IAS 36 Impairment of Assets
The conceptual framework does not allow an asset to sit in the statement of financial position at more than it is worth to the business. IAS 36 Impairment of Assets is how that principle is enforced: when something goes wrong — the market turns, a machine is damaged, a product line stops selling — the asset is written down to what the entity can actually recover from it.
The standard works in three steps, and questions are set on all three:
Identify whether there is any indication of impairment, from external or internal sources
If there is, perform an impairment review — compare the carrying value with the recoverable amount
Record any impairment loss
This recording predates the 2027 syllabus. It is sound on the indicators, the impairment review and the machine example; carry three things with you.
Annual review: the yearly test that needs no indicator applies to goodwill and to intangible assets with an indefinite useful life (see the aside under “Indicators of impairment”).
Cash-generating units: allocating a unit’s impairment across its assets, goodwill first, is F2 group-accounts material; at F1 you need only the idea of a cash-generating unit and why it is used (see “When an asset cannot be tested on its own”), so treat that worked example as background.
IFRS 18: the recording does not cover where the loss lands in the 2027 statement of profit or loss — see “Where the impairment appears in the financial statements”.
1 Indicators of impairment
An entity assesses at each reporting date whether there is any indication that an asset may be impaired. Only if there is does a review follow — you do not value every asset every year.
1.1 External sources
A significant decline in the asset's market value, greater than would be expected from normal use or the passage of time
A significant adverse change in the technological, market, economic or legal environment in which the entity operates
An increase in market interest rates, which reduces the present value of the asset's future cash flows
The carrying value of the entity's net assets exceeding its market capitalisation
1.2 Internal sources
Obsolescence or physical damage
Significant changes, in the period or expected soon, in how the asset is used — it becomes idle, or there are plans to dispose of it early or to discontinue or restructure the operation it belongs to
Evidence that the asset's economic performance will be worse than expected
Operating losses or net cash outflows attributable to the asset
Loss of a key employee on whom the asset's earning power depends
There is one exception to "only test when there is an indicator". Goodwill and intangible assets with an indefinite useful life must be reviewed for impairment every year whether or not anything looks wrong, because there is no depreciation charge steadily writing them down. Neither arises in F1's own financial statements — goodwill belongs to group accounts in F2 — so you need the point for awareness only.
2 The impairment review
The review compares two numbers:
Recoverable amount
The higher of an asset's fair value less costs to sell and its value in use.
Fair value less costs to sell is the amount receivable from selling the asset, less the costs of disposal. Value in use is the present value of the future cash flows the asset will generate if the entity keeps using it.
If the carrying value is greater than the recoverable amount, the asset is impaired and is written down to the recoverable amount. If it is not, there is no impairment and nothing is recorded.
Recoverable amount is the higher of the two, not the lower — and the logic is worth holding on to, because it stops you guessing. The entity has two ways of getting value out of the asset: sell it, or keep using it. A rational business takes whichever is worth more, so that is the amount it can recover. Writing an asset down to the lower of the two would assume the business deliberately chooses the worse outcome.
Then a second comparison: the asset is impaired only if the carrying value exceeds that recoverable amount. Two comparisons, in that order — that is the whole mechanism.
Impairment
A machine was acquired on 1 January 20X5 at a cost of $50,000 and has a useful economic life of ten years.
At 31 December 20X9 an impairment review was performed. The fair value of the machine is $26,000 and the selling costs are $2,000.
The expected future cash flows are $5,000 per annum for the next five years. The current cost of capital is 10%; the annuity factor for this rate over this period is 3.791.
Prepare extracts from the financial statements for the year ended 31 December 20X9.
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3 Recording the impairment
An impairment loss on an asset carried at cost is charged to profit or loss, in the operating category, exactly like depreciation.
If the asset has been revalued, the loss is treated as a reversal of that revaluation: it is charged first against any revaluation surplus still held for that same asset, through other comprehensive income, and only the excess goes to profit or loss. This is the same rule as a downward revaluation in Chapter 6, because that is exactly what it is.
Once the impairment has been recorded, the written-down amount becomes the new carrying value and is depreciated over the remaining useful life. The depreciation charge therefore falls in later years — an impairment does not just hit one year's profit.
3.1 Reversing an impairment
If the conditions that caused an impairment reverse in a later period, the loss is reversed. Two limits apply: the asset may not be written back above the carrying value it would have had if the impairment had never been recognised (so the depreciation that would have been charged still comes off), and an impairment of goodwill is never reversed.
4 When an asset cannot be tested on its own
Value in use is the present value of the cash flows from an asset — which assumes the asset generates identifiable cash flows. Many do not. A restaurant's tables, oven, crockery and cutlery earn nothing individually; the restaurant earns, and the assets earn together.
Cash-generating unit
The smallest identifiable group of assets that generates cash inflows largely independently of the cash inflows from other assets.
Where an individual asset does not generate independent cash flows, the impairment review is performed on its cash-generating unit instead: the unit's combined carrying value is compared with the unit's recoverable amount, and any impairment is then allocated across the assets in the unit. The mechanics of that allocation — which assets absorb the loss and in what order, and the special treatment of goodwill — belong with group accounts and are developed in F2. At F1 you need the idea and the reason for it.
5 Where the impairment appears in the financial statements
An impairment loss on an asset used in the business is an expense of the main business activities, so it sits in the operating category — above operating profit, the first of the two subtotals IFRS 18 requires (Chapter 5)
Where the asset had been revalued, the part of the loss taken against that asset's revaluation surplus is other comprehensive income, and only the excess reaches profit or loss
The written-down carrying value is what appears in the statement of financial position, and the impairment loss for the year is shown in the class-by-class reconciliation of carrying amounts required by IAS 16 (Chapter 6)
An entity also discloses, for each material impairment, the amount of the loss, the events and circumstances that led to it, and whether the recoverable amount is fair value less costs to sell or value in use.
6 Test your knowledge
Two quick checks before you move on: work through the flashcards to fix this chapter’s terms and definitions, then sit the objective questions for exam-style practice. Both mark themselves and explain the answers as you go.
IAS 36 Impairment of Assets
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