IAS 36 : Impairment Part 1 Flashcards
INTRODUCTION
INTRODUCTION
In principle an asset is impaired when an entity will not be able to recover that asset’s carrying value, either through using it or selling it. If circumstances arise which indicate assets might be impaired, a review should be undertaken of their cash generating abilities either through use or sale.
This review will produce an amount which should
be compared with the assets’ carrying value, and if the carrying value is higher, the difference must be written off as an impairment in the statement of comprehensive income. The provisions within IAS 36 – Impairment of Assets – that set out exactly how
this is to be done, and how the figures involved are to be calculated, are detailed and quite complex.
The theory behind the impairment review
The purpose of the impairment review is to ensure that intangible assets, including goodwill, and tangible assets are not carried at a figure greater than their recoverable amount (RA).
This recoverable amount is compared with the carrying value (or carrying amount (CA)) of the asset to determine if the asset is impaired.
The theory behind the impairment review 1
Recoverable amount is defined as the higher of fair value less costs of disposal (FVLCD) and value in use (VIU); the underlying concept being that an asset should not be carried at more than the amount it could raise, either from selling it now or from using it.
Fair value less costs of disposal essentially means what the asset could be sold for, having deducted costs of disposal (incrementally incurred direct selling costs). Value in use is defined in terms of discounted future cash flows, as the present value of the cash flows expected from the future use and eventual
sale of the asset at the end of its useful life. As the recoverable amount is to be expressed as a present value, not in nominal terms, discounting is a central feature of the impairment test.
The theory behind the impairment review 2
Diagrammatically, this comparison between carrying value and recoverable amount, and the definition of recoverable amount, can be portrayed as follows: see OneNote
It may not always be necessary to identify both VIU and FVLCD, as if either of VIU or FVLCD is higher than the carrying amount then there is no impairment and no write down is necessary. Thus, if FVLCD is greater than the carrying amount then no further consideration need be given to VIU, or to the need for an impairment write down. The more complex issues arise when the FVLCD is not greater than the carrying value, and so a VIU calculation is necessary
Key features of the impairment review 1
Although an impairment review might theoretically be conducted by looking at individual assets, this will not always be possible. Goodwill does not have a separate FVLCD at all. Even if FVLCDs can be obtained for individual items of property, plant and equipment, estimates of VIUs usually cannot be. This is because the cash flows necessary for the VIU calculation are not usually generated by single assets, but by groups of assets being used together. Often, therefore, the impairment review cannot be done at the level of the individual asset and it must be applied to a group of assets.
IAS 36 uses the term cash generating unit (CGU)
for the smallest identifiable group of assets that together have cash inflows that are largely independent of the cash inflows from other assets and that therefore can be the subject of a VIU calculation. This focus on the CGU is fundamental, as it has the effect of making the review essentially a business-value test. Goodwill cannot always be allocated to a CGU and may therefore be allocated to a group of CGUs. IAS 36 has detailed guidance in respect of the level at which goodwill is tested for impairment which is discussed at IMPAIRMENT OF GOODWILL below.
Key features of the impairment review 2
Most assets and CGUs need only be tested for impairment if there are indicators of impairment. The ‘indications’ of impairment may relate to either the assets themselves or to the economic environment in which they are operated. IAS 36 gives examples of
indications of impairment, but makes it clear this is not an exhaustive list, and states explicitly that the entity may identify other indications that an asset is impaired, that would equally trigger an impairment review.
[IAS 36.13]. There are more onerous requirements for goodwill, intangible assets with an indefinite useful life and intangible assets that are not available for use on the reporting date.
These must be tested for impairment at least on an annual basis, irrespective of whether there are any impairment indicators. This is because the first two, goodwill and indefinite-lived intangible assets, are not subject to annual amortisation while it is argued that intangible assets are intrinsically (natural way) subject to greater uncertainty before they are brought into use. Impairment losses are recognised as expenses in profit or loss except in the case of an asset carried at a revalued amount where the impairment loss is recorded first against any previously recognised revaluation gains in respect of that asset in other comprehensive income.
Key features of the impairment review 3
The entity assesses, at each reporting date, whether an impairment assessment is required and acts accordingly:
• If there is an indication that an asset may be impaired, an impairment test is required.
• For goodwill, intangible assets with an indefinite useful life and intangible assets that are not available for use on the reporting date an annual impairment
test is required irrespective of whether there are any impairment indicators
• An asset is assessed for impairment either at an individual asset level or the level of a CGU depending on the level at which the recoverable amount can be determined, meaning the level at which independent cash inflows are generated.
• If the impairment test is performed at a CGU level then the entity needs to be divided into CGUs.
• After the identification of the CGUs, the carrying amount of the CGUs is determined.
• If goodwill is not monitored at the level of an individual CGU, then it is allocated to the group of CGUs that represent the lowest level within the entity at which
goodwill is monitored for internal management purposes, but not at a level that is larger than an operating segment.
Key features of the impairment review 4
•The recoverable amount of the asset or CGU assessed for impairment is established and compared with the carrying amount.
• The asset or CGU is impaired if its carrying amount exceeds its recoverable amount, defined as the higher of FVLCD and VIU.
• For assets carried at cost, any impairment loss is recognised as an expense in profit or loss.
• For assets carried at revalued amount, any impairment loss is recorded first against any previously recognised revaluation gains in other comprehensive income in
respect of that asset.
- Impairment losses in a CGU are first recorded against goodwill and second, if the goodwill has been written off, on a pro-rata basis to the carrying amount of other assets in the CGU. However, the carrying amount of an asset should not be reduced below the highest of its fair value less costs of disposal, value in use or zero. If the preceding rule is applied, further allocation of the impairment loss is made pro rata to the other assets of the unit (group of units).
- Extensive disclosure is required for the impairment test and any impairment loss that has been recognised.
- An impairment loss for an asset other than goodwill recognised in prior periods must be reversed if there has been a change in the estimates used to determine the asset’s recoverable amount.
Scope 1
The standard is a general impairment standard and its provisions are referred to in other standards, for example IAS 16 – Property, Plant and Equipment, IAS 38 – Intangible Assets – and IFRS 3 – Business Combinations – where impairment is to be considered. The standard has a general application to all assets, but the following are outside its scope:
• inventories (IAS 2 – Inventories);
• contract assets and assets arising from costs to obtain or fulfil a contract that are recognised in accordance with IFRS 15;
• deferred tax assets (IAS 12 – Income Taxes);
• assets arising from employee benefits under IAS 19 – Employee Benefits;
• financial assets that are included in the scope of IFRS 9 – Financial Instruments;
• investment property that is measured at fair value under IAS 40 – Investment Property;
• biological assets under IAS 41 – Agriculture, except bearer plants, e.g. apple trees, which are in the scope of IAS 16 and therefore fall under the IAS 36
impairment guidance;
• non-current assets (or disposal groups) classified as held for sale in accordance with IFRS 5 – Non-current Assets Held for Sale and Discontinued Operations.
[IAS 36.2]
Scope 2
This, the standard states, is because these assets are subject to specific recognition and measurement requirements. [IAS 36.3]. The effect of these exclusions is to reduce the scope of IAS 36. While investment properties measured at fair value are exempt,
investment properties not carried at fair value are in the scope of IAS 36. The standard applies to assets carried at revalued amounts, e.g. under IAS 16 (or rarely IAS 38). [IAS 36.4]. A lessee shall apply IAS 36 to determine whether the right-of-use asset is impaired and to account for any impairment loss identified.
[IFRS 16.33].
Financial assets classified as subsidiaries as defined in IFRS 10 – Consolidated Financial Statements, joint ventures as defined in IFRS 11 – Joint Arrangements – and associates as defined in IAS 28 – Investments in Associates and Joint Ventures – are within its scope.
[IAS 36.4]. This will generally mean only those investments in the separate financial statements of the parent. Interests in joint ventures and associates included in the consolidated accounts by way of the equity method are brought into scope by IAS 28.
[IAS 28.42].
WHEN AN IMPAIRMENT TEST IS REQUIRED
WHEN AN IMPAIRMENT TEST IS REQUIRED
There is an important distinction in IAS 36 between assessing whether there are indications of impairment and actually carrying out an impairment test. The standard has two different general requirements governing when an impairment test should be
carried out:
• For all other classes of assets within the scope of IAS 36, the entity is required to assess at each reporting date (year-end or any interim period end) whether there
are any indications of impairment. The impairment test itself only has to be carried out if there are such indications. [IAS 36.8-9].
• For goodwill and all intangible assets with an indefinite useful life the standard requires an annual impairment test. The impairment test may be performed at any time in the annual reporting period, but it must be performed at the same time every year. Different intangible assets may be tested for impairment at different times. [IAS 36.10].
In addition, the carrying amount of an intangible asset that has not yet been brought into use must be tested at least annually. This, the standard argues, is because
intangible assets are intrinsically subject to greater uncertainty before they are brought into use.
[IAS 36.11].
The particular requirements of IAS 36 concerning the impairment testing of goodwill and of intangible assets with an indefinite life are discussed separately at 8 (goodwill) and 10 (intangible assets with indefinite useful life) below, however the methodology used is identical for all types of assets.
For all other assets, an impairment test, i.e. a formal estimate of the asset’s recoverable amount as set out in the standard, must be performed if indications of impairment exist. [IAS 36.9]. The only exception is where there was sufficient headroom in a previous
impairment calculation that would not have been eroded by subsequent events or the asset or CGU is not sensitive to a particular indicator; the indicators and these exceptions are discussed further in the following section. [IAS 36.15].
Indicators of impairment 1
Identifying indicators of impairment is a crucial stage in the impairment assessment process. IAS 36 lists examples of indicators but stresses that they represent the minimum indicators that should be considered by the entity and that the list is not exhaustive.
[IAS 36.12-13]
They are divided into external and internal indicators.
Indicators of impairment 2
External sources of information:
(a) A decline in an asset’s value during the period that is significantly more than would be expected from the passage of time or normal use.
(b) Significant adverse changes that have taken place during the period, or will take place in the near future, in the technological, market, economic or legal environment in which the entity operates or in the market to which an asset is dedicated.
(c) An increase in the period in market interest rates or other market rates of return on investments if these increases are likely to affect the discount rate used in calculating an asset’s value in use and decrease the asset’s recoverable amount materially.
(d) The carrying amount of the net assets of the entity exceeds its market capitalisation.
Indicators of impairment 3
Internal sources of information:
(e) Evidence of obsolescence or physical damage of an asset.
(f) Significant changes in the extent to which, or manner in which, an asset is used or is expected to be used, that have taken place in the period or soon thereafter and that will have an adverse effect on it. These changes include the asset becoming idle, plans
to dispose of an asset sooner than expected, reassessing its useful life as finite rather than indefinite or plans to restructure the operation to which the
asset belongs.
(g) Internal reports that indicate that the economic performance of an asset is, or will be, worse than expected. [IAS 36.12].
Indicators of impairment 4
The standard amplifies and explains relevant evidence from internal reporting that indicates that an asset may be impaired:
(a) cash flows for acquiring the asset, or subsequent cash needs for operating or maintaining it, are significantly higher than originally budgeted;
(b) operating profit or loss or actual net cash flows are significantly worse than those budgeted;
(c) a significant decline in budgeted net cash flows or operating profit, or a significant increase in budgeted loss; or
(d) operating losses or net cash outflows for the asset, if current period amounts are aggregated with budgeted amounts for the future. [IAS 36.14].
Indicators of impairment 5
The presence of indicators of impairment will not necessarily mean that the entity has to calculate the recoverable amount of the asset in accordance with IAS 36. A previous calculation may have shown that an asset’s recoverable amount was significantly greater
than its carrying amount and it may be clear that subsequent events have been insufficient to eliminate this headroom. Similarly, previous analysis may show that an asset’s recoverable amount is not sensitive to one or more of these indicators. [IAS 36.15].
If there are indications that the asset is impaired, it may also be necessary to examine the remaining useful life of the asset, its residual value and the depreciation method
used, as these may also need to be adjusted even if no impairment loss is recognised. [IAS 36.17].
Indicators of impairment Market capitalisation
If market capitalisation is lower than the carrying value of equity, this is a powerful indicator of impairment as it suggests that the market considers that the business
value is less than the carrying value. However, the market may have taken account of factors other than the return that the entity is generating on its assets. For
example, an individual entity may have a high level of debt that it is unable to service fully. A market capitalisation below equity will not necessarily be reflected in an equivalent impairment loss. An entity’s response to this indicator depends very much on facts and circumstances.
Most entities cannot avoid examining their CGUs
in these circumstances unless there was sufficient headroom in a previous impairment calculation that would not have been eroded by subsequent events or
none of the assets or CGUs is sensitive to market capitalisation as an indicator. If a formal impairment review is required when the market capitalisation is below equity, great care must be taken to ensure that the discount rate used to calculate VIU is consistent with current market assessments. IAS 36 does not require a formal reconciliation between market capitalisation of the entity, FVLCD and VIU. However, entities need to be able to understand the reason for the shortfall and consider whether they have made sufficient disclosures describing those factors that
could result in an impairment in the next periods.
[IAS 36.134(f)].
Indicators of impairment - (Future) performance
Another significant element is an explicit reference in (b), (c) and (d) above to internal evidence that future performance will be worse than expected. Thus IAS 36 requires an impairment review to be undertaken if performance is or will be significantly below that
previously budgeted.
In particular, there may be indicators of impairment even if the asset is profitable in the current period if budgeted results for the future indicate that there will be losses or net cash outflows when these are aggregated with the current period results.
Indicators of impairment - Individual assets or part of CGU?
Some of the indicators are aimed at individual fixed assets rather than the CGU of which they are a part, for example a decline in the value of an asset or evidence that it is obsolete or damaged. Such indicators may also imply that a wider review of the business or CGU is required. However, this is not always the case. For example, if there is a slump in property prices and the market value of the entity’s new head office falls below its carrying value this would constitute an indicator of impairment and trigger a review. At the level of the individual asset, as FVLCD is below carrying amount, this might indicate
that a write-down is necessary.
However, the building’s recoverable amount may have
to be considered in the context of a CGU of which it is a part. This is an example of a situation where it may not be necessary to re-estimate an asset’s recoverable amount because it may be obvious that the CGU has suffered no impairment. In short, it may be irrelevant to the recoverable amount of the CGU that it contains a head office whose market value has fallen.
Indicators of impairment - Interest rates
Including interest rates as indicators of impairment could imply that assets are judged to be impaired if they are no longer expected to earn a market rate of return, even though they may generate the same cash flows as before. However, it may well be that an upward movement in general interest rates will not give rise to a write-down in assets because they may not affect the rate of return expected from the asset or CGU itself. The standard indicates that this may be an example where the asset’s recoverable amount is not sensitive to a particular indicator.
The discount rate used in a VIU calculation should be based on the rate specific for the asset. An entity is not required to make a formal estimate of an asset’s
recoverable amount if the discount rate used in calculating the asset’s VIU is unlikely to be affected by the increase in market rates. For example the recoverable amount for an asset that has a long remaining useful life may not be materially affected by
increases in short-term rates. Further an entity is not required to make a formal estimate of an asset’s recoverable amount if previous sensitivity analyses of the recoverable amount showed that it is unlikely that there will be a material decrease in the recoverable amount because future cash flows are also likely to increase to compensate for the increase in market rates. Consequently, the potential decrease in the recoverable amount may simply be unlikely to result in a material impairment loss. [IAS 36.16].
DIVIDING THE ENTITY INTO CASH-GENERATING UNITS (CGUS)
DIVIDING THE ENTITY INTO CASH-GENERATING UNITS (CGUS)