ACCT5942 Corporate Accounting and Regulation : Impairment Test

The excess of carrying amount of the asset over its recoverable amount can be defined as impairment loss and recoverable amount refers to the net selling price or its value in use whichever is higher. ‘Value in use’ of the asset is calculated by taking present value of the expected cash flows (including residual value) arising from the use of asset. (Sehgal, 2014) 

Earlier assets were shown on the balance sheet at cost less accumulated depreciation, known as the carrying amount of the asset. Now, impairment loss is also written off and subtracted from the carrying amount of the asset. The conduct of impairment testing basically indicates whether the value of the assets shown in the balance sheet is actually worth or not. The value of the assets in the balance sheet needs to be reduced if the impairment testing indicates a lower value of the assets. This helps in showing the reality of the firm in the current scenario. By impairing the assets the firm is portraying a true and fair picture of its financial statements to its stakeholders. It is quite possible that even the liabilities can be impaired. For example if there is a provision created against realization of some amount and there is no chance of realizing that amount in future, then because of such provision the company can be under performing and such liabilities needs to be impaired. 

Whenever there is an indication that the assets are impaired the impairment testing should be conducted. Many internal and external sources determine whether an asset is impaired or not. The external sources are the outcomes of those event which are not under the control of the management like significant negative changes in the technology, the legal environment, the economy, market, the interest rates of the market, the discount rate may decline which would further affect the calculation of value in asset, decline in the market value of the company. There are internal sources, which are in the control of the management like information that depicts the impairment of the assets like any evidence of physical damage or obsolescence of technology, any internal restructuring or an asset that will no longer be in use, or if there is a worse economic performance of the company then expected. There may be situations in the internal management, which can depict impairment of assets like cash inflows to be much less than budgeted, a significant decline in the cash flows of an asset etc. These and many more such circumstances indicates that the carrying amount of the asset may not be recoverable and indicates the need for testing of impairment of assets and to show them at a correct and fair value. 

The main aim of impairment testing is to see that the assets value is not more than their recoverable amount. The recoverable amount needs to be calculated whenever there is a sign of impairment seen in the assets of the firm.

The higher of the fair value less cost and the value in use can be defined as the recoverable amount. (IasPlus, 2017) .For individual assets the recoverable amount is determined. If in any case the value of either the fair value less cost to sell or the value in use is higher than the asset’s carrying amount, then it will imply that the asset is not impaired. Many a times the recoverable amount of individual assets is not determined because the cash inflows from that asset is dependent on other assets, then the recoverable amount of the CGU is determined. The impairment test can be conducted at any time during an accounting period, but there is only one condition that the test is to be conducted at the same time year after year.

The optimal time for conduct of impairment testing is calculated on the availability of various facts and figures of the firm. Impairment testing can be conducted at different times of the year based on the availability of the information od different cash generating units 

Generally goodwill and intangible assets require impairment testing on annual basis. Comparing their carrying value with recoverable amounts does this. If the changes in circumstances are very frequent then even these assets needs to be tested very frequently. However, a firm can rely on its previous calculations of impairment for intangible assets when all of the following criteria are met

• When earlier the carrying amount was substantially less as compared to the carrying amount.
• It is quite possible that the new calculation of the recoverable amount be less than the amount of cash generating unit
• Since the most recent calculation, if the value of the assets and liabilities of the CGU have not changed much.

Goodwill is also tested at an interim period. When there is high uncertainty in the market then the goodwill is tested at the end of the accounting period as well as at an interim period. 

Impairment loss can be stated as the case when the carrying amount is more than the recoverable amount, then the carrying amount has to be reduced to the recoverable amount. Unless and until it is a revalued asset, the impairment loss will be treated as an expense and if it is treated as a revalued asset then it will be treated as revaluation decrease. The impairment loss is recorded in the profit and loss account. Whenever, there is a recognition of impairment loss, the asset’s carrying amount will never be reduced to the below of either the higher of its recoverable amount or zero.

When an impairment loss is calculated of a cash-generating unit, then firstly the loss is accustomed to reduce the amount of the goodwill. Any loss, which is not yet allocated, will then be allocated to the other assets of the cash generating units on pro rata basis. Even in this scenario the value of particular assets will not be reduced below to the higher of its recoverable amount or zero. 

References 

Iasplus.com. (2017). IAS 36 — Impairment of Assets. [online] Available at: https://www.iasplus.com/en-us/standards/international/ias/ias36 [Accessed 19 May 2017]. 

(2017). [online] Available at: https://www.ey.com/Publication/vwLUAssets/Impairment_accounting_the_basics_of_IAS_36_Impairment_of_Assets/$FILE/Impairment_accounting_IAS_36.pdf [Accessed 19 May 2017].

 (2017). [online] Available at: https://www.ey.com/Publication/vwLUAssets/Impairment_accounting_the_basics_of_IAS_36_Impairment_of_Assets/$FILE/Impairment_accounting_IAS_36.pdf [Accessed 19 May 2017]. 

 (2017). What is an impairment test? | AN Valuation Services. [online] AN Valuation Services. Available at: https://www.anvaluations.com/2014/07/15/impairment-test/ [Accessed 19 May 2017]. 

UKEssays. (2017). An Impairment Loss Is Deemed To Have Occurred. [online] Available at: https://www.ukessays.com/services/example-essays/accounting/an-impairment-loss-is-deemed-to-have-occurred.php [Accessed 19 May 2017]. 

(2017). [online] Available at: https://www.powertechexposed.com/IAS_36_impairment_testing_GL_IFRS.pdf [Accessed 19 May 2017]. 

Sehgal, D. (2014). Financial Accounting. 1st ed. Delhi: Vikas Publishing House Pvt Ltd, p.141.