Nature of Impairment Loss
Impairment loss can be defined as the amount that by which asset’s carrying amount or a cash generating unit surpasses the recoverable amount. It always occurs when the recoverable amount of the asset is lower than the carrying amount demanding reduction of recoverable asset. It must be considered as an expense in the profit and loss statements unless the asset is accepted at revalued amount according to the Accounting Standard whereby the loss is considered as revaluation decrease. In the profit and loss statement, the impairment loss of any revalued asset is recognized as an expense. Paragraphs 57 to 62 of the Accounting Standards describe the requirements that must be met for an asset to be considered an impairment loss. Recognition as well as measurement of this loss is well stipulated in paragraphs 87 to 92. When the estimated impairment loss amount is higher than the carrying amount of an asset then the enterprise must identify a liability. Usually after an impairment loss has been recognized there is need to adjust the depreciation charge of the assets in future periods to allocate revised carrying amount and less the residual value systematically over time (Oppermann, 2001).
Paragraphs 64-92 of the Accounting Standards spells out the requirements for identification of a cash-generating asset unit where an asset belongs, determination of the carrying amount and recognition of impairment loss of these assets. Estimation of recoverable amount of an individual asset is necessary whenever there is an indication that someday the asset might be impaired. If an enterprise finds it difficult to estimate the recoverable amount it must then determine that of the cash-generating asset unit where that asset belongs (Hashim, 2016). It is impossible to determine recoverable amount if the estimated value of assets is not closer to the selling price. For instance, when cash flows from continued use of assets is not negligible. And when continued use of asset does not generate cash inflows. In such a case it becomes difficult to estimate the recoverable amount for the cash generating unit. For example, a mining company that owns private railway as a way of supporting its operations. If the private railway is sold at scrap value and does not generate cash inflows as it is being used, estimation of recoverable asset becomes challenging because the value in use of the railway cannot be established. Thus, the company has to estimate the recoverable amount of the whole mine where the railway actually belongs (Kieso, 2012).
Paragraph 4 of Accounting Standards defines the cash-generating unit of an asset as small collection of assets that includes assets generating cash inflows from continuous use and do not depend on cash inflows from other assets. Usually judgment is used to determine the cash-generating unit of an asset. If determination of recoverable amount of an asset becomes difficult, the enterprise has to use aggregation of assets generating cash inflows independently. For instance, a bus company can sign a contract with municipal council whereby it is required to provide certain services on five different routes. There will be assets devoted to every route and their cash flows can be established separately. In such a scenario, one of the routes may be operating at a great loss. Since the company does not want to curtail any route, the continuing use cash inflows independent from cash inflows coming from other assets is the cash inflow from all the five routes. The company establishes its recoverable amount by determining the cash-generating unit of every route (KPMG International Financial Reporting Group, 2013).
Continuing use of cash inflows are all the inflows of cash as well as money received from outside parties. Identification of whether an asset’s cash inflow is independent from that of other assets an organization must consider other factors including its operations such as individual location, product line and management structure or how it makes its decisions on continued use and disposition of assets. Where there is an active market exists for assets, the assets must be classified as cash-generating units separately even though sometimes the output must be used separately (Oppermann, 2001).
When grouping assets according to recoverability assessment it is important to always include cash-generating units for all assets that are in use. If that is not done, the cash-generating unit may seem recoverable but in the real sense, there has been impairment loss. Even though most assets contribute to the future cash flows of the cash-generating unit it is not possible to allocate it to any other cash-generating unit on consistent and reasonable basis. All these requirements are clearly explained in paragraphs 78-86 of the Accounting Standards (Riccardi, 2015). In addition, it is important to consider recognized liabilities to establish the recoverable amount of any cash-generating unit. It occurs when the disposal of the unit demands that both the buyer and the seller take responsibility of liability. Here the net selling price of the unit is estimated as the selling price of assets of the unit plus liability less disposal cost. To make a clear comparison between the cash-generating unit and the carrying amount it is important to deduct liability. For example, a mine company operating in a country whose regulations demands restoration of the site to its original status has to carefully set the selling price of the mine because of the restoration cost. Practically, recoverable amount of any cash-generating unit is normally determined after considering assets that are not part of the unit such as receivables, pensions, payables and recognized liabilities. To reduce asset’s carrying amount it is good to allocate impairment loss (Riccardi, 2015). All reductions in the carrying amount must be classified as impairment loss of assets as per paragraph 58 of the Accounting Standards. Allocation of impairment loss that is described in paragraph 87 of the standard must not be reduced below zero, value in use or selling price. Moreover, goodwill that has been allocated to a given cash-generating unit must be reduced before reduction in the carrying amount of assets included in the unit.
In conclusion, impairment loss is the amount that by which asset’s carrying amount or a cash generating unit surpasses the recoverable amount. This loss can be reversed according to paragraphs 94-100 of the Accounting Standards (Duh, 2009). Requirements stated in these paragraphs uses the word an asset to refer to cash-generating unit and individual assets. Therefore, it is important for an enterprise to understand how to deal with it because it has the ability to generate profit or cause loss depending on how it is handled.
Duh, R., Lee, W., & Lin, C. (2009). How to reverse impairment loss and manage earnings: The foundational role of corporate governance. The International Journal of Accounting.
Hashim, N., Li, W., & O’Hanlon, J. (2016). Expected-loss-based Accounting for Impairment of Financial Instruments: The FASB and IASB Proposals 2009–2016. Accounting in Europe, 13(2), 229-267. doi:10.1080/17449480.2016.1210179
Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2012). Intermediate accounting.
KPMG International Financial Reporting Group. (2013). Insights into IFRS: KPMG's practical guide to international financial reporting standards. London: Sweet & Maxwell.
Oppermann, H. R. (2001). Accounting standards. Lansdowne [South Africa: Juta.
Riccardi, L. (2015). Accounting Standards for Business Enterprises No. 28—Changes of Accounting Policies and Accounting Estimates and Error Correction. China Accounting Standards, 217-222. doi:10.1007/978-981-10-0006-5_32
Riccardi, L. (2015). Accounting Standards for Business Enterprises 2014. China Accounting Standards, 307-334. doi:10.1007/978-981-10-0006-5_43