Chapter 7 - IMPAIRMENT OF ASSETS (IAS36)

1. Chapter 7 - IMPAIRMENT OF ASSETS(IAS36) ACTG 6580

2. Definition of an Impairment Loss IAS36 defines an impairment loss as "the amount by which the carrying amount of an asset or cash-generating unit exceeds its recoverable amount". Broadly, the recoverable amount of an asset is the amount that can be obtained by either using it or selling it.

3. Cash-generating Units (CGUs) IAS36 defines a CGU as "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". If the recoverable amount of an individual asset which might be impaired cannot be determined, the recoverable amount of the CGU to which the asset belongs should be determined instead and an impairment loss should be recognised if the CGU's recoverable amount is less than its carrying amount.

4. US GAAP ASC 360-10-35-21 requires a review for impairment indicators in PP&E “whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.” A recoverability test is required: If the carrying amount of the asset exceeds the sum of the expected net future undiscounted cash flows, then the asset is not recoverable and an impairment loss must be calculated. Periodic ValuationImpairment – impairment indicators and recoverability test IFRS • IAS 36 requires an entity to assess annually whether there are any indicators of impairment. • There is no recoverability test, simply calculate an impairment loss if impairment indicators are present.

5. External Indications of Impairment • Decline in the market value of the asset • Adverse technological, market, economic or legal changes • Increase in the discount rate used when computing value in use • Carrying amount of the entity’s net assets exceeds market capitalisation.

6. Internal Indications of Impairment • Evidence of obsolescence or physical damage to the asset • The asset has become idle • Plans to discontinue the operation in which the asset is used • Plans to dispose of the asset • Useful life of the asset reassessed as finite • Evidence that the asset’s economic performance will be worse than expected.

7. Recoverable Amount IAS36 defines the recoverable amount of an asset as "the higher of its fair value less costs to sell and its value in use". • Fair value less costs to sell is defined as "the amount obtainable from the sale of an asset … in an arm's length transaction between knowledgeable, willing parties, less the costs of disposal". • Value in use is defined as "the present value of the future cash flows expected to be derived from an asset …".

8. Recognition and Measurement ofan Impairment Loss If the recoverable amount of an asset is less than its carrying amount, the asset's carrying amount should be reduced to its recoverable amount. The amount of this reduction is an impairment loss. In general, an impairment loss is recognised as an expense. But, for revalued assets: (a) an impairment loss is first debited to revaluation reserve to the extent of any credit balance previously existing in that reserve in respect of the same asset (and is shown as a negative figure in other comprehensive income); (b) any excess is then recognised as an expense.

9. Allocation of an ImpairmentLoss for a CGU An impairment loss for a CGU is recognised by reducing the carrying amount of the CGU's assets. The loss is allocated between assets as follows: • First, to any goodwill which has been allocated to the CGU; • Next, to the other assets of the CGU, in proportion to their carrying amounts. The carrying amount of an asset should not be reduced below the highest of its fair value less costs to sell, its value in use and zero.

10. Impairments Example 1: On January 1, 2009, a company acquired a piece of equipment for $100,000. It was decided that the equipment would be depreciated over ten years with zero salvage value. At December 31, 2012, the equipment has significantly decreased in value due to technological innovations in the industry in which the company operates. The current carrying value of the equipment is $60,000 ($100,000 cost less $40,000 of accumulated depreciation). The expected future undiscounted cash flows from the use of this equipment are $61,000. The discounted net present value of expected cash flows from this piece of equipment is $51,000. Additionally, the fair value of the piece of equipment is $50,000 and the selling costs are minimal. Is the equipment impaired under either US GAAP or IFRS?

11. Impairments Example 1 solution: Using US GAAP, the carrying value of the equipment of $60,000 is less than the expected future undiscounted cash flows of $61,000, so the equipment is not impaired. Using IFRS, the equipment is impaired because the carrying value of $60,000 is greater than the recoverable amount of $51,000.

12. Impairments Example 2: Use the same facts as the previous example, except the expected future undiscounted cash flows from the use of this equipment are $59,000. What, if any, impairment loss should be recorded using US GAAP and IFRS? Show any required journal entries.

13. Impairments Example 2 solution: Using US GAAP, the piece of equipment now fails the recoverability test. The $60,000 carrying value of the equipment exceeds the sum of the expected net future undiscounted cash flows of $59,000. Therefore, an impairment loss must be calculated. The impairment loss is the difference between the carrying value of $60,000 and the fair value of $50,000. A $10,000 impairment loss would be recorded as follows: Impairment loss $ 10,000 Equipment $ 10,000 Using IFRS, there are impairment indicators so an impairment loss must be calculated. Using IAS 36, the recoverable amount is $51,000 (the higher of the net fair value of $50,000 or the discounted net present value of the cash flows of $51,000). Therefore, a $9,000 impairment loss needs to be recorded as follows: Impairment loss $ 9,000 Equipment $ 9,000

14. Reversal of an Impairment Loss • Entities must assess whether there are any indications that previous impairment losses have decreased or no longer exist. • These indications are generally the opposite of the indications of impairment. • If any of these indications exist, the recoverable amount of the asset or CGU must be determined again, with a view to reversing all or part of the previously recognised impairment loss. However, IAS36 states that "an impairment loss recognised for goodwill shall not be reversed in a subsequent period".

15. US GAAP A reversal of the impairment loss is prohibited. Reversals of Impairments IFRS • The impairment loss can be reversed up to the newly calculated recoverable amount, but it cannot exceed what the original carrying amount, net of depreciation, would have been.

16. Example 3: Use the same facts as the previous example, except in 2014 it is discovered that the technological innovations related to this piece of equipment are not effective. As a result, the fair value of this piece of equipment is now $41,000. The discounted net present value of expected cash flows from this piece of equipment is also $41,000. Using IFRS, what amount of the original impairment loss of $9,000 can be reversed? Show any required journal entries to reverse the impairment loss. Impairment Reversals

17. Example 3 solution: The impairment loss can be reversed up to the newly calculated recoverable amount of 41,000, but it cannot exceed what the original carrying amount, net of depreciation, would have been. ImpairedNot impaired Net asset value 2012 $ 60,000 $ 60,000 Impairment 2012 (9,000) 51,000 Depreciation 2013 $51,000/(6) (8,500) (10,000) Depreciation 2014 $51,000/(6) (8,500) (10,000) 34,000 $ 40,000 Reversal of impairment loss 6,000 $ 40,000 Equipment $ 6,000 Impairment loss $ 6,000 Impairment Reversals

18. Intangibles - Impairments US GAAP IFRS Indefinite-lived intangible assets including goodwill must be reviewed annually for impairment and when impairment indicators exist. Similar

19. Intangibles - Impairments US GAAP • Finite-lived intangibles are tested whenever impairment indicators exist. • A review for impairment indicators for finite-lived intangible assets is performed whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. IFRS • The existence of impairment indicators must be assessed annually for finite-lived assets.

20. Intangibles - Impairments US GAAP IFRS A one-step process is used to determine whether to impair indefinite-lived assets other than goodwill. Similar

21. Finite-lived Intangible Assets US GAAP • A two-step approach is used for determining impairment of finite-lived assets: 1. A recoverability test is performed first. The carrying amount of the asset is compared to the sum of the future undiscounted cash flows generated through use and eventual disposition. 2. If it is determined the asset is not recoverable, an impairment loss is calculated. IFRS • A one-step approach is used to determine impairment and is the same calculation used to determine the amount of the loss as described following.

22. Goodwill Impairment US GAAP • The impairment is the amount by which the carrying amount of the goodwill exceeds the implied fair value of the goodwill within its Reporting Unit (RU). The implied fair value is the fair value of the RU less the fair value of the net assets (excluding goodwill) of the RU. IFRS • Using IFRS, the impairment is the amount by which the CGU carrying amount exceeds its recoverable amount (as defined previously). • The impairment amount is first allocated to reduce goodwill to zero, then to the other assets in the CGU pro rata on the basis of the carrying value of each asset. • Goodwill impairment CANNOT be reversed upon recovery.

23. Finite-lived intangible asset Example 4: The Corporate Protection Company (CPC) has a patent on new fingerprint security technology. The fair value of the patent is $18 million, excluding selling costs of$3 million. The present value of future cash flows is $16 million. The sum of the undiscounted future cash flows is $19 million. CPC currently carries the patent at a value of $20 million. • What journal entries would CPC prepare to record an impairment of the patent using both US GAAP and IFRS?

24. Finite-lived intangible asset Example 4 solution: US GAAP Recoverability test: is the carrying value greater than the sum of the future undiscounted cash flows? • Yes, since $20 million is greater than $19 million. Calculation of the impairment: • Carrying value - fair value = $20 million - $18 million Journal entry to record the impairment: Impairment loss $2 million Patent $2 million

25. Finite-lived intangible asset Example 4 solution (continued): IFRS Test for impairment: does the carrying amount exceed the recoverable amount? • Yes, the carrying amount of $20 million is higher than the recoverable amount of $16 million. The recoverable amount is calculated as the higher of the fair value less the selling costs ($18 million - $3 million = $15 million), and the value in use (present value of future cash flows = $16 million) Calculation of the impairment (note that the determination and calculation of impairment are the same step): • Carrying value - recoverable amount = $20 million - $16 million = $4 million Journal entry to record the impairment: Impairment loss $4 million Patent $4 million

26. Periodic valuationImpairment – reversal US GAAP • Reversal of impairment losses is prohibited for all intangible assets. IFRS • Finite and indefinite-lived intangible assets (other than goodwill) must be reviewed annually for reversal indicators. • If appropriate, a loss may be reversed up to the newly estimated recoverable amount, not to exceed the initial carrying amount adjusted for amortization. This amount is recorded in income.

27. Summary • Compare the carrying value to the sum of undiscounted cash flows. • Compare the carrying value of the reporting unit to the fair value of the RU(including goodwill). • The implied fair value of goodwill equals the fair value of the RU less the fair value of the net assets (excluding goodwill) of the RU. • Recoverable amount is the higher of: (1) the fair value less selling costs and (2) the present value of future discounted cash flows. • Companies have the option of assessing qualitative factors to determine whether it is more likely than not that the fair value is greater than the carrying value of the RU. If so, the two-step process is required to test for impairment. If not, no further testing is required.

28. IAS36 Disclosure Requirements For each class of assets, the entity should disclose: • The amount of impairment losses (or reversals) recognised as expenses (or income) during the period and the line items in which these are included; • The amount of impairment losses (or reversals) recognised in other comprehensive income during the period. For each material impairment loss or reversal recognised in the period, the entity should make various disclosures with regard to the nature, amount and circumstances of the loss or the reversal.