IAS 36 Impairment of Assets- The Ultimate Guide
Mar 30, 2024
In this article, we won't just unravel the technicalities; we'll embark on a journey to demystify IAS 36, exploring its real-world implications and equipping ourselves with a sharper lens to decode the financial stories told by companies.
IAS 36 is applicable to almost all entities. In this friendly guide, let me distill the the key requirements of IAS 36 into the following questions:
- What is an impairment under IAS 36
- Which assets are impaired under IAS 36
- How to identify assets to be impaired
- How to measure the recoverable amount
- Measuring the impairment loss
- How to reverse the impairment loss
- How to impair cash-generating units and goodwill
Understanding impairment under IAS 36
Just as we do not want the inventories to be carried above their net realizable value, in the same manner, we do not want our assets over their recoverable amount.
Any difference between the carrying amount and the recoverable amount is an impairment loss.
For inventories, we can only consume or sell them in a given accounting period. But for some assets such as property plant and equipment, we can use them to generate cash over a long period of time or to sell them. A rational person would do whatever is more profitable.
This is exactly why the recoverable amount is the higher of fair value less cost to sell and value in use. Whatever is more beneficial to the owners is expected to be realized.
Conceptually, this is not too far-fetched from the concept of net realizable value for inventories.
Which assets are impaired under IAS 36
For which assets do we compute impairment this way?
As we just discussed, because of the difference in the nature of assets we can not apply the exact net realizable value requirement for property and equipment. Similarly, for many other assets, the computation of recoverable amount is not the most relevant. Consequently, they are outside the scope of IAS 36.
In a nutshell, this standard, IAS 36, deals with assessing asset impairments, but it doesn't cover the following types of assets:
- Inventories
- Contract assets and assets related to contract costs under IFRS 15
- Deferred tax assets as per IAS 12
- Assets associated with employee benefits following IAS 19
- Financial assets within IFRS 9
- Investment property valued at fair value under IAS 40
- Biological assets tied to agricultural activity under IAS 41, measured at fair value less costs to sell
- Assets related to insurance contracts as defined in IFRS 17
- Non-current assets (or disposal groups) are classified as "held for sale" under IFRS 5.
IAS 36 focuses on assessing impairments for all other types of assets.
But here is the catch. Do not think that IAS 36 is only applicable to tangible assets!
This Standard applies to financial assets classified as:
a) subsidiaries, as defined in IFRS 10 Consolidated Financial Statements;
b) associates, as defined in IAS 28 Investments in Associates and Joint Ventures; and
c) joint ventures, as defined in IFRS 11 Joint Arrangements.
For impairment of other financial assets, refer to IFRS 9.
And here is another catch. The impairment requirements are not only applicable to assets carried at the cost model.
This standard also applies to assets that are carried at the revalued amount (ie fair value at the date of the revaluation less any subsequent accumulated depreciation and subsequent accumulated impairment losses) in accordance with other IFRSs, such as the revaluation model in IAS 16 Property, Plant and Equipment, and IAS 38 Intangible Assets.
How to identify assets to be impaired
Now that we have clarified what is impairment and for which assets we need to apply these requirements, we now need to understand when should an asset be tested for impairment.
Assets tested for impairment annually
Some assets are tested for impairment annually these are:
- an intangible asset with an indefinite useful life or an intangible asset not yet available for use (This impairment test may be performed at any time during an annual period, provided it is performed at the same time every year. Different intangible assets may be tested for impairment at different times. However, if such an intangible asset was initially recognized during the current annual period, that intangible asset shall be tested for impairment before the end of the current annual period.)
- goodwill acquired in a business combination
Assets tested for impairment on indication
All other assets are tested for impairment upon indication of impairment
What is an indication of impairment?
An asset may if impaired if the following indication from external sources exist:
- the asset’s value has declined during the period more than depreciation
- significant changes with an adverse effect on the entity have taken place during the period
- market interest rates or other market rates of return on investments have increased during the period
- the carrying amount of the net assets of the entity is more than its market capitalization.
On the other hand, the internal sources may provide the following indications of impairment
- obsolescence or physical damage of an asset.
- changes in the extent to which, or manner in which, an asset is used or is expected to be used
- economic performance of an asset is, or will be, worse than expected.
Measuring the recoverable amount
How do we measure the recoverable amount?
Before we measure the recoverable amount, we need to understand 2 concepts. Fair value less cost to sell and Value in Use.
Value in use is defined in IAS 36 as the present value of the future cash flows expected to be derived from an asset or cashā€‘generating unit.
Fair value has the following definition consistent with IFRS 13
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
Costs of disposal are incremental costs directly attributable to the disposal of an asset or cashā€‘generating unit, excluding finance costs and income tax expense.
Should we always compute both value-in-use and fair value less cost to sell?
Here are 3 important simplifications to note:
Firstly, we do not always need to compute both the amounts (an asset’s fair value less costs of disposal and its value in use.) If either of these amounts exceeds the asset’s carrying amount, the asset is not impaired and it is not necessary to estimate the other amount. [reference: para 19]
Secondly, there might be circumstances where the value in use is not expected to be higher than fair value less cost to sell. This may be because the asset is about to be disposed of. 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 fair value less costs of disposal may be used as its recoverable amount. In this case, there is no need to compute value in use. [reference: para 20]
Thirdly, on the contrary, sometimes it will not be possible to measure fair value less costs of disposal because there is no basis for making a reliable estimate of the price at which an orderly transaction to sell the asset would take place between market participants at the measurement date under current market conditions. In this case, the entity may use the asset’s value in use as its recoverable amount. [reference: para 20]
But here is the catch: it may be possible to measure fair value less costs of disposal, even if there is not a quoted price in an active market for an identical asset. How? By considering the fair value of a “similar” asset and making necessary adjustments. But really fair value is dealt with in detail in IFRS 13.
How to compute the value in use?
This is something that I do regularly for my clients at athGadlang. The following elements shall be reflected in the calculation of an asset’s value in use:
- an estimate of the future cash flows the entity expects to derive from the asset;
- expectations about possible variations in the amount or timing of those future cash flows;
- the time value of money, represented by the current market riskā€‘free rate of interest;
- the price for bearing the uncertainty inherent in the asset; and
- other factors, such as illiquidity, that market participants would reflect in pricing the future cash flows the entity expects to derive from the asset.[reference: para 30]
Basically, value in use is typically based on a free cash flow model. And like any cash flow model estimating the value in use of an asset involves the following steps:
- estimating the future cash inflows and outflows to be derived from continuing use of the asset and from its ultimate disposal; and
- applying the appropriate discount rate to those future cash flows.
[reference: para 31]
However here is the catch: The free cash flow projection can not reflect an expansion plan or can not be based on addition to production capacity. In fact, these future cash flows are specifically estimated for the asset in its current condition.
Estimates of future cash flows shall not include estimated future cash inflows or outflows that are expected to arise from:
a) a future restructuring to which an entity is not yet committed; or
b) improving or enhancing the asset’s performance.
[reference: para 44]
Here is another catch: the following cash flows shall not be included in the estimates:
a) cash inflows or outflows from financing activities; or
b) income tax receipts or payments.
[reference: para 50]
For further details about value-in-use calculations you can consult us at athGadlang
Measuring the Impairment Loss
Now that we have the recoverable amount in hand, measuring impairment loss is a simple task.
If, the recoverable amount of an asset is less than its carrying amount, the carrying amount of the asset shall be reduced to its recoverable amount. That reduction is an impairment loss.
An impairment loss shall be recognized immediately in profit or loss, unless the asset is carried at revalued amount in accordance with another Standard (for example, in accordance with the revaluation model in IAS 16). Any impairment loss of a revalued asset shall be treated as a revaluation decrease in accordance with that other Standard.
Side note: For assets carried at fair value the impairment is treated as a revaluation decrease. This is interesting because this is in contrast to impairment under IFRS 9 where the impairment on financial assets carried as FVOCI is also treated as an impairment loss through income statement. Side-side-note: Yes, certain FVOCI assets are impaired under IFRS 9.
[reference: para 59 and 60]
After recognition of the impairment loss, the revised carrying amount is used:
- To calculate the depreciation (amortization) charge for the asset to allocate the asset’s revised carrying amount, less its residual value (if any), on a systematic basis over its remaining useful life.
- To calculate any related deferred tax assets or liabilities are determined in accordance with IAS 12 by comparing the revised carrying amount of the asset with its tax base.
[reference: para 63 and 64]
Reversing the Impairment Loss
Once an asset is impaired, it needs to be assessed annually for reversal.
An entity shall assess at the end of each reporting period whether there is any indication that an impairment loss recognized in prior periods for an asset other than goodwill may no longer exist or may have decreased. If any such indication exists, the entity shall estimate the recoverable amount of that asset.
[reference: para 110]
Similar to indicators for impairment, there are internal and external indicators for the reversal of impairment.
An impairment loss recognized in prior periods for an asset other than goodwill shall be reversed if, and only if, there has been a change in the estimates used to determine the asset’s recoverable amount since the last impairment loss was recognized.
[reference: para 114]
However, there is a limit to such a reversal
The increased carrying amount of an asset other than goodwill attributable to a reversal of an impairment loss shall not exceed the carrying amount that would have been determined (net of amortisation or depreciation) had no impairment loss been recognised for the asset in prior years.
[reference: para 117]
Impairment for Cash Generating Units and Goodwill
A cashā€‘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 groups of assets.
Allocation of Goodwill
Goodwill is allocated to CGUS before on acquisition. However, we need to understand that in accordance with IFRS the goodwill is not always required to be allocated to each individual cash-generating unit.
In the light of Para 81 of IAS 36, Goodwill sometimes cannot be allocated on a non-arbitrary basis to individual cash-generating units, but only to groups of cash-generating units. As a result, the lowest level within the entity at which the goodwill is monitored for internal management purposes sometimes comprises a number of cash-generating units to which the goodwill relates, but to which it cannot be allocated.
If any goodwill is reconized on initial recognition, there is a case that the goodwill representsthe future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognised and can not be allocated to individual pharmacies on a non-arbitrary basis.
These requirements, in accordance with para 82, result in goodwill being tested for impairment at a level that reflects the way an entity manages its operations and with which the goodwill would naturally be associated. This level can be a group of cash generating units instead of a single cash generating unit.
The group of cash generating units to which goodwill has been allocated shall be tested for impairment annually, and whenever there is an indication that the unit may be impaired, by comparing the carrying amount of the group of cash generating units, including the goodwill, with the recoverable amount of the unit.
If goodwill has not been allocated to individual CGU, should it be tested for impairment?
Yes. The above requirement does not preclude the requirement to test individual cash-generating units for impairment upon indication.
Individual cash-generating units
When goodwill relates to a cash-generating unit but has not been allocated to that unit, the unit shall be tested for impairment, whenever there is an indication that the unit may be impaired, by comparing the unit’s carrying amount, excluding any goodwill, with its recoverable amount.
The carrying amount of individual cash generating unit will include all the assets and liabilities associated with that unit and the corporate assets associated with it.
What are corporate assets?
Corporate assets are assets other than goodwill that contribute to the future cash flows of both the cashā€‘generating unit under review and other cashā€‘generating units.
If a portion of the carrying amount of a corporate asset can be allocated on a reasonable and consistent basis to that unit, the entity shall compare the carrying amount of the unit, including the portion of the carrying amount of the corporate asset allocated to the unit, with its recoverable amount.
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. If there is a head office brand it would be a corporate asset.