Ind AS 36

Understanding Ind AS 36: The Core Idea

Ind AS 36, “Impairment of Assets,” is an Indian Accounting Standard that sets out the procedures an entity must apply to ensure that its assets are carried at no more than their recoverable amount. An asset is considered “impaired” if its carrying amount (the value at which it is recognized in the financial statements) exceeds its recoverable amount (the higher of its fair value less costs of disposal and its value in use). When such an impairment is identified, the standard requires the entity to recognize an impairment loss immediately in the Statement of Profit and Loss, thereby reducing the asset’s carrying value to its recoverable amount.

The primary objective of Ind AS 36 is to prevent assets from being overstated on the balance sheet, ensuring that financial statements present a true and fair view of an entity’s financial position.

Tracing Its Roots: The Genesis of Ind AS 36

Ind AS 36 is part of India’s broader initiative to converge its accounting standards with International Financial Reporting Standards (IFRS), issued by the International Accounting Standards Board (IASB). Specifically, Ind AS 36 is largely based on IAS 36, “Impairment of Assets.”

The Ministry of Corporate Affairs (MCA) in India notified the Ind AS framework, making it mandatory for certain classes of companies in phases, starting from April 1, 2016. This convergence aims to enhance the comparability, transparency, and quality of financial reporting by Indian companies, making it easier for global investors and stakeholders to understand and analyze their financial performance.

The adoption of Ind AS 36 replaced the corresponding Indian Generally Accepted Accounting Principle (GAAP) on impairment, bringing India’s approach to asset valuation and impairment in line with global best practices.

Diving Deeper: How Ind AS 36 Works

Ind AS 36 provides a detailed framework for identifying, measuring, and recognizing impairment losses. The process involves several critical steps:

Identifying Impairment Indicators

An entity must, at the end of each reporting period, assess whether there is any indication that an asset may be impaired. These indicators can be external or internal:

• External Indicators:
  • Significant decrease in the asset’s market value.
  • Significant adverse changes in the technological, market, economic, or legal environment in which the entity operates.
  • Increase in market interest rates or other market rates of return on investments, which could materially affect the discount rate used to calculate value in use.
  • The carrying amount of the net assets of the entity being more than its market capitalization.
• Internal Indicators:
  • Evidence of obsolescence or physical damage of an asset.
  • Significant adverse changes in the extent to which, or manner in which, an asset is used or expected to be used (e.g., restructuring, discontinuing operations).
  • Worse-than-expected economic performance of an asset.

If such indicators exist, the entity must estimate the asset’s recoverable amount. For certain assets, specifically goodwill and intangible assets with indefinite useful lives or not yet available for use, an annual impairment test is mandatory, regardless of whether impairment indicators exist.

Calculating the Recoverable Amount

The recoverable amount of an asset is defined as the higher of:

• Fair Value Less Costs of Disposal (FVLCOD): This is the price that would be received to sell an asset or CGU in an orderly transaction between market participants at the measurement date, less the direct costs of disposal (e.g., legal costs, stamp duty). Fair value is often determined using market prices for similar assets, or valuation techniques such as discounted cash flows if no active market exists.
• Value In Use (VIU): This is the present value of the future cash flows expected to be derived from an asset or Cash-Generating Unit (CGU). Calculating VIU involves:
  • Estimating future cash inflows and outflows from the asset’s continued use and ultimate disposal.
  • Applying an appropriate discount rate that reflects the current market assessment of the time value of money and the risks specific to the asset.

  This calculation is often complex, requiring robust financial forecasting and careful selection of assumptions, including growth rates and the terminal value.

Cash-Generating Units (CGUs)

Often, individual assets do not generate cash flows independently. In such cases, Ind AS 36 requires assets to be grouped into the smallest identifiable group of assets that generates cash inflows largely independent of the cash inflows from other assets or groups of assets. This group is called a Cash-Generating Unit (CGU). Impairment tests for assets like goodwill are always performed at the CGU level to which the goodwill is allocated.

Recognizing and Reversing Impairment Losses

• Recognition: If the carrying amount of an asset or CGU exceeds its recoverable amount, an impairment loss is recognized immediately in the Statement of Profit and Loss. The carrying amount of the asset (or CGU) is reduced to its recoverable amount.
• Reversal: For assets other than goodwill, an impairment loss recognized in prior periods must be reversed if there has been a change in the estimates used to determine the asset’s recoverable amount since the last impairment loss was recognized. The reversal is limited to the asset’s carrying amount (net of depreciation/amortization) that would have been determined had no impairment loss been recognized. Ind AS 36 generally prohibits the reversal of impairment losses for goodwill.

Disclosure Requirements

Ind AS 36 mandates extensive disclosures, including the amount of impairment losses and reversals recognized, the events and circumstances that led to the impairment, the methods used to determine the recoverable amount (FVLCOD or VIU), and key assumptions used in the calculations (e.g., discount rates, growth rates).

Why This Standard Matters to Your Business

Ind AS 36 is not merely a compliance burden; it holds significant strategic and financial importance for businesses:

• Accurate Financial Reporting: It ensures that the assets presented on a company’s balance sheet are not overstated, providing a more accurate and realistic view of its financial health and performance. This is crucial for maintaining the credibility of financial statements.
• Informed Decision-Making: Reliable asset valuations enable management, investors, creditors, and other stakeholders to make better, more informed economic decisions regarding investments, lending, and operational strategies.
• Enhanced Transparency and Comparability: By aligning with international standards, Ind AS 36 improves the transparency of financial reporting and makes it easier for stakeholders to compare the performance of Indian companies with global peers.
• Investor Confidence: Transparent and conservative accounting for assets builds trust with investors, potentially leading to better access to capital and lower cost of funding.
• Risk Management: The requirement to regularly assess assets for impairment forces companies to monitor the economic viability and performance of their assets, acting as an early warning system for potential operational or market challenges.
• Corporate Governance: Robust impairment testing processes are an important aspect of sound corporate governance, demonstrating management’s accountability for asset stewardship.

Real-World Scenarios: Where Ind AS 36 Applies

Ind AS 36 applies to a wide range of non-financial assets, including but not limited to:

• Property, Plant, and Equipment (PPE): For instance, a manufacturing company’s machinery becoming obsolete due to rapid technological advancements, or a factory building losing value because of a significant decline in demand for its products or adverse changes in local economic conditions.
• Intangible Assets:
  • Goodwill: Often the largest intangible asset on a balance sheet, acquired in business combinations. If an acquired business unit fails to meet its projected performance targets, the goodwill allocated to that unit would be subject to impairment. This is tested annually.
  • Patents, Trademarks, and Brand Names: These could be impaired if a competitor introduces a superior product, if the brand’s reputation is severely damaged, or if legal challenges invalidate a patent.
  • Capitalized Development Costs: If a research and development project, for which costs were capitalized, fails to achieve commercial viability or is abandoned.
• Investment Property: When carried at cost, if its recoverable amount falls below its carrying amount.
• Other Assets: Ind AS 36 applies to assets that are not specifically covered by other Ind AS standards for impairment, such as Ind AS 2 (Inventories), Ind AS 109 (Financial Instruments), and Ind AS 105 (Non-current Assets Held for Sale and Discontinued Operations), which have their own impairment rules.

Connecting the Dots: Related Concepts and Standards

Ind AS 36 operates within a broader framework of accounting standards and concepts:

• Ind AS 16 (Property, Plant and Equipment) & Ind AS 38 (Intangible Assets): These standards govern the initial recognition, measurement, and depreciation/amortization of tangible and intangible assets, respectively, setting the initial carrying amounts that Ind AS 36 then assesses for impairment.
• Ind AS 103 (Business Combinations): Defines how goodwill is recognized initially when one company acquires another, establishing the basis for subsequent impairment testing under Ind AS 36.
• Ind AS 113 (Fair Value Measurement): Provides authoritative guidance on how to determine fair value, which is a key component of the recoverable amount calculation (Fair Value Less Costs of Disposal).
• Discount Rate: A critical input in the Value In Use calculation, typically derived from a company’s Weighted Average Cost of Capital (WACC) adjusted for asset-specific risks or a risk-free rate plus a risk premium.
• Cash Flow Forecasting: The accuracy of future cash flow projections is paramount for a reliable Value In Use calculation, linking Ind AS 36 closely with financial planning and analysis.
• Ind AS 10 (Events after Reporting Period): May require adjustments or disclosures if impairment indicators arise between the reporting date and the date the financial statements are authorized for issue.

Staying Current: Recent Developments and Focus Areas

While Ind AS 36 itself has been stable for some time, its application remains a critical area of focus:

• Economic Volatility: Global economic uncertainties, inflationary pressures, supply chain disruptions, and geopolitical events can trigger impairment indicators more frequently, requiring companies to conduct more rigorous and frequent impairment tests.
• Auditor Scrutiny: Auditors continue to apply significant scrutiny to impairment tests, particularly for goodwill and large intangible assets, challenging management’s assumptions (e.g., discount rates, growth forecasts, terminal values) and the robustness of CGU identification.
• Climate Change and ESG Factors: There’s increasing debate and guidance on how environmental, social, and governance (ESG) factors, particularly climate-related risks (e.g., transition risk to a low-carbon economy, physical risks of extreme weather), should be integrated into impairment assessments, potentially impacting the useful lives, cash flows, and discount rates for certain assets.
• Digital Assets & Data: The growing importance of digital assets, customer data, and complex proprietary software raises new challenges in defining CGUs and estimating cash flows for impairment testing.

Who Needs to Know? Impact Across Business Functions

Understanding and applying Ind AS 36 is not confined to a single department; its implications spread across various functions within an organization:

• Finance and Accounting Departments: These are the primary owners, responsible for performing impairment tests, preparing the necessary calculations, ensuring compliance, and handling financial statement disclosures.
• Valuation Teams (Internal or External): Essential for providing expert opinions on fair value and assisting in the complex calculations of value in use, including cash flow projections and discount rates.
• Strategy and Business Development Teams: Their long-term strategic plans, market analyses, and acquisition rationales directly influence the future cash flow forecasts and the allocation of goodwill to CGUs.
• Operations and Asset Management: Operational performance and asset utilization directly impact the cash flows generated by assets, providing critical inputs for impairment analysis.
• Legal Department: May be involved in reviewing contractual obligations, intellectual property rights, or regulatory changes that could affect asset values or the entity’s ability to utilize assets.
• Internal Audit: Responsible for reviewing the integrity and effectiveness of the impairment testing process and controls.
• Investor Relations: Plays a key role in explaining the impact of impairment losses or reversals to investors and other external stakeholders.

Looking Ahead: The Future Landscape of Impairment Reporting

The core principles of Ind AS 36 are expected to remain stable, but several trends will shape its application:

• Increased Granularity in Disclosures: There’s an ongoing push for more transparent and detailed disclosures, particularly concerning the judgments and assumptions used in impairment testing, to provide better insights for investors.
• Integration of Sustainability Factors: As ESG reporting becomes more mainstream, the integration of climate-related and other sustainability risks into asset valuation and impairment assessments will likely become more formalized and prescriptive.
• Leveraging Technology: Advanced analytics, artificial intelligence, and machine learning could play a growing role in automating aspects of cash flow forecasting, identifying impairment indicators, and streamlining the overall testing process, though human judgment will remain critical.
• Focus on Non-Financial Assets: With the increasing importance of brand value, customer relationships, and proprietary technology, the complexity of valuing and impairing non-financial and intangible assets will continue to be a significant challenge.
• Global Standard Alignment: While Ind AS 36 is aligned with IAS 36, any future amendments or interpretations by the IASB (e.g., from ongoing post-implementation reviews) could trigger corresponding changes in Ind AS, ensuring continued global harmonization.

In essence, Ind AS 36 will continue to be a cornerstone of financial reporting, demanding careful judgment, robust processes, and cross-functional collaboration to ensure assets are presented fairly and transparently.