General principles

Impairment should be identified at the individual asset level, where possible. The recoverable amount should be calculated for the CGU to which the asset belongs only where the recoverable amount for the individual asset cannot be identified.

Test impairment at the individual asset level where possible Machine B is one of the assets used within a CGU. Machine B has become redundant and is being abandoned by management. The recoverable amount of the CGU (which is profitable) that contains machine B, exceeds it carrying amount. Machine B will be removed from the CGU and tested for impairment separately as its recoverable amount can be determined. Machine B’s recoverable amount will be the higher of value in use (zero) or fair value less cost of disposal (scrap value).

The recoverable amount of an individual asset cannot be determined if the asset does not generate cash inflows that are largely independent from other assets. Assets should be grouped for an impairment test in these circumstances. The recoverable amount is estimated for the smallest group of assets that generate cash inflows that are largely independent of each other. These are referred to as cash-generating units (CGUs). The vast majority of assets are tested for impairment as part of a CGU or group of CGUs.

The independence of cash inflows will often be evident. Shared support assets and infrastructure does not undermine the independence of cash inflows.

Asset that does not generate separate cash inflows Example 1 An entity owns and operates a large waste recycling plant and a private railway that transports the processed waste in containers from the plant to the main public rail network. The private railway could be sold only for scrap value, and it does not generate cash inflows from continuing use that are largely independent of the plant’s cash inflows as a whole. It is not possible to estimate the private railway’s recoverable amount, because the railway’s value in use cannot be determined. The entity should estimate the recoverable amount of the CGU (that is, the plant and railway as a whole) to which the railway belongs. Example 2 An entity that provides mobile telephone services in a number of countries under a single strong global brand is acquired. The acquirer recognizes the license to provide services in each country and recognizes a group of trademarks and trade names that its groups as the brand. The brand is assigned an indefinite useful life. The licenses have fixed terms with significant costs to renew or a requirement to renew at an auction, and have all been assigned finite useful lives. The license in each country should be grouped with the CGU or CGUs in each country for the purpose of impairment testing. The individual CGUs should be tested first for impairment if there are indicators of impairment. The brand would need to be included in the group of CGUs comprising all of the countries that benefit from the brand. The existence of the brand, an indefinite-lived intangible asset, imposes a requirement for annual impairment testing for the groups of CGUs that benefit from it.

An impairment review of a CGU should cover all of its tangible assets, intangible assets and attributable goodwill. The carrying value of each CGU containing the assets and goodwill being reviewed should be compared with the higher of its value in use and fair value less costs of disposal.

An impairment test is performed for an individual asset, unless the asset does not generate independent cash inflows. If this is the case the impairment test is performed for the CGU to which the asset belongs unless:

• the asset’s fair value less costs of disposal is higher than it carrying amount; or
• the asset’s value in use can be estimated as being close to its fair value less costs of disposal, and the fair value less costs of disposal can be determined.

Building considered separately for impairment testing A CGU includes a building, and that asset has a readily determinable market value. There is a trigger that the building is impaired. The building will be considered separately from the CGU, for the purpose of impairment testing, if its fair value less costs of disposal is clearly higher than it carrying amount. The head office building would be tested as part of the CGU if the fair value was less than it carrying amount, because it does not generate cash inflows independently.

Impairment of individual assets in a closure An entity is closing a division after the year end. No provision has been made for redundancies at the year-end, because the announcement of the closure was not made until after the year end. However, the entity is looking at impairment of the division’s assets. The plant and equipment are likely to be impaired, because the recoverable amount is expected to be lower than the carrying amount, but the property is expected to be sold at a profit (the entity will start to look for a buyer after the year-end). In determining the charge for impairment at the year-end, does the entity consider the division’s total assets, including the property, as one CGU, or does it look at individual assets? The profit expected to be made on the property is large enough to offset the impairment on the plant. Assets should be individually considered for impairment if there is any indication that the asset is impaired and the asset generates independent cash inflows. Since the property is to be sold separately from the plant and equipment, the cash flows are independent. The plant and equipment are impaired, and the impairment should be booked in the current year financial statements.

The diagram below shows the decisions needed to decide the level of testing:

Indefinite lived intangible asset An entity has a brand with an indefinite useful life that does not generate independent cash inflows since it is only used for marketing products produced by the entity. There is no indicator for impairment, but because the useful life is indefinite, the brand must be tested annually. The only circumstances under which a brand that does not generate independent cash inflows can be tested for impairment as an individual asset rather than as part of a CGU are when all of the following conditions are met: ·        The asset has an indefinite useful life. ·        There is no indicator of impairment (that is, annual test is being performed). ·        Fair value less costs of disposal can be determined for the brand. ·        Fair value less costs of disposal exceed the carrying amount, that is, there is no impairment. All other conditions will lead to testing the brand at the level of the CGU, or group of CGUs, associated with the brand.

Identifying CGUs

Identifying CGUs is the first key step in carrying out impairment reviews. This establishes the level of aggregation at which impairment reviews would normally be carried out. An impairment test must be done at the lowest level of independent cash inflows.

Determination of CGU Entity H uses asset O to manufacture plastic components that are sold to third parties. Entity H’s management has discontinued production of the components as a result of a fall in demand, and it has reconfigured the asset for use in the manufacture of product T. Revenues from the sale of product T cannot be directly attributed to any single asset used in its manufacture. Asset O will only render economic benefit as part of product T’s CGU. Because revenues from the sale of product T cannot be directly attributed to any asset, asset O will be tested for impairment as part of T’s CGU. It is not possible to determine asset O’s recoverable amount on a stand-alone basis. The recoverable amount of the entire CGU will be compared with the carrying value of the entire CGU, including asset O, in order to identify any impairment.

A cash-generating unit is “the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or group of assets”.

Cash inflows are cash flows received from external parties. The independence of cash flows will be indicated by various factors – for example, how management monitor’s the entity’s operations (this could be by product lines, businesses, individual locations, districts or regional areas), or how management makes decisions about continuing or disposing of the entity’s assets and operations. Management’s day-to-day operation of the business might not reflect the legal structure through which the operations are conducted.

Individual hotels and retail operations Individual hotels usually generate cash inflows that are largely independent of others, and their performance is monitored closely by management on an individual basis. It is, therefore, probable that they form individual CGUs, even if there are central sales and marketing and finance functions. Similarly, in retail operations each individual store would generally be a CGU because it generates independent cash inflows. Management may monitor goodwill on a regional basis by aggregating stores, hotels, or transport routes by region or by some other criteria that relate to how the entity is managed. Goodwill is reviewed at the higher level.

Magazine titles that are separate CGUs Entity A owns 150 titles, 70 of which were purchased and 80 were created internally. The costs of purchasing the 70 titles are capitalized as an intangible, and the costs of creating titles internally are written off. Cash inflows from sales and advertising are separately identifiable for each title. Titles are managed by customer segments. The level of advertising income for a title depends on the range of titles in the customer segment to which the title relates. The management policy is to abandon titles before the end of their useful economic lives and replace them with new, internally generated titles for the same customer segment. Individual titles are CGUs. Cash inflows for each individual title can be identified, even though the advertising income for each title might be influenced by the range of titles in the customer segment to which it belongs. In addition, although titles are managed by customer segment, decisions to abandon titles are made on an individual title basis.

Indefinite-lived intangible asset (brand) A CGU is defined as the smallest group of assets that generate cash inflows that are largely independent of each other. A brand is normally used to support production of a branded product, and the revenues from sales of the branded product are not capable of being split between revenue for the brand and revenue for the costs of production. A brand is typically not a CGU, and it should not normally be tested alone. The brand should be tested with the associated manufacturing CGU or group of CGUs.

Integrated businesses treated as country CGUs Entity A, a telecommunications entity, owns an integrated voice and data network over several countries. The network is connected end-to-end over entity A’s footprint. Each country network comprises city rings, regional rings and a long-distance network. The network assets and associated revenue streams in each country are recorded and monitored independently. Entity A makes decisions on the deployment of resources on a geographical basis. Entity A can distinguish between voice and data revenues. However, because the voice and data networks are integrated, it is not possible to identify specific assets or groupings of assets that generate either voice or data revenues. Entity A should classify each country as a separate CGU in these circumstances. Entity A can reliably identify and measure cash flows generated from each country’s asset base. This represents the smallest identifiable group of assets that generate independent cash flows that are monitored by management. Entity A cannot reliably measure, and does not monitor separately, the cash flows from the city and regional rings or from the long-distance network. Although entity A can identify revenue from voice and data services separately, it cannot attribute those cash flows to distinct network assets. The appropriate CGUs are, therefore, on a country-by-country basis.

Transport entities Entities involved in the transport business commonly provide services on a number of routes. The assets deployed to each route and that route’s cash inflows can usually be separately identified. Each route can be identified as a CGU even though the entity may market its services on a regional basis. Loss-making routes will be an indicator of impairment, except if a regulatory requirement dictates that these routes be serviced alongside the entity’s more profitable routes.

Different locations but centralized functions Entity A runs a fast-food restaurant chain. Each restaurant is supplied by Entity A’s central purchasing and distribution system. There are five restaurants in London (but in different neighborhoods), and another 50 in other cities and towns in the United Kingdom. All of the restaurants are managed in the same way. Pricing, marketing, advertising, and personnel policy (except for the local recruitment of waiters and kitchen staff) is decided centrally by Entity A. Seven of the restaurants were purchased five years ago, and goodwill was recognized. In determining the CGU in this situation, several factors should be considered, including whether: ·        Performance is monitored on an individual restaurant basis, or at regional or other levels—for example, considering the lowest level at which meaningful profitability statements are produced. ·        Product offering and investment decisions are made at individual, regional, or other grouping levels. Individual outlets generate business for other parts of the network. ·        Units are managed on a combined basis, share systems, centralized purchasing, and distribution functions. ·        Product pricing is determined locally or on a regional or national basis. All the restaurants are in different neighborhoods and probably have different customer bases. Each restaurant generates cash inflows that are largely independent from the cash flows of the other restaurants, and therefore it is likely that each restaurant is a CGU in this situation. The goodwill arising on the acquisition of the seven restaurants would have been allocated to the group of CGUs that incorporated the seven restaurants or other CGUs that benefited from the business combination. Each restaurant (CGU) should be tested for impairment when there is an indicator. Only after the underlying assets are tested for impairment should the group of restaurants and goodwill be tested for impairment.

An asset or group of assets is identified as a separate CGU if there is an active market for the output generated by the asset(s), even if the output is used internally.

An active market is defined as follows: “A market in which transactions for the asset or liability take place with sufficient frequency and volume to provide pricing information on an ongoing basis”.

Value in use is based on management’s best estimate of future cash flows. Management should use its best estimate of future arm’s length prices for the internal cash flow to:

• estimate the future cash inflows that relate to the sale of the output by the CGU to the entity’s other CGUs; and
• estimate the future cash outflows that relate to the purchase of the output by the other CGUs.

CGUs in a vertically integrated group Entity P is a vertically integrated electricity utility. It has three distinguishable businesses: generation, distribution and supply. There are active markets for the output of the generation and distribution businesses. The generation business sells power to the distribution business, which distributes electricity to the supply business. Each business is considered a separate CGU. Management should use external prices when determining value in use for a CGU in a vertically integrated operation.

Vertically integrated CGUs The reporting entity has two plants. Plant A produces raw material, that is sold to plant B of the same entity, at a price that transfers all of the margins to plant A. Of plant A’s production, 60% is sold to plant B, and 40% is sold to external customers outside the reporting entity. Of plant B’s production, 80% is sold to the reporting entity’s external customers. Question 1: What are the CGUs for plants A and B, where plant A could sell its production in an active market instead of to plant B? Answer: There is an active market for plant A’s production, so it is likely that plant A is a separate CGU. Plant B would also be a separate CGU, because it sells 80% of its output externally, and so it generates cash inflows that are largely independent of the cash inflows from the reporting entity’s other assets. In the financial forecasts and budgets used for determining the recoverable amount for both plants A and B, the internal transfer prices for the production sold by plant A to plant B should be adjusted to arm’s length prices. Question 2: What are the CGUs for plants A and B, where there is no active market for the production of plant A? Answer: There is no active market for the output of plant A, and the cash inflows of plant A depend on the demand for the product sold by plant B. Plant A does not generate cash inflows that are largely independent of the cash inflows of assets operated by plant B. Also, the two plants are managed together, as the use of internal transfer prices demonstrates. Therefore, the two plants should be treated as one CGU.

CGUs should be identified on a consistent basis, from one period to the next for the same assets or types of assets, unless a change is justified. If there is a change, it must be disclosed.

Assessing the recoverable amount for an individual CGU is difficult where management has multiple assets and has the ability to choose the assets that are used. Determination of what is a CGU can be an area of significant judgement, but it is not an accounting policy choice. Significant judgements should be disclosed.

IAS 36 is focused on identifying and recognizing impairment losses from a group perspective. The whole group is divided into separate CGUs for the purpose of impairment reviews. The CGUs in aggregate cover the whole group and are non-overlapping. The allocation of a group’s activities between separate entities within a group does not necessarily coincide with the way in which the group’s CGUs are defined.

CGU with goodwill or indefinite-lived assets

Goodwill and indefinite-lived intangible assets are required to be tested annually for impairment. In some circumstances there is an accommodation to carry forward the calculation of recoverable amount made in the previous period, which can be used in the current period if the following conditions are met:

• For goodwill allocated to a CGU and those intangibles that do not generate cash inflows independently of other assets, and so are tested as part of a CGU:
• The CGU’s assets and liabilities, to which such goodwill or intangibles were allocated, have not changed significantly since the last impairment test.
• The most recent impairment test resulted in an amount that exceeded the CGU’s carrying amount by a substantial margin.
• Analysis of events that have occurred and changes in circumstances since the last review indicates that the likelihood that the current CGU’s recoverable amount would be less that it carrying amount is remote.
• If an intangible asset is assessed for impairment as a single asset (that is, it generates cash flows independently of other assets and is not reviewed for impairment as part of a CGU):
• The most recent impairment test resulted in an amount that exceeded the asset’s carrying amount by a substantial margin.
• Analysis of events that have occurred and changes in circumstances since the last review indicates that the likelihood that the asset’s current recoverable amount would be less than it carrying amount is remote.

Allocating assets and liabilities to CGUs

The determination of the carrying amount of a CGU should be consistent with the determination of its recoverable amount. The test should compare like with like.

The carrying amount of a CGU is established by allocating assets and liabilities to individual CGUs. The carrying amount of a CGU consists of:

• Assets that are directly and exclusively attributable to the CGU.
• An allocation of assets that are indirectly attributable, on a reasonable and consistent basis, to the CGU including:
• corporate assets; and
• capitalized goodwill.

Liabilities are generally excluded from the carrying amount of the CGU.

There might be circumstances where it is not possible to determine recoverable amount without taking account of a recognized liability. For example, if the disposal of a CGU would require the buyer to take over a liability, the fair value less costs of disposal is the price for the assets and the liability together, less costs of disposal. So that the comparison of recoverable amount and carrying amount is on a consistent basis, the liability should also be included in the CGU’s carrying amount.

Restoration obligation part of the CGU’s carrying amount An entity operates a mine and has made a provision, in accordance with IAS 37, for the costs of restoration of the site when mining operations are completed. The provision represents the cost of restoring the damage that was done to the site when the mine was opened, and the same amount has been capitalized as part of the cost of the mine and is being depreciated over the mine’s life. The mine is a single CGU, and any purchaser would be required to take over the obligation for restoration if the mine was sold. The restoration is taken into consideration in the fair value less costs of disposal. The carrying amount of the CGU must also take into account the recognized liability for restoration costs in determining the carrying amount of the CGU, to compare like with like.

May 2015 NIFRIC on paragraph 78 In May 2015, the IFRS Interpretations Committee (‘IFRIC’) issued a rejection to clarify the application of paragraph 78 of IAS 36. In the agenda decision the IFRIC observed that an entity should deduct the carrying amount of the recognized liability in determining both the CGU’s carrying amount and its ViU. For example, if a decommissioning liability is calculated using IAS 37, the IAS 37 value would be removed from both the carrying amount and the ViU and not included as a cash flow in the ViU model.

Restoration obligation in a ViU The recoverable amount of the asset is determined under the ViU cash flow model approach described in IAS 36. The ViU cash flow model excludes the cash outflows for decommissioning provision. The recorded amount of the provision is deducted from the amount determined in the ViU model to produce a net recoverable amount. The net recoverable amount is then compared to the carrying amount of the cash generating unit including the decommissioning provision under IAS 37. It is not appropriate to include the cash outflows for the decommissioning obligation in the ViU cash flow model. The model uses a discount rate that is specific to the assets being tested, reflects the time value of money and the return investors would require to invest in the asset. The performance of the asset will have a number of uncertainties associated with it; demand, price and operational risk among others. The cash outflows associated with the decommissioning obligation have different uncertainties associated with them, but these are more around amount and timing rather than occurrence or performance risk. Future sales might be uncertain but the need to restore at the end of the asset’s life is not. The effect of discounting these cash outflows using the asset rate rather than the risk-free rate required by IAS 37 is likely to materially decrease the amount of the liability; this effect is known as the ‘discount rate cushion’.

Restoration obligation in FVLCOD The impairment standard has little specific guidance on determining FVLCOD generally and none on using how to use FVLCOD as the recoverable amount for a cash generating unit with a non-separable liability. Fair value is almost always developed using a cash flow model to produce an enterprise value unless there is a binding offer in place to sell the relevant asset or business. Fair value is defined in IAS 36 as the price that would be paid to sell an asset or assume a liability. The challenge arises both from the different approaches that might be taken to measure assets and liabilities at fair value as well as the practical approach often used by values. Valuation practice is to produce a single cash flow model that produces a fair value for the business (cash generating unit) that includes the cash outflows for the liability. This approach is consistent with how a market participant would think about determining the fair value of the business. The core asset might have a very long life, and decommissioning or restoration is many years in the future. Cash outflows for an obligation that will commence in 20 years in the future would seldom be specifically modelled, even by a party looking to buy the assets, but would be incorporated in a terminal value in the cash flow model. However, if the cash-generating unit is coming to the end of its life and the cash flows are imminent (say expected to begin within the next five years or the period covered by the specific projections), a market participant might take a different approach to consider at what price it is willing to transact for the assets and the non-separable liabilities. An alternative approach would be to calculate the fair value of the asset excluding the cash outflows to satisfy the liability and discount those using a market participant discount rate. Separately, the liability would be calculated using market participant assumptions, rather than an IAS 37 approach. The liability measurement should reflect the amount the entity would need to pay a third party to assume the obligation, this would include a profit margin to the third party, plus a margin for estimation risk (that it might be underestimated) and similar market participant type assumptions. This is likely to produce a higher value for the liability than under IAS 37. The amount determined for the liability would then be deducted from the amount determined for the asset to produce a ‘net’ fair value. The recoverable amount determined under FVLCOD under either of the valuation approaches described is then compared to the carrying amount of the CGU including the decommissioning obligation measured under IAS 37.

Compare like with like

The assets (and liabilities, where appropriate) attributed to CGUs should be consistent with the cash flows that are identified for calculating recoverable amount. Cash flows prepared for fair value less costs of disposal are prepared on a different basis from those for value in use. As a result, the CGU’s carrying value, in a value in use test, differs from that on a fair value less costs of disposal basis. Non-current assets in a CGU will be the same, whether using value in use or fair value less costs of disposal.

Hedging instruments Management might use hedging instruments, such as swaps and collars, to hedge cash flows. The cash flows prepared for the value in use calculation should reflect management’s best estimate of the future cash flows expected to be generated from the assets in the CGU. Management should use the contracted price for the relevant cash flows in its value in use calculation, unless the contract (for example, the hedging instrument) is already on the balance sheet at fair value. The instrument is accounted for under IFRS 9 (IAS 39). The hedged cash flows are included in the value in use calculation at the spot price at the date of the impairment test. Impairment of financial instruments is addressed by IFRS 9 (IAS 39). Including the contracted prices of a contract already on the balance sheet at fair value would double count the effects of the contract. One approach is to exclude working capital balances (including commodity contracts recognized at fair value in accordance with IFRS 9 (IAS 39) from both the CGU’s carrying amount and the cash flows of the value in use calculation. Alternatively, following the principle of comparing like with like, the balances can be left in the CGU, with the associated cash flows (that is, the hedged cash flows at the hedged rates) being included in the value in use calculation.

Leased assets within a CGU: IAS 17 Guidance on how to account for leased assets and liabilities in an impairment test is not included in IAS 36. An acceptable approach would be as follows: ·        For finance leases, follow the approach for IFRS 16 leases which are on balance sheet. ·        For operating leases, follow the approach for IFRS 16 leases which are off balance sheet (that is, lease payments are treated as an operating cash outflow).

IFRS 16 considerations for impairment testing Under IFRS 16, most leases are on the lessee’s balance sheet as right of use assets. Each right of use asset will be allocated to a cash generating unit. Guidance on how to account for leased assets and liabilities in an impairment test is not included in IAS 36. An acceptable approach would be as follows: ·        Include the right of use asset in the carrying amount of the CGU. ·        Exclude the lease liability from the carrying amount of the CGU because it relates to financing. ·        Exclude the cash outflow for the lease payments which are included in the lease liability in the ViU calculation. This compares like with like as the liability has not been included. ·        Include the cash outflow for lease payments which are excluded from the lease liability in the ViU calculation. ·        Lease payments which are excluded from the lease liability include variable payments which are not based on an index or rate or leases using the low-value or short-term exemptions. ·        Include cash outflows to replace leased assets which are essential to the ongoing operation of the CGU, which could be in the form of future lease payments or future capital expenditures.

Working capital

Working capital is sometimes included for practical reasons. It might be appropriate to include movements in working capital in the value in use model, as working capital is required to operate plant and equipment and generate the cash flow from those assets. If an entity includes the cash flows from trade debtors, trade creditors and inventory in the value in use calculation for a CGU, it should include the trade debtors, trade creditors and inventory as part of the CGU’s carrying amount.

Comparing like with like when including working capital balances Entity A is performing a value in use test for a CGU with a finite life and no terminal value. The carrying value of assets, excluding working capital balances, is C180. The carrying value of working capital balances is C9. Entity A holds no inventory. The expected future discounted cash flows and movements in working capital are given below. Year 1 Year 2 Year 3 Year 4 Total C C C C C Net cash flow 90 108 117 126 441 Movements in working capital 10 12 13 14 49 Cash flows, excluding movement in working capital 100 120 130 140 490 Method 1 – Including opening working capital The cash flows are determined based on actual cash movements for each year, with no adjustment for the opening working capital. Total cash flows of C441 are compared to the carrying value of assets, including the opening working capital (C189). This results in a surplus of C252. Method 2 – Excluding opening working capital Under this method, the cash projections should include a one-off cash flow in year 1, because the entity ‘buys’ the working capital to perform its business. Year 1 also includes the normal working capital movement for that year. Year 1 Year 2 Year 3 Year 4 Total C C C C C Net cash flow 90 108 117 126 441 Movements in working capital (9) − − − (9) Net cash flow 81 108 117 126 432 The cash flows included in year 1 include the movement from nil to the closing working capital at the end of the year. Closing working capital is C19 (being the opening position of C9 plus the working capital movement during the year of C10), and so the total cash flows included in the model for year 1 are C81 – that is, the C100 of cash flows excluding working capital movements less the working capital closing balance and movement in year 1 of C19 (C10 + C9). The carrying value of assets excluding working capital (C180) is compared to the cash flow of C432 calculated above. The result is a surplus in the calculation of C252. The outcome is the same under both methods.

Treatment of negative working capital balances in value in use It is common for entities in certain industries, such as retail or gambling, to have negative working capital, because they operate largely on a cash basis, with few receivables. Negative working capital is a benefit to the cash flows, and it increases the business’ value. Negative working capital should be included in the impairment test. However, care should be exercised in determining the extent to which the negative balances are expected to continue into perpetuity, to avoid artificially inflating the business’ value in the impairment test.

Treatment of inventory in value in use Inventory is measured in accordance with IAS 2, and so it is not necessary to include the carrying amount in the CGU. It can be included for practical reasons, provided that the calculation compares like with like. Cash receipts from the sale of inventory would be included in the discounted cash flows, and the inventory’s carrying value would be included within the CGU’s carrying value. The inclusion or exclusion of inventory, unlike other working capital balances, could make a difference to the outcome of the impairment calculation. Inventory is held at cost on the balance sheet, but associated future cash flows would include the expected margin to be made on sale. If margins are considerable, this could create a material discrepancy in the impairment calculation. In such a situation, an appropriate response might be to gross up the inventory’s value within the CGU’s carrying value, to reflect the expected selling price.

Financing

The cash outflows associated with financing the CGU’s operations (including interest-bearing debt, dividends and interest payable) are excluded from the value in use calculations. The carrying amount of a CGU should exclude liabilities that relate to financing the CGU’s operations. No distinction is made between external and inter-company financing. The associated cash outflows, both principal and interest, are not considered in determining recoverable amount. Finance costs are indirectly considered, in measuring recoverable amount, by using the present value method to discount future cash flows.

Fixed asset impairment review when interest is capitalized Entity A has constructed a fixed asset. In constructing the asset, entity A capitalized interest relating to the borrowings that it used to finance the construction, in accordance with IAS 23. The borrowings are still outstanding. The fixed asset’s carrying amount includes capitalized interest. This will be included when carrying amount is compared to recoverable amount. The borrowings are not deducted from the CGU’s carrying value being tested for impairment. The future net cash flows used in the impairment test should exclude cash flows relating to the outstanding borrowings, to compare like with like. The interest cost is effectively included in the calculation of the recoverable amount by discounting the future cash flows.

Inter-company funding Group A is carrying out a first-year impairment review of the goodwill allocated to entity B, which was acquired last year. Entity B has net liabilities, which include inter-company funding from group A to allow the business to meet its short-term needs and to fund post-acquisition restructuring costs. The carrying amount of entity B should exclude the inter-company funding, because the carrying value of a CGU should exclude the carrying amount of a recognized liability, unless the recoverable amount cannot be determined without it. The cash flows associated with the funding are excluded from the calculation of value in use.

Tax

The cash flows in a value in use calculation are prepared on a pretax basis. Tax assets and liabilities are therefore not included as part of the CGU’s carrying value.

Deferred tax reflects the future tax consequences of recovering assets. Future tax payable in relation to a CGU will be recognized as a deferred tax liability. Value in use is a pre-tax measure, so tax (current and deferred) cannot be included in the carrying amount of the CGU.

Tax: comparing like with like Entity T usually tests its goodwill on a pre-tax value in use basis. This year, the value in use test would lead to an impairment and the fair value less costs of disposal is expected to be different from the value in use, so a post-tax fair value less costs of disposal value need to be determined. What are the consequences for the assets’ carrying amounts tested? It is important to compare like with like. Whereas value in use is a pre-tax model, fair value less costs of disposal is a post-tax model. Deferred tax liabilities would generally be included in the carrying amount of the CGU when a FVLCD is being performed. IAS 36 excludes deferred tax assets from its scope, which means that they are usually not included in the carrying value. In some cases, a deferred tax asset arises from a tax allowance which is specifically linked to, and transferable with, the underlying asset. The entitlement to the allowance and related deferred tax asset might go with the asset on sale and would no longer exist after the sale. Under these circumstances, it might be appropriate to include the deferred tax assets in the carrying value of a CGU when a FVLCD is being performed. Calculating the impairment charge could be complex, because temporary differences will change once the impairment charge has been recognized. Deferred tax assets arising from tax losses are not included, because the losses are entity- rather than asset-specific. Another consequence is the discount rate that should be used. For a fair value less costs of disposal test, this would need to be a post-tax rate. A post-tax discount rate is usually readily available at the market and is, therefore, less of a problem to determine than the pre-tax discount rate.

Current and deferred tax balances, with the exception of unused tax losses, and their associated cash flows are taken into account, when calculating fair value less costs of disposal, if a market participant would also include them.

Fair value adjustments in a business combination often result in the recognition of deferred tax liabilities and a corresponding increase in goodwill. A value in use calculation might lead to an impairment charge soon after an acquisition, due to the higher amount of goodwill that is recorded and the exclusion of deferred tax liability in the CGU. A test should be performed using fair value less costs of disposal in these circumstances.

Identified intangibles acquired in a business combination and goodwill Where intangible assets are acquired within a business combination, an entity should apply IAS 12. If the intangible in question is not tax deductible on either consumption or sale, a deferred tax liability based on the intangible’s value and the prevailing tax rate will be recognized. The corresponding debit entry will increase goodwill. Deferred tax liabilities on intangible assets in a business combination might be significant, as there might be no tax deduction for these assets. This leads to the recognition of a higher amount of goodwill. A value in use calculation, which is a pre-tax value, might indicate an impairment charge soon after an acquisition is made, due to the higher amount of goodwill that is recorded as a result of recognizing a deferred tax liability. In order to address this anomaly, a test should be performed using fair value less costs of disposal. The fair value less costs of disposal is a post-tax measure of recoverable value. The carrying value of a CGU under the fair value less costs of disposal method should include the deferred tax liabilities. The comparison of discounted post-tax cash flows and the CGU’s carrying value including deferred tax liabilities might eliminate or reduce the amount of the impairment charge.

Entities might have unused tax losses that could reduce taxes to be paid in the future. A CGU that consists of a business that has a taxable identity might have brought forward tax losses. These tax losses might result in a lower level of cash tax being payable over future periods. Alternatively, there might be no tax losses specifically attributable to the CGU or asset being tested, but tax losses are available from elsewhere within the entity that could be allocated to the CGU or asset being tested.

A CGU’s recoverable amount should not change because there are tax losses attaching to the CGU’s assets. Any difference in value between otherwise identical CGUs, with or without tax losses, relates to the value of the tax losses and not to the value of the assets subject to impairment testing. Any such losses should, therefore, be excluded from the impairment test. This applies to value in use and fair value less costs of disposal. Tax losses are sometimes sold in conjunction with the disposal of a business. However, these are typically treated as a separate transaction, because there is uncertainty as to whether the new owner will be able to realize the benefit of those losses.