Impairment of Assets under IAS 36: Which Indicators Trigger an Impairment Test?

What does IAS 36 require at the end of each reporting period?

IAS 36 rests on one principle: an asset must not be carried in the financial statements at more than the amount that can be recovered from it through use or sale. ^[2] To achieve this, the standard requires an entity to assess at the end of each reporting period whether there is any indication that an asset may be impaired; if there is, it must estimate the recoverable amount. ^[1]

Alongside this indicator-driven test, some categories are tested every year whatever the circumstances: goodwill acquired in a business combination, intangible assets with an indefinite useful life, and intangible assets not yet available for use. The test may be performed at any time during the year provided it is done at the same time each year, and an intangible asset first recognised during the year must be tested before the year ends. ^[1]

Watch the scope too. The standard does not apply to inventories, deferred tax assets, assets held for sale under IFRS 5, financial assets within IFRS 9 or investment property measured at fair value, among other exclusions it lists. ^[1]

Which external and internal indicators trigger a test?

Paragraph 12 of the standard sets out indicators that an entity must consider as a minimum; it is not an exhaustive list. ^[1]

External indicators include a market value decline significantly greater than expected from the passage of time or normal use; significant adverse changes in the technological, market, economic or legal environment; increases in market interest rates that are likely to reduce recoverable amount materially; and the carrying amount of the entity’s net assets exceeding its market capitalisation. ^[1]

Internal indicators include obsolescence or physical damage, and significant adverse changes in how the asset is used, such as the asset becoming idle, plans to discontinue or restructure the operation, plans to dispose of the asset early, or reassessing an intangible asset’s useful life from indefinite to finite. Internal reports showing economic performance worse than expected are also an indicator. ^[1]

An investor in a subsidiary, joint venture or associate has one further indicator: it recognises a dividend from the investment and there is evidence that the dividend exceeds the investee’s total comprehensive income for the period in which it is declared, or that the carrying amount of the investment in the separate financial statements exceeds the investee’s net assets, including associated goodwill, in the consolidated financial statements. ^[1]

Does every indicator mean a full test?

Materiality applies when deciding whether recoverable amount needs to be estimated, except for the assets the standard requires to be tested annually. If earlier calculations showed recoverable amount comfortably above carrying amount, and nothing has happened to eliminate that headroom, re-estimation may not be needed. ^[1]

An indicator still has consequences even when no loss results. The standard notes that it may mean the remaining useful life, depreciation method or residual value of the asset needs to be reviewed under the standard that applies to it. ^[1] So record in the closing file what you identified, how you assessed it and why you did or did not test.

At what level is the test performed: the asset or the cash-generating unit?

An asset that does not generate cash inflows largely independent of other assets is tested within the cash-generating unit to which it belongs. A cash-generating unit is the smallest identifiable group of assets that generates cash inflows largely independent of those from other assets. ^[1]

The exceptions are where the asset’s own fair value less costs of disposal exceeds its carrying amount, or where its value in use is close to its fair value less costs of disposal and the latter can be measured. ^[1] Goodwill generates no cash flows on its own, so it is assessed with the cash-generating units to which it has been allocated. ^{[1, 2]}

How is recoverable amount calculated?

Recoverable amount is the higher of fair value less costs of disposal and value in use. If either exceeds the carrying amount, there is no impairment and the other need not be calculated. ^[1]

Under IFRS 13, fair value is an exit price: the amount that would be received to sell the asset in an orderly transaction between market participants at the measurement date, using their assumptions rather than the entity’s. ^[3]

Value in use is the present value of the cash flows expected from the asset, and several rules govern it: ^[1]

• It rests on reasonable and supportable assumptions, giving greater weight to external evidence.
• It uses the most recent budgets or forecasts approved by management, generally covering no more than 5 years unless a longer period is justified.
• It is estimated for the asset in its current condition, excluding restructurings the entity is not yet committed to and enhancements to the asset’s performance.
• It is discounted at a pre-tax rate reflecting the time value of money and asset-specific risks not already reflected in the cash flows.

Hypothetical example: production equipment with falling utilisation

Hypothetical example: a manufacturer holds equipment measured under the cost model, with a carrying amount of AED 500,000 and a remaining useful life of 5 years with no residual value. During the year, the production line it serves is partly shut down after a major customer is lost; this adverse change in use is an internal indicator.

The team estimates value in use at AED 430,000 and fair value less costs of disposal at AED 450,000, based on offers for similar equipment. Recoverable amount is the higher figure, AED 450,000, so the impairment loss is AED 50,000, recognised in profit or loss because the asset is not revalued. ^[1]

Future depreciation is then adjusted to spread the new carrying amount over the remaining life: 450,000 ÷ 5 = AED 90,000 a year instead of 100,000. ^[1] The example assumes the equipment generates independent cash flows so it can be tested on its own; otherwise it would be tested within its cash-generating unit.

What happens after the loss is recognised?

The carrying amount is reduced to recoverable amount and the loss is recognised immediately in profit or loss. If the asset is carried at a revalued amount under another standard, the loss is treated as a revaluation decrease in other comprehensive income, up to the surplus available for that asset. ^[1]

In a cash-generating unit, the loss is allocated first to the goodwill allocated to the unit and then to its other assets pro rata to their carrying amounts. In later periods, a loss on assets other than goodwill can be reversed if circumstances improve, but the carrying amount cannot exceed what it would have been without the loss; a goodwill impairment loss is not reversed. ^{[1, 2]}

How do you apply it in practice in the Gulf?

In Saudi Arabia, the Saudi Organization for Chartered and Professional Accountants (SOCPA) requires publicly accountable entities to apply IFRS Accounting Standards as endorsed in the Kingdom, with additional disclosures that SOCPA adds; SMEs apply the IFRS for SMEs Accounting Standard as endorsed in the Kingdom unless they choose full IFRS Accounting Standards. ^[4] Elsewhere in the GCC, check the framework set by the regulator responsible for your sector before assuming that one country’s position applies in another.

Whatever the country, an impairment file satisfies the external auditor when it contains:

• An indicator log reviewed at every close, with the date each indicator appeared and the source of the evidence.
• A clear map of cash-generating units and the allocation of goodwill to them.
• The source of every assumption in the value-in-use model and the name of the person who approved it.
• A comparison of assumptions against prior-period actuals, rather than rolling them forward unchanged after the market has moved.

Conclusion

An impairment test starts with monthly or quarterly discipline in spotting indicators, not with the valuation model. Set the right level of testing, compare the carrying amount with the higher of the two values and document the source of every assumption; that is what keeps the statements from overstating assets and makes the entry defensible.