IFRS Impairment Testing: Asset Valuation under IAS 36

Understanding IFRS IAS 36 Asset Impairment Valuation

Asset impairment testing according to IAS 36 is very essential in assuring that the assets are not reported at higher amounts than its recoverable values. In the modern business world, where economic instability, technological interference and volatile market trends can quickly impact on the performance of assets, the concept of impairment testing is critical in proper and compliant financial reporting.

IAS 36 is the name of the impairment of assets which gives the framework of how the companies are to measure, assess and disclose impairment losses. It makes sure that financial statements indicate the actual economic value of assets that the carrying amount is in line with the recoverable amount, which is maximum between fair value less costs of disposal (FVLCD) and the value in use (VIU).

This guide is a comprehensive discussion of the IFRS impairment testing procedures, including the main principles, cash generating units or CGUs valuation, and the calculation of the impairment losses step by step.

The Principles of Asset Valuation and Asset Impairment.

IAS 36 provides the basic criteria on how assets can be impaired and in the case that the impairment occurs, which way to measure and identify the loss realised. This ensures that there is transparency and credibility in financial reporting especially when it comes to firms that have a high level of tangible or intangible assets.

IAS 36 Overview

The main purpose of the IAS 36 is to make sure that assets will be carried at a recoverable amount at most. In the case where the carrying amount of an asset is more than the recoverable amount, an impairment loss should be recorded at the time. This is applicable to a majority of non-financial assets such as property, plant and equipment (PPE), goodwill, intangible assets and investment property measured at cost.

When it is indicated that an asset can be impaired, then an impairment review has to be conducted. Nevertheless, testing of impairment of particular assets such as goodwill and intangible assets which have unlimited useful life is required yearly under the IAS 36 even where indicators are inexistent.

Indicators of Impairment

IAS 36 differentiates between external and internal pointers to impairment. Outside signals consist of a major decline in market value, unfavorable shifts in the economy or alterations in the interest rates in the market. The internal indicators can be such evidence of obsolescence, damage, or a marked underperformance of a given asset or cash-generating unit.

As an illustration, a manufacturing company might experience reduction in the sales of a particular product line because of the new technology that has made the manufacturing equipment ineffective. This would cause an impairment test to be carried out so as to ascertain whether recovery of the carrying value of the asset would still take place.

Fair Value Less Costs of Disposition versus Value in Use.

Recoverable amount of an asset is the greater between:

• Fair value less costs of disposal (FVLCD) – this is the price at which the asset could be sold in an orderly transaction, less expenditure that is directly related to the sale.
• Value in use (VIU)- the present value of the estimated future cash flows of the continued use of the asset and its ultimate disposal.

Practically, the computation of VIU needs to be made based on expected cash flows in future, choice of discount rate and use of discounted cash flow (DCF) methods. This aspect is at the core of impairment testing and asset valuation methods in IAS 36 guidelines, which means that the management makes decisions that are realistic and supported by estimations.

Fair Value of Cash Generating Unit.

In most situations, individual assets do not produce individual cash inflows, and therefore testing them to be impaired versus a larger group of assets referred to as a cash-generating unit (CGU) is essential.

How to Identify CGUs

A CGU is the smallest identifiable unit of assets which has cash inflows that are relatively unrelated to other assets or collections of assets. The right CGU should be identified since it can be the cause of over-aggregation or under-aggregation of impairment testing.

As an example, a retail chain might consider having the separate CGU in the individual stores when the cash inflows are generated by the separate locations. On the other hand, a manufacturing facility which makes in-house components can be consolidated with other entities to make one CGU.

Allocation of Goodwill and Other Assets.

In cases where a company purchases another business, there is the goodwill which consist of the surplus of the purchase consideration and the current value of identifiable net assets acquired. The goodwill should be pooled to the CGUs or groups of CGUs that are likely to receive the synergies of the combination.

These impairments are then tested once allocated either after a period of a year or more often in cases where there are signs of impairment. In case the recoverable portion of the CGU (including goodwill) is less than carrying amount, then the impairment loss is to be recognised initially against goodwill and then proportionally against other assets included in the CGU.

This process often requires professional asset impairment valuation services for IFRS financial reporting, as it involves complex forecasting, discount rate selection, and sensitivity analysis. The professional valuation teams will make sure that assumptions are reasonable and congruent with market expectations and hence reduce the audit risk.

CGU Valuation and Impairment Testing.

Examples of a CGU can be a manufacturing facility, brand name and goodwill. The carrying amount amount is RM100 million and the recoverable amount with reference to VIU is RM90 million. The impairment loss is the RM10 million loss. In case goodwill is a part of RM5 million of the carrying value, the full amount is written off and the remainder of RM5 million is put on the other assets in a pro-rata manner.

This makes sure that, both tangible and intangible assets are reported in the financial statements at their recoverable economic value.

Computation of Impairment Loss to Value.

Impairment loss computation has to be done in a methodical manner that concurs with the principles of measurement of impairment loss as stipulated in the IAS 36.

Calculation of impairment Step-by-Step.

Determine the asset or CGU – Determine which assets are possibly impaired.

• Calculate the recoverable amount – Calculate FVLCD and VIU and use the larger.

• Compare recoverable amount and carrying amount – In case carry value is bigger than the recoverable value, the difference between the carrying value and recoverable value would simply write off the impairment loss.
• Allocate impairment – First allocate the loss to goodwill and subsequently describe the loss in terms of other CGU assets.
• Adjust carrying amount – Adjust the financial records to show the post-impairment carrying amounts.

To illustrate, where a company has equipment of carrying amount of RM12 million and decides that the recoverable amount is RM9 million, an impairment loss of RM3 million will be recognized.

This impairment calculation process is often complemented by external valuation specialists who apply impairment testing and asset valuation techniques under IAS 36 standards to validate assumptions such as growth rates, cash flow projections, and discount rates.

Journal Entries for Impairment Losses

The entry of an impairment loss in the journal is a simple one:

1. Debit: Impairment Loss (P&L)
2. Credit: Accumulated Impairment (Balance sheet)

For example:

Dr. Impairment Loss (Profit or Loss) RM3,000,000  

Cr. Accumulated Impairments – Equipment RM3,000,000.

This entry makes sure that the carrying amount of the asset is adjusted to the recoverable amount of the asset, and the loss should be recorded in either profit or loss.

Financial Statements Disclosure.

IAS 36 is mandatory to make full disclosures to increase transparency. Entities must disclose:

• Value of impairment losses which have been identified and reversed within the period.
• The type of the asset or CGU that undergoes testing of impairment.
• Some of the main assumptions employed in the calculation of recoverable amounts (e.g. discount rates, growth rates, forecast periods).
• Sensitivity analysis to indicate the effect of variation in assumptions on recoverable amount.

These disclosures will enable investors, auditors and regulators to determine the credibility of the impairment assessment undertaken by the management and the financial soundness of the entity in general.

Conclusion

The IAS 36 impairment testing is used to make sure that the assets are not overstated in the balance sheet which keeps the integrity and reliability of the financial statements. Companies can comply and present a more realistic financial position through a systematic assessment of the recoverable amounts which is based on fair value and less costs of disposal and value in use.

Impairment testing on a regular basis is not just a form of compliance, it is a key management instrument that is used to expose underperforming assets and helps to improve strategic decision-making. Businesses can use IAS 36 principles by employing independent professionals in order to ensure that their asset portfolios are properly valued transparently and credibly in the different market conditions, highlighting the importance of financial statements in valuation.