In this session we shall look at the objective and scope of IAS 36 Impairment of Assets and then define what is meant by an impaired asset and an impairment loss. We shall look at how to calculate the value of an impaired asset and when checks for impairment should be made. Lastly, we will explain the effects of an impairment loss on a company’s financial statements.
Objective and scope of IAS 36
The objective of IAS 36 is to ensure that the carrying amount of a company’s assets are not shown at more than the amount that could be recovered from the asset; i.e. the amount to be gained from its sale or use.
IAS 36 applies to assets dealt with by IAS 16 Property, Plant and Equipment, IAS 38 Intangible Assets and IFRS 16 Leases.
Impaired Assets
A non-current asset is impaired if its recoverable amount is less than its carrying amount (i.e. if the value of the asset to the company has fallen unexpectedly).
When an asset becomes impaired, the company should record an impairment loss in order to reduce its carrying amount down to its recoverable amount.
Carrying amount
The carrying amount (or carrying value) of a non-current asset is the amount it is recorded at in the company’s books and financial statements. It is the asset’s cost (or its latest fair value if the Revaluation Model is being used) less the asset’s:
- Accumulated depreciation
- Accumulated impairment losses
Recoverable amount
The recoverable amount is the most the company can expect to achieve from the asset, either by selling it or through its use in the business.
It is calculated as the higher of:
- The asset’s fair value less costs to sell
- i.e. The net amount that would be gained from selling the item
- The asset’s value in use
- i.e. The present value of the future cash flows expected to be derived from the asset
- The amount the company would benefit by if it used the asset
Summary
Illustration 1
A company owns the assets shown below and wishes to identify any whose value has been impaired. The company has recorded each asset’s current carrying value, its fair value less costs to sell and its value in use.
The company would first calculate each asset’s recoverable amount. This is the higher of its fair value less costs to sell and its value in use.
The company can now compare the assets’ carrying values against their recoverable amounts. An impairment occurs when the carrying value is less than the recoverable amount.
This process has identified that the company’s land has been impaired and should be reduced in value from £120,000 to £110,000, an impairment loss of £10,000.
Illustration 2
Medusa plc owns a retail park that cost £19.6m to build. Accumulated depreciation charges against the retail park to date is £1.3m and accumulated impairment losses of £4.2m have been incurred.
If the retail park was sold it would be priced at £12.5m and estate agents and legal fees would total an estimated £0.4m. If however the retail part was not sold the present value of future net rents from retailers are £11.3m.
In order to determine whether the retail park’s value is impaired the company would have to compare its carrying value, its fair value less costs to sell and its value in use as shown below.
The company can calculate the recoverable amount (the higher of the fair value less costs t sell and the value in use) and compare it against the carrying value.
As the retail park’s carrying amount is higher than its recoverable amount, it should be reduced from £14.1m to £12.1m, an impairment loss of £2.0m.
Question
A company owns a machine that originally cost £85,600 and against which accumulated depreciation of £31,722 has charged to date. The company estimates that the present value of future cash inflows to be gained from using the machine is £60,000 and the company also estimates that the machine could be sold for £57,500 less sales commission of £3,000.
What is the value of the asset?
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- The value of the asset is its current carrying value of £53,878, being the lower of:
- The carrying value of £53,878 (i.e. 85600-31722); and
- The recoverable amount of £54,500, being the higher of:
- The fair value less costs to sell of £54,500 (i.e. 57500-3000); and
- The value in use of £60,000
- The asset is not impaired and there is no impairment loss
When to test for impairment
A company should consider whether an asset is impaired:
- Annually for acquired goodwill
- Annually for an intangible asset with indefinite useful life (e.g. purchased brands)
- When there is an indication that an asset may be impaired
Indications that an asset may be impaired
Indications of impairment can come from sources outside the company (external sources) or from sources within the company (internal sources).
Question
Which of the following assets would require an impairment test?
a) A tractor has incurred some minor superficial damage to its paintwork
b) An office building has developed a large crack in one of its outer walls
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(a) the damage to the tractor is superficial and would be expected in this type of vehicle. There is no indication that an impairment test would be required
(b) the office building would require an impairment test as the crack may indicate a serious problem
Impairment losses
When a company has identified that an asset is impaired the impairment loss will be deducted from the asset’s carrying amount. It will also be recorded as an expense in the Statement of Profit or Loss unless the asset is carried at a revalued amount. If the asset has been revalued the impairment loss will be treated as a revaluation decrease and would be recorded in Other Comprehensive Income up to the value of the revaluation reserve associated with the asset. Any remaining impairment loss will be treated as an expense and recorded in the Statement of Profit or Loss.
Illustration
One of the fields in an arable farm has a carrying value of £625,000. The land is valued under the Revaluation Model and has a revaluation reserve associated with it of £250,000.
It was then found that the land was contaminated and its recoverable amount is now £180,000. An impairment loss of £465,000 has been incurred.
£250,000 of the impairment loss would be set against the Revaluation Reserve for the land and would be recorded as a loss in Other Comprehensive Income. The remaining impairment loss of £215,000 would be recorded as an expense in the Statement of Profit or Loss.
Question
A company owns two properties which are valued using the revaluation model.
Property 1: Carrying value of £125,000, the revaluation reserve associated with the property is £30,000. Its recoverable amount is £80,000
Property 2: Carrying value of £260,000, the revaluation reserve associated with the property is £175,000. Its recoverable amount is £150,000
a) Calculate the impairment losses for both properties
b) State how the impairment losses for both properties will be recorded in the Statement of Profit or Loss and Other Comprehensive income
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a) The impairment loss for Property 1 is £45,000 (i.e. £125,000 – £80,000). The impairment loss for Property 2 is £110,000 (i.e. £260,000 – £150,000). The total impairment losses are therefore £155,000
b) The impairment loss of £45,000 for Property 1 should be recorded as follows; £30,000 should be recorded as a loss in the Other Comprehensive Income section and £15,000 should be recorded as an expense in the Statement of Profit or Loss section.
The impairment loss for Property 2 of £110,000 should all be recorded as a loss in the Other Comprehensive Income section.
Effects of impairments on depreciation
If an asset suffers an impairment loss, current and future depreciation charges shall be based on the new carrying amount, the asset’s remaining useful life and its residual value (which are likely to have changed as a result of the impairment).
Illustration
A company owns a warehouse that cost £800,000 and was being depreciated on a straight line basis over its estimated useful life of 20 years. The warehouse had no residual value. The annual depreciation charge was therefore £40,000 (i.e. £800,000/20yrs).
After 5 years, the warehouse had a carrying value of £600,000 but the warehouse had incurred some damaged and as a result its value was impaired. Its recoverable amount was £450,000, it still had no residual value but its remaining useful life was now 8 years.
The company would therefore record an impairment loss of £150,000 which would reduce the carrying value to £450,000 and the loss would be recorded as an expense.
The company would also recalculate its future deprecation charges. The new charge would be calculated as the new carrying value of £450,000 less the residual value of £nil and then divided by the updated remaining useful life of 8 years. The charge is (450,000-0)/8; i.e. £56,250 per year.
Question
A company owns a lorry that is being depreciated on a straight-line basis. It cost £92,000 and and accumulated depreciation of £68,000 has been charged to date. The lorry was involved in a crash and whilst it has been repaired to make it safe its recoverable amount has been calculated at £20,000. The company intends to use the lorry for a further two years before it is disposed of for an estimated £14,000.
a) What impairment loss should be recorded?
b) What is the amended annual depreciation charge?
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a) The impairment loss is £4,000. This is the difference between the carrying value of £24,000 (i.e. £92,000-£68,000) and its recoverable amount of £20,000.
b) The amended annual depreciation charge is the new carrying value of £20,000 less its residual value of £14,000, divided by its remaining useful life of 2 years. The depreciation charge is £3,000.
Disclosures
For each class of asset, a note should disclose the amount of impairment losses included in the Statement of Profit or Loss and Other Comprehensive Income and also state which line(s) the losses are recorded in the Statement.
For example:
“Administration expenses in the Statement of Profit or Loss includes impairment losses of £730,000 relating to a property where the recoverable amount fell when planning permission was granted to a business building an abattoir on an adjacent site.”
