CFAR - Financial Accounting & Reporting - Part 1

Overview

You’re looking at IAS 36 impairment testing: when to test, how to measure recoverable amount, and how to apply the rules to individual assets versus cash‑generating units (CGUs) and goodwill. By the end, you should be able to (1) spot impairment indicators, (2) compute recoverable amount using the two measurement bases, (3) understand discount rate and cash flow rules for value in use, and (4) explain why goodwill is tested at the CGU level. I’ll talk through this “vlog-style,” like we’re working problems on a whiteboard—focusing on patterns and reasoning, not memorizing options.

Concept-by-Concept Deep Dive

Recoverable Amount: The Core Measurement (Higher of Two Bases)

• What it is (2–4 sentences). Under IAS 36, an asset (or CGU) is impaired when its carrying amount exceeds its recoverable amount. Recoverable amount is defined as the higher of: (a) fair value less costs of disposal and (b) value in use. The “higher of” rule matters because you’re asking: “What is the best economic recovery route—sell it, or keep using it?”
• Components / subtopics.

  Carrying amount vs recoverable amount

  • Carrying amount is what’s on the books (cost less accumulated depreciation/amortization and any prior impairment).
  • Recoverable amount is the best estimate of what you can get back, either through sale or through continued use.

  Two measurement bases

  • Fair value less costs of disposal (FVLCD): market-based exit value (sell), net of incremental disposal costs.
  • Value in use (VIU): entity-specific present value of future cash flows from using the asset and disposing of it at the end of its useful life.
• Step-by-step reasoning / calculation recipe.
  1. Identify the asset or CGU you’re testing (individual asset if independent cash inflows exist; otherwise CGU).
  2. Determine carrying amount (ensure it includes directly attributable assets and allocated amounts when testing CGUs).
  3. Estimate FVLCD (market data if available; otherwise valuation techniques).
  4. Estimate VIU (forecast cash flows + terminal disposal proceeds; discount appropriately).
  5. Set recoverable amount = higher of FVLCD and VIU.
  6. Compare: if carrying amount > recoverable amount, recognize impairment loss for the difference.
• Common misconceptions and how to fix them.
  • Misconception: “Recoverable amount is the average of FVLCD and VIU.”
    Fix: It’s the higher of the two, not an average.
  • Misconception: “If one measure is below carrying amount, you automatically impair.”
    Fix: You only impair if both measures are below carrying amount (because you choose the higher).
  • Misconception: “Costs to sell include general overhead.”
    Fix: Use incremental, directly attributable disposal costs (e.g., legal fees, broker commissions), not ongoing operating costs.

Fair Value Less Costs of Disposal (FVLCD): Market Logic and Practical Shortcuts

• What it is (2–4 sentences). FVLCD is the amount you’d get from selling the asset in an orderly transaction between market participants, minus costs to dispose. When an active market exists, IAS 36 expects you to anchor your estimate to observable market prices. When a binding sale agreement exists, that contract price is often a key input—subject to the idea of orderly, enforceable terms.
• Components / subtopics.

  Active market scenario

  • Use the quoted market price (appropriately adjusted for the asset’s condition/location if needed).
  • Deduct costs of disposal (commissions, taxes on sale, removal costs if directly attributable).

  Binding sale agreement

  • Start with the contract price (assuming it reflects an orderly transaction).
  • Still deduct costs of disposal to arrive at “less costs of disposal.”

  When market data is limited

  • Use valuation techniques (e.g., discounted cash flows from a market participant perspective, recent transactions for similar assets, or appraisals).
• Step-by-step reasoning / calculation recipe.
  1. Ask: Is there an active market or observable transaction price?
  2. Choose the best evidence (quoted price > recent comparable sales > valuation model).
  3. Identify incremental disposal costs.
  4. Compute FVLCD = fair value – costs of disposal.
• Common misconceptions and how to fix them.
  • Misconception: “Fair value is entity-specific.”
    Fix: Fair value is market participant based; VIU is the entity-specific one.
  • Misconception: “If there’s a sale agreement, you ignore market conditions.”
    Fix: You start from the agreement price, but still apply the idea of orderly, enforceable pricing and subtract disposal costs.

Value in Use (VIU): Cash Flow Discipline + Discount Rate Discipline

• What it is (2–4 sentences). Value in use is the present value of the future cash flows expected from continuing to use the asset (or CGU) and from its disposal at the end of its useful life. IAS 36 is strict about what cash flows you can include and what discount rate characteristics are acceptable. Most exam errors happen because learners mix “investment plans” or financing effects into VIU.
• Components / subtopics.

  Cash flows to include

  • Cash inflows/outflows from continuing use of the asset in its current condition.
  • Cash flows from ultimate disposal (salvage/terminal value), net of disposal costs (consistent with the model).

  Cash flows to exclude (highly testable)

  • Cash flows from future restructurings that the entity is not yet committed to.
  • Cash flows from future enhancements/improvements that would increase performance beyond current condition.
  • Financing cash flows (interest, principal) and income tax cash flows are typically excluded in IAS 36 VIU modeling (the standard’s approach keeps financing separate and uses pre-tax inputs in a consistent way).

  Discount rate characteristics (also highly testable)

  • Rate should reflect the time value of money and risks specific to the asset for which cash flow estimates have not been adjusted.
  • It should be consistent with the cash flows (e.g., if cash flows are pre-tax, rate is pre-tax; if risks are embedded in cash flows, don’t double-count them in the rate).
• Step-by-step reasoning / calculation recipe.
  1. Define the cash-generating context (asset or CGU) and remaining useful life.
  2. Forecast cash flows from current use (often based on budgets/forecasts, then extrapolated).
  3. Remove excluded items: future restructuring not committed, future enhancements, financing and tax cash flows (per IAS 36 discipline).
  4. Add terminal disposal proceeds (inflow) at end of life.
  5. Choose a discount rate consistent with the cash flows and risk treatment.
  6. Discount to present value: $VIU = \sum \frac{CF_t}{(1+r)^t}$.
• Common misconceptions and how to fix them.
  • Misconception: “Include cash flows from planned upgrades because management intends to do them.”
    Fix: Intent isn’t enough—VIU generally reflects the asset in its current condition, excluding uncommitted enhancements.
  • Misconception: “Use any rate the company uses internally.”
    Fix: The rate must reflect asset-specific risks and be consistent with how cash flows were estimated (avoid double counting risk).
  • Misconception: “Discount rate must always be post-tax because that’s what finance uses.”
    Fix: IAS 36 emphasizes consistency (often pre-tax in the standard’s mechanics). The key is matching cash flow basis and rate basis.

Indicators of Impairment: External vs Internal Signals

• What it is (2–4 sentences). IAS 36 typically requires an entity to assess at each reporting date whether there are indicators that an asset may be impaired. Indicators are grouped into external (market/economic/legal environment) and internal (asset performance/condition/usage) sources.