International Financial Reporting Standards_guide.pdf

Chapter 26 Impairment of Assets (IAS 36) 291
26.6 FINANCIAL ANALYSIS AND INTERPRETATION
26.6.1 An impaired asset is an asset that will be retained by the entity and whose book
value, prior to recognizing any impairment charges, is not expected to be recovered from
future operations. Lack of recoverability is indicated by such factors as:
■ a significant decrease in market value, physical change, or use of the asset;
■ adverse changes in the legal or business climate;
■ significant cost overruns; and
■ current, historical, and probable future operating or cash flow losses from the asset.
26.6.2 Management makes the decisions about whether or not an asset’s value is impaired
by reference to internal and external sources of information, using cash flow projections
based on reasonable and supportable assumptions and its own most recent budgets and
forecasts. In IFRS financial statements, the need for a write-down, the size of the write-down,
and the timing of the write-down are determined by objective and supportable evidence
rather than at management’s discretion. Impairment losses, therefore, cannot be used in IFRS
financial statements to smooth or manipulate earnings in some other way. The discount rate
used to determine the present value of future cash flows of the asset in its recoverability test
must be determined objectively, based on market conditions.
26.6.3 From an external analyst’s perspective, it is difficult to forecast impairment losses.
However, the impairment losses themselves and the related disclosures provide the analyst
with useful information about management’s projections of future cash flows.
26.6.4 When impairment losses are recognized the financial statements are affected in several
ways:
■ The carrying amount of the asset is reduced by the impairment loss. This reduces the
carrying amount of the entity’s total assets.
■ The deferred tax liability is reduced and deferred tax income is recognized if the entity
cannot take a tax deduction for the impairment loss until the asset is sold or fully used.
■ Retained earnings and, hence, shareholders’ equity is reduced by the difference
between the impairment loss and any associated reduction in the deferred tax liability.
■ Profit before tax is reduced by the amount of the impairment loss.
■ Profit is reduced by the difference between the impairment loss and any associated
reduction in deferred tax expense.
26.6.5 In addition, the impairment loss affects the following financial ratios and elements:
■ Asset turnover ratios increase because of the lower asset base.
■ The debt-to-equity ratios rise because of the lower equity base.
■ Profit margins suffer a one-time reduction because of the recognition of the
impairment loss.
■ The book value (shareholders’ equity) of the entity is reduced because of the reduction
in equity.
■ Future depreciation or amortization charges are reduced because the carrying amount
of the depreciable or amortizable asset is reduced.
■ Lower future depreciation charges tend to cause the future profitability of the firm to
increase (because the losses are taken in the current year).
■ Higher future profitability and lower asset values tend to increase future returns on
assets.
■ Higher future profitability and lower equity values tend to increase future returns on
equity.