Chapter 1: Introduction

A non-financial asset is impaired if it carrying amount exceeds its recoverable amount. Recoverable amount is the higher of value in use and fair value less costs of disposal. IAS 36 requires annual impairment tests for certain assets and for any non-financial asset where there is an indicator of impairment.

Where recoverable amount is determined on the basis of fair value less costs of disposal, the measurement guidance in IFRS 13 applies.

Scope

IAS 36 applies to the impairment of all assets, unless specifically excluded from the standard’s scope. Assets that are excluded are:

• Inventories (IAS 2).
• Contract assets and assets arising from costs to obtain or fulfil a contract that are recognized in accordance with IFRS 15.
• Deferred tax assets (IAS 12).
• Financial assets that are included within the scope of IFRS 9. (Examples include cash, debtors and equity investments other than investments in subsidiaries, associates or joint ventures not accounted for under IFRS 9 (IAS 39).)
• Investment property that is measured at fair value (IAS 40).
• Biological assets related to agricultural activity measured at fair value (IAS 41).
• Deferred acquisition costs and intangible assets arising from an insurer’s contractual rights under insurance contracts that are within IFRS 4’s scope.
• Non-current assets (or disposal groups) classified as held for sale under IFRS 5.
• Assets arising from employee benefits under IAS 19.

IAS 36 applies to financial assets classified as subsidiaries (as defined in IFRS 10), associates (as defined in IAS 28) and joint ventures (as defined in IFRS 11).

Revalued assets measured at fair value in IAS 16 and IAS 38 are within IAS 36’s scope. The only difference between an asset’s fair value and its fair value less costs of disposal is the direct incremental costs attributable to the asset’s disposal. Costs of disposal could, therefore, cause an impairment if fair value less cost of disposal is higher than value in use.

Definitions

The terms used in IAS 36 have specific meanings within the context of the Standard. The more important definitions, as set out in IAS 36, are reproduced below for reference.

• Recoverable amount for an asset or a cash-generating unit is the higher of its fair value less 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 (see IFRS 13).
• Costs of disposal are incremental costs directly attributable to the disposal of an asset or a cash-generating unit, excluding finance costs and income tax expense.
• Value in use is the present value of the future cash flows expected to be derived from an asset or a cash-generating unit.
• An impairment loss is the amount by which the carrying amount of an asset or a cash-generating unit exceeds its recoverable amount.
• Carrying amount is the amount at which an asset is recognized in the statement of financial position after deducting any accumulated depreciation (amortization) and accumulated impairment losses thereon.
• 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.
• 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.

Basic principles of impairment

An asset cannot be carried in the balance sheet at more than its recoverable amount. An impairment review compares the asset’s recoverable amount with it carrying value. If the recoverable amount is lower, the asset is impaired and should be written down to the recoverable amount.

An asset’s carrying amount is the amount at which the asset is recognized on the balance sheet, after deducting any accumulated depreciation or amortization and accumulated impairment losses thereon.

An asset’s recoverable amount represents its greatest value to the business in terms of the cash flows that it can generate. That is the higher of:

• fair value less costs of disposal (measured in accordance with IFRS 13); and
• value in use (the present value of the future cash flows that are expected to be derived from the asset).

Identifying assets that might be impaired

All assets within the standard’s scope are to be tested for impairment where there is an impairment indicator.

Goodwill, indefinite life intangible assets and intangible assets that are not yet ready for use should also be tested annually for impairment.

An entity should assess, at each reporting date, whether there is any indication that an asset might be impaired. The term ‘reporting date’ includes the year-end date and interim (half-year or quarterly) reporting dates. An entity might be required to complete an impairment test more than once per annum.

In assessing whether there is any indication that an asset might be impaired, an entity should consider at least the following: External sources of information, including:

• Observable indications that the asset’s value has declined during the period significantly more than would be expected as a result of the passage of time or normal use.
• Changes in market values reflect economic conditions, so a significant fall in value could be a symptom of another more pervasive change (for example, change in demand for the asset’s output).
• Significant adverse changes that have taken place (or are expected in the near future) in the technological, market, economic or legal environment in which the entity operates or in its markets.
• Increases in interest rates, or other market rates of return, that might materially affect the discount rate used in calculating the asset’s recoverable amount.
• Where the carrying amount of the entity’s net assets exceeds the entity’s market capitalization.

Internal sources of information, including:

• Obsolescence or physical damage affecting the asset.
• Significant adverse changes that have taken place (or are expected in the near future) in the extent to which, or in the way that, an asset is used or expected to be used. This includes the asset becoming idle, plans to discontinue or restructure the operation to which the asset belongs, or the asset’s disposal. It also includes reassessing the asset’s useful life from indefinite to finite.
• Deterioration in the expected level of the asset’s performance.
• Where management’s own forecasts of future net cash inflows or operating profits show a significant decline from previous budgets and forecasts.

This list is not exhaustive, and other indicators might be apparent that are relevant to a business’ particular circumstances.

Impairment indicator: reduced selling price of recently acquired asset Entity A bought (and capitalized) a computer system off the shelf for £2 million. Shortly afterwards, the manufacturer dropped the selling price to £1.5 million. A change in the market value of an asset is an indicator of impairment.

Impairment indicator: trends that develop over time Indicators might assume more significance over time (for example, as general market conditions worsen or as an entity’s performance gradually deteriorates). Entities should be alert to such trends and to their potential for becoming indicators of impairment. Management should have such trend information readily available. It is a judgement as to when a particular trend becomes significant enough to be deemed an impairment indicator. Example An entity is in the business of manufacturing CD players. Industry forecasts indicate a decrease in demand for the entity’s product over the next five years, due to growth in demand for competing products such as MP3 players. Management should consider this trend in assessing impairment. External trends, as well as discrete events, might indicate that an asset is impaired. Trends such as overcapacity in a particular industry, or a change in the demand for a product due to technological, market or other conditions, should be considered in assessing impairment. Management’s ability and plans to reverse negative trends should be considered in assessing impairment.

Impairment indicator: government price controls Entity A is a water and sewage entity, with a countrywide water and sewage network. Although entity A is a listed entity, the government is the controlling shareholder. Management has asked the government to allow a 3% increase in prices in order to cover recent cost increases. This is a regulated business, and any price rise must be authorized by the government. The government has only authorized a 0.5% price increase. The fact that the government has not approved the requested price increase is an indication that the entity’s assets used in the water and sewage network might be impaired. The assets should be tested for impairment.

Impairment indicator: change of asset’s use Entity X uses asset M to manufacture product A. There has been a significant reduction in demand for product A as a result of a change in consumer taste. Asset M can be used by entity X in the manufacture of its new product T with minimal reconfiguration. Entity X should review asset M for impairment. The change in use is an indicator of impairment. Entity X’s management will need to assess the impact of both the change in consumer tastes and the asset’s proposed change of use on the asset’s recoverable amount.

Impairment indicator: introduction of a superior competitor product Entity Q produces printers for home computers and has, for some time, been the market leader. Its chief competitor, entity R, has recently developed a new product that is widely acknowledged as being superior to that of entity Q, because it has the ability to also photocopy documents, send and receive facsimile and color-print photographs. Entity Q’s management has not performed an impairment review on its plant, on the grounds that annual production and sales are ahead of budget. Entity Q should review its plant and equipment for impairment. The change in the market for its product can have a significant impact on the equipment’s value, based on the economic benefit to be obtained from its continued use. The existence of a conflicting indicator (sales ahead of budget) is not sufficient to negate the need for an impairment review. Management will be required to assess the impact of this new competing product on demand for its existing product and on expected future cash flows.

Impairment indicator: economic downturn An economic downturn would not always be considered a triggering event for impairment testing in its own right. However, it might result in any number of the following indicators: ·        Actual figures are significantly lower than the original budget. ·        Cash flow is significantly lower than earlier forecasts. ·        Material decreases in mid-term and/or long-term growth rates, as compared to the previous estimates. ·        Significant or prolonged decrease in the entity’s stock price. ·        Market capitalization less than book value of net assets. ·        Announced change in business model, restructuring or discontinued operations. ·        Increases in the cost of capital. ·        Change of market interest rates or other market rates of return. ·        Fluctuations in the foreign exchange rates or commodity prices that impact the entity’s cash flows. ·        Deferral of investment projects.

Evidence from internal reporting, which indicates that an asset might be impaired, includes:

• The actual net cash outflows or operating profit or loss are significantly worse than budgeted.
• Operating losses or net cash outflows are forecast.
• Cash flows for constructing the asset, or for maintaining or operating it, are significantly higher than those budgeted.

An increase in market interest rates might not trigger an impairment test in all circumstances. For example, a marginal increase in short-term interest rates is unlikely to lead to an impairment charge where there was significant headroom in the last test.

Materiality applies in determining whether an impairment review is required. If previous impairment reviews have shown a significant excess of recoverable amount over carrying amount, no review would be necessary in the absence of an event that would eliminate the excess. Previous reviews might also have shown that an asset’s recoverable amount is not sensitive to one or more of the impairment indicators.

If there is an indication that an asset might be impaired, the useful life, the depreciation method and the residual value for the asset need to be reviewed and adjusted, if necessary, under the appropriate IFRS. This applies, even if no impairment loss is recognized for the asset.

Events after the reporting period

Events after the reporting period might provide indications that an asset was impaired at the period end. The impairment test should be updated after the period end only if material changes in assumptions provide additional evidence relating to conditions that existed at the balance sheet date. This requires an analysis of facts and circumstances in order to distinguish between adjusting and non-adjusting information. A continuation of a previously observed trend does not usually warrant further adjustment, because the trend should have been incorporated into the most recent impairment calculation by adopting the spot rate at year end. Foreign exchange and commodity movements after the year-end would also seldom be a reason to update year-end impairment calculations.

Customer announces plant closure after the year end Entity A is a major supplier to a car manufacturer, entity Z. Its year end is 30 June. In August, entity Z announces the closure of its manufacturing plant in the UK in two years’ time. As a result of this, entity A’s plant and machinery, which is dedicated to supplying entity Z, will have a remaining useful life of only two years. In addition, the entity’s factory premises will be impaired, because they have no alternative use. Entity Z’s decision to close the plant is an indicator of impairment. If the entity was not aware of the decision until the August announcement, the impact from plant closure is a non-adjusting event, and any impairment that might result should be recognized in the year when entity Z announces its decision. However, if entity A was aware at 30 June that entity Z was intending to close its plant, it would be appropriate to book an impairment at the year-end.

Impairment triggers after the year end ABC Plc has a subsidiary, XYZ Ltd, which has a carrying value on consolidation of £30m, including £5m of goodwill. Management has performed an annual impairment review using ViU, which showed no impairment. Post-year end, prior to the accounts being signed, ABC Plc is approached by a third party to purchase XYZ Ltd for £28m. Management has agreed to sell XYZ Ltd, because it wants to raise cash to settle some existing debt in the remaining group. By settling the debt early, the group is likely to save up to £1m per year for five years; management therefore believes that it would be sensible to sell XYZ Ltd. Is the goodwill associated with XYZ Ltd impaired at the year-end, and does this result in an adjusting post balance sheet event? The fact that management is accepting an offer lower than the carrying value of the entity might indicate an impairment at the balance sheet date. Normally, an impairment loss might be recognized if the entity becomes aware of conditions after the balance sheet date that must have existed at the balance sheet date. The lower offer does not necessarily reflect the fair value of the subsidiary at the balance sheet date, nor does it indicate that there were impairment triggers in place at the balance sheet date. Management could accept a lower price, in some circumstances, because it might want to obtain cash quickly; this is the case here, whereby management wishes to realize cash in order to settle debt in the remaining group. This would not be regarded as an impairment indicator. This transaction would result in a disclosable, non-adjusting post-balance sheet event according to IAS 10, ‘Events after the reporting period’, if it is material.