IAS 36 How Impairment test

IAS 36 How Impairment test is all about this – When looking at the step-by-step IAS 36 impairment approach it comes down to the following broadly organised steps: IAS 36 How Impairment test

  • What?? – Determining the scope and structure of the impairment review, explained here,
  • If and when? – Determining if and when a quantitative impairment test is necessary, explained here,
  • IAS 36 How Impairment test or understanding the mechanics of the impairment test and how to recognise or reverse any impairment loss, if necessary. Which is explained in this section…

The objective of IAS 36 Impairment of assets is to outline the procedures that an entity applies to ensure that its assets’ carrying values are not stated above their recoverable amounts (the amounts to be recovered through use or sale of the assets). To accomplish this objective, IAS 36 Impairment of assets provides guidance on:

  • the level at which to review for impairment (eg individual asset level, CGU level or groups of CGUs), explained here,
  • if and when a quantitative impairment test is required, including the indicator-based approach for an individual asset that is not goodwill, an indefinite life intangible asset or intangible asset not yet ready for use, explained here,
  • how to perform the quantitative impairment test by estimating the asset’s (or CGU’s) recoverable amount, Which is explained in this section…
  • how to recognise an impairment loss, Which is explained in this section…
  • when and under what circumstances an entity must reverse an impairment loss (Which is explained in this section…) and finally,
  • disclosure requirements (IAS 36.1). IAS 36 How Impairment test

This Section covers the following Steps:

Step 4: Estimate the recoverable amount

Step 5: Compare recoverable amount with carrying amount

Step 6: Recognise or reverse any impairment loss.

Step 4: Estimate the recoverable amount

The following steps are explained in Step 4: Estimate the recoverable amount

impairment

1. Recoverable amount

Defining recoverable amount and related terms (IAS 36.6)

The recoverable amount of an asset or a CGU is the higher of its fair value less costs of disposal (FVLCOD) and its value in use (VIU).

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

Costs of disposal are incremental costs directly attributable to the disposal of an asset or CGU, excluding finance costs and income tax expense.

Value in use is the present value of the future cash flows expected to be derived from an asset or CGU.

Or in summary: IAS 36 How Impairment test IAS 36 How Impairment test

IAS 36 How Impairment test

Therefore, an impairment test involves estimating both FVLCOD and VIU and comparing the higher amount to the asset’s carrying amount. Exception to calculating both FVLCOD and VIU discusses the circumstances in which it is unnecessary to estimate both FVLCOD and VIU.

2 Fair value less costs of disposal

The ‘fair value’ and ‘costs of disposal’ elements of FVLCOD are discussed in turn below. IAS 36 How Impairment test

Fair value

The FVLCOD component of recoverable amount applies whether or not management currently intends to sell the asset. While IAS 36 previously included its own hierarchy of guidance to determine fair value, this has now been superseded by IFRS 13 ‘Fair Value Measurement’ (issued May 2011).

The key term in IFRS 13 that drives measurement is fair value: the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is an exit price (e.g. the price to sell an asset rather than the price to buy that asset).

An exit price embodies expectations about the future cash inflows and cash outflows associated with an asset or liability from the perspective of a market participant (i.e. based on buyers and sellers who have certain characteristics, such as being independent and knowledgeable about the asset or liability).

Fair value is a market-based measurement, rather than an entity-specific measurement, and is measured using assumptions that market participants would use in pricing the asset or liability, including assumptions about risk. As a result, an entity’s intention to hold an asset or to settle or otherwise fulfill a liability is not relevant in measuring fair value.

Fair value is measured assuming a transaction in the principal market for the asset or liability (i.e. the market with the highest volume and level of activity). In the absence of a principal market, it is assumed that the transaction would occur in the most advantageous market.

This is the market that would maximize the amount that would be received to sell an asset or minimize the amount that would be paid to transfer a liability, taking into account transaction and transportation costs. In either case, the entity needs to have access to that market, although it does not necessarily have to be able to transact in that market on the measurement date. IAS 36 How Impairment test

A fair value measurement is made up of one or more inputs, which are the assumptions that market participants would make in valuing the asset or liability. The most reliable evidence of fair value is a quoted price in an active market. When this is not available, entities use a valuation approach to measure fair value, maximizing the use of relevant observable inputs and minimizing the use of unobservable inputs. IAS 36 How Impairment test

Consider this – Estimating fair value

Background

An entity operates in the hotels sector. Management is testing a hotel for impairment for which the internal budget and cash flow forecasts include outflows and inflows relating to a significant enhancement planned to start in two years’ time.

This will involve temporary closure and undertaking a major upgrade from four to five star status. Management has determined that fair value and FVLCOD should be estimated using an income approach (ie a discounted cash flow approach).

Management is aware of IAS 36.44’s requirement that, for VIU purposes, an asset’s future cash flows should be estimated based on the asset’s current condition. Management is considering whether, for the purposes of estimating FVLCOD using an income approach, adjustments are also required to exclude cash flows from the planned upgrade.

Analysis

A fair value estimate takes into account characteristics of an asset that market participants would take into account in pricing the item. Put another way, when estimating fair value and FVLCOD (in the absence of a quoted price), management should aim to use inputs and assumptions consistent with those that prospective buyers would use.

Accordingly, although FVLCOD should be based on the hotel’s current condition, IAS 36.44’s requirement to exclude cash flows relating to enhancements when estimating VIU does not apply in the same way when estimating FVLCOD. Cash flows relating to the upgrade would therefore be included if market participants would consider these in their pricing decisions.

This does not mean that management’s budget and cash flow forecasts can simply be used without adjustment: various adjustments may be required to ensure that the estimates are unbiased and consistent with the assumptions that market participants would make.

Costs of disposal

Costs of disposal are incremental costs directly attributable to the disposal of an asset or CGU, excluding finance costs and income tax expense (and any other costs that have already been recognised as liabilities in the statement of financial position). Potential Cases of costs of disposal that should be deducted to derive the FVLCOD include:

  • legal costs
  • stamp duty and similar transaction taxes
  • costs of removing the asset
  • direct incremental costs to bring an asset into condition for its sale (IAS 36.28).

3 Value in use

VIU in effect assumes that the asset will be recovered principally through its continuing use and ultimate disposal. VIU is therefore ‘entity-specific’ in that it reflects the entity’s intentions as to how an asset will be used.

VIU therefore differs from fair value because fair value reflects the assumptions that market participants would use when pricing the asset. Fair value does not reflect any of the following factors to the extent they would not be generally available to market participants:

  • additional value derived from grouping assets
  • synergies between the asset being measured and other assets
  • legal rights or legal restrictions that are specific only to the current owner of the asset
  • tax benefits or tax burdens that are specific to the current owner of the asset (IAS 36.53A(a) – (d)).

Estimating VIU involves the following:

  • estimating the future cash inflows and outflows to be derived from continuing to use the asset and from its ultimate disposal (IAS 36.31(a))
  • applying the appropriate discount rate to those future cash flows (IAS 36.31(b)).

3.1 Estimating the future cash inflows and outflows

3.2 Applying the appropriate discount rate

The VIU estimate incorporates the following risk factors, either as adjustments to the cash flows or as adjustments to the discount rate, but not both:

  • expectations about possible variations in the amount or timing of those future cash flows (IAS 36.30(b))
  • the price for bearing the uncertainty inherent in the asset (IAS 36.30(d))
  • other factors, such as an illiquid market, that market participants would reflect in pricing the future cash flows that the entity expects to derive from the asset (IAS 36.30(e)).

Approaches to incorporating risk in present value

Appendix A to IAS 36 discusses two broad approaches to incorporating risk in the present value estimate:

The ultimate objective is to reflect the expected present value of the future cash flows, while incorporating possible variations in the amount or timing of future cash flows (IAS 36.32). The following table briefly describes each approach at a high level.

Traditional approach

The traditional approach uses the single most likely cash flow projection and assumes that a single discount rate can incorporate all the expectations about the future cash flows and the appropriate risk premium. Therefore, the traditional approach places the most emphasis on the selection of a discount rate (IAS 36.A.4).

Expected cash flow approach

The expected cash flow approach uses all expectations about possible cash flows (instead of a single most likely cash flow) and applies probabilities to the estimated cash flows. As some risk assessment is incorporated into the cash flows using the expected cash flow approach, generally, a lower discount is applied when compared to the traditional approach.

The rest of this Section breaks down these elements (estimating future cash flows and determining the appropriate discount rate) in estimating VIU.

3.1 Estimating the future cash inflows and outflows

The starting point for estimating future cash flows is the most recent financial budget or forecast approved by management. From this starting point, the budget or forecast typically needs to be both adjusted and extrapolated. IAS 36 specifically requires that these budgets/forecasts are adjusted to:

  • exclude any estimated future cash inflows/outflows expected to arise from future restructuring or
  • improving or enhancing the asset’s performance (IAS 36.33(b))
  • exclude cash inflows or outflows from financing activities or income tax receipts/payments (IAS 36.50)
  • include costs for day-to-day servicing, future directly attributable overheads (IAS 36.41) and cash flows necessary to maintain the level of economic benefits expected to arise from the asset in its current condition (IAS 36.49)
  • cover a maximum period of five years (unless a longer period can be justified) (IAS 36.33(b)). Cash
  • flow projections needed beyond the period covered must be estimated by extrapolating the budget/ forecast projections using a steady or declining growth rate for subsequent years (unless an increasing rate can be justified) (IAS 36.33(c))
  • incorporate net cash flows, if any, to be received (or paid) for the disposal of the asset at the end of its useful life (IAS 36.39(c)).

This list of adjustments is not exhaustive. The specific adjustments required in each case will naturally vary depending upon the basis of the budgets or projections used as a starting point and the nature of expected cash flows. As an overarching principle, it is also essential to ensure that the estimates and projections are based on reasonable and supportable assumptions (IAS 36.33(a), 34, 38).

The figure below summarises how to estimate future cash flows. Each consideration is discussed in further detail below.

IAS 36 How Impairment test

A. Exclude restructuring and anticipated cash flows from improving or enhancing asset performance

Cash flows should be estimated for an asset based on the asset’s current condition. Therefore, the estimated future cash flows should not incorporate:

  • cash flows related to future restructuring to which an entity is not yet committed (eg cost savings for reductions in staff costs) or
  • cash flows related to improving or enhancing the asset’s performance (IAS 36.44).

Restructuring

Estimates of future cash inflows and outflows should include any projected cost savings and other benefits of a future restructuring only when the entity becomes committed to the restructuring (IAS 36.47(a)).

Once the entity is committed to the restructuring, it will meet the requirements in IAS 37 ‘Provisions, Contingent Liabilities and Contingent Assets’ (IAS 37) to recognise a provision (see Section E.4.4 for discussion of the interaction between IAS 36 and IAS 37). The estimates of future cash outflows for restructuring will, at that time, be included in the restructuring provision in accordance with IAS 37 (IAS 36.47(b)).

IFRS Guidance note: Effects of future restructuring when estimating VIU

Case 5 in the Illustrative Cases accompanying IAS 36 explains how a restructuring affects the VIU calculation for a CGU. It shows the effects of the restructuring (costs and benefits) being excluded from the cash flow estimates prior to the entity being committed to it.

Once the entity is committed, which is itself a potential indicator of impairment reversal, the benefits expected from the restructuring are considered in forecasting the future cash flows. A provision is also recognised for the restructuring.

Improving or enhancing an asset’s performance

Until an entity actually incurs cash outflows that improve or enhance the asset’s performance, estimates of future cash flows do not include the estimated future cash inflows that are expected to arise from the enhancement (IAS 36.48).

Case – Improving or enhancing an asset’s performance

Background

At the reporting period-end date (31 December 20X0), there is an indication that asset A may be impaired. Management estimates asset A’s recoverable amount on the basis of a VIU calculation. Management’s approved budgets reflect:

  1. estimated cash flows necessary to maintain the level of economic benefit expected to arise from asset A in its current condition and

  2. that in 20X2, management plans to incur CU50,000 to enhance asset A’s performance.

Should Management include both (a) and (b) in its estimation of VIU in 20X0?

Analysis

No. At 31 December 20X0, the future cash flows used to determine VIU should include estimated costs necessary to maintain the level of economic benefit expected to arise from asset A in its current condition but exclude any estimated costs to enhance asset A’s performance and the estimated benefits anticipated from enhancing its performance.

B. Exclude financing activities or income tax receipts/payments

Because the time value of money is considered by discounting the estimated future cash flows, the cash flows used to estimate VIU exclude cash inflows and outflows from financing activities. Similarly, because the VIU and discount rate are determined on a pre-tax basis, future cash flows are estimated on a pre-tax basis (IAS 36.51). See this link for more discussion on pre-tax vs. post-tax cash flows and discount rates.

C. Include day-to-day servicing and cash flows to maintain the level of economic benefit from the asset in its current condition

The premise underlying VIU is that the carrying value of the asset will be recovered through its continued use and ultimate disposal. Therefore, all cash outflows that are necessary to maintain the level of economic benefits expected to arise from the asset in its current condition should be included.

These future cash outflows include day-to-day servicing of the asset, as well as overheads that can be directly attributed, or allocated on a reasonable and consistent basis, to the asset.

When a CGU consists of assets with different estimated useful lives (all of which are essential to the ongoing operation of the unit), the replacement of assets with shorter lives and the replacement of a component of a single asset are considered to be part of the day-to-day servicing of the unit/asset when estimating the future cash flows associated with the unit/asset (IAS 36.41, 49).

Case – Day-to-day servicing and the consideration of the ‘core’ asset

IAS 36 requires that the replacement of component parts necessary to maintain the cash inflows from the continued use of an asset are treated as cash outflows when estimating VIU. These components could include items that might be treated as separate depreciable components in accordance with IAS 16 ‘Property, Plant and Equipment’ (IAS 16) (eg the lining of a furnace, the seating of an aircraft, the roof of a building).

When estimating the VIU of a single asset, identifying the ‘core’ asset is straightforward (eg the furnace, aircraft or entire building). For Case, when estimating the VIU of an airplane with an estimated useful life of 30 years, the entity would include the cash outflows for the day-to-day servicing and replacement of the components of the aircraft that have shorter useful lives such as the seating and engines.

The application of IAS 36.41 and 49 requires more judgement when estimating VIU for a CGU, or group of CGUs, if goodwill is being tested. If goodwill is treated as the core asset, the CGU’s future life might be considered indefinite and the cash flows would include the replacement of the other assets within the CGU (in order to maintain the goodwill). If a particular identifiable asset is considered the core asset then the cash flows and useful life would be based on the useful life of that asset.

In general, the appropriate approach will depend on the entity’s business model and the particular facts and circumstances of the impairment test in question. For Case, when assessing a hotel for impairment as part of a CGU with goodwill, the entity may deem the hotel to be the core asset as the cash flows from the hotel presumably support the life of the goodwill (there would not be goodwill without the core asset of the hotel).

In practice, when calculating the VIU of a CGU that includes goodwill, it is common to include a terminal value at the end of the specific projection period. This terminal value should be based on the ‘normalised’ forecast cash flows in the final period of the detailed budget or projection period, extrapolated using the long-term steady or declining growth rate and discounted to present value. The terminal value therefore takes account of a normalised level of cash flows for day-to-day servicing including replacement parts.

Consider this – Including directly attributable (or reasonably allocated) future overheads

IAS 36.41 requires that projections of cash outflows include those for ‘…future overheads that can be attributed directly, or allocated on a reasonable and consistent basis, to the use of the asset’. The Standard does not expand on what such ‘future overheads’ may be included.

In general, the key objective should be to ensure that the projections include all estimated outflows necessary to generate the estimated inflows. For Case, a magazine company may identify two CGUs for impairment testing purposes (an online segment and a print segment). It is likely to be appropriate to allocate central marketing costs to the relevant CGUs where such costs are directly attributable or reasonably allocated.

Also, as noted in Step 2 Corporate assets, when a portion of a corporate asset is allocated to a CGU then this typically indicates that a portion of the cash outflows associated with the corporate asset should also be allocated.

However, applying this guidance requires judgement and will depend on the facts and circumstances.

Something else -   Third-party pricing service in fair value measurement

Cash outflows incurred before the asset is ready for use or sale

IAS 36 requires an entity to include an estimate of any further cash outflow that is expected to be incurred before the asset is ready for use or sale when the carrying amount of the asset does not yet include all the cash outflows to be incurred before it is ready for use or sale (eg building under construction or development project that is not yet completed) (IAS 36.42).

Consider this – Considerations for capitalised development projects

IAS 36 requires that intangible assets not yet ready for use are tested for impairment at least annually and at the end of the current annual period if initially recognised during the current annual period (IAS 36.10(a)). Capitalised development projects/assets require further development before they are ready for commercial use.

IAS 36.42 requires an entity to include an estimate of any further cash outflow that is expected to be incurred before the asset is ready for use (or sale) when the carrying amount of the asset does not yet include all the cash outflows to be incurred before it is ready for use (or sale) (eg a development project that is not yet completed).

This is an exception to the general principle that an asset is tested for impairment in its current condition (IAS 36.44).

When estimating VIU, in general, estimated future expenditure (including expenditure that does not yet meet the capitalisation criteria) and estimated cash inflows from potentially successful projects should be included in the cash flow estimates. When there is uncertainty about a project ultimately reaching commercialisation (as may be the case for acquired research and development costs, for Case) this risk should be taken into account.

Keep in mind to look for a situation in which, risk and uncertainty can be factored in either by adjusting the cash flows or by adjusting the discount rate.

In some cases the projections used for testing capitalised development project assets may (appropriately) extend beyond the normal five year period that IAS 36.35 sets as a benchmark for the availability of detailed, explicit and reliable financial budgets/forecasts.

(In estimating FVLCOD for a capitalised development project, the entity’s objective should be to use assumptions consistent with a market participant perspective. These would normally include a market-based perspective on the probability of the project reaching commercialisation.)

D. Extrapolate projections based on budget/forecast information beyond the period covered

IAS 36 asserts that detailed and reliable budget/forecast information for periods longer than five years is not usually available. Estimates of future cash flows should therefore normally be based on the most recent budgets/forecasts covering no longer than this, and then extrapolated if necessary (see below – Consider this – Extrapolating future cash flows).

An exception to the five year limit applies if management can demonstrate its ability to forecast cash flows accurately over a longer period (IAS 36.33(b), 35).

Assets with useful lives longer than the budget/forecast cash flows should be extrapolated using a growth rate for subsequent years. This rate is steady or declining, unless an increase in the rate matches objective information about patterns over a product or industry lifecycle. A growth rate of zero, or a negative rate, might also be appropriate (IAS 36.36).

IAS 36 notes that entities will generally have difficulty exceeding the average historical growth rate over the long term (IAS 36.37).

Consider this – Extrapolating future cash flows

IAS 36 implies, but does not state explicitly, that the final period covered by a detailed budget or forecast (normally up to five years in duration) should be used as the ‘baseline’ for extrapolating cash flows into the future. This approach is reasonable for projecting future cash flows for an established, ‘going concern’ CGU in a reasonably stable state.

In other scenarios, such as start-ups or limited life projects or assets, other approaches may be more appropriate. It is also important to ensure that the baseline used for extrapolation is not affected by non-recurring factors (eg a planned shutdown that occurs less than annually). The approach taken will require judgement based on the particular circumstances.

E. Incorporate disposal proceeds

An estimate of the net cash flow to be received (or paid) for the disposal of an asset at the end of its useful life should be included in determining the estimated future cash flows (IAS 36.39(c)). This estimate is determined in a similar manner to determining FVLCOD, except that, in estimating those net cash flows, the entity:

  • uses prices at the date of the estimate for similar assets that have reached the end of their useful life and operated under similar conditions (IAS 36.53(a))
  • adjusts prices for general inflation and specific future price increases or decreases (IAS 36.53(b)) (although general inflation is not taken into account if the future cash flows from continuing use and discount rate exclude the effect of general inflation) (IAS 36.53(b)).
F. Reflect reasonable and supportable assumptions

It is an overarching principle of the VIU estimate that assumptions should be ‘reasonable and supportable’. IAS 36 includes a requirement under which management should compare past projections with actual cash flows to ensure that the assumptions on which current projections are based are consistent with past actual outcomes (IAS 36.34).

IAS 36 requires consideration of whether the budget/forecast information used as the basis for the cash flow estimates reflects reasonable and supportable assumptions and management’s best estimate of the set of economic conditions that will exist over the remaining useful life of the asset (IAS 36.38).

Consider this – Reflecting reasonable and supportable assumptions

A budget is of course a management tool and not simply a prediction about the future. A budget may therefore incorporate stretch targets or similar aspirational features. In using such a budget for VIU purposes, management should carefully consider whether these types of assumptions are reasonable and supportable in the context of IAS 36.

Supporting the assumptions in a budget is more challenging in situations such as start-ups and development projects. Budgets may be less reliable and past projections can vary greatly compared to actual cash flows.

Sometimes different budgets may be prepared (one being highly aggressive while another incorporates more realistic expectations and assumptions). In such cases the more realistic budget should be the basis used for future cash flow projections in accordance with IAS 36.

Finally, IAS 36.34 requires management to ‘examine the causes of differences between past projections with actual cash flows’ to ensure that the assumptions on which current projections are based are consistent with past actual outcomes. In our view, this examination is not limited to actual and projected outcomes for the past 12 months (ie the current period). Management should also consider the longer term track record of projecting cash flows over its specific forecasting period (as used for IAS 36 purposes – eg 5 years).

3.2 Applying the appropriate discount rate

The discount rate applied to the estimated cash flows should reflect the return that investors would require if they were to choose an investment that would generate cash flows of amounts, timing and risk profile equivalent to those that the entity expects to derive from the asset (IAS 36.56).

In other words, the estimated cash flows in the VIU calculation are entity-specific, but the discount rate is not. IAS 36 prescribes that management apply a pre-tax discount rate(s) that reflects the current market assessment of both:

  • the time value of money; IAS 36 How Impairment test
  • the risks specific to the asset for which the future cash flow estimates have not been adjusted (IAS 36.55).

This rate may be estimated: IAS 36 How Impairment test

  • from the rate in current market transactions for similar assets (IAS 36.56) or
  • from the weighted average cost of capital (WACC) of a listed entity that has a single asset (or a portfolio of assets) similar in terms of service potential and risks to the asset under review (IAS 36.56).

In the event that neither of the above are available, the entity estimates the discount rate using surrogates (IAS 36.57).

The discount rate should reflect assumptions consistent with the estimated future cash flows. For Case, a nominal discount rate should be used if the cash flows are estimated on a nominal rather than real terms basis. Both the cash flows and the discount rate should be prepared on a pre-tax basis (IAS 36.40, 51).

The following figure illustrates IAS 36’s guidance on determining an appropriate discount rate.

impairment

3.2.1 Using a surrogate

When an asset-specific rate is not directly available in the market (as is usually the case), the entity uses a surrogate to estimate the discount rate. The objective is to derive a market assessment of:

  • the time value of money through the end of the asset’s useful life (IAS 36.A16(c))
  • expectations about possible variations in the amount or timing of those cash flows (IAS 36.A1(b))
  • the price for bearing the uncertainty inherent in the asset (IAS 36.A1(d))
  • other, sometimes unidentifiable, factors (such as illiquidity) that market participants would reflect in pricing the future cash flows from the asset (IAS 36.A1(e)).

One common approach is for the entity to determine a market-consistent discount rate for the entity as a whole, then adjust this rate to take into account factors specific to the asset or CGU being tested. For Case: IAS 36 How Impairment test

Adjustments might also be necessary to exclude risks that are not relevant to the asset’s estimated cash flows or for which the estimated cash flows have already been adjusted (IAS 36.A18).

Estimating the discount rate when no asset-specific market rate is available

Estimating the discount rate

Consider this – Determining the discount rate in practice

In general, entities most often estimate a risk-adjusted discount rate starting with the entity’s WACC.

The WACC is a post-tax measure of the overall required return on the entity as a whole – essentially the rate that an entity is expected to pay on average to all its capital providers to finance its assets. This calculation proportionately weighs each category of an entity’s capital (eg equity and long-term debt) to derive an entity-wide cost of capital. The proportionate weights are based on the fair value of debt and equity (not carrying amounts).

Keeping with the objective outlined for deriving an appropriate discount rate, an entity also needs to adjust the entity-wide WACC to achieve a discount rate for each asset or CGU, consistent with a market participant perspective.

If the entity is partially financed through long-term debt, the cost of debt in the WACC calculation will be based on long-term rates; therefore, an entity wishing to derive a discount rate for an asset with a short-term expected life will need to adjust appropriately.

The Capital Asset Pricing Model (CAPM) is a method of calculating anticipated investment risks and returns and is often used to determine the cost of equity component of an entity’s WACC. The CAPM takes into account two factors: the return on an investment that is virtually risk-free (such as certain government bonds) and the market risk premium that would be required by an investor in the acquired business.

The risk-free rate for the purposes of calculating the CAPM is generally obtained from yields on government bonds in the same currency and of the same or similar duration as the cash flows of the asset or CGU (eg 10- or 20-year government bonds).

Adjustments may be required if government bond yields of the appropriate duration are not available. The market risk premium typically includes: an equity risk premium (the long-term rate of return for equities in excess of the risk-free rate), an adjustment for the specific industry or sector risk relative to the market as a whole (beta factor) and an additional asset- or CGU-specific risk premium (alpha factor).

Finally, given that the WACC is a post-tax rate, it needs to be adjusted to a pre-tax rate. See below for a discussion about making this adjustment.

3.2.2 Pre-tax and post-tax discount rates

IAS 36 requires the discount rate(s) used in estimating VIU to be a pre-tax rate(s) (IAS 36.55). If the rate is derived initially on a post-tax basis, it must be adjusted to reflect a pre-tax rate (IAS 36.A20). This is often necessary because many observable market rates and the entity’s WACC are post-tax rates.

Using a post-tax discount rate to discount post-tax cash flows should lead to the same result as discounting pre-tax cash flows using a pre-tax discount rate if the pre-tax discount rate reflects an adjustment to take into account the specific amount and timing of the future tax cash flows (IAS 36.BCZ85).

Calculating a pre-tax rate involves applying a post-tax rate to post-tax cash flows (tax cash flows being based on the allowances and charges available for the asset and related non-tax cash flows). The effective pre-tax rate is then calculated by removing the tax cash flows and using an iterative technique to calculate the rate that makes the present value of the adjusted cash flows equal the VIU calculated using post tax cash flows.

Paragraph BCZ85 of IAS 36’s Basis for Conclusions provides an Case of how to calculate a pre-tax discount rate from post-tax calculations using the iterative method.

Consider this – Deriving pre-tax discount rates from post-tax rates

Despite IAS 36 calling for a pre-tax discount rate, we note that a post-tax analysis is sometimes undertaken in practice. This is because most rates that are observable in the market and the entity’s WACC are post-tax.

Computing a ‘true’ pre-tax discount rate starting from a post-tax rate can be complex, requiring information about the specific timing of tax-related cash flows for the asset or CGU and also iterative or goal-seek calculations.

IAS 36 highlights that the ‘…pre-tax discount rate is not always the same as the post-tax discount rate grossed up by the standard rate of tax’ (IAS 36.BCZ85). This is because the tax cash flows do not normally occur proportionately with or at the same time as the pre-tax cash flows (eg due to temporary differences, tax loss carry-forwards and the timing of tax payments).

However, in general, a gross-up approach may provide a reasonable approximation in some circumstances (although consideration should be given to any facts and circumstances that would impact the relationship between the pre-tax and post-tax rate).

Moreover, if a simplified approach results in a VIU significantly above the carrying amount, management may reasonably conclude that it is unlikely that an impairment exists.

Also note that IAS 36 requires disclosure of information about the discount rate.

3.3 Foreign currency issues

IAS 36 requires an entity to estimate future cash flows in the currency in which the cash flows will be generated and discount the cash flows to present value using a discount rate appropriate for that currency. IAS 36 How Impairment test

The entity then determines the VIU in its functional currency by translating the present value using the spot exchange rate at the date of the VIU calculation (IAS 36.54).

Case – Estimating VIU for a foreign investment

Entity P’s functional currency is the Euro. P has an equity-method investment (Investment I) in an investee located in the United States with USD functional currency. Entity P determines there is a need to estimate the recoverable amount of Investment I, having identified an impairment indicator at 31 December 20X0. Entity P calculates Investment I’s VIU using cash flows based in USD and a discount rate that reflects USD. The present value so derived is translated to Euro using the spot exchange rate at 31 December 20X0.

Consider this – Practical issues related to cash flows in a foreign currency

The use of the forward rate for converting foreign currency cash flows is prohibited. This is because the time value of money is taken into account by discounting the foreign currency cash flows at a rate appropriate for that currency (IAS 36.BCZ49). Converting expected foreign cash flows at estimated future spot exchange rates is also prohibited on the grounds of the unreliability of those future estimates (IAS 36.BCZ50).

4 Exceptions to calculating both fair value less costs of disposal and value in use

Although recoverable amount is defined as the higher of the FVLCOD and VIU, IAS 36 makes clear that it is not always necessary to determine both estimates. The table below outlines instances when an entity need only calculate either FVLCOD or VIU.

Instances when an entity need only calculate either FVLCOD or VIU

IAS 36 How? - Impairment test

Short-cuts for estimating FVLCOD or VIU

IAS 36 also clarifies that it is sometimes not necessary to perform the detailed computations (as described in Step 4) for determining FVLCOD or VIU. Estimates, averages and/or computational short cuts may be used when they provide reasonable approximations of the detailed computations for determining FVLCOD or VIU (IAS 36.23).

IAS 36 also provides relief from calculating recoverable amount in some situations when an indicator has been identified or the annual impairment testing date has been reached. The figure below summarises the relief provisions available in IAS 36 for intangible assets and goodwill. Broadly, the relief provisions note that the concept of materiality applies in identifying the need to estimate recoverable amount.

Asset type

Reference

Description of relief

Intangible assets with an indefinite useful life (or not yet available for use) and goodwill

IAS 36.15

The concept of materiality applies. Cases include:

(see Case Considering materiality despite an indicator of impairment being present or reaching the annual impairment testing date (IAS 36.16) below)

Intangible assets with an indefinite useful life

IAS 36.24

The most recent detailed calculation of such an asset’s recoverable amount made in a preceding period may be used in the impairment test for that asset in the current period, provided all of the following criteria are met:

  • where an intangible asset is tested for impairment as part of the CGU to which it belongs, the asset and liabilities making up that unit have not changed significantly since the most recent recoverable amount calculation;
  • the most recent recoverable amount calculation resulted in an amount that exceeded the asset’s carrying amount by a substantial margin; and
  • based on an analysis of events that have occurred and circumstances that have changed since the most recent recoverable amount calculation, the likelihood that a current recoverable amount determination would be less than the asset’s carrying amount is remote.

Goodwill

IAS 36.99

The most recent detailed calculation made in a preceding period of the recoverable amount of a CGU to which goodwill has been allocated may be used in the impairment test of that unit in the current period provided all of the following criteria are met:

  • the assets and liabilities making up the unit have not changed significantly since the most recent recoverable amount calculation;
  • the most recent recoverable amount calculation resulted in an amount that exceeded the carrying amount of the unit by a substantial margin; and
  • based on an analysis of events that have occurred and circumstances that have changed since the most recent recoverable amount calculation, the likelihood that a current recoverable amount determination would be less than the current carrying amount of the unit is remote.

The following two Cases illustrate the application of this guidance. In practice, this is of course an area that requires careful judgement based on the particular facts and circumstances.

Something else -   Impairment Example

Case – Considering materiality despite an indicator of impairment being present or reaching the annual impairment testing date (IAS 36.16)

Background

Market interest rates and returns on investments in general have increased during the period, indicating that Entity A’s asset may be impaired (IAS 36.12(c)). Entity A’s management is considering if it needs to estimate the recoverable amount of its asset.

Analysis

Entity A would not be required to estimate the recoverable amount of the asset if the discount rate used in calculating the asset’s VIU is unlikely to be affected by the increase in these market rates (eg, increases in short-term interest rates may not have a material effect for an asset with a long remaining useful life).

Further, even if the discount rate is likely to be affected by the increase in these market rates, Entity A would not be required to estimate the recoverable amount of the asset if a previous sensitivity analysis of recoverable amount shows that it is unlikely that there will be a material decrease in recoverable amount or the decrease in recoverable amount is unlikely to result in a material impairment loss.

Case – Using the most recent detailed calculation

Background

Entity P has a 31 December 20X0 reporting date. In June 20X0, Entity P acquires subsidiary S, which will be accounted for in accordance with IFRS 3. In November 20X0, Entity P completes the determination of the acquisition date fair values and allocates the resultant goodwill to the appropriate CGUs.

At 31 December 20X0, the measurement period has closed (as Entity P has received the information it was requesting about subsidiary S) and the amounts are considered final (IFRS 3.45). Entity P carries out a detailed impairment test on the goodwill as at 31 December 20X0 in accordance with IAS 36.96. The test indicates that recoverable amount exceeds carrying value by a comfortable margin.

Entity P wishes to set its annual impairment testing date for the goodwill at 30 June. Should it carry out another detailed test at 30 June 20X1 in order to establish its annual testing date?

Analysis

In general, Entity P need not carry out a full impairment test as at 30 June 20X1 if the conditions in IAS 36.99 apply. This paragraph provides relief from performing a detailed impairment test if various conditions are met, but is still regarded as an impairment test for the purposes of IAS 36.90.

The assumptions used in the previous ‘full’ impairment test calculation remain valid until facts and circumstances change such that a new detailed calculation becomes necessary.

Step 5: Compare recoverable amount with carrying amount

After calculating the asset’s recoverable amount (as discussed in Step 4), the next step is to compare this to the carrying amount. Where the carrying amount exceeds the recoverable amount, the entity will record an impairment loss (Step 6).

iMPAIRMENT LOSS

Although making this comparison may appear straightforward, practical issues arise in relation to:

1. Like-for-like comparison of recoverable amount and carrying amount of a cash generating unit

When assets are grouped for recoverability assessments, it is important to include in the CGU all assets that generate or are used to generate the relevant cash inflows. If assets are omitted inappropriately, the CGU may appear to be fully recoverable when an impairment loss has in fact occurred (IAS 36.77). The overarching objective is that the CGU’s carrying amount is determined consistently with its recoverable amount (IAS 36.75).

The recoverable amount of a CGU (as discussed in Step 4) is determined excluding cash flows that relate to:

  • assets whose cash flows are largely independent of the cash inflows from the asset under review (for Case, financial assets such as receivables)
  • liabilities that have already been recognised (IAS 36.43).

Certain exceptions to this general rule apply and are discussed in more detail below.

1.1 Exceptions to the rule – including other assets and liabilities

Liabilities that are inseparable from the CGU

It may be necessary to consider some recognised liabilities to determine the recoverable amount of a CGU. This may be the case when the disposal of the CGU would require the buyer to assume the liability. As such, the FVLCOD of the CGU might be estimated using pricing information that takes account of the liability that buyers would assume.

To perform a meaningful comparison between the carrying amount of the CGU and its recoverable amount, the liability is also deducted from the CGU’s carrying amount and the cash flows from settling the liability are included in the VIU calculation (IAS 36.78). The following Case illustrates this point.

Case – Including liabilities that relate to the CGU (IAS 36.78)

Background

A company operates a mine in a country where legislation requires that the owner must restore the site on completion of its mining operations. The cost of restoration includes the replacement of the overburden, which must be removed before mining operations commence. A provision for the costs to replace the overburden was recognised as soon as the overburden was removed.

The amount provided was recognised as part of the cost of the mine and is being depreciated over the mine’s useful life. The carrying amount of the provision for restoration costs is CU500, which is equal to the present value of the restoration costs. The entity is testing the mine for impairment. The CGU is the mine as a whole. The entity has received various offers to buy the mine at a price around CU800.

The price reflects the fact that the buyer will assume the obligation to restore the overburden. Disposal costs for the mine are negligible. The VIU of the mine is approximately CU1,200, excluding restoration costs. The carrying amount of the mine is CU1,000.

Analysis

The CGU’s FVLCOD is CU800. This amount considers the restoration costs that have been provided for. As a consequence, the VIU for the CGU is determined after consideration of the restoration costs and is estimated to be CU700 (CU1,200 less CU500).

The carrying amount of the CGU is CU500, which is the carrying amount of the mine (CU1,000) less the carrying amount of the provision for restoration costs (CU500). Therefore, the recoverable amount of the CGU (CU800 being the higher of the FVLCOD and VIU) exceeds its carrying amount (CU500) and the CGU is not impaired.

It should also be noted that, in this Case, it would not be necessary in practice to calculate both FVLCOD and VIU (as both amounts exceed carrying value).

Consider this – Including liabilities that relate to the CGU

The key reason to include some liabilities in a CGU is that the market-based transaction price on which fair value is based necessarily includes the transfer of any liabilities that are inseparable from the asset.

If the impairment test is based solely on VIU (eg because FVLCOD cannot be measured reliably) it may not be necessary to include inseparable liabilities and the related cash flows to achieve a meaningful and like-for-like comparison.

In any case, including or excluding the liability (and related cash outflows) will often make little or no practical difference (eg if the liability is short-term or if it is discounted using a similar rate to that used for estimating VIU).

Other assets/liabilities

Sometimes, for practical reasons, the recoverable amount of a CGU is determined after consideration of assets that are not part of the CGU (for Case, receivables or other financial assets) or liabilities that have been recognised (for Case, payables, pensions and other provisions). In such cases the carrying amount of the CGU is:

Consider this – Other assets/liabilities

The carrying amount of a liability may not be the present value of its future cash outflows or may not be discounted using the same rate as for estimating VIU. One such Case is a pension obligation which might be discounted using a high quality corporate bond rate.

If an entity includes the pension contributions in its cash flows for VIU purposes, it will need to consider if some portion of those contributions relates to past services and is therefore a settlement of part of the pension liability.

Achieving a like-for-like comparison is potentially a complex exercise. However, it is not possible to simply ignore the costs of providing pensions and other employee benefits when estimating VIU and a pragmatic approach (such as including future service costs rather than contributions, and excluding the liability) might need to be taken.

Consider this 2 – Rent-free periods

A situation frequently met in practice is the case of ‘rent-free’ periods whereby a lessee recognises a liability and expense during the period of time in which no cash payment is due to the lessor as a result of straight-lining the lease payments over the lease term.

A question arises as to whether the lessee should include this liability as part of the carrying amount of the CGU being tested for impairment if the estimates of future cash flows include 100% of the future lease payments (therefore including those that effectively settle the liability).

As discussed in Value in use above, in estimating VIU, an entity will incorporate the future cash inflows and outflows from continuing to use the group of assets and from its ultimate disposal; however, estimates of future cash flows would not include cash outflows for settling liabilities that have already been recognised unless the associated liability is included as part of the CGU being tested for impairment.

In the case of a rent-free period, comparing like-for-like could be achieved either by:

  • including all the future lease payments in the cash outflows when estimating VIU and deducting the rent-free period liability from the CGU’s the carrying amount; or
  • excluding both the liability and the portion of the future lease payments that effectively settle it. In many cases including the straight-lined based lease expense (instead of the full lease payment) should prove a sufficiently accurate approximation.

Consider this 3 – Working capital balances

In general, cash flows from the settlement or realisation of working capital balances (that exist at the measurement date) may be included or excluded in the cash flow projections in estimating VIU, so long as a consistent approach is taken when deriving the carrying amount of the CGU.

The net effect should be insignificant where the present value of cash flows from the settlement or realisation of working capital items would be similar to the balances themselves. However, in estimating future cash flows for VIU purposes, material changes in future working capital requirements associated with the asset or CGU under review need to be considered.

Careful consideration must be given to inventory. The basic approach would be to exclude inventory balances from the impairment review as it is excluded from the scope of IAS 36 (and addressed in IAS 2). Under this approach, the estimated future cash flows from future sales of the inventory held at the measurement date should be excluded when estimating VIU.

Where management includes inventory in its VIU calculation for practical reasons, it will include the estimated future cash flows from future sales of the inventory. An adjustment may be necessary for gross margins, where deemed significant.

2 The order of impairment testing for corporate assets and goodwill

IAS 36 specifies the order of testing in three circumstances:

The order of impairment testing

2.1 Order of testing for corporate assets that cannot be allocated

2.2 Order of testing for assets and cash generating units to which goodwill has been allocated in the section below discusses the process of allocating corporate assets to a CGU. If a portion of the carrying amount of a corporate asset can be allocated on a reasonable and consistent basis, the carrying amount of the CGU, including the portion of the carrying amount of the corporate asset allocated, is compared with its recoverable amount (IAS 36.102(a)).

The assessment becomes more complex where a portion of the carrying amount of a corporate asset cannot be allocated on a reasonable and consistent basis to an individual CGU being tested. In this case, the entity will:

  • first, compare the carrying amount of the unit, excluding the corporate asset, with its recoverable amount and recognise any impairment loss (IAS 36.102(b)(i)) [see Step 1 in Case D.8]
  • next, compare the carrying amount of the smallest group of CGUs under review to which a portion of the carrying amount of the corporate asset can be allocated on a reasonable and consistent basis (IAS 36.102(b)(ii)) and compare that amount with the recoverable amount of the group of units and recognise any impairment loss (IAS 36.102(b)(iii)) [see Step 2 in Case D.8]. Any additional impairment loss calculated in this step should be recognised as follows:
    • first, to reduce the carrying amount of any goodwill allocated to the CGU (or groups of CGUs) and
    • next, to the other assets of the CGU (or groups of CGUs) pro rata based on the carrying amount of each asset in the CGU (or groups of CGUs)
  • when all or part of the corporate asset remains untested, the entity should test for impairment on an entity-wide basis and follow the same allocation process as outlined in bullet 2 above for any additional impairment calculated at this level.

The following case depicts the order of testing where the corporate asset cannot be allocated on a reasonable and consistent basis, other than on an entity-wide level.

Case – Order of testing corporate assets that cannot be allocated on a reasonable and consistent basis

Background

Entity A identifies two CGUs for impairment testing purposes. Entity A determines that it cannot allocate its ‘brand’ asset to a CGU or group of CGUs on a reasonable and consistent basis.

Analysis

Entity A will first test the individual CGUs (CGU 1 and CGU 2) for impairment, excluding any allocation of the brand asset which cannot be allocated on a reasonable and consistent basis, and record any impairment loss if necessary.

Next, Entity A will compare the carrying amount of the entity as a whole with the recoverable amount of the group of units (including the brand). Any additional impairment loss arising from this step should be allocated:

  1. first, to reduce the carrying amount of any goodwill allocated to CGU 1, CGU 2 (or the group of CGUs) and

  2. next, on a pro rata basis to the other assets of CGU 1, CGU 2, and the brand corporate asset. However, the impairment loss does not reduce the carrying amount of any asset below the highest of:

    1. its fair value less cost to sell

    2. its value in use and

    3. zero.

cORPORATE ASSETS GOODWILL IMPAIRMENTS

2.2 Order of testing for assets and cash generating units to which goodwill has been allocated

If certain assets forming part of a CGU to which goodwill has been allocated are tested for impairment at the same time as the CGU, these assets are tested before the CGU as a whole is tested (IAS 36.97).

This enables the entity to isolate any impairment at an individual asset level (if applicable) before proceeding to test at the CGU level. This requirement would apply only when the entity:

  • is required to test the individual asset (eg because an impairment indicator has been identified); and
  • it is possible to determine the asset’s recoverable amount even though it is part of a CGU (eg an asset that does not generate largely independent cash flows but whose recoverable amount is estimated based on FVLCOD).

Similarly, if a group of CGUs to which goodwill has been allocated is tested for impairment at the same time as the individual CGUs, the individual CGUs are tested for impairment before the group of CGUs (IAS 36.97).

Not adhering to the prescribed order of testing in these particular cases will usually result in a different allocation of any impairment loss among the individual assets or CGUs. Step 6 discusses the allocation of impairment losses in more detail.

Case – Order of testing for assets and CGUs to which goodwill has been allocated

Background

Entity Z includes assets A, B, and C (among other assets) in CGU 1 for purposes of testing goodwill. Entity Z tests the goodwill for impairment annually at 30 June. At 30 June 20X0, management determines that an impairment indicator necessitates the impairment testing of assets A, B and C.

Analysis

Entity Z first tests the individual assets (assuming that their recoverable amount can be determined individually), recording any impairment loss(es) at the individual asset level. Next, Entity Z tests CGU 1 and records any remaining impairment loss (as outlined in Recognising an impairment loss for cash generating units).

If any additional loss arises in this second step, it is first allocated to goodwill. Assets A, B and C are not reduced to less than their individual recoverable amounts.

Order of testing for assets and CGUs

Step 6: Recognise or reverse any impairment loss

The requirements for recognising and measuring impairment losses differ based on the structure of the impairment testing as determined in Step 2.

The requirements for recognising and measuring impairment losses for an individual asset (other than goodwill) are addressed in 1 Recognising an impairment loss for an individual asset below; while the requirements for recognising and measuring impairment losses for CGUs and goodwill are addressed in 2 Recognising an impairment loss for cash generating units below.

1 Recognising an impairment loss for an individual asset

When the recoverable amount of an asset is less than its carrying amount, the carrying amount of the asset needs to be reduced to its recoverable amount and that reduction is recognised as an impairment loss (IAS 36.59).

For assets accounted for using the revaluation model in IAS 16 or IAS 38 ‘Intangible Assets’ (IAS 38), the impairment loss is treated in the same way as a downward revaluation in accordance with those standards (IAS 36.60-61). Accordingly any impairment is recognised in other comprehensive income to the extent that it does not exceed a previous revaluation surplus. Any excess is recognised in profit or loss (IAS 36.60-61).

To the extent the amount estimated for an impairment loss exceeds the carrying amount of the asset to which it relates, an entity shall recognise a liability if, and only if, required by another Standard (IAS 36.62).

Consider this – Impairment loss exceeds the carrying amount of the asset to which it relates

An unallocated impairment loss for an individual asset (ie a loss exceeding the carrying amount of the asset in question) might arise if the asset is expected to generate negative net future cash flows – for Case an asset that is nearing the end of its economic life and requires significant decommissioning or holding costs.

In such cases the VIU estimate would be negative. In addition, the entity might need to pay potential buyers to acquire the asset in which case FVLCOD would also be negative. In these cases, the entity would not reduce the carrying value of the asset to less than zero. The entity would look to IAS 37 to determine whether a provision for decommissioning costs must be recognised.

Something else -   1 Best disclosure requirements for impairments

Finally, when an entity recognises an impairment loss for an individual asset, it must:

Case – Adjusting future depreciation of an asset after recognising an impairment

Background

A machine was purchased on 1 January 20X1 by Entity A for CU300,000 with an estimated useful life of 3 years and no residual value; therefore, CU100,000 of depreciation expense was recognised on a straight-line basis for both 2001 and 2002 (or CU8,333 per month). At 31 December 20X2, management determines an impairment indicator exists and estimates the recoverable amount of the machine to be CU80,000 (carrying amount at 31 December 20X2 is CU100,000).

Analysis

Entity A recognises an impairment loss for the difference (CU100,000-CU80,000 or CU20,000). In accordance with IAS 36.63, the entity also adjusts future depreciation of the machine after recording the impairment at 31 December 20X2 and will therefore recognise CU6,667 per month of depreciation from 1 January 20X3 – 31 December 20X3.

Case – Determining any related deferred tax assets/liabilities after recognising an impairment

Background

An entity owns a machine with a carrying amount of CU2,000. After finding evidence of an impairment indicator, management estimates the recoverable amount of the machine to be CU1,600. The entity records an impairment loss of CU400 (CU2,000 – CU1,600) for the machine. The tax rate is 35% and the tax base of the machine is CU1,800. Impairment losses are not deductible for tax purposes.

Analysis

The recognition of the impairment loss creates a deferred tax asset of CU70 as shown below, subject to meeting the criteria in IAS 12 for recognition of deferred tax assets.

Before impairment

Effect of impairment

After impairment

Carrying amount

2,000

-400

1,600

Tax base

1,800

1,800

Taxable (deductible) temporary difference

200

-400

-200

Deferred tax liability (asset) at 35%

70

-140

-70

The following figure summarises IAS 36’s requirements for recording an impairment for an individual asset.

recording an impairment for an individual asset

2 Recognising an impairment loss for cash generating units

An impairment loss must be recognised for a CGU when the recoverable amount of the unit is less than its carrying amount. IAS 36 prescribes that the impairment loss be allocated:

  • first, to reduce the carrying amount of any goodwill allocated to the CGU (IAS 36.104(a))
  • then, to the other assets of the unit, pro rata on the basis of the carrying amount of each asset in the unit (IAS 36.104(b)).

However, in allocating the impairment loss, an entity cannot reduce the carrying amount of an individual asset below the highest of:

  • its FVLCOD (if measurable);
  • its VIU (if determinable); and
  • zero (IAS 36.105).

These amounts serve as a ‘floor’ as outlined in the figure below.

If, for an individual asset within an impaired CGU, it is possible to measure FVLCOD but not VIU (and therefore not possible to determine the individual asset’s recoverable amount), then the floor is the higher of FVLCOD and zero. Under this scenario no impairment loss is recognised for the individual asset if the asset’s CGU is not impaired, even if the asset’s FVLCOD is less than its carrying amount (IAS 36.107(b)).

Should the ‘floor’ be applicable for an asset; any amount that would have been allocated to that individual asset must be allocated pro rata to the other assets of the unit (IAS 36.105). The reductions in carrying amounts from applying the above requirements are treated as impairment losses on the individual assets and recognised as outlined in Step 6 / Recognising an impairment loss for an individual asset (IAS 36.104).

Allocating an impairment loss to assets within a CGU

impairment

The following Case illustrates the interaction of these requirements in allocating the impairment loss to individual assets comprising a CGU.

Case – Allocating an impairment loss to assets within a CGU

Background

Entity X carries out an impairment test of CGU 1 on 31 December 20X0. CGU 1 has a total carrying amount of CU800 and consists of two identifiable intangible assets (Asset A, CU400, and Asset B, CU300) in addition to allocated goodwill of CU100.

Asset A was also tested for impairment at 31 December 20X0 and found not to be impaired because its FVLCOD (CU450) exceeds its carrying amount (CU400). Management has concluded that Asset B’s VIU cannot be determined individually and its FVLCOD cannot be measured reliably. The results of the impairment test of CGU 1 show a recoverable amount of CU500; as such, an impairment loss of CU300 must be recognised.

CGU 1

Carrying amount

Recoverable amount (individual asset level)

Impairment loss allocation

Goodwill

100

N/A

100

Asset A

400

450

Asset B

300

N/A

200

Total

800

Recoverable amount in CGU 1

500

Impairment loss

300

300

Analysis

Entity X first allocates the impairment loss to goodwill (IAS 36.104(a)). Next, Entity X allocates the remaining impairment loss (in this case CU200) to the individual assets comprising the CGU, subject to the floor (IAS 36.104(b), 105). No impairment loss can be allocated to Asset A (due to the floor) as the asset cannot be reduced to less than its recoverable amount. Therefore, the remaining impairment loss of CU200 is allocated to Asset B.

Case – Understanding if the recoverable amount can be determined for individual assets and the effect on recognising an impairment (IAS 36.107)

Background

A machine has suffered physical damage but is still working, although not as well as before it was damaged. The machine’s FVLCOD is less than its carrying amount. The machine does not generate independent cash inflows. The smallest identifiable group of assets that includes the machine and generates cash inflows that are largely independent of the cash inflows from other assets is the production line to which the machine belongs. The recoverable amount of the production line shows that the production line (taken as a whole) is not impaired.

Scenario 1: budgets/forecasts approved by management reflect no commitment of management to replace the machine.

Scenario 2: budgets/forecasts approved by management reflect a commitment to replace the machine and sell it in the near future. Cash flows from continuing to use the machine until its disposal are estimated to be negligible.

Scenario 1 Analysis

The recoverable amount of the machine alone cannot be estimated because the machine’s VIU:

  1. may differ from its FVLCOD; and

  2. can be determined only for the CGU to which the machine belongs (the production line).

The production line is not impaired. Therefore, no impairment loss is recognised for the machine. Nevertheless, the entity may need to reassess the depreciation period or the depreciation method for the machine.

Scenario 2 Analysis

The machine’s VIU can be estimated to be close to its FVLCOD. Therefore, the recoverable amount of the machine can be determined. Because the machine’s FVLCOD is less than its carrying amount, an impairment loss is recognised for the machine.

Remaining (unallocated) amount of an impairment loss for a CGU

When the requirements above have been applied and result in a remaining unallocated amount of impairment loss for a CGU, such an amount is only recognised as a liability if required by another IFRS (IAS 36.108).

Consider this – Any remaining (unallocated) amount of an impairment loss for a CGU

This situation might arise in relation to a loss-making CGU that is in need of restructuring (for Case). As noted in Exclude restructuring and anticipating cash flows from improving or enhancing asset performance, the effects of a future restructuring would be excluded from the VIU estimate before the entity has an obligation for the restructuring in accordance with IAS 37.

Also, the need for future restructuring may result in FVLCOD being negative. In this situation the entity would limit any impairment loss to the carrying value of the CGU’s assets and separately evaluate whether the criteria in IAS 37 to recognise a restructuring provision have been met.

3 Considerations for foreign operations

Any impairment loss is not a partial disposal for the purposes of IAS 21 ‘The Effects of Changes in Foreign Exchange Rates’. The foreign exchange gain or loss recognised in other comprehensive income on translating the foreign operation’s financial statements is not therefore reclassified to profit or loss when recognising an impairment (IAS 21.49).

4 Reversing an impairment loss

4.1 Indicators for reversing an impairment loss

In addition to assessing evidence of possible impairment, entities must also assess whether there is any indication that a previously recognised impairment loss for an asset (other than goodwill) no longer exists or may have decreased. If an indication of possible reversal is identified, the entity must estimate the recoverable amount of that asset (IAS 36.110).

Consider this – Goodwill impairments cannot be reversed

IAS 36 prohibits any reversal of impairment losses recognised on goodwill (IAS 36.124). The reason for this is because IAS 36 views any increase in the recoverable amount of goodwill after the recognition of an impairment loss to likely be an increase in the internally generated goodwill (not a reversal of the impairment loss recognised for the acquired goodwill). IAS 38 prohibits the recognition of internally generated goodwill.

Accordingly, the references to impairment reversals in Recognising an impairment loss for cash generating units do not include goodwill.

Similar to the list provided in IAS 36 of indications of an impairment loss, IAS 36 provides a non-exhaustive list of indications that a previously recognised impairment loss may no longer exist. These are summarised below.

External sources of information (IAS 36.111(a) – (c))

  • Observable indications that the asset’s value has increased significantly during the period
  • Significant favourable changes (have occurred or are expected) in the technological, market, economic or legal environment
  • Market interest rates or other market rates of return on investments have decreased during the period (which will decrease the discount rate used in caluclating the asset’s VIU)

Internal sources of information (IAS 36.111(d) – (e))

  • Significant favourable changes (have occurred or are expected) in the extent to which an asset is used (or is expected to be used) (eg, costs incurred during the period to improve or enhance the asset’s performance or restructure the operation to which the asset belongs)
  • Evidence is available from internal reporting that indicates that the economic performance of an asset is, or will be, better than expected

The reversal of an impairment loss reflects an increase in the estimated service potential of an asset (either from use or from sale) since the date when an entity last recognised the impairment loss for the asset (IAS 36.115). A reversal of an impairment loss should therefore only be recognised if there has been a change in the estimates used to determine the asset’s recoverable amount since the last impairment loss was recognised.

Said differently, an impairment loss is not reversed solely because of the passage of time or the unwinding of the discount, even if the recoverable amount of the asset becomes higher than its carrying amount (IAS 36.114, 116).

Consider this – Disclosure required for an increase in the estimated service potential

IAS 36.130 requires that the entity identify and disclose the change in estimates that cause the increase in the estimated service potential. Cases include:

  1. a change in the basis for measuring recoverable amount (ie whether recoverable amount is based on FVLCOD or VIU)
  2. where the recoverable amount was based on VIU, a change in the amount or timing of estimated future cash flows or in the discount rate; or
  3. where the recoverable amount was based on FVLCOD, a change in estimate of the components of FVLCOD (IAS 36.115).

Regardless of whether an impairment loss is reversed for an asset, if the entity identifies an indication that a previously recognised impairment loss may no longer exist, the entity may need to review and adjust the:

Consider this – Indicators for reversing a previously recognised impairment loss

Most of the ‘reversal indicators’ listed are the inverse of the loss indicators listed in IAS 36.12 (discussed in Step 3 / Indicator-based impairment testing); there are however some exceptions to this. In particular, an increase in market capitalisation above carrying value of an entity’s net assets is not listed as a reversal indicator.

4.2 Reversing impairment losses for individual assets (other than goodwill)

When recoverable amount is recalculated and exceeds the asset’s carrying value, the carrying amount is increased to the recoverable amount subject to a ‘ceiling’ (ie an upper limit). The increased carrying amount cannot exceed the carrying amount that would have been determined (net of amortisation or depreciation) had no impairment loss been recognised for the asset in prior years (IAS 36.117).

For assets accounted for using the revaluation model in IAS 16 or IAS 38, the reversal of the impairment loss is accounted for in the same way as a revaluation increase in accordance with those Standards.

The following figure depicts the requirements for reversals of impairment losses for individual assets and the Case illustrates their practical application.

Reversing impairment losses for individual assets

Case – Reversing a previously recognised impairment loss for an individual asset

At 1 January 20X1, Entity T purchased an item of PP&E (a machine) for CU1,800 (T will depreciate the machine on a straight-line basis over its useful life of 15 years). In 20X1, T recognised an impairment loss of CU500 on this machine, having identified indicators showing a reduction in expected demand for the machine output due to the introduction of a superior product released by a competitor.

T applies the cost model in accordance with IAS 16 and the impairment loss was recognised in profit or loss. The amounts before and after the recognition of the impairment loss were as follows with respect to the machine:

mACHINE ONE TABLE

In 20X3, T determines that the competitor product is experiencing technical issues and that its effect on demand for T’s output is less than expected. Sales have exceeded forecast and management estimates that production will increase by 25%. At 31 December 20X3, T estimates the recoverable amount of the machine in accordance with IAS 36.111(b). The recoverable amount of the machine is estimated to be CU1,300.

Machine two table

*T revised the depreciation charge (from CU120 per year to CU84 per year) for the machine based on the revised carrying amount and remaining useful life at 31 December 20X1 (CU1,180/14 years or CU84 depreciation expense per year). Depreciated historical cost of the machine at 31 December 20X3 is as follows:

Machine Three table

Analysis

T recognises a reversal of the impairment loss recognised in 20X1 in accordance with IAS 36.114. T increases the carrying amount of the machine by CU316 (to lower of recoverable amount (CU1,300) and the depreciated historical cost (CU1,440)) (IAS 36.117). The increase is recognised immediately in profit or loss (IAS 36.119) and T will again adjust future depreciation to allocate the asset’s revised carrying amount (IAS 36.121).

4.3 Reversing impairment losses for cash generating units

Any reversal of an impairment loss for a CGU must be allocated to the individual assets that make up that CGU (excluding goodwill). The entity allocates the reversal of an impairment loss to the CGU’s assets pro rata to their carrying amounts. This is again however subject to a ‘ceiling’ whereby no individual asset’s carrying amount is increased above the lower of:

If this ‘ceiling’ takes effect for one or more of the CGU’s assets, the reversal of the impairment loss that would otherwise have been allocated to those assets is allocated on a pro rata basis to the other assets, subject to the same ceiling (IAS 36.122-123).

The figure below depicts the allocation process.

Reversing impairment losses for cash generating units

Case – Reversing a previously recognised impairment loss for a CGU with allocated goodwill

Entity T is in the healthcare industry and has identified three CGUs for impairment review purposes (CGU 1, CGU 2 and CGU 3), each located in a different country. In 20X1, Entity T recognised an impairment loss of CU1,250 with respect to CGU 1, following the election of a new government in the country in which CGU 1 operates and anticipated changes in healthcare laws that would reduce demand for Entity T’s products. The amounts before and after the recognition of the impairment loss were as follows with respect to CGU 1:

31 December 20X1

Goodwill

CGU identifiable assets

Total

Historical cost

750

1,800

2,550

Accumulated depreciation

-120

-120

Carrying amount

750

1,680

2,430

Impairment loss

-750

-500

-1,250

Carrying amount after impairment

1,180

1,180

In 20X3 T determines that the impact of the new healthcare laws is less than expected. Sales have exceeded forecast and management estimates that production will increase by 25%. At 31 December 20X3, T estimates the recoverable amount of CGU 1 in accordance with IAS 36.111(b). The recoverable amount of CGU 1 is estimated to be CU1,500. It is not possible to determine recoverable amount for any of the individual assets in the CGU.

31 December 20X3

Goodwill

CGU identifiable assets

Total

31 December 20X1

1,180

1,180

Accumulated depreciation (20X2 and 20X3)

-168

-168

Carrying amount

1,012

1,012

Recoverable amount

1,500

Excess of recoverable amount over carrying amount

488

*T revised the depreciation charge (from CU120 per year to CU84 per year) for the identifiable assets of CGU 1 based on the revised carrying amount and remaining useful life at 31 December 20X1. Depreciated historical cost of CGU 1 at 31 December 20X3 is as follows:

31 December 20X3

CGU identifiable assets

Historical cost

1,800

Accumulated depreciation (CU120 x 3)

-360

Depreciated historical cost

1,440

Carrying amount

1,012

Difference

428

Analysis

At 31 December 20X3, T recognises a reversal of the impairment loss (recognised at 31 December 20X1) in accordance with IAS 36.114. T will increase the carrying amount of CGU 1’s identifiable assets by CU428 (to the lower of recoverable amount (CU1,500) and the depreciated historical cost of the non-goodwill assets (CU1,440) had no impairment loss been recognised in prior periods) (IAS 36.122-123). The increase is recognised immediately in profit or loss. The impairment loss recognised for goodwill in 20X1 is not reversed (IAS 36.124).

IAS 36 How Impairment test

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