Impairment of Assets LU 3

LEARNING UNIT
3
Impairment of Assets
IAS 36
Overview

IAS 36 Impairment of Assets seeks to ensure that an entity's assets are not carried at more than their
recoverable amount (i.e. the higher of fair value less costs to sell and value in use). With the exception of
goodwill and certain intangible assets for which an annual impairment test is required, entities are required
to conduct impairment tests where there is an indication of impairment of an asset, and the test may be
conducted for a 'cash-generating unit' where an asset does not generate cash inflows that are largely
independent of those from other assets.

IAS 36 was reissued in March 2004 and applies to annual periods beginning on or after 1 January 2005.

Summary of IAS 36

Objective of IAS 36

To ensure that assets are carried at no more than their recoverable amount, and to define how recoverable
amount is determined.

Scope

IAS 36 applies to all assets except: [IAS 36.2]

Therefore, IAS 36 applies to (among other assets):

• land
• buildings
• machinery and equipment
• investment property carried at cost
• intangible assets
• goodwill
• investments in subsidiaries, associates, and joint ventures carried at cost
• assets carried at revalued amounts under IAS 16 and IAS 38

Key definitions [IAS 36.6]

Impairment: an asset is impaired when its carrying amount exceeds its recoverable amount
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Carrying amount: the amount at which an asset is recognised in the balance sheet after deducting
accumulated depreciation and accumulated impairment losses

Recoverable amount: the higher of an asset's fair value less costs to sell (sometimes called net selling price)
and its value in use

Fair value: the amount obtainable from the sale of an asset in an arm's length transaction between
knowledgeable, willing parties

Value in use: the discounted present value of the future cash flows expected to arise from:

• the continuing use of an asset, and from

• its disposal at the end of its useful life

Identifying an asset that may be impaired

At each balance sheet date, review all assets to look for any indication that an asset may be impaired (its
carrying amount may be in excess of the greater of its net selling price and its value in use). IAS 36 has a list
of external and internal indicators of impairment. If there is an indication that an asset may be impaired,
then you must calculate the asset's recoverable amount. [IAS 36.9]

The recoverable amounts of the following types of intangible assets should be measured annually whether
or not there is any indication that it may be impaired. In some cases, the most recent detailed calculation
of recoverable amount made in a preceding period may be used in the impairment test for that asset in the
current period: [IAS 36.10]

• an intangible asset with an indefinite useful life

• an intangible asset not yet available for use
• goodwill acquired in a business combination

Indications of impairment [IAS 36.12]

External sources:

• market value declines

• negative changes in technology, markets, economy, or laws
• increases in market interest rates
• company stock price is below book value

Internal sources:

• obsolescence or physical damage

• asset is part of a restructuring or held for disposal
• worse economic performance than expected

These lists are not intended to be exhaustive. [IAS 36.13] Further, an indication that an asset may be
impaired may indicate that the asset's useful life, depreciation method, or residual value may need to be
reviewed and adjusted. [IAS 36.17]

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Determining recoverable amount

• If fair value less costs to sell or value in use is more than carrying amount, it is not necessary to
calculate the other amount. The asset is not impaired. [IAS 36.19]
• If fair value less costs to sell cannot be determined, then recoverable amount is value in use. [IAS
36.20]
• For assets to be disposed of, recoverable amount is fair value less costs to sell. [IAS 36.21]

Fair value less costs to sell

• If there is a binding sale agreement, use the price under that agreement less costs of disposal. [IAS
36.25]
• If there is an active market for that type of asset, use market price less costs of disposal. Market
price means current bid price if available, otherwise the price in the most recent transaction. [IAS
36.26]
• If there is no active market, use the best estimate of the asset's selling price less costs of disposal.
[IAS 36.27]
• Costs of disposal are the direct added costs only (not existing costs or overhead). [IAS 36.28]

Value in use

The calculation of value in use should reflect the following elements: [IAS 36.30]

• an estimate of the future cash flows the entity expects to derive from the asset
• expectations about possible variations in the amount or timing of those future cash flows
• the time value of money, represented by the current market risk-free rate of interest
• the price for bearing the uncertainty inherent in the asset
• other factors, such as illiquidity, that market participants would reflect in pricing the future cash
flows the entity expects to derive from the asset

Cash flow projections should be based on reasonable and supportable assumptions, the most recent
budgets and forecasts, and extrapolation for periods beyond budgeted projections. [IAS 36.33] IAS 36
presumes that budgets and forecasts should not go beyond five years; for periods after five years,
extrapolate from the earlier budgets. [IAS 36.35] Management should assess the reasonableness of its
assumptions by examining the causes of differences between past cash flow projections and actual cash
flows. [IAS 36.34]

Cash flow projections should relate to the asset in its current condition – future restructurings to which the
entity is not committed and expenditures to improve or enhance the asset's performance should not be
anticipated. [IAS 36.44]

Estimates of future cash flows should not include cash inflows or outflows from financing activities, or
income tax receipts or payments. [IAS 36.50]

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Discount rate

In measuring value in use, the discount rate used should be the pre-tax rate that reflects current market
assessments of the time value of money and the risks specific to the asset. [IAS 36.55]

The discount rate should not reflect risks for which future cash flows have been adjusted and should equal
the rate of return that investors would require if they were to choose an investment that would generate
cash flows equivalent to those expected from the asset. [IAS 36.56]

For impairment of an individual asset or portfolio of assets, the discount rate is the rate the entity would
pay in a current market transaction to borrow money to buy that specific asset or portfolio.

If a market-determined asset-specific rate is not available, a surrogate must be used that reflects the time
value of money over the asset's life as well as country risk, currency risk, price risk, and cash flow risk. The
following would normally be considered: [IAS 36.57]

• the entity's own weighted average cost of capital;

• the entity's incremental borrowing rate; and
• other market borrowing rates.

Recognition of an impairment loss

• An impairment loss should be recognised whenever recoverable amount is below carrying amount.
[IAS 36.59]
• The impairment loss is an expense in the income statement (unless it relates to a revalued asset
where the value changes are recognised directly in equity). [IAS 36.60]
• Adjust depreciation for future periods. [IAS 36.63]

Cash-generating units

Recoverable amount should be determined for the individual asset, if possible. [IAS 36.66]. If it is not
possible to determine the recoverable amount (fair value less cost to sell and value in use) for the individual
asset, then determine recoverable amount for the asset's cash-generating unit (CGU). [IAS 36.66] The CGU
is 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. [IAS 36.6]

Impairment of goodwill

Goodwill should be tested for impairment annually. [IAS 36.96]

To test for impairment, goodwill must be allocated to each of the acquirer's cash-generating units, or groups
of cash-generating units, that are expected to benefit from the synergies of the combination, irrespective
of whether other assets or liabilities of the acquiree are assigned to those units or groups of units. Each unit
or group of units to which the goodwill is so allocated shall: [IAS 36.80]

• represent the lowest level within the entity at which the goodwill is monitored for internal
management purposes; and
• not be larger than an operating segment determined in accordance with IFRS 8 Operating
Segments.

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A cash-generating unit to which goodwill has been allocated shall be tested for impairment at least annually
by comparing the carrying amount of the unit, including the goodwill, with the recoverable amount of the
unit: [IAS 36.90]

• If the recoverable amount of the unit exceeds the carrying amount of the unit, the unit and the
goodwill allocated to that unit is not impaired.
• If the carrying amount of the unit exceeds the recoverable amount of the unit, the entity must
recognise an impairment loss.

The impairment loss is allocated to reduce the carrying amount of the assets of the unit (group of units) in
the following order: [IAS 36.104]

• first, reduce the carrying amount of any goodwill allocated to the cash-generating unit (group of
units); and
• then, reduce the carrying amounts of the other assets of the unit (group of units) pro rata on the
basis.

The carrying amount of an asset should not be reduced below the highest of: [IAS 36.105]

• its fair value less costs to sell (if determinable),

• its value in use (if determinable), and
• zero.

If the preceding rule is applied, further allocation of the impairment loss is made pro rata to the other assets
of the unit (group of units).

Reversal of an impairment loss

• Same approach as for the identification of impaired assets: assess at each balance sheet date
whether there is an indication that an impairment loss may have decreased. If so, calculate
recoverable amount. [IAS 36.110]
• No reversal for unwinding of discount. [IAS 36.116]
• The increased carrying amount due to reversal should not be more than what the depreciated
historical cost would have been if the impairment had not been recognised. [IAS 36.117]
• Reversal of an impairment loss is recognised as income in the income statement. [IAS 36.119]
• Adjust depreciation for future periods. [IAS 36.121]
• Reversal of an impairment loss for goodwill is prohibited. [IAS 36.124]

Disclosure

Disclosure by class of assets: [IAS 36.126]

• impairment losses recognised in profit or loss

• impairment losses reversed in profit or loss
• which line item(s) of the statement of comprehensive income
• impairment losses on revalued assets recognised in other comprehensive income
• impairment losses on revalued assets reversed in other comprehensive income

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Disclosure by reportable segment: [IAS 36.129]

• impairment losses recognised

• impairment losses reversed

Other disclosures:

If an individual impairment loss (reversal) is material disclose: [IAS 36.130]

• events and circumstances resulting in the impairment loss

• amount of the loss
• individual asset: nature and segment to which it relates
• cash generating unit: description, amount of impairment loss (reversal) by class of assets and
segment
• if recoverable amount is fair value less costs to sell, disclose the basis for determining fair value
• if recoverable amount is value in use, disclose the discount rate

If impairment losses recognised (reversed) are material in aggregate to the financial statements as a whole,
disclose: [IAS 36.131]

• main classes of assets affected

• main events and circumstances

Disclose detailed information about the estimates used to measure recoverable amounts of cash generating
units containing goodwill or intangible assets with indefinite useful lives. [IAS 36.134-35]

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Example
Example 1

Tswelo Limited owns a manufacturing machine on 31 December 20X1, for which there is an active market.
Due to technological changes it is expected that the value of the machine may be negatively affected.

The machine can at this date be disposed of to a knowledgeable, willing buyer for R250 000. Any broker
involved in such a transaction will charge a fee of 3% of the transaction amount and the cost to dismantle
and remove the asset will be R9 000. The machine initially cost R400 000 and is depreciated over 5 years
on the straight-line basis. A total of 2 years of the useful life of the machine has already expired at
31 December 20X1. The residual value is R40 000.

Tswelo Limited is of the opinion that information about the present value in use for this machine over its
remaining useful life is as follows:

Operating income R120 000

Operating expenses R30 000
After-tax discount rate 12%
Residual value R40 000

REQUIRED

1. Determine the impairment loss in 20X1.

2. Disclose the property, plant and equipment and the impairment loss in the notes to the financial
statements of Tswelo Ltd for the financial year ended 31 December 20X1.
3. Determine the depreciation for the machine on 31 December 20X2.
4. Prepare the journals for machinery for the 20X1 financial year.

Suggested Solution to Example 1

1. The impairment loss is:

Carrying amount (400 000 – 72 000 – 72 000) 256 000
Recoverable amount (233 500)
Impairment loss R22 500

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2. Tswelo Limited
Notes to the financial statements for the financial year ended 31 December 20X1

Property, plant and equipment

Machinery
Cost at 1 January 20X0 400 000
Accumulated depreciation and impairment losses (72 000)
Carrying amount at 31 December 20X0 328 000
Depreciation (72 000)
Impairment losses (22 500)
Carrying amount at 31 December 20X1 233 500
Cost / Revaluation 400 000
Accumulated depreciation and impairment losses (166 500)

Impairment loss
An impairment loss of R22 500 is recognised on a manufacturing machine. The recoverable
amount was determined by using fair value less costs to sell. The impairment loss is due to
technological changes.

Workings

Fair value less costs to sell

Selling price in an active market 250 000
Less:
Brokerage (7 500)
Cost of dismantling/removing the asset (9 000)
Fair value less costs to sell R233 500

Value in use
Net cash flow per annum (120 000 – 30 000) PMT R90 000
Period over which inflows will occur n 3 years
Expected net cash flow at disposal FV R40 000
Discount rate (12% / 0,72) i 16.67%
Total value in use therefore is R225 118

3. Depreciation for 20X2

(R233 500 – 40 000)/ 3 = R64 500

4. Journal entries for 20X1

31/12/X1 Depreciation 72 000
Accumulated depreciation 72 000
(Depreciation on machinery for the year)

31/12/X1 Impairment loss 22 500

Accumulated impairment 22 500
(Recognition of impairment loss on machinery)

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Complete the following:

Financial Accounting - Chapter 13

Discussion Questions: 1 to 4

Exercise Questions: 1

Student Question Bank: 9.1 to 9.3

Supplement - LU 4

Homework questions 1 to 3

Homework questions
Question 1

Grade Ltd acquired equipment on 30 September 2015. The following information regarding this equipment
is available:

Cost price R900 000

Useful life 5 years
Depreciation Straight-line method
Disposable value at the end of useful life R140 000
Disposable value on 31 December 2018 R310 000
Selling and removal cost at end of useful life R5 000

Additional information:

1. The company’s tax rate is 28% and it is using an after-tax discount rate of 12.6%.
2. A net operating cash inflow of R176 640 is expected over the remainder of the economic life of the
machine.

REQUIRED

Determine the impairment loss for the financial year ending 31 December 2018 and disclose the
impairment loss in accordance with IFRS.

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Question 2

Impala Ltd manufactures high voltage cables and acquired a new insulation machine from CBB Limited
during 2015. The purchase price for the machine was R1 886 000 including VAT. Installation of the machine
was completed on 30 June 2015 and the machine was incorporated in the production process since 1 July
2015. Costs incurred before this time included transport and delivery costs of R32 000, installation costs of
R16 000, fees payable to technicians from CBB Limited assisting with calibration and testing of the machine,
R12 000.

The estimated economic life of the machine is 5 years and it will be depreciated at 20% on cost over this
period. It is expected that the machine can be sold at the end of its economic life for R340 000. Due to
changes in the demand for the product it was necessary to test the asset for impairment at the end of the
2018 financial year.

Information gathered regarding testing for impairment is as follows:

Disposable value on 31 December 2018 R700 000

Estimated net operating cash inflow per annum R370 000
After-tax discount rate 13.32%

The company is registered as a VAT vendor and may therefor claim any input VAT against its output VAT
payable to SARS.

REQUIRED

1. Disclose the following notes to the financial statements for the year ended 31 December 2018:
• Property, plant and equipment
• Profit before tax
• Impairment loss

2. Determine the depreciation expense on the machine for the 2019 financial year.

Question 3

Cyclone Ltd acquired a manufacturing machine on 1 October 2016 and since acquisition the following
expenses regarding the machine was incurred:

Purchase price R700 000

Transport and delivery costs R16 000
Installation costs R3 000
Sundry pre-production costs R23 100
Cost of testing and samples R32 400
Estimated annual operating expenses of machine R141 200
Estimated annual operating cash inflow from machine R266 700
Useful life 5 years

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Depreciation 20% pa over useful life

Disposable value / residual value at the end of useful life R246 500
Disposable value on 31 December 2018 R500 000

Additional information

1. The samples made as a trial run were sold to the public for R28 000.

2. The company’s tax rate is 28% and it is using an after-tax discount rate of 10.26%. The company
is registered for VAT.

3. The machine was put into production on 1 October 2016 and during the first year the operating
expenses exceeded operating income.

4. The machine was extensively damaged due to the flooding of the plant in September 2018 and it
is the opinion of the engineer that the production capacity of the machine has been negatively
affected.

REQUIRED

Disclose the following notes to the financial statements of Cyclone Ltd for the financial year ending
31 December 2018 in accordance with IFRS:
• Property, plant and equipment
• Profit before tax
• Impairment loss

Note: Ignore comparative figures

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Notes

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