IAS 36 - Impairment of Assets (detailed review)
Objective
This standard provides guidelines to be followed by the entity to make sure that its assets are notstated atmore than its recoverable value. If carrying value of an asset exceeds its recoverable value then the excess is treated as impairment loss. The standard also prescribes the circumstances for the reversal of impairment loss and related disclosures required.
Scope
This standard is applicable for the impairment of all the non-current assets, other than the following:
- Financial assets under IFRS 9
- Deferred tax asset under IAS 12
- Inventory which is covered under IAS 2
- Investment property under fair value model in accordance with IAS 40
- Biological assets which are measured at fairvalue less costs to sell under IAS 41
- Non-current asset or a disposal group classified as held for sale under IFRS 5
- Asset arising from construction contract underIAS 11
However, this standard is applicable for the impairment of financial assets which are classified as subsidiaries as per IFRS 10, joint ventures which are covered under IFRS 11, and associates covered under IAS 28.
Definitions
Impairment Loss
If the carrying value of an asset exceeds the recoverable value of an asset, the excess is known as Impairment loss.
Recoverable Value
Recoverable value for an asset or a cash generating unit is determined as the higher of:
- The Value in Use and
- The Fair Value less costs to sell
Value in Use
It is present value of estimated future net cash inflows that an entity would obtain from the continuous use of the asset over its useful life and from its ultimate disposal.
Costs to Sell
These are additional costs which are expected to be incurred to sell an asset or a cash generating unit, other than finance cost and income tax expense.
Carrying Value
It is the amount at which the asset appears in the statement of financial position and it is calculated as Cost less Accumulated Depreciation and Accumulated Impairment Loss.
Depreciation
It is the systematic allocation of the depreciable amount of an assetover its related useful life.
Useful Life
It is the period of time for which asset will be used by the management.
Cash Generating Unit
It is the smallest identifiable group of assets that is capable to generate cash inflows which are largely independent of the cash flows from other assets orgroups of assets.
Corporate Assets
These are the assets, other than goodwill, which do not generate cash inflows independently but these support other assets to generate future cash inflows
Identification of impairment Loss
An asset or cash generating unit is considered to be impaired when its carrying value exceeds the recoverable value.However an entity should apply the impairment test as follows:
1) The entity is required to apply impairment test on annual basis for the following assets:
(a) Goodwill acquired in a business combination
(b) Intangible assets having indefinite useful life
(c) Intangible asset under development
2) For all other non-current assets or a cash generating unit, the entity will assess at each reporting date that whether an indication exist for the impairment loss. If such an indication exists the entity is required to apply the impairment test as prescribed in this standard. The indications reflecting impairment loss are as follows:
Internal Indications
Following are the internal indicators which may reflect the existence of impairment loss:
- Significant reduction in the actual cash inflows than budgeted
- Physical damage or deterioration
- Operating Loss or net cash outflows from the asset
- Frequent repair and maintenance of asset
External Indications
Following are the external indicators which may reflect the existence of impairment loss:
- Sudden fall in market value
- Technological, economic or legal changes in the market with an adverse effect upon the entity
- Increase in the interest rates which will affect the discount rate of the entity
- Decrease in demand of the product related to the asset
Determination of Recoverable Value
The entity will follow the following rules for the determination of recoverable value of an asset or a cash generating unit:
- Normally recoverable value is the higher of value in use or fair value less cost to sell
- If either the value in use or fair value less the cost to sell is determined to be higher than the carrying value, there is no need to determine the second element as there is no impairment loss.
- If the entity is unable to determine the fair value less cost to sell of an asset because of its specialized nature then it’s value in use will be taken as its recoverable value
- The recoverable value of the asset which is classified as held for sale will be its fair value lesscost to sell
- This standard requires that the recoverable value should be determined for individual assets. If it becomes impracticable, then it should be determined for a cash generating unit.
Fair value less cost to sell
It is determined as market value of asset less its cost to sell such as legal charges, stamp duty charges or transaction duties other than amount which is recognized as liability.
Value in Use
It is present value of estimated future net cash inflows that an entity would obtain from the continuous use of asset over its useful life and from its ultimate disposal. The entity should consider the following aspects in determination of value in use of an asset or a cash generating unit:
- Value in use is determined by estimating asset’s future cash inflows and outflows; then multiplying these with an appropriate discount rate
- The future cash inflows include the estimated cash inflows that an entity would obtain from continuous use of asset and from its ultimate disposal proceeds expected at the end of its useful life
- The future cash outflows include the regular or day to day repair and maintenance of the asset
- In determining the future cash flows, the entity should take into account the effect of any expected variation in cash flows and timing of such cash flows
- The effect of passage of time
- The cash flow forecasts prepared by the entity should be supplemented by the appropriate and realistic assumptions by the management on the basis of management’s best estimate in the current circumstances
- The cash flow forecasts prepared should be based on most recent financial forecast approved by management up to maximum of five years unless a later period could be justified and then cash flows for entire life of the asset are determined by extrapolation.
- The entity should consider the expected future cash flows in the present condition of the asset without taking into account the effect of:
- Any future reorganization to which entity has not been committed yet or
- Any planned future improvement , up-grade, or enhancement to the asset
- The entity should use pre-tax discount rate and pre-tax expected future cash flows i.e. before taking into account the effect of any income tax
- For foreign currency cash flows, these will be determined in the currency in which such cash flows will arise and entity will use applicable discount rate.
Recognition & Measurement of Impairment Loss on Individual Asset
The entity will account for the impairment loss related to the individual asset as follows;
- Impairment loss is only when carrying value of asset exceeds its recoverable value. The excess is treated as impairment loss and in such circumstances the asset will be written down to its recoverable value.
- The impairment loss on the asset under cost model will be charged to statement of profit or loss as an expense. However, impairment loss on the asset under revaluation model will be charged first against its revaluation surplus if any, to the extent it is available in the previous periods and any excess impairment loss will be charged to statement of profit or loss.
- After the charge of impairment loss, asset’s depreciation or amortization charge will be determined on the basis of any recoverable value less any residual value, over its remaining useful life
Identifying a Cash Generating Unit
This standard requires the entity to determine the recoverable value for an individual asset when there is an indication of impairment. However, if it becomes impracticable to calculate the recoverable value of an individual asset then in such circumstances recoverable value will be determined for the group of assets i.e. the cash generating unit to which the asset belongs. The recoverable value of an individual asset may not be determinable in the following circumstances:
- When value in use of an asset is not determinable on individual basis or value in use is materially different from its fair value less cost to sell
- When asset is dependent upon other asset to generate economic benefits
In such circumstances, recoverable value should be determined for the group of assets i.e. the cash generating unit to which asset belongs. Cash generating unit is the smallest, identifiable combination of assets that is capable to generate cash inflows which are significantly independent of the cash flows from other assets orgroups of assets.
Example
An entity engaged in mining operations owns a customizedprivate railway to be used for its mining activities and operations. There is an indication that the private railway is impaired. However, the private railway does not generate cashinflows independently from the cash inflows of the other assetsof the mine, and is dependent upon other assets of the mine to generate economic benefits or alternativelyit could be sold only for scrap value.
The recoverable of the private railway is not determinable because its value in use cannot be determined on individual basis, as it does not generate cash inflows independently from other assets and is probably different from its scrap value. Therefore, the entity needs to determine the recoverable value of the cash generating unit as whole to which the private railwaybelongs, i.e. the mine as a whole.
- If an active market is available for the output produced by an asset or group of assets,that asset or group of assets shall be identified as a cash-generating unit even if some or all of itsoutput is used internally and in such circumstances, the cash flows of the cash generating unit should reflect the management’s best estimate of future price(s) that can be obtained in an arm’s length transaction.
- The entity is required to identify the cash generating units consistently over the accounting periodsusing the same asset or types of assets, unless a change in assets of cash generating unit can be justified.
Determination of Carrying Value of a Cash Generating Unit
The carrying value of a cash generating unit includes the following:
1) The carrying value of directly related assets in the cash-generating unit that are inter-dependentto generate future cash inflows, withouttaking into account any recognized liability related to the assets in the cash generating unit, unless therecoverable value of the cash generating unit is not determinable without consideration of this liability
2) Share of goodwill, as goodwill does not generate economic benefits independently and it supports other assets to generate future cash inflows, therefore, goodwill arising in a businesscombination at the date of acquisition, will be allocated to each of the cash generating units of the acquirer, or group of cash generating units, to which goodwill is expected to support to generate future economic benefits using reasonable consistent basis. However, each cash generating unit or group of cash generating units to which the goodwill is allocated should:
a) Reflect the smallest level in the entity at which the goodwill isassessed for internal reporting purposes and
b) Not greater than the operating segment as defined in IFRS 8
3) The entity should also allocate the share of all thecorporate assets which relate to the cash generating unit under review for impairment as follows:
a) If a portionof the carrying value of a corporate asset can be allocated on a reasonable and consistent basis to the cash generating unit, the entitywill compare the carrying value of the cash generating unit, including the allocated share of carrying value of corporate asset, with itsrecoverable value and will recognizeany resultant impairment loss as per the requirements of this standard.
b) If entity does not have any reasonable and consistent basis to allocate the portion of carrying value of corporate asset to the cash generating unit, entity will:
i) Compare the carrying value of such cash generating unit, excluding the corporateasset, with its recoverable valueand will recognizeany resultant impairment loss as per the requirements of this standard, and then,
ii) The entity is required to determine the smallest group of cash generating units including the cash generating unit under review, to which a share of the carrying value of the corporate asset can be allocated on areasonable consistent basis and compare the carrying value of such group of cashgenerating units,including allocatedshare of the corporate asset with the recoverable value of thegroup of cash generating units and will recognizeany resultant impairment loss as per the requirements of this standard.
Impairment Loss for a Cash Generating Unit
If the carrying value exceeds the recoverable value of cash generating unit, the excess is treated as impairment loss and it will be accounted for in the following order:
a) First, to the allocated goodwill in the cash generating till it comes to zero
b) Then any remaining impairment lossto the remaining assets in the cash generating unit on proportionate basis, using the carrying values of assets in the cashgenerating unit
The allocated impairment loss to each asset will be treated as impairment loss on individual asset and will be recognizeas per the requirements of this standard. However, while allocating impairment loss, the carrying value of each asset in the cash generating unit should not decrease thanthe higher of:
a) Recoverable Value
b) Zero
Reversal of Impairment Loss
After the impairment loss is recognized, the entity should assess at each year end date that is there any indication of reversal of impairment loss, if any indication exist such as increase in demand of the product related to the asset or decrease in interest rates, in such circumstances the entity will reverse the impairment loss as follows:
- The impairment loss on individual asset will be reversed but up to a limit i.e. the carrying value of the asset should not go beyond the amount that would have been if impairment loss has never been charged, after the reversal of impairment loss.
- The reversal of impairment loss on individual asset will be charged to statement of profit or loss, however reversal of impairment loss of asset under revaluation model will be accounted for as revaluation increase as per IAS 16
- After the reversal of impairment loss, the depreciation or amortization charge will be based on the revised carrying value less residual value over its remaining useful life.
- The reversal of impairment loss on a cash generating unit will be allocated to the assets on pro-rata basis of carrying values of assets in that cash generating unit and the allocated increase in the carrying value of each asset in the cash generating unit will be accounted for, as the increase in carrying value of individual asset as per the requirements of this standard, however the impairment loss on goodwill is not reversed.
Disclosures
- The impairment loss recognized in the current reporting period
- The line item in which loss is presented in the statement of profit or loss
- The amount of impairment loss recognized, related to asset under revaluation model in the other comprehensive income statement and any reversal related to such assets
- The amount of reversal of impairment loss recognized in the current period and the line item in the statement of profit or loss in which such reversal is presented
- The entity is required to disclose the following in respect of individual asset, cash generating unit and goodwill for which impairment loss is recognized in the current period:
a) The description of individual asset
b) The description of cash generating unit
c) The circumstances reflecting impairment loss
d) Any change in the assets of the cash generating unit as compared to the previous accounting period
- How the entity has determined the recoverable value
- Basis to determine the fair value less cost to sell and value in use
- The entity’s estimates of future cash flows, related supportable assumptions and discount rates for determination of value in use
- Amount of goodwill allocated to the cash generating unit
- Description of the assets forming cash generating unit
Worked Examples
Example 1
The financial controller of AB Ltd has identified a matterbelow which may indicate an impairment loss:
AB Ltd operates a plant which has a cost of $1,280,000 and accumulated depreciation of $800,000 at 1 January 2013. It is being depreciated at 12.5% on cost using straight line method. On 1 July 2013 in the mid of the current year, the plant was damaged because of collusion with a factory vehicle. On this date, the entity estimated that present value of the plant in use is $300,000 and it has a current disposal value of $40,000.
Required
Calculate impairment loss on the company’s plant if any, and prepare the extracts of financial statements for the year ended 31 December 2011 for AB Ltd.
Solution:
Statement of Profit or Loss |
31.12.11 |
|
$’000 |
Depreciation Expense ($80 + $75) (W1) |
(155) |
Impairment Loss(W1) |
(100) |
Statement of Financial Position |
31.12.11 |
|
$’000 |
Assets: |
|
Non-Current Asset: |
|
Plant(W1) |
225 |
(W1)
Plant |
31.12.11 |
|
$’000 |
Cost |
1,280 |
- Accumulated Depreciation |
(800) |
Carrying Value at 01.01.13 |
480 |
- Current Year Dep. (6 months) ($1,280 × 12.5%) × 6/12 |
(80) |
Carrying Value at 30.06.13 |
400 |
Impairment loss |
(100) |
Recoverable value(W2) |
300 |
- Current Year Dep. (6 months) ($300 / 2 years) × 6/12 |
(75) |
Carrying Value at 31.12.13 |
225 |
(W2) Recoverable Value:
It is determined as the higher of,
- Value in Use $300
- Fair Value less costs to sell $40
Example 2
AB Ltd has acquired 100% share capital of Advent on I January 2011, which is engaged in the supply of basic foods. The entity was generating healthy profits, but has now started reporting operating losses from the last few months because of bad reputationresulting from numerous customers becoming ill, because of the supply of sub-standard foods inMay 2011.
The carrying values of Advent'sassets at 31 December 2011 are as follows:
|
$'000 |
Goodwill |
14,000 |
Factory Building |
24,000 |
Purifying plant |
16,000 |
Inventories |
10,000 |
Total |
64,000 |
Based on the estimated future cash flows, the directors have estimated that the value in use of Advent as a cash generating unit at 31 December 2011is $40 million. Thereis no reliable estimate of the fair value less costs to sell of Advent.
Required
Calculate the carrying values of Advent’s assets at which thesewill be presented in the consolidated statement offinancial position of AB Ltd, for the year ended 31 December 2011.
Solution:
(W1) Impairment loss at 31 December 2013
|
$’000 |
Carrying value of cash generating unit |
64,000 |
Impairment Loss |
(24,000) |
Recoverable value |
40,000 |
(W2) Allocation of Impairment loss to cash generating unit
|
C.V at
|
Imp. Loss at
|
New C.V at
|
Goodwill |
14,000 |
(14,000) |
- |
Factory Building |
24,000 |
(6,000) |
18,000 |
Purifying plant |
16,000 |
(4,000) |
12,000 |
Inventory |
10,000 |
- |
10,000 |
|
64000 |
24,000 |
40,000 |
Notes:
- The impairment loss of $14,000 out of 24,000 will be first allocated to goodwill.
- Then the remaining loss of $10,000($24,000 - $14,000) will be allocated to other assets of the cash generating unit i.e. factory building and purifying plant on the basis of their respective carrying value as follow:
Factor Building = $10,000 × $24,000 / ($24,000 + $16,000) = $6,000
Purifying plant = $10,000 × $16,000 / ($24,000 + $16,000) = $4,000
- The inventory will not be charged any impairment loss under IAS 36 as it is covered under IAS 2.
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