 Hello and welcome to the session. This is Professor Farhad and the session we're going to be looking at impairments of assets, which is IAS 36. This topic is covered in international accounting for a course as well on the CPA exam. Yes, this topic is covered on the CPA exam because you need to know the rules for impairment for IFRS as well as USGAP. As always, I would like to remind you, which is you, my viewers, to connect with me on a professional level. If you have a LinkedIn account, please connect with me on LinkedIn. If you don't have one, I strongly suggest you create one. It's very important for your professional image and network ability. YouTube is where you would need to subscribe. I have all my lectures on YouTube, over 1500 accounting, auditing and tax lectures. If you're benefiting from my lectures, other people might benefit as well. Please like my lectures, share them, put them into the playlist, let the world know about them. This is my Instagram account. I'm trying to grow my Instagram following. This is my Facebook. I do have some premium product on Gumroad. This is my website. Let's talk about impairment of assets. What is impairment of asset? What is the big idea? I'm just going to give you a big idea example. Let's assume Uber. This is what actually happened. Uber operates in London. Before they operate in a city, they have to make investment. They have to invest in the company. They might have to buy servers. They may have to buy other assets. Let's assume for the sake of this example, they bought one million worth of euros, worth of assets. They made an investment of one million. And Uber started to operate in London. Then suddenly, the municipality of London decided to ban Uber. We don't care about why, but let's assume they decided to ban Uber. Well, Uber made all this investment. And suddenly, the legal environment has changed. The municipality said, the local government said, well, guess what? We don't want to have Uber in the city. It's not safe. And for other reasons, we don't want Uber to operate. So what happened to this one million euros? Basically, if they want to sell this one, they want to go back and sell those servers, sell the assets that they invested, let's assume they can only get for it $200,000. So what happened is the assets for Uber were impaired. It means they lost utility. They lost utility. Now, how do we measure exactly impairment? We're going to see exactly how we measure impairment. I'm giving you this example to give you the big picture. So basically, you bought something. You made an investment in your, let's assume you made an investment in your property, plant, and equipment. And for some reason, we're going to look at what reasons could happen. One of them is legal reasons. Those property, plant, and equipment became less useful. They're not giving you the same utility that you thought you're going to generate from them. So if you invest one million euros, you expect to make more than one million euros. But now your investments basically went down to $200,000. So if you want to sell those servers and those investments, whatever you invested in and someone else, they would sell pay you $200,000. So they lost utility. So that's the big idea of this lesson. It's basically you lost utility. Your assets lost utility. So impairment applies to, as I just mentioned, property, plant, and equipment, intangibles, asset as well, goodwill, investment in subsidiaries, associates, and joint venture. This is what it applies to. It does not apply to inventory or construction and progress, which is kind of, in a sense, it's inventory. The third taxed asset, we have a different valuation for this. Employee benefit asset. If you have any employee benefit asset, it cannot be subject to asset impairment or financial assets such as accounts or notes receivable. Those are not subject to impairment. They're subject to something else, which is allowance and valuation accounts. Now both USGAP and IFRS require impairment testing of asset. It's different. USGAP is different than IFRS. But nevertheless, they both require it. Now how often do you have to assess your assets for impairment? Simply put, when do you ask yourself, are my assets impaired? So under the IAS 36, which is the IFRS requirement, an entity must assess annually whether there are any indicator that an asset is impaired. How would they know if there's an indicator exist? Well, I'm going to give you some indicators, and those are not the only ones that should give you an idea what should companies be looking at. For example, we have some external events. What are some external events? A decline in market value. So basically what happened, you bought an asset, you paid for it a million dollars. Suddenly it's worth $600. Why? Because maybe there's a new technology, a better technology, a more efficient technology. What you bought, you made a mistake. You bought it too early. There's a market decline in the market value of your asset while it might be subject to impairment. An increase in the market interest rate. What happened is if you have an increase in the market interest rate, it's going to affect your cash flow. Because when you discount your cash flow, you would use an interest rate. When interest rate goes up, your present value goes down. Therefore, it's going to affect your cash flow from that investment. Or economic, legal, or technological changes. I gave you an example of a legal. Basically the city of London, the municipality of London banned Uber. That was a legal decision. Or for example, there's a new technology on the market. That's better than yours. It's more efficient than yours. It's cheaper than yours. Then what happened to your technology? It became obsolete. Another external event, if the FDA pulled your drug out of the market. Well, that's a legal, that's a legal major legal event. Or economic event in general. Just the economy goes down and your assets are no longer useful because you bought them to produce 10 million units per year. Now, there's no demand for 10 million units. There's a demand for barely 3 million units. Well, guess what? Your asset is impaired. There are also some internal events that we could look at such as physical damage. Well, if your asset is damaged, something happened. Your employee broke it. Just there was an accident. Well, if there's a physical damage, your asset is impaired. Upsolescence. Upsolescence, it's still good physically. But from a production perspective, it's not as useful. And this is especially important for technology. For example, you bought a software. The software is still in good condition. But there is a better software, a faster software. Basically your old software becomes Upsolescence. Idleness of an asset. If you're not using an asset, if you bought an asset and somehow you're not using it or using it less than you should, you should ask yourself, is the asset impaired? The restructuring of part of an asset. Now you're using your asset for something else. Why? Did it lost utility for its original intent? Or worse than expected, economic performance of the asset. You thought this asset's going to produce a million unit for you? Well, the maximum it can produce 600,000. Guess what? Your asset is impaired because you assumed it's going to produce a million unit. Now those are events. Any of these indicators of the company feels that those indicators exist, then you go into the impairment. So if indicators of the impairment are present, an entity must estimate. Now they're going to go into the details. They must estimate what's called the recoverable amount, which we'll talk about the recoverable amount in a moment. Then we're going to compare something called the recoverable amount of the asset to the asset carrying value or the asset book value. So simply put, an impairment exists if the carrying amount, if your book value is greater than something called the recoverable amount. Now we should all know what the carrying amount is. If it's for property or plant or equipment, that's the cost minus depreciation. That's the book value. But what is the recoverable amount? Well, the recoverable amount is the greater of. So we're going to have to look at two amount, the greater of net selling price or value in use. Now again, what is the net selling price and what's the value in use? Well, the net selling price is how much you can sell the asset for in an active market minus disposal cost. So how much can you sell this asset today in an arm length transaction minus any disposal cost? That's your net selling price. So for example, you can sell the asset for $700,000 and there is a $20,000 commission. Well, that's $680,000. So your net selling price is $680,000. What is the value in use? The value in use is determined as the present value of the future net cash flow expected to arise from continuing use of the asset of its remaining useful life and upon disposal. So basically what you do here is you do a cash flow analysis and hopefully you all know what a cash flow analysis is. You would look into the future and you discount those cash flow into the present. Now IFRS, they have specific rules. You have to use approved budget and should cover a maximum of five year. So what you do is with that cash flow to assume it's going to give you 100,000, 100,000, 100,000, 100,000 and 100,000. What you do is you discount those to the present value. Generally speaking, you should use five years into the future unless you can justify longer period and the discount rate should reflect your current market assessment. So the discount rate that you choose has to be reasonable. Otherwise, the present value will be incorrect as well as the nature of the asset under review. If the asset is risky, it may justify a higher interest rate. So basically it's either the value and use. Let's assume the value and use is 750,000. Well, forget about the 680, I'm going to use my value and use and compare this to my carrying amount. Whatever my carrying amount is, we'll work an example. So this is how you compute impairment under IFRS. Under US GAAP, an impairment exists. When an asset, book value exceeds when the book value is greater than the future cash flow, that's not discounted, undiscounted. So what you do is you take your book value versus your undiscounted cash flow, undiscounted cash flow. So the net selling price is not involved in this test when it comes to US GAAP. And future cash flow are not discounted to their present value. Now, if you are interested in US GAAP, because I'm not going to cover US GAAP in this session, go to my intermediate accounting, I believe chapter 12. And I have maybe over an hour about asset impairment under US GAAP. So just know that US GAAP is different. That's all you need to know for now. And to illustrate the IFRS, let's work an example. So on December 31st, T Company has specialized equipment with the following characteristic. They have a book value of 50,000. That's the book value. Selling price of 40. Cost of disposal of 1,000. Expected future cash flow of 55. Present value of expected future cash flow is 46. So this is what we have now. Well, let's see if we're going to be applying IAS 36. We have to compare the recoverable amount to the carrying value. So obviously we do have the carrying value right here. The carrying value is easy. 50,000. Now, what's the recoverable amount? The recoverable amount, either the net selling price or the value in use. Let's see if we have the net selling price, I believe. So the selling price is 40. And cost of disposal is 1,000. The net selling price is 39. The value in use is the present value of the expected future cash flow. This is the value in use. So between 39 and 46, we'll use the greater. The greater is 46. So notice the greater is 46. Now is 46 lower than 50? Yes, 46 is lower than 50. Now, why did this company undertake this test? Because they think something happened. So that's why they're undertaking this test. And what they find out, the recoverable amount is less than the book value. Therefore, we have a loss. And we have an impairment loss. And the impairment loss is $4,000. So this is the carrying amount. This is the recoverable amount. And we have an impairment loss of 4,000. IFRS is easy. It's kind of one-step test. USGAP, they have two steps. So we're done with IFRS. So we have a loss of 4,000. We debit. Impairment loss, which is an income statement account, goes profit and loss, and we credit equipment. And that's it, basically. This is how we impair an asset under IFRS. Now, bear in mind, in USGAP, a little bit different, please see intermediate accounting. OK, reversal of impairment. What does reversal mean? Let's go back to the Uber example. Remember, Uber, we said, the city of London banned them from operating in London. So all the investments that they made became impaired. Let's assume Uber appealed the decision and the decision was reversed. Now, what happened is they had the reversal of impairment. Those assets that they thought they're useless, now they become useful again. What do we have to do? Can we reverse the impairment? Under IFRS, yes. Under USGAP, no. So here we are talking about IFRS. So let's take a look at what we need to do. At the end, at each balance sheet date, a review should be undertaken to determine an asset impairment loss have reserved. So basically, at the end of the accounting period, we have to ask ourselves, where are down those assets the prior period? Did we recover anything? If subsequent to recognizing an impairment loss, the recoverable amount of an asset is determined to exceed the new carrying amount. So again, we look at the recoverable amount. Is it exceeding the new carrying amount? If the answer is yes, we need to reverse the impairment. Now, how do we do this? Loss should be reversed only if there are changes in estimate used to determine the original impairment loss. So if we use a certain estimate to make the, to book the loss initially, we have to look at those same estimate and see if there's any changes in those estimate. Or we could look at the change in the basis of determining recoverable amount, which is net selling price or from value and use. So those are the factors that we look at. If there's any changes in those and the changes as positive, simply put the recoverable amount. Now it's greater than the new carrying amount. We can reverse. The carrying value of the asset is increased, but not exceed what it would have been if no impairment loss has been recognized. So simply put, we can reverse the loss, but the loss, the reversal cannot exceed, notice what it would have been if no impairment has been recognized. Not what it is now. What would have been if no impairment has been recognized. And what does that mean? We'll work an example and I'll remind you what I mean by this statement. And any reversal is income that goes immediately into the income statement. Just to remind you, USGAP does not allow reversal of previously impaired losses. Basically, the USGAP says, you wrote down that asset. This is the new cost basis for this asset. Move on with your life. Now, if it impaired further, you need to write it down, but you cannot write it up. Let's take a look at an example to see how reversal work. So we have Spring Valley Water Company purchase a new water filtration equipment at the beginning of the year for a million dollars. So basically they debited asset, they credited cash for a million dollars. They debited equipment and they credited cash. The equipment is expected to have a useful life of 40 years with no residual value. Simply put, we'll take a million dollars divided by 40, one million divided by 40 will give us 25,000 in depreciation. Therefore, we're going to depreciate the asset year one, year two, year three, each year 25,000. So by year three, we already depreciated for three years, the book value is 925. This is the book value for the asset because a million minus 75,000 is 925. So by the end of the year, year three, Spring Valley concluded that the filtration system was not performing up to expectation. It's not processing enough water, it's not cleaning enough volume of water, whatever the performance is, it's not performing of what we thought it will. And we determined that the recoverable amount based on the net selling price is 740. So basically we looked at the selling price, at the value in use and we find that the recoverable amount based on the net selling price is greater and it happens to be 740, that's given to us. So look, the book value is 925, the recoverable amount is 740, guess what, we do have an impairment. We do have an impairment. Why? Because the book value, the recoverable amount is less than the book value. So the book value is 925, we already computed this for you, an impairment loss of 185,000, which is 925 minus 740. Let's take a look at this, just kind of go through this step by step. So if we take 925 minus 740, oops, minus 740, we have to impair this asset by 185,000. Therefore we debit impairment loss by 185,000, credit equipment 185,000. Now once we bring down the asset to 740, now we have to compute the new depreciation. The new depreciation is based on 740, that's basically the new asset, and we have 37 years remaining. Therefore 740 divided by 37, our new depreciation amount is 20,000 rather than 25. So for year 4 and year 5, we lived with that depreciation. We were depreciating the asset $20,000 per year, hopefully so far so good. Now what's going to happen? We're going to go into year 6 and something's going to happen. In January 1st year 6, a technician discovered that the filtration equipment had not been properly set up at the time of the initial installation. The technician discovered that there is nothing wrong with the filtration system. All what happened is we did not install it properly. That's why it's not working properly. That's why it's not filtering enough volume of water properly. And what they did is adjustment of the installation result in significant boost in performance, which led the company to evaluate whether the equipment was still impaired. So what they did said, let's go ahead and fix that installation and see what happened. They did fix it and the asset, now it's performing even better than expected. Now we look at the new estimate of future cash flow to be generated through continuing operation of the equipment resulted in a recoverable amount based on the value of use $900,000. Now we looked within another cash flow analysis, which is value and use, and we find out the value and use of this asset is $900,000. And the company determined it was appropriate to reverse the impairment loss in year three. Now we looked at year three when we made the impairment loss and we find out, hold on a second, we need to have a reversal because now the asset is back to its original intent or it's performing better than before. So it recovered some of that impairment loss. So the company will have to calculate what the carrying amount would have been. You remember I highlighted that in yellow. What would the carrying amount would have been if no impairment have been taken. So let's take a look at this concept. So the company computed what's the carrying amount of the equipment would have been if the impairment had never been recognized. So we have to assume, let's assume the impairment was never recognized. Well, the impairment was never recognized. We were taken $25,000 of depreciation times five. Then we would have $125,000 of depreciation. Well, the book value would have been $875, which is less than the new recoverable amount of $900,000. We do have a reversal. Now the question becomes how much do we reverse? How much do we reverse? With impairment, the carrying amount of the equipment at the end of year five is $700,000. Remember when we originally impaired the equipment, we brought it down to $740,000. That was year three. Then in year four, we took $20,000 of depreciation. And in year five, we took another $20,000 of depreciation. So the book value of the equipment, right before we discovered this installation issue, was $700,000. Now we need to take it from $700,000 to what it should be $875,000. Well, what's the difference between those two? You guessed it, $175,000. So therefore, we have to reverse it by $175,000. And the reversal goes into income. So basically, it reverse and it goes into the income statement. Therefore, we increase the equipment $175,000. And we reduce a loss, which is increased income by $175,000. Again, what we'll have to do, we have to compute the book value. What was the book value would have been if we did not take the impairment? Remember that specific rule, would have been. It would have been $875,000. Why $875,000? Well, $25,000 per year depreciation times five years because five years went by. Let's give you $125,000. A million minus $125,000 is $875,000. And this is the impairment of assets under the IFRS. If you want to go to and see my USGAP, please go to my intermediate accounting course. If you visit my website for additional lectures, please consider donating. Good luck and study hard for your CPA exam. This topic is covered on the exam.