What Is an Impairment Loss?
Under IAS 36 Impairment of Assets, an asset is impaired when its carrying amount exceeds its recoverable amount. The recoverable amount is the higher of:
- Fair value less costs of disposal (FVLCD): what the asset could be sold for, net of selling costs; and
- Value in use (VIU): the present value of the cash flows the entity expects from using the asset and eventually disposing of it.
The asset is written down to its recoverable amount and the reduction is recognised as an impairment loss, normally in profit or loss. The logic is that an entity should not carry an asset at more than it can recover, whether by selling it or by using it.
| Step | Question | IAS 36 |
|---|---|---|
| 1 | Is there an indication of impairment, or is an annual test required? | Paragraphs 9-17 |
| 2 | Can the asset's recoverable amount be determined individually? If not, identify its cash-generating unit. | Paragraphs 22, 66-73 |
| 3 | Measure the recoverable amount: the higher of FVLCD and VIU. | Paragraphs 18-57 |
| 4 | Recognise and allocate any impairment loss. | Paragraphs 58-64, 104-108 |
| 5 | At each later reporting date, assess whether the loss should be reversed. | Paragraphs 109-125 |
Where several assets are tested together, the loss must be spread across them in a set order. That allocation is covered in detail in allocating impairment losses.
Scope
IAS 36 applies to most non-financial assets: property, plant and equipment, right-of-use assets, intangible assets, goodwill, investment property at cost, and investments in subsidiaries, associates and joint ventures in separate financial statements that are not measured under IFRS 9.
It does not apply to assets that have their own measurement or impairment requirements:
- Inventories (IAS 2);
- Contract assets and contract costs (IFRS 15);
- Deferred tax assets (IAS 12);
- Employee benefit assets (IAS 19);
- Financial assets within the scope of IFRS 9;
- Investment property measured at fair value (IAS 40);
- Biological assets measured at fair value less costs to sell (IAS 41); and
- Non-current assets classified as held for sale (IFRS 5).
These assets are measured under their own standards first. When they form part of a group of assets tested under IAS 36, they can be included in the carrying amount being tested, but they never absorb any part of an IAS 36 impairment loss.
Link with IFRS 5
A decision to sell an asset is itself an indicator of impairment. An asset is therefore tested under IAS 36 immediately before it is classified as held for sale, after which IFRS 5 measures it at the lower of carrying amount and fair value less costs to sell.
When to Test for Impairment
At the end of each reporting period, an entity assesses whether there is any indication that an asset may be impaired. A full impairment test is required only if an indication exists. IAS 36.12 lists the minimum indicators to consider:
| External sources | Internal sources |
|---|---|
| A significant decline in the asset's market value | Evidence of obsolescence or physical damage |
| Adverse changes in the technological, market, economic or legal environment | Plans to discontinue or restructure the operation, or to dispose of the asset early |
| Increases in market interest rates that affect the discount rate used in VIU | An asset that was in use becoming idle |
| The entity's net assets exceeding its market capitalisation | Internal reports showing economic performance is, or will be, worse than expected |
The assessment is subject to materiality. If previous calculations showed a recoverable amount well above carrying amount and nothing has since eliminated that headroom, a new estimate is not required.
Annual testing regardless of indicators. The following are tested at least annually, at the same time each year (not necessarily at the reporting date):
- Goodwill acquired in a business combination;
- Intangible assets with an indefinite useful life; and
- Intangible assets not yet available for use.
Revise estimates first. An indicator of impairment may also mean the asset's useful life, depreciation method or residual value needs to be revised under IAS 8, even if no impairment loss arises. Any revision is made first; the revised carrying amount is then compared with the recoverable amount.
Recoverable Amount
The recoverable amount is the higher of FVLCD and VIU. Using the higher amount reflects the assumption that a rational entity will either sell the asset or keep using it, whichever recovers more.
Both measures are not always needed:
- If either measure exceeds the carrying amount, the asset is not impaired and the other measure need not be estimated.
- If there is no reason to believe VIU materially exceeds FVLCD, FVLCD may be used as the recoverable amount. This is typical of an asset held for disposal, where the cash flows from continued use are minimal.
- If fair value cannot be measured reliably, VIU is used as the recoverable amount.
The recoverable amount is determined for an individual asset unless the asset does not generate cash inflows that are largely independent of those from other assets. In that case it is determined for the asset's cash-generating unit.
Fair Value Less Costs of Disposal
Fair value is measured under IFRS 13: the price that would be received to sell the asset in an orderly transaction between market participants. IFRS 13 fair value excludes transaction costs, which is why IAS 36 deducts them separately.
Costs of disposal are incremental costs directly attributable to the disposal, such as legal costs, stamp duty, removal costs and costs to bring the asset into a condition for sale. They exclude:
- Finance costs and income tax expense;
- Costs already recognised as liabilities, which would otherwise be deducted twice; and
- Termination benefits and costs of reorganising the business after the disposal, which are not directly incremental to selling the asset.
Example
A company intends to sell a machine, but it does not yet meet the IFRS 5 held-for-sale criteria. At year-end:
- The machine's fair value is 420,000.
- Legal fees of 30,000 for drafting the sale agreement have been incurred and accrued as a liability.
- Removal and transport costs of 15,000 will be incurred on disposal.
- Severance pay of 25,000 is expected for the machine operators who will be retrenched.
| Item | Amount |
|---|---|
| Fair value | 420,000 |
| Removal and transport costs | (15,000) |
| Legal fees (already recognised as a liability) | - |
| Severance pay (termination benefit, not a cost of disposal) | - |
| Fair value less costs of disposal | 405,000 |
Value in Use
Value in use is the present value of the future cash flows expected from the asset's continuing use and eventual disposal. It involves two steps: estimating the cash flows and discounting them at an appropriate rate.
Cash flows
Cash flow projections are based on reasonable and supportable assumptions, and on the most recent budgets approved by management:
- Budget period. Budgets cover a maximum of five years unless a longer period can be justified. Beyond that, cash flows are extrapolated using a steady or declining growth rate that does not exceed the long-term average for the products, industry or country.
- Current condition. Cash flows reflect the asset in its current condition. They exclude outflows to improve or enhance the asset and the related inflows, and the effects of a future restructuring to which the entity is not yet committed.
- Day-to-day servicing is included. Outflows to maintain the asset's current level of performance, including replacing components, are included.
- Financing and tax are excluded. Interest, loan repayments and income tax receipts and payments are excluded.
- Disposal. The net cash flow expected on disposal at the end of the asset's useful life is included. This is an estimate of future proceeds, not the residual value used for depreciation.
- Inflation. Cash flows and the discount rate must be consistent: nominal cash flows with a nominal rate, or real cash flows with a real rate.
- Foreign currency. Cash flows are estimated in the currency in which they will be generated and discounted at a rate appropriate to that currency. The present value is then translated at the spot rate on the date of the calculation.
Discount rate
The discount rate is a pre-tax rate reflecting the time value of money and the risks specific to the asset that have not already been reflected in the cash flows. A post-tax rate such as a weighted average cost of capital can be a starting point, but it must be adjusted to a pre-tax equivalent.
Avoid counting risk twice
Risk can be reflected either by adjusting the cash flows (for example, probability-weighting higher costs) or by adding a premium to the discount rate, but not both. Both approaches should produce the same present value.
Practical Example
A packaging line has a remaining useful life of five years. Management's approved budget includes the following items. The pre-tax discount rate is 12%.
| Budget item | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Treatment |
|---|---|---|---|---|---|---|
| Net cash flows from operating the line in its current condition | 400,000 | 550,000 | 480,000 | 480,000 | 480,000 | Include |
| Upgrade to increase output | - | (250,000) | - | - | - | Exclude: enhancement |
| Additional inflows from the upgrade | - | - | 150,000 | 150,000 | 150,000 | Exclude: enhancement |
| Replacement of a worn component | - | - | (120,000) | - | - | Include: maintains current performance |
| Savings from a restructuring not yet committed to | - | - | - | - | 180,000 | Exclude: not committed |
| Interest on the equipment loan | (60,000) | (60,000) | (60,000) | (60,000) | (60,000) | Exclude: financing |
| Net proceeds on disposal | - | - | - | - | 80,000 | Include |
| Cash flows used in VIU | 400,000 | 550,000 | 360,000 | 480,000 | 560,000 |
Discounted at 12%, the VIU is 1,674,648. The line's fair value less costs of disposal is 1,560,000, so the recoverable amount is the higher VIU of 1,674,648.
Recognising an Impairment Loss
When the recoverable amount is below the carrying amount, the asset is written down and the impairment loss is recognised:
- In profit or loss, for assets carried at cost; or
- In other comprehensive income first, for assets carried at a revalued amount under IAS 16 or IAS 38. The loss reduces the revaluation surplus for that asset, and only the excess over the surplus is recognised in profit or loss.
If the impairment loss exceeds the asset's carrying amount, a liability is recognised only if another standard requires it.
After the impairment, depreciation is based on the revised carrying amount, less residual value, over the remaining useful life.
Practical Example
Continuing the packaging line above, its carrying amount before the test is 1,900,000 and its tax base is 1,500,000. The tax rate is 27%.
| Carrying amount | Tax base | Temporary difference | Deferred tax liability | |
|---|---|---|---|---|
| Before impairment | 1,900,000 | 1,500,000 | 400,000 | 108,000 |
| Impairment loss | (225,352) | - | (225,352) | (60,845) |
| After impairment | 1,674,648 | 1,500,000 | 174,648 | 47,155 |
| Account | Debit | Credit | |
|---|---|---|---|
| Dr | Impairment loss (P/L) | 225,352 | |
| Cr | Accumulated depreciation and impairment losses (SFP) | 225,352 | |
| Dr | Deferred tax liability (SFP) | 60,845 | |
| Cr | Income tax expense (P/L) | 60,845 |
The tax base is unaffected because tax allowances are based on cost, so the impairment reduces the taxable temporary difference. See deferred tax for the underlying mechanics.
Cash-Generating Units
Many assets do not generate cash on their own. A forklift in a warehouse, a production line feeding a factory, or a corporate head office contribute to cash flows only together with other assets. Their VIU cannot be determined individually, so they are tested as part of a cash-generating unit (CGU): the smallest identifiable group of assets that generates cash inflows largely independent of the cash inflows from other assets.
Identifying CGUs.
- Cash inflows are inflows from parties outside the entity. However, 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 then based on arm's length prices, not internal transfer prices.
- CGUs are identified consistently from period to period unless a change is justified.
Carrying amount of a CGU. The carrying amount must be determined on the same basis as the recoverable amount. It includes the assets that generate the cash flows used in the recoverable amount and generally excludes recognised liabilities. A liability is included only when the recoverable amount cannot be determined without it, such as a restoration obligation a buyer would have to assume.
For example, a quarry is a single CGU with assets carried at 1,150,000 and a restoration provision of 600,000 that any buyer would take over. Its FVLCD, which reflects the buyer assuming the obligation, is 900,000. Its VIU before restoration outflows is 1,400,000. To compare like with like, the provision is deducted from both sides: the CGU's carrying amount is 550,000 and its VIU is 800,000. The recoverable amount of 900,000 exceeds 550,000, so the quarry is not impaired.
Goodwill and corporate assets. Goodwill and corporate assets such as a head office or shared IT platform never generate independent cash flows. They are allocated to the CGUs that benefit from them and tested as part of those CGUs. CGUs carrying goodwill are tested at least annually.
When a CGU is impaired, the loss is applied first to goodwill and then to the other assets pro rata, subject to a floor for each asset. The detailed rules, including corporate assets, non-controlling interests and the order of testing, are set out in allocating impairment losses.
No CGU impairment, no asset impairment
If an asset's recoverable amount cannot be determined individually and its CGU is not impaired, no impairment loss is recognised for that asset, even if its fair value less costs of disposal is below its carrying amount.
Right-of-Use Assets
Right-of-use assets recognised under IFRS 16 are within the scope of IAS 36. A leased store, office or vehicle seldom generates independent cash inflows, so it is usually tested as part of a CGU, such as a store or a business segment.
Because lease payments are financing cash flows, they are excluded from the VIU cash flows, and the lease liability is generally excluded from the CGU's carrying amount. If the lease liability is deducted in arriving at the recoverable amount, it is deducted from the carrying amount too, so that both sides are measured consistently.
For leases recognised on the statement of financial position, a loss-making lease is reflected by impairing the right-of-use asset rather than by recognising an onerous lease provision under IAS 37. Store closures, a decision to vacate premises or subletting at a lower rent than the head lease are common indicators. See impairment of right-of-use assets for an example.
Reversing an Impairment Loss
At each reporting date, an entity assesses whether there is an indication that an impairment loss recognised in prior periods no longer exists or has decreased. The indicators mirror those for impairment. If one exists, the recoverable amount is estimated again.
- A change in estimates is required. A loss is reversed only if the estimates used to determine the recoverable amount have changed since the loss was recognised. An increase in VIU caused only by the passage of time, as the discounting unwinds, is not a reversal.
- Cap. The increased carrying amount cannot exceed the carrying amount, net of depreciation, that would have been determined had no impairment loss been recognised.
- Recognition. A reversal is recognised in profit or loss, unless the asset is carried at a revalued amount, in which case it is a revaluation increase in other comprehensive income (to the extent a previous loss on that asset was not recognised in profit or loss).
- Depreciation. Future depreciation is based on the new carrying amount.
- Goodwill. An impairment loss on goodwill is never reversed.
Example
A machine costs 500,000 and is depreciated over five years with no residual value.
- At the end of Year 1, its carrying amount is 400,000 and its recoverable amount is 320,000. An impairment loss of 80,000 is recognised.
- In Year 2, depreciation is 80,000 (320,000 ÷ 4), leaving a carrying amount of 240,000.
- At the end of Year 2, improved market conditions increase the recoverable amount to 330,000.
| End of Year 2 | Amount |
|---|---|
| Recoverable amount | 330,000 |
| Carrying amount had no impairment been recognised (500,000 − 2 × 100,000) | 300,000 |
| Limited to the lower of the two | 300,000 |
| Current carrying amount | (240,000) |
| Reversal recognised in profit or loss | 60,000 |
Depreciation for Years 3 to 5 is 100,000 a year (300,000 ÷ 3). Reversals in a CGU are allocated across its assets, as shown in reversing impairment losses in a CGU.
Disclosure
The main disclosures are:
- For each class of assets (IAS 36.126): impairment losses and reversals recognised in profit or loss and the line items that include them, and impairment losses and reversals recognised in other comprehensive income.
- For each material impairment loss or reversal (IAS 36.130): the events and circumstances that led to it, the amount, the nature of the asset or a description of the CGU, whether the recoverable amount is FVLCD or VIU, and the discount rate used in a VIU calculation or the fair value hierarchy level for FVLCD.
- For aggregate losses not individually disclosed (IAS 36.131): the main classes of assets affected and the main events and circumstances.
- For CGUs containing significant goodwill or indefinite-life intangible assets (IAS 36.134): the carrying amount of goodwill and those intangibles, the basis for the recoverable amount, the key assumptions, the period of the projections, the growth rate used to extrapolate them, the discount rate and, where a reasonably possible change in a key assumption would cause an impairment, a sensitivity analysis.
An example of a note for a material individual impairment loss:
An impairment loss of 225,352 was recognised on a packaging line, included in other operating expenses. A new competitor entering the market reduced the expected cash flows from the line. The recoverable amount of 1,674,648 is its value in use, determined using a pre-tax discount rate of 12%.
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Conclusion
IAS 36 ensures assets are not carried above the amount they can recover. An asset is tested when there is an indication of impairment, or annually for goodwill and certain intangible assets, by comparing its carrying amount with the higher of fair value less costs of disposal and value in use. Value in use is based on the asset in its current condition, on pre-tax cash flows excluding financing, and on a pre-tax discount rate.
Where an asset does not generate independent cash flows, it is tested as part of a cash-generating unit, and the resulting loss is allocated across the unit's assets in the order set out in allocating impairment losses. Impairment losses on assets other than goodwill are reversed when the estimates improve, up to the carrying amount that would have applied without the impairment.
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