OVERVIEW
Objective
¾
To give guidance on the recognition and reversal of impairment losses.BASIC RULES
CASH-GENERATING
UNITS MEASUREMENT
OF RECOVERABLE AMOUNT
ACCOUNTING FOR IMPAIRMENT
LOSS
¾ All assets ¾ Intangible assets ¾ Indications of potential
impairment loss
¾ General principles ¾ Fair value less costs
to sell ¾ Value in use
¾ Basics
¾ Allocation within a cash-generating unit
¾ Basic concept
¾ Allocating shared assets INTRODUCTION ¾¾ Objective of the standard Definitions
SUBSEQUENT REVIEW
¾ Basic provisions
1
INTRODUCTION
1.1
Objective of the standard
¾
Prudence is a widely applied concept in the preparation of financial statements. A specific application of prudence is that assets should not be carried in the statement of financial position at a value, which is bigger than the cash flows which they are expected to generate in the future.¾
Several standards (IAS 16, IAS 28 and IAS 31) include a requirement that states that if the recoverable amount of an asset is less than its carrying value (“impairment”), then the carrying value should be written down immediately to this recoverable amount.¾
IAS 36 prescribes detailed procedures to be followed in terms of identifyingimpairments and accounting for them. It applies to all assets (including subsidiaries, associates and joint ventures) except those covered by the specific provisions of other statements, i.e.:
inventories (IAS 2);
assets arising from construction contracts (IAS 11); deferred tax assets (IAS 12);
financial assets that are included in the scope of IAS 39; assets arising from employee benefits (IAS 19);
investment property that is measured at fair value (IAS 40);
biological assets measured at fair value less estimated costs to sell (IAS 41); non-current assets classified as held for sale (IFRS 5).
1.2
Definitions
¾
An impairment loss – is the amount by which the carrying amount of an asset exceeds its recoverable amount.¾
Recoverable amount – is the higher of an asset’s fair value less costs to sell and its value in use.¾
Fair value less costs to sell – is the amount obtainable from the sale of an asset (in an arm’s length transaction between knowledgeable, willing parties) less costs of disposal.¾
Value in use – is the present value of the future cash flows expected to be derived from an asset (or cash-generating unit).Commentary
The concept of a cash-generating unit is a solution to the problem of measuring value in use and comparison with carrying value.
2
BASIC RULES
2.1
All assets
¾
At the end of each reporting period an entity should assess whether there is any indication that an asset (or cash-generating unit) may be impaired. If any such indication exists, the entity should estimate the recoverable amount of the asset.¾
If no indications of a potential impairment loss are present there is no need to make aformal estimate of recoverable amount, except for intangible assets with indefinite useful lives and those intangible assets that are not yet ready for use.
2.2
Intangible assets
¾
Irrespective of whether there is any indication of impairment, the following intangible assets must be tested annually for impairment: those with an indefinite useful life; those not yet available for use;
goodwill acquired in a business combination.
¾
The impairment tests for these assets may be performed at any time during an annual period, provided they are performed at the same time every year. Note that all other assets (including intangibles that are amortised) are tested at the end of the financial period.¾
Where an intangible asset with an indefinite life forms part of a cash-generating unit and cannot be separated, that cash-generating unit must be tested for impairment at least annually, or whenever there is an indication that the cash-generating unit may be impaired.2.3
Indications of potential impairment loss
¾
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.¾
The carrying amount of the net assets of the reporting entity is more than its market capitalisation.2.3.2
Internal sources of information
¾
Evidence is available of obsolescence or physical damage.¾
Significant adverse changes have taken place during the period, or are expected to take place in the near future, in the extent to which, or manner in which, an asset is used or is expected to be used.¾
Evidence is available from internal reporting that indicates that the economicperformance of an asset is, or will be, worse than expected. Such evidence that indicates that an asset may be impaired includes the existence of:
cash flows for acquiring the asset, or subsequent cash needs for operating or maintaining it, that are significantly higher than those originally budgeted; actual net cash flows or operating profit or loss flowing from the asset that are
significantly worse than those budgeted;
a significant decline in budgeted net cash flows or operating profit, or a significant increase in budgeted loss, flowing from the asset; or
operating losses or net cash outflows for the asset, when current period figures are aggregated with budgeted figures for the future.
The above lists are not exhaustive.
3
MEASUREMENT OF RECOVERABLE AMOUNT
3.1
General principles
¾
The recoverable amount is the higher of the asset’s fair value less costs to sell and value in use.RECOVERABLE AMOUNT
Higher of VALUE IN
USE and FAIR VALUE LESS COSTS TO SELL
¾
Recoverable amount is determined for an individual asset, unless the asset does not generate cash inflows from continuing use that are largely independent of those from other assets or groups of assets. If this is the case, recoverable amount is determined for the cash-generating unit to which the asset belongs (see later).Illustration 1
Recoverable amount is the greater of:
Value in
use Fair value less costs to sell
Therefore recoverable
amount is:
Carrying
amount Commentary
900 1,050 1,050 1,000 No impairment
900 980 980 1,000 An impairment loss of $20 must be recognised. The carrying value of the asset is written down to 980.
there is no reason to believe that the asset’s value in use materially exceeds its fair value less selling costs, the asset’s recoverable amount is its fair value less selling costs.
Commentary
For example when an asset is held for imminent disposal the value in use will consist mainly of the net amount to be received for the disposal of the asset. Future cash flows from continuing use of the asset until disposal are likely to be negligible.
3.2
Fair value less costs to sell
¾
Fair value less costs to sell – the amount obtainable from the sale of an asset in an arm’s length transaction between knowledgeable, willing parties, less the costs of disposal. The best evidence of an asset’s fair value less costs to sell is a price in a binding saleagreement in an arm’s length transaction, adjusted for incremental costs that would be directly attributable to the disposal of the asset.
If there is no binding sale agreement but the asset is traded in an active market, the asset’s market price (adjusted for costs of disposal) is the basis for calculating the fair value of the asset less costs to sell.
Commentary
The appropriate market price will usually be the current bid price. If current bid prices are not obtainable, the price of the most recent transaction can provide a basis for the estimation of the fair value.
If no binding sale agreement or active market exists for the asset, fair value less costs to sell is determined based on the best information available in the
circumstances.
Commentary
An entity should consider the results of recent transactions in the same industry.
¾
An active market – is a market in which all the following conditions exist: the items traded within the market are homogeneous; willing buyers and sellers can normally be found at any time; and prices are available to the public.
¾
Costs of disposal – are incremental costs directly attributable to the disposal of an asset, excluding finance costs, income tax expense and any cost which has already been included as a liability. Examples include: Legal costs Stamp duty
Costs of removing the asset
Commentary
Examples of costs that are not costs of disposal include termination benefits and costs associated with reducing or re-organising a business following the disposal of an asset.
Illustration 2
X operates in leased premises. It owns a bottling plant which is situated in a single factory unit. Bottling plants are sold periodically as complete assets. Professional valuers have estimated that the plant might be sold for $100,000. They have charged a fee of $1,000 for providing this valuation.
X would need to dismantle the asset and ship it to any buyer. Dismantling and shipping would cost $5,000. Specialist packaging would cost a further $4,000 and legal fees $1,500.
Fair value less costs to sell: $
Sales price 100,000
Dismantling and shipping (5,000)
Packaging (4,000)
Legal fees _______ (1,500)
Fair value less costs to sell _______ 89,500
Commentary
The professional valuers fee of $1,000 would not be included in the fair value less costs to sell as this is not a directly attributable cost of selling the asset.
3.3
Value in use
¾
Value in use – is the present value of the future cash flows expected to be derived from an asset. Estimating it involves: estimating the future cash inflows and outflows to be derived from continuing use of the asset and from its ultimate disposal; and
Illustration 3
X holds a patent on a drug. The patent expires in 5 years. During this period the demand for the drug is forecast to grow at 5% per annum.
Experience shows that competitors flood the market with generic versions of a profitable drug as soon as it is no longer protected by a patent. As a result X does not expect the patent to generate significant cash flows after 5 years. Net revenues from the sale of the drug were $100m last year.
The entity has decided that 15.5% is an appropriate discount rate for the appraisals of the cash flows associated with this product.
Time Cash flow Discount factor Present $m @15.5% value ($m)
1 100 × 1.05 = 105 0.86580 91
2 100 × 1.052 = 110.3 0.74961 83
3 100 × 1.053 = 115.8 0.64901 75
4 100 × 1.054 = 121.6 0.56192 68
5 100 × 1.055 = 127.6 0.48651 ____ 62
Value in use 379
____
3.3.1
Cash flow projections
¾
Projections should be based on reasonable and supportable assumptions that represent management’s best estimate of the set of economic conditions that will exist over the remaining useful life of the asset. Greater weight should be given to external evidence.¾
They should be based on the most recent financial budgets/forecasts that have beenapproved by management.
¾
Projections based on these budgets/forecasts should cover a maximum period of five years, unless a longer period can be justified.¾
Beyond the period covered by the most recent budgets/forecasts, the cash flows should be estimated by extrapolating the projections based on the budgets/forecasts using a steady or declining growth rate for subsequent years, unless an increasing rate can be justified.¾
Estimates of future cash flows should include: projected cash inflows including disposal proceeds;
projected cash outflows that are necessarily incurred to generate the cash inflows from continuing use of the asset.
¾
Estimates of future cash flows should exclude: cash flows relating to the improvement or enhancement of the asset’s performance; cash flows that are expected to arise from a future restructuring that is not yet
committed;
Commentary
Future cash flows are estimated based on the asset in its current condition or in maintaining its current condition (e.g. maintenance, or the replacement of components of an asset, to enable the asset as a whole to achieve its estimated current economic benefit).
cash outflows that will be required to settle obligations that have already been recognised as liabilities;
cash inflows or outflows from financing activities; and
Commentary
These are already taken account of in discounting.
income tax receipts or payments.
Example 1
Sumter is testing a machine, which makes a product called a union, for impairment. It has compiled the following information in respect of the machine.
$
Selling price of a union 100
Variable cost of production 70
Fixed overhead allocation per unit 10
Packing cost per unit 1
All costs and revenues are expected to inflate at 3% per annum.
Volume growth is expected to be 4% per annum. 1,000 units were sold last year. This is in excess of the long term rate of growth in the industry. The management of Sumter have valid reasons for projecting this level of growth. The machine originally cost $400,000 and was supplied on credit terms from a fellow group entity. Sumter is charged $15,000 per annum for this loan. Future expenditure:
In 2 years time the machine will be subject to major servicing to maintain its operating capacity. This will cost $10,000.
In 3 years time the machine will be modified to improve its efficiency. This improvement will cost $20,000 and will reduce unit variable cost by 15%.
The asset will be sold in 8 years time. Currently the scrap value of machines of a similar type is $10,000.
All values are given in real terms (to exclude inflation).
Required:
Solution
Time Narrative Cash flow Comment
Net revenue Per unit Volume 1
2 3 4 5 6 7 8
Other flows 2
8
4
CASH-GENERATING UNITS
¾
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 groups of assets.4.1
Basic concept
¾
If there is any indication that an asset may be impaired, the recoverable amount must be estimated for the individual asset.¾
Identifying the lowest aggregation of assets that generate largely independent cash inflows may be a matter of considerable judgement.¾
Management should consider various factors including how they monitor the entity’s operations (e.g. by product lines, individual locations, regional areas, etc) or how they make decisions about continuing or disposing of the entity’s assets and operations.Illustration 4
An entity owns a dry dock with a large crane to support its activities. The crane could only be sold for scrap value and cash inflows from its use cannot be identified separately from all of the operations directly connected with the dry dock.
It is not possible to estimate the recoverable amount of the crane because its value in use cannot be determined. Therefore, the entity estimates the
recoverable amount of the cash-generating unit to which the crane belongs, i.e., the dry dock as a whole.
¾
Sometimes it is possible to identify cash flows that stem from a specific asset but these cannot be earned independently from other assets. In such cases the asset cannot be reviewed independently and must be reviewed as part of the cash-generating unit.Illustration 5
An entity operates an airport that provides services under contract with a government that requires a minimum level of service on domestic routes in return for licence to operate the international routes. Assets devoted to each route and the cash flows from each route can be identified separately. The domestic service operates at a significant loss.
Because the entity does not have the option to curtail the domestic service, the lowest level of identifiable cash inflows that are largely independent of the cash inflows from other assets or groups of assets are cash inflows generated by the airport as a whole. This is therefore the cash-generating unit.
¾
If an active market exists for the output produced by an asset or a group of assets, this asset or group of assets should be identified as a cash-generating unit, even if some or all of the output is used internally.4.2
Allocating shared assets
¾
The carrying amount of a cash-generating unit should include the carrying amount of only those assets that can be directly attributed, or allocated on a reasonable and consistent basis, to it.Commentary
Goodwill acquired in a business combination and corporate (head office) assets are examples of shared assets that will need to be allocated.
4.2.1
Goodwill acquired in a business combination
¾
Goodwill acquired in a business combination must be allocated to each of the acquirer’s cash-generating units that are expected to benefit from the synergies of the combination, irrespective of whether other assets or liabilities of the acquiree are assigned to those units.¾
Each unit (or group of units) to which the goodwill is so allocated must: represent the lowest level within the entity at which the goodwill is monitored for internal management purposes; and
not be larger than an operating segment determined in accordance with IFRS 8 “Operating Segments”.
Commentary
This aims to match the testing of impairment of goodwill with the monitoring level of goodwill within the entity. As a minimum, this is considered to be based on segmental reporting requirements such that listed companies will not be able to “net-off” and shield goodwill impairment at the entity level.
¾
Once goodwill has been allocated to a cash-generating unit, that unit must be tested for impairment: at least annually; or
Illustration 6
Entity Q is a wholly owned subsidiary of M and has 3 divisions, X, Y and Z. There are indications that Y is impaired and Q has estimated its recoverable amount to be $230m. There are no indications that X and Z are impaired. The value of Q has been estimated, by M, to be $1,380m.
The management of M have allocated $450m of the goodwill held in the group accounts to Q. As X, Y and Z are separately reported to M, they are considered to be the lowest level within the entity that goodwill is monitored.
Cash-generating unit X Y Z Total
$m $m $m $m
Net assets directly involved
in the activities of the unit 350 150 250 750
Goodwill 210 90 150 450
____ ____ ____ _____
Total 560 240 400 1,200
____ ____ ____ _____
The goodwill has been apportioned in the ratio that the directly attributed assets bear to each other.
The carrying value that would be compared to the recoverable amount is $240m.
Y $m
Carrying amount 240
Recoverable amount (230)
____
Impairment loss 10
____ Thus an impairment loss of $10m should be recognised even though the fair value of Q as a whole is greater than its carrying value.
¾
Different cash-generating units may be tested for impairment at different times.Illustration 7
Facts as above except that Q is reported as an operating segment and is the level at which goodwill is monitored by the group, regardless of the fact that X, Y and Z are separate cash-generating units.
Cash-generating unit X Y Z Total
$m $m $m $m
Net assets directly involved
in the activities of the unit 350 150 250 750
Goodwill 450
_____
Total 1,200
_____
Step 1 Test the division (as a separate cash-generating unit)
Y $m
Carrying amount 150
Recoverable amount _____ (230)
Impairment loss _____ –
Step 2 Test the goodwill (at the reporting level)
Q $m
Carrying amount 1,200
Recoverable amount (1,380)
_____
Impairment loss –
_____ Thus there is no recognised goodwill impairment.
4.2.2
Corporate assets
¾
Because corporate assets do not generate separate cash inflows, the recoverable amount of an individual corporate asset cannot be determined unless management has decided to dispose of the asset.¾
Corporate assets are allocated on a reasonable and consistent basis to each cash-generating unit.¾
If a corporate asset cannot be allocated to a specific cash-generating unit, the smallest group of cash-generating units that includes the unit under review must be identified.¾
The carrying amount of the unit or group of units (including the portion of corporateassets) is then compared to its recoverable amount. Any impairment loss is dealt with in the same way as dealing with an impairment loss for goodwill.
5
ACCOUNTING FOR IMPAIRMENT LOSS
5.1
Basics
¾
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.¾
An impairment loss should be recognised as an expense in the profit or loss immediately, unless the asset is carried at revalued amount under another IAS.¾
Any impairment loss of a revalued asset should be treated as a revaluation decreaseunder that other IAS, and presented within other comprehensive income.
Commentary
This will usually mean that the fall in value must be charged to the revaluation surplus to the extent that the loss is covered by the surplus. Any amount not so covered is then charged to profit or loss.
Illustration 8
Carrying
value (1) Recoverable amount Profit or loss Revaluation surplus
Situation 1
Asset carried at historic
cost 100 80 20 Dr –
Situation 2
Historic cost of asset =
100 but revalued to 150 150 125 – 25 Dr
Situation 3
Historic cost of asset =
100 but revalued to 150 150 95 5 Dr 50 Dr
¾
After impairment the carrying value of the asset less any residual value is depreciated (amortised) over its remaining expected useful life.5.2
Allocation within a cash-generating unit
¾
If an impairment loss is recognised for a cash-generating unit, the problem arises as to where to set the credit entry in the statement of financial position.¾
The impairment loss should be allocated between all assets of the cash-generating unit in the following order: goodwill allocated to the cash-generating unit (if any);
then, to the other assets of the unit on a pro-rata basis based on the carrying amount of each asset in the unit.
¾
In allocating an impairment loss the carrying amount of an asset should not be reduced below the highest of: its fair value less costs to sell (if determinable); its value in use (if determinable); and
zero.
¾
The amount of the impairment loss that would otherwise have been allocated to the asset should be allocated to the other assets of the unit on a pro-rataExample 2
At 1 January, an entity paid $2,800 for a company whose main activity consists of refuse collection. The acquired company owns four refuse collection
vehicles and a local government licence without which it could not operate. At 1 January, the fair value less costs to sell of each lorry and of the licence are $500. The company has no insurance cover.
At 1 February, one lorry crashed. Because of its reduced capacity, the entity estimates the value in use of the business at $2,220.
Solution
1
January Impairment loss 1 February
Goodwill
Intangible asset
Lorries
Example 3
Following on from Example 2.
At 22 May, the government increased the interest rates. The entity
re-determined the value in use of the business as $1,860. The fair value less costs to sell of the licence had decreased to $480 (as a result of a market reaction to the increased interest rates). The demand for lorries was hit hard by the increase in rates and the selling prices were adversely affected.
Required:
Show how the above information would be reflected in the asset values of the business.
Solution
1 February Impairment
loss May 22
Goodwill
Intangible asset
6
SUBSEQUENT REVIEW
6.1
Basic provisions
¾
Once an entity has recognised an impairment loss for an asset other than goodwill, it should carry out a further review in later years if there is an indication: that the asset may be further impaired;
that the impairment loss recognised in prior years may have decreased.
¾
An entity should consider, as a minimum, the following indications of both external and internal sources of information.6.1.1
External sources of information
Significant increase in the asset’s market value during the period.
Significant favourable changes during the period, or taking place in the near future, in the technological, market, economic or legal environment in which the entity operates or in the market to which the asset is dedicated.
Decrease in market interest rates or other market rates of return likely to affect the discount rate used in calculating the asset’s value in use and materially increase the asset’s recoverable amount.
6.1.2
Internal sources of information
Significant favourable changes in the actual or expected extent or manner of use of the asset.
Commentary
For example, if capital expenditure incurred enhances the asset.
Evidence available from internal reporting indicates that the economic performance of the asset is, or will be, better than expected.
¾
Any increase in the carrying amount of an asset above 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 is a revaluation and should be treated accordingly.¾
A reversal of an impairment loss for an asset should be recognised in profit or loss immediately, unless the asset is carried at revalued amount under another IFRS.¾
Any reversal of an impairment loss on a revalued asset should be treated as arevaluation increase under the relevant IFRS.
6.2.2
Reversal of an impairment loss for a cash-generating unit
¾
A reversal of an impairment loss for a cash-generating unit should be allocated to increase the carrying amount of the assets (but never to goodwill) pro-rata with the carrying amount of those assets.¾
IAS 38 prohibits the recognition of internally-generated goodwill. Any increase in the recoverable amount of goodwill in the periods following the recognition of animpairment loss is likely to be an increase in internally generated goodwill, rather than a reversal of the impairment loss recognised for the acquired goodwill.
¾
Increases in carrying amounts should be treated as reversals of impairment losses for individual assets.¾
In allocating a reversal of an impairment loss for a cash-generating unit, the carrying amount of an asset should not be increased above the lower of: its recoverable amount (if determinable); and
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.
7
DISCLOSURE
7.1
For each class of assets
¾
Impairment losses, and reversals of impairment losses, recognised during the period and the line item(s) of the statement of comprehensive income in which thoseimpairment losses are included.
¾
The amount of impairment losses, or reversals, recognised against any revaluation surplus during the period.7.2
Segment reporting
7.3
Material impairment losses recognised or reversed
7.3.1
Individual asset or cash-generating unit
¾
The events and circumstances that led to the recognition or reversal of the impairment loss.¾
The amount of the impairment loss recognised or reversed.¾
Whether the recoverable amount of the asset (cash-generating unit) is its fair value less costs to sell or its value in use:7.3.2
Individual asset
¾
The nature of the asset.¾
The reportable segment to which the asset belongs, (if applicable).7.3.3
Individual cash-generating unit
¾
A description of the cash-generating unit (e.g. product line, plant, business operation, geographical area, reportable segment, etc).¾
The amount of the impairment loss recognised or reversed by class of assets and by reportable segment (if applicable).FOCUS
You should now be able to:
¾
define an impairment loss;¾
identify the circumstances that may indicate impairment to assets;¾
describe what is meant by a cash generating unit;EXAMPLE SOLUTIONS
Solution 1 — Cash flows
Time Narrative Cash flow Commentary
Net revenue Per unit Volume
1 29.87 (W1) 1,040 (W1) 31,065
2 30.77 1,082 33,293
3 31.69 1,125 35,651
4 32.64 1,170 38,189
5 33.62 1,217 40,916
6 34.63 1,217 42,145
7 35.67 1,217 43,410
8 36.74 1,217 44,713
Net revenue per unit inflates at 3% per annum for 8 years. Volume inflates at 4% per annum for 5 years. After this IAS 36 prohibits the use of a growth rate which exceeds the industry average. In the absence of further information zero growth has been assumed.
Efficiency improvements from the future capital improvement are not included.
2 Service (10,000 × 1.032) 10,609 The capital improvement is not
included in the estimate of future cash flows.
8 Disposal (10,000 × 1.038) 12,668
WORKING
(1) In the first year
Net revenue per unit = (100 − (70+1)) × (1.03) = 29.87 Volume = 1,000 × 1.04 = 1,040
Solution 2 — Impairment loss
1
January Impairment loss 1 February
Goodwill 300 (80) 220
Intangible asset 500 – 500
Lorries 2,000 (500) 1,500
2,800 (580) 2,220
An impairment loss of 500 is recognised first for the lorry that crashed because its recoverable amount can be assessed individually. (It no longer forms part of the cash-generating unit that was formed by the four lorries and the licence.)
The remaining impairment loss (80) is attributed to goodwill.
Solution 3 — Impairment loss
1
February Impairment loss May 22
Goodwill 220 (220) –
Intangible asset 500 (20) 480 Note 1
Lorries 1,500 (120) 1,380 Note 2
2,220 (360) 1,860
Commentary
220 is charged to the goodwill to reduce it to zero. The balance of 140 must be pro rated between the remaining assets in proportion to their carrying value.
