IFRS 5 & IAS 36: When Disposal Meets Impairment—How to Select the Right Valuation Basis’
Introduction to Certified IFRS 5 Asset Disposal Course
The interplay between the IFRS 5 and the IAS 36 is also one of the most advanced spheres of the financial reporting since it compels entities to decide not only which basis to employ when valuing an item, but also on when each basis should prevail.
In a contemporary business world where companies continually review portfolios, liquidate unproductive assets, redistribution of funds and activities and changes in operations, the management can often be placed into the difficulty of having an asset simultaneously underperforming and at the same time to be sold off. Such a duality compels entities to scrupulously consider which part of the asset is economic, how that part of the asset will contribute to future cash flows, and the probability and the time period when the asset could be sold.
According to IAS 36, the entities are to investigate the impairment of assets and to determine the carrying amounts and recoverable amounts in comparison. At the same time, IFRS 5 presents a different approach that is only relevant in those situations when an asset can be classified as held for sale with a set of stringent requirements. The instant classification is made, the new basis of valuation under the IAS 36 is deemed to be a recoverable amount whereas under IFRS 5, the basis of valuation is the fair value less costs to sell.
This transition is more than a simple shift in concept, it transforms the main premises, modeling approaches, How to choose between IAS 36 recoverable amount and IFRS 5 fair value less costs to sell during asset disposal and perceptions of the market upon which measurement is based. In the absence of a high level of technical knowledge, there are chances that the entities can misuse the valuation bases which will result in the misstatements in the charges of impairment, inconsistency and the decreased comparability among the reporting periods.
Selecting the right valuation basis is thus not an easy compliance process. It determines the way in which investors will understand the way the entity uses capital, the quality of assets, the future profitability and the capability of the entity to carry out the restructuring plans. Getting a misclassification or inaccurate mark to market will affect key financial ratios, debt covenants, performance measures, and raise management credibility concerns. Due to this fact, entities have to use a stringent, organized, and valuation based method when operating at the intersection point of impairment assessment and disposal classification.
Impairment Indicators: Understanding the Early Warning Signs That Demand IAS 36 Assessment Before IFRS 5 Classification Takes Effect
The first gateway in the valuation process is the impairment indicators as IAS 36 does not have any annual impairment tests on all assets. Rather, the standard is also founded on a trigger based approach whereby the existence of internal or external indicators is followed by a complete impairment analysis required of the entity. These signs are normally hidden and complex and they normally come up when the management has not yet officially decided on a plan of disposal.
On the outside, market forces can degenerate at an alarming rate and the value of the asset can start to drop. The competitors can also use more sophisticated technologies, or change in consumer preference can render some of the assets obsolete in an economic perspective, or some regulations can also hamper businesses, and limit the cash flows which the asset can bring. De Facto pressure like the increase in the interbank rates, inflation, currency exchange variability or political crises can also alter the favorable environment and depressed the anticipated returns.
On the internal front, the management can notice a deteriorating performance pattern, the maintenance expenses are rising, the operation is becoming inefficient, or both the performance projections as earlier planned cannot be attained. A change in the budgets or restructuring of an organization or the change in strategy of the business can be an indication that the asset has ceased to be in line with the long year objectives. The decision to consider strategic alternatives such as potential sale or divestment may end up being indicative of impairment even itself.
That identification of impairment indicators is important is due to the fact that IAS 36 should be in full application at this stage with the management expecting that such impairment to be settled later. In case of a recoverable amount that is less than carrying amount preceding the IFRS 5 classification requirements, then the impairment loss should be recognised. This is to have surety that assets are not overstated due to the lack of fulfillment of all of the held-for-sale conditions by the management. Effectively, indicators of impairments are protective in the sense that they guarantee that as the economic deterioration occurs, it is recognized promptly irrespective of whether there will be future disposal plans.
Recoverable Amount: Performing Rigorous IAS 36 Valuation Through Value in Use and Fair Value Less Costs of Disposal Before Any Movement Into Held-for-Sale Measurement
IAS 36 has provided that amount of recoverable under recoverable amount as the greater of the value in use and the fair value less disposal costs. These measures are complicated in calculations since both of them use different types of valuation methods and assumptions. Value in use dwells upon the potential of the service of the asset in the existing entity. It will involve the preparation of multi-year projections of cash flows that are expected to represent the best estimates of how the economy will behave over the next several years based on the estimates made by the management, such as the revenue trends, cost structure, production efficiencies, working capitalism, capital expenditures, and the assumption in the macroeconomic environment.
Such projected cash flows should be then discounted taking a rate that captures the existing participant expectation of risk of the market. The discount rate has to take into consideration offense-specific risks, the time appreciation of money and also adapt to insecurities. Value in use thus necessitates entities to make some decisions at various levels and these include: how long the forecast should be made, soundness of the underlying assumptions, consistency of the business plans, and the level at which the discount rate should be applied in accordance with the market needs. Even the slight adjustments in the assumptions of the discount rate or terminal value will have a significant impact on the result of the valuation.
The fair value and less disposal costs in IAS 36 bring in a market-based approach. The parties can use prices observed in similar operations in the market, quotations of the brokers, external pricing, or discounted cash flow analysis mitigated to accommodate an approach of valued assets by market participants, not the entity. The disposal cost also comprises legal expenses, transfer taxes, and Agents commissions, environmental obligations and other expenses which can be directly connected to the sale. Significantly, the IAS 36 fair value concept is quite different from the IFRS 13 fair value since the former relates more to disposal aspects assumptions even prior to held-sale classification.
Such dual-analysis also provides that any deterioration in recoverable amount is realised as soon as possible. It is essentially after this point of IAS 36 that one can then move to establish whether an asset is to be classified as a held-for-sale asset under IFRS 5. The sequence is important since IAS 36 frequently records impairment losses sooner than IFRS 5 would thus, assets are not recorded at higher carrying value at times of economic recession.
Disposal Group Assessment: Analysing Whether the Asset or Collection of Assets Should Be Grouped for Measurement and Presentation Under IFRS 5
The 5 th IFRS presents a new concept of a disposal group that is undertaken when an entity intends to sell numerous assets in a single spot. Determining whether the assets make a disposal group is an important valuation and accounting decision as the grouping is the unit of measurement after the attainment of held-for-sale classification. The entity will need to analyze physical and operational interdependency of the assets, saleability of the assets, natural existence of liabilities or obligations of the assets and whether it needs to put the assets together is economically reflective of the intended transaction.
As an illustration, the entity can be planning to get rid of a manufacturing facility that contains land, buildings, machinery, inventories as well as environmental clean up liabilities. Although these items can be identified individually on the balance sheet, they can be a single group in which they can be measured. In another scenario, the management can devise the idea of selling a business unit consisting of several cash generating units. The use of IFRS 5 will involve analysis of whether they will be sold in a single transaction or separately.
The disposal group assessment is also directly connected to the IAS 36 since before the classification under IFRS 5, impairment tests are required to be conducted at the CGU level. When a CGU has two or more assets that may be combined in generating cash flows then IAS 36 requires impairment testing of that level although the disposal group under IFRS 5 may have more assets/liabilities at the end. This implies that management has to be keen in matching the CGU structure applied in the impairment testing to the disposal group structure as envisaged in case of sale. Inequality may skew the results of valuation and comparability.
This is a great amount of judgment in the assessment process, a profound knowledge of the operations of the entity, and the strategic intent of the management. Finally, disposal group analysis preconditions the classification of the held-for-sale and fair value less costs to sell measurement, occurring to be a pillar of the IFRS 5 strategy.
Cash Flow Review: Ensuring Cash Flow Assumptions Reflect Both Internal Use (IAS 36) and Market Participant Expectations (IFRS 13) as Disposal Strategy Evolves
Both the IAS 36 and IFRS 5 are based on the assessment of cash flows, although this looks different when the two standards are used. Cash flows contained in IAS 36 are influenced by the internal expectations of the entity how the management intends to manage the asset, use resources and gain returns. This flow of cash includes entity based synergies, economies of scale, cost bases and strategy. They should be acceptable and maintainable and in line with the latest financial budgets and forecasts.
But as the asset is being disposed of, the principles of fair values as stipulated in IFRS 13 start to have an effect on the cash flow expectations that can be incorporated to estimate fair value less costs to sell as provided in IFRS 5. In this respect, cash flows should be market-oriented but not entity-oriented. The market actors can anticipate various growth directions, risk, or investment spending. They can also put in place various probabilities to future performance situations. Organizations have to amend their cash flow of assumptions to reflect the perception of a hypothetical buyer of the asset.
The move of the specific-entity valuation to the market-participant assumptions brings in a lot of valuation complexity. The management has to figure out whether internal projections should be altered, whether transactions on the market give superior signs on the projected returns and whether synergies peculiar to buyers should be eliminated. Meanwhile, disposal schedules affect the valuation since the anticipated proceeds could be based on the nature of bargaining, the value of the asset at the act of sale, and the macroeconomic cycles.
This cash flow review is consequently the analytical conduit connecting both IAS 36 impairment testing and IFRS 5 testing disposal measurement. Lack of inconsistency, transparency and compatibility with the economic reality is essential as cash flow assumptions are directly related to the impairment losses, fair value measurements, and, ultimately, profit or loss.
Selecting the Valuation Basis: Applying the Full IFRS Process—from Identifying the Asset or Group, Testing for Impairment, Computing VIU and FVLCD, Achieving Held-for-Sale Classification, Remeasuring at FVLCTS, and Producing Comprehensive Disclosures
This is initiated by estimating the asset or disposal group which would have to be impaired or classified as held-to-sell. After the indicators of impairment have been identified, IAS 36 indicates that entities need to determine the carrying amount of the assets mentioned against the recoverable amount. This is calculation of fair value of less cost of disposal and recognising impairment in case carrying amount is higher than either of the two.
The management will only be able to test the qualifiers of IFRS 5 classification after impairment testing has been carried out. These conditions force the management to commit to a plan of selling the asset, commence an active programme aimed at finding a buyer, price the specific asset fairly as compared to its fair value, and anticipates the sale to be realized within a period of twelve months. In the event that these conditions are met then the shift in the valuation basis occurs in decisive terms.
The group of assets or disposals should be estimated by carrying an amount minus fair value that does not include selling less costly. Any further impairment that will come due to this measure will be realised immediately.
Contrary to the IAS 36, IFRS 5 does not allow the use of value in use upon achieving held-for-sale classification. The depreciation is ceased, reclassification of the assets on the face of the balance sheet and measurement entirely on the proceeds of the sale. In case of fair value post classification, impairment reversals may be made, however, up to the maximum of the cumulative impairment realised following IFRS 5 classification.
The disclosure requirements will make sure that the users know the strategic reason behind the sale, the valuation methods, assumptions made in arriving at fair value less cost to sell as well as when to expect a sale and the type of impairment losses. These sources of disclosure not only increase transparency but also enable the stakeholders to consider decisions made by the management in allocating capital and the soundness of the valuation procedures.
Conclusion
When IAS 36 impairment assessment and IFRS 5 held-for-sale classification converge they give rise to a valuation environment that places high demands on the level of precision, discipline and depth of economic substance. The initiators of the evaluation process are the indicators of impairment, which calculate the recoverable amount to determine whether or not the carrying values can be maintained, the disposal group element arranges the assets to be sold one day, and the cash flow review process ensures that the internal and market-driven assumptions are properly implemented.
The substitution between value in use and fair value less costs to sell is so critical and organizations are required to adopt a systematic approach that will require that any measurement is in line with the reality of the disposal strategy.
Through meticulous application of the entire IFRS process, which includes the identification of the asset or group, identification of impairment, calculation of value in use and fair value less costs, confirmation of held-for-sale classification, remeasuring at fair value less costs and discomforting disclosures enable entities to maintain quality of the financial statements and give the users a clear and sound idea about the quality of assets and strategic orientation.
As more organisations rely on disposals, restructurising, and asset optimisation to become normal practices in a business environment, it is no longer optional to learn how the interaction between IAS 36 impairment testing sequence before IFRS 5 held-for-sale classification and valuation transition works but rather a necessity.