Impairment of non-financial assets: Materials for directors
This is Information Sheet 203 (INFO 203). It explains your responsibilities as a director in connection with the testing of non-financial assets for impairment in the financial report of a company.
This information sheet discusses:
- what impairment testing is
- why impairment testing is important
- the assets covered by this information sheet
- how impairment testing is performed
- the role of directors and audit committees
- the matters that may be considered in assessing the impairment of non-financial assets, including:
- questions that may be asked of external auditors.
This information sheet is for audit committee members and directors, whether or not they are members of a company’s audit committee.
What impairment testing is
Impairment testing is the process of reviewing the values of assets shown in the balance sheet of a company (known as the ‘carrying amount’) to determine whether those values continue to be supportable or should be reduced.
Why impairment testing is important
Financial reports should provide useful and meaningful information for investors and other users of those financial reports so that they can be confident and informed in making investment and other decisions.
Non-financial assets are often significant assets of a company. The value attributed to these assets may affect not only the company’s reported financial position, but also its reported performance.
The assets covered by this information sheet
Financial reports must comply with accounting standards. Accounting standards AASB 136 Impairment of assets (AASB 136) and AASB 13 Fair value measurement (AASB 13) deal with the impairment of non-financial assets, such as:
- goodwill
- identifiable intangible assets, and
- property, plant and equipment.
Other accounting standards deal with the valuation or impairment of specific types of assets, such as investment properties, inventories, biological assets, deferred tax assets, employee benefit assets, construction contract assets, and for capitalised exploration and evaluation expenditure during the pre-development phase for companies in the extractive industries. This information sheet does not specifically address the valuation or impairment testing of these types of assets.
How impairment testing is performed
Where there are any indicators that assets may be impaired, a company must determine whether the carrying amount of assets exceeds the recoverable amount. This determination must also be made for intangible assets that are not amortised, such as goodwill, even if there are no indicators.
While there may be restrictions or prohibitions on upwards revaluations of particular types of non-financial assets, AASB 136 requires the value of a non-financial asset to be written down to its recoverable amount where this is lower than the carrying amount of the asset (i.e. the asset is impaired). The recoverable amount of an asset is the higher of its fair value less the costs of disposal and its value in use (as defined in the accounting standards).
The recoverable amount is assessed for assets attributable to parts of a company’s business known as ‘cash generating units’ (CGUs). A CGU is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows of other assets or groups of assets. CGUs should not be larger than any of the company’s operating segments. In some cases, the recoverable amount may be assessed for individual assets.
The role of directors and audit committees
Each director has a duty of skill, competence and diligence in understanding their company’s financial report. You should determine that the information in the financial report is consistent with your knowledge of the company’s financial position and affairs. See also Information Sheet 183 Directors and financial reporting (INFO 183).
Many companies have audit committees. While the existence of an audit committee does not alter the need for directors to take responsibility for financial reports, audit committees can play an important role in the financial reporting process.
Directors and members of audit committees should question the need for, and adequacy of, asset impairment and the adequacy of related disclosures. You may also need to critically assess whether management and staff have adequate skills to deal with impairment issues.
You should question the company’s approach to impairment testing, particularly where there is a risk that assets may be materially impaired. This information sheet sets out some questions that may help to do that. It is not a checklist. Rather, it is a resource that can be referred to (as relevant) according to the circumstances.
Impairment testing often relies on estimating the value of assets by discounting estimated future cash flows using appropriate discount rates. Although calculations supporting impairment or valuation of significant assets can be complex, you can review the cash flows and assumptions used in calculations prepared by management or experts for material assets, bearing in mind your knowledge of the business, the assets, the environment in which the company operates, and the future prospects of the business.
Given the subjectivity of elements of impairment calculations, disclosures concerning uncertainties and key assumptions are generally important to users of financial reports.
The extent to which directors can rely on management’s work on impairment will vary depending on the circumstances. Considerations may include:
- whether the assets are material
- the level of expertise of management and staff in the area of impairment
- the appropriate use of external experts, and
- how the performance of the company and the environment in which it operates may affect the recoverability of the value of assets through operating activities or the sale of those assets.
It follows that not all of the matters in this information sheet will be relevant or necessary to consider in every case.
Matters that may be considered
In assessing the impairment of non-financial assets, directors and audit committees may consider:
- the need for impairment testing
- the process for assessing impairment, and
- common issues with impairment calculations.
The need for impairment testing
A company must test non-financial assets for impairment when there are any indicators that the assets may be impaired. Paragraphs 12–14 of AASB 136 provide a list of the minimum indicators of impairment to be considered by a company.
Even if there are no impairment indicators, companies must undertake annual impairment tests of:
- identifiable intangible assets with indefinite useful lives
- intangible assets not yet available for use, and
- goodwill.
To ascertain the need for impairment testing, directors and audit committees may find it useful to consider the matters in Table 1.
Table 1 Matters to consider to ascertain the need for impairment testing
|
Matter to consider |
Questions to consider |
|---|---|
|
Assets requiring annual testing |
Does the company have identifiable intangible assets with indefinite useful lives, intangible assets not yet available for use, or goodwill requiring annual impairment testing? |
|
Possible indicators of impairment |
If the company is listed, is its market capitalisation less than the net assets shown by the company’s statement of financial position? Are there indicators that the overall value of any of the company’s CGUs may be less than the value attributed to the related assets? Has the financial performance of any CGU declined in recent years or in the last year? Has performance declined since the end of the financial year, or is it projected to decline in the future? Have past forecasts used in impairment calculations been met? Are there significant changes in the business or its environment now or in the future? Examples may include the following matters if significant:
Are there any other indicators that the value of non-financial assets may be impaired? |
|
Management’s assessment of indicators of impairment |
Has management undertaken a review of the company’s business and the environment in which it operates? Has management assessed impairment indicators and the need for impairment testing? Has management provided information to the board with its assessment of indicators of impairment? Is the analysis by management and the conclusions reached consistent with your knowledge of the business? |
The process for assessing impairment
To ascertain whether the company has sufficient and appropriate processes for assessing any impairment of non-financial assets, directors and audit committees may consider the matters in Table 2.
Table 2 Matters to consider when ascertaining appropriate processes
|
Matter to consider |
Questions to consider |
|---|---|
|
Culture |
Does the company have a culture that supports high quality financial reporting and realistic assessments of the business, its assets and the environment in which it operates? Does management show sufficient scepticism in relation to the value of assets? |
|
Planning |
Is there an appropriate plan for undertaking reviews and assessments of asset values for impairment? Have sufficient resources and time been allocated to impairment testing? Is impairment testing being performed before the end of the reporting period and updated before completion of the financial report? Has sufficient time been allowed for adequate review by the company’s external auditor? |
|
Experience and expertise |
Does the company have management and staff with sufficient qualifications, experience, expertise and time to undertake complex impairment testing? Do staff and any experts involved in impairment testing have a good understanding of the business, the environment in which it operates and future prospects? |
|
Source information and assumptions |
Is the source information (e.g. historical cash flows) properly extracted and tested for reliability? Are there strong internal controls over the extraction of source information and the impairment testing process? Have key assumptions been tested by appropriate benchmarking against industry and competitor information or other appropriate sources? |
|
Supervision and review |
Does management have sufficient experience, expertise and time to instruct the internal or external experts, and to supervise, monitor and review the work performed and reports? Does management have appropriate internal review processes, including independent reviews of work performed by staff with sufficient authority, experience, expertise and scepticism? Do staff undertaking reviews have a good understanding of the business, the environment in which it operates and future prospects? Do reviewers ensure that the scope of the work is adequate, that results are reasonable, source information is reliable, assumptions used are appropriate, and calculations are accurate? |
|
Incentives and accountability |
Are there appropriate incentives for management to focus on quality financial reporting? Is management held to account for the quality of financial reporting? Is there an appropriate balance between incentives and accountability for financial performance and for quality financial reporting? |
|
Use of external experts |
Have external experts been engaged where management and staff do not have sufficient experience, expertise or time to undertake impairment assessments? Do external experts have sufficient qualifications, experience and expertise? Have appropriate instructions been given to any external experts as to the scope of their work (e.g. the assets to be valued, and the methods to be applied) and ensuring that calculations are in accordance with the methodologies outlined in the accounting standards? Do external experts have a good understanding of the company’s businesses, its assets and the environment in which it operates? Do external experts have appropriate internal review processes? Have external experts adequately supported and tested key assumptions? Have any issues raised in valuation reports been adequately considered and addressed by management? Has management ensured that the cash flows, assumptions and results are reasonable and appropriate? |
|
Adequate documentation |
Is there adequate documentation of the source data used, and the impairment calculations and their review – whether performed by internal staff or external experts? Is the basis for future cash flows and key assumptions and the testing of these assumptions adequately documented? Is the documentation of a suitable standard for independent audit? |
Common issues with impairment calculations
In our experience, common issues with impairment calculations performed by companies include:
- cash flows and assumptions are not reasonable, having regard to matters such as historical cash flows, economic and market conditions, and funding costs
- discounted cash flows used to determine fair value less costs of disposal are based on forecasts and assumptions that are not reliable (in which case, value in use may need to be applied)
- value in use calculations:
- do not use sufficiently reliable cash flow estimates
- use increasing cash flows after five years that exceed long-term average growth rates, and without taking into account offsetting impacts on discount rates, and
- include cash flows from restructurings and improving or enhancing asset performance
- cash flows used are not matched to carrying amounts of all assets that generate those cash flows, such as inventories, receivables and tax balances
- similar discount rates are used for different CGUs, even though the risks are different and the CGUs are located in different countries, or different discount rates are used where the risks are similar
- CGUs are identified at too high a level, including where cash inflows for individual assets are largely independent or CGUs are at a level higher than operating segments
- not checking the determination of values by cross-checking with alternative valuation methods
- not applying the impairment test in AASB 136 for exploration and evaluation assets after technical feasibility and commercial viability have been demonstrated, and
- not making disclosures important to investors and others, such as the key assumptions used.
Directors and audit committees should consider the matters in Table 3 to ensure that the common issues with impairment calculations have been addressed.
Table 3 Matters to consider on impairment calculations
|
Matter to consider |
Questions to consider |
|---|---|
|
Forecasting cash flows |
Are cash flow forecasts reasonable and supportable? If cash flows are predicted to increase significantly after year end, is there a strong basis for this prediction? Have any risks been considered? Is the growth consistent with past growth achieved and is it sustainable? Have predictions been met in the months since year end to the completion of the financial report? If cash flows are based on an internal budget, is the budget realistic or based on stretch goals? Have past cash flow forecasts been met? If not:
Are management’s forecasted cash flows consistent with your understanding of the business and its future prospects? Has the cyclical nature of a business over time been properly recognised, rather than assuming cash flows at the top of a cycle will continue? Are nominal cash flows discounted using discount rates that include the effect of inflation? |
|
Key assumptions |
Have key assumptions such as growth or discount rates been adequately supported? Is the discount rate appropriate, having regard to funding costs, and an appropriate weighted average cost of capital or other appropriate rate? Is there a reasonable and supportable basis for use of different or similar discount rates for different CGUs? Has the impact of risks associated with matters such as market changes, climate |
|
Use of fair values less costs of disposal |
Are fair values less costs of disposal based on available market prices or observable market data? If not, it may be necessary to use value in use to determine the recoverable amount. Have valuations been checked by using different valuation methods, particularly where a market value is not available? Is the range of possible fair values too broad to determine a reliable estimate? Is the value chosen in a range of possible fair values representative of the fair value? This may not be the midpoint. Have maximum observable market inputs been used? |
|
Use of value in use |
Does the value in use calculation include any of the following:
|
|
Not matching cash flows with related assets |
Has the recoverable amount been compared to the carrying amount of all assets supporting the cash flows used in determining the recoverable amount? Has tax been treated consistently in the cash flows, discount rates and the assets/liabilities to which the recoverable amount is compared? Have corporate expenses and overheads been taken into account in the forecast cash flows? Have corporate assets been allocated to CGUs? Have liabilities (such as borrowings, payables and lease liabilities) been incorrectly deducted from the carrying amount of the assets tested for impairment when comparing their carrying amount to the recoverable amount? |
|
Identification of CGUs |
Do CGUs only relate to assets with cash inflows that are not largely independent? Have CGUs been identified at no higher level than the operating segments? |
|
Disclosures |
Have key assumptions used in the impairment calculations for each CGU been disclosed in the financial report, including whether the assumptions reflect past experience? Where a reasonably possible change in a key assumption could lead to an impairment loss, has this been adequately disclosed in accordance with AASB 136? Have disclosures necessary for investors and others been made as appropriate beyond the minimum prescribed in AASB 136? |
|
Consistency with other information |
Are forecast cash flows and other assumptions consistent with other information, such as:
Has the impairment test in AASB 136 for exploration and evaluation assets been applied after technical feasibility and commercial viability have been demonstrated? |
Questions that may be asked of external auditors
Directors and audit committees should also inform themselves of any concerns raised by the external auditors on impairment of non-financial assets, as well as any other aspects of the financial report or reporting processes.
The auditor gives an independent opinion that follows after the directors’ opinion on a financial report. A company must have its own systems, processes and controls, as well as appropriate resources, to produce high quality financial reports. Directors must not rely on the auditor in forming their own opinion on the financial report. See also INFO 183.
Directors and audit committees should also consider the quality of the external audit. See Information Sheet 196 Audit quality: The role of directors and audit committees (INFO 196).
Directors and audit committees may wish to consider the matters in Table 4 in connection with the external audit review of the company’s work on impairment of non-financial assets.
Table 4 Matters to consider regarding external audit
|
Matter to consider |
Questions to consider |
|---|---|
|
Concerns of the auditor |
Does the auditor have any concerns about the value of non-financial assets? Has the auditor raised any matters in their current or recent past management letters or reports to the audit committee relating to impairment, or with the company’s process for testing for impairment? Have any concerns of the auditor been adequately addressed on a timely basis? Have you raised any concerns that you have with impairment testing with the auditor? |
|
Quality of the audit |
Does the auditor have appropriate experience and expertise to review the impairment work? Has the auditor devoted sufficient resources and time to the review of the impairment testing? Is impairment work made available on a timely basis to ensure that the auditor has sufficient time to undertake their review? Is impairment work adequately performed and documented to facilitate the audit? Have asset values and impairment calculations been made available to, and assessed by, the auditor well before the reporting deadline? Has the auditor demonstrated a sufficient understanding of the business, operations and risk areas relevant to the financial report, and have they responded appropriately to assessed risks of impairment? Has the auditor exhibited sufficient professional scepticism in challenging, rather than rationalising, cash flows and assumptions used in asset values and the resulting values? Has the auditor addressed any risks or concerns identified by the directors and the audit committee? Has the auditor used their own experts to review the work of experts engaged by management? |
Where can I get more information?
- For copies of accounting standards and related guidance, go to www.aasb.gov.au.
- Download a copy of Information Sheet 183 Directors and financial reporting (INFO 183).
- Download a copy of Information Sheet 196 Audit quality: The role of directors and audit committees (INFO 196).
- Contact ASIC on 1300 300 630.
Important notice
Please note that this information sheet is a summary giving you basic information about a particular topic. It does not cover the whole of the relevant law regarding that topic, and it is not a substitute for professional advice. We encourage you to seek your own professional advice to find out how the applicable laws apply to you, as it is your responsibility to determine your obligations.
You should also note that because this information sheet avoids legal language wherever possible, it might include some generalisations about the application of the law. Some provisions of the law referred to have exceptions or important qualifications. In most cases, your particular circumstances must be taken into account when determining how the law applies to you.
Information sheets provide concise guidance on a specific process or compliance issue or an overview of detailed guidance.
This information sheet was reissued in August 2019.