IAS 36: Impairment of

Assets
Objective and scope of IAS 36:
• An asset is said to be impaired when its recoverable amount is less
than its carrying amount in the statement of financial position.
• From time to time an asset may have a carrying value that is greater
than its fair value but this is not necessarily impairment as the
situation might change in the future. Impairment means that the asset
has suffered a permanent loss in value.
• The objective of IAS 36 Impairment of assets is to ensure that assets
are ‘carried’ (valued) in the financial statements at no more than their
recoverable amount.
Definitions

• The recoverable amount of an asset is defined as the higher of its fair

value minus costs of disposal, and its value in use.
• Fair value is the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market participants
at the measurement date.
• Value in use is the present value of future cash flows from using an asset,
including its eventual disposal.
• Impairment loss is the amount by which the carrying amount of an asset
(or a cash-generating unit) exceeds its recoverable amount.
Stages in accounting for an impairment loss

• Stage 1: Establish whether there is an indication of impairment.

• Stage 2: If so, assess the recoverable amount.
• Stage 3: Write down the affected asset (by the amount of the impairment) to its
recoverable amount.
• Identifying impairment or possible impairment
• Indicators of impairment
The following are given by IAS 36 as possible indicators of impairment. These
may be indicators outside the entity itself (external indicators), such as market
factors and changes in the market. Alternatively, they may be internal indicators
relating to the actual condition of the asset or the conditions of the entity’s
business operations.
Indicators of impairment
External Sources
An unexpected decline in the asset’s
market value.
Significant changes in technology,
markets, economic factors or laws
and regulations that have an adverse
effect on the company.
An increase in interest rates, affecting
the value in use of the asset.
The company’s net assets have a
higher carrying value than the
company’s market capitalization
(which suggests that the assets are
over-valued in the statement of
financial position).
Internal Sources
Evidence that the asset is damaged or
no longer of use to the entity.
There are plans to discontinue or
restructure the operation for which the
asset is currently used.
There is a reduction in the asset’s
expected remaining useful life.
There is evidence that the entity’s
expected performance is worse than
expected.
Measuring recoverable amount:
• If there is an indication that an asset (or cash-generating unit) is impaired
then it is tested for impairment. This involves the calculating the
recoverable amount of the item in question and comparing this to its
carrying amount.
• Measuring recoverable amount:
• It has been explained that recoverable amount is the higher of an asset’s:
fair value less costs of disposal; and
its value in use.
• If either of these amounts is higher than the carrying value of the asset,
there has been no impairment.
Measuring fair value less costs of disposal

• Fair value is normally market value. If no active market exists, it may

be possible to estimate the amount that the entity could obtain from
the disposal.
• Direct selling costs normally include legal costs, taxes and costs
necessary to bring the asset into a condition to be sold. However,
redundancy and similar costs (for example, where a business is
reorganised following the disposal of an asset) are not direct selling
costs.
Calculating value in use

• Value in use is a value that represents the present value of the expected
future cash flows from use of the asset, discounted at a suitable
discount rate or cost of capital.
• Estimates of future cash flows must include:
a) cash inflows from the continuing use of the asset;
b) cash outflows that will be necessarily incurred to generate the cash
inflows from continuing use of the asset; and
c) net disposal proceeds at the end of the asset’s useful life.
Calculating value in use
• Also note that future cash flows are estimated for the asset in its current
condition. Therefore, any estimate of future cash flows should not include
a) estimated future cash flows that are expected to arise from: a future
restructuring to which an entity is not yet committed; or
b) improving or enhancing the asset’s performance.
• The discount rate must be a pre-tax rate that reflects current market
assessments of:
a) the time value of money; and
b) the risks specific to the asset for which the future cash flow estimates
have not been adjusted.
Example: Measurement of recoverable amount

• A company has a machine in its statement of financial position at a carrying amount

of Rs. 300,000.
• The machine is used to manufacture the company’s best-selling product range, but
the entry of a new competitor to the market has severely affected sales.
• As a result, the company believes that the future sales of the product over the next
three years will be only Rs. 150,000, Rs. 100,000 and Rs. 50,000. The asset will then
be sold for Rs. 25,000.
• An offer has been received to buy the machine immediately for Rs. 240,000, but the
company would have to pay shipping costs of Rs. 5,000.The risk-free market rate of
interest is 10%.
• Market changes indicate that the asset may be impaired and so the recoverable
amount for the asset must be calculated.
Solution
• Fair value less costs of disposal Rs.
Fair value 240,000
Costs of disposal (5,000)
Fair value less costs of disposal 235,000
Value in use:
Year Cash Flow (000) Discount Present Value
Factor(1/1+i)ˆn
1 150,000 1/(1.1)ˆ1 136,364
2 100,000 1/(1.1)ˆ2 82,645
3 50,000+25,000 1/(1.1)ˆ3 56,349
Total 275,358
Solution
• The recoverable amount is the higher of Rs. 235,000 and Rs. 275,358,
i.e. Rs. 275,358.
• The asset must be valued at the lower of carrying value and
recoverable amount.
• The asset has a carrying value of Rs. 300,000, which is higher than the
recoverable amount from using the asset.
• It must therefore be written down to the recoverable amount, and an
impairment of Rs. 24,642 (Rs. 300,000 – Rs. 275,358) must be
recognised.
Accounting for impairment
• The impairment loss is normally recognised immediately in profit or
loss.
• Example:
• A company has a machine in its statement of financial position at a
carrying amount of Rs. 300,000.
• The machine has been tested for impairment and found to have
recoverable amount of Rs. 275,358 meaning that the company must
recognise an impairment loss of Rs. 24,642.
• This is accounted for as follows:
Debit Credit
Statement of profit or loss 24,642
Accumulated impairment loss 24,642

• (Property, plant and equipment would be presented net of the balance

on this account on the face of the statement of financial position).
• However, an impairment loss recognised in respect of an asset carried
at a previously recognised revaluation surplus is recognised in other
comprehensive income to the extent that it is covered by that surplus.
Thus it is treated in the same way as a downward revaluation, reducing
the revaluation reserve balance relating to that asset.
• Impairment not covered by a previously recognised surplus on the
same asset is recognised in profit or loss.
Example: Measurement of recoverable amount

• A company has a machine in its statement of financial position at a carrying amount of Rs.
300,000 including a previously recognised surplus of Rs. 20,000.
• The machine has been tested for impairment and found to have recoverable amount of Rs.
275,358 meaning that the company must recognise an impairment loss of Rs. 24,642.
• This is accounted for as follows:
Debit Credit
Statement of profit or loss 4,642
Other comprehensive income 20,000
Property, plant and equipment 24,642
• Following the recognition of the impairment, the future depreciation of the asset must be
based on the revised carrying amount, minus the residual value, over the remaining useful
life.
Summary of the approach
(1) At the end of each reporting period, the entity should assess whether there are any indications that
an asset may be impaired.
(2) If there are such indications, the entity should estimate the asset’s recoverable amount.
(3) When the recoverable amount is less than the carrying value of the asset, the entity should reduce
the asset’s carrying value to its recoverable amount. The amount by which the value of the asset is
written down is an impairment loss.
(4) This impairment loss is recognised as a loss for the period.
(5) However, if the impairment loss relates to an asset that has previously been re-valued upwards, it
is first offset against any remaining revaluation surplus for that asset. When this happens it is reported
as other comprehensive income for the period (a negative value) and not charged against profit.
(6) Depreciation charges for the impaired asset in future periods should be adjusted to allocate the
asset’s revised carrying amount, minus any residual value, over its remaining useful life (revised if
necessary).
Practice Question

• On 1 January Year 1 Entity Q purchased for Rs. 240,000 a machine with an

estimated useful life of 20 years and an estimated zero residual value.
• Depreciation is on a straight-line basis
• On 1 January Year 4 an impairment review showed the machine’s recoverable
amount to be Rs. 100,000 and its remaining useful life to be 10 years.
• Calculate:
a) The carrying amount of the machine on 31 December Year 3 (immediately
before the impairment).
b) The impairment loss recognised in the year to 31 December Year 4.
c) The depreciation charge in the year to 31 December Year 4.)
Practice Question
• On 1 January Year 1 Entity Q purchased for Rs. 240,000 a machine with an estimated useful life of
20 years and an estimated zero residual value.
• Depreciation is on a straight-line basis.
• The asset had been re-valued on 1 January Year 3 to Rs. 250,000, but with no change in useful life at
that date.
• On 1 January Year 4 an impairment review showed the machine’s recoverable amount to be Rs.
100,000 and its remaining useful life to be 10 years.
• Calculate:
a) The carrying amount of the machine on 31 December Year 2 and hence the revaluation surplus
arising on 1 January Year 3.
b) The carrying amount of the machine on 31 December Year 3 (immediately before the impairment).
c) The impairment loss recognised in the year to 31 December Year 4.
d) The depreciation charge in the year to 31 December Year 4.
CASH GENERATING UNITS

• It is not always possible to calculate the recoverable amount of

individual assets. Value in use often has to be calculated for groups of
assets because assets may not generate cash flows in isolation from
each other. An asset that is potentially impaired may be part of a larger
group of assets which form a cash-generating unit.
• IAS 36 defines a cash-generating unit (CGU) as 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.
Allocating an impairment loss to the assets of a cash-
generating unit
• When an impairment loss arises on a cash-generating unit, the impairment loss
is allocated across the assets of the cash-generating unit in the following order:
a) first, to the goodwill allocated to the cash-generating unit; then
b) to the other assets in the cash-generating unit, on a pro-rata basis (i.e. in
proportion to the carrying amount of the assets of the cash- generating unit).
• However, the carrying amount of an asset cannot be reduced below the highest
of:
a) its fair value less costs of disposal (if determinable);
b) its value in use (if determinable); and
c) zero.
Example: Allocation of impairment loss in cash-
generating unit
• A cash-generating unit is made up of the following assets.
Rs. m
Property, plant and equipment 90
Goodwill 10
Other assets 60
160
• The recoverable amount of the cash-generating unit has been assessed
as Rs. 140 million.
Solution:

• The impairment loss would be allocated across the assets of the cash-
generating unit as follows:
• There is a total impairment loss of Rs. 20 million (= Rs. 160m – Rs. 140m). Of
this, Rs. 10 million is allocated to goodwill, to write down the goodwill to Rs.
0.The remaining Rs. 10 million is then allocated to the other assets pro-rata.
Therefore:
• Rs. 6 million (= Rs. 10m × 90/150) of the impairment loss is allocated to
property, plant and equipment, and
• Rs. 4 million (= Rs. 10m × 60/150) of the loss is allocated to the other assets
in the unit.
• The allocation has the following result:
Description Before Impairment After
Loss (Rs. m) Loss (Rs. m) Loss (Rs. m)
Property, plant and 90 (6) 84
equipment
Goodwill 10 (10) -
Other assets 60 (4) 56
Total 160 (20) 140