14.3 Impairment Testing & Accounting for Individual Assets

14.3 Impairment Testing & Accounting for Individual Assets

Core Principle: When an asset's carrying amount exceeds its recoverable amount, an impairment loss must be recognized immediately. Under the cost model, the loss is charged directly to profit or loss. Under the revaluation model, the loss is recognized in other comprehensive income to the extent of any existing revaluation surplus for that asset, with any excess recognized in profit or loss.

Once Recoverable Amount ($RA$) has been determined—as the higher of Fair Value Less Costs of Disposal (FVLCD) and Value in Use (VIU)—the final phase of the IAS 36 individual asset framework is testing and accounting recognition. Under paragraph 59 of IAS 36:

If, and only if, the recoverable amount of an asset is less than its carrying amount, the carrying amount of the asset shall be reduced to its recoverable amount. That reduction is an impairment loss.

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1. Impairment Testing Formulation & Recognition Criteria

The fundamental impairment equation for an individual asset is:

$$\text{Impairment Loss} = \max\Big(0,\, \text{Carrying Amount} - \text{Recoverable Amount}\Big)$$

• If $RA \ge CA$: The asset is not impaired. No accounting write-down is recorded. The asset continues to be carried at its existing book value, subject to standard depreciation.
• If $CA > RA$: An impairment loss exists. The asset's carrying amount must be written down immediately to its recoverable amount.
• Asset Balance Floor: An individual asset's carrying amount can never be reduced below zero, nor below the higher of its FVLCD and VIU if determinable (a critical rule for Cash-Generating Units explored in Chapter 15).

                         Impairment Decision Matrix
                                     │
           ┌─────────────────────────┴─────────────────────────┐
           ▼                                                   ▼
   Cost Model Asset                                   Revalued Asset
  (IAS 16 / IAS 38)                                  (IAS 16 / IAS 38)
           │                                                   │
           ▼                                                   ▼
  Recognise FULL loss                                 Does a Revaluation Surplus
  immediately in                                      exist for THIS SPECIFIC asset?
  PROFIT OR LOSS (P/L)                                         │
                                        ┌──────────────────────┴──────────────────────┐
                                        ▼                                             ▼
                                   YES: Surplus > 0                              NO: Surplus = 0
                              1. Debit Revaluation Surplus (OCI)              Recognise FULL loss
                                 up to existing balance.                      immediately in
                              2. Debit any EXCESS to P/L.                     PROFIT OR LOSS (P/L)

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2. Accounting Treatment: Cost Model vs Revaluation Model

The double-entry mechanics for an impairment loss depend strictly on whether the underlying asset is carried under the historical cost model or the revaluation model of IAS 16 or IAS 38.

Pathway A: Assets Carried at Historical Cost (IAS 36.60)

For operational assets carried under the cost model (historical cost less accumulated depreciation and accumulated impairment losses):

• The impairment loss is recognized immediately in Profit or Loss as an operating expense.
• The credit entry is recorded either directly to the asset account or to a dedicated contra-asset account titled Accumulated Impairment Losses.

$$\begin{aligned} \textbf{General Journal Entry (Cost Model):} & \\ \quad \text{Dr Impairment Loss (Profit or Loss)} & \quad [\text{Full Loss Amount}] \\ \quad \quad \text{Cr Accumulated Impairment Losses (Contra-Asset)} & \quad [\text{Full Loss Amount}] \end{aligned}$$

Pathway B: Assets Carried at Revalued Amounts (IAS 36.60)

Under paragraph 60 of IAS 36, if the asset is carried at a revalued amount in accordance with another standard (such as the revaluation model in IAS 16 or IAS 38):

An impairment loss on a revalued asset is recognized in other comprehensive income to the extent that the impairment loss does not exceed the amount in the revaluation surplus for that same asset. Such an impairment loss on a revalued asset reduces the revaluation surplus for that asset. To the extent that the impairment loss exceeds the revaluation surplus for that same asset, the excess is recognized in profit or loss.

The Two-Step Allocation for Revalued Assets:

1. Step 1 (Offset OCI Surplus): Debit Revaluation Surplus (Other Comprehensive Income) up to the credit balance sitting in equity for that specific asset. This reverses previously recognized revaluation gains without affecting current-year profit or loss.
2. Step 2 (Excess to Profit or Loss): Debit Impairment Loss (Profit or Loss) for any remaining unabsorbed impairment loss.
3. Step 3 (Reduce Asset): Credit the Asset Carrying Amount (or Accumulated Impairment Losses) for the total impairment loss.

$$\begin{aligned} \textbf{General Journal Entry (Revalued Asset with Existing Surplus):} & \\ \quad \text{Dr Revaluation Surplus (OCI)} & \quad [\text{Up to asset's existing surplus}] \\ \quad \text{Dr Impairment Loss (Profit or Loss)} & \quad [\text{Excess beyond existing surplus}] \\ \quad \quad \text{Cr Asset (or Accumulated Impairment)} & \quad [\text{Total Impairment Loss}] \end{aligned}$$

Strict Anti-Netting Rule: An entity cannot cross-subsidize revaluation surpluses between different assets! If Building A has an existing revaluation surplus in equity of $400,000, and Building B experiences an impairment loss of $250,000 with zero revaluation surplus, the entire $250,000 loss on Building B must be recognized in Profit or Loss. Management is strictly prohibited from offsetting Building B's impairment against Building A's revaluation surplus.

3. Consequential Depreciation & Revision of Accounting Estimates (IAS 36.63-64)

Recognizing an impairment loss alters the economic carrying amount of the asset. Paragraph 63 of IAS 36 establishes the mandatory subsequent depreciation rule:

After the recognition of an impairment loss, the depreciation (amortisation) charge for the asset shall be adjusted in future periods to allocate the asset's revised carrying amount, less its residual value (if any), on a systematic basis over its remaining useful life.

The Prospective Recalculation Formula

Depreciation is never adjusted retrospectively. The adjustment is accounted for strictly prospectively as a change in accounting estimate under IAS 8 / AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors:

$$\text{Revised Annual Depreciation} = \frac{\text{Revised Carrying Amount (Recoverable Amount)} - \text{Revised Residual Value}}{\text{Revised Remaining Useful Life}}$$

Mandatory Review of Useful Life, Residual Value, and Depreciation Method (IAS 36.64)

Paragraph 64 of IAS 36 contains a critical procedural requirement often tested in exam scenario questions:

If an indication of impairment exists, the remaining useful life, the depreciation (amortisation) method or the residual value for the asset shall be reviewed and adjusted in accordance with the standard applicable to the asset (e.g. IAS 16 or IAS 38), even if no impairment loss is recognised for the asset.

Why does IAS 36 mandate this review even when no impairment loss is recorded? Because the external or internal event that triggered the impairment test (e.g. technological change, physical wear, or economic decline) signals that the operational utility of the asset has changed. Even if current high market prices (FVLCD) protect the asset from an impairment write-down, its remaining useful life may have shortened from 10 years to 4 years, requiring higher annual depreciation in subsequent periods.

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4. Comprehensive Worked Example 1: Operational Asset Under the Cost Model

Fact Pattern

On 1 July 2023, Kestrel Mining Ltd purchased a specialized autonomous ore-hauler for $1,200,000. At acquisition, Kestrel estimated:

• Useful life: 10 years
• Residual value: Nil
• Depreciation method: Straight-line ($120,000 per year)
• Measurement model: Historical Cost Model under IAS 16

On 30 June 2026 (after 3 full years of operation), an aggressive new zero-emissions mining mandate is introduced by state regulators. The ore-hauler is an older diesel-powered model, triggering an indicator of impairment.

At 30 June 2026, management estimates the following recoverable amount figures:

• Fair Value Less Costs of Disposal (FVLCD): $580,000
• Value in Use (VIU): $620,000

Following the impairment review, Kestrel's fleet engineers determine that due to regulatory restrictions, the hauler's remaining useful life is now 5 years (instead of the original remaining 7 years), and its revised residual value is $20,000.

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Accounting Calculations & Journal Entries

Step 1: Record Standard Annual Depreciation for FY2026 (Year Ended 30 June 2026)

Prior to performing the impairment test at reporting date, standard depreciation for the third operational year must be recognized:

$$\begin{aligned} \textbf{General Journal — 30 June 2026:} & \\ \quad \text{Dr Depreciation Expense (Profit or Loss)} & \quad \$120,000 \\ \quad \quad \text{Cr Accumulated Depreciation (Ore-Hauler)} & \quad \quad \$120,000 \\ \quad \textit{(To record annual straight-line depreciation: \$1,200,000 / 10 years)} & \end{aligned}$$

Step 2: Determine Carrying Amount Prior to Impairment

$$\begin{aligned} \text{Original Cost} & = \$1,200,000 \\ \text{Accumulated Depreciation (3 years } \times \$120,000) & = (\$360,000) \\ \hline \mathbf{\text{Carrying Amount at 30 June 2026 (before impairment)}} & = \mathbf{\$840,000} \end{aligned}$$

Step 3: Determine Recoverable Amount & Impairment Loss

$$\begin{aligned} \text{Recoverable Amount} & = \max(\text{FVLCD},\, \text{VIU}) = \max(\$580,000,\, \$620,000) = \mathbf{\$620,000} \\ \text{Impairment Loss} & = \text{Carrying Amount} - \text{Recoverable Amount} \\ & = \$840,000 - \$620,000 = \mathbf{\$220,000} \end{aligned}$$

Step 4: Record Impairment Loss Journal Entry at 30 June 2026

$$\begin{aligned} \textbf{General Journal — 30 June 2026:} & \\ \quad \text{Dr Impairment Loss (Profit or Loss)} & \quad \$220,000 \\ \quad \quad \text{Cr Accumulated Impairment Losses (Contra-Asset)} & \quad \quad \$220,000 \\ \quad \textit{(To write down ore-hauler carrying amount to recoverable amount)} \end{aligned}$$

Balance Sheet Presentation at 30 June 2026

$$\begin{array}{lr} \text{Ore-Hauler (Gross Cost)} & \$1,200,000 \\ \text{Less: Accumulated Depreciation} & (\$360,000) \\ \text{Less: Accumulated Impairment Losses} & (\$220,000) \\ \hline \mathbf{\text{Net Carrying Amount (Statement of Financial Position)}} & \mathbf{\$620,000} \\ \hline \end{array}$$

Step 5: Recalculate Prospective Depreciation for FY2027 (Year Ended 30 June 2027)

Under IAS 36.63, depreciation for the year ended 30 June 2027 is calculated using the revised carrying amount ($620,000), revised residual value ($20,000), and revised remaining useful life (5 years):

$$\begin{aligned} \text{Revised Annual Depreciation} & = \frac{\text{Revised Carrying Amount} - \text{Revised Residual Value}}{\text{Revised Remaining Useful Life}} \\ & = \frac{\$620,000 - \$20,000}{5 \text{ years}} = \frac{\$600,000}{5} = \mathbf{\$120,000 \text{ per year}} \end{aligned}$$ $$\begin{aligned} \textbf{General Journal — 30 June 2027:} & \\ \quad \text{Dr Depreciation Expense (Profit or Loss)} & \quad \$120,000 \\ \quad \quad \text{Cr Accumulated Depreciation (Ore-Hauler)} & \quad \quad \$120,000 \\ \quad \textit{(To record revised annual depreciation over revised 5-year useful life)} \end{aligned}$$

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5. Comprehensive Worked Example 2: Operational Asset Under the Revaluation Model

Fact Pattern

On 1 July 2022, Meridian Properties Ltd acquired a commercial administrative building for $5,000,000. Key initial terms:

• Useful life: 50 years
• Residual value: Nil
• Depreciation method: Straight-line ($100,000 per year)
• Measurement model: Revaluation Model under IAS 16 (revaluations performed every 2 years)

Prior Revaluation History at 30 June 2024

On 30 June 2024 (2 years after purchase), an independent valuation assessed the building's fair value at $5,400,000.

• Carrying amount prior to revaluation: $5,000,000 - (2 years $\times$ $100,000) = $4,800,000.
• Revaluation Surplus recognized in OCI: $5,400,000 - $4,800,000 = $600,000.
• Remaining useful life at 30 June 2024: 48 years.
• Revised annual depreciation: $5,400,000 / 48 years = $112,500 per year.
• Meridian does not make annual piecemeal transfers of revaluation surplus to retained earnings.

Current Year Impairment Event at 30 June 2026

On 30 June 2026 (2 years after the revaluation), severe structural foundation cracking is discovered following seismic tremors (internal indicator under IAS 36.12(e)).

Prior to impairment testing, standard depreciation for the 2 years ended 30 June 2026 has been recognized (2 $\times$ $112,500 = $225,000 accumulated depreciation since revaluation).

An independent engineering and appraisal firm calculates:

• Fair Value Less Costs of Disposal (FVLCD): $4,300,000
• Value in Use (VIU): $4,450,000

Structural engineers advise that while the building remains operational after reinforcing beams are installed, its remaining useful life is drastically reduced to 25 years from 30 June 2026. Residual value remains nil.

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Accounting Calculations & Journal Entries

Step 1: Determine Carrying Amount at 30 June 2026 Prior to Impairment

$$\begin{aligned} \text{Revalued Carrying Amount at 30 June 2024} & = \$5,400,000 \\ \text{Less Depreciation FY2025 \& FY2026 (2 years } \times \$112,500) & = (\$225,000) \\ \hline \mathbf{\text{Carrying Amount at 30 June 2026 (before impairment)}} & = \mathbf{\$5,175,000} \end{aligned}$$

Status of Equity: The Revaluation Surplus sitting in equity for this specific building stands at $600,000.

Step 2: Determine Recoverable Amount & Total Impairment Loss

$$\begin{aligned} \text{Recoverable Amount} & = \max(\text{FVLCD},\, \text{VIU}) = \max(\$4,300,000,\, \$4,450,000) = \mathbf{\$4,450,000} \\ \text{Total Impairment Loss} & = \text{Carrying Amount} - \text{Recoverable Amount} \\ & = \$5,175,000 - \$4,450,000 = \mathbf{\$725,000} \end{aligned}$$

Step 3: Allocate Total Impairment Loss Under IAS 36.60

Applying the two-tier revaluation allocation rules:

1. Allocate to Revaluation Surplus (OCI): The loss is recognized in Other Comprehensive Income to the extent of the revaluation surplus for this specific asset:

$$\text{Absorption by Revaluation Surplus} = \mathbf{\$600,000}$$

This reduces the building's revaluation surplus balance in equity from $600,000 to $0. 2. Allocate Excess to Profit or Loss: The remaining unabsorbed impairment loss is recognized immediately in Profit or Loss:

$$\text{Excess Charged to P/L} = \$725,000 - \$600,000 = \mathbf{\$125,000}$$

Step 4: Record Impairment Journal Entry at 30 June 2026

$$\begin{aligned} \textbf{General Journal — 30 June 2026:} & \\ \quad \text{Dr Revaluation Surplus (Other Comprehensive Income)} & \quad \$600,000 \\ \quad \text{Dr Impairment Loss (Profit or Loss)} & \quad \$125,000 \\ \quad \quad \text{Cr Commercial Building (Carrying Amount)} & \quad \quad \$725,000 \\ \quad \textit{(To record impairment loss on revalued building under IAS 36.60)} \end{aligned}$$

Status of Accounts at 30 June 2026

• Commercial Building Carrying Amount: $5,175,000 - $725,000 = $4,450,000 (matches Recoverable Amount).
• Revaluation Surplus in Equity: $600,000 - $600,000 = $0.
• Current-Year Profit or Loss Impact: ($125,000) impairment expense.
• Current-Year OCI Impact: ($600,000) revaluation decrease.

Step 5: Recalculate Prospective Depreciation for FY2027 (Year Ended 30 June 2027)

Under IAS 36.63, future depreciation must be based on the revised carrying amount of $4,450,000, zero residual value, and the revised remaining useful life of 25 years:

$$\begin{aligned} \text{Revised Annual Depreciation} & = \frac{\text{Revised Carrying Amount}}{\text{Revised Remaining Useful Life}} \\ & = \frac{\$4,450,000}{25 \text{ years}} = \mathbf{\$178,000 \text{ per year}} \end{aligned}$$ $$\begin{aligned} \textbf{General Journal — 30 June 2027:} & \\ \quad \text{Dr Depreciation Expense (Profit or Loss)} & \quad \$178,000 \\ \quad \quad \text{Cr Accumulated Depreciation (Commercial Building)} & \quad \quad \$178,000 \\ \quad \textit{(To record revised annual depreciation over revised 25-year useful life)} \end{aligned}$$

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6. Comparative Synthesis: Cost Model vs Revaluation Model Impairment