Impairment testing: What to be aware of

Why is this important?

Standard-setters are keen on impairment testing for the purpose of enhancing the accuracy and transparency of financial reporting (although they are notably less willing to recognise upward revaluations of balance sheet items).  

A large impairment write-down can naturally have an impact not only on the company’s balance sheet, but also on the confidence of the company’s shareholders and other stakeholders in the market. Therefore, it is important that management addresses any impairment concerns proactively, so that proper testing can performed, necessary reporting disclosures can be made, and findings can be communicated with shareholders in good time.  

Indicators of impairment 

IAS 36 provides a list of potential external, internal, and other indicators of impairment. A list of the key, albeit non-exhaustive, indicators is outlined below: 

External Indicators 

• A perceived decline in market value  
• A significant negative change in the technological, market, economic or legal environment  
• An increase in market interest rates  
• When the net assets of a listed entity are higher than its market capitalisation 

Internal Indicators 

• Signs of obsolescence or physical damage  
• The asset is idle, part of a restructuring, or is currently being held for disposal  
• The economic performance of the asset (or the entity in which it used to generate earnings) is worse than expected  

Other Indicators 

• There is no longer an active market for the asset  
• For investments: 
• There is a discrepancy between the carrying value of the investment and the carrying value of the assets within the investee’s accounts.  
• The dividend received from the investment is greater than the total comprehensive income of the investee company for the period in which the dividend was declared.

As mentioned above, interest rates in the UK remain substantially higher than the low levels seen between 2008 and 2021. This environment has resulted in a slowdown in economic activity in certain sectors, due to higher borrowing costs and diminished consumer spending power, which has likely led to a rise in impairment indicators for many UK companies. If in doubt on what this might mean for your company, we would always recommend consulting with specialist advisors or your company’s auditors to identify the risk potential.

How assets are tested for impairment  

To determine if an asset is impaired, arriving at an accurate assessment of the recoverable value of an asset is essential. This will be determined as the higher of its net selling price or VIU. 

Fair value less cost of disposal  

The fair value of an asset is essentially its market value, i.e. the price that would be received if the asset was sold in an orderly arms-length transaction between knowledgeable parties. To accurately determine the cost of disposal, the incremental costs directly attributable to the disposal of the asset, excluding any financing and tax expenses, should be considered.

Value in use 

A VIU assessment determines an asset’s value with respect to the future cashflows it is expected to generate in its current condition, expressed in ‘present value’ terms using an appropriate discount rate. This is commonly referred to as a discounted cash flow (DCF) analysis. This assessment will require appropriate cash flow forecasts, based on management's best estimates, to be prepared. This may differ from its net selling price, for example where an asset is more valuable in situ to the company, than can be realised in a sale on the open market. 

Curiously, for impairment testing, the rules state that the projection period should not exceed five years beyond the measurement date (unless a longer period can be explicitly supported). The accounting standard also requires the use of pre-tax cash flows (albeit, in practice, often post-tax cashflows and post-tax discount rates are used, with a pre-tax discount rate being “imputed” for disclosure in the accounts thereafter). These rules are specific to impairment testing (i.e. they do not correspond to any particular rationale that is adopted for valuations more widely) and accordingly are frequently missed. 

Future developments in impairment testing

There have been recent developments over impairment testing to the extent that the standard-setters released an exposure draft on IFRS 3 and IAS 36 in March 2024, with a consultation period running until July 2024.  

The exposure draft recommended simplifications to the impairment review process, centred on the allowance of proposed restructurings within VIU calculations and the appropriate discount rate determination. Depending on the IASB’s review of feedback received, this may result in crystallised amendments to IAS 36 being released in either late 2024 or 2025.  

How we can help you

If you are in the process of preparing annual accounts, including forming an assessment as to the quantum of any potential impairment, (and unless you are an existing Buzzacott audit client, where we would unfortunately face a conflict of interest) we would be delighted to support you. Our specialist valuations team have many years of combined experience in performing (and auditing) impairment reviews, including the understanding of the specific requirements of the reporting standards, and so would be very happy to discuss your needs with you. 

Looking for more information? 

If you require any assistance with the performance of an impairment review, please fill out the form below and one of our experts will be in touch.