Chapter 10 IMPAIRMENT OF ASSETS

Related standard: PAS 36 Impairment of Assets

Learning Objectives
• State the core principle of PAS 36.
• Account for the impairment of individual assets and cash-generating units.
• Account for the reversal of impairment.

Scope
PAS 36 applies in the accounting for the impairment of the following noncurrent asset:
1. Property, plant and equipment
2. Investment property measure under the cost model
3. Intangible assets
4. Investment in associates, joint venture, and subsidiaries

Core Principle

If the carrying amount of an asset is greater than its recoverable amount, the asset is impaired. The
excess is impairment loss.

Computation of Impairment loss

Recoverable amount xx
Less: Carrying amount (xx)
Impairment loss xx

Recoverable amount is the amount to be recovered through use or sale of an asset. It is the higher of an
asset’s:
a. Fair value less costs of disposal, and
b. Value in use

Value in use is the present value of the future cash flows expected to be derived from an asset or cash-
generating unit.

Illustrative Problem

On December 31, 2021, Entity A Determines that its building is impaired. The following information is
gathered:

building 1,000,000
accumulated depreciation 300,000
fair value less cost of disposal 600,000
value in use 580,000

The impairment loss is computed as follows:

Recoverable amount (FVLCD) 600,000

 Less: Carrying amount (1,000,000 - 300,000) 700,000
Impairment Loss (100,000)

Identifying an asset that may be impaired

An entity shall assess at the end of each reporting period whether there is any indication that an asset may
be impaired. If any such indication exists, the entity shall estimate the recoverable amount of the asset.

If there is no indication that an asset may be impaired, an entity is not required to estimate the
recoverable amount of the asset.

Indications of impairment

I. External sources of information

a. Significant decline in the asset’s value more than what is expected as a result of passage of time
of normal use.
b. Significant changes in technological, market, economic or legal environment in which the entity
operates or in the market to which an asset is dedicated.
c. Increase in market interest rates or other market rates of return on investments which are likely to
affect discount rates used in calculating asset’s value in use and decrease asset’s recoverable
amount materially.
d. Carrying amount of the net assets is more than its market capitalization.

II. Internal sources of information

a. Evidence of obsolescence or physical damage
b. Significant change with adverse effect to the entity has taken place or will take place, which will
affect expected use of asset, e.g., discontinuance, disposal, restructuring plans.
c. Evidence is available from internal reporting that indicates that the economic performance of an
asset is, or will be, worse than expected.

Required testing for impairment

The following assets are required to be tested for impairment at least annually, whether or not there are
indications for impairment:
a. Intangible asset with indefinite useful life
b. Intangible asset not yet available for use
c. Goodwill acquired in a business combination
Measuring recoverable amount

• Recoverable amount is the higher of the asset’s fair value less costs of disposal and value in use.

• However, if there is no reason to believe that an asset’s value in use materially exceeds its fair value
less costs of disposal, the asset’s fair value less costs of disposal may be used as its recoverable
amount. This will often be the case for an asset that is held for disposal.

Value in use

Value in use is the present value of the future cash flows expected to be derived from an asset or cash-
generating unit.
• Any residual value of the asset and disposal costs should be included in estimating future cash
inflows and outflows.
• Cash flow projections shall cover a maximum period of 5 years.
• Projections beyond 5 years are extrapolated.
• The discount rate to be used shall be a pre-tax rate

When making estimates of future cash flows for purposes of computing value in use:

Exclude cash flows arising from:
1. Future restructurings not yet committed
2. Improving or enhancing the asset’s
performance
3. Income taxes
4. Financing activities
Include cash flows arising from:
1. Revenues to be derived from the
continuing use of the asset
2. Day-to-day costs of using the asset
3. Any residual value of the asset and
disposal costs

Recognizing and measuring an impairment loss

Impairment loss is recognized in profit or loss, unless the asset is carried at revalued amount, in which
case revaluation surplus is decreased first and any excess is recognized in profit or loss. The decrease in
the revaluation surplus is recognized in other comprehensive income.

Depreciation after impairment

After the recognition of an impairment loss, the depreciation (amortization) charge for the asset shall be
adjusted in future periods to allocate the asset’s revised carrying amount, less its residual value (if any),
on a systematic basis over its remaining useful life.
Illustrative Problem: Cost of Disposal

On December 31, 2021, ABC co. identified that its machinery with a carrying amount of P1,000,000 and
remaining useful life of 5 years has been impaired. In estimating the recoverable amount, ABC
determined that the fair value of the asset is P800,000. The following cost were also estimated:

 Transaction taxes P50,000

 Legal cost, stamp duty, commissions and similar
Fees 10,000
 Costs of dismantling or removing the asset
Included in provision for restoration and
decommissioning cost 5,000
 Termination benefits and costs associated with reducing or4
reorganizing a business following the disposal of an asset 15,000

ABC does not have any reason to believe that the value in use of asset materially exceeds fair value less
cost of disposal. The remaining useful life of the machinery is unchanged. ABC uses the straight-line
method of the depreciation.

Requirements:
a. Compute the impairment loss
b. Compute for the revised annual depreciation expense after impairment testing.

Solution:

Requirement a: impairment loss

Fair value less costs of disposal is computed as follows:

Fair value 800,000

Cost of disposal:
Transaction taxes 50,000
Legal costs, stamp duty, commission
and similar fees 10,000
Total cost of disposal (60,000)
Fair value less cost of disposal 740,000

The impairment loss is computed as follows:

Recoverable amount – FVLCS 740,000

Carrying Amount (1,000,000)
Impairment Loss (260,000)

Requirement b: Depreciation after impairment

Revised carrying amount (recoverable amount) 740,000

 Residual value 0
Depreciable Amount 740,000
Divided by: Remaining Useful Life 5
Revised annual deprecation after impairment 148,000

Illustrative Problem: Value in Use

On December 31, 20x1, MASSIVE HEAVY Co. identified that its building with a carrying amount of
₱2,400,000 has been impaired. In estimating the recoverable amount, MASSIVE has determined that the
fair value less costs of disposal of the asset is ₱1,600,000.

In estimating the value in use, MASSIVE determined the following:

Future cash in Future cash out
Year flows flows
20x1 1,200,000 400,000
20x2 1,120,000 400,000
20x3 1,040,000 320,000
Additional information:
 Each year’s estimated future cash flows include ₱40,000 representing cash outflows from future
restructuring not yet committed and ₱20,000 representing cash outflows on planned improvement and
enhancement of the asset.
 Not included in the estimated future cash flows are costs of day-to-day servicing of the asset
amounting to ₱8,000 per year.
 The discount rate is 10%.

Requirement: How much is the impairment loss?

Solution:
The adjusted future cash outflows are computed as follows:
Future costs not yet
Costs of day-to-day Adjusted cash out
Year Unadjusted cash outflows committed & Costs of
servicing flows
improvement

(a) (b) = (40K + 20K) (c) (d) = (a) - (b) + (c)

20x1 400,000 60,000 8,000 348,000

20x2 400,000 60,000 8,000 348,000

20x3 320,000 60,000 8,000 268,000

The future net cash flows are computed as follows:

Year Cash in flows Adjusted cash out flows Net cash flows
(a) (b) (c) = (a) - (b)

20x1 1,200,000 348,000 852,000

20x2 1,120,000 348,000 772,000
20x3 1,040,000 268,000 772,000

The value in use is computed as follows:

Year Net cash flows PV of ₱1 factors Present value

20x1 852,000 PV of ₱1 @10%, n=1 0.909091 774,544

20x2 772,000 PV of ₱1 @10%, n=2 0.826446 638,016

20x3 772,000 PV of ₱1 @10%, n=3 0.751315 580,016

1,992,576

The recoverable amount is determined as follows:

Fair value less costs of disposal 1,600,000
Value in use 1,992,576
Recoverable amount (higher) 1,992,576
Impairment loss is computed as follows:
Recoverable amount 1,992,576
Carrying amount (2,400,000)
Impairment loss (407,424)

Illustrative Problem: Impairment Loss – Revaluation model

Information on LISTLESS WEAK Co.’s impaired building is shown below:

Carrying amount 3,200,000
Revaluation surplus 320,000
Fair value less costs of disposal 2,800,000
Value in use 2,720,000

Requirement: How much is the impairment loss?

Solution:
Recoverable amount (FVLCS – higher) ₱2,800,000
Carrying amount (3,200,000)
Excess over carrying amount (400,000)
Offset to revaluation surplus 320,000
Excess charged as Impairment loss (₱ 80,000)
Illustrative Problem: Intangible Asset with indefinite useful life
INSUPERABLE UNSURPASSABLE Co. determined that its trademark is impaired. INSUPERABLE
cannot estimate reliably the trademark’s fair value less costs of disposal. However, the following
information has been determined:

Carrying amount ₱520,000

Annual future cash flows from the trademark 40,000
Discount rate 10%

Requirement: How much is the impairment loss?

The recoverable amount or value in use is determined as follows:

Annual future cash flows from the trademark 40,000
Divide by: Discount rate 10%
Present value of indefinite cash flows (value in use) 400,000

Recoverable amount (value in use) ₱400,000

Carrying amount (520,000)
Impairment loss ₱120,000

When there is a series of indefinite cash flows, the present value is determined by simply dividing the
cash flows by the discount rate.

Cash-generating unit (CGU)

Cash-generating unit (CGU) is the smallest identifiable group of assets that generates cash inflows that
are largely independent of the cash inflows from other assets or groups of assets.

Impairment of individual assets included in a CGU

Assets whose recoverable amount can be determined reliably are tested for impairment individually.

Assets whose recoverable amount cannot be determined reliably (e.g., assets that do not generate their
own cash flows) are included in a CGU. The CGU is the one tested for impairment.

Allocating goodwill to CGU’s

For purposes of impairment testing, goodwill acquired in a business combination shall be allocated to
each of the acquirer’s CGU in the year of business combination.
Illustrative Problem: Allocation of Goodwill

At the end of 20x1, ABC Co. acquires Alpha Corp. for P10,000,000 Alpha has manufacturing plants in
three countries. Data at the end of 20x1 is shown below:
Fair Value of Identifiable Assets
Activities in Country #1 1,000,000
Activities in Country #2 3,000,000
Activities in Country #23 4,000,000
Total fair value of identifiable assets 8,000,000

Requirement: How much goodwill is allocated to each of the CGU’s?

Consideration Transferred P10,000,000

Fair Value of identifiable Assets Acquired (8.000,000)
Purchase goodwill P2,000,000

Goodwill is allocated as follows:

CGU Fair Values Fraction Allocation of Goodwill
Country #1 1,000,000 1/8 250,000
Country #2 3,000,000 3/8 750,000
Country #3 4,000,000 4/8 1,000,000
8,000,000 2,000,000

Impairment loss for a CGU

The impairment loss on a CGU shall be allocated

1. First, to any goodwill allocated to the CGU
2. Then, to the other assets of the unit pro rata on the basis of the carrying amount of each asset in the
unit.

Illustration Problem:
INSTIGATE PROVOKE Co. determined that one of its cash-generating units is impaired. Information on
the assets of the CGU is shown below:

Assets Carrying amount

Inventory 800,000
Investment property (at cost model) 1,600,000
Building 2,400,000
Goodwill 1,200,000
6,000,000

It was estimated that the value in use of the CGU is ₱3,600,000 and its fair value less costs of disposal is
₱2,400,000.
Requirement:
a. How much is the impairment loss?
b. How much is the carrying amount of the building after the impairment testing?

Solution: Impairment Loss

Impairment loss is computed as follows:

Recoverable amount (value in use – higher) ₱3,600,000
Carrying amount (6,000,000)
Impairment loss (₱2,400,000)

Solution: Limit on allocation of impairment loss

Allocation of Impairment
Assets Carrying amount Fraction Loss
Inventory N/A N/A -
Investment property 1,600,000 1,600/4,000 480,000
Building 2,400,000 2,400/4,000 720,000
4,000,000 4,000/4,000 1,200,000

Carrying amount (₱2,400,000)

Less: Allocation of Impairment Loss 720,000
Carrying amount of the building after the impairment testing 1,680,000

Reversal of Impairment loss

The increased carrying amount of an asset other than goodwill due to a reversal of an impairment loss
should not exceed the carrying amount that would have been determined (net of amortization or
depreciation) had no impairment loss been recognized for the asset in prior years.

Any increase in excess of this amount would be a revaluation and would be accounted for under the
appropriate Standard (e.g. PAS 16 for an item of property, plant and equipment).

d Recoverable amount on date of reversal

c CA if no impairment loss had been recognized previously

b CA on date of reversal

(d) – (c) = Reversal of impairment loss recognized in other comprehensive income

(c) – (b) = Reversal of impairment loss recognized in profit or loss
Illustrative Problem:

On January 1, 20x1, FALLACIOUS MISLEADING Co. acquired a building for ₱4,000,000. The asset is
depreciated using the straight-line method over an estimated useful life of 10 years.

On January 1, 20x6, the building was estimated to have a recoverable amount of ₱1,600,000.
Consequently, impairment loss was recognized on that date. There was no change in the estimated
useful life.

On January 1, 20x9, the building was estimated to have a new recoverable amount of ₱2,400,000 and a
remaining useful life of 3 years. The building is measured under the revaluation model.

Requirements:

a. How much of the impairment reversal is recognized in profit or loss?

b. How much of the impairment reversal is recognized in equity?

Solution: Impairment reversal is recognized in profit or loss

The carrying amount of the building on January 1, 20x9 is computed as follows:

Recoverable amount on January 1, 20x6 ₱1,600,000
Depreciation from 20x6 to 20x8 (400,000 x 3/5) ( 960,000)
Carrying amount on January 1, 20x9 ₱ 640,000

The carrying amount of the building on January 1, 20x9 had no impairment loss been
recognized previously is computed as follows:
Historical cost ₱4,000,000
Depreciation from 20x1 to 20x8 (4M x 8/10) ( 3,200,000)
Carrying amount on January 1, 20x9 (assuming no IL) ₱ 800,000

Recoverable amount - Jan.

2.4M 1, 20x9

CA had no IL recognized previously -

.8M Jan. 1, 20x9

.64M CA - Jan. 1, 20x9

Impairment loss recognized in profit or loss = (.8M - .64M) = ₱160,000

Solution: Impairment loss recognized in other comprehensive income (equity)

Recoverable amount - Jan. 1, 20x9 ₱2,400,000

Carrying amount on January 1, 20x9 (assuming no IL) 800,000
Impairment loss recognized in other comprehensive income (equity) ₱1,600,000

Video Reference:
https://www.youtube.com/watch?v=QDxjMZp8X4U
https://www.youtube.com/watch?v=SM8wSmpoNWA
https://www.youtube.com/watch?v=hj9GGHDRHk0