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Impairment and CGU: key concepts, allocation rules, and reversal mechanics (IFRS IAS 36)

Impairment basics

Impairment is the process of ensuring that an asset or a cash-generating unit (CGU) is not carried at more than its recoverable amount. The recoverable amount (RA) is defined as the higher of two values: fair value less costs of disposal (FVLCOD) and value in use (VIU). Mathematically, for an asset i or a CGU, RAi = RAi = ext{max}(FVLCODi, VIUi)
FVLCOD is the amount obtainable from disposal in an arm’s-length transaction, minus costs of disposal. VIU is the present value of the future cash flows expected to be derived from the asset or CGU. The recoverable amount is a key reference point: if Carrying Amount (CA) > RA, impairment is recognised. If CA ≤ RA, no impairment.

Some items are not subject to impairment on their own, though they may be included in a CGU’s CA for impairment testing purposes. Notably, cash and cash equivalents, inventories, and accounts receivable are excluded from impairment loss allocation to individual assets (they are “subject to impairment” in some contexts, but not allocated as part of the impairment loss for a CGU). This means:

  • Cash and cash equivalents are excluded from the impairment allocation, even though they may be part of the CA of the CGU.
  • Inventories are excluded because they are covered by another standard (lower of cost and NRV).
  • Accounts receivable are typically excluded from impairment allocation, though they contribute to the CGU’s CA.

When impairment testing is performed, we compare the CGU’s CA (including all assets in the CGU) with its RA. If CA > RA, impairment losses must be recognised and allocated to the assets within the CGU in a prescribed order. The impairment loss is recognised in profit or loss. If impairment losses later reverse (e.g., due to improved conditions), increases in asset carrying amounts are recognised up to certain caps, as described in the reversal section.

Recoverable amount and value in use

Value in use (VIU) requires estimating future cash flows attributed to the asset or CGU and discounting them to present value. If VIU cannot be reliably estimated, you may rely on FVLCOD. The relation between VIU and FVLCOD explains why the recoverable amount is the higher of these two values:
RA = ext{max}(FVLCOD, VIU)
Value in use hinges on expected cash inflows from continued use of the asset (or CGU) and often requires judgments about future cash flows and appropriate discount rates. FVLCOD uses the current market-based price to dispose of the asset, less costs of disposal.

An illustrative example used in teaching is the mobile phone: if you keep using the phone, its VIU reflects the cash flows from continued use; if you sell it, FVLCOD reflects its disposal value. The recoverable amount is determined by whichever option yields a higher value to you in context. This helps explain why recoverable amount is defined as the higher of FVLCOD and VIU.

When to perform impairment testing

Impairment testing is not routine for all assets every year (except indefinite-life intangible assets, which require annual impairment testing). In general, impairment tests are performed when there is an indication that an asset may be impaired (internal or external indicators), such as adverse changes in market conditions, a decision to restructure, a drop in asset’s use, or other external events (e.g., COVID-19 impact). For indefinite-life intangible assets, impairment testing occurs annually regardless of indicators.

If there is sufficient indication, test the asset or CGU by comparing CA with RA. If CA > RA, impairment loss is recognised. The impairment loss equals CA − RA (for the CGU, the amount is allocated across the assets in the CGU according to prescribed rules). The impairment loss is recognised in profit or loss immediately (except for models where impairment losses are treated as part of a revaluation under the revaluation model).

Impairment versus depreciation

Impairment is not the same as depreciation. Depreciation is a systematic allocation of cost over the asset’s useful life under the cost or revaluation model. Impairment is a potential write-down to recoverable amount and is not a routine allocation of cost. If impairment occurs, it reduces profit in the P&L immediately. If impairment losses are subsequently reversed, profits may increase through a reversal in P&L, subject to caps described later.

CGU concepts and allocation rules (paragraphs 104 and 105)

A CGU is the smallest identifiable group of assets that generates cash inflows largely independent of other assets or groups of assets. Impairment testing at the CGU level requires allocating any impairment loss to the assets within the CGU in a specific order:

  • Step 1: If the CGU includes goodwill, allocate impairment loss to goodwill first, in full, to the extent of the impairment amount.
  • Step 2: Allocate the remaining impairment loss pro rata on the basis of the carrying amounts of the other assets within the CGU, excluding inventory, cash and cash equivalents, and accounts receivable from absorbing impairment losses.
  • Step 3: After allocating according to Step 1 and Step 2, ensure that no asset’s carrying amount falls below its own recoverable amount RAi (the highest of FVLCODi and VIUi). If any asset would fall below RAi, cap that asset’s allocation to RA_i and reallocate the remainder to other assets in proportion to their carrying amounts.

This process uses two important paragraphs:

  • Paragraph 104: guides the order of allocation (goodwill first, then pro rata among other assets).
  • Paragraph 105: introduces the cap rule – an asset’s carrying amount cannot be reduced below its RA_i (the recoverable amount for that asset).

In many CGU problems, inventories, cash, and accounts receivable should not absorb impairment losses in the first round, but they still form part of the CGU’s CA for comparison to RA. If an impairment loss is allocated to a CGU where these items are present, you must justify why they do not absorb the loss and confirm they are not subject to impairment in this allocation. The justification often rests on the idea that they are governed by other standards (e.g., NRV for inventories) or are monetary assets whose impairment is not recognized in this way.

Example: impairment test for a CGU with goodwill (journal entries and allocation)

A common exam-style setup includes a CGU with goodwill and several other assets (e.g., plant, land, patent, office equipment), with inventories and cash/cash equivalents present in the CGU but not absorbing impairment in the first round. Suppose the CGU’s CA totals to CACGU and its recoverable amount RACGU is given or calculated as the higher of FVLCOD and VIU for the CGU as a whole. The impairment loss is:
ext{Impairment loss (CGU)} = ext{max}(0, CA{ ext{CGU}} - RA{ ext{CGU}})
If impairment loss is positive, allocate it in order:

  • Allocate to goodwill first: impairment{ ext{goodwill}} = ext{min}( ext{Impairment loss}, CA{ ext{Goodwill}})
  • Remaining loss to allocate: impairment{ ext{remaining}} = impairment{ ext{CGU}} - impairment_{ ext{goodwill}}
  • Pro rata allocation to other assets by their CA until impairment_{i} is exhausted, excluding inventories, cash, and receivables from absorption in this first round (you may explain their exclusion).
  • After the first round, verify Rule 105: for each asset i, ensure CAi,new ≥ RAi. If any asset would fall below RAi, you must cap the loss allocated to that asset to CAi − RA_i and reallocate the remainder to other assets in proportion to their carrying amounts post-first round.

If a land asset or any other asset has a recoverable amount that caps its impairment (i.e., CAi,new cannot drop below RAi), you must adjust accordingly and possibly perform a second round of allocation among the remaining assets.

Journal entries (illustrative, cost model):

  • At impairment recognition (CGU):
    • Dr Impairment loss (P&L) for CACGU − RACGU
    • Cr Accumulated depreciation and impairment losses (or the respective asset accounts) to reduce CA accordingly
      The impairment is typically recorded as a reduction in the asset’s CA, aggregated into the relevant contra accounts as appropriate for the asset class (e.g., accumulate depreciation and impairment). If the asset uses the cost model and you have a separate accumulated impairment loss account, you may combine depreciation and impairment when presenting, but you must be able to identify impairment losses for potential reversal.

Reversal of impairment losses

Impairment losses may be reversed when there is an indication that the recoverable amount of the CGU or asset has increased since the impairment was recognised. Reversal is allowed only up to the carrying amount that would have been determined had no impairment loss ever been recognised for the asset (i.e., up to the higher of the original recoverable amount implied by the pre-impairment scenario and any subsequent recoverable amount cap), and not beyond the asset’s CA that would result if impairment had never occurred. Weak points to note:

  • Do not reverse impairment for goodwill; once goodwill is impaired, it cannot be reinstated.
  • Reversal cannot increase the asset above its recoverable amount had no impairment occurred.
  • If the CGU contains several assets, the reversal is allocated in the reverse order of impairment allocation, respecting the RA caps for each asset (Paragraphs 104 and 105).
  • Any reversal that increases the asset’s CA will appear in P&L as income (or as a reversal of impairment loss).

Numerical illustration (conceptual steps):

  • Suppose after impairment, RAi and CAi are updated. If later RAi > CAi, you may reverse up to min(impairedamountcap, RAi − CAi). The stepwise process mirrors the initial allocation but in reverse: first reverse to the assets with the prior impairment, respecting the caps (which relate to what CA_i would have been if no impairment occurred).
  • The practical approach is to compute the maximum reversal per asset using its post-first-round CA and the corresponding RAi, then allocate the reversal in proportion to each asset’s CA (or according to the impairment allocation logic), ensuring no asset exceeds its RAi or the cap implied by the no-impairment scenario.

Example logic for reversal (high level):
1) Determine total reversal allowed: reversecap = min(Impairmentintendedtoreverse, sum of per-asset caps)
2) Allocate reversalcap to assets in reverse order of impairment, respecting each asset’s cap: CAi,new = CAi,old + reversalalloci, ensuring CAi,new ≤ RAi and CAi,new ≤ CAifnoimpairmentforasseti
3) Recognise reversal in P&L: Dr Accumulated depreciation and impairment losses, Cr Income (to reflect an increase in profit).

Practical guidance for exam preparation

  • Start with the big picture: impairment = write-down when CA > RA. Use the RA_i for each asset as the test threshold.
  • Remember the CGU logic: impairment at CGU level is allocated first to goodwill, then pro rata to other assets in the CGU, excluding inventories, cash, and receivables from absorption in the first round.
  • Always check paragraph 105 caps after the first allocation; adjust and reallocate if any asset would fall below its RA_i.
  • In examinations, show your workings. The examiner often awards marks for the process (the computations, the allocation logic, and the explanation) even if the final figure isn’t perfect.
  • For impairment reversals, understand the cap: you cannot reverse above the amount that would have existed if no impairment occurred and cannot restore goodwill.
  • Understand the difference between cost model and revaluation model: under a revaluation model, impairment losses are treated as a revaluation decrease, not as an immediate P&L expense; the reversal rules also adjust accordingly.
  • Indefinite-life intangible assets require annual impairment testing; other assets require impairment only if indicators exist.
  • When discussing CGUs in exams, be prepared to define what constitutes a CGU and to reason about how assets could be grouped to form a CGU (including practical examples like McCafe within McDonald’s).
  • In your explanations, connect concepts: impairment testing reflects prudence in not overstating asset values; the recovery framework aligns asset values with expected future cash flows and market conditions; the process supports reliable financial reporting and decision-making.

Real-world relevance and ethics

Impairment testing, including CGU allocations and potential reversals, is a core part of financial reporting under IFRS/IAS. It requires professional judgment in estimating VIU and FVLCOD, selecting discount rates, and determining cash flow projections. Decisions about impairment have material effects on earnings, asset values, and capital management, and misapplication can mislead stakeholders. The discussion in class emphasizes the importance of documenting the rationale behind judgments and the consistent application of the impairment framework across periods.

Takeaways for assessments and studying

  • Be comfortable with the RA concept and the formula RAi = max(FVLCODi, VIU_i).
  • Know which assets typically do not absorb impairment losses in the first allocation (inventories, cash, receivables) and why.
  • Practice a CGU impairment problem with and without goodwill to understand the allocation sequence and the cap rules under paragraphs 104 and 105.
  • Practice reversal calculations, including the cap logic and how to allocate reversals across assets within a CGU.
  • Ensure you can explain the practical differences between impairment and depreciation, and the implications for the P&L and balance sheet under different accounting models.
  • Be ready to justify your allocations with clear reasoning and to show the working so you can secure marks for the process, not just the final numbers.