IAS 36 Scope and Framework
IAS 36 applies to all assets except:
- Inventories (IAS 2)
- Deferred tax (IAS 12)
- Financial instruments (IFRS 9)
- Investment property measured at fair value (IAS 40)
The core principle: an asset is impaired if its carrying amount exceeds its recoverable amount (the higher of fair value less costs and value-in-use).
Impairment Indicators: When to Test
You must test for impairment if there are external or internal indicators that an asset may be impaired:
External Indicators
- Market value decline (technology obsolescence, real estate crash)
- Industry downturn (retail sector distress, commodity price collapse)
- Economic conditions (recession, interest rate spike)
- Regulatory changes (license revoked, pollution standards tighten)
Internal Indicators
- Asset no longer used as planned (discontinued product line)
- Actual performance < budget (sales 40% below plan)
- Asset damage or obsolescence
- Strategic decision to restructure or divest
Audit focus: Did management identify indicators during the year? Many companies miss them. Auditors will specifically look for external/internal events and challenge if impairment wasn't tested.
Cash-Generating Units: Identification & Allocation
A CGU is the smallest identifiable group of assets that generates independent cash flows.
Examples of CGU Identification
| Entity Type | CGU Definition | Why |
|---|---|---|
| Retail chain | Individual store or store cluster | Each store generates separate cash flows; can be tested/sold independently |
| Manufacturing (multi-product) | Production line or division | Each line has distinct cash flows and customer base |
| Software company | Each product (SaaS subscription, license) | Different revenue streams, customer bases, margins |
| Bank (multi-business) | Retail banking, investment banking, trading | Distinct cash flows and risk profiles |
Recoverable Amount: Fair Value vs Value-in-Use
1. Fair Value Less Costs of Disposal (FVLCD)
2. Value-in-Use (VIU)
Fair Value Measurement
FVLCD is what you'd get if you sold the asset today in an orderly transaction.
Valuation Approach: Three Methods
- Market approach: Use comparable assets' selling prices (rare for specialized assets)
- Cost approach: Replacement cost minus depreciation (often used for PP&E)
- Income approach: Present value of future cash flows (most common for CGU-level)
Value-in-Use: Discount Rate (WACC) & Cash Flows
VIU = PV of future cash flows the asset is expected to generate over its life.
Three Components
- Forecast period (5— 10 years): Detailed cash flow projections
- Terminal value: Perpetual cash flows beyond forecast period (often 2— 3% growth)
- Discount rate (WACC): Weighted average cost of capital
WACC Formula
Where:
- E/V = Proportion of equity in capital structure
- D/V = Proportion of debt in capital structure
- Cost of Equity = Risk-free rate + Beta × equity risk premium (CAPM)
- Cost of Debt = Interest rate on debt (adjusted for credit risk)
WACC Example
Company's capital structure: 60% equity, 40% debt
— Cost of equity: 10% (risk-free rate 3% + Beta 1.4 × 5% equity risk premium)
— Cost of debt: 5%
— Tax rate: 20%
WACC = (60% × 10%) + (40% × 5% × (1 −’ 20%))
= 6% + (2% × 0.8)
= 6% + 1.6% = 7.6%
Goodwill Impairment Testing
Goodwill must be tested annually (or whenever indicators arise). No exceptions.
Allocation Process
- Identify the CGU(s) that benefited from the goodwill acquisition
- Allocate goodwill to each CGU
- Test the CGU (including allocated goodwill) for impairment
- If CGU's recoverable amount < carrying amount, impair goodwill first
Worked Example: Goodwill Impairment
Scenario: Acquisition of Tech Startup
- Parent company acquired Tech Startup for £50m in 2023
- Fair value of net assets acquired: £35m
- Goodwill recognized: £15m
- Carrying amount (1 Dec 2025): £15m (no amortization under IFRS 3)
Impairment Test (31 Dec 2025): Revenue Down 30%
- Recoverable amount of CGU (Tech Startup): £35m (calculated via value-in-use)
- Carrying amount of CGU (net assets + goodwill): £40m (£25m assets + £15m goodwill)
- Impairment loss: £40m −’ £35m = £5m
- Goodwill impairment: £5m (all impairment allocated to goodwill first)
Journal Entry
Cr Goodwill £5,000,000
Goodwill reduced from £15m to £10m. Future periods: goodwill is retested; additional impairments likely if Tech Startup remains underperforming.
Real Company Example: Unilever's Acquisition Writeoff (2017)
Unilever acquired Tresemmé/Sun Silk hair brands for ~£850m in 2014. In 2017, facing sluggish sales and market consolidation, Unilever wrote down ~£650m of the goodwill. The impairment test showed that value-in-use (based on updated cash flows) fell significantly below the acquisition price due to:
- Lower-than-expected organic growth in the acquired brands
- Increased competitive pressure in the hair care segment
- Higher discount rates reflecting increased business risk
Audit Red Flags in IAS 36
Red Flag 1: No Impairment Test Despite Indicators
Finding: Company's revenue dropped 25%, but management didn't test goodwill for impairment.
Auditor action: Perform impairment test yourself; likely find significant impairment required.
Red Flag 2: Overstated Terminal Value Growth
Finding: VIU assumes 4% perpetual growth, but long-term GDP growth is 2% and the company faces headwinds.
Auditor action: Reduce terminal growth to GDP proxy; increases discount rate; reduces recoverable amount →’ impairment.
Red Flag 3: Underestimated Discount Rate (WACC)
Finding: WACC is 5%, but company's debt is speculative-grade; cost of debt should be 8%+.
Auditor action: Recalculate WACC with risk-adjusted rates; typically increases WACC by 1— 2%, reducing VIU significantly.
Red Flag 4: No Sensitivity Analysis
Finding: Impairment model shows no sensitivity to changes in key assumptions (WACC, growth rate).
Auditor action: Require sensitivity analysis; if impairment is near the threshold, small assumption changes flip the outcome.
IAS 36 vs ASC 350/360 (US GAAP)
Key difference: Two-step goodwill test (ASC 360). Step 1 tests if impairment is likely (qualitative); Step 2 measures it (quantitative). IFRS uses simpler single-step (direct VIU/FV comparison). But both eventually reach the same conclusion.
Real-Life Case Study: Impairment After a Lost Contract
Scenario. A company's cash-generating unit (a factory) loses its largest customer, a clear impairment indicator. The CGU's carrying amount is £8m.
Test. Recoverable amount is the higher of fair value less costs of disposal (£5.5m, from a broker estimate) and value in use (£6.2m, from discounted cash flows). Recoverable amount = £6.2m, so an impairment loss of £1.8m is recognised, first against any goodwill, then pro-rata across the CGU's other assets.
Takeaway. You only need one of the two measures to exceed carrying amount to avoid impairment, so preparers often start with whichever is easier to support. Once impaired, non-goodwill assets can be reversed later if conditions improve, goodwill impairment never reverses.
Illustrative composite scenario for educational purposes. Figures are indicative and do not represent any specific company.
• IAS 36 CGU Identification: Allocation & Testing
• IAS 36 Value-in-Use: Calculating WACC, Terminal Value & Discount Rate