Did you know that the world-wide economic crisis followed by the recession caused a sharp downfall of assets’ prices? In some countries, the prices of property fell by 30-50%!
Such a steep and fast decrease had an impact on the IFRS financial reporting, too. Companies showing assets in their accounts had to reassess their book value.
What should you do when you think the value of your assets went down? And how do you determine it?
That’s where the standard IAS 36 Impairment of Assets comes in. So let’s see what’s inside.
What is the objective of IAS 36?
The objective of IAS 36 Impairment of assets is to make sure that entity’s assets are carried at no more than their recoverable amount.
The Standard also defines when an asset is impaired, how to recognize an impairment loss, when an entity should reverse this loss and what information related to impairment should be disclosed in the financial statements.
The following scheme shows to what assets IAS 36 does and does not apply:
Basically, when you’re dealing with property, plant and equipment in line with IAS 16 or intangible assets in line with IAS 38, then you need to look to IAS 36, too.
What is an impairment of assets?
An asset is impaired when its carrying amount exceeds its recoverable amount.
Identify an asset that might be impaired
If you want to be compliant with IAS 36, you have to perform the following procedures:
- You need to assess whether there is any indication that an asset might be impaired at the end of each reporting period.
You don’t need to perform impairment testing if there’s no indication. However, you need to assess the existence of such an indication. - If you hold some intangible asset with an indefinite useful life (such as trademarks) or intangible asset not yet available for use, then you need to test these assets for impairment annually.
- If your accounting records show some goodwill acquired in a business combination, you also need to test this goodwill for impairment annually.
What are the indications of impairment?
External sources of information
- Observable indications that the asset’s value has declined during the period significantly more than would be expected as a result of the passage of time or normal use.
- Significant changes with an adverse effect on the entity in the technological, market, economic or legal environment in which the entity operates or in the market to which an asset is dedicated.
- Market interest rates or other market rates of return on investments have increased during the period, and those increases are likely to affect the discount rate used in calculating an asset’s value in use and decrease the asset’s recoverable amount materially.
- The carrying amount of the net assets of the entity is higher than its market capitalization.
Internal sources of information
- Obsolescence or physical damage of an asset.
- Significant changes with an adverse effect on the entity related to the use of an asset, for example: an asset becoming idle, plans to discontinue or restructure the operation to which an asset belongs, plans to dispose of an asset before the previously expected date, and reassessing the useful life of an asset as finite rather than indefinite.
- Evidence is available from internal reporting that indicates that the economic performance of an asset is, or will be, worse than expected.
Standard also outlines the indications related to subsidiaries, associates and joint ventures.
Measure recoverable amount
Recoverable amount is the higher of an asset’s (or cash-generating unit’s) fair value less costs of disposal and its value in use.
You don’t necessarily need to determine both of these amounts, because if just one of them is higher than asset’s carrying amount, then there’s no impairment.
When an individual asset does not generate cash inflows that are largely independent of those from other assets (or groups of assets), then you need to determine recoverable amount for the cash-generating unit (CGU) to which this asset belongs.
Fair value less costs of disposal
Rules and guidelines for measuring the fair value of any assets are set by the standard IFRS 13 Fair Value Measurement. This standard applies for all periods beginning on 1 January 2013 or later, so you need to make sure to take it into account.
Costs of disposal are for example legal costs, stamp duties and similar transaction taxes, costs of removing the asset and direct incremental costs to bring an asset into condition for its sale.
Value in use
Value in use is the present value of the future cash flows expected to be derived from an asset or cash-generating unit.
In order to determine value in use, you need take the following elements into account:
- An estimate of the future cash flows the entity expects to derive from the asset.
- Expectations about possible variations in the amount or timing of those future cash flows.
- The time value of money, represented by the current market risk-free rate of interest.
- The price for bearing the uncertainty inherent in the asset.
- Other factors, such as illiquidity, that market participants would reflect in pricing the future cash flows the entity expects to derive from the asset.
Estimating the value in use can usually be performed in 2 following steps:
Step 1: Estimate your future cash flows
When you measure value in use, you shall always base your cash flow 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 most recent financial budgets/forecasts but for a maximum period of 5 years.
- Extrapolation of cash flow projections for the periods beyond 5 years using a steady or declining growth rate for subsequent years.
In your cash flow estimations, you shall include:
- Projections of cash inflows from the continuing use of the asset.
- Projections of cash outflows to generate the cash inflows from continuing use of the asset and can be directly attributed, or allocated on a reasonable and consistent basis, to the asset.
- Net cash flows to be received (or paid) for the disposal of the asset at the end of its useful life.
In your cash flow estimations, you shall NOT include:
- Cash inflows from receivables.
- Cash outflows from payables.
- Cash outflows expected to arise from future restructurings to which an entity is not yet committed.
- Cash outflows expected to arise from improving or enhancing the asset’s performance.
- Cash inflows and cash outflows from financing activities.
- Income tax receipts and payments.
Let me also warn you about the inflation. You need to be consistent in projecting your cash flows and selecting your discount rate. You can either adjust your future cash flows by the inflation and use the nominal discount rate or alternatively you can project your future cash flows in the real terms and use the real discount rate.
Step 2: Determine discount rate
After projecting your cash flows you need to determine a discount rate used to calculate the present value.
The discount rate shall be a pre-tax rate that reflects current market assessment of both the time value of money and the risks specific to the asset for which the future cash flow estimates have not been adjusted.
The best way to select your discount rate is to look on the market and pick a market rate of return. Here, please be careful! Market rates of return are usually quoted as POST-tax rate and you need PRE-tax rate, so you need to determine pre-tax rate from post-tax rate yourself.
Recognize and measure an impairment loss
If the asset’s recoverable amount is lower than its carrying amount, then an entity must recognize an impairment loss as a difference between these 2 amounts.
An impairment loss shall be recognized to profit or loss or as a revaluation decrease if the asset is carried at revalued amount in line with other IFRS.
Don’t forget to adjust the depreciation in the future periods in order to reflect the asset’s new carrying amount.
Cash-generating units
A cash-generating unit is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets.
If you are not able to determine recoverable amount for an individual asset, then you might need to establish cash-generating unit to which this asset belongs.
For example, you might not be able to set the fair value less costs to sell for used 5 years-old pizza oven as the quotes might not be available. At the same time, you might not be able to calculate pizza oven’s value in use because you really cannot estimate future cash inflows from pizza oven – this pizza oven does not generate any cash inflows itself.
Therefore your need to establish cash-generating unit for this pizza oven – it would probably be the whole pizzeria.
In determining your cash-generating unit you need to be consistent from period to period to include the same asset or type of assets.
You need to be consistent in determining the carrying amount of cash-generating unit with determining recoverable amount of that unit. It means that you need to include the same assets in calculation of carrying amount and recoverable amount, too.
Goodwill
If there is a goodwill acquired in a business combination, then it must be allocated to each of the acquirer’s cash-generating units (or group of them) that are expected to benefit from the synergies of the combination.
Each unit to which the goodwill is allocated shall:
- Represent the lowest level within the entity at which the goodwill is monitored for internal management purposes; and
- Not be larger than an operating segment determined in accordance with IFRS 8 Operating Segments.
Goodwill should be tested for impairment on an annual basis.
A cash-generating unit (CGU) with allocated goodwill shall be tested for impairment at least annually. In this case testing means to compare:
- The carrying amount of CGU including the goodwill, and
- The recoverable amount of that CGU.
Corporate assets
Corporate assets are assets (other than goodwill) that contribute to the future cash flows of both the CGU under review and other CGUs.
The examples of corporate assets are a headquarters’ building, EDP equipment or a research center.
When you are testing a CGU, then you should first identify all the corporate assets that relate to the CGU under review.
Then, if a portion of the carrying amount of a corporate asset can be allocated to that unit on some reasonable and consistent basis, then you shall compare the carrying amount of that unit plus allocated portion of a corporate asset with its recoverable amount.
If such an allocation is not possible, then you go so-called bottom-up direction:
- You shall test the CGU without corporate asset for impairment first and recognize any impairment loss.
- Identify the smallest group of CGUs that includes the CGU under review and to which a portion of the carrying amount of the corporate asset can be allocated on a reasonable and consistent basis.
- Compare the carrying amount of that group of CGUs including the allocated portion of a corporate asset with the recoverable amount of the group of CGUs.
- Recognize impairment loss in line with the next paragraph.
Impairment loss of cash-generating unit
If the recoverable amount of CGU is lower than its carrying amount, then an entity shall recognize the impairment loss.
The impairment loss shall be allocated to reduce the carrying amount of the assets of the unit in the following order:
- Reduce the carrying amount of any goodwill allocated to the CGU.
- Allocate remaining impairment loss to the other assets of the unit pro rata on the basis of the carrying amount of each asset in the unit. These reductions are recognized as impairment losses on individual assets.
In allocating an impairment loss you must make sure that you don’t reduce the carrying amount of an asset below the highest of:
- Its fair value less cost of disposal;
- Its value in use;
- Zero.
Reversal of impairment loss
Here, you need to take the same approach as in identifying the impairment loss. You need to assess at the end of each reporting period whether there is any indication that an impairment loss recognized in prior periods for an asset (other than goodwill) may no longer exist or may have decreased.
You need to assess the same set of indications from external and internal sources than when assessing the existence of impairment, just from the other side.
You can reverse an impairment loss only when there is a change in the estimates used to determine the asset’s recoverable amount. It means that you cannot reverse an impairment loss due to passage of time or unwinding the discount.
Reversal of an impairment loss for an individual asset
You can reverse an impairment loss only when there is a change in the estimates used to determine the asset’s recoverable amount. It means that you cannot reverse an impairment loss due to passage of time or unwinding the discount.
Reversal of an impairment loss is recognized in the profit or loss unless it relates to a revalued asset. The increased carrying amount due to reversal should not be more than what the depreciated historical cost would have been if the impairment had not been recognized.
Also, you must not forget to adjust the depreciation for future periods to reflect revised carrying amount.
Reversal of an impairment loss for a cash-generating unit
When you reverse an impairment loss for a cash-generating unit, you need to allocate reversal to the assets of the unit (except for goodwill) pro rata with the carrying amounts of these assets.
The carrying amount of an assets shall not be increased above the lower of:
- Its recoverable amount and
- The carrying amount that would have been determined (net of amortization or depreciation) without any prior impairment loss.
Reversal of an impairment loss for goodwill
Reversal of an impairment loss for goodwill is prohibited.
Please watch the following video with the summary of IAS 36 Impairment of Assets here:
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