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What section of FRS 102 deals with accounting for impairment?
Section 27 of FRS 102 addresses accounting for impairment.
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What assets are within the scope of impairment under section 27 of FRS 102?
Section 27 applies to the impairment of assets and the recognition of impairment losses except for the following assets where impairment or changes in value are addressed separately:
- Assets arising from construction contracts (section 23 Revenue)
- Deferred tax assets (section 29)
- Assets arising from employee benefits (section 28)
- Financial assets within the scope of section 11 and section 12 (financial instruments)
- Investment property measured at fair value (section 16)
- Biological assets related to agricultural activity measured at fair value less estimated costs to sell (section 34)
- Deferred acquisition costs and intangible assets arising from contracts within the scope of FRS 103.
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What is an entity required to assess in relation to inventory when considering if it is impaired?
At the end of each reporting date, an entity should assess whether inventories are impaired. This should be done by comparing the carrying amount of each item of inventory (or group of similar items) with its selling price less costs to complete and sell.
If an item (or group of items) is impaired then the carrying amount of the inventory should be reduced to its selling price less costs to complete and sell, with the reduction recognised immediately in profit or loss.
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How should inventory that has previously been impaired be adjusted if at a later date the impairment no longer exists?
If, at a later reporting date, there is evidence that the previously recognised impairment no longer exists then the entity should reverse the amount of the impairment so that the new carrying amount is the lower of the original cost and revised selling price less costs to complete and sell. Any such adjustment should not cause the carrying value to exceed the original cost.
Example
ABC Limited manufactures footballs and held 10,000 units in stock at 31 December 2020. The original cost of these was €70,000 (€7 each per football). ABC Limited’s main customer XYZ Sports Retail Ltd decided to change supplier in December 2020 and ended its contract with ABC Limited (where they had an agreement to buy footballs at €10 per unit). ABC Limited therefore found itself with excess stock at the year end.
ABC Limited estimated that it could sell all of the footballs to a discount retailer but at a reduced price of €6.50 per unit. There would be an additional distribution cost of €0.50 per unit which ABC Limited would have to pay to fulfil the order. Therefore, at the year ended 31 December 2020, ABC Limited recognised an impairment loss as follows;
Carrying amount- €70,000
Minus Selling price less costs to complete and sell- €60,000
(10,000 units times €6)
Equals Impairment- €10,000
During 2021, the discount retailer only purchased 3,000 units of footballs but ABC Limited found a new customer willing to pay €9 per football. 7,000 units remained in stock at 31 December 2021 and the new customer agreed to bulk buy all of the footballs in January 2022, signing the contract in 2021.
At 31 December 2021, ABC Limited has an impairment to reverse as follows;
Carrying amount- €42,000
(being prior year carrying value of €60,000 less 3,000 units sold at a carrying value of €6)
December 2021 revised selling price less cost to complete €63,000
(being 7,000 units times €9 per unit)
As the estimated selling price less costs to complete now exceeds original cost, the inventory should be limited to the original cost as follows:
Original unit cost of €7 times 7,000 units = €49,000. Impairment reversal of €7,000 is recognised.
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When should assets, other than inventory, be impaired under Section 27 of FRS 102?
An entity should impair an asset (or cash generating unit) if, and only if, the recoverable amount (see below) of the asset is less than its carrying amount (see below).
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What is the “carrying amount” of an asset?
FRS 102 defines the “carrying amount” as follows;
“The amount at which an asset or liability is recognised in the statement of financial position”.
This is simply the value that it is recognised at on the balance sheet at the reporting date.
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What is the “recoverable amount” of an asset?
FRS 102 defines the “recoverable amount” as follows:
“The higher of an asset’s (or cash-generating unit’s) fair value less costs to sell and its value in use.”
Therefore in order to determine the recoverable amount, an entity is required to assess the value of the following (and use the higher amount for the purposes of establishing the “recoverable amount”).
Fair value less costs to sell
“The amount obtainable from the sale of an asset or cash-generating unit in an arm’s length transaction between knowledgeable, willing parties, less the costs of disposal. The best evidence of the fair value less costs to sell of an asset is a price in a binding sale agreement in an arm’s length transaction or a market price in an active market. If there is no binding sale agreement or active market for an asset, fair value less costs to sell is based on the best information available to reflect the amount that an entity could obtain, at the reporting date, from the disposal of the asset in an arm’s length transaction between knowledgeable, willing parties, after deducting the costs of disposal. In determining this amount, an entity considers the outcome of recent transactions for similar assets within the same industry.”
Value in Use
“The present value of the future cash flows expected to be derived from an asset or cash-generating unit.”
The present value calculation involves the following steps:
(a) estimating the future cash inflows and outflows to be derived from continuing use of the asset and from its ultimate disposal; and
(b) applying the appropriate discount rate to those future cash flows.
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What is a “cash generating unit”?
FRS 102 defines a cash generating unit (CGU) as follows;
“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”.
Where it is not possible to estimate the recoverable amount of an individual asset, an entity should assess the recoverable amount of the cash generating unit.
An example of a cash generating unit is a hotel. While a fixed asset register may contain hundreds of individual assets (i.e. Site, building, carpark, fixtures & fittings, etc), these assets are not income generating in their own right but when they come together they form a cash generating unit (i.e. the hotel).
Example
EO Limited is a car dealership group operating across Ireland and the UK. It has 20 car dealerships across both countries operating independently of each other. In this instance, EO may consider that the smallest identifiable group of assets that generates cash inflows largely independent of each other are each of the 20 car dealerships. In this instance, they could assess each of these CGUs for impairment.
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When and how should an impairment loss be recognised?
An impairment loss should be recognised if the recoverable amount (defined above) is less than its carrying amount. If this occurs, then the entity should reduce the carrying amount of the asset to its recoverable amount.
This impairment loss should be recognised immediately in profit or loss, unless the asset is carried at a revalued amount in accordance with another section of FRS 102 (eg. Property, plant and equipment held at a revalued amount). Any such impairment loss should be treated as a revaluation decrease in accordance with the section of FRS 102 to which it relates.
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What are impairment indicators?
Impairment indicators are factors or conditions that indicate an asset may be impaired. FRS 102 highlights the following indicators that should be considered at a minimum. Where an impairment indicator is present, the entity should estimate the recoverable amount of the asset. If there are no indicators present, it is not necessary to estimate the recoverable amount.
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“External sources of information
(a) During the period, an asset’s market value has declined significantly more than would be expected as a result of the passage of time or normal use.
(b) Significant changes with an adverse effect on the entity have taken place during the period, or will take place in the near future, in the technological, market, economic or legal environment in which the entity operates or in the market to which an asset is dedicated.
(c) Market interest rates or other market rates of return on investments have increased during the period, and those increases are likely to affect materially the discount rate used in calculating an asset’s value in use and decrease the asset’s fair value less costs to sell.
(d) The carrying amount of the net assets of the entity is more than the estimated fair value of the entity as a whole (such an estimate may have been made, for example, in relation to the potential sale of part or all of the entity).
Internal sources of information
(e) Evidence is available of obsolescence or physical damage of an asset.
(f) Significant changes with an adverse effect on the entity have taken place during the period, or are expected to take place in the near future, in the extent to which, or manner in which, an asset is used or is expected to be used. These changes include the asset becoming idle, plans to discontinue or restructure the operation to which an asset belongs, plans to dispose of an asset before the previously expected date, and reassessing the useful life of an asset as finite rather than indefinite.
(g) Evidence is available from internal reporting that indicates that the economic performance of an asset is, or will be, worse than expected. In this context economic performance includes operating results and cash flows.”.
Example
ABC Limited owns a hotel that it holds as property, plant and equipment. It’s carrying value is €10m. During the year, demand throughout the country fell for hotels due to a recession.
This scenario, would indicate that the impairment indicators marked (a) and (b) above are present and as a result ABC Limited should establish what the recoverable amount is (higher of fair value less costs to sell and value in use). If, following this, ABC Limited determines that the recoverable amount is less than the carrying value, then an impairment should be recognised in the financial statements.
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What should a value in use calculation include?
A value in use calculation should include;
(a) an estimate of the future cash flows the entity expects to derive from the asset;
(b) expectations about possible variations in the amount or timing of those future cash flows;
(c) the time value of money, represented by the current market risk-free rate of interest;
(d) the price for bearing the uncertainty inherent in the asset; and
(e) other factors, such as illiquidity, that market participants would reflect in pricing the future cash flows the entity expects to derive from the asset.
Estimates of cashflow should include the following:
(a) projections of cash inflows from the continuing use of the asset;
(b) projections of cash outflows that are necessarily incurred to generate the cash inflows from continuing use of the asset (including cash outflows to prepare the asset for use) and can be directly attributed, or allocated on a reasonable and consistent basis, to the asset; and
(c) net cash flows, if any, expected to be received (or paid) for the disposal of the asset at the end of its useful life in an arm’s length transaction between knowledgeable, willing parties.
Recent budgets or forecasts may be used to estimate future cashflows and any future projections should be based on a steady or declining growth rate unless an increasing rate can be justified.
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What should a value in use calculation not include?
Estimates of future cash flows should not include:
(a) cash inflows or outflows from financing activities; or
(b) income tax receipts or payments.
Estimates of future cash flows should not include cash inflows or outflows that are expected to arise from:
(a) a future restructuring to which an entity is not yet committed; or
(b) improving or enhancing the asset’s performance.
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Is a value in use calculation suitable for an asset held for service potential?
An asset held for service potential is an asset that is held for:
“The capacity to provide services that contribute to achieving an entity’s objectives. Service potential enables an entity to achieve its objectives without necessarily generating net cash inflows.”
An example of such an asset is a community centre that is held for the purposes of providing a public facility and not cash generation.
The standard recognises that a cash flow driven valuation (such as value in use) may not be appropriate and suggests that depreciated replacement cost may be a more suitable measurement model.
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How should an impairment of a cash generating unit be measured and recognised?
If the recoverable amount is less than the carrying amount then an impairment loss should be recognised. The impairment loss should be allocated to reduce the carrying amount of the assets of the cash generating unit in the following order (Section 27.21 - 27.22 of FRS 102);
“(a) first, to reduce the carrying amount of any goodwill allocated to the cash-generating unit; and
(b) then, to the other assets of the unit pro rata on the basis of the carrying amount of each asset in the cash-generating unit.
However, an entity shall not reduce the carrying amount of any asset in the cash-generating unit below the highest of:
(a) its fair value less costs to sell (if determinable);
(b) its value in use (if determinable); and
(c) zero.”
Any excess amount of the impairment loss that cannot be allocated to an asset because of the restriction above should be allocated to the other assets of the unit pro rata on the basis of the carrying amount of those other assets.
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Can I reverse an impairment loss for goodwill?
No - an impairment loss recognised for goodwill should not be reversed in a subsequent period.
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My entity impaired an individual asset in the prior year as its recoverable amount was less than its carrying value. In the current year there are indications that the previously recognised impairment no longer exists. What process must I follow to recognise the required impairment reversal?
Section 27.30 of FRS 102 sets out the requirements in relation to this as follows:
a. The entity should estimate the recoverable amount of the asset at the current reporting date.
b. If the estimated recoverable amount of the asset exceeds its carrying amount then the entity should increase the carrying amount to the recoverable amount.
i. This is subject to the limitation described in c below.
ii. The increase in carrying amount is a reversal of an impairment loss and this should be recognised immediately in profit or loss unless the asset is carried at a revalued amount (i.e. revaluation model for property, plant and equipment). Any reversal of an impairment loss of a revalued asset should be treated as a revaluation increase in accordance with the relevant section of FRS 102.
c. The reversal of an impairment loss should not increase the carrying amount of the asset above the carrying amount that would have been determined (net of depreciation or amortisation) had no impairment loss been recognised for the asset in prior years.
d. After a reversal of an impairment loss is recognised, the entity should adjust the depreciation or amortisation charge for the asset 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.
Example
DEF Limited produce craft beer and purchased brewing equipment for €200,000 in 2019. This equipment was classified as property, plant and equipment and depreciated over 10 years.
At year ended December 2020, the carrying value was €160,000. However, an impairment indicator was identified due to the reduction in an underlying market for the product lines that the company produced. Following an impairment review, the recoverable amount was calculated at €100,000. An impairment loss was charged to the P&L of €60,000 in year ended 31 December 2020.
During the year ended 31 December 2021, the market recovered significantly and the recoverable amount was estimated to be €150,000. DEF Limited is now in a position that it must recognise an impairment reversal as follows;
Carrying value at the end of 2021 is €87,500, (being value at the end of year 2020 of €100,000 less 1/8 years depreciation).
Recoverable amount €150,000
As outlined above, the entity must reverse the impairment loss, but only to the extent that it does not increase the carrying amount of the asset above the carrying amount that would have been determined had no impairment loss been recognised for the asset in prior years.
If no impairment had been charged, the carrying value would have been as follows:
Cost in 2019 - €200,000
Depreciation (assume full year) in 2019 (€20,000)
Depreciation in 2020 (€20,000)
Depreciation in 2021 (€20,000)
Carrying value without impairment €140,000
Therefore, an impairment reversal is required as follows:
Carrying value without impairment- €140,000
Carrying value before reversal - (€87,500)
Impairment reversal required €52,500.
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My entity impaired an asset that is part of a cash-generating unit in the prior year as its recoverable amount was less than its carrying value. In the current year there are indications that the previously recognised impairment no longer exists. What process must I follow to recognise the required impairment reversal?
Section 27.31 of FRS 102 sets out the requirements in relation to this as follows:
a. The entity should estimate the recoverable amount of the cash generating unit at the current reporting date;
b. If the estimated recoverable amount of the cash-generating unit exceeds its carrying amount, the excess is a reversal of an impairment loss. The entity should allocate the amount of that reversal to the assets of the unit, except for goodwill, pro rata with the carrying amount of those assets;
i. This is subject to the limitation described in c below
ii. The increases in carrying amount should be treated as reversals of impairment losses and recognised in profit or loss unless the asset is carried at a revalued amount (i.e. revaluation model for property, plant and equipment). Any reversal of an impairment loss of a revalued asset should be treated as a revaluation increase in accordance with the relevant section of FRS 102.
c. The reversal of an impairment loss for a cash generating unit should not increase the carrying amount of any asset in the unit above the lower of:
i. Its recoverable amount; and
ii. The carrying amount that would have been determined (net of depreciation or amortisation) had no impairment loss been recognised for the asset in prior years.
d. Any excess amount of the reversal of the impairment loss that cannot be allocated to an asset because of the restriction in c above should be allocated pro rata to the other assets of the cash-generating unit, except for goodwill.
e. After a reversal of an impairment loss, if applicable, the entity should adjust the depreciation or amortisation charge for each asset in the cash-generating unit 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.
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What disclosures are required for impairments under FRS 102?
Under full FRS 102, the following disclosures are required for each class of assets listed below:
- The amount of impairment losses recognised in profit or loss during the period and the line items in the P&L or SOCI that the impairment losses are included.
- The amount of impairment losses reversed in profit or loss during the period and the line items in the P&L or SOCI that the impairment losses are included.
The information required above should be disclosed under the following classes of asset:
- Inventories
- Property, plant and equipment (including investment property accounted for by the cost method)
- Goodwill
- Intangible assts other than goodwill
- Investments in associates
- Investments in joint ventures
The entity should also disclose a description of the events and circumstances that led to the recognition or reversal of the impairment loss.
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