Impairing Cash-Generating Units (CGUs) - IAS 36 (With Examples)

What Is a Cash-Generating Unit?

A cash-generating unit (CGU) 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 (IAS 36.6).

Impairment is tested at asset level where possible. Many assets do not generate cash on their own, though: a delivery vehicle, a production line or a leased store only produce cash inflows together with other assets. Their value in use cannot be measured individually, so IAS 36 tests them as part of the CGU to which they belong.

Testing a CGU follows the same steps as testing a single asset, set out in impairment of assets under IAS 36:

1. Identify the CGU;
2. Determine its carrying amount, including allocated goodwill and corporate assets;
3. Determine its recoverable amount: the higher of fair value less costs of disposal (FVLCD) and value in use (VIU); and
4. If the carrying amount is higher, recognise an impairment loss and allocate it to the CGU's assets.

Identifying Cash-Generating Units

Identification starts with the individual asset and moves to the smallest group of assets whose cash inflows are largely independent. It is a matter of judgement. IAS 36.69 points to:

• How management monitors operations, for example by product line, business, location or region; and
• How management makes decisions about continuing or disposing of the entity's assets and operations.

Three principles apply:

• Inflows from outside parties. Only cash inflows from parties outside the entity count. Cost savings or internal recharges do not make a group of assets a CGU.
• Active markets override internal use. If an active market exists for the output of a group of assets, that group is a CGU even if its output is used internally. Its VIU is based on arm's length prices, not internal transfer prices.
• Consistency. CGUs are identified consistently from period to period unless a change is justified.

The following illustrate the judgement involved:

A leased store or office is typically part of a CGU in the same way. Specific points for leased assets are covered in impairment of right-of-use assets.

Carrying Amount of a CGU

The carrying amount must be determined on the same basis as the recoverable amount (IAS 36.75). Whatever generates the cash flows in the recoverable amount must be in the carrying amount, and nothing else.

Included:

• Assets that can be attributed directly, or allocated on a reasonable and consistent basis, to the CGU and that generate the cash inflows used in VIU;
• Goodwill allocated to the CGU; and
• The portion of corporate assets, such as a head office or shared IT platform, that can be allocated to the CGU on a reasonable basis.

Generally excluded:

• Recognised liabilities, such as borrowings and lease liabilities, unless the recoverable amount cannot be determined without them. A restoration obligation that a buyer would assume is the usual example: the liability is then deducted from both the carrying amount and VIU.
• Working capital, unless the recoverable amount includes the related cash flows. For practical reasons, receivables, inventory and payables are sometimes included on both sides.

Assets outside the scope of IAS 36, such as inventory and receivables, are measured under their own standards before the test. Even when they are included in the carrying amount, they do not absorb any of the impairment loss.

Goodwill and corporate assets that cannot be allocated to an individual CGU are tested with the smallest group of CGUs to which they can be allocated, as shown in corporate assets and goodwill across several CGUs.

Recoverable Amount of a CGU

The recoverable amount of a CGU is the higher of its FVLCD and its VIU, measured on the same principles as for an individual asset.

Fair value less costs of disposal. For a CGU, this is usually estimated using a valuation technique under IFRS 13, such as earnings multiples of comparable businesses or a discounted cash flow model based on market participant assumptions, less the costs of selling the business.

Value in use. The cash flow projections reflect the CGU in its current condition and exclude financing and tax cash flows. Points specific to CGUs:

• Overheads. Cash outflows necessarily incurred to generate the CGU's inflows, including head office costs allocated on a reasonable and consistent basis, are included.
• Transfer prices. Where a CGU's inflows or outflows are affected by internal transfer pricing, management's best estimate of arm's length prices is used, both for the CGU that sells and the one that buys.
• Consistency. Cash flows from assets excluded from the carrying amount, such as working capital, are excluded from VIU, and the reverse.

When to Test a CGU

A CGU is tested when:

• There is an indication of impairment for an asset whose recoverable amount cannot be determined individually; or
• There is an indication that the CGU itself may be impaired, such as a loss-making division.

A CGU to which goodwill or an indefinite-life intangible asset has been allocated is also tested at least annually. The annual test may be performed at any time during the year, provided it is at the same time each year, and different CGUs may be tested at different times.

The most recent detailed calculation of a goodwill CGU's recoverable amount from a prior period may be used if:

• The CGU's assets and liabilities have not changed significantly;
• The previous calculation showed a recoverable amount substantially above the carrying amount; and
• The likelihood that the current recoverable amount is below the carrying amount is remote.

Practical Example: Impairing a CGU

A manufacturer has a foundry and a machining plant. The foundry transfers all its castings to the machining plant at a transfer price below cost, and the machining plant sells finished components to customers. Castings are traded in an active market, so the foundry is a separate CGU.

New competitors have reduced market prices for castings, which is an indication of impairment. The foundry's assets are:

The lease liability for the furnace is excluded, because the lease payments are excluded from VIU as financing cash flows. The foundry's inventory is measured under IAS 2 and excluded, as are the cash flows from selling it.

Recoverable amount. The foundry's VIU, using arm's length market prices for castings and including its share of head office costs, is 4,860,000. Using the internal transfer price would have produced a lower VIU and overstated the foundry's impairment, while overstating the machining plant's cash flows. FVLCD is estimated at 4,500,000, so the recoverable amount is 4,860,000.

Impairment loss. The carrying amount of 5,400,000 exceeds the recoverable amount by 540,000. There is no goodwill, so the loss is allocated to the assets pro rata to their carrying amounts. None of the assets has an individual recoverable amount above its reduced carrying amount, so no floor applies.

Each asset is then depreciated on its revised carrying amount. Where a CGU contains goodwill, or an asset's floor prevents it from absorbing its full share, the allocation follows the additional steps in allocating impairment losses.

Disclosure

For a material impairment loss or reversal on a CGU, IAS 36.130 requires, among other items:

• A description of the CGU, such as a product line, plant, business operation or geographical area;
• The amount of the loss or reversal by class of assets; and
• If the aggregation of assets in the CGU has changed since the previous estimate, a description of the current and former aggregation and the reasons for the change.

For CGUs with significant goodwill or indefinite-life intangible assets, IAS 36.134 adds the key assumptions, the projection period, growth and discount rates, and sensitivity information.

Conclusion

A cash-generating unit is the smallest group of assets with largely independent cash inflows. Assets that cannot be tested individually are tested within their CGU, together with allocated goodwill and corporate assets. The carrying amount and recoverable amount are measured on the same basis, with liabilities and working capital included on both sides or on neither, and transfer prices replaced by arm's length prices where an active market exists.

When a CGU is impaired, the loss is allocated across its assets, first to goodwill and then pro rata, as set out in allocating impairment losses.

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