ImpairmentIAS (International Accounting Standard) 36 Impairment of Asset as issued at 1 January 2012. The term impairment is usually associated with a long-lived asset that has a market which has decreased significantly. For example, a meat packing plant may have recently spent large amounts for capital expenditures and then experienced a dramatic drop in the plants value due to business and community conditions.If the undiscounted future cash flows from the asset (including the sale amount) are less than the assets carrying amount, an impairment loss must be reportedIf the impairment loss must be reported, the amount of the impairment loss is measured by subtracting the assets fair value from its carrying value.The credit crisis starting in late 2008 has affected many financial and nonfinancial institutions. As a result of the global slump, many companies are considering write-offs of some of their long-lived assets. These write-offs are referred to as impairments.Various events and changes in circumstances might lead to an impairment. Examples are: A significant decrease in the fair value of an asset A significant change in the extent or manner in which an asset is used. A significant adverse change in legal factors or in the business climate that affects the value of an asset. A accumulation of costs significantly in excess of the amount originally expected to acquire or construct an asset. A projection or forecast that demonstrates continuing losses associated with an assetThese events or changes in circumstances indicate that the company may not be able to recover the carrying amount of the asset. In that case, recoverability test is used to determine whether an impairment has occurred. IAS 36 Impairment of Assets (the standard) sets out the requirements to account for and report impairment of most-financial assets. IAS 36 specifies when an entity needs to perform an impairment test, how to perform it, the recognition of any impairment losses and the related disclosures. Having said that, the application of IAS 36 is wide and its requirement may be open to interpretation.The recent economic uncertainty has thrown a spotlight on impairment. As such, many entities have decided to reassess their impairment testing processes, models and assumptions.Impairment principle and key requirementsIAS 36 deals with impairment testing for all tangible and intangible assets, except for assets that are covered by other IFRS.IAS 36 requires that assets can be carried at no more than their recoverable amount. To meet this objective, the standard requires entities to test all assets that are within its scope for potential impairment when indicators of impairment exist or, at least, annually for goodwill and intangible assets with indefinite useful lives.Diagram 1 illustrates the process for measuring and recognizing impairment loss under IAS 36. Some of the components in the diagram are discussed in more detail in the sections below.Key requirements of IAS 36 illustrated in diagram 1The entity assesses, at each reporting date, whether there is any indication that an asset may be impaired If there is an indication that an asset may be impaired, the recoverable amount of the asset(or, if appropriate, the cash generating unit (CGU)) is determined The recoverable amount of goodwill, intangible assets with an indefinite useful life and intangible assets that are not available for use on the reporting date, is required to be measured at least on an annual basis, irrespective of whether any impairment indicators exist. The asset or CGU is impaired of its carrying amount exceeds its recoverable amount. The recoverable amount is defined as the higher of the fair value less costs to sell and the value in use Any impairment loss is recognized as an expense in profit or loss for assets carried at cost. If the affected asset is a revalued asset, as permitted by IAS 16 Property, Plant and Equipment (IAS 16) and IAS 38 Intangible Assets (IAS 38), any impairment loss is recorded first against previously recognized revaluation gains in other comprehensive income in respect of that asset. Extensive disclosure is required for the impairment test and any impairment loss recognized. An impairment loss recognized in prior periods for an asset other than goodwill is required to be reversed if there has been a change in the estimates used to determine the assets recoverable amount.

Indicators of ImpairmentThe standard requires an entity to assess, at each reporting date, whether there are any indicators that assets may be impaired. An entity is required to consider information from both external sources (such as market interest rates, significant adverse changes in the technological, market, economic, or legal environment in which the entity operates, market capitalization being lower than net assets) and internal sources (such as internal restructurings, evidence of obsolescence or physical damage to the asset). Not with standing whether indicators exist, recoverability of goodwill and intangible assets with indefinite useful lives or those not yet in use are required to be tested at least annually. Recoverable amountThe recoverable amount of an asset is greater of its fair value less costs to sell and its value in use. To measure impairment, the assets carrying amount is compared with its recoverable amount.

The recoverable amount is determined for individual assets. However, if an asset does not generate cash inflows that are largely independent of those from other assets, the recoverable amount is determined for the CGU to which the asset belongs. A CGU is the smallest identifiable group of assets that generate cash inflows that are largely independent of the cash inflows from other assets or group of assets. Value in useValue in use (VIU) is the present value of the future cash flows expected to be derived from an asset or a CGU. A VIU calculation includes: Cash flow projections: An estimate of the future cash flows that the entity expects to derive from the asset Expectation about possible variations in the amount or timing of those future cash flows. Discount rate The time value of money that is a pre-tax discount rate that reflects current market assessments of the time value of money and risks specific to the asset for which the future cash flow estimates have not been adjusted The price for bearing the uncertainty inherent in the asset which can be reflected in either the cash flow estimate or the discount rate. Other factors, such as illiquidity, that market participants would reflect in pricing the future cash flows the entity expects to derive from the asset.

When measuring VIU, the entitys cash flow projections: Must be based on reasonable and supportable assumptions that represent managements best estimate of the set of economic conditions that will exist over the remaining useful life of the asset. Must be based the most recent financial budgets/forecasts approved by management without including cash inflows or outflows from future restructurings to which the entity is not yet committed. Should exclude borrowing costs, income tax receipts or payments and capital expenditure that improve or enhance the assets performance. Should include overheads that are directly attributed or can be allocated on a reasonable and consistent basis and the amount of transaction costs if disposal is expected at the end of the assets useful life. For periods beyond the periods covered by the most recent budgets/forecasts should be based on extrapolations using a steady or declining growth rate unless an increasing rate can be justified. Fair value less costs to sellFair value less costs to sell (FVLCS) is the amount obtainable from the sale of the asset in an arms length transaction between knowledge and willing parties, less the costs of disposal. IAS 36 establishes a hierarchy for determining an assets FVLCS as follows: The best evidence of the assets FVLCS is a price in a binding sale agreement in an arms length transaction, adjusted for incremental costs that would be directly attribute to the disposal of the asset. If there is no binding sale agreement, but the asset is traded in an active market, FLVCS is the assets market price less the costs of disposal. If there is no binding sale agreement or active market for the asset, FLVCS is based on the best information available to reflect the amount that the entity could obtain at the end of the reporting period from the disposal of the asset in an arms length transaction after deducting the costs of disposal.If the market price is not available, FLVCS can be determined using a discounted cash flow (DCF) approach. The following valuation principles will apply when determining FLVCS: The calculation of FLVCS should reflect all future events that would affect the expected cash flows for a typical market participant that holds the asset. Fair value should reflect information that is available without under cost or effort about the markets assessment of the future cash flows. Market-based assumptions should be based on current market data, unless reliable evidence indicates current experience will not continue. If there is contrary data indicating that market participants would not use the same assumptions as the entity, the entity should adjust its assumptions to incorporate the market information. FLVCS also includes the amount of transaction costs that would be incurred at the reporting date in disposing of the asset.

Risk and uncertaintyBoth FVLCS and VIU should reflect risk and uncertainty to the extent that these would be reflected in the price of an arms length transaction. Risk may be reflected by adjusting either the cash flows or the discount rate, but not both.

Determining an appropriate discount rate that reflects current market assessments and the appropriate risks (the risks not already reflected in the cash flows) will often be difficult and will require consideration and input from financial management, line management and, perhaps valuation professionals.

Input from these parties will also be required to formulate assumptions regarding growth rates used to project cash flows until the end of the assets useful life, which will also require significant judgment to formulate. Cash generating unitsIf its not possible to estimate the recoverable amount of an individual asset, the entity should determine the recoverable amount of the CGU to which the asset belongs. It is not possible to estimate the recoverable amount of the individual asset if: The assets VIU cannot be estimated to be close to its FVLCS The asset does not generate cash inflows that are largely independent of those from other assets.

Measuring ImpairmentsIdentifying an asset that may be impairedAn 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. Irrespective of whether there is any indication of impairment, an entity shall also:a. Test an intangible asset with an indefinite useful life or an intangible asset not yet available for use for impairment annually by comparing its carrying amount with its recoverable amount. This impairment test may be performed at any time during an annual period, provided it is performed at the same time every year. Different intangible assets may be tested for impairment at different times. However, if such an intangible asset was initially recognized during the current annual period, that intangible asset shall be tested for impairment before the end of the current annual period.b. Test goodwill acquired in a business combination for impairment annually in accordance.If there is any indication that an asset may be impaired, recoverable amount shall be estimated for the individual asset. If it is not possible to estimate the recoverable amount of the individual asset, an entity shall determine the recoverable amount of the cash-generating unit to which the asset belongs (the assets cash generating unit)A cash-generating unit is the smallest identifiable group of assets that generate cash inflows, that are largely independent of the cash inflows from other assets or group of assets.Impaired assetDefinition of impaired assetA companys asset that is worth less on the market than the value listed in the companys balance sheet. This will result in a write-down of that same asset account to the stated market price.Accounts that are likely to be written down are the companys goodwill, accounts receivable and long-term assets.In the sum of all estimated future cash flows is less than the carrying value of the asset, then the asset would be considered impaired and would have to be written down to its fair value. Once an asset is written down, it may only be written back up under very few circumstances.Firms carrying goodwill on their books are required to make tests of impairment annually. Any impairments found will then be expensed on the companys income statement.Impairment charge is the new term for writing off worthless goodwill. These charges started making headlines in 2002 as companies adopted new accounting rules and disclosed huge goodwill write-offs (for example, AOL -$$54 billion, SBC -$1.8 billion, and McDonalds -$99 million). While impairment charges have since then gone relatively unnoticed, they will get more attention as the weak economy and faltering stock market force more goodwill charge-offs and increase concerns about corporate balance sheets. Measuring recoverable amountThe recoverable amount of an asset or a cash-generating unit is the higher of its fair value less costs of disposal and its value in use.It is not always necessary to determine both an assets fair value less cost of disposal and its value in use. If either of these amounts exceeds the assets carrying amount, the asset is not impaired and it is not necessary to estimate the other amount.Fair value is 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. Costs of disposal are incremental costs directly attributable to the disposal of an asset or cash-generating unit, excluding finance costs and income tax expense. Value in use is the present value of the future cash flows expected to be derived from an asset or cash-generating unit.The following elements shall be reflected in the calculation of an assets value in use: An estimate of the future cash flows the entity expects to derive from the asset 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 Other factors, such as illiquidity, that market participants would reflect in pricing the future cash flows the entity to derive from the asset.Estimate of future cash flows shall include:a. Projections of cash inflows from the continuing use of the assetb. 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, c. Net cash flows, if any, to be received (or paid) for the disposal of the asset at the end of its useful lifeFuture cash flows shall be estimated for the asset in its current condition. Estimate of future cash flows shall not include estimated future cash inflows or outflows that are expected to arise from:a. A future restructuring to which an entity is not yet committed, orb. Improving or enhancing the assets performanceEstimates of future cash flows shall not include:a. Cash inflows or outflows from financing activities, orb. Income tax receipts or paymentRecognizing and measuring an impairment loss.If, and only 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. That reduction is an impairment loss.An impairment loss shall be recognized immediately in profit or loss, unless the asset is carried at revalued amount in accordance with another standard (for example, in accordance with the revaluation model in IAS 16 Property, Plant, and Equipment). Any impairment loss of a revalued asset shall be treated as a revaluation decrease in accordance with other standard.An impairment loss shall be recognized for a cash-generating unit (the smallest group of cash-generating units to which goodwill or a corporate asset has been allocated) if, and only if, the recoverable amount of the unit (group of units) is less than the carrying amount of the assets of the unit (group of units) in the following order: First, to reduce the carrying amount of any goodwill allocated to the cash-generating unit and, Then, to the other assets of the unit pro rata on the basis of the carrying amount of each asset in the unit.

However, an entity shall not reduce the carrying amount of an asset below the highest of: Its fair value less costs to sell (if determinable) Its value in use (if determinable) ZeroThe amount of the impairment loss that would otherwise have been allocated to the asset shall be allocated pro rata to the other assets of the unit.

Goodwill For the purpose of impairment testing, goodwill acquired in a business combination shall, from the acquisition date, be allocated to each of the acquirers cash-generating units, or groups of cash-generating units, that is expected to benefit from the synergies of the combination, irrespective of whether other assets or liabilities of the acquire are assigned to those units or groups of units.The annual impairment test for a cash-generating unit to which goodwill has been allocated may be performed at any time during an annual period, provided the test is performed at the same time every year. Different cash-generating units may be tested for impairment at different times. However, if some or all the goodwill allocated to a cash-generating unit was acquired in a business combination during the current annual period, that unit shall be tested for impairment before the end of the current annual period.