IAS 36 – IMPAIRMENT OF ASSETS
The objective of this IAS is to set rules to ensure that the assets of an enterprise are carried at no more than their recoverable amount.
- Recoverable amount is the higher of an asset‘s net selling price and its value in use.
- Value in use is the present value of estimated future cash flows expected to arise from the continuing use of an asset and from its disposal at the end of its useful life.
- Net selling price the amount obtainable from the sale of an asset in an arm‘s length transaction between knowledgeable, willing parties, less the costs of disposal.
- An impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable amount.
- A cash-generating unit is the smallest identifiable group of assets that generates cash inflows from continuing use 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.
An enterprise should assess at each reporting date: –
- Whether there is any indication that an asset may be impaired;
- Irrespective of any indication of impairment, an entity shall also: –
- Test in case of intangible assets having indefinite life or under development; and
- Test goodwill acquired in business combination for impairment annually
External sources of information include:
- Decline in asset‘s market value significantly more than expected
- Significant changes with an adverse effect in the technological, market, economic or legal environment in which the enterprise operates;
- 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 an asset‘s value in use and decrease the asset‘s recoverable amount materially
Internal sources of information include:
- Obsolescence or physical damage
- Significant changes with an adverse effect in the extent to which, or manner in which, an asset is used or is expected to be used. These changes include plans to discontinue or restructure the operation to which an asset belongs.
- Economic performance of an asset is worse than expected.
Other evidence from internal reporting may be: –
- Cash flows for acquiring and maintaining the asset are significantly higher than the originally budgeted;
- Actual cash flows are worst that the budgeted; and
- Operating losses or net cash outflows when current period amounts are aggregated with the budgeted amounts for the future
MEASURING RECOVERABLE AMOUNT
Entities have to bear in mind the following steps and considerations when evaluating an asset‘s recoverable amount:
- Recoverable amount is the higher of an asset‘s net selling price and its value in use
- It is not always necessary to determine both an asset‘s net selling price and its value in use. For example, 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.
- If asset is held for disposal then present value of cash flow from the use of asset until its disposal are likely to be negligible, in this case recoverable amount shall be equal to the selling price.
- If it is not possible to determine the fair value less costs to sell because there is no active market for the asset, the company can use the asset’s value in use as its recoverable amount. Similarly, if there is no reason for the asset’s value in use to exceed its fair value less costs to sell, then the latter amount may be used as its recoverable amount.
For example, where an asset is being held for disposal, the value of this asset is likely to be the net disposal proceeds. The future cashflows from this asset from its continuing use are likely to be negligible
- Recoverable amount is determined for an individual asset. If the asset does not generate cash flows independent from other assets. This asset is clubbed to cash generating unit and impairment loss is calculated of this cash-generating unit.
Measurement of net selling price (Value in sale)
- Price in Binding Sale Agreement less Disposal Cost.
- Cost of disposal includes legal costs, stamp duty and similar transaction taxes, costs of removing the asset, and direct incremental costs to bring an asset into condition for its sale.
Measurement of Value in Use
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 these future cash flows.
It is important that any cashflows projections are based upon reasonable and supportable assumptions over a maximum period of five years unless it can be proven that longer estimates are reliable. They should be based upon most recent financial budgets and forecasts.
- The discount rate should be a pre-tax rate.
- It should reflect the current market assessments of the time value of money and the risks that relate to the asset for which the future cashflows have not yet been adjusted.
RECOGNITION AND MEASUREMENT OF IMPAIRMENT LOSS
If, and only if, the recoverable amount of an asset is less than its carrying amount, the carrying amount of the asset should be reduced to its recoverable amount. That reduction is an impairment loss.
An impairment loss should be recognized as an expense in the statement of profit or loss immediately, unless the asset is carried at revalued amount. An impairment loss on a revalued asset is recognized directly against any revaluation surplus for the asset to the extent that the impairment loss does not exceed the amount held in the revaluation surplus for that same asset.
After the recognition of an impairment loss, the depreciation (amortization) charge for the asset should be adjusted in future periods to allocate the asset‘s revised carrying amount, less its residual value (if any), on a systematic basis over its remaining useful life.
CASH GENERATING UNIT
A cash generating unit (CGU) is the smallest identifiable group of assets for which independent cash flows can be identified and measured. For example, for a restaurant chain a CGU might be each individual restaurant.
Identification of Cash-Generating Unit to which an asset belongs
- If there is any indication that an asset may be impaired, recoverable amount should be estimated for the individual asset. If it is not possible to estimate the recoverable amount of the individual asset, an enterprise should determine the recoverable amount of the cash-generating unit to which the asset belongs (the asset‘s cash-generating unit).
- The recoverable amount of an individual asset cannot be determined if:
- The asset‘s value in use cannot be estimated to be close to its net selling price (for example, when the future cash flows from continuing use of the assets cannot be estimated to be negligible); and
- The asset does not generate cash inflows from use that are independent of those from other asset. In such cases, value in use and, therefore recoverable amount, can be determined only for the asset‘s cash-generating unit.
- An asset‘s cash generating unit is the smallest group of assets that includes the asset and that generates cash inflows from continuing use that are largely independent of the cash inflows from other assets or groups of assets.
Recoverable amount and carrying amount of cash generating unit
The recoverable amount of a cash-generating unit is the higher of the cash-generating unit‘s net selling price and value in use.
The carrying amount of a cash-generating unit includes the carrying amount of only those assets that can be attributed directly, or allocated on a reasonable and consistent basis, to the cash-generating unit and that will generate the future cash inflows estimated in determining the cash-generating unit‘s value in use.
- As goodwill acquired in a business combination does not generate cash flows independently of other assets, it must be allocated to each of the acquirer‘s cash generating units
- A CGU to which goodwill has been allocated is tested for impairment annually. The carrying amount of the CGU including the goodwill is compared with its recoverable amount.
RECOGNITION OF IMPAIRMENT LOSS OF CASH-GENERATING UNIT
An impairment loss should be recognized for a cash-generating unit if, and only if, its recoverable amount is less than its carrying amount. The impairment loss should be allocated to reduce the carrying amount of the assets of the unit in the following order:
- First to any asset that is impaired (e.g. if an asset was specifically damaged)
- Second, to goodwill in the cash generating unit
- Third, to all other assets in the CGU on a pro rata basis based on carrying value
These reductions in carrying amounts should be treated as impairment losses on individual assets.
In allocating in impairment loss, the carrying amount of an asset should not be reduced below the highest of:
If this rule is applied then the impairment loss not allocated to the individual asset will be allocated on a pro-rata basis to the other assets of the group.
REVERSAL OF IMPAIRMENT LOSS
An enterprise should assess at each reporting date whether there is any indication that an impairment loss recognized for an asset in prior years may no longer exist or may have decreased. If any such indication exists, the enterprise should estimate the recoverable amount of that asset.
Considerations on reversal of an impairment loss for an individual asset:
- The increase in carrying value of the asset due to a reversal on impairment loss can only be up to should not exceed the carrying amount that would have been determined (net of amortization or depreciation) had no impairment loss been recognized for the asset in prior years.
- A reversal of an impairment loss been recognized as income immediately in the statement of profit or loss, unless the asset is carried at revalued amount (for example, under the allowed alternative treatment in IAS 16, Property, Plant and Equipment). Any reversal of an impairment loss on a revalued asset should be treated as a revaluation increase as per the respective standard.
- A reversal of an impairment loss on a revalued asset is credited directly to equity under the heading revaluation surplus. However, to the extent that an impairment loss on the same revalued asset was previously recognized as an expense in the statement of profit or loss, a reversal of that impairment loss is recognized, as income in the statement of profit or loss.
After a reversal of an impairment loss is recognized, the depreciation (amortization) charge for the asset should be adjusted in future periods to allocate the asset‘s revised carrying amount, less its residual value (if any), on a systematic basis over its remaining useful life.
Considerations on reversal of an impairment loss for a cash generating unit:
A reversal of an impairment loss for a cash-generating unit should be allocated to increase the carrying amount of the asset of the unit in the following order:
- First, reverse on assets other than goodwill on a pro-rata basis based on the carrying amount of each asset in the unit; and
- An impairment loss recognized for goodwill shall not be reversed in a subsequent period.