IAS 36 Impairment of Assets

This briefing document summarizes the main themes and important ideas from the provided sources related to IAS 36, Impairment of Assets. The sources cover various aspects of the standard, including its scope, the process of impairment testing, the determination of recoverable amount, the concept of cash-generating units (CGUs), and practical considerations in applying the standard.

1. Core Principle and Objective of IAS 36:

The fundamental principle of IAS 36 is that assets should not be carried at more than their recoverable amount. The objective of the standard is to prescribe the procedures that an entity applies to ensure that its assets are carried at no more than their recoverable amount, and to specify when an entity should recognize an impairment loss and how it should reverse an impairment loss. (Module 27)

2. Scope of IAS 36:

IAS 36 applies to a wide range of assets, including property, plant, and equipment (PP&E), intangible assets (excluding those covered by other standards), and goodwill. However, certain assets are outside the scope of IAS 36, as they are covered by other specific accounting standards. These include:

• Deferred tax assets (IND AS 12)
• Assets arising from employee benefits (IND AS 19)
• Financial assets within the scope of IND AS 39/IFRS 9
• Biological assets (IND AS 41)
• Deferred acquisition costs and intangible assets from insurance contracts (IND AS 104/IFRS 17)
• Non-current assets (or disposal groups) classified as held for sale

The reasons for these exclusions often relate to the fact that other standards provide specific guidance or that these assets are considered too technical in nature for the general impairment model. (IND AS 36)

3. The Impairment Review Process:

The impairment review process generally involves the following steps:

• Step 1: Identify Assets within the Scope of IAS 36.
• Step 2: Determine the Structure of the Impairment Review (Scope and Structure). This involves determining the level at which assets are reviewed for impairment, which can be an individual asset or a cash-generating unit (CGU).
• Step 3: Determine if and when to Test for Impairment. Impairment testing is required when there are indicators of impairment or annually for certain intangible assets (like goodwill and indefinite-lived intangible assets).
• Step 4: Estimate the Recoverable Amount. This is the higher of an asset’s (or CGU’s) fair value less costs of disposal and its value in use.
• Step 5: Compare Recoverable Amount with Carrying Amount. An impairment loss is recognized if the carrying amount exceeds the recoverable amount.
• Step 6: Recognize or Reverse any Impairment Loss. The impairment loss is recognized in profit or loss (unless the asset is carried at a revalued amount). Impairment losses can be reversed if the reasons for the impairment no longer exist (except for goodwill).

4. When to Test for Impairment (Step 3):

Impairment testing is triggered by:

• Indicator-based impairment testing: This occurs when there are internal or external indicators that an asset may be impaired. Internal indicators include evidence of obsolescence, physical damage, discontinuance/disposal/restructuring plans, and declining asset performance. External indicators can include significant adverse changes in the market, economic, or legal environment.
• Annual impairment testing: This is required annually for:
• Goodwill acquired in a business combination.
• Intangible assets with an indefinite useful life.
• Intangible assets not yet available for use.

5. Estimating the Recoverable Amount (Step 4):

The recoverable amount is the higher of:

• Fair value less costs of disposal: This is the price that would be received to sell an asset in an orderly transaction between market participants less the costs of disposal. 
• Value in use: This is the present value of the future cash flows expected to be derived from continuing to use the asset and from its ultimate disposal.

Estimating value in use involves:

• Projecting future cash inflows and outflows derived from the asset.
• Applying an appropriate discount rate to these future cash flows. The discount rate should be a pre-tax rate that reflects current market assessments of the time value of money and the risks specific to the asset for which the future cash flow estimates have not been adjusted.

Quote: “Estimating VIU involves the following: * estimating the future cash inflows and outflows to be derived from continuing to use the asset and from its ultimate disposal (IAS 36.31(a)) * applying the appropriate discount rate to those future cash flows (IAS 36.31(b)).”

6. Cash-Generating Units (CGUs):

A CGU is defined as: “…the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets.” 

• The identification of a CGU involves judgment and is specific to the entity’s operations.
• Examples of CGUs can include an entire entity, departments or business units, or even a single mine if its cash inflows are largely independent.
• If the recoverable amount of an individual asset cannot be determined, the impairment test is performed for the CGU to which the asset belongs.

Quote: “If recoverable amount cannot be determined for an individual asset, an entity identifies the lowest aggregation of assets that generate largely independent cash inflows.”

7. Allocation of Impairment Losses:

• For an individual asset, the impairment loss is recognized in profit or loss (unless the asset was previously revalued, in which case it is treated as a revaluation decrease).
• For a CGU, an impairment loss is allocated to reduce the carrying amount of the assets of the unit in the following order:

1. First, to reduce the carrying amount of any goodwill allocated to the CGU.
2. Then, to the other assets of the CGU pro rata based on the carrying amount of each asset in the CGU.

• The carrying amount of an asset should not be reduced below the highest of its fair value less costs of disposal, its value in use, and zero. (IAS 36.105)

8. Discount Rate Determination:

• The discount rate should reflect the time value of money and the risks specific to the asset or CGU.
• Often, entities estimate a risk-adjusted discount rate starting with the entity’s weighted average cost of capital (WACC) and then adjusting it to reflect the specific risks of the asset or CGU and a market participant perspective.
• The Capital Asset Pricing Model (CAPM) is frequently used to determine the cost of equity, a component of WACC.
• The discount rate should be pre-tax.

Quote: “In our experience, entities most often estimate a risk-adjusted discount rate starting with the entity’s WACC. The WACC is a post-tax measure of the overall required return on the entity as a whole – essentially the rate that an entity is expected to pay on average to all its capital providers to finance its assets.”

9. Reversal of Impairment Losses:

• Impairment losses (other than those for goodwill) are reversed if there has been a change in the estimates used to determine the asset’s recoverable amount since the last impairment loss was recognized. (IAS 36.110)
• The reversal of an impairment loss is recognized immediately in profit or loss, unless the asset is carried at a revalued amount.
• The increased carrying amount of an asset due to a reversal of an impairment loss shall not exceed the carrying amount that would have been determined (net of amortization or depreciation) had no impairment loss been recognized for the asset in prior years. (IAS 36.119)

Quote: “Individual asset – recognise in profit and loss unless asset carried at revalued amount.”

10. Practical Considerations and Challenges:

• Determining CGUs: This often requires significant judgment, especially in complex organizations with shared infrastructure or interdependent cash flows.
• Estimating Future Cash Flows: This involves making assumptions about future market conditions, technological developments, and the entity’s strategic plans, which can be inherently uncertain.
• Selecting the Discount Rate: Choosing a discount rate that accurately reflects the risks associated with the asset or CGU can be challenging, particularly when market-specific data is limited.
• Impairment Testing of Specific Assets:Limestone Mines: Challenges in valuation include the lack of an active trading market and the heterogeneous nature of mines, often necessitating the use of the income approach (value in use). (IND AS 36)
• Telecom Licenses: Impairment testing often involves market approaches (comparable auctions) or income approaches (greenfield). Licenses typically do not generate independent cash flows and should be assessed together with related network assets. 
• Right-of-Use Assets: Determining the fair value less costs of disposal can be complex, especially when these assets do not generate independent cash inflows. 

11. Disclosure Requirements:

IAS 36 requires entities to disclose information about impairment losses recognized or reversed during the period, the recoverable amount and how it was determined, and key assumptions used.

Quote: “IAS 36.134(d)(iii)” (14.-ias-36 – presentation-and-disclosure – indicating disclosure requirements)

12. Industry and Country Variations:

A survey indicated variations in impairment frequency and intensity across different countries and asset types (PP&E, Intangible Assets, Goodwill). This suggests that economic conditions, industry-specific factors, and accounting practices can influence the prevalence and magnitude of impairment losses. The survey also looked at IFRS compliance in impairment reporting across countries and industries, highlighting areas where sensitivity to methods, assumptions, and estimates is important.

This briefing provides a comprehensive overview of the key aspects of IAS 36 based on the provided sources. Applying IAS 36 effectively requires a thorough understanding of the principles, careful judgment in making estimates and assumptions, and attention to the specific facts and circumstances of each asset or Cash Generating Unit.