Under both old Canadian GAAP and IFRS, the basic principle for impairments is the same – recognize a loss if the recoverable amount of an asset or group of assets is less than its carrying amount. Nevertheless, the requirements for determining when and how to test for impairment, and what to disclose, can be significantly different. In this memorandum, we summarize key reminders for achieving IFRS compliance at year end.1
1. Watch for impairment indicators. Testing for impairment is necessary if there is any indication that an asset or group may be impaired. Indicators include:
- A company's market capitalization below the carrying of its net assets.
- Adverse changes in operations such as, discontinuing or restructuring operations, disposal plans, etc.
- Economic performance being or being expected to be worse than forecast.
- Decisions to curtail expenditures.
- Changes in market interest rates or market rates of return for investments.
Economic factors that contribute to unsettled macro economic conditions may also be impairment indicators.
Goodwill and indefinite lived intangible assets have to be tested for impairment at least annually. Doing this in an earlier interim period doesn't eliminate the responsibility for assessing whether indications of impairment exist at year end.
2. Test for impairment at the appropriate level. Evaluating an individual asset for impairment is appropriate only if it generates largely independent cash inflows. If not, an asset should be included in one or more of the entity's cash generating units (CGUs) – the smallest grouping of assets that produce independent cash inflows (old Canadian GAAP which looked to net cash flows). Attribution or allocation is necessary even for indefinite lived intangible assets that under old Canadian GAAP always were tested on a stand-alone basis.
3. Use a "bottoms up" approach for allocating assets to CGUs. The startingpoint for identifying CGUs is often theindividual operating unit (e.g. plant, store,outlet, etc). If cash inflows from a unit arenot largely independent, the unit shouldbe combined with other assets or unitsuntil a CGU can be identified Assets usedby more than one CGU such as patents ortrademarks as well as corporate assets (e.g.head office, computer equipment, researchcentres) must be allocated to CGUs on areasonable and consistent basis. Specialrules apply if this is not possible.
For exploration and evaluation assetsrelated to mineral resources, CGUs may begrouped for impairment testing (but thegroup cannot be larger than an operatingsegment).
All identifiable long-lived assets have to be included in CGUs (if not tested separately). Reconciling the attributions and allocations to the long-lived assets on the balance sheet is a good way of ensuring completeness.
4. Use a "top down" approach for goodwill. For goodwill, an entityallocates goodwill to the lowest level atwhich goodwill is monitored for internalmanagement purposes (except that thislevel cannot be larger than an operatingsegment). Often goodwill is monitored ata higher level than the individual CGUs.When this happens, the CGUs to whichthe goodwill relates are combined andimpairment tested on a combined basis.
If the CGUs with goodwill have non-controlling interests, goodwill impairment testing can be complicated if NCI is measured using the proportionate interest method. You will have to gross up the goodwill and allocating any resulting loss.
5. Determine recoverable amount in accordance with valuation principles. The recoverable amount foran asset or CGU is the higher of its fairvalue, less cost to sell (FVLCTS), or its valuein use (VIU). Fair value represents marketparticipants' assessment of the value of theassets, while VIU represents management'sassessment of the value. Recoverableamount is a value concept and not simplyundiscounted cash flows as used under oldCanadian GAAP.
While VIU is based on the present value of expected cash flows, FVLCTS may be based on different measures and valuation techniques. The recoverable amount should be based on currently available information. As a result, in both cases:
- Forecasted cash flows or results and discount rates or multiples should be adjusted as necessary to reflect current economic conditions, including the impacts of macro economic indicators and currency, price, liquidity and country risks.
- Greater weight should be given to available external evidence such as independent economic forecasts, industry analysis, and other external experts.
- Changes in discount rates and multiples will have an immediate impact on value. To the extent that risks and uncertainties are not reflected in estimated cash flows or results (e.g., through probability weighting), they will need to be reflected by adjusting the discount rate or multiples.
Exercise caution in relying on recently observable transactions as bench marks for discounted cash flow valuations. Significant volatility may indicate that observations should be made over a longer period.
6. If the carrying amount of a CGU exceeds its recoverable amount, allocate the loss to the underlying individual assets. The impairmentloss is first applied to reduce any goodwillincluded in the CGU and then to other long-livedassets pro rata on the basis of theircarrying amounts. However, an individualasset cannot be reduced below its FVLCTSor VIU, if determinable, or zero.
There are special rules for determining the fair value of individual assets. The ability to assign a fair value to an asset acquired in a business combination does not necessarily mean that the fair value is determinable for impairment testing. If there is no reliable estimate of the amount obtainable from a sale of the asset or it is not able to generate independent cash flows, FVLCTS or VIU may not be determinable.
7. Disclose, disclose, disclose. IFRS requires significant additional disclosures about impairments recognized, and goodwill and indefinite lived intangibles, compared to old Canadian GAAP. These include disclosures about the basis of the recoverable amount used for impairment testing, key assumptions used in determining those estimates, the carrying amounts of goodwill and indefinite lived intangibles by CGUs and sensitivities to possible future impairments.
1 Long-lived assets include property, plant and equipment, investment properties carried at cost, exploration and evaluation assets and goodwill. Impairment testing for long-lived assets is covered by IAS 36, Impairment of Assets, with additional guidance for mineral resources in IFRS 6, Exploration for and Evaluation of Exploration Assets. Investment properties carried at fair value, biological assets and non-current assets held for sale are measured on a fair value basis and therefore are not subject to impairment testing.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.