Recoverable amount

IAS 36 Definition: Recoverable amount of an asset or a cash-generating unit is the higher of its fair value less costs to sell and its value in use.

Recoverable amount is determined for an individual asset, unless the asset does not generate cash inflows that are largely independent of those from other assets or groups of assets. If this is the case, recoverable amount is determined for the cash-generating unit to which the asset belongs (see IAS 36 65–103), unless either:

  1. the asset’s fair value less costs of disposal is higher than its carrying amount; or
  2. the asset’s value in use can be estimated to be close to its fair value less costs of disposal and fair value less costs of disposal can be measured. (IAS 36 22)

In a diagram this shows as follows (assuming the carrying amount of the asset or cash-generating unit is at (historical) costs less depreciation and/or impairments):

An asset is impaired when its carrying amount exceeds its recoverable amount. The recoverable amount is determined for individual assets. However, if an asset does not generate cash inflows that are largely independent of those from other assets, the recoverable amount is determined for the cash-generating unit to which the asset belongs. A cash-generating unit is the smallest identifiable group of assets that generate cash inflows that are largely independent of the cash inflows from other assets or groups of assets.

Just a small example to make the learning/decision making easier:

Inspire Ltd carries out impairment reviews of three of the company’s assets. The following information is relevant:

(Amounts in CU)

Carrying amount

Fair value less costs of disposal

Value in use

Asset A

9,000

6,000

7,000

Asset B

17,000

19,000

13,000

Asset C

26,000

21,000

24,000

The carrying amount of an asset (A, B or C) is the amount at which it is recognised in the statement of financial position after deducting accumulated depreciation, or amortisation in the case of intangibles, and previous accumulated impairment losses. This amount is simply derived from the trial balance of Inspire Ltd.

Fair value less costs of disposal is the price that would be received from the sale of an asset (A, B or C) in an orderly transaction between market participants at the measurement date, less the costs of disposal – for example, legal costs, stamp duty and the costs of removing the asset. (Example fair value less costs of disposal)

Value in use is the present value of the future cash flows expected to be derived from an asset (A, B or C) in respect of its continuing use and ultimate disposal. (Example value in use)

Which of these assets, if any, will be impaired?

Solution Recoverable amount

Asset A ReConsolidation exceptions and exemptionscoverable amount

This asset is impaired as the carrying amount of CU 9,000 exceeds the recoverable amount of CU 7,000 (the higher of CU 7,000 and CU 6,000).

Asset B Recoverable amount

The carrying amount of CU 17,000 is less than the recoverable amount of CU 19,000 (the higher of CU 19,000 and CU 13,000), and so this asset is not impaired.

Asset C Recoverable amount

This asset is impaired as the carrying amount of CU 26,000 exceeds the recoverable amount of CU 24,000 (the higher of CU 24,000 and CU 21,000).

Value in use

Value in use (VIU) is the present value of the future cash flows expected to be derived from an asset or a cash-generating unit. A value-in-use calculation includes:

  • Cash flow projections: Recoverable amount
    • An estimate of the future cash flows that the entity expects to derive from the asset Recoverable amount
    • Expectations about possible variations in the amount or timing of those future cash flows Recoverable amount
  • Discount rate: Recoverable amount
    • The time value of money — that is a pre-tax discount rate that reflects current market assessments of the time value of money and risks specific to the asset for which the future cash flow estimates have not been adjusted Recoverable amount
    • The price for bearing the uncertainty inherent in the asset which can be reflected in either the cash flow estimate or the discount rate
    • Other factors, such as illiquidity, that market participants would reflect in pricing the future cash flows the entity expects to derive from the asset

When measuring value-in-use, the entity’s cash flow projections:

  • Must be based on reasonable and supportable assumptions that represent management’s best estimate of the set of economic conditions that will exist over the remaining useful life of the asset Recoverable amount
  • Must be based on the most recent financial budgets/forecasts approved by management — without including cash inflows or outflows from future restructurings to which the entity is not yet committed Recoverable amount
  • Should exclude borrowing costs, income tax receipts or payments and capital expenditures that improve or enhance the asset’s performance
  • Should include overheads that are directly attributed or can be allocated on a reasonable and consistent basis and the amount of transaction costs if Cost of self-constructed assets Cost of self-constructed assets Cost of self-constructed assets disposal is expected at the end of the asset’s useful life Recoverable amount
  • For periods beyond the periods covered by the most recent budgets/forecasts should be based on extrapolations using a steady or declining growth rate unless an increasing rate can be justified Recoverable amount

IAS 36 requires that entities compare their previous estimates of cash flows to actual cash flows as part of the assessment of the reasonableness of their assumptions, particularly where there is a history of management consistently overstating or understating cash flow forecasts. The results of past variances should be factored into the most recent budgets/forecasts. However, to the extent this has not occurred, management should make the necessary adjustments to the cash flow projections. Recoverable amount Recoverable amount

IAS 36 requires that value-in-use should reflect the present value of the expected future cash flows, that is, the weighted average of all possible outcomes. In practice, present values are computed either by a ‘traditional’ or ‘expected’ cash flow approach. In theory, the outcome of the impairment test should be the same regardless of which approach is used. Under a traditional approach, a single set of estimated cash flows and a single discount rate, often described as ‘the rate commensurate with the risk,’ are used. The expected cash flow approach applies different probabilities to expected cash flows rather than using a single most likely cash flow. Recoverable amount Recoverable amount

When comparable assets can be observed in the market place, the traditional approach is relatively easy to apply. However, as indicated in IAS 36, the expected cash flow approach is, in some situations, a more effective measurement tool than the traditional approach. Regardless of which approach is selected, both cash flows and the discount rate should be expressed consistently, either in real terms, which exclude inflation, or in nominal terms. Recoverable amount Recoverable amount

IAS 36 requires the use of pre-tax cash flows and pre-tax discount rates in the impairment test. In practice, primarily because of the widespread use of the Capital Asset Pricing Model — post-tax costs of equity are generally determined and used in the entity’s computations of the discount rate. Discounting post-tax cash flows at a post-tax discount rate and discounting pre-tax cash flows at a pre-tax discount rate should give the same result when there are neither temporary differences nor available tax losses at the measurement date.

The pre-tax rate needs to be determined on an iterative basis, adjusted to reflect the specific amount and timing of the future tax cash flows, though still excluding the effects of any existing temporary differences and available tax losses at the measurement date. However, in many cases, a post-tax discount rate grossed up by a standard rate of tax may be a reasonable estimate of the pre-tax rate. Recoverable amount

Recoverable amount

Recoverable amount

Annualreporting.info provides financial reporting narratives using IFRS keywords and terminology for free to students and others interested in financial reporting. The information provided on this website is for general information and educational purposes only and should not be used as a substitute for professional advice. Use at your own risk. Annualreporting.info is an independent website and it is not affiliated with, endorsed by, or in any other way associated with the IFRS Foundation. For official information concerning IFRS Standards, visit IFRS.org.

Leave a comment