Professional Documents
Culture Documents
Impairment Test in Covid-19
Impairment Test in Covid-19
Articles
Standards
IFRS and Other Courses
Our Services
Contact Us
My Account
Pandemic entered into our lives in early 2020 and we all must admit it – this was totally new
experience, since only older generations can remember similar situation.
Yes, it was and still is hard for all of us.
The pandemic affects (almost) every single aspect of our private and business lives.
Let me bring up one special consideration that you must make prior completing the closing of
your 2020 accounts – impairment of assets under IAS 36.
With strong governmental measures to prevent the virus spread, it may well happen that
the value of your assets is overstated and you have some impairment in fact.
Just look around you – many businesses are closed, people almost stopped travelling and
limited spending, and we can continue listing many affected economic areas.
So what to do?
Let’s focus on all non-financial assets under the scope of IAS 36.
For most of them, you should perform the impairment test ONLY if indicator of impairment
exists.
Special For You! Have you already checked out the IFRS Kit ? It’s a full IFRS learning
package with more than 40 hours of private video tutorials, more than 140 IFRS case studies
solved in Excel, more than 180 pages of handouts and many bonuses included. If you take
action today and subscribe to the IFRS Kit, you’ll get it at discount! Click here to check it
out!
Specifically in the pandemic situation, I would say that most common indicators are as
follows:
I. Limitations to PRODUCE
Here, any factors somehow limiting the ability of your company to produce goods or services
and thus complete your operational cycle belong, for example:
Here, any factors somehow limited the ability of your company to distribute and/or sell your
goods and services to the end customers fall, for example:
Here, I would categorize the broader situation on the main markets, for example decline in
market prices of shares can trigger lower market capitalization and that can be the indicator
of an impairment of goodwill.
However, I need to point out here, that at the time of writing this article, the situation looks
very unexpectedly – despite decrease in profitability, market prices of shares and similar
assets reach their all time highs.
I am not an investment adviser or expert in trading, but to me this seems very
counterintuitive, maybe some sell-off or bigger correction is behind the door (then watch out
for the indicator of impairment).
Just follow what FED and other central banks do and learn basics of MMT (modern monetary
theory) – anyway, it is out of scope of this topic, so I will leave you with some thought to
consider yourself.
If any of these indicators are present in your business, then you should go and perform the
impairment test.
And, you HAVE to perform impairment test on goodwill and certain intangibles regardless
the factors above.
By now you should have implemented IFRS 16 Leases, as it was mandatory from 1 January
2019.
As a result, you might have seen new assets in your balance sheet – ROU (right-of-use)
assets.
Some of ROU assets were not in the balance sheet before IFRS 16, especially if you had
operating leases with all expenses recognized straight in profit or loss.
Yes, unfortunately the combined effect of IFRS 16 and pandemic is the need to perform even
greater volume of impairment testing.
Special For You! Have you already checked out the IFRS Kit ? It’s a full IFRS learning
package with more than 40 hours of private video tutorials, more than 140 IFRS case studies
solved in Excel, more than 180 pages of handouts and many bonuses included. If you take
action today and subscribe to the IFRS Kit, you’ll get it at discount! Click here to check it
out!
On the other note – if you add ROU asset to cash-generating unit (CGU), it will NOT in
general change CGU’s fair value, but it will change CGU’s carrying amount, hence there is a
potential impairment.
How to perform the impairment test
Let me just remind the basics to you very basics of the impairment loss calculation.
That is – assess whether the company will be able to survive the next 12 months after the
end of the reporting period.
The closure of businesses and complete loss of revenues can have devastating effect on the
business itself and it is absolutely crucial to assess the ability to survive.
Yes, government may promise compensations, but really – are you going to get them on
time?
Will you be able to pay the salaries of your employees from own source of cash without
reliance on government? Or will you be forced to lay off some people? Will this lay off
jeopardize the ongoing future operations?
But these are very frustrating and stressful times, so we must critically and realistically think
about them.
Let’s say you assess that you are no longer going concern – here’s what you should do.
If you are still a going concern (able to survive), then let me come up with a few
considerations related to two critical amounts in the impairment test.
You should follow the standard IFRS 13 Fair Value Measurement to determine the
asset’s fair value;
This measure is NOT an entity-specific, but reflects the current market conditions.
Examine the general price level and the prices of similar/identical assets on the
market if available – did they go up or down?
However, most companies performing the impairment test will focus on determining value
in use as in many cases, the market information about the specific asset is not available.
Value in use
Value in use is basically the present value of cash flows that you expect to derive from the
asset under review (or cash-generating unit).
Here, the main challenge is to think of cash flows from your asset and make appropriate
cash flow projections.
You can learn more about setting cash flow projections for impairment testing here and see
the example here.
For this reason, you should consider multiple scenarios in your projections with probabilities
of occurrence as weights, NOT single scenario.
In your cash flow projections, you should particularly consider the things, like:
Effect of government measures to prevent the spread – closures and their length,
severity of closures, limitations on operational capacity…
Increased cost of operations – you might need to purchase new hygienic tools, hire
new medical personnel…
Expected compensations of lost revenue by government, if any
Strength of your competitors – will they survive?
Changed demand on the market – if you are a food producer, you are perhaps OK as
everyone needs to eat. But, if you run an airline…
Now, let me give you a short illustration of calculating value in use (inspired by the reality in
our country):
Let’s say your government monitors the situation with the spread of the virus and makes
short-term plans of closure of non-essential businesses.
You run a network of fitness centers and as of 31 October 2020, they had been closed for 4
weeks already and the government plans to reopen them depending on the infection cases.
Based on previous experience over past 4-5 months, you can reasonably assume the
following:
In a best-case scenario, the government will re-open the fitness centers right after 1
January 2021, however, the maximum number of visitors is limited to 50% of
capacity. You will be able to return to the full capacity only after the vaccine is
available and at least 60% of people take it – which is not probable before the year
2022. The probability is 20%.
In a neutral scenario, the government will re-open the fitness centers on 1 March
2021, when the vaccine and/or cure is available. However, you assume here that there
will be restrictions and condition for people to visit the centers and as a result, you
will still operate 50% capacity until the end of 2021. The probability is 70%.
In a worst-case scenario, the government will re-open the fitness centers only after
60% of people takes the vaccine, which will not happen before 2022. The probability
is 10%.
Additional information:
Average monthly revenue of your network is CU 70 000, average monthly fixed costs
are CU 35 000, average monthly variable costs are CU 15 000;
The government promised a compensation of 20% of lost revenue as a result of
complete closure and you are reasonable sure that you are entitled to it.
Special For You! Have you already checked out the IFRS Kit ? It’s a full IFRS learning
package with more than 40 hours of private video tutorials, more than 140 IFRS case studies
solved in Excel, more than 180 pages of handouts and many bonuses included. If you take
action today and subscribe to the IFRS Kit, you’ll get it at discount! Click here to check it
out!
The following table sums up using multiple-case scenario for cash flow projection for 2021.
In reality, you should split the calculation to individual cash-generating units, but let’s keep it
simple here and illustrate using of multiple scenarios in discounted cash flow models:
Worst-case
Cash flow Best-case scenario Neutral scenario
scenario
0
Compensation from 28 000 168 000
(no complete closure in
government (20%*2*70 000) (20%*12*70 000)
2021)
Thus, the expected value of net cash flows in 2021 based on multiple scenarios is – 125
100 (-18 000-81 900-25 200).
You would still need to make cash flow projections for the next 4 years, add terminal value
and then calculate value in use.
A few notes:
Forecast period:Remember not to project your cash flows for more than 5 years.
Terminal value: This is the estimate of the cash flows that you would get from the
asset or CGU beyond forecasted period of 5 years. Learn more here and here. Bear in
mind that if there is a sharp decline in market prices, that can hugely affect your
terminal value.
Discount rate: Use the same discount rate for each scenario. The reason is that if you
use different discount rates, these would reflect the same risks as were reflected in the
cash flow projections and you would be double counting.
Restructurings: I can’t stress this enough – do NOT include the costs and revenues
being the effects of future restructurings to which your company has not been
committed!
Market information and statistics: If you ever need to use certain market data or
statistics in your forecasts or cash flow projections, there are many sources, both paid
and free. I can only recommend the free source, website by Professor Damodaran,
loads of valuable data and free knowledge there.
Finally…
Do not forget loads of disclosures related to impairment test to describe uncertainties
you are facing, probabilities, weighting, assumptions, how you determined discount
rate, etc.
I would love to hear from you – has your business been affected by Covid-19? Will
you perform the impairment test at the year-end? Please let me know in the comments
below. Thank you!
Tags In
IAS 16 IAS 36
JOIN OUR FREE