Chapter 15

Impairment of Assets

Objectives

1. Understand the purpose of the impairment test for assets

2. Understand when to undertake an impairment test

3. Explain how to undertake an impairment test for an individual asset

4. Impairment losses for cash generating units5. Impairment of goodwill6. Account for reversals of impairment losses7. Outline the disclosures required by IFRS 3

Introduction to IAS 36

Entities are required to conduct impairment tests to ensure their assets are not overstated

Impairment results when an asset’s carrying amount (CA) is more than its recoverable amount (RA)

Not all assets require this test. Notable exclusions include:

InventoriesDeferred tax assetsAssets held for resale

When to Undertake an Impairment Test

Assets must be tested for impairment when there is an indication (or evidence) of impairment Not necessarily annually

The following assets must be tested annually for impairment: Intangibles with indefinite useful lives Intangibles not yet available for use Goodwill acquired in a business combination

Collecting Evidence of Impairment

IAS 36 provides internal and external minimum indicators of impairment External sources

Decline in market value Adverse changes in entity’s environment/ market Increases in interest rates Market capitalization

Internal sourcesObsolescence or physical damageChange in asset useAn asset’s economic performance being worse than expected

Impairment Test for an Individual Asset

Fair Value Less Costs to Sell

Defined as

Two parts to the definition: Fair value Costs of disposal

Fair Value Less Costs to Sell

Fair value is determined using the following ‘value hierarchy’

Price in a binding sale agreement Market price Appropriate estimation

Costs of disposal include: legal fees stamp duty costs of removing the asset

Finance costs and income tax are not considered to be costs of disposal

Value in Use

Defined as

Five elements when calculating value in use1. Estimate of future cash flows 2. Expectations about possible variations in amount or

timing of future cash flows3. Time value of money4. Price for bearing uncertainty inherent in asset5. Other factors such as illiquidity

“ … the present value of future cash flows expected to be derived from an asset or cash-generating unit”

Determining Future Cash Flows

Objective overall is to: Estimate future cash flows Apply a discount rate

Projections should be based on: Managements best estimates External evidence Budgets/forecasts covering a minimum 5 year period

Cash inflows & outflows should include: Those from the continuing use of the asset Those expected on the disposal of the asset

Determining the Discount Rate

The discount rate should reflect: The time value of money The risks specific to the asset for which future

cash flows have not been adjusted

Discount rates are commonly based on: The entity’s weighted average cost of capital The entity’s incremental borrowing rate Other market borrowing rates

The rate must reflect specific risks relating to: Country risk Currency risk Price risk

Recognition & Measurement of an Impairment Loss for an

Individual Asset

An impairment loss is recognized where carrying amount > recoverable amount

Where the asset is accounted for under the cost model, the impairment loss is recognized immediately in profit or loss

Where the asset is accounted for under the revaluation model, the impairment loss is treated as a revaluation decrease

Any subsequent depreciation/amortization is based on the new recoverable amount.

Comparison to US GAAP

US GAAP ASC 360-10-35-21 requires a

review for impairment indicators in PP&E “whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.”

A recoverability test is required:

If the carrying amount of the asset exceeds the sum of the expected net future undiscounted cash flows, then the asset is not recoverable and an impairment loss must be calculated.

IFRS► IAS 36 requires an entity to assess

annually whether there are any indicators of impairment.

► There is no recoverability test, simply calculate an impairment loss if impairment indicators are present.

ExamplesExample 1:On January 1, 2009, a company acquired a piece of equipment for $100,000. It was decided that the equipment would be depreciated over ten years with zero salvage value. At December 31, 2012, the equipment has significantly decreased in value due to technological innovations in the industry in which the company operates. The current carrying value of the equipment is $60,000 ($100,000 cost less $40,000 of accumulated depreciation). The expected future undiscounted cash flows from the use of this equipment are $61,000. The discounted net present value of expected cash flows from this piece of equipment is $51,000. Additionally, the fair value of the piece of equipment is $50,000 and the selling costs are minimal.

– Is the equipment impaired under either US GAAP or IFRS?

Examples

Example 1 solution:

Using US GAAP, the carrying value of the equipment of $60,000 is less than the expected future undiscounted cash flows of $61,000, so the equipment is not impaired.

Using IFRS, the equipment is impaired because the carrying value of $60,000 is greater than the recoverable amount of $51,000.

Examples

Example 2:Use the same facts as the previous example, except the expected future undiscounted cash flows from the use of this equipment are $59,000.

– What, if any, impairment loss should be recorded using US GAAP and IFRS?

– Show any required journal entries.

Examples

Example 2 solution:Using US GAAP, the piece of equipment now fails the recoverability test. The $60,000 carrying value of the equipment exceeds the sum of the expected net future undiscounted cash flows of $59,000. Therefore, an impairment loss must be calculated. The impairment loss is the difference between the carrying value of $60,000 and the fair value of $50,000. A $10,000 impairment loss would be recorded as follows:

Impairment loss $ 10,000Equipment $ 10,000

Using IFRS, there are impairment indicators so an impairment loss must be calculated. Using IAS 36, the recoverable amount is $51,000 (the higher of the net fair value of $50,000 or the discounted net present value of the cash flows of $51,000). Therefore, a $9,000 impairment loss needs to be recorded as follows:

Impairment loss $ 9,000Equipment $ 9,000

Cash-Generating Units

Where the fair value less costs to sell (FVLCTS) < CA it is necessary to calculate the value in use (VIU) of an asset to determine whether or not it has been impaired

It may not be possible to identify an individual assets VIU when the asset only has a value due to its relationship with other assets

In such cases the VIU of the asset must be determined in the context of the asset’s cash-generating unit (CGU)

Defined as the smallest identifiable group of assets (generating cash flows from continuing use) that are independent of the cash inflows from other assets or groups of assets

Identifying Cash Generating Units

Identification of CGUs requires consideration of: How management monitors the entity’s operations; How management makes decisions about continuing or

disposing of the entity’s assets and operations

If an active market exists for the output of a group of assets, this group of assets is classified as a CGU

CGUs must be identified consistently from period to period

IAS 36 allows a segment to be used as a CGU where the segment equates to the smallest group of assets generating independent cash flows

Impairment Losses and CGUs –

Excluding Goodwill Where an impairment loss arises in a CGU with no

goodwill the loss is allocated across all of the assets in the CGU on a pro-rata basis based on the CA of each asset relative to the total CA amount of the CGU

Losses are accounted for in the same way as for individual assets

The CA of an individual asset cannot be reduced below the highest of: FVLCTS (if determinable); VIU (if determinable); or Zero

Corporate assets – should try to allocate these across CGUs on a reasonable and consistent basis if possible

Cash Generating Units &Goodwill

Where a CGU includes goodwill, IAS 36 contains specific requirements for accounting for the allocation of impairment losses arising in relation to the CGU

Goodwill is a residual balance, consisting of assets that cannot be individually identified or separately recognized

Therefore it is not possible to determine a FVLCTS for goodwill, or to identify cash flows relating specifically to goodwill

Rather, goodwill can only be tested for impairment at the CGU level

Cash Generating Units &Goodwill

IAS 36 requires that goodwill be allocated to the lowest level at which management monitors the goodwill

Where an impairment loss arises in a CGU with goodwill the following allocation rules apply: To reduce the carrying amount of the CGU’s goodwill to

zero To the other assets of the CGU on a pro rata basis

Reversal of an Impairment Loss

Recognized losses are reassessed annually

Indicators for reversals of impairment losses are the same as those used for initially recognizing a loss

Ability to recognize a reversal of an impairment loss and the accounting for that reversal is dependent on whether the reversal relates to an individual asset, a CGU, or goodwill

Previously recognized impairment losses in relation to individual assets are able to be reversed

The new CA cannot be higher than the CA that would have been determined had no impairment loss been previously recognized

Reversal of an Impairment Loss – Cash Generating Unit

Impairment losses relating to goodwill cannot be reversed

The reversal of any impairment loss relating to a CGU is allocated across the assets of the CGU (excluding goodwill) on a pro-rata basis

The reversals for specific assets will be accounted for in the same way as for individual assets

Example 3:Use the same facts as Examples 1 and 2, except in 2014 it is discovered that the technological innovations related to this piece of equipment are not effective. As a result, the fair value of this piece of equipment is now $41,000. The discounted net present value of expected cash flows from this piece of equipment is also $41,000.

– Using IFRS, what amount of the original impairment loss of

$9,000 can be reversed?

– Show any required journal entries to reverse the impairment loss.

Examples

Example 3 solution: The impairment loss can be reversed up to the newly calculated recoverable amount of 41,000, but it cannot exceed what the original carrying amount, net of depreciation, would have been.

ImpairedNot impaired

Net asset value 2012 $ 60,000 $ 60,000Impairment 2012 (9,000)

51,000Depreciation 2013 $51,000/(6) (8,500)(10,000)Depreciation 2014 $51,000/(6) (8,500)(10,000)

34,000 $ 40,000Reversal of impairment loss 6,000

$ 40,000

Equipment $ 6,000Impairment loss $ 6,000

Examples

Examples

Example 4 - Intangibles:

The Corporate Protection Company (CPC) has a patent on new fingerprint security technology.

The fair value of the patent is $18 million, excluding selling costs of$3 million. The present value of future cash flows is $16 million. The sum of the undiscounted future cash flows is $19 million. CPC currently carries the patent at a value of $20 million.

What journal entries would CPC prepare to record an impairment of the patent using both US GAAP and IFRS?

Examples

Example 4 solution:

US GAAP

Recoverability test: is the carrying value greater than the sum of the future undiscounted cash flows?

Yes, since $20 million is greater than $19 million.

Calculation of the impairment: Carrying value - fair value = $20 million - $18 million

Journal entry to record the impairment:Impairment loss $2 million

Patent $2 million

Examples

Example 4 solution (continued):IFRSTest for impairment: does the carrying amount exceed the

recoverable amount? Yes, the carrying amount of $20 million is higher than the

recoverable amount of $16 million. The recoverable amount is calculated as the higher of the fair value less the selling costs ($18 million - $3 million = $15 million), and the value in use (present value of future cash flows = $16 million)

Calculation of the impairment (note that the determination and calculation of impairment are the same step):

Carrying value - recoverable amount = $20 million - $16 million = $4 million

Journal entry to record the impairment:Impairment loss $4 million

Patent $4 million

Disclosures

Key disclosures include:

The amount of impairment losses recognized in profit or loss during the period and line on income statement

The amount of reversals of impairment losses recognized in profit or loss during the period and line on income statement

The amount of impairment losses on revalued assets recognized directly in equity during the period

The amount of reversals of impairment losses on revalued assets recognized directly in equity during the period

Homework

Exercises 15.4, 15.5 and 15.16DUE THURSDAY, OCTOBER 2