# Impairment of property, plant and equipment

Impairment loss is the difference between an asset’s carrying amount and its recoverable amount. Purpose of this concept of calculating and recording impairment of assets is to ensure that no asset is carried at an amount which is greater than its recoverable amount.

But what is recoverable amount? It is the maximum amount that an asset is expected to fetch either by its use or sale. So, if in the books of account of a company, the carrying amount of an item of property, plant and equipment (PPE) is more than its recoverable amount, only logical thing to do is to write it down to its recoverable amount, as otherwise, it will be a misrepresentation. Therefore, impairment loss must be recorded if the carrying amount of an item of PPE is greater than its recoverable amount.

## Formula

Impairment loss = Carrying amount – Recoverable amount

Whereas recoverable amount is the higher of the following:

• Net realizable value i.e. fair value less cost to sell
• Value in use

### Net realizable value

Net realizable value (NRV) represents the value that an entity can expect to obtain from selling an asset and is calculated using the following formula:

Net realizable value = Fair value – Cost to sell

It has two components:

•  Fair value of the asset (which is determined by reference to an active market, or if there is a legally binding agreement, then referring to that agreement price)
• Cost to sell (if any costs are required for selling the asset)

### Value in use

Value in use represents the present value of the future economic benefits which an entity expects to obtain by using the asset over its useful life. To determine the value in use, future cash inflows and outflows associated with the use of asset and ultimate disposal at the end of its useful life are estimated. Estimated future cash flows are then discounted using an appropriate discount rate to arrive at the present value of future cash flows.

Determining the discount rate often involves significant judgement. However, discount rate should be determined keeping in mind the time value of money and uncertainty inherent with the estimated future cash flows. For instance, a company can use its weighted average cost of capital, or its incremental borrowing rate as discount rate for determining the value in use.

## Impairment requirements for PPE

It is not required to perform impairment reviews each year. At the end of each year, an entity is required to assess whether there are any indications that an item of PPE might be impaired. If there is an indication that an item of PPE might be impaired, then the entity must proceed towards impairment review which involves determining the recoverable amount and comparing it with the carrying amount of PPE.

Impairment indicators can be from external sources as well as internal sources. Here are some examples of impairment indicators.

### External sources

• Changes in the market and decrease in asset’s market value
• Significant technological changes
• Significant changes in the economic or legal environment
• A pandemic affecting the overall business
• Increase in interest rates (this will affect the determination of discount rate for calculating value in use)

### Internal sources

• Evident damage to the asset
• Significant drop in the financial performance of the asset observed in internal reporting

## Treatment of impairment loss

Default approach: Impairment loss is recognized directly in the income statement as an expense.

Only exception to this default approach is if there is any balance in the revaluation surplus reserve pertaining to previous revaluations. In such case, impairment loss to the extent of revaluation surplus balance is recorded in statement of comprehensive income, and only excess impairment loss is recognized as expense in income statement.

### Journal entry to record impairment loss

Impairment loss (Dr.)
Accumulated impairment loss (Cr.)

In case there is revaluation surplus, journal entry will be as follows:

Impairment loss (Dr.) – OCI
Impairment loss (Dr.) – P/L
Accumulated impairment loss (Cr.)

Following illustration will further clarify this concept.

### Illustration

As at 31 December 2020, an impairment test was carried for an asset. Following information is available in this regard:
Carrying amount                               USD 900,000
Recoverable amount                         USD 500,000

Record journal entries for recognizing impairment loss in the following two scenarios:

• Asset is carried at cost model.
• Asset is carried at revaluation model and there is a balance of revaluation surplus of USD 300,000 as at 31 December 2020.

Scenario-1: Journal entry for impairment (without revaluation surplus)

Impairment loss (P/L) – Dr. USD 400,000
Accumulated impairment loss – Cr. USD 400,000

Scenario-2: Journal entry for impairment (with revaluation surplus)

Impairment loss (OCI) – Dr. USD 300,000
Impairment loss (P/L) – Dr. USD 100,000
Accumulated impairment loss – Cr. USD 400,000

First, the revaluation reserve is adjusted by recording the impairment (reversal of revaluation surplus) in the statement of comprehensive income and only the excess amount is recognized in income statement.

### Reversal of impairment loss

When an asset has been impaired, there is a possibility that in future, circumstances change favorably for the impaired asset. So, an entity must assess the indicators for reversal of impairment loss at each year end or reporting date. If the recoverable amount turns out to be more than the impaired carrying amount, a reversal of impairment is recorded. However, reversal of impairment should not in any case take the asset’s value beyond its depreciated historical cost.

Depreciated historical cost represents the amount that would have been the asset’s carrying amount at any time, had there been no impairment i.e. initial cost less accumulated depreciation based on initial cost.

Reversal of impairment loss is recognized in income statement. However, if the impairment was recorded in statement of comprehensive income, then the reversal is also recorded as other comprehensive income and credited in revaluation reserve.