Key Takeaways
- Right-of-use assets are subject to IAS 36 impairment requirements like any other non-financial asset
- An impairment loss is recognised when carrying amount exceeds recoverable amount
- Recoverable amount is the higher of fair value less costs of disposal and value in use
- ROU assets are often tested as part of a larger cash-generating unit (CGU)
- Impairment losses can be reversed if circumstances change, but only up to the carrying amount that would have existed (net of depreciation) had no impairment been recognised
IAS 36 and IFRS 16
IFRS 16.33 requires lessees to apply IAS 36 (Impairment of Assets) to determine whether right-of-use assets are impaired and to account for any impairment loss identified. IAS 36 applies to the right-of-use asset, not to the lease liability. The lease liability continues to be measured under IFRS 16 regardless of any impairment.
What is Impairment?
An impairment loss is recognised when an asset's carrying amount exceeds its recoverable amount. It reduces the asset's carrying value on the balance sheet and is recognised in profit or loss. Impairment losses can be reversed in later periods if circumstances change.
The key principle is that an asset should not be carried at more than its recoverable amount. When circumstances suggest this may be the case, an impairment test is required.
Impairment Indicators
ROU assets are tested for impairment when indicators exist, rather than being subject to mandatory annual testing (which applies to goodwill and indefinite-life intangibles, not ROU assets). Entities must assess at each reporting date whether there are indicators that an asset may be impaired.
External Indicators
Internal Indicators
ROU Asset-Specific Indicators
For leased assets, additional indicators might include: ceasing to use the leased premises, subletting at below-market rates, or significant declines in the profitability of operations using the leased asset.
Impairment Testing Process
When indicators suggest a right-of-use asset may be impaired, follow a systematic approach:
Identify Cash-Generating Units (CGUs)
Determine the CGUs containing right-of-use assets. A CGU is the smallest group of assets that generates cash inflows largely independent of other assets. An ROU asset that doesn't generate independent cash flows must be tested as part of a larger CGU.
The carrying amount of a CGU does not include the carrying amount of any recognised liability, unless the recoverable amount of the CGU cannot be determined without consideration of that liability (IAS 36.76).
Determine Recoverable Amount
Calculate the recoverable amount - the higher of:
- Fair value less costs of disposal - for a right-of-use asset, this may depend on whether the lease rights can be assigned, transferred, or sublet, and can be difficult to determine directly
- Value in use - present value of future cash flows expected from the asset
Compare and Recognise
If the carrying amount exceeds the recoverable amount, recognise an impairment loss. The asset is written down to its recoverable amount.
Calculating Recoverable Amount
Fair Value Less Costs of Disposal
For right-of-use assets, determining fair value can be challenging because there may not be an active market for the lease rights. Consider:
- Sublease income potential (if permitted by the lease)
- Lease assignment value
- For vehicles and equipment: observable market prices minus disposal costs
Value in Use
Value in use requires estimating future cash flows and discounting them at an appropriate rate. For ROU assets as part of a CGU:
- Include cash flows from operations using the asset
- Consider the remaining lease term
- Use a pre-tax discount rate reflecting time value of money and asset-specific risks
Asset Class Considerations
Different asset classes require different approaches. Vehicles have observable market prices enabling easier fair value assessment. Retail property leases typically require value-in-use calculations examining expected cash flows from the store as a cash-generating unit.
Recognition and Measurement
Recognising Impairment Loss
When the carrying amount of an ROU asset (or the CGU containing it) exceeds the recoverable amount, recognise an impairment loss immediately in profit or loss.
Example: Recognising an Impairment Loss
- ROU asset cost: £100,000 on a 5-year lease (£20,000 depreciation per year)
- Carrying amount at end of Year 2: £60,000
- Recoverable amount: £45,000
- Impairment loss: £60,000 - £45,000 = £15,000
Allocating CGU Impairment
When a CGU is impaired, allocate the loss:
- First, to reduce goodwill allocated to the CGU
- Then, to other assets (including ROU assets) pro rata based on carrying amounts
An individual asset should not be reduced below the highest of:
- Its fair value less costs of disposal
- Its value in use
- Zero
Post-Impairment Depreciation
After recognising an impairment loss, depreciate the revised carrying amount over the remaining depreciation period determined under IFRS 16, which is often, but not always, the remaining lease term.
Example: Post-Impairment Depreciation
- Original ROU asset: £100,000, 5-year lease
- After 2 years: carrying amount £60,000, impaired to £45,000
- Remaining lease term: 3 years
- New annual depreciation: £45,000 ÷ 3 = £15,000
Impairment Reversal
Unlike US GAAP, IFRS permits reversal of impairment losses (except for goodwill) when circumstances change. For ROU assets:
Monitor for Reversal Indicators
Assess at each reporting date whether indicators exist that a previously recognised impairment may no longer exist or may have decreased.
Reassess Recoverable Amount
If reversal indicators exist, re-estimate the recoverable amount using current assumptions.
Reverse Within Limits
Reverse the impairment loss, but not exceeding what the carrying amount would have been (net of depreciation) had no impairment been recognised.
Example: Reversing an Impairment Loss
Continuing the scenario above. The impaired asset is depreciated over the remaining 3 years at £15,000 per year. At the end of Year 3:
- Post-impairment carrying amount: £45,000 - £15,000 = £30,000
- Reassessed recoverable amount: £50,000
- Carrying amount that would have existed without impairment: £100,000 - (3 × £20,000) = £40,000
- Reversal is capped at £40,000 - £30,000 = £10,000
Maximum reversal: The increased carrying amount cannot exceed the carrying amount that would have existed (after depreciation) if no impairment had been recognised in prior periods.
Interaction with IFRS 16 Events
Lease Modifications
When a lease is modified, the ROU asset is remeasured. After remeasurement, reassess whether impairment indicators exist on the new carrying amount. An extended lease term might increase both the liability and the asset, potentially requiring additional impairment assessment.
Remeasurements
Lease liability remeasurements (e.g., due to index changes) adjust the ROU asset. Consider whether the remeasured amount triggers impairment indicators, particularly if payments have increased significantly.
| IFRS 16 Event | Impairment Consideration |
|---|---|
| Lease modification (extension) | Reassess for indicators after remeasurement |
| Lease modification (scope change) | May create new CGU structure requiring reallocation |
| Index-linked remeasurement | Higher payments may indicate reduced profitability |
| Changes in lease-related cash outflows | Changes in expected profitability may indicate impairment, even where the change does not itself remeasure the lease liability |
Practical Considerations
Documentation Requirements
Robust documentation supports impairment assessments and audit reviews:
- Indicator assessment at each reporting date
- CGU identification and allocation of ROU assets
- Recoverable amount calculations with key assumptions
- Sensitivity analysis for significant judgements
Lease Accounting Software
Effective lease accounting systems support impairment tracking by:
- Centralising lease data enabling reliable assessments
- Tracking adjusted carrying values post-impairment
- Recalculating depreciation on impaired amounts
- Maintaining audit trails of impairment decisions
Annual Process
Build impairment indicator assessment into your year-end close process. For material ROU assets or portfolios, document the indicator review even when no impairment is identified.
This article is provided for general informational purposes only and does not constitute accounting, legal or professional advice.