IAS 36 — Performing the Impairment Test

IAS 36.12 — Impairment indicators

An impairment test is required whenever there is an indication that an asset may be impaired (IAS 36.12). Indicators are assessed at each reporting date and fall into two categories:

External indicators:

• Significant decline in the asset's market value beyond normal use and passage of time
• Adverse changes in the operating environment — technological, market, economic, or legal
• Increase in market interest rates that would materially reduce the VIU discount rate
• Entity's net asset carrying amount exceeding its market capitalisation

Internal indicators:

• Evidence of obsolescence or physical damage
• Decision to restructure, discontinue, or dispose of the asset or CGU
• Worse-than-expected performance shown in internal management reporting

Mandatory annual test: goodwill from a business combination and intangible assets with indefinite useful lives must be tested annually regardless of whether indicators exist (IAS 36.10). The test may be performed at any time during the year, provided it is performed at the same time each year.

IAS 36.6 — Cash-generating unit (CGU)

Many assets do not generate cash inflows independently, so impairment testing is performed at the level of the cash-generating unit — the smallest identifiable group of assets whose cash inflows are largely independent of those from other assets or groups (IAS 36.6).

Practical rules:

• Identification: start with the individual asset; escalate to CGU only when independent cash inflows cannot be attributed to it
• Consistency: CGU boundaries must be applied consistently from period to period unless a change is justified and disclosed
• Corporate assets: head office buildings, IT systems, and shared infrastructure cannot generate independent cash flows; they are allocated to individual CGUs proportionately for testing (IAS 36.102)
• Goodwill allocation: goodwill is allocated at the lowest level at which management monitors it for internal purposes, and never larger than a reportable operating segment (IAS 36.80)

IAS 36.18 — Recoverable amount

Recoverable amount is the higher of fair value less costs of disposal (FVLCD) and value in use (VIU) (IAS 36.18). If either measure alone clearly exceeds carrying amount, no calculation of the other is necessary.

FVLCD (IAS 36.28):

• Best evidence: price in a binding sale agreement in an arm's length transaction
• Active markets: market price less incremental costs directly attributable to disposal
• No active market: use Level 2 or Level 3 valuation techniques consistent with IFRS 13 (e.g. comparable transactions, discounted cash flows from a market participant perspective)
• Disposal costs: incremental costs only — exclude allocated overheads and finance costs

VIU (IAS 36.30):

• Present value of future cash flows from continuing use of the asset or CGU
• Plus present value of the net proceeds on ultimate disposal at the end of its useful life
• Discounted at a pre-tax rate reflecting current market assessments of time value and the risks specific to the asset

IAS 36.33 — Cash flow projections

For VIU, cash flow projections must be based on the most recent board-approved financial budgets/forecasts, covering no more than 5 years of explicit projections (IAS 36.33). Beyond the explicit period, extrapolate using a terminal value.

Key requirements:

• Terminal value (IAS 36.36): calculated using a steady-state growth rate no higher than the long-term average for the country, industry, or market in which the CGU operates — GDP growth rates are the standard ceiling; zero growth is conservative and defensible
• Pre-tax basis: projections and discount rate must be on a consistent pre-tax basis
• Exclude financing effects: no interest income/expense; cash flows represent pre-financing free cash flows

Cash flows must exclude:

• Uncommitted future restructurings or performance improvements (no approved board resolution = not included)
• Improvements from future capital expenditure not yet committed
• Income tax receipts or payments (these are excluded because the discount rate is pre-tax)

Auditors and regulators scrutinise terminal growth rates and budget-versus-actual variances; management assumptions must be supported by external evidence.

IAS 36.55 — Discount rate

The VIU discount rate is a pre-tax rate reflecting (IAS 36.55):

• Current market assessments of the time value of money
• The risks specific to the asset or CGU, but only for risks that have not already been incorporated into the cash flow estimates

Standard derivation approach:

1. Identify a comparable listed company WACC (observable from market data)
2. Gross up to pre-tax equivalent
3. Adjust for asset-specific risks not captured in cash flows

Critical rules:

• No double-counting: if cash flows already incorporate a risk discount (probability-weighted scenarios), the discount rate must not be further increased for the same risk
• Asset-specific, not entity-wide: a high-risk CGU requires a higher rate than the parent entity's WACC
• Sensitivity analysis: test outcomes at ±1–2% discount rate — this is standard practice and required as a disclosure for material CGUs (IAS 36.134)

IAS 36 — Practical Example

Company ABC manufactures automotive components. Division X (a CGU) has carrying amount €150m — net assets €100m + goodwill €50m. Competitive pricing pressure triggers an impairment test.

Step 1 — FVLCD: Market-comparable company trades at 4.2× EBITDA; no binding offer available. Estimated FVLCD = €125m.

Step 2 — VIU: Present value of €18m/year free cash flows for 10 years + terminal value €40m, discounted at 8% pre-tax WACC = €130m.

Step 3 — Recoverable amount: max(€125m, €130m) = €130m.

Step 4 — Impairment loss: €150m − €130m = €20m.

Step 5 — Allocation: goodwill is reduced first → goodwill reduced by €20m (to €30m); no impairment on other CGU assets since goodwill absorbs the full loss.

IAS 36 — Common Pitfalls

• Cash flow overoptimism: projecting uncommitted restructuring savings, synergies, or revenue growth not formally approved by the board. IAS 36.33 requires board-approved budgets; speculative improvements breach the standard and will be challenged by auditors.

• Post-tax discount rate: IAS 36.55 requires pre-tax rates. Applying post-tax WACC without grossing up inflates recoverable amount and understates impairment.

• CGU boundary manipulation: aggregating underperforming assets with profitable ones to avoid triggering impairment at the CGU level. Boundaries must reflect how management actually monitors assets, not how impairment is minimised.

• Ignoring corporate asset allocation: omitting head office assets from CGU carrying amounts means the test is incomplete. IAS 36.102 requires proportional allocation of shared assets that cannot generate independent cash inflows.