General matters

Recoverable amount is the higher of an asset’s fair value less costs of disposal and its value in use. This reflects the greatest value of an asset in terms of the cash flows that can be derived from it, either by selling it or by continuing to use it in the business.

Determination that recoverable amount exceeds the carrying amount Entity A is involved in the generation and distribution of electricity. Management is reviewing all of its assets for impairment, as a result of a fall in the market price of electricity. One of the entity’s power stations is two years old, has a carrying value of C2.5 million and a value in use of C2.2 million, taking into account the revised electricity price. The market for these assets is an active one, because investors are keen to enter the market to pursue the opportunities arising from market deregulation. A similar asset was recently sold to a US-based global power utility for C2.6 million. The estimated incremental costs that would be directly attributable to the disposal are C50, 000. Management has no intention of selling the power station. Should management recognize an impairment charge based on its value in use? Management should not recognize an impairment charge, because the recoverable amount (that is, the higher of value in use and fair value less costs of disposal) exceeds the carrying amount. Management could recover the asset’s carrying amount if it chose to sell it rather than use it in its operations, and so no impairment would be recorded in this situation.

Measurement of recoverable amount – example An entity buys a machine for CU7 million on 1 January 20X1. The asset has a seven-year life, with nil residual value. The carrying amount at 31 December 20X3 is CU4 million. The machine generates largely independent cash inflows and, therefore, is tested for impairment as a stand-alone asset. Due to changes in market conditions, the entity considers that the machine may be impaired. It is determined that the asset could be sold for CU2 million (with costs of disposal of CU200,000). The directors have estimated that the value in use of the asset is CU3.5 million. First, the fair value less costs of disposal of the asset (CU1.8 million) is compared with the estimated value in use (CU3.5 million). The recoverable amount is the higher of these, i.e., CU3.5 million. The recoverable amount is then compared with the carrying amount and an impairment loss of CU500,000 is recognized.

Determination of recoverable amount for an asset that does not generate cash flows independently – example A CGU includes an office building whose fair value can be readily determined. If either (1) the fair value less costs of disposal of the office building is higher than its carrying amount, or (2) its value in use can be estimated to be close to its fair value less costs of disposal, the building is first considered by itself for impairment testing. In addition, if an impairment test is required for the CGU of which the building forms part, the building should be included within the carrying amount of the CGU for the purpose of that impairment test. However, any loss identified for the CGU (in excess of any loss already recognized for the building) should be allocated to other assets. As explained, when allocating an impairment loss to an individual asset within a CGU, the carrying amount of such an asset should not be reduced below its fair value less costs of disposal.

Impairment testing of assets when financial statements are not prepared on a going concern basis As discussed, it is always appropriate to consider the need to recognize impairment losses when an entity is planning to cease or has already ceased trading. This assessment will require a comparison of the carrying amount of an asset (or, when appropriate, CGU) with the higher of its value in use and fair value less costs of disposal. The question arises as to whether, in such circumstances, it is possible to assess impairment by reference to a value-in-use calculation. In theory, it is possible to assess impairment of assets by reference to a value-in-use calculation even when the financial statements are prepared on a basis other than that of a going concern. However, in practice, often the cash flows forecast to arise from the continuing use of such assets are not significant because the expectation is that the assets will be sold or abandoned in the near future. In such circumstances, the amounts arrived at using a value-in-use calculation will not be materially different from the fair value less costs of disposal.

Circumstances in which it is not necessary to calculate both fair value less costs of disposal and value in use

For the purposes of an impairment review, it is not always necessary to calculate both fair value less costs of disposal and value in use.

• If either the fair value less costs of disposal or the value in use is found to be higher than the carrying amount, the asset is not impaired, and there is no need to calculate the other amount.
• If there is no basis for making a reliable estimate of fair value less costs of disposal, recoverable amount is measured by reference to value in use alone.
• The detailed calculations involved in measuring value in use may be avoided if a simple estimate is sufficient to show either that value in use is higher than the carrying amount (in which case there is no impairment) or that it is lower than fair value less costs of disposal (in which case recoverable amount is the fair value less costs of disposal).

Circumstances in which recoverable amount is determined in the context of a cash-generating unit

Recoverable amount is determined for an individual asset, unless the asset does not generate cash inflows that are largely independent of those from other assets or groups of assets. If this is the case, recoverable amount is determined for the CGU to which the asset belongs, unless either:

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

Recoverable amount based on fair value less costs of disposal – example Entity A is reviewing all of its assets for impairment as a result of a fall in the demand for its products. One item of machinery is 10 years old and has a carrying amount of CU80 million and a value in use of CU75 million (calculated on the basis of revised sales estimates). The fair value of the machine is CU82 million. It is estimated that if the machine were to be disposed of, costs attributable to the disposal would be approximately CU1 million. Management has no intention of selling the machine. The fair value less costs of disposal of the machine (CU81 million) is higher than its value in use; therefore, the fair value less costs of disposal represent the machine’s recoverable amount. The carrying amount is less than the recoverable amount; consequently, no impairment loss should be recognized.

Lower of value in use and fair value less costs of disposal give a lower impairment charge IAS 36 defines the recoverable amount as the higher of value in use and fair value less costs of disposal. Given the computational differences between the two measures in relation to tax balances and cash flows, it is possible that the impairment test using the higher measure shows an impairment but the test using the lower measure shows a smaller impairment or no impairment at all. We would consider it appropriate to recognize the smaller (or no) impairment. This is because we believe that the requirement to consider the higher of the two measures is designed to ensure that the lowest impairment charge generated by the two measures is the amount that is actually recognized in profit or loss. Example Entity A has performed an impairment calculation on a CGU. The CGU’s carrying value, excluding tax balances, is C1, 000. The CGU also has an associated C200 deferred tax liability. The value in use, calculated on a pre-tax basis, is C900. The fair value less costs of disposal, calculated on a post-tax basis, is C750. When the value in use is compared to the carrying value excluding the tax balances, this shows a deficit of C100 (C900 – C1, 000). When the fair value less costs of disposal is compared to the carrying value including tax balances, this shows a deficit of C50 (C750 – C800). We would consider it appropriate to recognize the lower impairment charge of C50. The impaired carrying value of the CGU’s assets might need to be further adjusted to reflect any future tax effects resulting from the impairment charge. This approach will result in an iterative calculation to determine the gross impairment charge and resulting tax effect. This is not usually necessary when only goodwill is impaired.

There are a number of differences between the two methods. The main differences are summarized as:

It is not always necessary to calculate both measures when performing an impairment review. If an asset’s fair value less costs of disposal or its value in use exceeds the asset’s carrying amount, the asset is not impaired and there is no need to estimate the recoverable amount using the other method.

Estimates, averages or computational shortcuts might provide a reasonable approximation of the detailed computations that would otherwise be required to determine recoverable amount.

If there is no reason to believe that an asset’s value in use materially exceeds its fair value less costs of disposal, the asset’s recoverable amount can be taken to be its fair value less costs of disposal. This will often be the case for an asset that is held for disposal where the value in use will consist mainly of the net disposal proceeds.

The recoverable amount should be determined by estimating the asset’s value in use if the fair value cannot be determined.