Specific Provisions of IAS 36 – Impairment of assets and its implication on Financial Reporting due to COVID-19

What is the purpose behind IAS 36?

The purpose of IAS 36 is to ensure intangible assets, including goodwill, and tangible assets are not carried higher than its recoverable amount (defined later). Intangible assets, including goodwill, and tangible assets are generally carried at carrying value, i.e. historical cost adjusted by depreciation/amortisation and impairment provision provided in earlier years if any. To ensure prudent value of such assets, IAS 36 lays down provisions that these assets are carried at lower of carrying value or recoverable amount.

What is the scope of IAS 36?

IAS 36 applies to many assets recognised in the entity’s financial statements and include:

• Goodwill; 
• Intangible assets; 
• Property, plant and equipment; 
• Right-of-use assets; 
• Associates and joint ventures accounted for under the equity method; 
• Investment properties not measured at fair value; and;
• Costs to obtain or fulfil a contract recognised in accordance with IFRS 15, after applying the impairment requirements of IFRS 15.

IFRS 9 covers impairment provision for financial assets at amortised cost and debt instruments classified at fair value through OCI, lease receivables and contract assets. Other respective accounting standards cover impairment provisions for assets like inventories, deferred tax assets, assets arising from employee benefits and insurance contracts.

When to test assets for impairment?

IAS 36 requires goodwill, intangible assets with indefinite useful lives and intangible assets not yet available for use (e.g. capitalised research costs on incomplete intangible assets) to be tested at least annually for impairment and at the end of each reporting date when there is any indication of impairment (IAS 36.9-10). Other assets within the scope of IAS 36 are tested for impairment when indicators of impairment exist at the end of a reporting period.

Timing of impairment testing within the scope of IAS 36 for impairment

At what level impairment test is performed and the concept of Cash-Generating Units (“CGU”)?

If an impairment assessment is required, one of the first tasks will be to identify the individual assets affected and if those assets do not have individually identifiable and independent cash inflows, to divide the entity into CGUs. The group of assets that are considered together should be as small as is reasonably practicable, i.e. the entity should be divided into as many CGUs as possible, and an entity must identify the lowest aggregation of assets that generate largely independent cash inflows (IAS 36.6, 68).

Example of assets that are unlikely to generate independent cashflow are brands, customer relationships, trademarks and right of use assets recorded under IFRS 16.

How carrying value of CGU is determined?

After an entity has established its CGU(s) for the impairment assessment, it needs to determine the carrying amount of the CGU(s). The carrying amount must be determined on the basis that is consistent with the way in which the recoverable amount is determined (IAS 36.75).

The carrying amount of a CGU includes only those assets that can be attributed directly or allocated on a reasonable and consistent basis.

The standard emphasises the importance of completeness in the allocation of assets to CGUs. Every asset used in generating the cash flows of the CGU being tested must be included in the CGU; otherwise, an impaired CGU might appear to be unimpaired, as its carrying value would be understated by having missed out assets (IAS 36.77).

How recoverable amount carrying is determined?

Recoverable amount is the higher of fair value less cost of disposal (FVLCD) and value in use (VIU). IAS 36 defines VIU as the present value of the future cash flows expected to be derived from an asset or CGU. FVLCD is the fair value as defined in IFRS 13 – Fair Value Measurement, the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, less the costs of disposal (IAS 36.6).

What is the importance of discount rates in VIU and FVLCOD?

VIU calculations will always require a discount rate to be used and, if FVLCOD is estimated using a discounted cash flow (‘DCF’) model, then discount rate considerations will apply to both. The following points should be noted in relation to discount rates and DCF models used in IAS 36:

• Discount rates are not entity-specific; they reflect the current market assessment of the time value of money and the risks specific to the assets (IAS 36.55). The rate should represent what market investors would require when choosing an equally risky investment, resulting in the use of a rate which is determined based on the rate implicit in current market transactions for similar assets, or from the weighted average cost of capital of a listed entity that has a single asset (or portfolio of assets) similar in terms of service potential and risk to the asset (or CGU) under review (IAS 36.56); and 
• Discount rates do not reflect risks for which the future cash flows have already been adjusted or else the risks are ‘double-counted’ (IAS 36.A18). 

In our opinion effects of COVID-19 on respective entities to be considered on case to case bases. However, the effects of the COVID-19 outbreak are expected to have comparative less impact on impairment of financial and non-financial assets when entities are reporting on years ending on or before December 31, 2019. Consequently, forecasts, projections, and valuations for impairment calculations as at December 31, 2019 will need to be carefully reviewed to ensure that significant events related to the COVID-19 outbreak are not being incorporated in hindsight. However, if these estimates are expected to change significantly due to the factors brought on by COVID-19 after year end, additional disclosures should be considered.

In periods ended after the outbreak of COVID-19, the impact on future cash flow projections used in impairment testing will need to be considered.

Impairment testing requirement

As mentioned above all assets, except goodwill, intangible assets with indefinite useful lives and intangible assets not yet available for use, are tested in case if impairment indicators exist at the reporting date. COVID-19 will trigger many of the indicators of impairment noted in IAS 36.12(a)-(h) such as decline in quoted asset values, operational disruptions to supply chains, and decreases in revenue and profitability. Hence, testing of these assets for impairment will become more pervasive

Impact of COVID-19 on entities reporting interim results

Entities that prepare interim financial statements may need to prepare impairment calculations on assets within the scope of IAS 36 more regularly. For multiple reporting dates as impairment, indicators may exist at multiple dates despite minimum requirement (i.e. annual test) having already been carried out earlier.

Impact of COVID-19 on discount rate

In general, the discount rates should not reflect the risk of cash flow. However, an appropriate discount rate in a VIU calculation with multiple scenarios may still increase discount rate compared to previous impairment calculations, as market investors may require higher returns to accept risks in those various scenarios that are not wholly entity-specific (e.g. risks related to a particular industry sector).  

Impact of COVID-19 on best estimate cashflow projection vs multiple scenarios in a DCF model

Additionally, entities may have previously used a single, best estimate cash flow projection in their DCF models. Such an approach may have been appropriate when the variability in future cash flows was low, or the risks inherent in the cash flows could be appropriately captured in the discount rate used. Given the high level of uncertainty that COVID-19 creates, entities may be required to consider multiple scenarios in a DCF model, each of which are probability-weighted. The expected cash flow approach, which uses multiple, probability-weighted cash flow projection is permitted (IAS 36.A4-A14) and not a new approach as per under IAS 36.  

For example, consider an entity that operates several restaurants, some of which are traditional ‘sit down’ dining, while others are primarily focused on delivery. Depending on the length of mandated cessation of operations by governments and the enduring caution of consumers to visit restaurants in the future, it will need to forecast multiple scenarios in its DCF models. An illustration of this follows:

IAS 36 – INTERACTION WITH IAS 34 AND IFRIC 10 

For entities that prepare interim financial statements in accordance with IAS 34, several specific points should be noted. IAS 34, Interim Financial Reporting requires the same accounting policies to be applied in interim financial statements as annual financial statements, and the frequency of an entity’s reporting should not affect the measurement of results in either an annual or an interim financial statement. For example, impairment recorded relating to property, plant and equipment in an interim financial statement may be reversed in subsequent interim or annual financial statements, as IAS 36 permits such a reversal. However, there is an exception because IFRIC 10, Interim Financial Reporting and Impairment requires that no such reversal may occur for goodwill, as IAS 36 does not permit an impairment recorded against the value of goodwill to be reversed.   

If indicators of impairment exist for CGUs that contain goodwill, then goodwill will need to be tested for impairment at an interim period reporting date, even if that does not align with the annual testing cycle for goodwill. IAS 36.9 requires an impairment test to be carried out at the end of any reporting period if there is any indication that an asset may be impaired. For a CGU that contains goodwill, any impairment is allocated first to goodwill and then pro-rata to other assets based on their carrying amounts. 

Additionally, if goodwill should have been impaired in an interim financial statement (e.g. a half-year or quarterly financial statement) due to the above-noted interaction between IAS 34, IAS 36 and IFRIC 10, then this will affect the next annual financial statements. Said another way, if goodwill was impaired in an interim financial statement, but it should not have been impaired if the impairment test had been performed at the annual reporting end (e.g. if conditions had improved by the year-end period), that impairment should be carried in annual financial statement.