Intermediate Accounting — Impairment of Assets: Recoverable Amount, Cash-Generating Units and Allocation

Impairment is not recognized automatically when a market price falls. It is recognized when the amount an asset will earn in future falls short of its carrying amount. K-IFRS 1036 Impairment of Assets (IAS 36) applies to property, plant and equipment, intangible assets, goodwill, investment property under the cost model and so on. Inventories, financial assets and deferred tax assets are covered by their own standards.

1. When to test for impairment

At the end of each reporting period, the entity assesses whether there is any indication of impairment, and estimates recoverable amount only if there is. The following, however, are tested every year regardless of indications:

goodwill
intangible assets with indefinite useful lives
intangible assets not yet available for use (development costs in progress)

Typical indicators of impairment
External information	Internal information
Market value has declined significantly more than expected	Evidence of obsolescence or physical damage
Adverse changes in the technological, market or legal environment	Significant changes in how the asset is used (idle, restructuring)
Higher market interest rates raising discount rates	Internal reports showing worse economic performance than expected
Carrying amount of net assets exceeds market capitalization

2. Recoverable amount

Recoverable amount and impairment loss

\begin{aligned}\text{Recoverable amount} &= \max(\text{Fair value less costs of disposal},\ \text{Value in use}) \\ \text{Impairment loss} &= \text{Carrying amount} - \text{Recoverable amount} \quad (\text{if carrying amount} > \text{recoverable amount})\end{aligned}

Fair value less costs of disposal is fair value minus incremental disposal costs. Value in use is the present value of future cash flows from continuing to use the asset and disposing of it.

The higher of the two is used because a rational manager chooses whichever is better, selling or using. If either exceeds the carrying amount, the asset is not impaired.

A. Calculating value in use

Value in use includes only cash flows from the asset in its current condition. It excludes the effects of restructurings not yet committed to or future investments that enhance performance, as well as income taxes and financing cash flows. The discount rate is a pre-tax rate reflecting the time value of money and risks specific to the asset.

Company R’s machine (carrying amount ₩12 million) will generate net cash inflows of ₩4 million a year for its remaining three years, with no disposal value at the end. The discount rate is 10%. Value in use is $400 \times 2.4869 ≈ 994.8$ (₩10,000), i.e. about ₩9.948 million. Fair value less costs of disposal is ₩9 million. Recoverable amount is ₩9.948 million and the impairment loss is $1{,}200 - 994.8 = 205.2$ , i.e. ₩2.052 million.

3. Cash-generating units and goodwill

If the recoverable amount of an individual asset cannot be estimated (because it generates cash only together with other assets), the test is carried out on the cash-generating unit (CGU) to which it belongs: the smallest group of assets generating cash inflows largely independent of other assets.

Goodwill does not generate cash on its own, so it is allocated to the CGUs (or groups of CGUs) expected to benefit from the synergies of the business combination and tested with them. The allocation level is the lowest at which goodwill is monitored for internal management purposes and cannot be larger than an operating segment.

A. Order of allocating an impairment loss

An impairment loss on a CGU is allocated in this order:

First reduce the goodwill allocated to the CGU.
Allocate the remaining loss to the other assets of the CGU pro rata to their carrying amounts.
But no individual asset may be reduced below the highest of its fair value less costs of disposal, its value in use (if determinable) and zero. Any amount that cannot be allocated because of this floor is reallocated pro rata to the other assets.

Allocating a CGU impairment loss (recoverable amount 900; unit: ₩10,000)
Asset	Carrying amount	Step 1	Step 2 pro rata	After impairment
Goodwill	200	−200		0
Building	600		−60 (100 × 6/10)	540
Machinery	400		−40 (100 × 4/10)	360
Total	1,200	−200	−100	900

4. Reversing impairment losses

At the end of each reporting period, the entity assesses whether there is an indication that a past impairment loss has decreased. If so, and recoverable amount has increased, the loss is reversed.

Goodwill: never reversed, because the increase in recoverable amount may be internally generated goodwill.
Other assets: the carrying amount after reversal cannot exceed the amount that would have remained, net of depreciation, had no impairment been recognized.

Depreciating the machine in section 2 straight-line over its remaining three years after impairment gives ₩3.316 million a year. If after one year its recoverable amount has recovered to ₩8 million, the carrying amount is $994.8 - 331.6 = 663.2$ (₩10,000). Without the impairment, original depreciation (carrying amount 1,200 over three years, 400 a year) would have left ₩8 million. So ₩1.368 million is reversed, up to the limit of ₩8 million.

Check your understanding

Company S’s CGU consists of goodwill of ₩1.5 million, a building of ₩5 million and machinery of ₩3.5 million, and its recoverable amount is ₩7 million. The machinery’s fair value less costs of disposal is ₩3.3 million; the building’s individual recoverable amount is unknown. How is the impairment loss allocated?

The impairment loss is the ₩3 million difference between the total carrying amount of ₩10 million and the recoverable amount. Goodwill of ₩1.5 million is first reduced to zero, and the remaining ₩1.5 million is split between the building and machinery at $500 : 350$ , giving ₩882,000 to the building and ₩618,000 to the machinery. But the machinery cannot fall below its fair value less costs of disposal of ₩3.3 million, so it can be reduced by only ₩200,000. The ₩418,000 that cannot be allocated goes to the building. The result is goodwill 0, building ₩3.7 million (down ₩1.3 million) and machinery ₩3.3 million (down ₩200,000), a total of ₩7 million.

References

Korea Accounting Standards Board, K-IFRS 1036 Impairment of Assets
Donald Kieso, Jerry Weygandt and Terry Warfield, Intermediate Accounting: IFRS Edition, ch. 11
IASB, IAS 36 Impairment of Assets