ABOUT ACCOUNTING CLUBS
Discover who we are and what we do
Expert Q&A’s
Read about various complex accounting concepts
PODCASTS
See the podcasts we offer to help in your respective areas
Chapter 3: Indications of impairment
Indications of impairment – general
A number of indications that an impairment loss may have occurred. In making its assessments as to the possibility of impairment losses having arisen, the entity is required, at a minimum, to consider the indications listed. The lists are not exhaustive, however, and all of the items listed will not apply to every entity. If an impairment indicator that is not on these lists exists at the end of the reporting period, a detailed impairment review is required nonetheless.
Internal sources of information
The following internal sources of information may indicate that an asset is impaired:
- evidence is available of obsolescence or physical damage of the asset;
- significant changes with an adverse effect on the entity have taken place during the period, or are expected to take place in the near future, in the extent to which, or the manner in which, an asset is used or is expected to be used. These changes include the asset becoming idle, plans to discontinue or restructure the operation to which an asset belongs, plans to dispose of an asset before the previously expected date, and reassessing the useful life of an asset as finite rather than indefinite; or
- evidence is available from internal reporting that indicates that the economic performance of an asset is, or will be, worse than expected.
Such evidence may include:
- cash flows for acquiring the asset, or subsequent cash needs for operating or maintaining it, that are significantly higher than those originally budgeted; or
- actual net cash flows or operating profit or loss flowing from the asset that are significantly worse than those budgeted; or
- a significant decline in budgeted net cash flows or operating profit, or a significant increase in budgeted loss, flowing from the asset; or
- operating losses or net cash outflows for the asset, when current period figures are aggregated with budgeted figures for the future.
Impairment indicators relating to obsolescence or physical damage may be the easiest to identify because they can be observed physically. Items such as unused factory equipment or equipment that has been damaged by fire are two examples that may indicate impairment.
An impairment indicator may also arise because an asset is to be taken out of use to be sold. If the asset qualifies as held for sale, in accordance with IFRS 5, it will be measured under the rules of that Standard and will fall outside the scope of IAS 36. However, immediately before this reclassification, IFRS 5 requires the asset to be measured in accordance with other applicable Standards. If the requirements of IAS 36 result in the recognition of an impairment loss before reclassification, that loss should be reported separately as an impairment loss and should not be included as part of the gain or loss disclosed in accordance with IFRS 5 or as part of any subsequent gain or loss on disposal disclosed in accordance with IAS 1.
External sources of information
The following external sources of information may indicate that an asset is impaired:
- there are 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;
Such a decline could be caused by a decrease in the external market value for an asset (e.g., a head office building), or by a decrease in the sales price of items produced by a group of assets, such as the property, plant and equipment making up a factory.
- significant changes with an adverse effect on the entity 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 the asset is dedicated;
For example, if a factory produces a product that is judged harmful to the environment, and the government introduces a ban on the use of such equipment after a phase-out period, the carrying amount of the factory and the associated plant and equipment would need to be assessed for impairment. As another example, the value of a luxury hotel would need to be assessed if occupancy rates are declining as a result of a downturn in the economy.
- the carrying amount of the net assets of the entity is more than its market capitalization;
In some cases, the business prospects of the entity may not have changed, but the sector in which the entity operates may be ‘out of favor’ with market analysts, resulting in a decline in share price. In such circumstances, a write-down may not be required, but a formal review should be carried out. In particular, great care should be taken in determining the appropriate discount rate with which to calculate value in use, to ensure that it is consistent with current market assessments.
- for an investment in a subsidiary, joint venture or associate, the investor recognizes a dividend from the investment and evidence is available that:
- the carrying amount of the investment in the separate financial statements exceeds the carrying amounts in the consolidated financial statements of the investee’s net assets, including associated goodwill; or
- the dividend exceeds the total comprehensive income of the subsidiary, joint venture or associate in the period the dividend is declared; and
Dividends are recognized in profit or loss, rather than as a reduction of the cost of the associated investment. Accordingly, when a dividend reduces the recoverable amount of an investment to below its carrying amount, the investment is impaired.
- market interest rates or other market rates of return on investments have increased during the period, and those increases are likely to affect the discount rate used in calculating the asset’s value in use and decrease the asset’s recoverable amount materially.
If in prior years an asset has been the subject of an impairment test, and there is a change in market interest rates in the current period that will affect the discount rate used in the previous calculation, it is appropriate to revisit the calculation. However, this does not necessarily mean that, once an impairment review has been carried out, it must be revisited each year or whenever market rates move. The review in subsequent periods is required only when the change in rates is likely to affect materially the recoverable amount of the asset.
IAS 36 specifically states that no formal review is required when the discount rate used in calculating the asset’s value in use is:
- unlikely to be affected by the increase in market interest rates or other market rates of return on investments. For example, increases in short-term interest rates may not have a material effect on the discount rate used for an asset that has a long remaining useful life; or
- likely to be affected by the increase in these market rates, but previous sensitivity analysis of recoverable amount shows that:
- it is unlikely that there will be a material decrease in the recoverable amount because future cash flows are also likely to increase. For example, in some cases, an entity may be able to demonstrate that it adjusts its revenues to compensate for any increase in market rates; or
- the decrease in recoverable amount is unlikely to result in a material impairment loss.
If there is an indication that the asset may be impaired, the underlying facts should be kept in mind when performing the annual reviews of the useful life of the asset, the depreciation or amortization method used and the estimated residual value. These items may need to be adjusted even if no impairment loss is recognized.
Other examples of impairment indicators
Directors are considering ceasing to trade
As discussed, it is usually appropriate to regard the fact that the directors of an entity are considering ceasing to trade as an indication of impairment. The directors of an entity do not usually consider ceasing to trade if the entity is expected to be profitable. The fact that the directors are considering ceasing to trade may call into question the ability of the entity to continue to trade profitably and, therefore, whether the carrying amounts of assets are recoverable.
Impairment review prompted by decline in demand for output – example
An entity has a machine that was purchased in January 20X1 for CU1 million. It is being depreciated over its estimated useful life of 10 years on a straight-line basis. The carrying amount at 31 December 20X3 is therefore CU700,000.
At 31 December 20X3, the directors become aware that a new technological development means that demand for the output produced by the machine is likely to decline significantly. Consequently, under IAS 36, they are required to estimate the asset’s recoverable amount.
The following items are required to be tested for impairment at least annually, irrespective of whether there is any indication of impairment:
- intangible assets with an indefinite useful life;
- intangible assets that are not yet available for use; and
- goodwill acquired in a business combination.
Computer software assets developed or purchased for internal use
It is necessary to exercise careful judgement when identifying impairment indicators for recognized computer software assets developed or purchased for internal use. In addition to the events and circumstances detailed in IAS 36 the following conditions may indicate that the entity may not be able to recover the amounts recognized as an asset (list is not exhaustive):
- the internal-use computer software is not expected to provide service potential as originally planned;
- a significant change occurs in the extent to which, or the manner in which, the software is used or is expected to be used such that the future benefits expected to be generated are reduced;
- a significant change is made or will be made to the software program such that the future benefits expected to be generated are reduced; or
- the cost of developing or modifying the software significantly exceeded the amount originally budgeted.
Specifically in connection with software currently in development for internal use, indications that the software may no longer be expected to be completed and placed into service include the following:
- no expenditures budgeted or being incurred for the project;
- programming difficulties that cannot be resolved on a timely basis;
- significant cost overruns;
- the cost of internally developed software is expected to significantly exceed the cost of comparable third-party software, and management intends to purchase the third-party software instead of completing the internally developed software;
- technologies are introduced in the marketplace so that management now intends to purchase third-party software instead of completing the internally developed software; or
- the business segment or unit to which the software relates, or relates in part, is unprofitable and has been or will be discontinued.
If events and circumstances indicate that the carrying amount of software recognized as an asset may not be recoverable, the entity will need to determine whether an impairment loss should be recognized.
Impairment indicator (closure announcement) after the reporting date – example
An entity is a manufacturer of aircraft engines. After the reporting date, management decides and announces its intention to close its operations in Country A. Closure of the operation will not be completed within three years. The equipment and fixtures will only have a remaining life of three years, and there is no alternative use for the property.
The decision after the reporting date to close the operations in Country A is an indication of impairment. Any assessment of recoverable amounts should be based on the conditions and commitments existing at the reporting date. In accordance with IAS 10, if the decision was made after the reporting date, then any impairment resulting only from that decision (i.e., that was not already present in the business) is a non-adjusting event after the reporting period, although disclosure may be required. For further guidance on whether an entity was committed to a restructuring at the end of the reporting period.
Although, in the circumstances described, the decision to close the operations in Country A may have been made after the reporting date, the decision may have resulted from conditions that existed at the reporting date (e.g., poor trading performance). Recognition of an impairment loss may therefore still be required to reflect those conditions that existed at the reporting date.
It will also be necessary to establish revised depreciation rates for the fixtures and equipment based on revised estimates of the useful lives and residual values of the affected assets, and those revised depreciation rates should be applied prospectively.
Asset life shortened by physical damage
An entity has an asset that is damaged such that the life of the asset is shortened, but the carrying amount of the asset will still be recovered by the cash flows over the shortened life. The damage to the asset is an indication of impairment in accordance with IAS 36 and, therefore, the asset must be tested for impairment.
Because the carrying amount of the asset will be recovered by the cash flows over the asset’s revised useful life, no impairment loss should be recognized. Nevertheless, the useful life of the asset is changed and the depreciation amount should be recalculated prospectively and accounted for as a change in estimate in accordance with the requirements of IAS 8.
Competitor enters an existing market
An entity has several retail outlets in an area where no other significant competition has previously existed. During the current period, a large well-established competitor opens two stores in the region, selling similar products at similar prices.
The entrance into the market of a competitor is an impairment indicator. In determining value in use, revised cash flow forecasts should be prepared and new estimations of assets’ recoverable amounts should be calculated, based on the best information available.
Cryptocurrency assets classified as indefinite-life intangible assets and used as means of exchange
Cryptocurrency assets that are used as means of exchange, and do not themselves generate economic benefits other than through their exchange for other assets (e.g., for other cryptocurrencies, or goods or services) are assessed for impairment on an individual asset basis because they generate cash inflows that are largely independent of those from other assets.
Cryptocurrency assets classified as indefinite-life intangibles assets are tested for impairment annually and also at the end of each reporting period when there is an indication that the asset may be impaired. For cryptocurrency assets for which there are observable selling prices from orderly transactions (e.g., information from an active market), an indication of an impairment loss exists when the observable selling prices are below the current carrying amount of the cryptocurrency asset. If there are no active markets or observable orderly transactions for the cryptocurrency assets, the entity will need to consider all available information, from external and internal sources, for indications that the asset may be impaired.
The recoverable amount of a cryptocurrency asset used as a means of exchange is its fair value less costs of disposal which also equals its value in use. Consistent with the fact that a cryptocurrency asset is tested for impairment on an individual asset basis, the fair value is based on the value of each unit individually and not on a portfolio basis.
An entity can choose, as a matter of accounting policy, a reasonable and rational method for determining the cost of each unit of cryptocurrency assets such as the first-in, first-out method or the weighted average method. The same accounting policy should be applied when the entity sells or transfers the cryptocurrency assets.
Increase in sales tax
An entity operates a chain of bookshops. Under the local tax regulations, a sales tax payable by purchasers of books is increased in the current period from 5 per cent to 10 per cent.
The change in tax rates may affect levels of demand for books and is an impairment indicator. Revised cashflow forecasts should be prepared by management, based on the best information available, so as to determine the value in use of the assets.
Events and circumstances indicating that goodwill is impaired
In addition to being tested for impairment annually, goodwill should be tested for impairment whenever there is an indication that it might be impaired (as for other assets). It is necessary to exercise careful judgement when identifying impairment indicators for goodwill. The following are examples of events and circumstances that might indicate that goodwill is impaired (list is not exhaustive):
- the merger of business information systems does not occur as planned, and the acquirer does not achieve the savings that were expected from operating a merged system;
- industrial agreements do not permit the level of workplace reform that the acquirer had planned, and the employee headcount is higher than that planned at acquisition;
- the acquirer identified at acquisition the feasibility of developing several research projects, and these projects subsequently have been abandoned;
- a regulatory ruling prevents the acquirer from operating in certain markets, and the acquirer will not achieve the level of sales planned at acquisition; or
- a competitor introduces a new product earlier than expected, and the acquirer will not achieve the level of sales planned at acquisition.
Impairment indicators identified after the reporting period
If information is received after the reporting period, but before the financial statements are authorized for issue, indicating that an asset is impaired, management should consider whether that information is indicative of impairment that existed at the end of the reporting period. If so, an impairment review should be carried out.
Even if management has already undertaken an impairment review in respect of that asset as at the end of the reporting period, additional information received after the reporting period that is indicative of impairment that existed at the end of the reporting period should lead management to re-perform that impairment review.
If the information received after the reporting period is not indicative of conditions existing at the end of the reporting period, it should not trigger an impairment test (or the re-performance of any impairment test already carried out). Rather, the information should be disclosed as a non-adjusting event after the reporting period when it is of such importance that non-disclosure would affect decisions of users of the financial statements.
Appraisal or valuation below carrying amount
The existence of an appraisal or other independent valuation information indicating that the fair value less costs of disposal of a held-and-used asset is below its carrying amount does not, in itself, require that an impairment loss be recognized. When the asset’s recoverable amount was previously based on value in use, the entity should consider whether the appraisal is an indication of impairment; it is possible that the factors resulting in the lower valuation do not affect the value-in-use calculations. When the entity does consider the lower valuation to be an indication of impairment, the entity should calculate the value in use of the asset (or, when appropriate, of the CGU to which it belongs). If the recoverable amount of the asset (i.e., the higher of the asset’s fair value less costs of disposal and its value in use) is less than its carrying amount, an impairment loss should be recognized.
Can the timing of an impairment test be changed?
Entities might wish to change the timing of their impairment test. This might be, for example, to align impairment testing with the budget cycle. The annual impairment test of goodwill is carried out at the same time each year. To the extent that the period between tests is less than one year, and the change is not made to achieve a specific result (that is, to avoid an impairment charge), we would consider it acceptable to change the date of the annual impairment test. It would generally not be appropriate to change testing dates in consecutive years. It would be necessary to perform the impairment test again before the year-end if a triggering event occurs after the date of the revised impairment test.
Is an impairment test needed at the time of a reorganization?
If an entity reorganizes its structure, this might result in the reallocation of goodwill between CGUs. The annual impairment test might have taken place before the reorganization. We would not usually consider the reorganization itself to be an impairment trigger unless it results in an adverse effect on the future economic benefit of the CGU. An impairment test would be performed if there were any impairment indicators prior to the year-end. The entity might wish to perform an impairment review under the new structure.
Events after the annual impairment review
An entity in the automotive component supply business has a 31 December year end. The annual impairment review was carried out in September 20X8, in line with budgeted information. In October 20X8, two major customers announced the closure of their sites for a prolonged period. This is an indicator of impairment, and so the entity should perform an additional impairment test in the period (for example, October to December 20X8, based on updated forecasts, instead of waiting until September 20X9).
The annual impairment test requirement for goodwill and intangibles with indefinite useful lives, or that have yet to be brought into use, is in addition to the overriding requirement to test those assets whenever there are indications of impairment. Goodwill and intangible assets might need to be tested for impairment more than once a year where an indicator of impairment exists.
Interim reporting
The same impairment testing, recognition and reversal criteria are applied at interim reporting dates. An entity will not necessarily have to make a detailed impairment calculation at the end of each interim period. An entity should review for indications of impairment, at each interim reporting date, to decide whether such a calculation is needed. See our Manual of accounting – Interim reporting for more details.
An entity might be required to recognize an impairment in an interim period but, by the year end, the impairment might have reversed, either in full or partially. An impairment of goodwill recognized in an interim period should not be reversed.