Impairment testing: key insights

This article addresses the following questions:

• When should an impairment test be performed?
• Which regulations should be considered when performing an impairment test?
• What factors should be taken into account when assessing the value of assets?

Which assets are subject to impairment testing?

Under the Polish Accounting Act and International Financial Reporting Standards (IFRS), financial statements must be prepared based on the entity’s best available knowledge, applying the prudence principle, and on the basis of properly maintained accounting records.

To meet these requirements, where external or internal factors arising in the course of an entity’s operations indicate a risk that its assets may no longer generate the expected economic benefits, the entity should perform an impairment test. This requirement is addressed by Polish National Accounting Standard No. 4 and International Accounting Standard 36 (IAS 36).

It should be noted, however, that impairment testing in this context applies to assets other than, among others: 

• inventories,
• deferred tax assets,
• biological assets,
• assets measured at fair value,
• financial assets measured in accordance with IFRS 9. 

For this reason, the said test is often referred to as an impairment test of non-current assets.

When should an impairment test be performed?

To comply with the requirements of relevant Polish and international regulations, at the end of each reporting period entities are required to assess whether there are any indications that an impairment test should be performed or, as referred to in Polish National Accounting Standard No. 4, whether a procedure for determining an impairment loss resulting from a decrease in the value of assets should be carried out. However, to avoid repeating this somewhat convoluted terminology, we will use the term “impairment test” throughout this article.

To determine whether any indicators of impairment exist and, consequently, whether an impairment test is required, an entity should consider the following circumstances relevant to its business.

External factors or circumstances:

• observable indications of a decline in the value of assets,
• significant technological, economic, market or legal changes in the environment in which the entity operates that have an adverse effect on its business,
• significant changes in interest rates,
• declines in order volumes and prices in the entity’s customer markets,
• increases in prices in supplier markets or, for example, the complete unavailability of components required to manufacture and sell the entity’s products,
• increases in costs necessary to complete sales.

Internal factors or circumstances:

• physical damage to assets,
• adverse changes in the manner in which assets are used or are expected to be used, for example, a decision to discontinue the lease of office premises where significant expenditure incurred in relation to those premises is not expected to be recovered and has a material carrying amount,
• organisational changes,
• the departure of key personnel,
• restructuring and other similar measures.

It should also be remembered that IAS 36 requires mandatory annual impairment testing of non-current assets that are not subject to depreciation or amortisation, such as goodwill. In their case, the impairment test must be performed annually. Under Polish National Accounting Standard No. 4, a reference to annual testing is made in the context of determining the value of goodwill recognised in consolidated financial statements.

What exactly is an impairment test?

The purpose of an impairment test is to determine whether the recoverable amount of an asset is lower than its carrying amount.

Recoverable amount is the higher of the following two amounts: 

• the net selling price (or the fair value of the asset less costs of disposal), and
• the value represented by the sum of the discounted cash flows that the entity expects to generate from using the asset under review (i.e. its value in use).

Accordingly, if a company has a reliable market or fair value for an asset and that value is not lower than its carrying amount, the accounting department does not need to undertake the more complex exercise of analysing forecasts and discounting cash flows.

However, obtaining a market valuation of assets, or even of an entire cash-generating unit, can often prove more challenging. In such cases, an analysis of the plans and assumptions for the coming years can provide valuable support.

Appropriate assumptions, the effective utilisation of Excel functions and discounting at an appropriate rate, supplemented, where necessary, by the support of a statutory auditor, are solutions that can significantly help a company determine the extent to which the DCF value diverges from the carrying amount and, consequently, whether an impairment loss should be recognised. Accountants should bear in mind, however, that an impairment loss recognised in respect of goodwill cannot be reversed in subsequent periods, unlike impairment losses recognised in respect of other assets.