‘Today, we announced a fundamental restructuring of our phone business. As a result, the company will take an impairment charge of approximately $7.6 billion related to assets associated with the acquisition of the Nokia Devices and Services business.’
Satya Nadella, Microsoft CEO
In a nutshell
Impairment refers to a permanent loss in the income-generating potential of an asset.
A fixed asset is considered impaired when the worth to the business (known as ‘recoverable amount’) falls below its ‘carrying value’ in the balance sheet.
Fixed assets (tangible and intangible) with a finite useful economic life are assessed annually for evidence of impairment. An impairment test must be carried out when indicators of impairment exist.
Impairments result in an accounting loss that is reflected in the profit and loss account.
Goodwill is treated differently because it has an indefinite life. An annual impairment test must be carried out for goodwill irrespective of whether indicators of impairment exist (see Chapter 10 Goodwill and other intangibles).
It is not always easy to identify whether an asset has suffered impairment.
Need to know 
Impairments are conceptually different to downward revaluations. Impairment accounting is not a matter of choice, whereas revaluation accounting is (see Chapter 17 Revaluation). All companies, whether they record assets at cost or market value, must reduce the carrying value of those assets when they have suffered an impairment.
Knowing whether an asset has been impaired, however, is not always easy. External and internal indicators can be used to identify whether an asset may be impaired.
External and internal indicators of impairment
- ■Market value decline
- ■Adverse changes in technology, the economy, or laws
- ■Increase in market interest rates
- ■Obsolescence or physical damage to an asset
- ■Economic performance from an asset is worse than expected
- ■Asset lying idle.
Examples
- 1Introduction of Ultra Low Emission Zones (ULEZ) by major cities such as London. Such restrictions may prevent or impose penalty charges for vehicles entering ULEZ zones that do not meet the Euro 6 standards. This may affect the income-generating potential of non-compliant vehicles.
- 2Boeing 737 Max fatalities. All 737 Max planes were grounded during 2018 and 2019 while investigations were conducted into the causes of the accidents. Airlines that acquired these planes were unable to operate them, directly affecting income generation.
- 3Many businesses were prevented from using property, plant and equipment as a result of the Covid-19 pandemic. The economic performance of these assets was adversely affected (see extracts from Greggs plc 2020 financial statements, below).
- 4Airbus A380 superjumbo. The plane’s extremely large capacity had been designed for a system of travel in which it was assumed passengers would travel between central hubs before being taken to their onward destinations (a ‘hub and spoke’ system). However, technological advances in the efficiency and range of newer aircraft has meant that passengers can increasingly travel using a ‘point to point system’, to get them to their destination in one flight, instead of two or three.
- 5Concorde supersonic plane. Following a fatal crash in the early 2000s the plane was consigned to the scrapyard. The asset suffered ‘impairment’ not because it had reached the end of its planned useful life but because of damage to its reputation, largely caused by safety concerns.
Why is this important? 
An impairment results in the carrying value of an asset being reduced to its (lower) recoverable amount. The reduction in value is an accounting loss that must be recognised in the profit and loss account in the year of impairment. This is an application of the accounting concept of prudence (see Chapter 6 Revenue recognition)
When is this important? 
The risk of fixed assets being impaired must be considered annually. Directors, who are expected to know their business, must consider at the end of each accounting period whether assets held by the business could be impaired, by considering the indicators of impairment (see above). While the presence of indicators does not prove that an asset has suffered impairment, it does point to the possibility that the asset value may be impaired. In the case of finite-life fixed assets, this possibility is sufficient to trigger a detailed consideration and calculation to determine the asset’s recoverable value.
Calculating impairment
Impairment is the amount by which the carrying (book) value of an asset exceeds its recoverable amount.
Recoverable amount is the worth of an asset to the business. ‘Worth’ is calculated as the higher of the asset’s sale price (i.e. fair value) less cost of disposal, or its future earnings potential through continued use (known as ‘Value in Use’ or ‘VIU’) as shown below.
Example 1
A company’s only asset, an item of plant and machinery, has a carrying value in the balance sheet of £100,000. The recoverable amount of the asset is calculated as £93,000.
The asset must be written down to the (lower) recoverable amount of £93,000.
Balance sheet
| Plant and machinery | £93,000 (previously £100,000) |
Profit and loss account
| Impairment loss | £7,000 (£100,000 − £93,000) |
Example 2
A landlord owns a property currently worth £300,000 (market value). Future rental income (VIU) expected from continued use of the property is projected to be £350,000.
The recoverable amount is therefore £350,000 (i.e. higher of fair value and VIU).
Assuming in this example that the property’s carrying value in the books was £400,000 then the property has suffered an impairment of £50,000 (£400,000 − £350,000). The asset’s carrying value will be reduced to £350,000 and an impairment loss of £50,000 will be recognised as an expense in the profit and loss account.
Example 3
Following on from Example 2, if the market value were, say, £375,000 (and not £300,000), the recoverable amount would be £375,000 (as this is higher than the VIU).
This would result in a lower impairment charge of £25,000 (£400,000 − £375,000).
Purchased goodwill
Unlike tangible fixed assets, purchased goodwill must be subjected to annual impairment testing because it is considered to have an indefinite life that is not subject to amortisation (see Chapter 10 Goodwill and other intangibles).
Because goodwill only arises on the purchase of one business by another, goodwill impairment testing involves the comparison of the cash flows for the acquired business every year to the cash flow forecasts used to support the carrying value of goodwill at the time of acquisition.
Impairment testing in the first-year post acquisition led Microsoft to write down goodwill on acquisition of Nokia by $7.6bn (see Chapter 10 Goodwill and other intangibles).
Saga, the insurer and cruise line operator, posted a £61m pre-tax loss for the year ended January 2021. This was largely due to a £60m goodwill impairment against its travel business, based on the impact of the Covid-19 pandemic.
Nice to know 
Should there be a significant impairment in the value of an acquired business, the underlying assets of the business may be impaired also. Goodwill is eliminated first with any additional write down allocated on a pro-rata basis against remaining assets.
Example 3
D Ltd acquired ABC business at the start of last year for £250,000. The fair value of the assets at acquisition was £200,000. Goodwill on acquisition of £50,000 (£250,000 – £200,000) was recognised in the books of the buyer.
Following a recent impairment test, the VIU of ABC is now estimated to be £180,000.
The impairment loss of £70,000 (£250,000 − £180,000) is set off against goodwill first and then against the remaining assets, as follows:
Because impairment results in a lower carrying value of an asset, depreciation (or amortisation) charges will consequently be based on a (lower) carrying value in the balance sheet and therefore be lower following any impairment.
In practice 
Impairment tests compare the carrying value of an individual asset to the recoverable amount of that asset. VIU forecasts should therefore be based on cash flows generated by each asset. In practice it is very difficult to assign future earnings or cash flows to a single asset. Even a small business, such as a car repair garage, whose assets might only comprise a premises and plant & equipment, would find it difficult to identify the cash flows generated by each asset individually, i.e. to the exclusion of other assets of the business.
The VIU of assets are therefore typically considered together as a ‘cash generating unit’ (CGU) because this represents the smallest collection of assets that generate an income stream.
Any impairment is allocated to the CGU’s assets proportionately.
Example 4
ABC is a motor garage with assets totalling £200,000 (comprising building £180,000, plant and equipment £20,000). The value in use (recoverable amount) is estimated at £180,000.
The impairment loss is £20,000 (£200,000 − £180,000)
The impairment is allocated against assets in proportion to their original carrying value, as follows:
| Asset | Original carrying value | Impairment loss | Recoverable amount (new carrying value) |
|---|---|---|---|
| Building (90%) | £180,000 | £18,000 | £162,000 |
| Plant and equipment (10%) | £20,000 | £2,000 | £18,000 |
| Total | £200,000 | £20,000 | £180,000 |
Optional detail 
If an asset subsequently recovers in value, then impairment losses can be reversed (although these are subject to certain limits). For finite-life assets impairments may not therefore be permanent.
However, in the case of goodwill, an impairment loss, once recognised, can never be reversed.
Reflect and embed your understanding 
- 1Explain the purpose behind impairment testing. Reflect on the principle of prudent accounting.
- 2Impairments are calculated by comparing the carrying value of assets to their recoverable amount, which is calculated by comparing the value in use (VIU) to the realisable value. Consider why this basis of calculation fairly reflects the quantum of any impairment loss.
- 3For an example organisation that you are familiar with, did the usage of the organisation’s assets change as a result of the Covid-19 pandemic? Consider whether the assets suffered impairment and identify the impact of any impairment on the financial statements of the organisation.
For the authors’ reflections on these questions, please go to financebook.co.uk
Where to spot in company accounts 
See the basis of preparation note (under accounting policies).
Extract from Greggs plc 2020 financial statements Appendix p. 452
Impairment
Property, plant and equipment and right-of-use assets are reviewed for impairment if events or changes in circumstances indicate that the carrying value may not be recoverable. For example, shop fittings and right-of-use assets may be impaired if sales in that shop fall. When a review for impairment is conducted the recoverable amount is estimated based on either value-in-use calculations or fair value less costs of disposal. Both value-in-use and fair value less costs of disposal calculations require management to estimate future cash flows generated by the assets and an appropriate discount rate. Consideration is also given to whether the impairment assessments made in prior years remain appropriate based on the latest expectations in respect of recoverable amount. Where it is concluded that the impairment has reduced, a reversal of the impairment is recorded.
The Covid-19 crisis has meant that all shops have had periods of no, or reduced, sales and the rate of recovery of sales is inherently uncertain. This is considered to be an impairment trigger and as a result all assets in company-managed shops have been tested for impairment.
As a result of the crisis and following the shutdown period a decision was made not to reopen 38 shops. All shop fittings and right-of-use assets in these shops have been fully impaired (with no significant degree of estimation required) at a cost of £5.3 million (of which £2.5 million relates to fixtures and fittings and £2.8 million relates to right-of-use assets). In addition, a provision of £2.5 million was made for onerous costs and dilapidations directly related to these closures which is expected to be utilised over the remaining term of these shop leases. The assumptions regarding the lease term in respect of these shops were reviewed and where required the lease liability was remeasured before assessing the shop for impairment.
For the remainder of the estate an impairment review was carried out using the following assumptions:
- –Shops have been categorised into different catchment areas (e.g. city centres, transport hubs) and assumptions made on the rate of like-for-like sales recovery for each catchment;
- –Like-for-like sales have been assumed to grow from December 2020 levels to a level six per cent lower than pre-Covid-19 levels (on average across the estate) by the end of 2021, then continuing to grow to pre-lockdown levels by December 2022, with a further one per cent growth per annum beyond that through to 2027. Where shops are used to fulfil online orders, the revenues from fulfilling these are included within the estimated cash flows for the shop;
- –The like-for-like sales recovery assumes temporary national lockdown restrictions (i.e. schools and non-essential retail closed) for the whole of Q1 2021, with further temporary lockdowns in November 2021 and February 2022. For those periods it is assumed that Greggs would trade at a sales level consistent with its recent experience of these conditions;
Consolidate and apply
To see how the concepts covered in this chapter have been applied within Greggs plc, review Chapter 36, p. 405.
Watch out for in practice 
- →By their very nature, forecasts and discount rates are subject to uncertainty. Forecasts cannot be verified and are therefore open to potential manipulation by management. A small change in the discount rate used can significantly impact VIU calculations and therefore impairment.
- →Forecast cash flows and assumptions underlying preparation.
- →Amount of annual and cumulative impairments.
- →Reasons stated in annual report for impairments.
- →If goodwill has been impaired (indicates the success or failure of acquisitions).