approved by management, or no sensitivity analysis on key assumptions
- Ignoring a market capitalisation below net assets as an indicator
- Allocating a CGU loss pro rata across all assets instead of goodwill first