Theory of Accounts

L. R. Cabarles
ToA.112_Impairment of Assets

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ToA.111

Theory of Accounts

L. R. Cabarles
LECTURE NOTES

Key Definitions
Impairment: An asset is impaired when its carrying amount exceeds its recoverable amount.
Carrying amount: the amount at which an asset is recognized in the statement of financial position after deducting
accumulated depreciation and accumulated impairment losses
Recoverable amount: The higher of an asset's fair value less costs to sell and its value in use:
Fair value less costs to sell: The amount obtainable from the sale of an asset or cash generating unit in an arms length
transaction between knowledgeable willing parties, less costs of disposal.
Costs of disposal: Incremental costs directly attributable to the disposal of an asset or cash-generating unit, excluding
finance costs and income tax expense.
Value in use: The discounted present value of estimated future cash flows expected to arise from:

the continuing use of an asset, and from

its disposal at the end of its useful life.

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.
Indications of Impairment
External sources:

market value declines

negative changes in technology, markets, economy, or laws

increases in market interest rates

company stock price is below book value

Internal sources:

obsolescence or physical damage

asset is part of a restructuring or held for disposal

worse economic performance than expected

These lists are not intended to be exhaustive. Also, must consider materiality. Further, an indication that an asset may be
impaired may indicate that the asset's useful life, depreciation method, or residual value may need to be reviewed and
adjusted.
Determining Recoverable Amount

If fair value less costs to sell or value in use is more than carrying amount, it is not necessary to calculate the other
amount. The asset is not impaired.
If fair value less costs to sell cannot be determined, then recoverable amount is value in use.
For assets to be disposed of, recoverable amount is fair value less costs to sell.

Fair Value Less Costs to Sell

If there is a binding sale agreement, use the price under that agreement less costs of disposal.
If there is an active market for that type of asset, use market price less costs of disposal. Market price means current
bid price if available, otherwise the price in the most recent transaction.
If there is no active market, use the best estimate of the asset's selling price less costs of disposal.
Costs of disposal are the direct added costs only (not existing costs or overhead).

Value in Use
The calculation of value in use should reflect the following elements:

an estimate of the future cash flows the entity expects to derive from the asset in an arm's length transaction;
expectations about possible variations in the amount or timing of those future cash flows;
the time value of money, represented by the current market risk-free rate of interest;
the price for bearing the uncertainty inherent in the asset; and
other factors, such as illiquidity, that market participants would reflect in pricing the future cash flows the entity
expects to derive from the asset.

Cash flow projections should be based on reasonable and supportable assumptions, the most recent budgets and
forecasts, and extrapolation for periods beyond budgeted projections. PAS 36 presumes that budgets and forecasts
should not go beyond five years; for periods after five years, extrapolate from the earlier budgets. Management should
assess the reasonableness of its assumptions by examining the causes of differences between past cash flow projections
and actual cash flows.

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L. R. Cabarles

Cash flow projections should relate to the asset in its current condition future restructurings to which the entity is not
committed and expenditures to improve or enhance the asset's performance should not be anticipated.
Estimates of future cash flows should not include cash inflows or outflows from financing activities, or income tax receipts
or payments.
Discount Rate
In measuring value in use, the discount rate used should be the pre-tax rate that reflects current market assessments of
the time value of money and the risks specific to the asset.
The discount rate should not reflect risks for which future cash flows have been adjusted and should equal the rate of
return that investors would require if they were to choose an investment that would generate cash flows equivalent to
those expected from the asset.
For impairment of an individual asset or portfolio of assets, the discount rate is the rate the company would pay in a
current market transaction to borrow money to buy that specific asset or portfolio.
If a market-determined asset-specific rate is not available, a surrogate must be used that reflects the time value of
money over the asset's life as well as country risk, currency risk, price risk, and cash flow risk. The following would
normally be considered:

the entitys own weighted average cost of capital;

the enterprise's incremental borrowing rate; and

other market borrowing rates.

Recognition of an Impairment Loss

An impairment loss should be recognized whenever recoverable amount is below carrying amount.
The impairment loss is an expense in the income statement (unless it relates to a revalued asset where the value
changes are recognized directly in equity).
Adjust depreciation for future periods.

Cash-Generating Units
Recoverable amount should be determined for the individual asset, if possible.
If it is not possible to determine the recoverable amount (fair value less cost to sell and value in use) for the individual
asset, then determine recoverable amount for the asset's cash-generating unit (CGU). The CGU is the smallest
identifiable group of assets:

that generates cash inflows from continuing use, and

that are largely independent of the cash inflows from other assets or groups of assets.
The impairment loss is allocated to reduce the carrying amount of the assets of the unit (group of units) in the following
order:

first, reduce the carrying amount of any goodwill allocated to the cash-generating unit (group of units); and

then, reduce the carrying amounts of the other assets of the unit (group of units) pro rata on the basis of the carrying
amount of each asset in the unit (group of units).
The carrying amount of an asset should not be reduced below the highest of:

its fair value less costs to sell (if determinable);

its value in use (if determinable); and

zero.
If the preceding rule is applied, further allocation of the impairment loss is made pro rata to the other assets of the unit
(group of units).
Reversal of an Impairment Loss

Same approach as for the identification of impaired assets: assess at each balance sheet date whether there is an
indication that an impairment loss may have decreased. If so, calculate recoverable amount.
No reversal for unwinding of discount.
The increased carrying amount due to reversal should not be more than what the depreciated historical cost would
have been if the impairment had not been recognized.
Reversal of an impairment loss is recognized as income in the income statement.
Adjust depreciation for future periods.

Impairment of Goodwill
Goodwill should be tested for impairment annually.
To test for impairment, goodwill must be allocated to each of the acquirer's cash-generating units, or groups of cashgenerating units, that are expected to benefit from the synergies of the combination, irrespective of whether other assets
or liabilities of the acquiree are assigned to those units or groups of units. Each unit or group of units to which the
goodwill is so allocated shall:

represent the lowest level within the entity at which the goodwill is monitored for internal management purposes; and

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Theory of Accounts

L. R. Cabarles

not be larger than a segment based on either the entity's primary or the entitys secondary reporting format
determined in accordance with PAS 14 Segment Reporting.

A cash-generating unit to which goodwill has been allocated shall be tested for impairment at least annually by comparing
the carrying amount of the unit, including the goodwill, with the recoverable amount of the unit:

If the recoverable amount of the unit exceeds the carrying amount of the unit, the unit and the goodwill allocated to
that unit is not impaired.

If the carrying amount of the unit exceeds the recoverable amount of the unit, the entity must recognize an
impairment loss.
The impairment loss is allocated to reduce the carrying amount of the assets of the unit (group of units) in the following
order:

first, reduce the carrying amount of any goodwill allocated to the cash-generating unit (group of units); and

then, reduce the carrying amounts of the other assets of the unit (group of units) pro rata on the basis of the carrying
amount of each asset in the unit (group of units).
The carrying amount of an asset should not be reduced below the highest of:

its fair value less costs to sell (if determinable);

its value in use (if determinable); and

zero.
If the preceding rule is applied, further allocation of the impairment loss is made pro rata to the other assets of the unit
(group of units).
Reversal of an Impairment Loss
Reversal of an impairment loss for goodwill is prohibited.
Disclosure
For

each class of asset an entity shall disclose

Impairment losses recognized in profit or loss
Impairment losses reversed in profit or loss
The line item in profit or loss in which the impairment losses are included

Additionally, any impairment losses recognized in other comprehensive income should be disclosed, including reversals of
impairment losses.
Each segment should disclose these items for each reportable segment: impairment losses recognized and reversed in the
period both in profit or loss and in other comprehensive income.
If an individual impairment loss or reversal is material, then this information should be disclosed:

The events and circumstances leading to the impairment loss.

The amount of the loss.

If it relates to an individual asset, the nature of the asset and the segment to which it relates.

For a cash-generating unit, the description of the amount of the impairment loss or reversal, by class of asset and
segment should be disclosed.

If the recoverable amount is fair value less costs to sell, the basis for determining fair value must be disclosed.

If the recoverable amount is the value-in-use, the discount rate should be disclosed.
If the impairment losses recognized or reversed are material in relation to the financial statements as a whole, the main
classes of assets affected should be disclosed and the main events and circumstances that lead to the recognition of those
losses should be disclosed.

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Theory of Accounts

L. R. Cabarles
MULTIPLE CHOICE QUESTIONS

1. It is a fall in the market value of an asset so that its

recoverable amount is now less than its carrying
amount in the balance sheet.
a. Impairment
b. Depreciation
c. Amortization
d. Decline in value

9. Costs of disposal are deducted in determining fair value

less cost to sell. Examples of disposal costs include all
of the following, except
a. Legal costs
b. Stamps and similar transactions taxes
c. Costs of removing the asset
d. Finance costs

2. Which of the following statements best describes the

term impairment loss?
a. The removal of an asset from an entitys statement
of financial position.
b. The amount by which the carrying amount of an
asset exceeds its recoverable amount.
c. The systematic allocation of an assets cost less
residual value over its useful life.
d. The amount by which the recoverable amount of an
asset exceeds its carrying amount.

10. Value in use of an asset is equal to the

a. Undiscounted future net cash flows from the use of
the asset
b. Undiscounted future net cash flows from the use
and eventual disposition of the asset
c. Discounted future net cash flows from the use of
the asset
d. Discounted future net cash flows from the use and
eventual disposition of the asset

3. What is the recoverable amount of an asset?

a. Fair value less cost to sell
b. Value in use
c. Fair value less cost to sell or value in use,
whichever is higher
d. Fair value less cost to sell or value in use,
whichever is lower
4. Carrying amount is the
I. Amount at which an asset is recognized in the
balance sheet after deducting any accumulated
depreciation and accumulated impairment loss
II. Cost of an asset or other amount substituted for
cost in the financial statements less its residual
value.
a. I only
b. II only
c. Both I and II
d. Neither I nor II
5. Fair value less cost to sell is the
I. Amount obtainable from the sale of an asset in
arms length transaction between knowledgeable,
willing parties, less cost of disposal.
II. Present value of estimated future cash flows
expected to arise from the continuing use of an
asset and from its disposal at the end of its useful
life.
a. I only
c. Both I and II
b. II only
d. Neither I nor II
6. What is the best evidence of fair value less cost to sell?
a. Sales price in a binding sale agreement in an arms
length transaction
b. Market value or fair value in an active market
c. Best estimate of knowledgeable, willing parties in
an arms length transaction
d. Sales price in a binding sale agreement in an arms
length transaction or fair value in an active market,
whichever is higher
7. If the fair value less costs to sell cannot be determined
a. The asset is not impaired
b. The recoverable amount is the value-in-use
c. The net realizable value is used
d. The carrying value of the asset remains the same
8. If assets are to be disposed of
a. The recoverable amount is the fair value less costs
to sell
b. The recoverable amount is the value-in-use
c. The asset is not impaired
d. The recoverable amount is the carrying value

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11. Which of the following is not relevant in determining a

noncurrent assets value in use?
a. The expected future cash flows from the asset.
b. The carrying amount of the asset.
c. Expectation about possible variation in the amount
and timing of future cash flows.
d. The time value of money.
12. The estimates of future cash flows in calculating value
in use should include all of the following, except
a. Cash inflows from the continuing use of the asset
b. Cash outflows incurred to generate the cash inflows
from the continuing use of the asset
c. Net cash flows from the disposal of the asset at the
end of its useful life
d. Future costs of improving or enhancing the assets
performance
13. When deciding on the discount rate to be used, which
factors should not be taken into account?
a. The time value of money.
b. Risks specific to the asset for which future cash
flow estimates have not been adjusted.
c. Risks specific to the asset for which future cash
flow estimates have been adjusted.
d. Pretax rate.
14. Which statement is incorrect concerning the estimation
of future cash flows?
a. Future cash flows shall be based on reasonable and
supportable assumptions.
b. Future cash flows shall be on the most recent
budgets or financial forecasts, usually up a
maximum of 5 years.
c. Foreign currency future cash flows shall be forecast
in the currency in which they will arise and will be
discounted using a rate appropriate to the entity.
d. The discount rate used in estimating future cash
flows shall be the current rate after tax.
15. Which
statement
is
incorrect
concerning
the
recognition and measurement of an impairment loss?
a. If the recoverable amount of an asset is less than
its carrying amount, the carrying amount of the
asset shall be reduced to its recoverable amount.
b. Impairment loss is te amount by which the carrying
amount of an asset exceeds its recoverable
amount.
c. An impairment loss shall be recognized in profit or
loss immediately.
d. After the recognition of an impairment loss,
depreciation charge for the future periods shall be
adjusted to allocate the revised carrying amount,
less its residual value, on a systematic basis over
its original useful life.

Theory of Accounts

L. R. Cabarles

16. An impairment loss that relates to an asset that has

been revalued shall be recognized in
a. Profit or loss
b. Revaluation surplus that relates to the revalued
asset
c. Opening retained earnings
d. Any reserve in equity
17. It is the smallest identifiable group of assets that
generate cash inflows from continuing use that are
largely independent of the cash inflows from other
assets or group of assets.
a. Cash generating unit
b. Goodwill
c. Corporate asset
d. The enterprise as a whole
18. When impairment testing a cash generating unit, any
corporate assets, such as the head office business or
computer equipment shall
a. Be allocated on a reasonable and consistent basis.
b. Be separately impairment tested.
c. Be included in the head office assets or parents
assets and impairment tested along with that cash
generating unit.
d. Not be allocated to cash generating units.
19. Which statement is incorrect concerning corporate
assets?
a. Corporate assets are group or divisional assets
such as head office building, EDP equipment or a
research center.
b. Essentially, corporate assets generate cash inflows
independently from other assets.
c. The recoverable amount of an individual corporate
asset cannot be determined unless management
has decided to dispose of the asset.
d. If there is an indication that a corporate asset may
be impaired, the recoverable amount of the cash
generating unit to which the corporate asset
belongs is determined and compared with the
carrying amount of the cash generating unit.
20. Which is incorrect concerning the reversal of an
impairment loss?
a. The reversal of the impairment loss should be
recognized immediately as an adjustment of the
opening balance of retained earnings.
b. The carrying amount of the asset should be
increased to its new recoverable amount.
c. The increased carrying amount of the asset due to
a reversal of an impairment loss should not exceed
the carrying amount that would have been
determined had no impairment loss been
recognized in the prior years.
d. Any reversal of an impairment loss on a revalued
asset should be treated as a revaluation increase.
21. What is the allocation of an impairment loss recognized
for a cash generating unit.
a. Across the assets of the unit based on carrying
amount.
b. Across the assets of the unit based on fair value.
c. First, to any goodwill, and the balance to the other
assets on a prorata basis based fair value.

d.

22. An entity is considering whether to apply an

impairment test to an individual asset or to the cash
generating unit to which that asset belongs. Which
statement is true?
I. If the individual asset does not generate cash
inflows that are largely independent of those from
other assets, then the cash generating unit shall be
identified.
II. If the individual asset generates an insignificant
proportion of the cash inflows of the entity as a
whole, then the cash generating unit shall not be
identified..
a. I only
c. Both I and II
b. II only
d. Neither I nor II
23. Recovery of impairment is recognized for all the
following except
a. Patent held for sale.
b. Patent held for use.
c. Trademark.
d. Goodwill.
24. All of the following are true regarding recovery of
impairments for intangible assets except:
a. After a recovery of impairment has been
recognized, the carrying value of the asset
reported on the statement of financial position will
be the higher of the fair value less cost to sell or
the value-in-use.
b. No recovery of impairment is allowed for Goodwill.
c. A recovery of impairment will be reported in the
"Other income and expense" section of the income
statement.
d. The amount of the recovery is limited to the
carrying value of the asset that would have been
reported had no impairment occurred.
25. The internal sources of information indicating possible
impairment include all of the following, except
a. Evidence of obsolescence or physical damage of an
asset
b. Significant change in the manner or extent in which
the asset is used with an adverse effect on the
enterprise
c. Evidence that the economic performance of an
asset will be worse than expected
d. Significant decrease or decline in the market value
of the asset
26. In relation to the impairment of assets, PAS 36
Impairment of Assets, requires the following
disclosures for each class of assets:
I. The line of the income statement in which
impairment losses are included.
II. The amount of reversals of impairment losses
during the period.
III. The amount of impairment losses recognized
directly in equity.
IV. The beginning and ending balances of any
provision for impairment account.
a. I, .II, III and IV;
b. I, II and III only;
c. II and IV only.
d. IV only.

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First, to any goodwill, and the balance to the other

assets on a prorata basis based on carrying
amount.