Impairment Test and Determination of Recoverable Amount for Assets

CORPORATE ACCOUNTING

A company needs to record in its books of accounts if the recoverable amount of assets held
by them exceeds their carrying amount. The process of identification of such assets and
recoding them is known as the impairment test. The difference between the two amounts is
known as impairment loss. The determination of recoverable amount is a complex job and so
it is very difficult to ascertain the recoverable amount for each asset separately. Therefore, the
recoverable amount for the cash generating unit (CGU) is determined. Cash generating asset
is the pool of assets that helps in generating cash inflow. Such assets which are contained in
the unit must have an active market or could be consumed within the company itself. Few
disclosures that a company has to make is when there is a transfer of any particular asset from
one CGU to another, if the company has reversed any impairment losses or if it has made any
sort of payments. However, the recoverable amount is dependent that is derived from the cash
flows and also the efficiency by which the assets are being used (Alvarez, 2013).
The impairment test for a normal asset and a CGU is done almost in the same manner. the
recoverable amount that is ascertained is compared with the carrying amount. The difference
between the two is allocated among all the assets of the CGU in the ratio of their carrying
value (Easton, 2010). The value of each asset gets decreased because impairment loss is
deducted against each asset that is contained in the cash generating unit.
In order to determine the recoverable amount, we require the value in use and the fair value
less cost of disposal. Let us now understand the process to determine the value in use
(Fridson & Alvarez, 2012).
Value in use can be determined by calculating the present value (PV) of the future cash flows
that are expected to be generated from the CGU (Girard, 2014). The steps that have to be
followed for calculating value in use are as follows:
 The company must be efficient enough to estimate the future cash flows using the
information available.
 Estimates are based on certain assumptions and are a judgemental process. Therefore,
the management must state about the variations that might occur.
 In order to calculate the present value, the company will require a discount rate which
is based on certain assumptions. The other factors that are taken into consideration is
risk bearing as well as liquidity.
The estimations of cash flows that are made by the company must be: