In this blog, we will delve into the intricate relationship between IAS 36 impairments and IFRS 16 lease accounting. Understanding the interplay between these standards is crucial for accurate financial reporting.
Let’s discuss in-depth insights into the impact of IAS 36 impairments on IFRS 16 lease accounting, and shed light on the accounting considerations that organizations must be aware of and offer practical guidance for businesses to navigate these complexities successfully.
Overview of IAS 36 (Impairment of Assets)
To understand the complexity between IFRS 16 and IAS 36, we will briefly discuss the impairment of assets. This assessment is only performed when impairment indicators exist (“the trigger”). Additionally, if you have identified that the impairment condition no longer exists, there is the possibility that the impairment can be reversed.
What are impairments in accounting?
An impairment is a permanent reduction in an asset’s carrying value (fixed asset or intangible asset). The impairment of an individual asset can be caused by physical damage, a shift in market demand or legal factors that have an impact on the asset value.
When addressing impairments, it’s essential to differentiate between financial assets and non-financial assets. A financial asset, such as an investment in bonds or shares, might be impaired due to factors like bankruptcy of the issuer or prolonged decline in the asset’s market value. On the other hand, non-financial assets, like machinery or real estate, can be impaired due to physical damage or obsolescence. Both types, however, underscore the importance of consistent monitoring and evaluation to ensure accurate financial reporting.
Impairment calculation
An indicator can be any event that causes doubt that the present value of the asset is overstated. For example, if there has been a building fire or a vehicle was in an accident, this could result in a reduced fair value of the asset. Other impairment indicators, unrelated to physical damage, may include:
- Market decline: A sudden decline in the market value of an asset, below its book value, is a clear indicator.
- Increased competition: For instance, a patented product might face stiff competition after the expiration of its patent, leading to a potential decline in its value.
- Legal factors: Regulatory changes or loss of a key license can impair the value of related assets. Imagine a mining company losing its rights to a particular mining area.
- Adverse changes in Usage: If an asset is expected to be abandoned or its usage is significantly reduced, it might hint towards impairment.
- Economic factors: Economic downturns, increased interest rates, or other unfavorable changes in the economic environment can signal impairment.
- Internal factors: A company’s internal reporting might show that the economic performance of an asset is worse than expected.
If the selling price or the value-in-use calculation is less than the carrying value of the asset, there is an adjustment required.
This adjustment is known as the impairment, which is recognised as an expense and Accumulated Impairment (similar to Accumulated Depreciation).
The selling price refers to the Fair value of the asset, i.e., the cost a consumer would be willing to pay for an asset, reduced by any direct selling costs. An asset’s value in use refers to the future cash inflows and/or cash outflows arising from the continued use of an asset. The net cash flow for each year is then adjusted for the time value of money, by applying an appropriate discount rate. Usually, the discount rate that is applied in a value-in-use calculation is the weighted average cost of capital for an entity. Carrying value refers to the value of an asset on the company’s balance sheet, determined by deducting the accumulated depreciation from the original cost.
To illustrate the calculation of impairment, let’s use the following scenario:
A vehicle is leased to operate as a delivery truck for the company. However, it was in an accident. The leased asset can either be repaired for continued use or the lease can be terminated. The recoverable amount will be based on the highest of the value-in-use or what the selling price is for a vehicle previously in an accident.
Going forward in this blog we will only focus on how IAS 36 affects IFRS 16 Lease Accounting. To gain a better understanding of impairments, we would encourage you to read more about it here – CPDbox – IAS 36.
Accounting for IFRS 16 leases and IAS 36 impairment
IFRS 16 sets out the guidelines for a lessee to recognize lease liabilities and right-of-use (ROU) assets on their balance sheet. IAS 36 then provides guidance on assessing and recognizing impairments of assets, including leased assets.
Here’s a systematic approach to recognizing impairments for IFRS 16 leased assets:
1. Identification of Cash Generating Units (CGUs)
- Ascertain the CGUs to which the right-of-use assets belong
- Allocate the lease liabilities and leased asset values to the CGUs systematically.
2. Impairment Testing
- Conduct impairment analysis upon indications of impairment.
- Calculate the recoverable amount of the cash-generating unit (CGU).
3. Recognition and Measurement
- Recognize an impairment loss if a CGU’s carrying amount exceeds its recoverable amount.
- Measure the impairment loss accordingly and allocate it to the assets.
Remember to consider as part of your recoverable amount assessment of the leased asset, you will have to include estimated future cash inflows. This may include any lease-specific factors impacting the impairment assessment. Once the impairment has been recognised, the leased asset will have a reduced carrying value. The adjusted asset value should be depreciated over the remaining useful life.
Accounting challenges involved between IFRS 16 and IAS 36
This chapter dissects the complexities of IFRS 16 and IAS 36, exploring challenges in lease contract terms, modifications, asset class assessments, and impairment reversals. Through a detailed lens, we navigate the nuanced intersections of these standards, highlighting key areas that mandate astute attention for accurate financial reporting.
Lease Contract Terms
The following could be factors that might impact your impairment assessment due to special lease terms and conditions:
- Residual value:
The estimated value of an asset at the end of its lease term or useful life. - Variable lease payments:
Payments that fluctuate based on predefined conditions, such as usage or performance metrics. - Clauses relating to the lease term (inclusive of any early termination clauses):
Stipulations in a lease agreement detailing term duration and conditions for premature contract cessation.
Lease Modifications and Remeasurements
Although IAS 36 requires an impairment that was recognised to be evaluated at least annually, when the lease is modified this assessment should be reconsidered. For example, if the lease period is extended, this increases the value of both the lease liability and the right-of-use (ROU) asset. The assessment might require a further impairment expense.
Change Assessment for an Asset Class
There are various types of leased assets and each individual asset class might have different IAS 36 impairment considerations.
For example, a vehicle would be relatively easier to consider as there are observable market prices. However, leasing a shopping centre store will require a more in-depth assessment. The expected future cash flows of the store as a cash-generating unit would be required for the assessment.
Impairment reversals
Lastly, subsequent to the impairment that was recognised on the lease asset, there is the possibility of reversing the impairment.
1. Indicators of Reversal:
Monitor for indications that impairment losses recognized in the past may no longer exist or may have decreased.
2. Recoverable Amount Reassessment:
Reassess the recoverable amount of the asset, ensuring it now exceeds its carrying amount.
3. Reversal of Impairment Loss:
Reverse the impairment loss, but not in a manner that the asset’s carrying amount exceeds its recoverable amount, nor the carrying amount that would have been calculated had no impairment loss been recognized.
Merging IFRS 16 Solutions with IAS 36 Best Practices
Implementing a robust lease accounting system is essential to effectively navigate the complexities of IFRS 16 and IAS 36.
Let’s find out how a holistic lease accounting software tool can help you merge IFRS lease accounting with asset impairments (IAS 36).
- Centralized data management: By centralizing lease information, including lease terms, payments, and lease-specific factors, and maintaining accurate up-to-date lease data – a business can ensure reliable impairment assessments.
- Automated calculations: Modern lease accounting software may help businesses auto-calculate depreciation, interest, and even preliminary impairment tests based on provided data and set indicators. These can automate some of the complex calculations required under IAS 36, especially when determining value-in-use or fair value less costs to sell.
- Compliance alerts: Some advanced software solutions also feature notification systems that alert finance teams about potential non-compliance issues or when impairment reviews might be due.
Choose Rubli IFRS 16 lease accounting software to navigate the impact of IAS 36 impairments
Choosing the right lease accounting software is pivotal to ensure accurate, efficient and compliant reporting.
Rubli’s IFRS 16 lease accounting software emerges as a leader in this realm, offering businesses a seamless, tried, and tested solution. While our platform doesn’t determine the impairment value, it excels at managing post-impairment data. Once the impairment amount has been determined, it can be seamlessly integrated within Rubli. The platform ensures the adjusted value of the asset is correctly depreciated. Moreover, if a lease undergoes modifications post-impairment, like an extended lease term, Rubli adeptly adjusts to ensure the enhanced asset value is depreciated accurately.
With innovative features and stress-free implementation, Rubli not only streamlines IFRS 16 lease accounting but also improves clarity and ensures rigorous compliance.
Please contact us to book a demo and our team can guide you through our platform and how it will support you as you navigate IFRS 16 leasing accounting and IAS 36 impairments.
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