Impairment Testing

What Is Impairment Testing?

Depreciation spreads cost over an expected life on the assumption that the asset will go on earning. Impairment addresses what happens when that assumption fails: the market for the output disappears, the plant is damaged, a process is superseded, or the asset is simply idle. The carrying amount is then compared with what can actually be recovered from it, and any excess is written off.

Recoverable amount is the higher of two figures, what a sale would fetch after the costs of selling, set against the value of continuing to run it, because any rational owner would choose whichever course pays better. Most assets are examined only where something has signalled a problem, not on an annual cycle, which is why spotting those signals matters so much. A physical verification is where several of them surface: equipment found idle, damaged, or superseded is carrying a value that assumes none of those things, and nobody at a desk would have known.

Impairment Testing Under Indian Law

Position: an asset is impaired where its carrying amount exceeds its recoverable amount, with the recoverable figure being whichever is greater, a net sale price or the value of keeping it in service.

• For most assets the examination is triggered by a signal that something has changed, not by the calendar, although goodwill and indefinite-lived intangibles are reviewed annually whatever the signals say. A reversal is permitted where the recoverable amount subsequently rises, except for goodwill.
• Source: Accounting Standard 28 and Ind AS 36, Impairment of Assets.
• Note: a reversal cannot lift the carrying amount above what it would have been, net of depreciation, had no impairment ever been recognised, which is why the original workings have to be retained.

How Impairment Testing Applies to a Fixed Asset Register

The register is both the source of the trigger and the place the result is recorded.

• Status and condition fields are what surface the indications: assets marked idle, damaged or awaiting disposal are the population a test starts from.
• The last verification date matters as much, since an asset nobody has seen for several years cannot generate an indication of anything.
• Where a charge is taken, it is posted against the individual line rather than to a general provision, so the reduced carrying amount belongs to a specific asset.
• The remaining life is then applied to that reduced amount, which changes the charge going forward and has to be reflected in the line's own fields.
• Any later reversal is capped by reference to what the line would have carried had the charge never been made, which requires the original workings to have been kept.

How Impairment Testing Works in Practice

1. At each reporting date the entity looks for signals that an asset may have lost value: idle plant, physical damage, a market in decline, a process superseded, or a unit consistently missing its output plan.

1. Where a signal exists, the asset's carrying amount is taken from the register as the figure to be tested against.

1. Two recoverable figures are then estimated. One is what a sale would realise after selling costs. The other is what continuing to operate the asset will produce, discounted to today.

1. The higher of those two is compared with the carrying amount. Where the carrying amount is greater, the difference is written off immediately as an impairment charge.

1. The reduced amount becomes the new base for depreciation over the remaining life. At later dates the position is retested, and where the cause has genuinely reversed the charge can be reversed, capped so the asset never exceeds what it would have been worth had no impairment occurred.

Impairment Testing: A Worked Example

A Ludhiana cycle-parts line loses its principal customer and is tested as a single cash generating unit.

The order of the middle rows is the part that gets reversed. The recoverable figure takes whichever is greater, value in use or fair value less costs to sell, so the comparison is against Rs 5.60 crore. Using the discounted cash flow figure alone would have produced a Rs 1.70 crore loss, Rs 50 lakh too much, because the assets are worth more sold than run. The test is applied to the unit rather than to individual machines, since no single press generates cash on its own. An indicator such as losing a major customer triggers the test; the annual calendar does not.

Common Mistakes With Impairment Testing

The test is skipped far more often than it is performed badly.

• Waiting for an annual review when the trigger is an indication that something has changed, so a plant idled in June is examined the following March at the earliest.
• Comparing the carrying amount against sale proceeds alone, ignoring that the asset may be worth more kept in use, which writes down equipment that is still earning.
• Treating a physical verification as unrelated to the question, when idle, damaged and superseded equipment found on the floor are exactly the indications that should start it.
• Applying it to an asset that has already been fully depreciated, where there is nothing left to impair and the effort achieves nothing.
• Recording the conclusion without the workings, so a later reviewer cannot tell whether the recoverable figure was estimated or simply asserted.

Related Stock Audit Terms

Assets not yet in use sit outside the charge entirely until they are, so capital work-in-progress (cwip) is the entry to read next. Every other term in this cluster is listed in the A-Z of stock audit terms, grouped by the part of the work it belongs to.