The development phase INTANGIBLES

Chapter 13 – Impairment Page 161

4.1 Stage 1 – Indicators of impairment

IAS 36 identifies two sources of information that may indicate that an impairment has occurred. [IAS 36.12] i External sources including:  a significant decline in the asset’s market value. This may arise, for example, as a result of a new competitor entering the market;  significant changes in the technological, market, economic or legal environment in which the entity operates. This could be as simple as a change in customer tastes; and  increases in market interest rates. ii Internal sources including:  obsolescence or physical damage to the asset;  significant changes in how an asset is used or is expected to be used, including the asset becoming idle and plans to discontinue or restructure the division in which an asset is used; and  performance of the asset being below that planned, for example actual net cash flows generated by the asset being below that budgeted.

4.2 Stage 2 – Measuring recoverable amount

If the carrying amount of an asset i.e. the cost of an item of plant less the accumulated depreciation charged in relation to it to date is greater than its recoverable amount, then an impairment has taken place. There has been a loss in the value of the asset. The recoverable amount of an asset is the higher of its fair value less costs to sell and its ‘value in use’. Fair value is the amount obtainable from a sale in an arm’s length transaction between a willing buyer and seller. [IAS 36.6] The ‘value in use’ calculation is a measure of the future cash flows expected to be derived from an individual asset or a cash-generating unit. Since cash flows are likely to be over several periods, they should be discounted to take account of the time value of money, i.e. based on their present value. The calculation needs to take into account the specific risks associated with the asset and the entity. There are two steps involved in calculating the value in use of an asset. The first is to estimate the future cash inflows and outflows that are expected to arise in relation to the asset. Inflows should include an estimate for the ultimate disposal of the asset. The second step is to discount the scheduled cash flows to arrive at a present value. The discount rate to be used should be the risk-free rate of interest adjusted to reflect the risk associated with the particular asset and entity. This risk-adjusted rate of interest should reflect the return that an investor would require if heshe were to make an investment with cash flows similar to those expected from the asset. Risk-adjusted rates are used in the discounting process and are an indication of the riskreturn profile of an entity. It is not always necessary to calculate both the asset’s fair value and its value in use. If either one of these figures is greater than the asset’s current carrying amount, then there is no impairment. This is particularly useful in cases of property where there is an active market and it is relatively straightforward and inexpensive to calculate the fair value. Chapter 13 – Impairment Page 162 The recoverable amount should be determined on an individual asset basis as far as possible. If, however, the individual asset does not generate cash flows largely independent from other assets, then the asset is grouped with other assets to form what is referred to in IAS 36 as a ‘cash-generating unit’. This is the smallest group of assets for which it is possible to identify separately independent cash flows. Illustration 2 A bus company has a contract with a local education authority to transport children to and from school. There are ten routes contracted to this particular bus company. One of the routes is making losses because it collects children from remote areas and, as a result, the number of children collected is much lower than on the highly populated routes. The bus company does not have the ability to withdraw from individual routes. The ten routes are contracted for as a group. The ten routes should therefore be grouped together as one cash-generating unit.

4.3 Stage 3 – Recognising an impairment loss

If the recoverable amount of an asset is less than its carrying amount, the asset should be reduced to its recoverable amount. The difference is an impairment loss. [IAS 36.59] An impairment loss is recognised immediately in profit or loss unless the impairment is in relation to a revalued asset. An impairment loss on a revalued asset is treated as a decrease in valuation in accordance with IAS 16. To the extent that the asset has previously been revalued upwards, and there remains a balance on the revaluation reserve for that upwards valuation, any impairment loss will be recognised in other comprehensive income and reduce the revaluation surplus. If the impairment is greater than a previous valuation surplus then the excess is recognised in profit or loss for the period. Illustration 3 An entity has a property that was originally acquired for CU500,000. The property was revalued to CU800,000, and the CU300,000 was recognised in other comprehensive income as a revaluation surplus in accordance with IAS 16. The current carrying amount for the property is CU750,000. Due to finding that the land on which the property stands is contaminated, the entity has undertaken an impairment review. The fair value of the property is now estimated to be only CU300,000 and the value in use of the property is calculated as being CU400,000. The recoverable amount of the property is therefore CU400,000. An impairment of CU350,000 has occurred, being the difference between the current carrying amount of CU750,000 and the recoverable amount of CU400,000. As the property was previously valued upwards, this part of the impairment loss should be recognised in other comprehensive income, reducing the surplus on the revaluation reserve. Consequently, CU300,000 is recognised in other comprehensive income, i.e. it reduces the revaluation reserve balance to zero. The remaining loss of CU50,000 is recognised in profit or loss. Following the recognition of an impairment loss, any depreciation charged in respect of the asset in future periods will be based on the revised carrying amount, less any residual value expected, over the remaining useful life of the asset as per IAS 16.