Scope of IAS 36
The carrying amount of assets in the statement of financial position should not be higher than the economic benefits expected to be derived from them. The amount of economic benefits is the recoverable amount as per IAS 36 terminology. If the carrying amount is higher than the recoverable amount, the asset is impaired, i.e. entities need to decrease the value of the asset through recognition of an impairment loss.
IAS 36 is applicable to most assets, however there are a few groups that are excluded from the scope of IAS 36 because other IFRS already give sufficient guidance. Those are listed and discussed in paragraphs IAS 36.2-5.
IAS 36 most often uses the term ‘an asset’ but this applies also to cash-generating units (‘CGU’). The same approach is followed in the discussion below.
Identifying an asset that may be impaired
IAS 36 requires entities to assess at the end of each reporting period whether an asset may be impaired (IAS 36.9) and provide a list of minimum impairment indicators to be considered (see paragraphs IAS 36.12-17). Irrespective of existence of any impairment indicators, goodwill and intangible assets with an indefinite useful life or not yet available for use must be tested for impairment at least annually (IAS 36.10).
Definition of the recoverable amount
Recoverable amount is the higher of an asset’s fair value less costs of disposal and its value in use (IAS 36.6).
Fair value less costs of disposal
Fair value less costs of disposal is the fair value less incremental costs directly attributable to the disposal of an asset (see IAS 36.28-29). It is important to note that fair value less costs of disposal may be used as a basis for recoverable amount even if the entity does not intend to sell the asset.
Fair value measurements are covered in IFRS 13.
Value in use
Overview of value in use
Value in use (IAS 36.30-57) can be shortly defined as future cash inflows and outflows from continuing use of the asset and from its ultimate disposal, which are then discounted to reflect time value for money and risk. In practice, a single estimate of cash flows derived from budgets is used most often, but IAS 36 allows also the use of the expected value approach. See Appendix A to IAS 36 (IAS 36.A1-A14) for more discussion on this topic.
As a part of the overview of value in use, below is a simple impairment test of a CGU that is based on value in use. I highly recommend to view it in the accompanying excel file available for download.
Value in use calculation starts with cash flow projections:
Note: you can scroll the table horizontally if it doesn’t fit your screen
|Capital expenditures (2)||530||530||530||530||530||570|
|Tax at nominal rate of 19% (3)||82||88||91||91||94||94|
|Reduction in tax (4)||27||29||30||30||31||31|
|Tax after tax credit||54||59||61||61||63||63|
|Cash flow generated|
by the CGU before tax
|Cash flow generated|
by the CGU post-tax
(1) Depreciation: this is notional tax depreciation needed for value in use purposes only (to calculate income tax charge). Notional, i.e. with the assumption that carrying value of CGU and it’s tax base are equal on day 1.
(2) Capital expenditures: Strictly speaking, this should include only replacements of existing assets after the end of their useful life (see the section below on improvements and restructuring). It may be different from the depreciation charge e.g. due to changes in technology.
(3) Tax at nominal rate of 19%: Tax is calculated as a % of operating income. Temporary differences should be ignored as they are already included in deferred tax. Interest in impairment tests is ignored in cash flow projections, as cost of capital is reflected in WACC calculation (covered below).
(4) Reduction in tax: it is assumed here that the entity from this example operates in a region with high unemployment rate and gets its tax charge reduced by a third.
Based on the cash flow projections above, the value in use in calculated as follows (see the formulas in the spreadsheet file linked to at the beginning of this example):
|12,311||Total recoverable amount|
|1,971||Present value of cash flows for years 20X1 to 20X5|
|10,341||Present value of terminal year|
The discount rate (WACC) used in this calculation amounts to 5.48% and PGR (perpetuity growth rate – estimated growth rate beyond period covered by cash flow projections) to 2%. These inputs will be covered later in this chapter.
This value is compared to the carrying amount of the CGU calculated as follows:
|11,710||Total carrying amount of CGU|
|7,230||Property, plant and equipment|
As the carrying amount of CGU is lower by $601, the CGU is impaired and an impairment loss is recognised in this amount.
Treatment of enhancements/improvements and restructuring
IAS 36 states (IAS 36.44-49) that projected cash flows should exclude any estimated future cash inflows or outflows expected to arise from future restructurings (until the criteria for recognition of provision are met) or from improving or enhancing the asset’s performance. See also illustrative examples 5 and 6 to IAS 36. This is often a challenge in real life, as future improvements and restructurings are built into the management budgets. Preparing cash flow projections that exclude such items would often necessitate major modification of an approved budget. A common solution to this challenge is to:
1/ calculate the value in use derived from an approved budget that includes future improvements/ restructurings
2/ estimate the present value of major future improvements/ restructurings (entities can base this estimation on a business case of a new project)
3/ deduct the value from point 2/ to arrive at value in use that excludes future major improvements/ restructurings
If the impact of future improvements/ restructurings makes a huge difference, it may be worth considering changing the base for recoverable amount calculation to fair value less costs of disposal. In arriving at the fair value of a CGU entities may take future improvements/ restructurings into account provided that they would be taken into account by a market participant. On the other hand, in fair value calculation entities can’t take into account any circumstances specific to our entity that would not be available to a third party (see IAS 36.53A).
IASB tentatively decided to remove (in future IAS 36 improvements) the requirement for an entity to exclude from the value in use calculation cash flows resulting from a future restructuring or a future enhancement to align value in use calculation with budgets and forecasts.
Future cash flows in foreign currency
IAS 36.54 requires foreign currency future cash flows to be discounted using a discount rate appropriate for that currency and translated using the spot exchange rate at the date of the value in use calculation. This requirement usually requires adjustments to management forecasts as these are often prepared using exchange rates different than the spot rate.
Payments of interest
Cash flows taken to value in use calculation should be consistent with the discount rate applied to them. As discount rate already reflects time value of money and business risks, entities should exclude interest and dividend payments from cash flows used for value in use calculation.
How to calculate the discount rate
Discount rate used for the value in use calculation should reflect current market assessments of: (IAS 36.55-57 and IAS 36.Appendix A15-A21):
– time value of money for the periods until the end of the asset’s useful life;
– risks specific to the asset for which the future cash flow estimates have not been adjusted.
The discount rate used for testing assets for impairment should not be specific to the capital structure of the entity (IAS 36.A19). Therefore, a benchmark rate for companies in similar industry operating in the same country/region should be used instead of entity-specific one.
As a rule, IAS 36 requires discounting pre-tax cash flows with pre-tax discount rate. In practice, a different approach is commonly adopted. The discussion below and calculations in the excel file lead to a post-tax WACC.
WACC (weighted average cost of capital) is the discount rate most often used in practice. One could easily write a 500-page book on calculating WACC, but a simple approach is presented below. Note that different WACC will be applicable to cash flows in different countries, currencies or even for different products, even if within the same CGU tested.
Below is a simplified calculation of WACC. I highly recommend to view it in the accompanying excel file available for download. Each element of the calculation is discussed in the following sections.
Let’s start with the equation:
Where:Re = cost of equity
Rd = cost of debt
g = gearing level
t = corporate tax rate
A calculation of WACC for a retail chain (groceries) in UK gives WACC at the level of 5.48% (again, check the excel file):
|5.48%||Calcualted post-tax WACC|
|1.66%||UK government bond yield (30Y)|
|19%||UK corporate tax rate|
|5.92%||ERP (equity risk premium) (includes country risk premium)|
|This gives Re and Rd at:|
|8.00%||Re (cost of equity)|
|3.62%||Rd (cost of debt)|
|Which leads to WACC at:|
Cost of equity
Cost of equity equation
There are many different approaches to estimating cost of equity. Below is an example based on the most popular: Capital Asset Pricing Model (CAPM). CAPM is given as a good starting point by IAS 36.A17. You can also check this excel file mentioned above for an example showing calculation of WACC for retail chain operating in UK with source data.
Re = Rf + β x ERP
Re = cost of equity
Rf = risk free rate
β = beta
ERP = equity risk premium
Risk free rate
Risk free rate usually equals the yield of government bonds (the same currency as estimated cash flows) with time horizon close to the timing of cash flows. For testing CGUs with cash flows discounted into perpetuity, use very long-term bonds (e.g. 30-year). If the government bond yield has a significant default risk built in the yield, entities will need to adjust the government bond yield for default risk by using credit spreads.
Beta is a measure of volatility (risk) relative to the market. If a stock’s beta = 1 then the stock, statistically speaking, moves in line with the market. The reference market is usually a broad index in a given country (such as S&P 500 in the US). If the beta = 1.2, the stock is more volatile than the market, e.g. when market is up by 10%, the stock with beta = 1.2 goes up by 12% (10% x 1.2).
Beta is calculated using regression analysis. Betas for specific entities or industries can be obtained from sources such as Bloomberg or Reuters (paid subscription). Free of charge data is published by Aswath Damodaran (http://pages.stern.nyu.edu/~adamodar/).
When obtaining betas, entities must understand the difference between unlevered and levered betas. Unlevered beta is beta of a company without debt, i.e. without the effects of financial leverage:
Unlevered beta = levered beta / [1 + (1 – tax rate) x gearing].
For the purpose of WACC used in impairment testing, entities need a levered beta, but this should not result from the gearing ratio or beta itself specific to our entity. Instead, a benchmark gearing should be used, e.g. average gearing for the sector in our country or region.
Equity Risk Premium (ERP)
ERP is a premium that investors expect to get because they invest in riskier assets. It is expressed as yield on the top of a risk free rate. E.g. if the risk free rate is 2% and ERP is 5%, then, on average, investors expect equities to yield 7%. ERP is usually calculated based on historical premiums, it is done by comparing returns on equities and risk free rates over a specified period.
For markets that are not mature enough, ERP is calculated by adding country risk premium (CRP) to ERP calculated for a mature market. E.g. for countries in Eastern Europe, entities can take ERP calculated for Germany and add CRP for a specific country. CRP is calculated based on sovereign rating and/or credit spreads.
As you can imagine, the whole exercise can get very sophisticated. For now, similarly to obtaining betas, entities can make use of sources like Bloomberg, Reuters (paid subscription) or Mr Damodaran.
Cost of debt
As with cost of equity, the aim is to obtain a benchmark cost of debt, not an entity specific borrowing rate. Estimating a benchmark cost of debt is usually a matter of adding the credit spread to risk free rate. Risk free rate is covered above. Credit spreads can be estimated based on benchmark bond ratings for entities from relevant sector and country/region and average credit spreads for bonds with the same ratings. Another approach, adopted by Mr Damodaran, is to estimate global credit spread which is then increased by additional risk premium based on standard deviation stock prices. Again, Bloomberg, Reuters (paid subscription) or Damodaran are your friends.
Pre-tax vs. post-tax approach
IAS 36 requires calculating value in use using pre-tax cash flows and a pre-tax discount rate. Such a requirement results from the fact that tax cash flows add complexity to value in use calculation. However, rates that can be observed on the market are generally post-tax, so in practice value in use is often calculated with post-tax cash flows and a post-tax discount rate.
When following post-tax approach to value in use calculation, tax cash flows taken for the calculation are not the same cash flows that the entity expects to pay to tax authorities. Entities should not take into account temporary differences and unused tax losses as they are dealt with in IAS 12 and already recognised as deferred tax where appropriate.
Ideally, entities should calculate tax payments as if the tax base of the assets was equal to their recoverable amount. This would be a complex and self-feeding calculation, so in practice it is often assumed that the tax base of assets is equal to their carrying value in the statement of financial position. In other words, accounting depreciation is used when arriving at income tax charge for value in use calculation.
If there are material timing differences between tax and accounting depreciation, it is also acceptable to use tax depreciation, but then the carrying amount of CGU should also include deferred tax assets/liabilities. Deferred tax is recognised on an undiscounted basis in the statement of financial position, so for impairment testing purposes it is appropriate to use discounted amount.
IAS 36 requires to disclose pre-tax discount rate and entities should follow this requirement even if the value in use was calculated on a post-tax basis. IAS 36.BCZ85 states that ‘In theory, discounting post-tax cash flows at a post-tax discount rate and discounting pre-tax cash flows at a pre-tax discount rate should give the same result, as long as the pre-tax discount rate is the post-tax discount rate adjusted to reflect the specific amount and timing of the future tax cash flows. The pre-tax discount rate is not always the post-tax discount rate grossed up by a standard rate of tax.’ So instead of grossing up the post-tax rate by nominal income tax rate, entities can calculate pre-tax rate iteratively, e.g. by using a goal seek function in excel so that the value in use based on pre-tax cash flows and pre-tax discount rate is the same as value in use based on post-tax cash flows and post-tax discount rate.
When adopting post-tax approach, it is a good idea to disclose both discount rates: pre-tax and post-tax.
Fortunately, the IASB plans to simplify the requirements a bit by removing the requirement to use pre-tax inputs in the calculation.
Cash-generating units (CGU)
Identification of cash-generating units
In most cases companies do not test individual assets for impairment. Assets are combined into cash-generating units (‘CGU’) consisting of assets for which it is impossible to estimate the recoverable amount individually. This is the case when (IAS 36.67):
- the asset does not generate cash inflows that are largely independent of those from other assets and
- asset’s value in use cannot be estimated to be close to its fair value less costs of disposal
CGU should be the smallest group of assets generating cash inflows that are largely independent of the cash inflows from other assets. CGUs are usually much bigger than that due to pragmatic reasons. See paragraphs IAS 36.66-73 for identification of cash generating units.
Q&A – identification of CGU on a country-by-country basis
Entity A is an ultimate parent of a multinational group that carries out its operations through subsidiaries in different countries, all of them operating under a single brand owned by A. Each subsidiary has its own management board which can make largely independent decisions relating to activities on local market. Each subsidiary has also its local sub-subsidiaries serving their needs. For the purpose of local financial statements (prepared also under IFRS), management boards of each subsidiary identify two CGUs: X and Y.
Entity A monitors the operations of the group on a country-by-country basis.
Question: Can entity A identify each country (i.e. each subsidiary together with its sub-subsidiaries) as single CGUs in consolidated financial statements of group A?
Answer: This is what often happens in practice, although it must be said that this is a practical simplification based on materiality, as it would be hard to present a conceptually sound reasoning why X and Y generate independent cash inflows for a subsidiary, but not for the group.
Entity A has a warehouse X that is a part of a CGU Y. Due to change in production process, the warehouse X is no longer used and the building remains empty. CGU Y is not impaired.
Question: can the unused warehouse X still be a part of CGU Y
Answer: No. Warehouse X no longer generates cash inflows that are dependent on other assets forming CGU Y. Moreover, its value in use can be estimated to be close to its fair value less costs of disposal. Warehouse should therefore be tested for impairment separately. As its use doesn’t generate any cash flows, the recoverable amount will determined based on fair value less costs of disposal. See also a footnote to paragraph IFRS 5.4.
Q&A – investment in subsidiaries in separate financial statements as a part of a larger CGU
Entity A has two subsidiaries: X and Y. Additionally, it owns other individual assets directly. In consolidated financial statements of A, there is only one CGU consisting of assets held directly by A and its subsidiaries.
Question: In separate financial statements, is it possible for Entity A to keep the same CGU consisting of assets held directly by A and, this time, investments in subsidiaries X and Y?
Answer: Yes. IAS 36 does not address this issue specifically, but based on general requirements of IAS 36 entities can argue that investments in subsidiaries X and Y do not generate independent cash flows. Of course it is possible to identify dividends paid by X and Y to A, but their amount is still dependent on other assets directly owned by A.
Keep in mind that the carrying amount of such a CGU will most likely be different in separate financial statements, as individual assets of X and Y will be substituted with the value of investments in X and Y, typically carried at historical cost.
Consistency between assets/liabilities tested for impairment and related cash flows
It is important to be consistent in determining carrying amount of a CGU and related cash flows. For practical reasons, value in use calculation often includes cash flows related to provisions, items of working capital or hedging instruments. The carrying amount of CGU in such cases should also include those assets and liabilities, e.g. when a trade payable decreases the carrying amount of a CGU, cash flows should also be decreased by the cash outflow required to settle this payable. When including changes in working capital in terminal year (i.e. projecting them into perpetuity), make sure that this balance in reasonable and supportable based on experience (especially for entities being paid mostly by cash and having negative working capital balances). As you can see in this example, terminal year forms a substantial part of value in use.
On the other hand, some liabilities, e.g. long term and post-employment benefits, are recognised and paid on an on-going basis, so it means that future payments partially relate to future events and these payments should be included in projected cash flows. In other words, entities can’t exclude payments of e.g. post-employment benefits from cash flows because they have got an actuarial provision already recognised. In will be difficult in practice to distinguish payments relating to provision already recognised and payments relating to service in future years, so it’s best to come up with a simplified solution, e.g. based on current service cost included in financial forecast.
Another important thing to note is that for some provisions, notably for dismantling provisions, entities should be very cautious when including them in the carrying amount of a CGU and its value in use. These provisions are discounted using a risk free rate (as required by IAS 37) in the statement of financial position and it is not appropriate to discount related cash flows in impairment testing using WACC applied to assets. For some CGUs, the difference may be material. Additionally, cash flows relating to some provisions may not be included in business plans that are used for impairment (e.g. cash flow will take place after the period covered by the plan). In such a case, the present value of cash outflow can be added separately to the value in use if the provision is taken into account in the calculation of carrying amount. Again, remember about using proper discount rate for the cash flow (not WACC).
Example: deferred tax liabilities and goodwill arising on fair value adjustments following a business combination
Entity A acquires Entity X for $100m. Following this acquisition, entity A recognises well-known brand of Entity X at its fair value of $70m. Brand is determined to have indefinite useful life and it is not tax deductible. Tax rate is 30%. Fair value (equal to tax base) of other identifiable assets of Entity X is $15m.
The following entries are made in consolidated financial statements of Entity A:
|Other assets of X||15|
|Deferred tax relating to brand X||21|
|Goodwill (balancing figure)||36|
Entity A recognised $21m of deferred tax liability relating to brand X ($70m x 30%), as the tax base of brand X is $0. The brand will not be amortised, so deferred tax will be released following a disposal of or impairment loss on the brand
Entity X is a separate CGU and the following assets should be tested for impairment according to IAS 36. For the sake of simplicity, let’s assume that impairment test takes place one day after the acquisition and the carrying of assets did not change.
|Other assets of X||15|
As we can see, the carrying amount of assets to be tested is $121m, which is counter-intuitive as Entity A paid only $100m for these assets. Let’s assume that the recoverable amount of Entity X is equal to what Entity A paid, i.e. $ 100m. Does it mean that an impairment loss of $21m needs to be recognised immediately after the acquisition?
As we can see, the $21 m of excess of carrying amount over recoverable amount results from deferred tax liability relating to brand X. IAS 36 does not take into account this kind of mismatch, but in practice it is acceptable to include the deferred tax liability in the calculation of carrying amount of CGU:
|Other assets of X||15|
|Deferred tax relating to brand X||(21)|
As a result, no impairment loss is recognised.
Internal transfer pricing
IAS 36.70 states that if an active market exists for the output produced by an asset or group of assets, that asset or group of assets shall be identified as a CGU, even if some or all of the output is used internally. However, for the purpose of calculating value in use, entities should adjust the internal pricing between CGUs to arrive at the estimation of market prices. The requirement to adjust internal transfer pricing relates to all CGUs, not only to those with active market for their output (IAS 36.71).
Q&A – transfer pricing between subsidiaries and impact on separate financial statements
Entity A has two subsidiaries X and Y. X produces goods that are then sold to Y, and Y uses them to produce final goods that are then sold to external customers. X sells its goods to Y below cost, therefore X is not profitable. X could sell its products to external customers at price higher than paid by Y. X and Y are separate CGUs in consolidated financial statements prepared by A.
Question 1: For the purpose of impairment tests, should entities adjust the prices paid by Y to X so that they reflect estimated market prices?
Answer 1: Yes. This results from paragraph IAS 36.71
Question 2: What prices should be used by entities X and Y for the purpose of impairment testing in their separate financial statements?
Answer 2: This is less obvious as IAS 36 does not refer explicitly to separate financial statements, but my answer is that in separate financial statements of X and Y prices should be adjusted as well based on IAS 36.71. If this is the case, the disclosure should make it clear what approach was applied. Prices should be adjusted by both entities X and Y.
Allocation of goodwill
For impairment testing, goodwill is allocated (IAS 36.80-87) to the CGU that benefits from the synergies of the related business combination. If goodwill cannot be allocated on a non-arbitrary basis to individual CGUs, it is allocated to groups of CGUs. It may be the case that an ‘old’ CGU benefits from the business combination even though the newly acquired assets are not allocated to this ‘old’ CGU. IAS 36 does not give any guidance on how to allocate goodwill to CGUs. In practice, the most common method is to allocate goodwill in proportion to fair values of allocated assets. But other methods are also acceptable, such as allocation based on difference in fair values of CGUs before and after acquisition of new business.
CGU (or group of CGUs) to which goodwill is allocated can’t be larger than an operating segment identified under IFRS 8 (before aggregation under paragraph IFRS 8.5) and must represent the lowest level within the entity at which the goodwill is monitored for internal management purposes.
On disposal of an operation that is a part of a CGU with goodwill allocated to it, entities should include part of the goodwill in the value of net assets sold. The amount of goodwill ‘sold’ is measured on the basis of the relative value of the operation disposed of and the portion of the CGU retained, unless the entity can demonstrate that some other method better reflects the goodwill associated with the operation disposed of (IAS 36.86). This some other method may be a situation when ‘old’ assets within a CGU are disposed of that are clearly separate from the assets acquired that ‘generated’ goodwill. IAS 36 is silent on how these ‘relative values’ should be calculated, in practice recoverable amounts are used most often.
See paragraphs IAS 36.80-87 for requirements relating to goodwill allocation.
Goodwill and non-controlling interests
When the CGU to be tested for impairment includes a subsidiary with non-controlling interest, make sure to familiarise yourself with Appendix C to IAS 36 and Illustrative examples 7A-7C. In particular, when non-controlling interest is not measured at fair value, entities need to make sure that, for the purpose of impairment testing, goodwill is grossed-up to include also the share of non-controlling interest.
Timing of impairment tests
Paragraphs IAS 36.88-99 set out the criteria for timing of impairment tests. As mentioned before, goodwill and intangible assets with an indefinite useful life or not yet available for use must be tested for impairment at least annually (IAS 36.10). Impairment test may be performed at any time during the year, at the same time every year. In practice though, impairment tests are performed near year-end. Assets and tested for impairment in the following order:
1/ individual assets
2/ individual CGUs
3/ groups of CGUs to which goodwill has been allocated
Individual assets and CGUs without goodwill are tested whenever there are impairment indicators. The requirement for annual testing applies only to goodwill (and intangible assets with an indefinite useful life or not yet available for use). IAS 36.99 allows also using a calculation from previous year to perform current year impairment test provided that the criteria listed in this paragraph are met.
See also the example on allocation of impairment loss below.
Allocation of corporate assets
Paragraphs IAS 36.100-103 set out the requirements for allocation of corporate assets for the purpose of impairment testing (see also Illustrative example 8 to IAS 36). Entities should remember that along with allocation of corporate assets, entities should also allocate corporate expenses in the cash flow estimates.
Recognition of impairment losses
If the recoverable amount of an asset is less than its carrying amount, the carrying amount must be reduced to its recoverable amount and the difference charged to P/L (or OCI for revalued assets). This is an impairment loss. Following an impairment loss, subsequent depreciation charge is adjusted to reflect lower carrying amount.
For CGUs, the impairment loss is allocated to goodwill first, and then to the rest of the assets pro rata on the basis of the carrying amount of each asset (IAS 36.104). However, the carrying amount of the asset after allocation of the impairment loss cannot decrease below its recoverable amount (fair value less cost of disposal) or zero.
Entity A has three CGUs: X, Y and Z. Additionally, there is $10m of goodwill allocated to this group of CGUs. According to IAS 36, goodwill should be tested for impairment annually. It order to do this, Entity A needs to calculate the recoverable amount of all three CGUs to see if they ‘cover’ the value of goodwill. Numbers are as follows:
|impairment of the CGU||-||-||2|
|carrying amount of assets||15||25||30|
As we can see, CGU Z is impaired as its recoverable amount is lower by $2m than the carrying amount. The $2m of impairment loss is allocated pro-rata to assets comprising CGU Z.
After the allocation of impairment loss on CGU Z, total carrying amount of assets and its recoverable amount is calculated as follows:
|carrying amount of assets||15||25||28||68|
The table below shows that, additionally to recognition of $2m of impairment loss on CGU Z, $3m of impairment loss on goodwill should be recognised:
|Carrying amount of CGUs X,Y,Z||68|
|Carrying amount of goodwill||10|
|Total carrying amount||78|
|Recoverable amount of CGUs X,Y,Z||75|
Q&A: allocation of impairment loss to an underperforming asset
Entity A tests a CGU for impairment. The carrying amount of the CGU is $ 10m, and the estimated recoverable amount is $ 9m, therefore the CGU is impaired. There is no goodwill allocated to this CGU. When allocating the impairment loss of $ 1m, Entity A plans to allocate $ 0.4m to an obsolete production line which is still working, but at a slower rate than other production lines. Entity A plans to allocate the remaining $ 0.6m to other assets on the pro rata basis.
Question: Can entity A allocate $ 0.4 million to the obsolete production line?
Answer: No. If this asset is a part of a CGU, it means that this asset doesn’t generate independent cash inflows and its value in use can’t be determined. Entity A should allocate $1m of impairment loss to all assets on a pro rata basis. However, Entity A may want to re-estimate the remaining useful life of this underperforming asset.
The situation would be different if the production line was not used at all.
Reversal of impairment losses
Similarly to assessing whether assets are impaired, entities are required to assess, at the end of each reporting period, whether there is any indication that an impairment loss recognised in prior periods should be reversed or partially reversed. Paragraph IAS 36.111 gives a list of minimum indicators to be considered. The list is analogous to IAS 36.12 with a notable exception of comparing the carrying amount of the net assets of the entity to its market capitalisation (IAS 36.12d).
It’s important to note that a reversal of an impairment loss must result from a change in estimates used for calculation of recoverable amount (e.g. cash flows, discount rate). In other words, entities cannot reverse an impairment loss simply because of unwinding of the discount or accumulating depreciation of assets (IAS 36.114-116).
Reversal of an impairment loss on CGU is allocated to individual assets on a pro-rata basis, but the increased carrying amount cannot be higher than the carrying amount that would have been determined (net of depreciation) without impairment loss in previous years. Furthermore, the increased carrying amount of an individual asset cannot also be higher than its recoverable amount (IAS 36.122-123).
Impairment loss on goodwill cannot be reversed (IAS 36.124).
Disclosure requirements are set out in paragraphs IAS 36.126-137. Key requirements are those of IAS 36.134 on how an entity arrived at a recoverable amount. Note that those disclosures are required only for CGUs with goodwill or intangible assets with indefinite useful lives. IAS 36 encourages, but doesn’t require, such disclosures for other CGUs.
In practice, disclosures made by entities are often too general to enable a user of financial statements to assess how an entity calculated the recoverable amount. Entities often believe that disclosing the value of WACC and PGR along with generic discussion relating to evolution of business activities is sufficient.
Particular attention to disclosure is required when ‘a reasonably possible change in a key assumption on which management has based its determination of the CGU’s recoverable amount would cause the CGU’s carrying amount to exceed its recoverable amount’ (IAS 36.134f). In such cases entities are required to disclose the value of so-called safety margin, the value assigned to key assumptions (note that WACC and PGR are not the only key assumptions) and sensitivity analysis. The criterion from IAS 36.134f is always met when an impairment loss was recognised.
When an impairment loss was recognised or reversed during the period, additional disclosure from IAS 36.130 comes into play, which includes the requirement for disclosure of recoverable amount.
National regulators often focus on disclosures relating to IAS 36 and some even issue their own requirements applicable to companies reporting within their jurisdiction, so check if a regulator in a specific country didn’t issue anything that entities need to comply with.
© 2018-2019 Marek Muc
Excerpts from IFRS Standards come from the Official Journal of the European Union (© European Union, https://eur-lex.europa.eu). The information provided on this website does not constitute professional advice and should not be used as a substitute for consultation with a certified accountant.