Impairment occurs when the carrying value of an asset on the balance sheet exceeds its recoverable amount. When this happens, the asset is worth less than the books say, and the difference must be written down as an impairment loss. This is a separate concept from depreciation or amortisation, which allocate cost systematically over an asset’s useful life.
Under FRS 102 Section 27, UK companies must assess at each reporting date whether there are any indicators that an asset may be impaired. If indicators exist, a formal impairment review must be carried out.
When Impairment Testing Is Required
FRS 102 does not require an annual impairment test for all assets. Instead, it operates on an indicator-based approach. An impairment review is triggered when there are signs that an asset’s value may have fallen.
External Indicators
| Indicator | Example |
|---|---|
| Significant decline in market value | Property values falling due to economic downturn |
| Adverse changes in technology or markets | A product line becoming obsolete |
| Increase in interest rates | Higher discount rates reducing the present value of future cash flows |
| Market capitalisation below net assets | The company’s share price implies assets are overvalued |
Internal Indicators
| Indicator | Example |
|---|---|
| Physical damage | Fire, flood or accident damaging equipment |
| Plans to discontinue or restructure | Decision to close a division |
| Worse-than-expected performance | An asset generating less revenue than forecast |
| Evidence of obsolescence | Equipment no longer used or underutilised |
Mandatory Annual Testing
Certain assets must be tested for impairment annually, regardless of whether indicators exist:
- Goodwill with an indefinite useful life (rare under FRS 102, which requires amortisation)
- Intangible assets not yet available for use
The Recoverable Amount
The recoverable amount of an asset is the higher of:
- Fair value less costs to sell: The price obtainable in an arm’s length transaction, minus disposal costs
- Value in use: The present value of the future cash flows expected from the asset’s continued use and eventual disposal
| Measure | How it is determined |
|---|---|
| Fair value less costs to sell | Market price, valuation, or recent transaction for a similar asset, minus selling costs |
| Value in use | Discounted cash flow calculation using the asset’s expected future cash flows and an appropriate discount rate |
The company only needs to calculate both if the first one tested is below carrying value.
Value in Use Calculation
A value in use calculation requires:
- Estimating future cash flows from the asset over its remaining useful life
- Including the expected disposal value at the end of the asset’s life
- Discounting the cash flows at a pre-tax rate that reflects current market assessments of the time value of money and risks specific to the asset
| Year | Expected cash flow (£) | Discount factor (10%) | Present value (£) |
|---|---|---|---|
| 1 | 50,000 | 0.909 | 45,450 |
| 2 | 45,000 | 0.826 | 37,170 |
| 3 | 40,000 | 0.751 | 30,040 |
| 4 | 35,000 | 0.683 | 23,905 |
| 5 | 30,000 + 10,000 disposal | 0.621 | 24,840 |
| Total value in use | 161,405 |
If the carrying value of this asset is £180,000, it is impaired by £18,595.
Recording an Impairment Loss
An impairment loss is recognised immediately in the profit and loss account (income statement). The journal entry is:
| Account | Debit (£) | Credit (£) |
|---|---|---|
| Impairment loss (P&L) | 18,595 | |
| Accumulated impairment - fixed asset | 18,595 |
After recording the loss, future depreciation is based on the revised carrying value over the remaining useful life.
Where Revaluation Has Been Applied
If the asset has previously been revalued upwards, the impairment loss is first charged against the revaluation reserve (to the extent of any previous revaluation surplus for that asset). Any remaining loss goes to the profit and loss account.
Cash-Generating Units
When an individual asset does not generate cash flows independently, it must be assessed as part of a cash-generating unit (CGU). A CGU is the smallest identifiable group of assets that generates cash inflows largely independent of other assets.
For example, a factory with multiple machines that together produce a single product line would be assessed as one CGU. The impairment test compares the carrying value of the entire CGU against its recoverable amount.
Allocating an Impairment Loss Within a CGU
When a CGU is impaired, the loss is allocated in this order:
- First, reduce the carrying amount of any goodwill allocated to the CGU
- Then, reduce the carrying amounts of other assets in the CGU pro rata based on their carrying values
No asset should be reduced below the highest of its fair value less costs to sell, its value in use, or zero.
Impairment of Goodwill
Goodwill arising on a business combination is particularly susceptible to impairment. Under FRS 102, goodwill is amortised over its estimated useful life (with a rebuttable presumption that this does not exceed five years, though up to ten years is permitted).
In addition to systematic amortisation, goodwill must be tested for impairment whenever there are indicators that its value may have fallen. Common triggers include:
- The acquired business performing below expectations
- Loss of key customers or contracts
- Departure of key personnel
- Adverse market or regulatory changes
Goodwill impairment losses cannot be reversed under FRS 102.
Impairment of Fixed Assets
Fixed assets are tested for impairment when indicators exist. The prudence concept requires that losses are recognised as soon as they are anticipated, even if the exact amount involves estimation.
Common Scenarios
| Scenario | Typical treatment |
|---|---|
| Property market decline | Revalue downwards; impairment loss to P&L (or revaluation reserve if previously revalued) |
| Machinery damaged by flood | Write down to recoverable amount; insurance proceeds recorded separately |
| Technology obsolescence | Write down specialised equipment to scrap value |
| Customer contract lost | Review assets dedicated to that contract; impair if no alternative use |
Reversal of Impairment Losses
Under FRS 102, an impairment loss on an asset other than goodwill may be reversed in a later period if the circumstances that caused the impairment no longer exist. The reversal is limited so that the carrying value does not exceed the amount that would have been determined (net of depreciation) had no impairment been recognised.
The reversal is credited to the profit and loss account (or the revaluation reserve if the asset is carried at a revalued amount).
| Rule | Treatment |
|---|---|
| Goodwill impairment | Never reversed |
| Other asset impairment | Reversed if conditions improve, up to the original depreciated amount |
| Revalued asset impairment | Reversed to revaluation reserve to the extent of original revaluation |
Disclosure Requirements
FRS 102 requires the following disclosures for impairment:
- The amount of impairment losses recognised in the period, by class of asset
- The amount of reversals of impairment losses recognised in the period
- The line item in the profit and loss account in which the losses or reversals are included
- For material impairments, the events and circumstances that led to the recognition or reversal
- For value in use calculations, the key assumptions used (discount rates, growth rates, forecast period)
Impairment is an area where significant judgement is required, and auditors scrutinise the assumptions underlying management’s assessments carefully.