IAS 16: IMPAIRMENT OF ASSETS
DEFINITIONS
1. Cash generating unit (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
2. Impairment loss
 is the amount by which the carrying amount of an asset or a CGU exceeds its
recoverable amount
3. Recoverable amount
 Is the higher of its fair value less costs to sell and its value in use.
4. Value in use
 Is the present value of the future cash flows expected to be derived from an asset
or CGU.
 Value in use is calculated by estimating future cash inflows and outflows from the
use of the asset and its ultimate disposal, and applying a suitable discount rate to
these cash flows.
 Therefore, there are two steps to the calculation.
i. Estimate future cash flows from use and from disposal at the end of useful
life.
ii. Discounting (pre-tax risk adjusted discount rate should be used for
calculating present value.
Basis for estimate of future cash flows:
a) Cash flow projection should be based on reasonable and supportable assumptions and
greater weight shall be given to external evidence
b) Projections based on these budgets/forecasts shall cover a maximum period of five years,
unless a longer period can be justified
c) Estimate cash flow projections beyond the period covered by extrapolating the
projections using a steady or declining growth rate for subsequent years, unless an
increasing rate can be justified
d) This growth rate shall not exceed the long-term average growth rate for the products,
industries, or country or countries in which the entity operates, or for the market in which
the asset is used, unless a higher rate can be justified
5. Fair value less cost to sell
 Is the amount at which an asset could be sold in an orderly transaction between
market participants less the costs of disposal.
Possible indicators of fair value may be:
a) A binding sale agreement
b) If an active market exists, the current market price less cost of disposal
c) Failing either of the above indicators, the best information available must be relied on.
6. Cost of disposal
 Are incremental costs directly attributable to the disposal of an asset or cashgenerating unit, excluding finance costs and income tax expense
 Cost of disposal might include:
i. Legal costs
ii. Stamp duty
iii. Costs relating to removal of sitting tenant
TIMING OF IMPAIRMENT REVIEW
 IAS 36 requires that at each reporting date, an entity must assess whether there are
indications of impairment. Indications may be derived from within the entity (internal
sources) or the external market (external sources).
A. Internal indicators
a) Obsolescence or physical damage
b) Significant changes with an adverse effect in the manner in which an asset is
used or is expected to be used.
c) Economic performance of an asset is worse than expected.
d) Actual cash flows are worse than the budgeted
B. External indicators
a) Asset’s market value has declined significantly more than expected.
b) Significant changes with an adverse effect in the technological, market,
economic or legal environment in which the entity operates
c) Market interest rates or other market rates of return on investments have
increased during the period, and those increases are likely to affect the
discount rate used in calculating an asset’s value in use and decrease the
asset’s recoverable amount materially.
d) The entity’s net assets are measured more than its market capitalisation
Note: indication exists
 If an indication of impairment exists then an impairment review must be performed.
Where there is no indication of impairment, then no further action needs to be taken
Annual review
 The following assets must be reviewed annually for impairment (in addition to when an
indication exists):
a) Goodwill acquired in a business combination
b) An intangible asset with an indefinite useful life
c) An intangible asset not yet available for use
MODULE 5 TPS – FINANCIAL REPORTING
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notes - value in use (VU).
NFV is the sales price of an asset in an arm’s length transaction less the costs of
disposal.
VU is the present value (PV) of future cash flows expected to arise from the asset
over its remaining life and from its disposal.
In other words we are looking at the financial outcome of the two choices a
company has with an asset:
 keep it (VU), or
 sell it (NFV).
The higher is taken as it is assumed that the company will opt for the more
beneficial outcome.
Example 1
A fixed asset was acquired in January 2008 for £200,000.
Depreciation policy is 15% straight line with a nil estimated
residual value. At 1 January 2011 the NFV of the asset is £95,000
and the value in use is estimated at £87,000.
Required:
Calculate the amount of any impairment at 1 January 2011.
Solution
NBV (carrying amount) of asset at 1.1.11
Cost £200,000
Less: depreciation 2008-10 (200,000 x 15% x 3 years) 90,000
NBV – 1.1.11 £110,000
Recoverable amount
This is measured as the higher of NFV and VU (higher of £95,000 and £87,000) ie
£95,000.
As the recoverable amount is £95,000, there has been an impairment of £15,000
(carrying amount of £110,000 less £95,000).
5.4 REQUIREMENT FOR IMPAIRMENT REVIEWS
The directors of a company should assess at each balance sheet date whether there
are indications of impairment. If there are, the recoverable amount should be
calculated (para 9). Para 12 details some external and internal sources of
information that might indicate an impairment eg falls in market values, changes in
legislation, physical damage of an asset, operating losses, new competition.
Para 10 has additional requirements for intangible assets and goodwill. A company
should estimate the recoverable amount of the following assets at least annually
even if there is no indication that the asset is impaired:
(a) an intangible asset with an indefinite useful life; and
(b) an intangible asset not yet available for use.
In addition, goodwill acquired in a business combination should be tested for
impairment annually.
SOTE TWAWEZA 2012
TPS – FINANCIAL REPORTING MODULE 5
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notes
You should now be able to achieve the first learning objective of the module.
5.5 MEASUREMENT OF RECOVERABLE AMOUNT
Impairment calculations in practice can be complex. This module provides an
overview of the impairment process and its application in more straightforward
situations.
The impairment review requires us to compare the carrying amount (which we will
know as it is the NBV figure in the current accounts) with the recoverable
amount (the higher of NFV and VU). We therefore require to know NFV
and VU. Note that if either of these is higher than the carrying amount no
impairment has occurred and we do not need to find the other figure. It is
often easiest (and quickest) to identify NFV first and compare it to carrying
amount. If NRV exceeds the carrying amount, no impairment has occurred
and there is no need to calculate VU.
If NFV cannot be established (perhaps because the asset is specialised) or it is
lower than carrying amount, VU will have to be calculated.
(a) Calculation of fair value less costs to sell
NFV is the amount the asset could be sold for less any direct selling costs.
Where there is an active market, NFV will be based on market value or, if
there is no active market, the best information available. The NFV will
often be easier to find than the VU as there is no calculation involved in
arriving at NFV.
If the asset is specialised it may not be possible to estimate fair value.
Costs of sale include such items as legal costs and costs of removing the
asset.
(b) Calculation of value in use
VU is the discounted future cash flow that the asset will generate. This is a
two stage process involving:
(i) estimation of the future cash flows from continuing use and ultimate
disposal, and
(ii) applying an appropriate discount rate.
Paragraphs 30 to 57 of IAS 36 deal with this issue.
Cash flows
Cash flows, consistent with budgets and plans and based on reasonable
assumptions, should be estimated. Cash flows extending beyond formal
budgets and plans (normally extending for a maximum of 5 years) should
assume a steady or declining growth rate. The growth rate assumed should
not normally exceed the long-term average growth rate of the products,
industries or country in which the business operates (approximately 2.75%
in real terms for the UK at Q3 2010), or the market in which the asset is
used. If appropriate the growth rate may be zero or negative.
Cash flows should be net (cash inflows net of the outflows necessarily
incurred to generate the cash inflow) and pre-interest and tax. Cash flows
should include an estimate of the amount to be received (or paid) on
disposal of the asset.