Impairment tests are carried out for assets to ensure that a firm’s assets are carried at a value not higher than their recoverable value or amount when either an asset is utilized in production or sold. There is a specific condition when assets can exceed their recoverable amount. It happens when the carrying value exaggerates the value to be recovered. In such circumstances, an asset is considered to be impaired. The firm that carries this asset should recognize such asset as an impairment loss.
Goodwill acquired by a business entity from the commencement of the business is allocated to each of the firm’s cash-generating units. Impairment tests for each cash-generating unit which the goodwill has been apportioned are performed annually at a particular set time for each unit. If part or whole amount of goodwill apportioned to a cash-generating unit was recouped in a firm during the current annual period then the revenue-generating unit will be tested for impairment before the end of the annual period. Unlike other assets, impairment loss for the goodwill that occurred in the prior assessment period is irreversible in the subsequent assessment period if a specific condition is not taken into account.
The following are basic steps followed in applying impairment tests
- Determination of impairment indicators – firms should be able to identify impairment indicators for different assets. Indicators are used to determine any indication of impairment on an asset. Indicators can be internal e.g. decline in market value, adverse changes in technology, economic or legal environment, and increased interest rates of return on investment. External indicators include physical damage or obsolescence of an asset, changes in regard to usage or expected usage of an asset.
- Assessment of impairment- firms at the end of each financial year should determine using identified indicators if there is evidence that an asset was impaired. If no evidence of impairment, the firm makes no formal report on estimates of recoverable amount.
- Measurement of recoverable amount – in the presence of impairment indicator firms should determine the recoverable amount.
- Recognition and measurement of impairment losses – impairment losses for individual assets should be considered in the only condition. Such process should take place if recoverable amount is less than their carrying amount. The same happens with the cash generating units.
- Reversing an impairment loss- at the end of a financial year, firms should assess impairment losses during the previous period and determine whether they should be reversed. Indicators such decline in market value, asset obsolescence among others are used to determine whether reversal of impairment loss is necessary. If there is evidence of reversal, an estimate of the assets recoverable amount is then made. If recoverable amount has increased, in this case the reservation of impairment loss occurs.
- Disclosure- the standard mandates that an extensive disclosure of impairment tests as well as impairment recognised is made. Key disclosure requirements will include; disclosure of impairment recognized and reversed and their causes, amount of goodwill allocated to each cash generating unit, key assumption in the evaluation method and process among others.
Although the standard ensures that a firm’s assets value is determined, identification and evaluation of cash generating units as well good will require several assumptions to be made especially in estimating the recoverable amount and fair value in use thus subjectivity is inherent in the standard.
Glasshouse Ltd Taxation Worksheet as at 30 June 2011
Taxable income.