Impairment of Assets

IAS - 36
The Concept
The basic principle underlying IAS 36 Impairment of Assets is relatively straightforward. If an
asset's value in the financial statements is higher than its realistic value, measured as its
'recoverable amount', the asset is judged to have suffered an impairment loss. It should
therefore be reduced in value, by the amount of the impairment loss. The amount of the
impairment loss should be written off against profit immediately.
Accounting issues
a) How is it possible to identify when an impairment loss may have occurred?
b) How should the recoverable amount of the asset be measured?
c) How should an impairment loss be reported in the financial statements?
Definition
Impairment is a reduction in the recoverable amount of an asset or cashgenerating unit
below its carrying amount.
Carrying amount. The net value at which the asset is included in the statement of financial
position (ie after deducting accumulated depreciation and any impairment losses).
IAS 36 Impairment of Assets says that an entity should carry out an impairment review at
least annually if:
◦ an intangible asset is not being amortised because it has an indefinite useful life
◦ goodwill has arisen on a business combination.

Otherwise, an impairment review is required only where there is an indication that

impairment may have occurred.
Scope
IAS 36 applies to impairment of all assets other than (IAS 36: para. 2):
◦ Inventories
◦ Deferred tax assets
◦ Employee benefit assets
◦ Financial assets
◦ Investment property held under the fair value model Biological assets held at fair value less costs to
sell
◦ Non-current assets held for sale
Identifying a potentially impaired asset
An entity should assess at the end of each reporting period whether there are any
indications of impairment to any assets. The concept of materiality applies, and only
material impairment needs to be identified.
If there are indications of possible impairment, the entity is required to make a formal
estimate of the recoverable amount of the assets concerned.
Indications of a possible impairment
Internal
a) Evidence of obsolescence or physical damage
b) Significant changes with an adverse effect on
the entity*:
(i) the asset becomes idle
(ii) plans to discontinue/restructure the
operation to which the asset belongs
(iii) plans to dispose of an asset before the
previously expected date
(iv) reassessing an asset's useful life as finite
rather than indefinite
c) Internal evidence available that asset
performance will be worse than expected
External
a) Observable indications that the asset's value
has declined during the period significantly
more than expected due to the passage of
time or normal use
b) Significant changes with an adverse effect on
the entity in the technological or market
environment, or in the economic or legal
environment
c) Increased market interest rates or other
market rates of return affecting discount rates
and thus reducing value in use
d) Carrying amount of net assets of the entity
exceeds market capitalisation.
Calculating an impairment loss
▪An impairment occurs if the carrying amount of an asset is greater than its recoverable
amount.
▪The recoverable amount is the higher of fair value less costs to sell and value in use.
▪Fair value is defined in IFRS 13 Fair Value Measurement as the price received when selling
an asset in an orderly transaction between market participants at the measurement date.
▪Costs to sell are incremental costs directly attributable to the disposal of an asset.
▪Value in use is calculated by estimating future cash inflows and outflows from the use of the
asset and its ultimate disposal, and applying a suitable discount rate to these cash flows.
▪Cash flow projections are based on the most recent management-approved
budgets/forecasts. They should cover a maximum period of five years, unless a longer
period can be justified. (IAS 36: paras. 33–35).
Cashflows Include/Exclude
The cash flows should include (IAS 36: para. 50):
a) Projections of cash inflows from continuing use of the asset
b) Projections of cash outflows necessarily incurred to generate the cash inflows from
continuing use of the asset
c) Net cash flows, if any, for the disposal of the asset at the end of its useful life
d) Future overheads that can be directly attributed, or allocated on a reasonable and consistent
basis

The cash flows should exclude:

a) Cash outflows relating to obligations already recognised as liabilities (to avoid double
counting) (IAS 36: para 43)
b) The effects of any future restructuring to which the entity is not yet committed (IAS 36: para.
44)
c) Cash flows from financing activities or income tax receipts and payments (IAS 36: para. 50)
Estimates of cash flows
With regards to estimates of cash flows, IAS 36 stipulates that:
◦ The cash flow projections should be based on reasonable assumptions and the most recent
budgets and forecasts
◦ The cash flow projections should relate to the asset’s current condition and should exclude
expenditure to improve or enhance it
◦ For periods in excess of five years, management should extrapolate from earlier budgets using a
steady, declining or zero growth rate
◦ Management should assess the accuracy of their budgets by investigating the reasons for any
differences between forecast and actual cash flows.
Discount Rate for Value in Use
The discount rate used to calculate value in use should reflect:
◦ 'the time value of money, and
◦ the risks specific to the asset for which the future cash flow estimates have not been adjusted' (IAS
36, para 55).
Explanation
▪The discount rate should be the pre-tax rate which reflects current market assessments of
the time value of money and the risks specific to the asset
▪IAS 36 specifies that a rate that reflects the current market assessment of the time value of
the money and the risks specific to the assets is the return that the investors would require
if they chose an investment that would generate cash flows of amounts, timing and risk
profile equivalent to those that the entity expects to derive from the assets.
▪If a market-determined asset-specific rate is not available, a surrogate must be used that
reflects the time value of money over the asset’s life as well as country risk, currency risk,
price risk, and cash flow risk.
▪This would include considering the entity’s own weighted average cost of capital, the
entity’s incremental borrowing rate and other market borrowing rates.
▪Therefore, the inputs to the determination of the discount rates should be based on current
credit spread levels in order to reflect the current market assessment of the time value of
the money and asset specific risks.
Recognising impairment losses in the
financial statements
An impairment loss is normally charged immediately in the statement of profit or loss and
other comprehensive income.
If the asset has previously been revalued upwards, the impairment is recognised as a
component of other comprehensive income and is debited to the revaluation reserve until
the surplus relating to that asset has been reduced to nil. The remainder of the impairment
loss is recognised in profit or loss.
The recoverable (impaired) amount of the asset is then depreciated/amortised over its
remaining useful life.
Example
On 31 December 20X1, an entity noticed that one of its items of plant and machinery is
often left idle. On this date, the asset had a carrying amount of $500,000 and a fair value of
$325,000. The estimated costs required to dispose of the asset are $25,000.
If the asset is not sold, the entity estimates that it would generate cash inflows of $200,000
in each of the next two years. The discount rate that reflects the risks specific to this asset is
10%.
Required:
◦ (a) Discuss the accounting treatment of the above in the financial statements for the year ended
31 December 20X1.
◦ (b) How would the answer to part (a) be different if there was a balance of $10,000 in other
components of equity relating to the prior revaluation of this specific asset?
Solution - a
The value in use is calculated as the present value of the asset's future cash inflows and
outflows.
$000
Cash flow Year 1 (200 × 0.909) 182
Cash flow Year 2 (200 × 0.826) 165
347

The recoverable amount is the higher of the fair value less costs to sell of $300,000
($325,000 – $25,000) and the value in use of $347,000.
The carrying amount of the asset of $500,000 exceeds the recoverable amount of $347,000.
Therefore, the asset is impaired and must be written down by $153,000 ($500,000 –
$347,000). This impairment loss would be charged to the statement of profit or loss.
Dr Profit or loss $153,000
Cr PPE $153,000
Solution - b
The asset must still be written down by $153,000. However, $10,000 of this would be
recognised in other comprehensive income and the remaining $143,000 ($153,000 –
$10,000) would be charged to profit or loss.
Dr Profit or loss $143,000
Dr Other comprehensive income $10,000
Cr PPE $153,000
Example
A company that extracts natural gas and oil has a drilling platform in the Caspian Sea. It is
required
by legislation of the country concerned to remove and dismantle the platform at the end of
its useful life. Accordingly, the company has included an amount in its accounts for removal
and dismantling costs, and is depreciating this amount over the platform's expected life.
The company is carrying out an exercise to establish whether there has been an impairment
of the platform.
a) Its carrying amount in the statement of financial position is $3m.
b) The company has received an offer of $2.8m for the platform from another oil company. The
bidder would take over the responsibility (and costs) for dismantling and removing the
platform at the end of its life.
c) The present value of the estimated cash flows from the platform's continued use is $3.3m.
d) The carrying amount in the statement of financial position for the provision for dismantling
and removal is currently $0.6m.

Required: What should be the value of the drilling platform in the

statement of financial position, and what, if anything, is the impairment
loss?
Solution
Fair value less costs of disposal $2.8m

Value in use Present value of cash flows from use less the
carrying amount of the provision/liability =
$3.3m – $0.6m = $2.7m

Recoverable amount Higher of these two amounts, ie $2.8m

Carrying value $3m

Impairment loss $0.2m

The carrying amount should be reduced to $2.8m.
Example
Shiplake is preparing its financial statements for the year ended 31 March 20X2. Shiplake
has undertaken an impairment review which has identified an issue with an item of earth-
moving plant, which is hired out to companies on short-term contracts. The plant's carrying
amount is $400,000. The estimated selling price of the plant is only $250,000, with
associated selling expenses of $5,000. A recent review of its value in use based on forecast
future cash flows was estimated at $500,000. Since this review was undertaken there has
been a dramatic increase in interest rates that has significantly increased the cost of capital
used by Shiplake to discount the future cash flows of the plant.
Required: Explain the effect of the above information on Shiplake's financial statements
to 31 March 20X2.
Solution
On the basis of the original estimates, Shiplake's earth-moving plant was not impaired, the
value in use of $500,000 being greater than its carrying amount. However due to the
'dramatic' increase in interest rates causing Shiplake's cost of capital, and therefore the
discount rate, to increase, the value in use of the plant will fall. There is insufficient
information to be able to quantify this fall. If the new discounted value is above the carrying
amount $400,000 there is still no impairment. If it is between $245,000 and $400,000, this
will be the recoverable amount of the plant and it should be written down to this value. As
the plant can be sold for $250,000 less selling costs of $5,000, $245,000 is the lowest
amount that the plant should be written down to even if its revised value in use is below
this figure.
Cash-generating units
It is not usually possible to identify cash flows relating to particular assets. For example, a
factory production line is made up of many individual machines, but the revenues are
earned by the production line as a whole. This means that value in use must be calculated
(and the impairment review performed) for groups of assets, rather than individual assets.
These groups of assets are called cash-generating units (CGUs).
Cash-generating units are segments of the business whose income streams are largely
independent of each other.
In practice they are likely to mirror the strategic business units used for monitoring the
performance of the business.
It could also include a subsidiary or associate within a corporate group structure.
Example
An entity has three stages of production:
◦ A – growing and felling trees
◦ B – creating parts of wooden furniture
◦ C – assembling the parts from B into finished goods.

The output of A is timber that is partly transferred to B and partly sold in an external
market. If A did not exist, B could buy its timber from the market. The output of B has no
external market and is transferred to C at an internal transfer price. C sells the finished
product in an external market and the sales revenue achieved by C is not affected by the
fact that the three stages of production are all performed by the entity.
Required: Identify the cash-generating unit(s).
Solution
A forms a cash-generating unit and its cash inflows should be based on the market price for
its output. B and C together form one cashgenerating unit because there is no market
available for the output of B. In calculating the cash outflows of the cash-generating unit B +
C, the timber received by B from A should be priced by reference to the market, not any
internal transfer price.
Allocation of an impairment to the unit’s
assets
If an impairment loss arises in respect of a cash-generating unit, IAS 36 requires that it is
allocated among the assets in the following order:
◦ goodwill
◦ other assets in proportion to their carrying amount.

However, the carrying amount of an asset cannot be reduced below the highest of:
◦ fair value less costs to sell
◦ value in use
◦ nil.
Example
Tinud has identified an impairment loss of $41m for one of its cashgenerating units. The carrying
amount of the unit’s net assets was $150m, whereas the unit’s recoverable amount was only
$109m. The draft values of the net assets of the unit are as follows:
$m
Goodwill 13
Property 20
Machinery 49
Vehicles 35
Patents 14
Net monetary assets 19
150
The net selling price of the unit’s assets were insignificant except for the property, which had a
market value of $35m. The net monetary assets will be realised in full.
Required:
◦ How is the impairment loss allocated to the assets within the cash-generating unit?
Solution
Firstly, the impairment loss is allocated to the goodwill, reducing its carrying amount to nil.
The impairment loss cannot be set against the property because its net selling price is
greater than its carrying amount.
Likewise, the impairment loss cannot be set against the net monetary assets (receivables,
cash, etc.) because they will be realised in full.
The balance of the impairment loss of $28 million ($41m – $13m) is apportioned between
the remaining assets in proportion to their carrying amounts. So, for example, the
impairment allocated to the machinery is $14 million ((49/(49 + 35 + 14)) × 28m)
Example
There was an explosion in a factory. The carrying amounts of its assets were as follows:
$000
Goodwill 100
Patents 200
Machines 300
Computers 500
Buildings 1500
2600

The factory operates as a cash-generating unit. An impairment review reveals a net selling price
of $1.2 million for the factory and value in use of $1.95 million. Half of the machines have been
blown to pieces but the other half can be sold for at least their carrying amount. The patents
have been superseded and are now considered worthless.
Required:
◦ Discuss, with calculations, how any impairment loss will be accounted for.
Solution
▪The patents have been superseded and have a recoverable amount of $nil. They therefore
should be written down to $nil and an impairment loss of $200,000 must be charged to
profit or loss.
▪Half of the machines have been blown to pieces. Therefore, half of the carrying amount of
the machines should be written off. An impairment loss of $150,000 will be charged to
profit or loss.
▪The recoverable amount of the other assets cannot be determined so therefore they must
be tested for impairment as part of their cash generating unit.
▪The total carrying amount of the CGU after the impairment of the patents and machines is
$2,250,000 (see working below), whereas the recoverable amount is $1,950,000. A further
impairment of $300,000 is therefore required.
▪This is firstly allocated to goodwill and then to other assets on a pro-rata basis. No further
impairment should be allocated to the machines as these have already been written down
to their recoverable amount.
Solution - Continued
Allocation of impairment loss to CGU

Draft Impairment Revised

$000 $000 $000
Goodwill 100 (100) Nil
Patents nil - Nil
Machines 150 - 150
Computers 500 (50) 450
Buildings 1,500 (150) 1,350
2,250 (300) 1,950

The total impairment charged to profit or loss is $650,000 ($200,000 + $150,000 +

$300,000).
Reversal of an impairment loss
▪The calculation of impairment losses is based on predictions of what may happen in the
future. Sometimes, actual events turn out to be better than predicted. If this happens, the
recoverable amount is re-calculated and the previous write-down is reversed.
▪Impaired assets should be reviewed at each reporting date to see whether there are
indications that the impairment has reversed.
▪A reversal of an impairment loss is recognised immediately as income in profit or loss. If the
original impairment was charged against the revaluation surplus, it is recognised as other
comprehensive income and credited to the revaluation reserve.
▪The reversal must not take the value of the asset above the amount it would have been if
the original impairment had never been recorded. The depreciation that would have been
charged in the meantime must be taken into account.
▪The depreciation charge for future periods should be revised to reflect the changed carrying
amount.
▪An impairment loss recognised for goodwill cannot be reversed in a subsequent period.
Example
Boxer purchased a non-current asset on 1 January 20X1 at a cost of $30,000. At that date,
the asset had an estimated useful life of ten years. Boxer does not revalue this type of asset,
but accounts for it on the basis of depreciated historical cost. At 31 December 20X2, the
asset was subject to an impairment review and had a recoverable amount of $16,000.
At 31 December 20X5, the circumstances which caused the original impairment to be
recognised have reversed and are no longer applicable, with the result that recoverable
amount is now $40,000.
Required:
◦ Explain, with supporting computations, the impact on the financial statements of the two
impairment reviews.
Solution
Impairment Loss = 24000 – 16000 = $8000
The asset is written down to $16,000 and the loss of $8,000 is charged to profit or loss. The
depreciation charge per annum in future periods will be $2,000 ($16,000 × 1/8).
In the year ended 31 Dec 20X5 there has been no impairment loss. In fact, there has been a
complete reversal of the first impairment loss. The asset can be reinstated to its depreciated
historical cost i.e. to the carrying value at 31 December 20X5 if there never had been an
earlier impairment loss.
Year 5 depreciated historical cost (30,000 × 5/10) = $15,000 Carrying amount: $10,000
Reversal of the loss: $5,000
The reversal of the loss is now recognised. The asset will be increased by $5,000 ($15,000 –
$10,000) and a gain of $5,000 will be recognised in profit or loss.
It should be noted that the whole $8,000 original impairment cannot be reversed. The
impairment can only be reversed to a maximum amount of depreciated historical cost,
based upon the original cost and estimated useful life of the asset.
Example
On 31 December 20X2, an impairment review was conducted on a cash generating unit and the results were
as follows:
Asset Carrying amount Impairment Carrying amount
pre-impairment post-impairment
$000 $000 $000
Goodwill 100 (100) Nil
Property, plant and 300 (120) 180
equipment
400 (220) 180
The property, plant and equipment was originally purchased for $400,000 on 1 January 20X1 and was
attributed a useful economic life of 8 years.
At 31 December 20X3, the circumstances which caused the original impairment have reversed and are no
longer applicable. The recoverable amount of the cash generating unit is now $420,000.
Required:
◦ Explain, with supporting computations, the impact of the impairment reversal on the financial statements for the
year ended 31 December 20X3.
Solution
The goodwill impairment cannot be reversed.
The impairment of the PPE can be reversed. However, this is limited to the carrying value of
the asset had no impairment loss been previously recognised.
The carrying amount of the PPE as at 31 December 20X3 is $150,000 ($180,000 × 5/6).
If the PPE had not been impaired, then its value at 31 December 20X3 would have been
$250,000 ($400,000 × 5/8).
Therefore, the carrying amount of the PPE can be increased from $150,000 to $250,000.
This will give rise to a gain of $100,000 in profit or loss.
Corporate assets
Corporate assets are group or divisional assets such as a head office building or a research
centre. Corporate assets do not generate cash inflows independently from other assets;
hence their carrying amount cannot be fully attributed to a cash-generating unit under
review. Corporate assets are treated in a similar way to goodwill.
The CGU includes corporate assets (or a portion of them) that can be allocated to it on a
'reasonable and consistent basis' (IAS 36: para. 77). Where this is not possible, the assets (or
unallocated portion) are tested for impairment as part of the group of CGUs to which they
can be allocated on a reasonable and consistent basis.
Allocation of loss with unallocated
corporate assets or goodwill
Where not all assets or goodwill will have been allocated to an individual CGU then different
levels of impairment tests are performed to ensure the unallocated assets are tested.
a) Test of individual CGUs
◦ Test the individual CGUs (including allocated goodwill and any portion of the carrying amount of
corporate assets that can be allocated on a reasonable and consistent basis).

b) Test of group of CGUs

◦ Test the smallest group of CGUs that includes the CGU under review and to which the goodwill can
be allocated/a portion of the carrying amount of corporate assets can be allocated on a reasonable
and consistent basis.
Example
The Satchell Group is made up of two cash-generating units (as a result of a combination of
various past 100% acquisitions), plus a head office, which was not allocated to any given
cash-generating unit as it supports both divisions.
Due to falling sales as a result of an economic crisis, an impairment test was conducted at
the year end. The consolidated statement of financial position showed the following net
assets at that date.
Division Division Head Unallocated Total
A B office goodwill
$m $m $m $m $m
Property, plant & equipment (PPE) 780 620 90 - 1490
Goodwill 60 30 - 10 100
Net current assets 180 110 20 - 310
1020 760 110 10 1900
Example - Continued
The recoverable amounts (including net current assets) at the year end were as follows:

£m
Division A 1000
Division B 720
Group as a whole 1825 (including head office PPE at fair value less
costs of disposal of $85m)

The recoverable amounts of the two divisions were based on value in use. The fair value less
costs of disposal of any individual item was substantially below this.
No impairment losses had previously been necessary.
Required: Discuss, with suitable computations showing the allocation of any impairment
losses, the accounting treatment of the impairment test. Use the proforma below to help
you with your answer.
Solution
Where there are multiple cash-generating units, IAS 36 requires two levels of tests to be
performed to ensure that all impairment losses are identified and fairly allocated. First
Divisions A and B are tested individually for impairment. In this instance, both are impaired
and the impairment losses are allocated first to any goodwill allocated to that unit and
secondly to other non-current assets (within the scope of IAS 36) on a pro-rata basis. This
results in an impairment of the goodwill of both divisions and an impairment of the
property, plant and equipment in Division B only.
A second test is then performed over the whole business including unallocated goodwill and
unallocated corporate assets (the head office) to identify if those items which are not a
cashgenerating unit in their own right (and therefore cannot be tested individually) have
been impaired.
The additional impairment loss of $15m (W2) is allocated first against the unallocated
goodwill of $10m, eliminating it, and then to the unallocated head office assets reducing
them to $85m. Divisions A and B have already been tested for impairment so no further
impairment loss is allocated to them or their goodwill as that would result in reporting them
at below their recoverable amount.
Solution - Continued
Carrying amounts after impairment test
Division Division Head Unallocated Total
A B office goodwill
$m $m $m $m $m
PPE 780/(620 – 10)/(90 – 5) 780 610 85 - 1475
Goodwill (60 – 20)/(30 – 30)/(10 – 10) 40 - 0 40
Net current assets 180 110 20 - 310
1000 720 105 0 1825
 Solution - Continued
Test of individual CGUs Test of group of CGUs
Division A Division B $m
$m $m Revised CV (1,000 + 720 + 110 + 10) 1840
Carrying amount 1020 760 Recoverable amount (1,825)
Recoverable amount (1000) (720) Impairment loss 15
Impairment loss 20 40 Allocated to:
Allocated to: Unallocated goodwill 10
Goodwill 20 30 Other unallocated assets 5
Other assets in the scope - 10 15
of IAS 36
20 40
Disclosures
IAS 36 requires disclosure of the following:
◦ losses recognised during the period
◦ reversals recognised during the period

For each material loss or reversal:

◦ the amount of loss or reversal and the events causing it
◦ the recoverable amount of the asset (or cash generating unit)
◦ whether the recoverable amount is the fair value less costs to sell or value in use
◦ the level of fair value hierarchy (per IFRS 13) used in determining fair value less costs to sell
◦ the discount rate(s) used.