DEFINITION OF KEY TERMS
Active market: This is a market in which all the following conditions exist:
(a) The items traded within the market are homogenous;
(b) Willing buyers and sellers can normally be found at any time; and
(c) Prices are available to the public.
Carrying amount: This is the amount at which the asset is recognised after deducting any accumulated depreciated (amortization) and accumulated impairment losses thereon.
Cash generating unit: This is the smallest identifiable group of assets that generate cash inflows that are largely independent of the cash inflows from other assets or group of assets.
Corporate assets: These are assets other than goodwill that contribute to the future cash flows of both the cash-generating unit under review and other cash-generating units.
Fair value less cost to sell: This is the amount obtainable from the sale of an asset or cash-generating unit in an arm’s length transaction between knowledgeable, willing parties, less the cost of disposal.
Impairment loss: This is the amount by which the carrying amount of an asset or cash-generating unit exceeds its recoverable amount.
Recoverable amount: of an asset or cash-generating unit is the higher of its fair value less costs to sell and its value in use.
Value in use is the present value of the future cash flows expected to be derived from an asset or cash-generating unit.
Assessing and testing assets for impairment
At the end of each reporting period, an entity should assess its assets to determine whether there is any indication that an asset may be impaired. If such indication exists, the entity should estimate the recoverable amount of the asset.
An entity should test an intangible asset with an indefinite useful life or an intangible asset not yet available for use for impairment annually, by comparing its carrying value with its recoverable amount.
Goodwill acquired in a business combination should also be tested for impairment annually.
SELF ASSESSMENT EXERCISE
What is an impairment loss?
INDICATIONS OF IMPAIRMENT
In assessing whether there is any indication that an asset may be impaired, an entity shall consider the following indications:
External source of information
(a) Market value declines significantly during the period;
(b) Significant changes with adverse effect on the entity in technological, market, economic and legal environment;
(c) Increases in market interest rates that are likely to affect the discount rate used in calculating an asset’s value in use; and
(d) The carrying amount of the net assets of an entity is more than its market capitalization.
Internal sources of information
(a) Obsolescence or physical damage of an asset;
(b) Assets likely to become idle or being earmarked for disposal; and
(c) Evidence is available that the economic performance of an asset is, or will be, worse than expected.
SELF ASSESSMENT EXERCISE
What are the internal and external source indications of impairment?
MEASURING RECOVERABLE AMOUNT
IAS 36, defines recoverable amount (RA) as the higher of an asset’s or cash-generating unit’ fair value less costs to sell (FV) and its value in use (VIU).
(a) It is necessary to calculate both FV and VIU. If FV is greater than the carrying amount of the asset, then the asset is not impaired and it is not necessary to calculate the VIU. Similarly, if VIU is greater than the asset’s carrying amount, the asset is not impaired and it is not necessary to calculate the FV.
(b) If FV cannot be estimated, then the RA is equal to VIU.
(c) For an asset held for disposal, RA is equal to FV.
Determining fair value less cost to sell
(a) If there is a binding sale agreement, then the price in that agreement attributable to the disposal of the asset is fair value less cost to sell.
(b) If there is no binding agreement but an asset is traded in active market, use the asset’s market price less cost to disposal.
(c) If there is no binding sale agreement or active market for an asset, use the amount that could be obtained from the disposal of the asset less costs of disposal.
Determining value in use
The following elements should be reflected in the calculation of an asset’s value in use:
(a) An estimate of future cash flows which the entity expects to derive from the asset;
(b) Expectations about possible variations in the amount or timing of those future cash flows;
(c) The time value of money, represented by the current market risk-free rate of interest;
(d) The price for bearing the uncertainty which is in the asset; and
(e) Other factors, such as illiquidity, that market participants would reflect in pricing the future cash flows which the entity expects to derive from the asset.
Recognizing and measuring an impairment loss
(a) If the recoverable amount of an asset is less than its carrying amount, the carrying amount should be reduced to its recoverable amount. That reduction is an impairment loss.
(b) An impairment loss is recognized immediately in profit or loss unless it relates to a re-valued asset where the increase in value was recognized in equity. The impairment loss of such an asset should be treated as a revaluation decrease.
(c) After the recognition of an impairment loss, the depreciation charges of the asset should be adjusted in future periods.
Cash generating units
If there is any indication that an asset may be impaired, recoverable amount shall be estimated for the individual asset. If it is not possible to estimate the recoverable amount of the individual asset, an entity should determine the cash-generating unit to which the asset belongs.
(a) Goodwill should be tested annually for impairment.
(b) To test for impairment, goodwill acquired in a business combination should be allocated to each of the acquirer’s cash-generating units, that is expected to benefit from the synergies of the combination.
(c) If goodwill has been allocated to a cash-generating unit, and the entity disposes of an operation within the unit, the goodwill associated with the operation disposed of shall be included in the carrying amount of the operation and measured on the basis of the relative values of the operations disposed of and the portion of the cash-generating unit retained.
(d) In testing a cash-generating unit for impairment, an entity is required to identify all the corporate assets of the cash-generating unit under review.
Impairment loss for a cash-generating unit
If the recoverable amount of a cash-generating unit is less than the carrying amount of the unit, an entity should recognize an impaired loss. The impairment loss is allocated to reduce the carrying amount of the assets of the unit in the following order:
(a) First, to reduce the carrying amount of any goodwill allocated to the cash-generating unit (group units); and
(b) Second, to the other assets of the unit (group of units) pro rata on the basis of the carrying amount of each asset of the unit (group of units).
These reductions in amounts are treated as impairment losses on the individual assets and recognized immediately in the profit or loss, or equity, if the asset is carried at a re-valued amount.
After an impairment test on 31 December 20X8, Ogene Hostels ltd, concluded that one of its cash- generating unit’s net assets at the date of impairment test was N800m.
Assets and liabilities of the cash-generating unit on 31 December 20X8 comprised:
First, the carrying amount of goodwill is reduced, and the remaining amount of impairment loss 150m (200m less 50m that is, total impairment loss less the carrying amount of goodwill) is allocated to property, plant and motor vehicles on a pro rata basis as required by IAS 36.104.
No impairment loss is attributable to the net monetary assets as they will be realized in full. Monetary items are money held and other items to be received or paid in money.
SELF ASSESSMENT EXERCISE
How do you recognize and measure impairment loss?
REVERSAL OF AN IMPAIRMENT LOSS
- An entity is required by IAS 36, to assess at each balance sheet date, whether there is any indication that an impairment loss recognized in prior periods for an asset may no longer exist or may have decreased. If such indication exists, the entity is required to calculate the recoverable amount of the asset. If the recoverable amount is greater than the impaired value, the impairment loss should be reversed and the reversal should be recognised immediately in the income statement.
- An increased carrying amount due to reversal of an impairment loss, should not exceed what the value would have been if the impairment had not been recognized for the asset in prior years.
- Depreciation charge for the asset should be adjusted in future periods to allocate the asset’s carrying amount less its residual value (if any), on a systematic basis over its remaining useful life.
- Reversal of an impairment loss recognized for goodwill is debarred.
- Reversal of unwinding of discount is also prohibited. (IAS 36.116)
SELF ASSESSMENT EXERCISE
Outline the provision for the reversal of impairment loss.
Disclosure by class of assets and reportable segments
An entity should disclose the following for each class of assets:
(a) Impairment losses recognized in profit or loss; and
(b) Reversal of impairment losses recognized in profit or loss.
Similar disclosures should be made for each reportable segment. (IAS 36.129)
For each material impairment loss, an entity is required to disclose:
The events and circumstances that led to the impairment loss or reversal of the loss;
The amount of the impairment loss;
In the case of individual assets, the nature of loss and the reportable segment involved;
For a cash-generating unit, a description of the unit and the amount of impairment loss recognized or reversed; and
(e) Whether the recoverable amount of the asset is its fair value less costs to sell or its value in use.
Obun Ltd is into Car Hire services. The notes relating to the fixed assets figure in the financial statements for the year ended 31 December 20X6, showed the following:
The cars on hire are being written off at the rate of 20% per annum. However, the car hire market has slumped, and as a result, it will only be able to generate N2.5 million income per annum for the year 20X7 and 20X8 only. Alternatively, the car could be sold immediately (31 December 20X6) for its fair value of N2.8 million, but a selling cost of N180,000, will be incurred. The cost of capital is 15%.
(i) calculate the impairment as at 31 December 20X6.
(ii) prepare a revised note to the fixed assets.
(iii) show the note to the fixed asset for the year ended 31 December 20X7
(iv) assuming the market for car hire services picked up, and the cars now have a recoverable amount of N3.9 million, you are required to draft the note to the accounts for the year ended 31
(ICAN NOV 2006)
(i) Calculation of impairment loss as at 31 December 20X6
IAS 36 requires that in the event of a reversal of an impairment loss, the increased carrying amount of the asset should not exceed the carrying amount that would have been determined (net of depreciation), had no impairment loss been recognized for the asset in prior years. Thus, the reversal has been restricted to such amount that will ensure that the carrying amount of the asset does not exceed the ceiling set by IAS 36.117.
SELF ASSESSMENT EXERCISE
What is an entity expected to disclose for material impairment loss?
Under U.S. GAAP impaired assets must be recognized once there is evidence of a lack of recoverability of the net carrying amount. Once impairment has been recognized it cannot be restored. Analysts must know that some foreign countries and the IASB allow companies to recognize increases in previously impaired assets.
Asset impairment occurs when there are:
- Changes in regulation and business climate
- Declines in usage rate
- Technology changes
- Forecasts of a significant decline in the long-term profitability of the asset
Once a company has determined that an asset is impaired, it can write down the asset or classify it as an asset for sale. Assets will be written down if the company keeps on using this asset. Write-downs are sometimes included as part of a restructuring cost.
It is important to be able to distinguish asset write-downs, which are non-cash expenses, from cash expenses like severance packages.