The pandemic has spread globally at an alarming pace since the spring of 2020, and has significantly affected consumer behavior, shopping patterns, supply-chains, travel, etc, resulting in an adverse impact on lifestyles, markets, and the global economy. Many companies globally are struggling with low demand for their products and services. Covid-19 has acted  as a trigger event for an impairment test of the assets, and accordingly, companies need to evaluate the impact of the outbreak for accounting and financial reporting purposes.

Scope of IAS 36

IAS 36 ‘Impairment of Assets’ sets out the requirement to ensure that the assets of a reporting entity are carried at amounts that should not exceed its recoverable amounts. According to IAS 36, the recoverable amount of an asset is the amount higher of its fair value less costs to sell (FVLCS) and its value in use (VIU). Fair value is defined as an amount obtainable in an arm’s length transaction between a willing buyer and seller. VIU is based on an estimate of the future cash flows the entity expects to generate from the use of the asset or associated Cash Generating Units (CGUs). If the carrying amount of an asset exceeds its recoverable amount the asset is required to be impaired. IAS 36 then requires the asset to be written down to its recoverable amount and the impairment loss to be recognised.

As per IAS 36 requirement, both intangible assets with an indefinite useful life, intangibles not yet ready for their intended use, and goodwill needs to be tested for impairment at least annually. For other asset classes, the entity is required to test the asset for impairment when indicators of impairment are present due to the occurrence of some material events. Assets are either tested for impairment at the individual asset level (e.g. a single item of property, plant and equipment) if the single asset generates cash flow on its own, or groups of assets. However, in practice, assets must  be grouped into CGUs for the purpose of impairment testing.

Covid-19 – Trigger Event for the Application of IAS 36

Indicators as defined in IAS 36 such as declines in quoted asset values, operational disruptions to supply chains, and decreases in revenue and profitability are likely to exist due to the effects of COVID-19. Entities with a reporting period from 31 March 2020 onwards are required to consider COVID-19 as an impairment indicator for financial reporting purposes.

The important element of estimating VIU or FVLCS are projections of cash flows, a discount rate, and adjustments to incorporate uncertainty, variability, and other factors that mustreflect in the pricing of asset or CGU. These adjustments will also be affected by COVID-19 and should be incorporated accordingly. IAS 36 allows these adjustments to be reflected either by adjusting the discount rate or by adjusting the cash flows (including assumptions for the long-term growth). Given the high uncertainty in the current scenario, an adjustment in the cash flow is often preferable as it involves more explicit consideration of possible future outcomes. It is also important to ensure the risk adjustment should be either in cash flow or discount rate but not both to avoid double-counting of COVID-19 risks.

Key considerations  

Forecasting cash flows – The ongoing uncertainty over the duration and longer-term impact is a matter of concern, as companies have experienced major disruptions to their operations, with steady declines in cash flows and profits. Entities with reporting dates after the outbreak of the COVID-19 pandemic are expected to face challenges reflecting the impact of COVID-19 in a single set of cashflow forecasts due to high uncertainty. Companies should therefore consider developing multiple scenarios with assigned probabilities to each scenario to arrive at the expected cash flows. Reporting entities applying the risk-adjusted expected cash flow approach should give more weightage to the downside scenario(s) to incorporate a market view of risk and uncertainty.

Calculation of the discount rate – Given the current conditions, it is very challenging to determine a risk-adjusted discount rate due to the volatility in financial markets. One of the components of discount rate such as risk-free rate using long-term government bond yields as a proxy may no longer be appropriate. Discount rates need to be assessed against current market conditions and any guidance provided by market evidence of value for comparable reporting entities or assets. It is also likely that the beta and cost of equity for the entity may increase.

Disclosure requirements – Entities need to pay close attention to disclosures and provide helpful information to the primary users of financial statements. The following are some factors which an entity needs to bear in mind when considering disclosures under IAS 36, mindful of the pandemic.

  • Sensitivity and key assumptions disclosures and major sources of estimated uncertainty
  • Determining what scenario information and sensitivities’ are to be disclosed regarding the impact from Covid-19 on business operations and therefore the potential impairment of assets
  • Determining if any CGU specific risks have to be disclosed (e.g. components of the discount rate, operational and other sector specific-issues, and potential functional/ economic obsolescence)

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