Unlocking Asset Values: How Impairment Loss Reshapes a Company's Balance Sheet

Key Insights: The Bottom Line on Impairment

Total Impairment Impact: Sam Ltd.'s Cash-Generating Unit (CGU) experienced a significant downturn, leading to a total impairment loss of £40 million, calculated as the difference between its carrying amount (£140 million) and its recoverable amount (£100 million).
Goodwill Takes the First Hit: In line with International Accounting Standard 36 (IAS 36), the impairment loss is first allocated to goodwill. Sam Ltd.'s entire goodwill of £25 million was written off.
Intangibles Revalued: After accounting for goodwill, the remaining £15 million impairment loss was distributed pro-rata among other non-current assets. This resulted in a £10 million reduction for intangible assets, bringing their new carrying amount to £50 million.

Navigating IAS 36: The Principles of Asset Impairment

When a company's assets are suspected of not being worth their recorded value on the balance sheet, an impairment review becomes necessary. This process is governed by IAS 36, "Impairment of Assets," which ensures that assets are not carried at more than their recoverable amount. Let's explore the core concepts relevant to Sam Ltd.'s situation.

What Triggers an Impairment Loss?

An impairment loss arises when an asset's carrying amount (its value in the accounting records) exceeds its recoverable amount. The recoverable amount is the higher of two figures: an asset's fair value less costs to sell (what it could be sold for, minus disposal costs) and its value in use (the present value of future cash flows expected from its continued use and eventual disposal). For Sam Ltd., a large drop in income signaled potential impairment, prompting the review.

Manager using a calculator, representing financial analysis for impairment

Financial analysis is crucial in determining impairment losses.

Focusing on the Cash-Generating Unit (CGU)

Sometimes, individual assets don't generate cash flows independently. In such cases, IAS 36 requires impairment testing at the level of a Cash-Generating Unit (CGU). A CGU is the smallest identifiable group of assets that generates cash inflows largely independent of the cash inflows from other assets or groups of assets. Sam Ltd.'s entire group of assets (£140 million) is treated as a single CGU for this impairment review.

The Order of Battle: Allocating the Impairment Loss

IAS 36 prescribes a specific hierarchy for allocating an impairment loss within a CGU:

Goodwill First: The loss is first allocated to reduce the carrying amount of any goodwill associated with the CGU.
Other Assets Pro-Rata: Any remaining loss is then allocated to the other assets within the CGU on a pro-rata basis, based on their carrying amounts.

An important caveat is that an individual asset's carrying amount cannot be reduced below the highest of its fair value less costs to sell, its value in use (if determinable), and zero. In Sam Ltd.'s case, current assets (Inventory and Trade Receivables) are already stated at their recoverable amounts, so they are excluded from this allocation of further impairment.

Crunching the Numbers: Sam Ltd.'s CGU Impairment Calculation

Let's walk through the precise calculations to determine the new carrying amount of Sam Ltd.'s intangible assets.

1. Calculating the Total Impairment Loss

The first step is to quantify the extent of the impairment.

Carrying amount of the CGU before impairment: £140 million
Recoverable amount of the CGU: £100 million

The impairment loss is the difference:

\[ \text{Impairment Loss} = \text{Carrying Amount} - \text{Recoverable Amount} \] \[ \text{Impairment Loss} = £140 \text{ million} - £100 \text{ million} = £40 \text{ million} \]

Thus, Sam Ltd. must recognize a £40 million impairment loss for this CGU.

2. Allocating the £40 Million Impairment Loss

Following IAS 36 guidelines, this £40 million loss is allocated systematically.

Phase 1: Targeting Goodwill

Goodwill is the first asset to absorb the impairment loss.

Carrying amount of Goodwill: £25 million
Impairment loss allocated to Goodwill: £25 million (reducing its carrying amount to £0)

After writing off goodwill entirely, the remaining impairment loss to be allocated is:

\[ \text{Remaining Impairment Loss} = £40 \text{ million} - £25 \text{ million} = £15 \text{ million} \]

Phase 2: Pro-Rata Allocation to Other Non-Current Assets

The remaining £15 million loss is distributed among the other non-current assets eligible for impairment (Intangibles and Property, Plant, and Equipment - PPE). Current assets are excluded as they are already at their recoverable amounts.

Carrying amount of Intangibles: £60 million
Carrying amount of Property, Plant, and Equipment (PPE): £30 million
Total carrying amount of these assets: £60 million + £30 million = £90 million

The £15 million loss is allocated pro-rata:

Allocation to Intangibles: \[ \left( \frac{£60 \text{ million}}{£90 \text{ million}} \right) \times £15 \text{ million} = \frac{2}{3} \times £15 \text{ million} = £10 \text{ million} \]
Allocation to Property, Plant, and Equipment (PPE): \[ \left( \frac{£30 \text{ million}}{£90 \text{ million}} \right) \times £15 \text{ million} = \frac{1}{3} \times £15 \text{ million} = £5 \text{ million} \]

3. Determining the New Carrying Amount of Intangibles

With the allocated impairment loss, we can now find the new carrying amount for the intangible assets:

Original carrying amount of Intangibles: £60 million
Impairment loss allocated to Intangibles: £10 million

\[ \text{New Carrying Amount of Intangibles} = £60 \text{ million} - £10 \text{ million} = \mathbf{£50 \text{ million}} \]

Therefore, after the impairment loss allocation, the carrying amount of Sam Ltd.'s intangible assets is £50 million. This corresponds to option B in the user's query.

Summary of Asset Values Post-Impairment

The following table summarizes the carrying amounts of all assets within the CGU before and after the impairment loss allocation:

Asset	Carrying Amount Before Impairment (£m)	Impairment Allocated (£m)	Carrying Amount After Impairment (£m)
Goodwill	25	25	0
Intangibles	60	10	50
Property, plant & equipment	30	5	25
Inventory	15	0	15
Trade receivables	10	0	10
Total CGU	140	40	100

As shown, the total carrying amount of the CGU after impairment is £100 million, which matches its determined recoverable amount.

Visualizing the Impact: Asset Value Transformation

A radar chart can help visualize how the carrying amounts of key non-current assets within Sam Ltd.'s CGU change due to the impairment. This chart compares the values before impairment, the allocated loss, and the values after impairment for Goodwill, Intangibles, and Property, Plant & Equipment (PPE).

The chart clearly illustrates that Goodwill is entirely written off. Intangible assets see a significant reduction but remain a substantial asset, while PPE also experiences a lesser impairment. The "Carrying Amount After Impairment" for Goodwill is £0m, which is greater than the axis minimum of -£5m, satisfying visualization constraints.

Mapping the Journey: The IAS 36 Impairment Process

To better understand the flow of an impairment review under IAS 36, particularly for a CGU, consider this mindmap. It outlines the key stages from identifying the need for a review to allocating the loss and determining new asset values, as applied in Sam Ltd.'s case.

mindmap root["IAS 36: CGU Impairment Allocation"] id1["1. Impairment Indication & Review"] id1a["Trigger: Drop in CGU Income"] id1b["Determine Recoverable Amount (£100m)"] id2["2. Calculate Total Impairment Loss"] id2a["Formula: Carrying Amount (£140m) - Recoverable Amount (£100m)"] id2b["Total Loss = £40m"] id3["3. Allocate Loss to Goodwill First"] id3a["Goodwill Original Value: £25m"] id3b["Loss Absorbed: £25m"] id3c["Goodwill New Value: £0m"] id3d["Remaining Loss to Allocate: £15m"] id4["4. Allocate Remaining Loss Pro-Rata"] id4a["Applicable Assets: Intangibles (£60m), PPE (£30m)"] id4b["Total Base for Allocation: £90m"] id4c["Intangibles Allocation: (£60m/£90m) * £15m = £10m"] id4d["PPE Allocation: (£30m/£90m) * £15m = £5m"] id5["5. Determine New Carrying Amounts"] id5a["Intangibles: £60m - £10m = £50m"] id5b["PPE: £30m - £5m = £25m"] id5c["Goodwill: £0m"] id5d["Current Assets: Unchanged (already at recoverable amount)"] id6["Outcome: CGU at Recoverable Amount (£100m)"]

This mindmap visually breaks down the structured approach mandated by IAS 36, ensuring that impairment losses are recognized and distributed in a logical and transparent manner, safeguarding the reliability of financial statements.

Delving Deeper: IAS 36 and Cash Generating Units Explained

For a more comprehensive understanding of how IAS 36 applies to Cash-Generating Units (CGUs) and the intricacies of impairment testing, the following video provides valuable insights, including worked examples similar to Sam Ltd.'s scenario. It covers the identification of CGUs, the calculation of recoverable amounts, and the allocation of impairment losses.

This video, "IAS 36 Impairment of Assets PART 6 | CGU(Cash Generating Unit) | Worked example," helps to solidify the concepts discussed. It walks through the mechanics of CGU impairment, emphasizing the order of allocation (goodwill first, then other assets pro-rata) and the importance of comparing the CGU's carrying amount to its recoverable amount. Such examples are crucial for grasping how theoretical accounting standards are applied in practice to reflect an entity's true financial position when assets lose value.