04 May 2020
Entities will need to make assessments on the recoverability of its assets in light of the issues caused by the coronavirus pandemic. Where there are indicators of impairment, an impairment review will be required.
What does FRS 102 say?
Indicators of impairment
An entity shall assess at each reporting date whether there is any indication that its assets are impaired. If an indication exists, the entity must estimate the recoverable amount of the asset, or, if the asset does not generate cash flows itself, the cash generating unit (CGU) to which the asset belongs. (FRS 102.27.7,8)
Management should be aware of any indicators of impairment that may develop up to the date of authorising the financial statements for issue and consider whether they indicate an impairment existed at the end of the reporting period:
- One of the primary indicators (FRS 102.27.9) is where significant changes have had an adverse effect on the economic environment in which the entity operates or in which an asset is located.
- Another key indication is where significant changes have had or are expected to have an adverse effect on the entity and how 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.
Measuring the recoverable amount
An asset or CGU is impaired if the recoverable amount is less than the carrying amount of the asset or CGU. The impairment charge is that which is required to reduce the carrying amount to the recoverable amount. The recoverable amount is the greater of the asset’s (or CGU’s) fair value less costs to sell and the value in use.
- The fair value less costs to sell can be best identified as the sale price that could be obtained in an arm’s length transaction in an active market, between willing participants, less the costs of disposal. It is based on the best information that an entity could be expected to obtain. When determining the fair value less costs to sell, entities should consider any restrictions imposed on the asset. Costs to sell should include any costs incurred to obtain permission to relax restrictions.
- The value in use is the present value of the future cash flows expected to be derived from an asset or CGU, and involves an entity estimating the future cash flows to be generated from the asset or CGU and applying an appropriate discount rate. Estimates of future cash flows shall include (FRS 102.27.17):
- projections of cash inflows from the continuing use of the asset;
- 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
- 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.
Applying an impairment loss to a CGU
For assets within a CGU, any identified impairment shall be allocated to the assets firstly to reduce the amount of any goodwill allocated to the CGU, and then to be allocated to the other assets within the CGU pro rata, on the basis of the carrying amount. The carrying amount of any assets within the CGU should not be reduced below its individual recoverable amount.
If goodwill cannot be allocated to a specific CGU, then an entity shall test the impairment of goodwill by determining the recoverable amount of the entire entity (if the goodwill has been integrated) or group of entities (if the goodwill has not been integrated).
Practical impact and interpretation for preparers
Where, due to Coronavirus, an assessment of impairment has resulted in the recognition of an impairment loss, the loss should be recognised immediately in the P&L, unless the asset is carried at a revalued amount in which case the loss should firstly be used to reduce any previously recognised valuation gains, and taken through other comprehensive income:
- Where an impairment charge has been calculated, the financial statements should disclose the amount of impairment for each class of asset or CGU, and a description of the events and circumstances that led to the recognition of an impairment charge.
- Any significant judgements or estimates used in the calculation of the recoverable amount should be disclosed in the accounting estimates and areas of judgement note.
- Management will need to consider whether there are any indicators of impairment from coronavirus for the entity’s individual assets or CGUs. This consideration should be maintained from the entity’s reporting date, to the date of authorisation of the financial statements.
- Where indicators of impairment are present, management must prepare assessments of recoverable amounts. When determining the fair value less costs to sell, this may involve engaging third party valuers to undertake valuations reflecting the price the entity could obtain from the disposal of the asset in an arm’s length transaction.
- One of the more complex challenges will be for entities to perform a robust review of expected future cash flows for an asset or CGU given the uncertainty of the current economic and market environment. Significant assumptions, such as forecast sales volumes, prices, gross margins, changes in working capital, foreign exchange rates and discount rates will need to be reassessed and updated as appropriate.
- When preparing the expected future cash flows, management should also consider if coronavirus will result in additional cash outflows to ensure the continuing use of the asset (such as additional marketing costs).
- Management should also consider whether the discount rate used in any recent valuations has been updated to reflect the impact of coronavirus on the risk environment at the reporting date.