(This article was published on 23 March 2022 and updated on 10 December 2025)
What's the issue?
External events may trigger economic uncertainty and may have significant adverse effects on companies’ operations or assets. In such circumstances, indicators of impairment often exist for non-current assets.
Companies using a discounted cash flow (DCF) model to estimate the recoverable amount of their assets or cash-generating units (CGUs) need to consider how to reflect the impact of these events. The impacts may be significant and could affect:
- key inputs to the model – e.g. forecasted revenues;
- profitability; and
- the discount rate.
These impacts may be a key area of focus for investors and regulators.
External events may trigger significant economic uncertainty and increase the likelihood that an asset may be impaired. Investors want to know how companies consider uncertainty when performing their impairment testing.
Getting into more detail
Trigger for impairment testing
At each reporting date – annual and interim – a company considers whether there are any internal or external indicators that its non-current assets may be impaired.1,2 [IAS 36.2, 4]
External events may significantly change market conditions or a company’s expectations about its performance. As a result, assets or CGUs may be impaired. In making this assessment, a company needs to consider the significance of the overall impact of the event.
For example, a company may have:
- significant assets or operations in an area affected by the external event – e.g. a natural disaster;
- a decline in sales and profitability – e.g. sales to key markets may be disrupted by trade sanctions and customers may change their spending habits during economic uncertainty;
- increased costs – e.g. because of supply chain disruption, a company’s ability to pass on increased costs to customers may depend on the nature of the product or service and the company’s competitive position; and/or
- adverse affects from volatility of commodity prices – e.g. energy, metals and agricultural commodities – and certain foreign exchange rates.
For a list of indicators included in IAS 36 Impairment of Assets, see Indicators of impairment, Question 2.
Recoverable amount
When a triggering event has occurred, management needs to determine the recoverable amount of an asset or CGU – i.e. the higher of:
- value in use (VIU); and
- fair value less costs of disposal (FVLCD). [IAS 36.9, 18]
Budgets and cash flow forecasts prepared by management typically serve as the starting point for the discounted cash flows used in calculating the recoverable amount. Significant changes in economic and market conditions could impact assumptions. As a result, companies will need to reassess and update their significant assumptions as appropriate, including assumptions related to:
- forecast sales;
- growth rates and inflation rates;
- profit margins;
- capital expenditure; and
- discount rates. [IAS 36.33, IFRS 13.2]
In times of economic uncertainty, estimating future cash flows can be particularly challenging for companies.
- Under VIU, the cash flow projections are based on reasonable and supportable assumptions that represent management’s best estimate of the range of economic conditions that will exist over the remaining useful life of the asset or CGU. Greater weight is given to external evidence – e.g. economic projections by respected central banks and other international organisations if they are available.
- Under FVLCD, the estimates and assumptions used are from the perspective of market participants. [IAS 36.33(a), IFRS 13.22]
In times of high and unstable inflation (e.g. in hyperinflationary economies), valuations may be performed in real terms – i.e. the cash flows and discount rate exclude the effect of inflation.
Under lower inflation conditions, valuations are often performed in nominal terms – i.e. including the effect of inflation – and a company needs to consider the impact of inflation on forecast cash flows.
- Costs: Expected changes in the costs of materials and services in the forecast period may differ significantly from the general level of inflation in the economy overall. Using inflationary measures such as CPI3 and PPI4 may not be appropriate.
- Capital expenditure: The cost of maintaining property, plant and equipment (PP&E) may not be equal to its depreciation expense. Instead, it may exceed it in real terms because capital expenditure is based on current and future prices of PP&E, whereas depreciation expense is based on historical price.
- Long-term growth rate5: The long-term growth rate comprises both inflationary growth and real growth. In an inflationary environment, companies with no real growth continue to exhibit growth in cash flows at the rate of the long-term price changes in their products/services and costs. Real long-term growth can be positive or negative, depending on the relative strengths and weaknesses and risks associated with the asset or CGU. Real growth requires expansionary investment in the business, whereas inflationary growth requires investment to maintain the company’s assets in real terms.
The rate used to discount the forecast cash flows may be significantly affected by the increase in uncertainty and risks. It reflects the interest rates and the risk environment at the reporting date. [IAS 36.56]
Economic uncertainty may have a significant impact on company-specific risk premiums – e.g. financing risk, country risk and forecasting risk – used in determining the appropriate discount rate to discount future cash flows. [IAS 36.A1, A16, A18]
- Financing risk: a premium that takes into account the potential difficulty of funding working capital or maintainable capital expenditure in the short to medium term.
- Country risk: a premium that takes into account the additional risk associated with generating and incurring cash flows in a particular country.
- Forecasting risk: a premium that takes into account the greater uncertainty in making economic and financial forecasts in the near term, as a result of the difficulty in forecasting the impact of the external event (if it is not already included in the cash flows). [Insights 3.10.300.170]
Significant judgement may be needed to quantify risk premiums and other adjustments for these risks.
The discount rate needs to be determined on a basis consistent with the cash flows. If the cash flows include the effects of general inflation, then the discount rate also includes the effects of inflation and vice versa.
Two approaches can be used to project cash flows.
- Single cash flow approach (‘traditional approach’): A company uses a single most likely cash flow projection.
- Expected cash flow approach (‘ECF approach’): A company uses multiple, probability-weighted cash flow projections. [IAS 36.A2, A4–A14]
The ECF approach may help identify and model various potential outcomes – e.g. different scenarios determine the value of operations when considering the effect of rapidly changing economic policies that may have global impacts. [IAS 36.A2, A7]
Whichever approach a company adopts, the rate used to discount cash flows does not reflect adjustments for factors that have been incorporated into the estimated cash flows and vice versa. Otherwise, the effect of some factors would be double counted. [IAS 36.55–56]
Impact on useful life and residual value
Companies may change their usage or retention strategy for some of their PP&E items as a result of an external event – e.g. properties or operations may be abandoned in areas of conflict. Management needs to review whether the useful life and residual value of these assets, and the depreciation method applied to them, remain appropriate. This review may also be required after testing an asset or a CGU for impairment, or if an indicator of impairment exists. Any changes as a result of the review are accounted for prospectively as a change in accounting estimate. [IAS 16.51, 56(a), 57, 61, 36.17, Insights 3.10.350.30]
Temporarily idling an item of PP&E – e.g. when a company temporarily shuts a manufacturing facility but intends to resume operations – may trigger impairment testing. However, even though the item is idle, a company does not stop depreciating it, unless it is fully depreciated or is classified as held-for-sale. Under usage methods of depreciation, the depreciation charge can be zero while there is no production. [IAS 16.55]
Disclosure
Annual reports
IAS 36 requires disclosure of the key assumptions used to determine the recoverable amount when testing goodwill and indefinite-lived intangible assets for impairment. It also requires sensitivity disclosures if a reasonably possible change in a key assumption would cause the CGU’s carrying amount to exceed its recoverable amount. [IAS 36.134(d)–(f)]
Under IAS 1 Presentation of Financial Statements, a company needs to disclose its key assumptions about the future and other major sources of estimation uncertainty at the reporting date that have a significant risk of resulting in a material adjustment to the carrying amounts of assets and liabilities in the next financial year. [IAS 1.125, 129]
In times of economic uncertainty, companies may need to expand their disclosures in the financial statements. In particular, disclosures relating to impairment testing of non-current assets are likely to be a focus area for investors and regulators.
A company may also need to provide sensitivity disclosures and disclosure of the key assumptions and judgements made by management. For example, companies exposed to high commodity price volatility as a result of political instability may need to provide granular disclosures on how they incorporate this into their key assumptions – e.g. their cash flow projections, terminal values and growth rates – both for their costs of production and their ability to pass on higher costs to customers.
Where appropriate, a company needs to connect the dots with relevant information about risks and uncertainties provided in other parts of its annual report.
Interim condensed reports
IAS 34 Interim Financial Reporting requires significant events and transactions since the most recent annual or interim reporting date to be explained. For example, if a company recognises a significant impairment loss, then this needs to be disclosed. IAS 36 provides relevant disclosures to be considered in this regard. [IAS 34.15B(b), 15C, 16A(d)]
Actions for management
Consider whether:
- any indicators of impairment exist for the company’s assets or CGUs;
- cash flow projections used in valuations have been updated to reflect information available at the reporting date;
- discount rates and long-term growth rates used in valuations have been updated;
- the assumptions used to project cash flows and the discount rate are consistent;
- changes are required to the useful lives and/or residual values of assets tested for impairment (or for which indicators of impairment exist); and
- sensitivity disclosures – and disclosures about the key assumptions and major sources of estimation uncertainty – need to be enhanced in the interim and annual reports.
References to ‘Insights’ mean our publication Insights into IFRS®
1 Irrespective of any indicator of impairment, IAS 36 Impairment of Assets requires goodwill, intangible assets with indefinite useful lives and intangible assets not yet available for use to be tested for impairment at least annually.
2 This article focuses on impairment of non-current assets in the scope of IAS 36. For investments in associates and joint ventures, a company considers the indicators of impairment in paragraphs 41A–41C of IAS 28 Investments in Associates and Joint Ventures. If there is an indication of impairment, then the impairment test follows the principles of IAS 36. [IAS 28.40–42]
3 Consumer price index.
4 Producer price index.
5 The long-term growth rate is used to calculate the terminal value – i.e. the value of an asset or a CGU beyond the forecast period. It is a key input in a DCF calculation. When calculating VIU, IAS 36 requires a company to use a steady or declining long-term growth rate that is consistent with that of the product, industry or country, unless there is clear evidence to suggest another basis. [IAS 36.33(c), 36]
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