Impairment is an ongoing area of concern for many entities in the current economic environment. Regulators remain focused on this area and continue to push for increased transparency in disclosures. Groups holding significant amounts of goodwill and intangibles or those that are affected to a greater extent by climate change, rising of inflation or the current economic impact of the Russian invasion of Ukraine, are at greater risk of a regulatory challenge to their impairment assessments and in particular the related disclosures. See UK In brief 2023-02
for common mistakes on impairment of non-financial assets.
There is a growing demand from the users of the financial statements for clear disclosures on how climate related risks are being incorporated into the impairment models. For the impact of climate change on the cash flow projections and IFRS impairment disclosures see UK In brief 2021-56
. For the impacts of Russia's invasion of Ukraine, see In depth INT2022-05
for further guidance. For the considerations relating to rising inflation, see In depth INT2022-12
The key points in impairment testing are:
- For the value-in-use (VIU) model – key assumptions should stand up against external market data. Cash flow growth assumptions should be comparable with up-to-date economic forecasts. The fair value-less costs of disposal (FVLCD) model, which is a post-tax model, must use market participant assumptions, rather than those of management.
- In times of greater uncertainty, it is likely to be easier to incorporate the impact of the economic environment uncertainties in impairment testing by using multiple cash-flow scenarios and applying relative probability weightings to derive a weighted average set of cash flows rather than using a single central forecast and attempting to risk adjust the discount rate to reflect the higher degree of uncertainty in the environment.
- Specific challenges might relate to incorporating cash outflows for replacing leased assets on expiry of the leases into the impairment models, for further guidance in this area see FAQ 24.84.2.
- IAS 36 requires that the VIU model uses pre-tax cash flows discounted using a pre-tax discount rate. In practice, post-tax discount rates and cash flows are used which theoretically can give the same answer but the need to consider deferred taxes makes this complicated. For guidance on how one might deal with deferred tax in a post-tax VIU model see EX 24.87.1.
- Rising costs are becoming a noticeable issue in many countries that have not suffered significant inflation for many years so it is worth noting that a VIU calculation should incorporate specific price changes as well as the effect of general inflation either by:
- Estimating future cash flows in real terms (i.e excluding the effect of general inflation but including the effect of specific price changes) and discounting them at a rate that excludes the effect of general inflation or
- Estimating future cash flows in nominal terms (i.e including the effect of general inflation) and discounting them at a rate that includes the effects of general inflation.
Where inflation assumptions could have a material impact on the financial statements, additional disclosures may be required to explain how inflation has been incorporated into the VIU.
- If impairment of goodwill is identified at the group level this will most likely trigger an impairment review of the parent entity’s investment in the relevant subsidiaries in the parent’s separate financial statements. VIU of an investment in a subsidiary would be determined by the present value of expected dividend receipts. The present value of the estimated post tax cash flows from the subsidiary’s underlying assets might be used as a proxy for this if the subsidiary has no debt. Otherwise, the present value of expected cash flows should be reduced by the fair value of outstanding debt (both external and inter-company), in order to determine the net amount available for distribution see FAQ 24.165.2.
The required disclosures in IAS 36 are extensive. IAS 36 requires disclosure of the key assumptions (those that the recoverable amount is most sensitive to) and related sensitivity analysis. Note also IAS 1 para 125 requires disclosure of critical accounting judgements and of key sources of estimation uncertainty.
Where a reasonable possible change in key assumptions would reduce the headroom (excess of the recoverable amount over the carrying amount) of a CGU to nil, it is required to disclose this headroom as well as the specific changes in assumptions that would erode headroom to nil (for example + / – x% in sales growth or discount rates). However, in cases where no reasonably possible change would either erode headroom for CGUs when testing goodwill or give rise to a material adjustment to any carrying value in the next year, companies should take care that additional sensitivity disclosures do not give the wrong impression that any such adjustment is reasonably possible.
Given the increased uncertainty and volatility in many markets at present, the range of reasonably possible changes has widened which means that more extensive impairment disclosures will typically be required.
Key assumptions and wider ranging assumptions covering multiple Cash Generating Units (‘CGUs’) should be clearly disclosed. Where material, assumptions specific to each CGU should be identified. Changes to assumptions used, such as the discount rate, which has changed significantly from the previous year should be explained. Furthermore, where an impairment arises, entities would need to clearly disclose the cause of the impairment and whether this is based on external data or changes in the company’s own estimates. An entity with a material impairment loss or reversal additionally needs to disclose the recoverable amount of the asset(s) or CGU(s) affected (IAS 36 para 130 [e]
Regulators have observed that, whilst the long-term growth rate used to extrapolate cash flow projections (to estimate a terminal value) and the pre-tax discount rate are important; they are not ‘key assumptions’ on which the cash flow projections for the period covered by the most recent budgets or forecasts are based. Therefore, attention should also be paid to the discrete growth rate assumptions applied to the cash flows projected to occur before the terminal period. Accounting policy disclosures should always be consistent with the basis used in the according impairment test. The regulators have pointed out that they will continue to challenge companies where the recoverable amount is measured using VIU, but the cash flow forecasts appear to include the benefits of developing new business or to rely on future investment capacity.
An additional issue to consider is whether previous impairments should be reversed.
For all assets that have been impaired, other than goodwill, paragraph 110 of IAS 36
requires entities to assess, at the end of each reporting period, whether there is any indication that an impairment loss might no longer exist or might have decreased. Determining whether there is an identifiable impairment reversal indicator might require the use of judgement. If there is any such indication, the entity has to recalculate the recoverable amount of the asset. Paragraph 111 of IAS 36
sets out example indicators that should be considered when assessing whether an impairment loss recognised in prior periods might no longer exist or might have decreased. The indicators are arranged, as in paragraph 12 of IAS 36
, into two categories: external and internal sources of information. These indicators of a potential decrease in an impairment loss mainly mirror the indications of a potential impairment loss in paragraph 12 of IAS 36
. The passage of time alone (also known as the ‘unwinding’ of the discount) would not be a sufficient trigger for reversal or impairment. Further details are in FAQ 24.153.2
and FAQ 24.154.2