IAS 36 – Impairment of Assets

2 Impairment

An asset is impaired when its carrying amount exceeds its recoverable amount.

An entity shall assess at the end of each reporting period whether there is any indication that an asset may be impaired. If any such indication exists, the entity shall estimate the recoverable amount of the asset. With few exceptions, entity is not required to formally make an estimate of recoverable amount in the absence of indications.

For certain assets entity is required to make formal estimates of recoverable amount irrespective of indications i.e. even if there are no indications still the estimate will be made which are as follows:

1. Intangible assets with indefinite useful life
2. Intangible asset not yet available for use
3. Goodwill acquired in business combination

Indications of impairment may come from a source outside the entity or within the entity. According to the standard entity is required to consider, as a minimum, following indications:

1. Decline in market value which is significantly larger than the expected decline due to normal usage and passage of time
2. Significant changes in technological, market, economic or legal environment adversely affecting the entity
3. Increase in market interest rate thus increasing the discount factor that decreases the value in use which ultimately cause decrease in asset’s recoverable amount.
4. Carrying amount of net assets exceeds market capitalization i.e. aggregate market value of entity’s shares is lesser than the book value of its net assets.

1. Obsolescence or physical damage
2. Significant changes to the extent to which or the manner in which asset is used or expected to be used thus adversely affecting the entity i.e. idle, restructuring, disposal, reassessed as finite asset.
3. Worse than expected economic performance of an asset.

The above list of indicators is not exhaustive and entity may identify other indications of impairment requiring assessment of recoverable amount. For example, significant imbalance in cash (inflows and outflows) flowing from the asset contrary to the expectations.

Additional considerations of indications

If there is an indication of possible impairment then it may also indicate that adjustments are required in the following:

1. Remaining useful life,
2. Depreciation (amortization) rate or method, or
3. Residual value of asset

3 Measuring recoverable amount

Recoverable amount of an asset is HIGHER of:

1. Fair value less cost to sell
2. Value in use

If either of these values exceeds asset’s carrying amount then asset is not impaired and estimating the other amount is not necessary.

Fair value less cost to sell may be determinable even if it is not traded in active market. However if reliable estimates cannot be made then entity may take value in use as asset’s recoverable amount.

In cases (e.g. asset held for disposal) when there is no reason to believe that value in use materially exceeds fair value less cost to sell (as future cash flows from continuing use are negligible and mainly consists of disposal proceeds) then asset’s fair value less cost to sell may be used as recoverable amount.

Intangible assets with indefinite useful life are required to be tested annually irrespective of indications of impairment. However, preceding period’s recoverable amount calculations can be used for current period’s impairment testing purposes if:

1. Intangible asset is impairment tested as part of a cash generating unit (CGU) and assets and liabilities constituting CGU have not changed significantly since the most recent recoverable amount calculation
2. Recoverable amount exceeded the asset’s carrying amount substantially in most recent calculations.
3. Analysis of events and circumstances since last calculation show that probability of asset’s carrying amount exceeding its current recoverable amount is remote

IAS 36 stated the following instructions to determine fair value less cost to sell:

1. The best evidence is the price in a binding sale agreement less directly attributable disposal costs.
2. In the absence of sale agreement, asset’s current market price (or price from most recent transaction if appropriate) less cost to sell.
3. In the absence of sale agreement and active market for an asset, fair value less cost to sell is based on the best information available to entity considering the industry estimates.
4. Fair value less cost to sell does not reflect forced sale unless management is compelled to sell immediately

Costs of disposal, other than those that have been recognised as liabilities, are deducted in determining fair value less costs to sell. Examples are:

1. legal costs,
2. stamp duty and similar transaction taxes,
3. costs of removing the asset,
4. direct incremental costs to bring an asset into saleable condition.

However disposal costs exclude:

1. termination benefits
2. reorganising costs of business following the disposal of an asset

The following points must be considered while calculating value in use:

1. estimate of the future cash flows the entity expects to generate from the asset;
2. possibility of variations in the amount or timing of those future cash flows;
3. the time value of money, represented by the current market risk-free rate of interest;
4. the cost of uncertainty inherent in the asset; and
5. other appropriate factors that needs to be considered

Estimating the value in use of an asset involves the following steps:

(a)    estimating the future cash flows generated from continuing use of the asset AND through disposal; and

(b)   discounting future cash flows.

In estimating future cash flows:

1. The calculations should be based:
   1. on reasonable and supportable assumptions based on management’s best estimate of economic conditions that will exist over the remaining useful life of the asset
   2. on most recent budgets/forecasts approved by the management excluding cash flows from restructuring or improving/enhancing asset
2. For projections, budgets and forecasts should cover period of five years at max unless a longer period is justified.
3. Extrapolate the projections based on periods beyond five years using a steady or declining growth rate. Increasing rate can be used if justified but not exceeding long-term average growth rate of the product, industry, country or countries in which the entity operations unless higher rate is justified.

Its upon management to assess the reasonableness of the assumptions on which its current cash flow projections are based by examining the causes of differences between past cash flow projections and actual cash flows.

Estimates of future cash flows shall include:

1. projections of cash inflows from the continuing use of the asset;
2. projections of cash outflows that are necessarily incurred to generate the cash inflows from continuing use of the asset e.g. servicing cost (including cash outflows to prepare the asset for use) and can be directly attributed, or allocated on a reasonable and consistent basis, to the asset; and
3. net cash flows, if any, to be received (or paid) for the disposal of the asset at the end of its useful life.

Future cash flows shall be estimated for the asset in its current condition.

Estimates of future cash flows shall exclude estimated future cash flows from:

1. cash flows from assets that are not dependant on assets under review to generate such cash flows.
2. Cash flows relating to obligations already recognized as liabilities
3. a future restructuring to which an entity is not yet committed; or
4. improving or enhancing the asset’s performance.
5. Financing activities
6. Income tax

The estimate of net cash flows from the disposal of asset shall be the amount obtained from the disposal of the asset less disposal cost.

For future cash flows generated in foreign currency, the present value is calculated in the same currency and then converted using spot rate at the date of value in use calculation.

The discount rate (rates) shall be a pre-tax rate (rates) that reflect(s) current market assessments of:

1. the time value of money; and
2. the risks specific to the asset for which the future cash flow estimates have not been adjusted.