When looking at the step-by-step IAS 36 impairment of assets approach it comes down to the following broadly organised steps: Assets in scope IAS 36

• What?? – Determining the scope and structure of the impairment review,
• If and when? – Determining if and when a quantitative impairment test is necessary, jump to this part here
• How? – Understanding the mechanics of the impairment test and how to recognise or reverse any impairment loss, if necessary, jump to this part here.

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:

• What – the level at which to review for impairment (eg individual asset level, CGU level or groups of CGUs),
• 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, The step-by-step IAS 36 impairment of assets
• How to perform the quantitative impairment test by estimating the asset’s (or CGU’s) recoverable amount,
• How to recognise an impairment loss, The step-by-step IAS 36 impairment of assets
• When and under what circumstances an entity must reverse an impairment loss and finally,
• Disclosure requirements (IAS 36.1).

IAS 36 Impairment of assets defines key terms that are essential to understanding its guidance. The most significant definitions are highlighted below:

Carrying amount	The amount at which an asset is recognised in the financial position after deducting any accumulated depreciation (amortisation) and accumulated impairment losses thereon.
Impairment loss	The amount by which the carrying amount of an asset or a Cash Generating Unit (CGU) exceeds its recoverable amount.
Recoverable amount	The higher of an asset or CGU’s fair value less costs of disposal (FVLCOD) and its value in use.
Value in use (VIU)	The present value of the future cash flows expected to be derived from an asset or CGU.
Other definitions are: CGU, corporate assets, costs of disposal, FVLCOD

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The step-by-step IAS 36 impairment of assets

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WHAT? Step 1: Identify assets within the scope of IAS 36

IAS 36 must be applied in accounting for the impairment of all assets, unless they are specifically excluded from its scope (IAS 36.2).

The scope exceptions cover assets for which the requirements of other IFRSs render an IAS 36-based impairment review irrelevant or unnecessary (eg – IAS 2 ‘Inventories’ requires that inventory be written down to its net realisable value if lower than cost, so inventory is explicitly excluded from the scope of IAS 36). Here is the overview: The step-by-step IAS 36 impairment of assets

Assets	In scope of IAS 36	In scope with
Inventories	No	IAS 2
Assets arising from construction contracts	No	IFRS 15
Assets under construction	Yes	IAS 16 / IFRS 15
Deferred tax assets	No	IAS 12
Assets arising from employee benefits	No	IAS 19
Financial assets within the scope of IFRS 9	No	IFRS 9
Financial assets classified as subsidiaries (as defined in IFRS 10), associates (as defined in IAS 28), and joint ventures (as defined in IFRS 11) accounted for under the cost method for purposes of preparing the parent’s separate financial statements	Yes
Investment property (measured using the fair value model)	No	IAS 40
Investment property (measured at cost)	Yes
Biological assets (measured at fair value less costs of disposal)	No	IAS 41
Investment components of insurance contracts	No	IFRS 17
Non-current assets (or disposal groups) classified as held for sale	No	IFRS 5
Plant, property and equipment, including revalued assets	Yes
Intangible assets	Yes
Goodwill	Yes

Other assets not specifically excluded above are within the scope of IAS 36.

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WHAT? Step 2: Determine the structure of the impairment review

Once the entity has confirmed that the asset in question is within the scope of IAS 36, the next step is to determine whether the asset will be reviewed for impairment individually or as part of a larger group of assets (in other words, the structure of the impairment review for purposes of applying IAS 36).

When possible, IAS 36 should be applied at the individual asset level. This will be possible only when: The step-by-step IAS 36 impairment of assets

• the asset generates cash inflows that are largely independent of those from other assets or groups of assets) (IAS 36.22), or
• the asset’s value-in-use can be estimated to be close to FVLCOD and FVLCOD can be measured (IAS 36.22).

An overview of determining the structure of the impairment review is as follows: The step-by-step IAS 36 impairment of assets

Here is a further explanation of the concepts of ‘cash inflows that are largely independent’ and where ‘VIU can be estimated to be close to FVLCOD and FVLCOD can be measured’ for the purpose of identifying whether assets are reviewed for impairment individually or as a part of a larger group.

A – Cash inflows that are largely independent The step-by-step IAS 36 impairment of assets

When determining if an asset generates cash inflows that are largely independent of the cash inflows from other assets (or groups of assets), an entity considers various factors including:

• how management monitors the entity’s operation (such as by product lines, businesses, individual locations, districts or regional areas) or
• how management makes decisions about continuing or disposing of the entity’s assets and operations (IAS 36.69).

The following example shows how this guidance may be applied in practice.

Background A television network owns 50 TC programmes of which 20 were purchased and 30 were self-created. The network recognises each purchased programme as an intangible asset at the price paid while it expenses the costs of developing new and maintaining old programmes as incurred. Cash inflows are generated from licensing of broadcasting rights to other networks and advertising sales and are identifiable for each programme. The network manages programmes by customer segments. Programmes within the same customer segment affect to some extent the level of advertising income generated by other programmes in the segment. Management often abandons older programmes before the end of their economic lives to replace them with newer programmes targeted to the same customer segment.

Analysis In this case, the cash inflows from each TV programme are largely independent. Even though the level of licensing and advertising income for a programme is influenced by the other programmes in the customer segment, cash inflows are identifiable for each individual programme. In addition, although programmes are managed by customer segments, decisions to abandon programmes are made on an individual basis.

Food for thought – Cash inflows versus net cash flows IAS 36’s guidance on whether the recoverable amount can be determined for an individual asset specifically refers to cash inflows, not net cash flows or cash outflows. Accordingly, if an asset’s cash inflows are largely independent but some of the related costs are interdependent with other assets, the recoverable amount must still be determined at the individual asset level (if necessary).

Operational assets Where it is not possible to estimate the recoverable amount of the individual operational asset it is allocated to the CGU to which it belongs.

Corporate assets In some cases, management may identify certain assets that contribute to the estimated future cash flows of more than one CGU. It would be inappropriate to allocate these assets entirely to a single CGU. Such assets are referred to as ‘corporate assets’ or ‘shared assets’ and may include (for example): a headquarters building IT equipment research centre corporate or global brands.

B – Value-in-Use can be estimated to be close to FVLCOD and FVLCOD can be measured

As depicted in the table below, if the entity determines that the asset in question does not generate cash inflows that are largely independent of those from other assets, it should assess if the asset’s VIU can be estimated to be close to FVLCOD and FVLCOD can be measured.

The VIU of an asset may be assessed as close to or less than FVLCOD when the asset is no longer in use, or soon to be replaced or abandoned, such that the estimated future cash flows from continuing use of the asset are negligible (eg, where an entity holds a brand solely for defensive purposes).

Further, VIU may be assessed to be close to FVLCOD in the limited circumstances when the entity’s estimated cash flows from using the asset are consistent with the cash flows market participants would expect to generate, and costs of disposal are not material (ie when there are no entity-specific advantages or disadvantages, including tax-related factors).

When VIU can be estimated to be close to FVLCOD, the entity will determine the recoverable amount for the individual asset (the asset will not be included in a CGU for impairment assessment purposes) and any impairment is recognised immediately at the individual asset level.

Finally, when there is no reason to believe that VIU materially exceeds FVLCOD, IAS 36 allows an entity to estimate FVLCOD only for purposes of determining the recoverable amount (IAS 36.21).

The following example based on IAS 36.67 illustrates one application of this guidance.

Where VIU cannot be estimated to be close to FVLCOD

Background A mining entity owns a private railway to support mining activities. The private railway does not generate cash inflows that are largely independent of the cash inflows from other assets of the mine. The costs of disposal of the private railway are expected to be high.

Analysis It is not possible to estimate the recoverable amount of the private railway on a standalone basis because its Value in Use cannot be determined stand-alone and is probably different from the amount it would receive on disposal (in part due to the high costs associated with disposal). Therefore, the entity estimates the recoverable amount of the CGU to which the private railway belongs, which could be the mine as a whole.

Food for thought – Structure of the impairment review Most assets generate cash inflows only in combination with other assets as part of a larger CGU. It is not possible to calculate a recoverable amount for most individual assets that are held for continuing use. Management must then identify the CGU to which an asset belongs to determine if quantitative impairment testing is required. This is further explained in step 2.1 Identify cash generating units (or groups of CGUs), below.

WHAT? Step 2.1: Identify cash generating units (or groups of CGUs)

Identifying CGUs is a critical step in the impairment review and can have a significant impact on its results. That said, the identification of CGUs requires judgement. The identified CGUs may also change due to changes in an entity’s operations and the way it conducts them.

A CGU is defined as follows:

A cash-generating unit (CGU) is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets.

2.1.1 Roles of the cash generating unit in the impairment review

A CGU serves two primary roles in the impairment review. It facilitates the testing of:

1. assets for which the recoverable amount cannot be determined individually; and
2. goodwill and corporate assets for impairment.

The roles of the CGU in the impairment review

Goodwill and corporate assets by definition do not generate cash inflows on their own and therefore, must be allocated to a CGU or groups of CGUs for impairment testing purposes. The allocation of goodwill and corporate assets is discussed in step 2.2.

2.1.2 Identifying cash generating units

The objective of identifying CGUs is to identify the smallest identifiable group of assets that generates largely independent cash inflows. CGUs are identified at the lowest level to minimise the possibility that impairments of one asset or group will be masked by a high-performing asset.

To identify a CGU, an entity asks two questions:

1. Does a group of assets generate largely independent cash inflows?
2. Is there an active market for the output?

A. Does a group of assets generate independent cash inflows?

Put simply, identifying CGUs involves dividing the entity into components. Because the CGU definition is based on cash inflows, the division process should focus on an entity’s sources of revenue and how assets are utilised in generating those revenues.

Management will consider various factors including how it monitors the entity’s operations (such as by product lines, businesses, individual locations, districts or regional areas) or how management makes decisions about continuing or disposing of the entity’s assets and operations (IAS 36.69).

Food for thought – Operational structure over legal structure It may be the case that the design and management of an antity does not reflect the legal structure of the group. Depending on the circumstances, a CGU might correspond with a legal entity, a division, product line, geographic region, physical location (such as a hotel or a retail store) or collection of assets.

The following example illustrates the identification of the lowest aggregation of assets that generate largely independent cash inflows when the recoverable amount cannot be determined for an individual asset. Identifying the CGU: lowest level of largely independent cash inflows (IAS 36.68) Background A bus company provides services under contract with a municipality that requires minimum service on each of five separate routes. Assets devoted to each route and the cash flows from each route can be identified separately. One of the routes operates at a significant loss. Analysis Because the entity does not have the option to curtail any one bus route, the lowest level of identifiable cash inflows that are largely independent of the cash inflows from other assets or groups of assets is the cash inflows generated by the five routes together. The cash-generating unit for each route is the bus company as a whole.

Identifying the CGU: supermarket chain Background Entity A owns and operates 10 supermarkets in a major city (City B), each store residing in a different neighbourhood throughout City B. Each supermarket in City B purchases its inventory though A’s purchasing centre. Pricing, marketing, advertising and human resources policies (except for the hiring of each supermarket’s local staff) are decided by A. Entity A also operates 50 other supermarkets in other major cities across the country. Analysis The supermarkets in City B probably have different customer bases as they reside in different neighbourhoods, Accordingly, although operations are managed at a corporate level by A, each supermarket generates cash inflows that are largely independent of those other supermarkets. Therefore, it is likely that each supermarket in City B is a separate CGU. In making its judgement about whether each supermarket is a separate CGU, Entity A might also consider if: management reporting monitors revenues on a supermarket-by-supermarket basis in City B; and how management makes decisions about continuing or closing its supermarkets (eg on a store-by-store or on a region/city basis). Note – The IFRIC was asked to develop an Interpretation on whether a CGU could combine more than one individual store location. The submitter developed possible considerations including shared infrastructures, marketing and pricing policies, and human resources. The IFRIC noted that IAS 36.6 (and supporting guidance in IAS 36.68) requires identification of CGUs on the basis of independent cash inflows rather than independent net cash flows and so outflows such as shared infrastructure and marketing costs are not considered. In its March 2007 agenda decision, the IFRIC took the view that developing guidance beyond that already given in IAS 36 on whether cash inflows are largely independent would be more in the nature of application guidance and therefore decided not to take this item on to its agenda.

B. Is there an active market for the output?

When management has identified a group of assets that generate an output, but those assets do not generate largely independent cash inflows, it needs to consider if there is an active market for the output.

For the purposes of applying IAS 36, even if part or all of the output produced by an asset (or a group of assets) is used by other units of the entity (ie, products at an intermediate stage of a production process), this asset (or group of assets) represents a CGU if the entity could sell the output on an active market.

This is because the asset (or group of assets) could generate cash inflows that would be largely independent of the cash inflows from other assets (or groups of assets) (IAS 36.71).

Food for thought – Vertically integrated businesses and an active market for output

This is a common issue for vertically integrated businesses whereby some groups of assets do not generate independent cash inflows, only because each operation’s output is used internally, rather than being sold externally. IAS 36 addresses this issue by clarifying that even if part of or all of the output produced by an asset (or a group of assets) is used by other units of the entity, this asset (or group of assets) forms a separate CGU if the entity could sell the output on an active market. An active market is defined in IFRS 13 as ‘A market in which transactions for the asset or liability take place with sufficient frequency and volume to provide pricing information on an ongoing basis’. This may be the case for certain commodities such as oil or gold.

Identifying the CGU: active market for the output

Background Entity X produces a single product (widgets) and owns production plants 1, 2 and 3. Each plant is located in a different region of the world. Plant 1 produces a component of the widgets that is assembled in either plant 2 or plant 3 and sold worldwide from either plant 2 or plant 3. Neither plant 2 nor plant 3 is operating at full capacity. The utilisation levels depend on the allocation of order fulfilment between the two location. Scenario 1: There is an active market for plant 1’s component Scenario 2: There is no active market for plant 1’s component Scenario 1: It is likely that plant 1 is a separate CGU because there is an active market for its output. As cash inflows for plant 2 and 3 depend on the allocation of production across the two locations, it is unlikely that the future cash inflows for plants 2 and 3 can be determined individually so they would probably be combined into a single CGU. Scenario 2: It is likely that the three plants are a single CGU because: there is no active market for plant 1’s output and its cash flows depend on sales of the final product by plants 2 and 3, cash inflows for plants 2 and 3 depend on the allocation of production across the two locations. It is unlikely that the future cash inflows for plants 2 and 3 can be determined individually.

Where the cash inflows generated by an asset or CGU are affected by internal transfer pricing, an entity uses management’s best estimate of future prices that could be achieved in an arm’s length transaction in estimating:

• the future cash inflows used to determine the asset’s or CGU’s VIU; and
• the future cash outflows used to determine the VIU of any other assets or CGUs that are affected by the internal transfer pricing (IAS 36.70).

Identifying the CGU: active market for the output – continued

In scenario 1, in determining the VIU of plants 1, 2 and 3, Entity X will adjust its financial budgets/forecasts to reflect its best estimate of future prices that could be achieved in arm’s length transactions for plant 1’s output while also incorporating future cash outflows used to determine the VIU of other assets impacted by the internal transfer pricing.

When the group of assets does not generate cash inflows that are largely independent and there is no active market for its output (even if used internally), the group is not a CGU. Management then combines these assets with others that contribute to the same revenue stream until a CGU is identified.

2.1.3 Changes in identified cash generating units

Unless a change is justified, CGUs are identified consistently from period to period for the same asset or types of assets (IAS 36.72). If a change in CGUs is justified (eg an asset belongs to a different CGU than in previous periods or previously recognised CGUs are combined or subdivided), and an impairment loss is recognised or reversed for the CGU, the entity must disclose additional information in accordance with IAS 36.130 (IAS 36.73).

Food for thought – Triggers for a change in CGU structure IAS 36 does not provide examples of events or circumstances that would justify a change in CGUs. Such a change would generally be appropriate only if there has been a change in the entity’s operations – ie different revenue-generating activities or different utilisation of assets in underlying those activities. Typical triggers for a change might include: business combinations or divestment of activities restructuring of activities introduction or withdrawal of products or services entry to or exit from new markets or regions.

Food for thought – A change in CGU structure over time The factors that justify a change in CGU structure sometimes develop over time rather than being driven by a specific event. For example, an entity might gradually change the way it allocates order intake across its production facilities or how it utilises assets to generate a revenue stream. In general, the change in CGU structure is justified if an asset’s cash inflows become, or cease to be, independent even if this cannot be attributed to a specific event. One practical suggestion for determining the effective date of the change is to consider when management began reviewing or assessing the CGUs differently (eg when management reporting is changed).

WHAT? Step 2.2: Allocate assets to the cash generating units

After the entity identifies its CGUs it must determine which assets belong to which CGUs, or groups of CGUs. The basis of allocation differs for:

• operational assets
• corporate assets
• goodwill.

The figure below summarises the different allocation bases. Each is discussed in turn below.

2.2.1 Operational assets

As discussed in Step 2 above, recoverable amount is determined (if required) at the level of individual assets when possible. Where it is not possible to estimate the recoverable amount of the individual operational asset it is allocated to the CGU to which it belongs.

Assets that contribute to the cash flows of a CGU also need to be allocated to that CGU even if it is possible to determine recoverable amount individually (because, for example, an asset’s VIU can be estimated as similar to its FVLCOD).

This is to ensure a like-for-like comparison when the CGU is tested and its recoverable amount is compared to its carrying value.

The discussion in Step 2.1 ‘Identify CGUs (or groups of CGUs)’ provides guidance on identifying the CGU to which an asset belongs.

2.2.2 Corporate assets

In some cases, management may identify certain assets that contribute to the estimated future cash flows of more than one CGU. It would be inappropriate to allocate these assets entirely to a single CGU. Such assets are referred to as ‘corporate assets’ or ‘shared assets’ and may include (for example):

• a headquarters building The step-by-step IAS 36 impairment of assets
• IT equipment   The step-by-step IAS 36 impairment of assets
• research centre  The step-by-step IAS 36 impairment of assets
• corporate or global brands. The step-by-step IAS 36 impairment of assets

Defining corporate assets (IAS 36.6)

Corporate assets are assets other than goodwill that contribute to the future cash flows of both the cash-generating unit under review and other cash-generating units.

Distinctive characteristics of corporate assets are that they do not generate cash inflows independently of other assets or groups of assets and their carrying amount cannot be fully attributed to the CGU under review (IAS 36.100).

If there is an indication of impairment for the corporate asset itself, recoverable amount cannot be determined at the individual asset level, unless management has decided to dispose of it (because corporate assets do not generate separate cash inflows) (IAS 36.101).

Corporate assets therefore need to be incorporated into the impairment review at the CGU level – not only to test the asset in question (when necessary), but also to test the CGUs that benefit from those assets. To do so, the entity must:

• identify corporate assets that relate to the CGU under review
• allocate the carrying amount of the corporate assets on a reasonable and consistent basis to the CGU under review (if a reasonable and consistent basis can be identified) (IAS 36.102(a)).

Where a portion of the carrying amount of a corporate asset cannot be allocated on a reasonable and consistent basis, the assets are incorporated into the impairment review at a higher level and the analysis becomes more complicated.

Identification and allocation of corporate assets to CGUs

Background Entity E has four CGUs: A, B, C and D. The carrying amounts of those units do not include goodwill. During the period, significant adverse changes in the legal environment in which Entity E operates take place. Entity E conducts impairment tests of each of its CGUs in accordance with IAS 36.12(b). At the end of the period, the carrying amounts of CGUs A, B, C and D are CU100, CU200, CU300 and CU250, respectively. The four CGUs all utilise a central office and a shared global brand (carrying amounts of CU100 and CU75, respectively). Management of E has determined that the relative carrying amounts of the CGUs are a reasonable approximation of the proportion of the central office building devoted to each CGU, but that the carrying amount of the global brand cannot be allocated on a reasonable and consistent basis to the individual CGUs. The remaining estimated useful life of CGUs A, B, C and D are 10, 15, 15 and 20 years respectively. The central office has a remaining useful life of 20 years and is depreciated on a straight-line basis. Analysis (ignoring tax effects) Entity E identifies all corporate assets that relate to the individual CGUs under review (the central office and shared global brand) (IAS 36.102). Entity E concludes that the carrying amount of the central office can be allocated on a reasonable and consistent basis to the CGUs under review while the carrying amount of the global brand cannot. Although not the only way to do so, Entity E allocates the carrying amount of the central office to the carrying amount of each individual CGU using a weighted allocation basis because the estimated remaining useful life of A’s CGU is 10 years, whereas the estimated remaining useful lives of B and C’s CGUs are 15 years and D’s CGU is 20 years. The step-by-step IAS 36 impairment of assets CGU A CGU B CGU C CGU D Total Carrying amount 100 200 300 250 850 Useful life (in years) 10 15 15 20 Weighting 1.0 1.5 1.5 2.0 Carrying amount weighted 10 300 450 500 1,350 Pro-rata allocation of the central office 7.4% 22.2% 33.3% 37.1% 100.0% Allocation of carrying amount of central office to CGU 7.4 22.2 33.3 37.1 100 Carrying amount CGU after allocation of central office 107.4 222.2 333.3 287.1 950 See link for discussion of how to account for the shared global brand (and other corporate assets) that cannot be allocated on a reasonable and consistent basis.

Food for thought – Allocating corporate assets     The step-by-step IAS 36 impairment of assets

IAS 36 provides only limited guidance as to what is meant by ‘allocated on a reasonable and consistent basis’ for allocation of corporate assets to CGUs or groups of CGUs. Judgement is therefore required. This judgement will depend on the nature of the asset and should aim to reflect the extent to which each CGU benefits from the corporate asset. In general, however, a reasonable and consistent basis of allocation should normally be possible in most circumstances by taking a pragmatic approach, even if the benefits obtained by the CGU are less clear-cut or observable. Example B.6 above shows one such pragmatic approach (allocating corporate assets using CGUs’ carrying amounts, weighted by their useful lives) but several other methods could also be supportable (for example, headcount, revenue, floor space or utilisation metrics depending on the circumstances).

Food for thought – Corporate assets and shared corporate costs in the regulatory spotlight

In estimating VIU (see Step 4) for a CGU that benefits from a corporate asset, an entity must ensure that it also allocates shared corporate costs that relate to that corporate asset. A regulatory decision published in the 3 April 2013 European Securities and Markets Authority (ESMA) Report (ESMA/2013/444) highlights this point whereby an issuer did not allocate the costs of corporate officers to the individual CGUs on the basis that the cash flows benefited the company as a whole rather than the individual CGUs (highlighting the criterion of independency of cash flows when determining the cash inflows and outflows of a CGU). In the regulator’s view, the corporate costs were cash outflows that were necessarily incurred to generate the cash inflows from continuing use of the assets and could be allocated on a reasonable and consistent basis to the asset. The regulator concluded that excluding certain corporate costs from the costs allocated to CGUs did not comply with the requirements of IAS 36 and that all cash outflows had to be included in the cash flow forecasts. The corporate costs were cash outflows that, according to IAS 36.39(b), were necessarily incurred to generate the cash inflows from continuing use of the CGU’s assets and could be allocated on a reasonable and consistent basis to the CGU.

2.2.3 Goodwill

It is not possible to determine the recoverable amount of goodwill independently from other assets because goodwill does not generate cash flows of its own; rather it contributes to the cash flows of individual CGUs or multiple CGUs (IAS 36.81).     The step-by-step IAS 36 impairment of assets

As such, goodwill must be allocated to individual CGUs (or groups of CGUs) for the purpose of impairment testing. The guidance in IAS 36.80 requires that goodwill acquired in a business combination is allocated to each of the acquirer’s CGUs or groups of CGUs that are expected to benefit from the synergies of the combination. Further, the level to which the goodwill is allocated must:

• represent the lowest level within the entity at which the goodwill is monitored for internal management purposes (IAS 36.80(a)); and
• not be larger than an operating segment before aggregation as defined by IFRS 8 ‘Operating Segments’ (IAS 36.80(b)).

Defining an operating segment (IFRS 8.5)   The step-by-step IAS 36 impairment of assets

An operating segment is a component of an entity:

that engages in business activities from which it may earn revenues and incur expenses (including revenues and expenses relating to transactions with other components of the same entity),

• whose operating results are regularly reviewed by the entity’s chief operating decision maker to make decisions about resources to be allocated to the segment and reassess its performance, and

• for which discrete financial information is available.

An operating segment may engage in business activities for which it has yet to earn revenues, for example, start-up operations may be operating segments before earning revenues.

Allocating goodwill acquired in a business combination

Background Entity A acquires competitor E for CU1M and determines that this new acquiree is a single CGU (E). Entity A performs an analysis of its existing business and determines that CGUs B, C and D will all benefit from the acquisition of E and expect to realise potential synergies from the transaction. The identifiable net assets of E total CU750,000. Total goodwill from the acquisition equals CU250,000 (CU1M – CU750,000). Analysis Because some of Entity A’s existing CGUs are expected to benefit from the synergies of the combination, a portion of the goodwill of CU250,000 should be allocated to these CGUs. IAS 36 provides little guidance on how to do this. However, if Entity A is able to estimate how much of the purchase price (and goodwill) relates to expected synergy benefits for its existing business, this can provide an initial basis for allocation. For example, if the estimated fair value of E is CU800,000 (ie excluding acquirer synergies), Entity A may allocate CU50,000 of goodwill to E (CU800,000-CU750,000) and allocate the remaining goodwill of CU200,000 between CGUs B, C and D, representing the expected synergies between E, B, C and D.

Allocating goodwill to groups of CGUs

IAS 36 acknowledges that sometimes goodwill cannot be allocated to individual CGUs on a non-arbitrary basis. It therefore allows or requires allocation to groups or clusters of CGUs, subject to the limits noted above.

If management has a monitoring process for goodwill, IAS 36 seems to require that goodwill is allocated to the lowest level at which it is monitored but limits this to the size of the operating segment before aggregation.

Allocation at such a level means that goodwill can be monitored using existing reporting systems consistent with the way that management monitors its operations (IAS 36.81-82). The step-by-step IAS 36 impairment of assets

If there is no separate monitoring process for goodwill, IAS 36 seems to allow a choice of allocation to:

• individual CGUs  The step-by-step IAS 36 impairment of assets
• groups of CGUs that form part of an operating segment before aggregation
• groups of CGUs that form an entire operating segment before aggregation.  The step-by-step IAS 36 impairment of assets

Food for Thought – Allocating goodwill acquired in a business combination

IAS 36 sets out requirements on both (a) the level of allocation and (b) the basis of allocation of goodwill to CGUs or groups of CGUs. IAS 36 offers some flexibility on the level to which goodwill is allocated. The allocation can be to CGUs, or to groups of CGUs, provided the level of allocation represents the lowest level within the entity at which the goodwill is monitored is not larger than an operating segment. In practice, the first condition rarely has a practical effect because few entities separately monitor goodwill outside the impairment review and external financial reporting process. The impact of the second condition is more varied. In some entities, an operating segment may comprise many CGUs while in others, the CGUs and operating segments might be similar or even identical. IAS 36 seems not to envisage that an operating segment could be smaller than a CGU – in general, this is possible in theory but rare in practice. The basis of allocation (the expected synergies from the combination) requires considerable judgement in practice. One approach is to perform a ‘pre-combination’ and ‘post-combination’ valuation and use this analysis as a basis to allocate the goodwill. Such an analysis may identify the factors that contribute to the synergies expected to arise from the acquisition (eg cost savings from economies of scale and reduced overheads or increased revenues from cross-selling opportunities to new markets). Others may use the relative carrying values of the CGUs to allocate the goodwill to impacted CGUs. In general, the entity should take a practical approach while aiming to arrive at the most representative allocation of goodwill to those CGUs that are expected to benefit from the combination. If the requirements in IAS 36.80 are overlooked, and goodwill is allocated entirely to the acquired business, this can lead to unnecessary future impairment losses and complications (eg when the CGUs are subsequently reorganised or disposed of, as discussed below).

Limit on the level at which goodwill can be allocated

Background Entity A manufactures and sells widgets. In year 20X1, it purchases Entity B, Entity C, and Entity D which also produce widgets, each in a different part of the world. Entity A recognised goodwill of CU1M with respect to the acquisition of Entity B, CU2M with respect to the acquisition of Entity C and CU4M with respect to Entity D, all attributable to the cost-savings opportunities from using Entity’s established centralised functions (purchasing, marketing, human resources). Management has identified several CGUs, each of which is a component of one of entities A, B, C and D. The operating segments before aggregation for the purposes of IFRS 8 are Entities A, B, C and D as management reporting and resource allocation decisions are based on the corporate structure. Goodwill is not separately monitored. Analysis Management can choose whether to allocate goodwill among individual CGUs that are expected to benefit from the synergies of each combination, or at the level of its four operating segments. If management determines that it cannot allocate goodwill among its individual CGUs except on an arbitrary basis it will allocate at the operating segment level.

Changes in the allocation of goodwill

For various reasons, the initial allocation of goodwill to CGUs or groups of CGUs may change. The below Sections discuss these circumstances and outline the appropriate accounting for each in accordance with IAS 36:

Provisional allocation of goodwill	A
Reallocation of goodwill disposal of an operation within a CGU reorganisation of the reporting structure	B B1 B2

A. Provisional allocation of goodwill

The initial allocation of goodwill acquired in a business combination should be completed before the end of the annual period in which the business combination takes place, if possible.

IFRS 3 ‘Business Combinations’ (IFRS 3) sets out guidance on provisional accounting for a business combination, including a requirement to finalise the IFRS 3 accounting within the so-called measurement period (not to exceed twelve months from the acquisition date).

In general, if goodwill has been determined only provisionally in accordance with IFRS 3, then that provisional amount should be allocated to CGUs or groups of CGUs if possible (and then adjusted as necessary when the IFRS 3 accounting is complete).

However, IAS 36 acknowledges that an initial allocation may not be possible, in which case the initial allocation should be completed before the end of the first annual period following the combination (IAS 36.84).

IFRS 3 resource reminder

In the event the entity is unable to allocate even the provisional amount of goodwill before the end of the period in which the combination takes place, it should disclose:

• the amount of unallocated goodwill and
• the reason(s) why it remains unallocated (IAS 36.133).

Compliance with IAS 36 when an initial allocation of goodwill is not possible

Background Entity P has acquired a subsidiary (Entity T) on 30 June 20X0 which will be accounted for in accordance with IFRS 3. At the reporting date of 31 December 20X0, Entity P has not completed its determination of the acquisition date fair values and therefore it cannot finalise its measurement of goodwill (ie the IFRS 3 measurement period remains open and the amounts reflected in the consolidated financial statements are stated as provisional). Entity P also concludes that it cannot complete the initial allocation of the provisional goodwill by 31 December 20X0. Question Does Entity P have to carry out an impairment test on the goodwill prior to 31 December 20X0 in accordance with IAS 36.96? Analysis When the initial allocation of goodwill has not been made in accordance with IAS 36.85 but facts and circumstances indicate that the goodwill may be impaired (eg, an overpayment for the acquisition), Entity P should use reasonable endeavours to ensure that the goodwill is not carried at an amount above its recoverable amount to comply with the overall principles of IAS 36 which require some form of recoverability test in such case. The fact that the allocation process remains incomplete does not exempt the entity from performing an impairment assessment using the best information available at the time. Depending upon the particular facts and circumstances, the form of this test may vary (for example, the entity may need to estimate the recoverable amount on an entity-wide basis).

B. Reallocation of goodwill

Various circumstances may necessitate a reallocation of goodwill among CGUs (or groups of CGUs) including:

• the disposal of an operation to which goodwill has been allocated
• the reorganisation of an entity’s reporting structure.

B.1 Disposal of an operation within a CGU to which goodwill has been allocated

When goodwill has been allocated to a CGU and the entity disposes of an operation within that unit,

the goodwill associated with the disposed operation must be:

• included in the carrying amount of the operation when determining the gain or loss on disposal (IAS 36.86(a)) and

measured on the basis of the relative values of the operation disposed of and the portion of the CGU retained (unless another method better reflects the goodwill associated with the disposed operation (IAS 36.86(b))).

Disposal of an operation to which goodwill has been allocated (IAS 36.86)

Background An entity sells for CU100 an operation that was part of a CGU to which goodwill has been allocated. The goodwill allocated to the CGU cannot be identified or associated with an asset group at a level lower than that CGU, except arbitrarily. The recoverable amount of the portion of the CGU retained is CU300. Analysis Because the goodwill allocated to the CGU cannot be non-arbitrarily identified or associated with an asset group at a level lower than that CGU, the goodwill associated with the operation disposed of is measured on the basis of the relative values of the operation disposed of and the portion of the unit retained. Therefore, 25 per cent of the goodwill allocated to the CGU is included in the carrying amount of the operation that is sold.

B.2 Reorganisation of the reporting structure

When an entity reorganises its reporting structure in a way that changes the composition of one or more CGUs to which goodwill has been allocated, the goodwill must be:

• reallocated to the units affected and
• measured using a relative value approach (again, unless another method better reflects the goodwill associated with the reorganised units (IAS 36.87)).

Reorganisation of the reporting structure (IAS 36.87)

Background Goodwill had previously been allocated to CGU A. The goodwill allocated to CGU A cannot be identified or associated with a lower level asset group, except arbitrarily. CGU A is to be divided and integrated into three other CGUs: B, C and D. Analysis Because the goodwill allocated to CGU A cannot be non-arbitrarily identified or associated with an asset group at a lower level, it is reallocated to CGUs B, C and D on the basis of the relative values of the three portions of CGU A before those portions are integrated into CGUs B, C and D.

Other methods that better reflect the goodwill associated with the operation disposed of or reorganised

When an entity disposes of part of a CGU to which goodwill has been allocated, IAS 36 sets out a benchmark ‘relative value’ approach for re-apportioning the goodwill within that unit, while also permitting some flexibility.

Similar guidance applies when an entity reorganises its reporting structure – if the reorganisation changes the composition of one or more CGUs to which goodwill has been allocated, the goodwill needs to be reallocated to the affected units.

In general, an alternative method of reallocation would be appropriate when the relative value approach does not take into account relevant differences between reorganised units (because the relative value approach assumes that each CGU has the same proportion of goodwill).

For example, assume an entity reorganises from three to two CGUs and the assets and activities of the third CGU (CGU C) are integrated with the remaining two (CGUs A and B). CGU C includes allocated goodwill of CU300 which must now be reallocated to CGUs A and B. Under the benchmark approach the reallocation would be based on the relative values of the portions of CGU C that are integrated into CGUs A and B.

However, assume also that the portion of CGU C integrated with CGU A is a manufacturing operation and the portion integrated with CGU B is a service-based operation. Using the figures in the table below, the relative value basis would result in the allocation of CU150 to CGU A and CU150 to CGU B.

The entity may deem it more appropriate in this case (given the different nature of the activities integrated into CGUs A and B) to allocate goodwill based on the notional goodwill of each portion resulting in an allocation of CU60 to CGU A (100/500*300) and CU240 to CGU B (400/500*300).

On the date of reorganisation	Portion of C integrated with CGU A	Portion of C integrated with CGU B	Total
Fair value of assets	500	200	700
Fair value of portion	600	600	1,200
Notional goodwill	100	400	500

2.2.4 Order of testing for corporate assets that cannot be allocated

2.2.1 to 2.2.3 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)). Assets in scope IAS 36

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 the example below]
• 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 the example below]. Any additional impairment loss calculated in this step should be recognised as follows: Assets in scope IAS 36
  • 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) Assets in scope IAS 36
• 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 example 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.

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.

 

Next – If & When – IAS 36 Impairment review

The step-by-step IAS 36 impairment of assets

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