Advanced Financial Accounting

Impairment of Assets

The core principle in IAS 36 is that an asset must not be carried in the financial statements at more than the highest amount to be recovered through its use or sale. If the carrying amount exceeds the recoverable amount, the asset is described as impaired. The entity must reduce the carrying amount of the asset to its recoverable amount, and recognise an impairment loss. IAS 36 also applies to groups of assets that do not generate cash flows individually (known as cash-generating units).

IAS 36 contains rules with regard to the impairment and the reversal of impairment losses of specific assets. For the purpose of consolidated financial statements, the scope of IAS 36 mainly comprises items of property, plant, and equipment (IAS 16), intangible assets including any goodwill resulting from a business combination (IAS 38 and IFRS 3), and investment property measured according to the cost model (IAS 40) (IAS 36.2–36.5). The rules of IAS 36 relating to the

asset in an orderly transaction between market participants at the measurement date). To determine whether an impairment loss should be recognized, an entity compares the carrying amount of the asset with its recoverable amount. If the carrying amount exceeds the recoverable amount, an impairment loss is recognized. For assets other than goodwill, an impairment loss is allocated first to reduce the carrying amount of any goodwill allocated to the asset and then to reduce the carrying amount of the other assets in the same unit of account on a pro-rata basis. If the recoverable amount of an asset is less than its carrying amount, the asset is considered impaired and an impairment loss is recognized. The impairment loss is recognized as an expense in the income statement, unless the asset is carried at revalued amount under another Standard, in which case the impairment loss is recognized as a revaluation decrease. The impairment loss is measured as the difference between the carrying amount of the asset and its recoverable amount. The carrying amount of the asset is reduced to its recoverable amount, and the impairment loss is recognized in the income statement. If, in a subsequent period, the recoverable amount of an impaired asset increases and the increase can be objectively related to an event occurring after the impairment loss was recognized, the impairment loss is reversed. The reversal is recognized as income in the income statement, up to the carrying amount that would have been determined (net of depreciation or amortization) had no impairment loss been recognized for the asset in prior periods. The impairment testing for goodwill is performed at least annually, or more frequently if events or changes in circumstances indicate that the carrying amount of the unit may be impaired. The impairment test for goodwill is a two-step process. In the first step, the carrying amount of the unit, including goodwill, is compared with its recoverable amount. If the recoverable amount of the unit exceeds its carrying amount, no impairment loss is recognized. If the carrying amount of the unit exceeds its recoverable amount, the second step is performed to determine the amount of the impairment loss. In the second step, the impairment loss is allocated to reduce the carrying amount of the unit's assets (including goodwill) on a pro-rata basis, except that the carrying amount of an asset is not reduced below its fair value less costs to sell, if determinable. Any remaining impairment loss is allocated to reduce the carrying amount of goodwill. The impairment loss for goodwill is not reversed in a subsequent period.

asset in an arm's length transaction between knowledgeable, willing parties, less the costs of disposal). In practice, it is often not possible to determine the future cash inflows generated by an individual asset on a rational basis, which would be necessary for calculating its value in use. For example, entity E produces (among others) product P. The machines and the factory building are employed in the production of P, as well as in the production of other products. It is therefore not possible to state to which extent the cash inflows from the sale of P are generated by each machine, by the factory building, by E's administrative building, etc. However, it is possible to allocate the cash inflows from the sale of P (and of other products) to the group of assets (which consists of the different machines, the buildings, etc.) as a whole. Such a group of assets to which cash inflows can be allocated and for which value in use can consequently be determined is referred to as a

A cash-generating unit (CGU) 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.

According to the Standard, the recoverable amount has to be calculated if there is an indication that an asset or a CGU is impaired (triggering event) (IAS 36.8). This assessment is done at the end of each reporting period (IAS 36.9). Examples of indications include:

• The asset's market value has decreased significantly more than would be expected as a result of the passage of time or normal use.
• Evidence is available of physical damage or obsolescence of an asset.
• Evidence is available from internal reporting which indicates that the economic performance of an asset is, or will be, worse than expected.
• Increases in the market interest rate or other market-oriented rate of return that are likely to affect the discount rate used in

determining the value in use of an asset and decreasing the recoverable amount materially-There have been significant internal changes to the entity or its operations adversely affecting the entity, such as assets becoming idle, product discontinuations, restructurings or reductions in the expected remaining useful life of its asset

The concept of materiality may be helpful in identifying whether the recoverable amount needs to be estimated. For example, if previous calculations show that an asset's or CGU's recoverable amount was significantly greater than its carrying amount, it is not necessary to re-estimate the recoverable amount if no events have occurred that could have eliminated that difference

Irrespective of whether there is an indication of impairment (i.e. irrespective of whether there are triggering events), the recoverable amount always has to be calculated annually for the following assets or CGUs:

• intangible assets with indefinite useful lives
• intangible assets not

yet available for use-a CGU to which goodwill (acquired in a business combination) has been allocated

Note that any type of asset (independently from his type) has to be tested for impairment whenever there is an indication that asset may be impaired.

review of useful life assessment: The useful life of an intangible asset that is not being amortised shall be reviewed each period to determine whether events and circumstances continue to support an indefinite useful life assessment for that asset. If they do not, the change in the useful life assessment from indefinite to finite shall be accounted for as a change in an accounting estimate in accordance with IAS 8.

In accordance with IAS 36, reassessing the useful life of an intangible asset as finite rather than indefinite is an indicator that the asset may be impaired. As a result, the entity tests the asset for impairment by comparing its recoverable amount, determined in accordance with IAS 36, with its carrying amount, and recognising any

excess of the carrying amount over the recoverable amount as an impairment loss. The calculation of the recoverable amount for an intangible asset or for CGUs just described may be performed at any time during an annual period, provided that the test is performed at the same time every year. Different intangible assets or CGUs may be tested for impairment at different times. However, if some or all of the goodwill allocated to a CGU was acquired in a business combination during the current annual period, or if such an intangible asset was initially recognized during the current annual period, the recoverable amount has to be calculated for that CGU or intangible asset before the end of the current annual period. When to reverse an impairment loss At the end of each reporting period it is necessary to assess whether there is any indication that an impairment loss recognized in prior periods for an asset (other than goodwill) no longer exists or has decreased. This applies equally to a CGU. If there

is such an indication, the recoverable amount has to be calculated.

Determining the recoverable amount for an individual asset or for an asset's CGU

The recoverable amount has to be calculated for an individual asset, if possible. The recoverable amount cannot be determined for the individual asset if both of the following criteria are met:

• the asset's value in use cannot be estimated to be close to its fair value less costs to sell
• the asset does not generate cash inflows that are largely independent of those from other assets

In such cases, value in use and thus the recoverable amount, can be determined only for the asset's CGU, unless the asset's fair value less costs to sell exceeds its carrying amount. In the latter case, the asset is not impaired.

In most cases, an asset is only able to generate cash inflows together with other assets. Consequently, impairment tests are normally conducted on the level of CGUs and not on the level of individual assets. In the case of

assets rented to others, impairment tests are possible for the individual assets.

A CGU 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 (IAS 36.6).

Cash inflows are inflows of cash and cash equivalents received from parties external to the reporting entity. In determining whether cash inflows from an asset (or group of assets) are largely independent of the cash inflows from other assets (or groups of assets), various factors are considered, including the following (IAS 36.69):

• how management monitors the entity's operations (such as by product lines or geographic criteria)
• how management makes decisions about continuing or disposing of the entity's assets and operations.

If an active market exists for the output produced by an asset or by a group of assets, it is likely that that asset or group is a CGU. This applies even if some or all of the output (e.g. products at an

The intermediate stage of a production process (also known as a CGU - Cash Generating Unit) is used internally. Consequently, what is critical is regularly the existence of an active market for the output, irrespective of whether this output is actually sold there (IAS 36.70-36.71, 36.IE6, and 36.IE12). An active market is a market that meets all the following criteria:

• The items traded within the market are homogenous
• Willing sellers and buyers can normally be found at any time
• Prices are available to the public

Determining the carrying amount of a CGU

The carrying amount of a CGU has to be determined on a basis consistent with the way the recoverable amount of the CGU is determined (IAS 36.75). The carrying amount of a CGU includes the carrying amount of the assets that can be attributed directly, or allocated on a reasonable and consistent basis to the CGU and will generate the future cash inflows used in determining the CGU's value in use. The carrying amount of a CGU does not include the carrying amount of any recognized

liability unless the recoverable amount of the CGU cannot be determined without consideration of this liability. The latter situation may occur if the disposal of a CGU would require the buyer to assume the liability.

For practical reasons, the recoverable amount of a CGU is sometimes determined after consideration of assets that are not part of the CGU (e.g. financial assets) or liabilities that have been recognized. In such cases, the CGU's carrying amount is increased by the carrying amount of those assets and decreased by the carrying amount of those liabilities (IAS 36.79).

However, to begin with, the assets and liabilities outside the scope of IAS 36 are measured according to the applicable standards. For example, at first inventories are written down to their net realizable value (if net realizable value is below cost) before they are added to the carrying amount of the CGU.

if: Recoverable amount < Carrying amount then: Impairment=(Carrying amount-Recoverable amount)

Determining recoverable assets