Impairment of Assets: Calculation of Recoverable Amount, Value in Use, Fair Value less Cost of Disposal

Impairment of Assets 1
ACCOUNTING OF IMPAIRMENT OF ASSETS
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Topic: calculate Recoverable amount, value in use, Fair value less cost of disposal

Impairment of Assets 2
Accounting of Impairment of Assets
The treatment of impairment of assets is addressed under IAS 36. According to IAS
36, an organization should not carry its asset at an amount higher than its
recoverable amount. However, some intangible assets and goodwill are excepted
from this requirement (Shamrock, 2012, p. 45). IAS 36 states that companies should
carry out an impairment test annually to ascertain whether or not its assets are
impaired. Before determining a recoverable amount of an asset, values of its value in
use and fair value less cost of disposal should be known first. This paper seeks to
illustrate the definition and calculation of recoverable amount, value in use, and fair
value less cost of disposal (Weygandt, et al., 2015, p. 61).
Recoverable amount
According to IAS 36 Impairment of Assets, Recoverable amount is defined as, "the
higher of fair value less costs to sell (FVLCTS) and value in use" (Everingham, et al.,
2007, p. 101). In other words, the recoverable amount refers to the highest amount
that can be generated from an entity's asset. There are two ways in which value can
be obtained from an asset: First, an asset can be used by a company to generate
cash flows. Second, value can be realized from selling off an asset to another person
or entity.
Why calculate recoverable amount? Recoverable amount is a test for impairment. It
is presumed that the management of a company will choose the highest amount to
maximize the entity's value that is why the expected amount from value in use or fair
value less costs to sell should be compared and choose the highest amount as the
recoverable amount (Bragg, 2016, p. 152).

Impairment of Assets 3
There are two formulas for calculating the recoverable amount;
a) Recoverable amount= Value in Use
b) Recoverable Amount= Fair Value – Cost of Disposal
Where:
Fair Value refers to the price an entity would receive by selling an asset
Cost of Disposal refers to the cost associated with selling an asset.
Note: There is a challenge when it comes to calculating the recoverable amount of
an asset that must be combined by other assets (cash-generating unit) to generate
cash flows. In such a case the recoverable amount for the cash-generating unit is
calculated.
Value in Use
The value in use refers to an amount that would be realized in the future by using an
asset to generate cash flows. The value in use is calculated by determining the
weighted (probable) future cash flows of an asset or cash generating unit. The cash
flows should, however, be discounted using a discount rate to address the risks
associated with the cash flows. At the end of the useful life of the asset, its
disposable value (if any) should be added to the cash flows to obtain the asset's
value in use (Dagwell, et al., 2015, p. 73).
The value in Use is calculated as shown below:
The value in Use = Discounted cumulated cash flows + Disposable Value (If any).