What Does an Impairment Test Involve?
An impairment test determines whether the carrying amount of an asset on the balance sheet can be recovered through its use or sale. If its carrying amount exceeds its recoverable amount, an impairment loss is recognised.
Generally, companies assess at the end of each reporting period whether there are indications of impairment. Additionally, certain assets, such as goodwill and intangible assets with indefinite useful lives or those not yet available for use, require impairment testing at least annually.
The Key Comparison: Carrying Amount vs. Recoverable Amount
The central element of an impairment test is the direct comparison of these two measures:
- Carrying amount: The amount at which an asset is recognised on the balance sheet, after deducting accumulated depreciation or amortisation and any previously recognised impairment losses, where applicable.
- Recoverable amount: The higher of fair value less costs of disposal and value in use.
Fair Value Less Costs of Disposal vs. Value in Use
Fair value less costs of disposal represents the amount that would be received from selling an asset in an orderly transaction between market participants, after deducting the costs directly attributable to its disposal.
Value in use, on the other hand, is the present value of the future cash flows expected to be generated from the asset—or the cash-generating unit—through its use.
It is not necessary to calculate both amounts. If either fair value less costs of disposal or value in use equals or exceeds the carrying amount, the asset is not impaired, and the impairment test is considered to have been passed.
These two measures reflect different perspectives: fair value is based on the assumptions that market participants would use in a transaction, while value in use is based on the company’s own estimates regarding the use of the asset, subject to the requirements of the applicable accounting standard.
When Is an Individual Asset Assessed and When Is a CGU Assessed?
Impairment testing is performed at the individual asset level when its recoverable amount can be estimated.
If this is not possible because the asset does not generate cash inflows independently of other assets, the assessment is performed at the level of the cash-generating unit (CGU) to which it belongs.
A CGU is the smallest identifiable group of assets that generates cash inflows largely independent of those from other assets or groups of assets.
How Is a CGU Impairment Loss Allocated?
If the recoverable amount of a CGU is lower than its carrying amount, the difference represents an impairment loss.
When goodwill has been allocated to the CGU, the impairment loss is allocated in the following order:
- First, to goodwill, reducing the carrying amount of the goodwill allocated to the CGU, down to zero if necessary.
- Then, to the other assets within the CGU, on a pro rata basis according to the carrying amount of each asset.
