Impairments of assets can occur at any time. However, with current inflation, potential increases in interest rates, political uncertainty surrounding Brexit and our future relationship with the EU, Covid’s longer term impacts, and the unknown lasting impacts of the war in Ukraine (a scary list!) all impacting on our day to day lives and our businesses, there is an increased need for an impairment review.
What is impairment and what are the triggers?
An impairment is the write down of the carrying value of an asset, or assets, down to a recoverable level. This write down is processed through the profit or loss account. The typical indicators of impairment are both internal and external. Internal triggers may constitute:
- Physical damage to an asset, or a change to its useful life;
- A forecasted loss or actual loss for the company;
- Technological obsolescence; or,
- Intention to close down an operation or service line.
In terms of external triggers, these could be:
- A decline in an asset’s market value;
- An increase in market interest rates; or,
- A significant adverse change in the technological, market, economic or legal environment in which the company operates.
Impairment of stock
Every year, a company must consider whether stock requires any impairment, regardless of economic conditions. The assessment is made by comparing cost, or carrying value, of the stock against its net realisable value i.e. its selling price. If the selling price is lower than the cost, then the stock requires an impairment write down. One point to note is that there is no requirement to write down raw materials if the finished goods into which they are used can be sold above cost.
Any impairment charge is taken to the profit or loss account and is reviewed annually for changes in circumstances.
Impairment of other assets
These assets (cash generating units – “CGUs”) are typically anything that generates revenue and could be anything from a brand, a fixed asset, debtor balance, or property. Where the internal and external conditions identified above are triggered, there is a need for an impairment review. If, for example, there is a significant drop in the market price of a revenue stream which leads to a loss, then all assets associated with the generation of this revenue should be considered for impairment.
How to do an impairment review
Unlike stock, an impairment review of CGUs is not simply a case of comparing selling price to carrying price for assets, although this can be the case for an investment property.
It is important to calculate the CGU assets carrying amount which can be done via a present value calculation on future expected cash flows and then applying an appropriate discount rate. These future cash flows should exclude future financing and tax, and not reflect any potential restructuring. They should also be accurate and reflect the future life of the asset i.e. 15 year forecasts for an asset with 5 years remaining would be inappropriate. In terms of the discount rate to be applied, there is significant judgement in arriving at this; however, it should reflect the time value of money at a risk-free rate. This could be for example the incremental borrowing interest rate adjusted for risk. The net present value of these future cash flows will then need to be compared to the carrying amount, and the difference, if negative, will be the required impairment.
Reversal of an impairment loss
For all assets other than goodwill, an impairment loss is reversed in subsequent years if the reasons for the loss no longer apply. This is not optional and if the carrying amount has increased then this new amount should be recognised as an impairment reversal in the profit or loss. It is important to note that any reversal of impairment is capped to the original value of the asset.
Recognition of an impairment is very important but can also be tricky. If you would like to discuss any of the matters in this article, please do get in touch.