Non-current assets

Property, plant and equipment

1/1/X1, XYZ bought a production machine #123 for 60,000.

For simplicity, this example does not discuss any additional costs such as agent's fees, transportation, installation, break-in, development, disposal, interest, etc.

The following (self-manufactured asset) example does.

It estimated the machine would be useful for 12 years and could be sold for 9,000.

It elected to depreciate the machine using a straight-line method.

An asset's "useful life" is the time over which it is expected to serve its purpose (a purpose).

Assets acquired for a particular purpose may or may not be reassigned to a different purpose.

For example, if a company acquired a machine to manufacture a particular product for a three-year production run, the machine's useful life would be 3 years.

If, on the other hand, the company intended to transition the machine to successive products, the machine's useful life would be longer.

As US GAAP does not specify how to determine useful life, entities may use judgment or refer to IFRS.

While ASC 360-10-35-4 requires entities to depreciate assets over their useful life, ASC 360-10 fails to specify how useful life should be determined leaving companies free to exercise judgment in setting depreciation periods.

Being able to use judgment does not, however, imply that companies are free to use any depreciation period they like.

If a period proves to be materially inaccurate, as this is generally apparent only at or near its end, it will trigger a restatement as outlined in ASC 250-10-50-12.

Caveat: intentionally failing to establishing realistic depreciation periods can have serious consequences because this is a method occasionally used to manage earnings, something the SEC takes especially seriously.

ASC 250-10-S99-1: “...the staff believes that a registrant and the auditors of its financial statements should not assume that even small intentional misstatements in financial statements, for example those pursuant to actions to "manage" earnings, are immaterial.”

Note: the only way to correct errors is retrospectively, in this case going back to the period the asset was acquired.

Also note: even if the correction of an intentional error is not sufficiently material to warrant a restatement of the financial statements, the error would still need to be disclosed and reported to the SEC.

While both ASC 360-10-35-4 and IAS 16.50 require useful life, only IAS 16.56 outlines criteria.

IAS 16.56 outlines four criteria ("factors") for determining useful life.

The first should be used if possible, while the remaining three should be applied as appropriate.

expected usage (a.k.a. units of production)
physical wear and tear
technical or commercial obsolescence
legal or similar limits

Units or production not only yields better results, it can also reduce accounting complexity.

IAS 16.55 (edited emphasis added) states: ...depreciation does not cease when the asset becomes idle or is retired from active use unless the asset is fully depreciated. However, under usage methods of depreciation the depreciation charge can be zero while there is no production.

While the difference between depreciation that has ceased and a zero depreciation charge is minimal (the former implies depreciation will not be restarted in the future), being able to stop/start depreciation can bring practical benefits.

For example, assume a company estimates it will be able to manufacture and sell 10,000 units of a product per year for 10 years. To manufacture the product, it purchases a machine for 10,000.

To save effort, it assigns a fixed 10-year useful life to the asset and elects straight-line depreciation (and ignores residual value).

If production hits the target, a depreciation charge of 0.10 will accrue to year unit. However, if production falls short, say 5,000 units, a depreciation charge of 0.20 would accrue to year unit, increasing cost of sales (relative to production volume) and decreasing gross profit.

While it is possible to adjust depreciation periods on the basis of an annual review (IAS 16.51), if a units of production method is used, the adjustment occurs automatically.

For example, a production die can have a 10,000 unit limit until exceeds engineering tolerance.

Each time a unit is product, a depreciation charge of 1/10,000 would be recognized.

The drawback of this method: relatively few assets have precisely definable usage parameters.

The disadvantage of this method: the asset will need to be disposed of when the limit is reached.

This criterion is similar expected usage because it reflects the physical attributes of an asset.

It would be used in situations where units of production cannot be determined.

For example, a press utilizing a production die would most likely not, unlike the die, have a precise technical limit on the number of units it could produce.

Nevertheless, the press would eventually deteriorate physically, so would eventually need to be replaced for this reason.

In contrast to the previous two, this criterion is external.

Instead of examining how the entity uses the asset, it looks at how the asset deteriorates due to changes in technology or market conditions, both of which are generally external to the entity (and often beyond its control).

For example, an entity acquires a machine that can print 12nm circuits. Subsequently, a competitor develops a machine that can print 8nm circuits. This change in technological means the 12nm machine is now (at least partially) technologically obsolete.

Commercial obsolescence is the other side of the same coin.

Before 8nm chips were available, 12nm chips (almost certainly) sold for more than after 8nm chips became available.

Note: while commercial obsolescence can be used to determine depreciation periods, IAS 16.62A prohibits a "depreciation method that is based on revenue that is generated by an activity that includes the use of an asset" in effect disallowing its use in determining deprecation methods.

Also note: as US GAAP does not provide similarly detained guidance, "contribution to earnings" can be used to determine both depreciation periods and depreciation methods.

In practice, this criteria usually applies to intangible assets such as patents or licensing agreements.

It would also apply to right of use assets under IFRS 16, though these are also (technically) intangible assets.

When it comes to property plant and equipment, this criterion would most often apply to assets like leasehold improvements, if the lease term is shorter than the useful life of the improvement.

As no authoritative generally accepted accounting principles (ASC 105-10-05-1) specifically address useful life, nonauthoritative accounting guidance such as IFRS (ASC 105-10-05-3.d) may be considered (ASC 105-10-05-2), implying the criteria outlined in IAS 16.56 could be used to determine accounting policy in a US GAAP context.

Most items of property, plant and equipment have some remaining value at the end of their useful lives.

If this residual | salvage value is material, the asset should be depreciated to it, not zero.

IAS 16.6 defines residual value while ASC 360-10-35-4 refers to salvage value.

Since both reflect an estimate of the value an asset will have at the end of its useful life, the terms are interchangeable.

To establish residual | salvage value in practice, a company will generally use its historical experience.

For example, if it commonly sells class A machines for an average of 10% or their acquisition cost and class B machines for 20%, it would set residual | salvage values of 10% and 20% respectively.

It is also possible to estimate using observable inputs in a manner consistent with IFRS 13.67 | ASC 820-10-35-36.

For example, a company could determine the average price comparable assets bring at auction (although a quick and dirty internet search is often good enough).

However, in practice, sticking to the 10% to 20% rule of thumb is often the best option.

Depreciating PP&E to zero is common practice under many national GAAPs.

However, under IFRS | US GAAP, if the asset has residual | salvage value, not recognizing it would be an error.

Although not setting a residual | salvage for assets that are eventually sold (demonstrating that they had residual | salvage value) would be an error, if would rarely be sufficiently material to trigger a restatement as outlined in IAS 8.42 | ASC 250-10-50-12.

Caveat: intentionally failing to establish residual | salvage in situations where residual | salvage demonstrably exists to achieve a particular end would always be material as outlined in IAS 8.41 | ASC 250-10-S99-1.2

Note: the only way to correct errors is retrospectively, in this case going back to the period the asset was acquired.

This example uses a straight-line depreciation method because it is both simple and commonly used.

This should not be taken as a suggestion to use this method in all circumstances.

Instead, companies should elect a method suitable to the circumstances.

IFRS and US GAAP provide additional guidance including both suggested and prohibited methods.

A discussion of depreciation methods is provided as a standalone section of this page.

IAS 16.62A prohibits methods based on revenue (a.k.a. contribution to earnings).

ASC 360-10-35-9 prohibits tax deprecation (specifically ACRS) unless it reflects a reasonable range of the asset's useful life and ASC 360-10-35-10 prohibits the annuity method (a.k.a. decelerated depreciation).

It sold the machine for 9,500 on 12/31/X12.

1/1/X1 \| 1.1.X1
Machine #123		60,000
	Accounts payable		60,000

12/31/X1 to X12 \| 31.12.X1 to X12
Depreciation expense		4,250
	Accumulated depreciation: Machine #123		4,250
12/31/X12 \| 31.12.X12
Accumulated depreciation: Machine #123		51,000
Cash		9,500
	Machine #123		60,000
	Gain on asset disposal		500

When a company disposes of an item of PP&E, it recognizes the difference between its net book value (carrying amount) and the sales price (if any) as a gain/loss.

Both IFRS and US GAAP prohibit recognizing revenue/expense, common practice in many national GAAPs.

IAS 16.68 (edited, emphasis added): The gain or loss arising from the derecognition of an item of property, plant and equipment shall be included in profit or loss... Gains shall not be classified as revenue.

While the paragraph is not similarly explicit with respect to losses, this is not because the guidance is asymmetrical. Instead, it is because in IFRS Expenses (the aggregated item) comprise expenses and losses (the disaggregated items).

An additional discussion of revenue vs gains and expenses vs losses is provided on the accounting elements page.

As outlined in ASC 610-20-32-2, when a company derecognizes a non-financial asset, it recognizes a gain or loss equal to the difference between amount received for the asset (ASC 610-20-32-3 to 6) and the asset's carrying amount.

Many national GAAPs do not distinguish between revenue/expenses gains/losses. The result is that when a company applying such a GAAP derecognizes an asset, it recognizes revenue/expense, which can have a dramatic impact on its reported results.

For example, some time ago a Czech company decided to list on a US exchange.

After retaining an underwriter, the underwriter retained us to draft a report consistent with US GAAP.

As, unlike CZ GAAP, US GAAP distinguishes revenue/gains and expenses/losses, this was one the first adjustments.

After reviewing our preliminary results, the underwater decided against pursuing a listing.

Our first step was to eliminate the major differences and draft a preliminary report.

Up to then, the company had only applied CZ GAAP.

As CZ GAAP does not distinguish between revenue and gains, when a company disposes of its fixed assets, it recognizes revenue in the amount received and an expense in the asset's book value.

Eliminating this difference caused a significant portion of its previously reported revenue to disappear.

In and of itself, this may have been enough to dissuade a listing, but there was more:

As the sale of receivables is recognized similarly by CZ GAAP, a similar adjustment had to be made to factored receivables.
As CZ GAAP (at the time) required increases in inventory and self-manufactured asset costs to be capitalized with a credit to revenue, this also had to be adjusted.

Eliminating the differences caused over half of the company’s previously reported revenue to disappear.

But there was more:

The company did not recognize the full value of its lease assets nor any associated liabilities because CZ GAAP does not require leased assets to capitalized nor liabilities to be recognized. It only requires the capitalization of advance payments, which are amortized over the lease term.
The company also did not recognize all of its leased assets because CZ GAAP does not require capitalization of operating leases even if their term is for substantially all the underlying asset's economic life.
The company also did not recognize all its contingent liabilities because CZ GAAP does not generally require recognition of constructive obligations.
The company also failed to distinguish between cost of sales, selling and administrative expenses as this distinction is not required by CZ GAAP.
The company also capitalized both development and some research as well as employee training which, at the time, was consistent with CZ GAAP.
The company also misapplied CZ GAAP guidance, for example by using tax depreciation periods for financial reporting purposes, but an examination of these issues was beyond the scope of our engagement.

What a mess.

A second step was not necessary.

After reviewing our preliminary report, the underwater decided to terminate its relationship with the company, which eventually wound up in receivership.

Loss on disposal

Same facts as above, except XYZ sold the machine for 8,500.

12/31/X12 \| 31.12.X12
Accumulated depreciation: Machine #123		51,000
Cash		8,500
Loss		500
	Machine #123		60,000

Intangible assets

Stand-alone asset

1/1/X1, XYZ bought a patent for 10,000.

The patent was acquired on its grant date in an orderly transaction. Its term of 20 years was nonrenewable.

1/1/X1 \| 1.1.X1
Patent		10,000
	Cash		10,000

12/31/X1 \| 31.12.X1
Amortization expense		500
	Accumulated amortization: Patent		500

Unlike PP&E, a "rebuttable presumption" of zero residual | salvage value applies to intangible assets.

As outlined in IFRS 38.100 | ASC 350-30-35-8, companies should assume intangible assets will have no value at the end of their useful lives unless (a) a third party has committed to buy them or (b) there is an active | existing market, which is expected to still exist, for them.

Useful life ≠ legal life

Same facts except XYZ planned to use the patent to manufacture a product it expected sell for 10 years.

1/1/X1 \| 1.1.X1
Patent		10,000
	Cash		10,000

12/31/X1 \| 31.12.X1
Amortization expense		1,000
	Accumulated amortization: Patent		1,000

Developed asset

Same facts except XYZ spent 9,500 from 1/1/X1 to 12/31/X1 to develop the patent and 500 to register the patent.

1/1/X1 to 12/31/X1 \| 1.1.X1 to 31/12/X1
Research and development expense		9,500
Patent (intangible asset)		500
	Cash, Payables, Enplyee benefits, etc.		10,000

As outlined in ASC 730-10-25-1, no research or development costs may ever be capitalized.

While not as categorical as US GAAP, the criteria outlined in IAS 38 practically eliminate any possibility of capitalizing the costs of internally generating a patent unless it will be used in existing operations.

As outlined in IAS 38.54, research costs may never be capitalized.

As outlined in IAS 38.57, development may be capitalized but only if the resulting asset can be sold or used.

IAS 38.57 (edited, emphasis added): An intangible asset arising from development ... shall be recognised if, and only if, an entity can demonstrate ...:
     (c) its ability to use or sell the intangible asset.
     (d) how the intangible asset will generate probable future economic benefits. Among other things,
            the entity can demonstrate the existence of a market for the output of the intangible asset or
            the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset...

As patents are unique, it is difficult to demonstrate that a market for the patent or the output of the patent (the product or service) exists.

It is also risky.

If a company capitalizes development of a patent for a new product or service which it later cannot sell, this inability demonstrates it misapplied IAS 38.57.c and d, so it will most likely need to correct its error as outlined in IAS 8.42 (by restating its previously issued financial reports).

In contrast, if the patent covers improved technology for an existing product or service (or some other useful internal purpose), capitalizing its development is fairly straightforward.

As outlined in IAS 38.59, development comprises (a) designing, producing and testing pre-production prototypes, (b) designing new tools, (c) designing, constructing and operating pilot plants and (d) designing, producing and testing alternative materials, devices or processes.

IAS 38 does not specify what a pilot plant is, only that it is “not of a scale economically feasible for commercial production.”

In practice, to be safe, this is generally interpreted to mean a production facility whose potential production volume will never be sufficient to cover its overhead (fixed and variable).

Note: if a pilot plant is later used for commercial production, the previously recognized development costs would be reversed and financial statements restated as outlined in IAS 8.42.

Also note: as US GAAP does not allow R&D to be capitalized, it does not refer to pilot plants. Instead, it requires any costs associated with facilities without an alternative use (apart from the particular research project) to be expensed as incurred.

The most effective development focuses on improving existing processes, not creating new products or services.

At the risk of stating the obvious, the downside of effective R&D is that innovation suffers.

This is one reason why older, well-established companies with well-developed internal cost control systems generally lag behind younger companies willing to take a risk on an unproven idea.

The flip side of the coin, well established companies with well-developed internal cost control systems generally go bankrupt less often than younger companies willing to take a risk on an unproven idea.

If a company is already selling a product or service, developing technology to improve its quality / reduce production costs not only involves less risk, but makes jumping the IAS 38.57.(c) and (d) hurdle much easier.

As outlined in IFRS 38.66, costs to develop an intangible asset may be capitalized once the asset meets the capitalization criteria outlined in paragraphs 21, 22 and (especially) 57.

These include (subparagraph c) fees to register the legal right.

In this example, as the costs to develop the patent did not meet IAS 38.57 criteria, XYZ only capitalized the costs to register.

While US GAAP does not provide similarly detailed guidance, ASC 350-30-25-3 does specify that costs of internally developing, maintaining, or restoring intangible assets that are not specifically identifiable, that have indeterminate lives, or that are inherent in a continuing business are expensed as incurred.

In general, this guidance is interpreted to mean that only registration costs and fees associated with developed patents are capitalized.

Note, it has been common practice in US GAAP to capitalize costs associated with a legal defense of a intangible asset such as a patent.

However, this practice was based on CON 6, which has since been superseded, and not standard level guidance. As the AICPA still considers this approach to be acceptable, one should consult with one’s CPA regarding this issue before making a decision.

For its part, IFRS (IAS 38.20) does not allow costs to defend an intangible asset such as a patent to be capitalized, as these costs maintain the asset instead of being part of its acquisition.

Indefinite useful life

1/1/X1, XYZ bought a customer list for 10,000. It could not determine how long the list would be useful.

1/1/X1 \| 1.1.X1
Customer list		10,000
	Cash		10,000

12/31/X1 \| 31.12.X1
Amortization expense		N/A
	Accumulated amortization: Customer list		N/A

As outlined in IAS 38.107 | ASC 350-30-35-15, intangible assets with indefinite lives are not amortized.

Because indefinite is transitory, indefinite should not be confused with infinite, unlimited, indeterminate or undeterminable (IAS 38.91 | ASC 350-30-35-4).

From a practical, accounting perspective this means assets with indefinite lives, while not amortized or depreciated, are tested for impairment at least every period.

In contrast, assets with unlimited lives, for example land, while also not depreciated or amortized, do not need to be regularly tested for impairment (IAS 38.108 | ASC 350-30-35-16).

Instead, they are tested for impairment (at minimum annually).

Both IAS 38.108 and provide ASC 350-30-35-16 relatively straight forward guidance, requiring assets with indefinite lives (not being amortized) to be tested for impairment annually (sooner if there is an indication they are impaired).

In a minor difference, ASC 350-30-35-17A prohibits acquired in-process R&D from being amortized until the project is completed (and useful life is determined) or the project is abandoned (and the asset is written off). Neither IFRS 3 nor IAS 38 provides similar guidance.

Additional guidance (IAS 38.108 | ASC 350-30-35-18A) stipulates that a review | qualitative assessment should be performed.

Note: the qualitative assessment in US GAAP is relatively involved. Paragraphs 350-30-35-18B through 35-18F outline how exactly it should be performed.

For its part, IAS 38 does not provide similarly detailed guidance. IAS 38.110 simply refers to IAS 36.

Goodwill

1/1/X1, XYZ acquired ABC for 10,000,000 in cash.

1/1/X1 / 1.1.X1
Assets		9,000,000
Goodwill		1,000,000
	Cash		10,000,000

The Assets acquired in business combination illustration examines this in more detail.

In its simplest form, goodwill results from this calculation:

Cash paid to the (previous) owners of the business

10,000,000

The fair value that business's net assets

(9,000,000)

Goodwill

1,000,000

In addition to cash, IFRS 3.37 | ASC 805-30-30-7 outline various other forms the consideration that can be paid (transferred) including, for example, the acquiring company’s shares (next example).

Interestingly, while both US GAAP and IFRS use the term consideration, neither define it.

This is not because its general meaning is unclear: it is the cash (or something of value like shares) paid in a transaction for something else of value (a product, service or, in this case, a company).

It is because its precise meaning is surprisingly difficult to pin down.

For example, entering "consideration" into Black's online law dictionary (link: thelawdictionary.org) brings up a blank page while Britannica (link: britannica.com), although it does define it, quickly goes off on a tangent about, among other things, love and affection.

... This definition, however, leaves unanswered the question of what is sufficient consideration. During certain periods of history, nominal consideration was held to be sufficient—even a cent or a peppercorn. Gradually, the courts came to require that the consideration be valuable, although not necessarily equal in value to what is received. The courts have had to decide specifically whether acts of forbearance on the faith of a promise, the giving of a counterpromise, money payments, preexisting duties to the promisor, preexisting duties to third parties, moral obligations, love and affection, surrender of another legal claim, or performance of a legal duty were sufficient, and the answer has varied considerably over time...

Fortunately, a quick google search (link: google.com) quickly brings up perhaps the best definition (link: law.cornell.edu).

In addition to consideration, IFRS 3.32 | ASC 805-30-30-1 also specifies the purchase price should include noncontrolling (minority) interest (if any) and any previously held equity (if the acquisition was done in stages).

It also specifies liabilities should be deducted from assets before the calculation is made.

A "business" may be a company (legal entity, or group of consolidated or combined legal entities) but it may also be an operating unit, division or segment.

What is important is that it could be a viable company if it were a stand-alone company.

To make this point, IFRS 13.B5–B12D | ASC 805-10-55-3A to 6 and 805-10-55-8 and 9 stipulate what an acquisition must have in order to be a “business.”

As outlined in IFRS 3.3 | ASC 805-10-25-1, goodwill may only be recognized if the acquired entity is a business. Otherwise, the acquisition is treated as an asset acquisition.

In general, as outlined in IFRS 3.B7 | ASC 805-10-55-4, a business is an entity with 1. inputs, 2. processes and 3. outputs.

Put simply:

Inputs are suppliers, employees, machinery, equipment, furniture, fixtures, patents, copyrights, etc.

A process is the factory (or office) where the material, parts or services supplied by the suppliers are combined or transformed into products (consumed providing services) by the employees using the machinery, equipment, furniture, fixtures, patents, copyrights, etc.

Outputs are the product or services produced in the processes. These are then sold to customers, who can be external (unrelated companies) or internal (operating units, divisions, segments or other related entities).

While inputs and a process are essential elements of a business, "outputs are not required for an integrated set to qualify as a business" (IFRS 3.B7 | ASC 805-10-55-4).

"However, to be considered a business, the set must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create output" (IFRS 3.B8 | ASC 805-10-55-5).

This implies, if an acquired operating unit only produced goods for other operating units, whether or not it had actual outputs (goods sold to unrelated, third parties) is beside the point. Whether it is capable of having these outputs is the point.

Note: IFRS 3.7A to C outline a simplified "concentration test" to assess if the assets acquired/liabilities assumed constitute a business. ASC 805-10-55 does not outline a similar test.

Also note: while both IFRS (IFRS 3.IE73 to IE123) and US GAAP (ASC 805-10-55-51 to 96) include various illustrative examples of how to determine if a business is a business, they do not use the same examples.

Net assets = assets - liabilities. An illustration of how liabilities are treated is presented below.

Cash and shares

1/1/X1, XYZ acquired ABC for 5,000,000 in cash and issued shares with a market value of 5,000,000.

IFRS 3.33 | ASC 805-30-30-2 specifies that acquisition-date fair value should be used to measure consideration transferred.

If the consideration includes shares traded on a liquid market, fair value would equal their market price.

While the guidance does not explicitly require it to be used, IFRS 3.IE72 | ASC 805-10-55-42 suggests that this market price be the closing market price on the day the acquisition closes.

Note: while acquisition announcements generally cause significant swings in share price, by the time the acquisition closes, the market has priced in its impact, giving a fair representation of fair value.

The guidance does however specify that, if acquiree’s equity interests are more reliably measurable, their fair value should be used.

This would likely occur only if the acquiree’s shares were publicly traded while the acquirer’s was not.

In situations where one public company acquires another public company, applying this guidance means the market price of the more liquid shares (higher trading volumes) should be used.

1/1/X1 / 1.1.X1
Assets		9,000,000
Goodwill		1,000,000
	Cash		5,000,000
	Equity		5,000,000

As outlined in IFRS 3.37 | ASC 805-30-30-7, consideration comprises:

Cash
Other assets (including, for example, shares in companies other than the acquirer)
Contingent consideration
Common or preferred equity instruments
Options
Warrants
Member interests of mutual entities

IFRS 3 | ASC 805 defines continent consideration: Usually an obligation of the acquirer to transfer additional assets or equity interests to the former owners of an acquiree as part of the exchange for control of the acquiree if specified future events occur or conditions are met. However, contingent consideration also may give the acquirer the right to the return of previously transferred consideration if specified conditions are met.

Additional guidance is provided in IFRS 3.39 and 40 | ASC 805-30-25-5 to 7.

In the past, if shares instead of cash were used to fund the acquisition, goodwill was not recognized.

Under current guidance, it makes no difference if the acquirer paid with cash, its own shares, or a combination.

Options and warrants are similar in that they convey the right the purchase equity instruments.

They differ in that options are generally issued by an investor that holds the company’s shares, while warrants are issued by the company itself.

As a result, funding an acquisition with options does not create new equity for the acquirer.

Warrants and options and are similar in that they convey the right the purchase equity instruments.

They differ in that warrants are issued by the company itself, while options are generally issued by an investor that holds the company’s shares.

As a result, funding an acquisition with warrants creates new equity for the acquirer.

Note: consideration also includes liabilities incurred by the acquirer to former owners of the acquiree.

Also note: the fair value of noncontrolling interest and the acquirer's previously held equity interest (for business combinations achieved in stages) are also included.

Assumed liabilities

1/1/X1, XYZ acquired ABC for 5,000,000 in cash and assumed 5,000,000 liabilities.

1/1/X1 / 1.1.X1
Assets		9,000,000
Goodwill		1,000,000
	Cash		5,000,000
	Liabilities		5,000,000

Net asset = total assets - liabilities assumed.

In contrast to recognizing assets, identifying liabilities is rarely the task of accountants.

Instead, it is better left to experts who specialize in due diligence.

Identifying, recognizing and measuring previously unrecognized assets (previous illustration) is not (usually) particularly difficult.

In contrast, identifying liabilities, especially those the acquired company's management may have gone out of its way to not disclose, is better left to experts (such as former FBI agents who left the agency due to its strict retirement policies) skilled wielding instruments not generally found in any accountant’s toolbox.

Obviously, once all the potential liabilities have been identified, the accounting department is still responsible for their recognition, measurement and disclosure but, assuming the due diligence was performed rigorously, relying on it should be sufficient .

It is important to note that responsibility is jurisdictional.

In the United States, section 302 of the Sarbanes Oxley act specifies the CEO and CFO are responsible for the company’s financial reports.

Obviously, they can rely on additional individuals, for example a chief accountant or controller who certifies the company’s accounts are SOX compliant. However, to “pass down” SOX responsibility, the CEO and CFO must be sure they are relying on individuals with sufficient professional expertise to understand the repercussions of certifying the company’s SOX compliance.

This implies, even if a chief accountant did certify that the acquiring company has recognized, measured and disclosed all the acquired company's liabilities, unless his skill set includes forensic audit, it is unlikely this certification will be sufficient to absolve the CEO and CFO of their SOX responsibility.

In contrast, IFRS is applied in various jurisdictions with varying requirements.

For example, in some EU member states, if a company employs the services of a court certified valuer, the valuer, not company’s officers, bear the responsibility for the content of the valuer’s report.

In such a jurisdiction, if the court certified valuer’s report outlines the assets acquired and liabilities assumed in a business combination, this report, not the judgment of the company’s accounting department, serves as the basis for recognition and measurement of those assets and liabilities.

When IFRS it applied in such a jurisdiction, that jurisdiction's rules and regulations may determine how IFRS is applied.

In a real-world example, company A acquired company B. Company B was domiciled in a jurisdiction where the acquisition price needed to be certified by a court appointed valuer.

Company B then used this valuer’s report to draft an "IFRS compliant" financial report. This report was certified by a statutory auditor licensed to express its opinion in this jurisdiction because, from the perspective of that jurisdiction’s legislation, the report was consistent with IFRS.

In an attempt to save time and effort, company A simply took this IFRS report and, with no significant adjustments (and in the belief IFRS and US GAAP were comparable), recognized the assets and liabilities it included.

However, as company A's shares were listed on a US exchange, its financial report was then reviewed by a US certified public accountant.

Rather than accept a qualified auditor's report (and risk a possible SOX compliance review), company A discarded company B's IFRS report and spent the next three months creating a report consistent with US GAAP.

The result?

What had been originally been bargain purchase, was magically transformed into an acquisition with goodwill (not in the same amount).

While some of the difference was due to inadequately measured assets, most was caused by liabilities not fully captured in the original valuer’s report.

Bargain purchase

Negative goodwill (a.k.a. badwill) is the opposite of goodwill.

It would be calculated thusly:

Consideration transferred to the (previous) owners of the business

9,000,000

The fair value of business's net assets

(10,000,000)

Badwill

(1,000,000)

Negative goodwill may not be reported on the balance sheet. It is recognized as a gain in the P&L | income statement.

No illustration given.

While IFRS 3.34 to 36 | ASC 805-30-25-2 to 4 specify that a bargain purchase is possible, in practice it generally means the acquirer did not correctly measure the acquiree's assets and, much more likely, failed to identify and measure all the acquiree's liabilities, especially provisions and contingent liabilities.

For this reason, as outlined in IFRS 3.36 | ASC 805-30-25-4, before recognizing any bargain purchase gain, it is imperative the acquirer repeat due diligence (this time thoroughly).

As recognizing a bargain purchase gain is practically never justifiable no illustrate is provided.

The only time we have ever encountered a company that considered recognizing a bargain purchase, on further review, it was determined the company had simply misapplied the guidance.

Fortunately, the company corrected its error before a whistle was blown (also see link: sec.gov).

Impairment

Overall

No sense sugar coating, impairment is arduous and the most traumatic event an accountant will ever face.

Fair value can be the easiest or hardest to apply guidance (see: FV page), depending on what is being remeasured.

If it happens to be a cash-generating unit | asset (asset group), it is certainly the latter.

As specified in IAS 36, a cash-generating unit is the smallest identifiable group of assets that generates cash inflows and outflows.

If a single asset has its own identifiable cash flows, it qualifies as a CGU.

More commonly, however, CGUs are found at a higher organizational level for example, a production line (that manufactures discrete product) or a production facility. Regardless, it should never be larger than a segment.

As specified in ASC 360-10-20 an asset group is the lowest level for which identifiable cash flows are largely independent of the cash flows of other groups of assets and liabilities.

Occasionally, a single asset generates discrete identifiable cash inflows and outflows, in which case it is not included in an AG, but treated as a stand-along item.

More commonly, however, AGs are found at a higher organizational level for example, a production line (that manufactures discrete product sold to generate cash inflows) or an entire production facility. In any event, it should never be larger than a segment.

IFRS uses a higher of test where a CGU's (above) value-in-use is compared to its fair value less cost of disposal.

US GAAP uses two-step test where the first step involves comparing undiscounted sum of cash flows of an A/AG (above) to its net book value.

However, as VIU involves first estimating future cash flows, both tests are comparably difficult.

Note: IAS 36 allows entities to skip VIU and start withFVLCOD. but, since going to FVLCOD is like going directly to jail, not passing Go and not collecting $200, it is practically never first.

Fortunately, IFRS | US GAAP does not jump straight to fair value. Instead, it tests the item for impairment first.

Be that as it may, since an impairment test (above) involves clairvoyantly forecasting events stretching five of more years, most accountants would rather have their wisdom teeth removed sans anesthetic than perform that test.

For example, imagine being the accountant that has to inform the CEO that, of the 11.7 billion he paid for an acquisition, 8.8 billion has to be written off.

When an investor reads the word impairment on a financial report what does he or she think?

First they consider that management had, at one time, financial resources it could have decided to allocate effectively.

For example, the company could have paid out dividends. What investor does not like dividends? True, not the most tax efficient way to distribute capital. But stock buybacks work too.

Or it could have invested in future profitability and spent the money on R&D. It could have also spent some cash on sales or marketing to make sure its goods or services keep selling. Maybe it could have bought some useful plant or equipment. True, having Foxconn or TSMC actually make its products would generate higher profits, but the long-term risks sometimes outweigh the short-term benefits.

But no. The company did none of these things.

It overpaid for some assets so it took that money and 🚽.

As investors prefer management to not flush their money down the 🚽, impairment charges often precipitate corporate restructurings (taking the old, expensive and incompetent management and 🚽), something Léo Apotheker learned the hard way after wasting 8.8 billion on goodwill.

Goodwill is not a building. Goodwill is not a machine. Goodwill is not equipment. Goodwill is not a patent. Goodwill is not a copyright. Goodwill is certainly not a stock, note or bond.

Truth be told, goodwill is not anything.

Goodwill is just a plug.

True, the literature says goodwill is a measure of immeasurable items such as assembled workforce, a good reputation, the synergies combined operations will bring.

Yada. Yada. Yada.

Mathematically, goodwill is just a plug.

From a more cynical perspective, goodwill is a vanity cost.

It is the exact amount a CEO decided to overpay for a company that he or she really, really, really wanted regardless of what I, as the ever-diligent accountant, demonstrated it was actually worth.

Now that I have gotten this rant off my chest, let’s return to our regularly scheduled program.

That being said, goodwill is special. So goodwill has special needs.

In a nutshell, goodwill is not tested alone. Goodwill is tested together with the group of cash-generating units | reporting unit to which it was assigned when it was created. Any impairment is then applied to the goodwill first.

Note: while IFRS and US GAAP agree on what to do with goodwill (irrevocably write it off), they differ on what to do after that. IFRS simply allocates any residual to the individuals CGUs on a pro-rata basis. US GAAP tests each A/AG to see which one is (ones are) also impaired and needs to be written down.

Now, imagine yourself as the accountant who has to tell boss that you will need to report an impairment charge in the next financial report.

Most likely, the first thing that will flash through his or her mind is, "Do I really need such a pesky accountant?" Would it not be better to 🚽?

Note: you may think I jest. However, when I was involved in an impairment (I was hired as a methodology consultant), at first management resisted. Finally, the auditor threatened to withdraw (and, obviously, inform the regulator of the reason for the withdrawal) so management acquiesced. The result? The company was restructured and management team replaced as commonly happens in these situations. What made this particular situation somewhat unusual, the accountant that first brought the issue to the auditor’s attention was rehired as the company's new CAO.

This story always reminds me the anecdote that the Chinese symbol for "crisis" is composed of the characters for "danger" and "opportunity."

BTW, Google seems to think JFK was not much of a linguist and that while 危机 does include 危, 机 actually means "incipient moment" or "crucial point," not "opportunity."

Be that as it may, since I'm not much of a linguist either, I don’t think any good crisis should go to waste, particularly if a restructuring leaves a chair higher up the food chain looking for a new butt.

But, for something like that to happen, I would need to approach the issue rationally (below).

IFRS and US GAAP guidance appears very different, but is actually comparable.

At first glance, IFRS and US GAAP appear very different.

IFRS uses a higher of test that compares a GCU's CA to max(FVLCOD RA, VIU RA).

As outlined in IAS 36, an entity tests a cash-generating unit for recoverability by comparing its carrying amount with its recoverable amount.

As specified in IAS 36, the item to be tested for impairment is the CGU. A CGU is defined as the lowest operational level where it is possible to identify cash inflows and cash outflows.

Thus, the guidance is applicable to both groups of assets as well as individual assets, provided the individual assets have their own identifiable cash flows.

Interestingly, IAS 36.10.a specifies that intangible assets with indefinite lives are to be tested for impairment (at minimum once per annum) even if they do not generate any cash flows and thus are not CGUs ¯\_(ツ)_/¯

For example, an entity acquires a customer list it intends to use for a product still under development. Or, the list could be to market a current product. Or, the list could be a current product that will continue to be sold, in various versions and updates, for the foreseeable future. Or, it could be for a variety of products that will continue to be sold for as long as the company continues to do business.

It makes no difference that the item generates no identifiable cash flow. It is intangible. It has an indefinite life. It must be tested for impairment. At least once every year.

Hopefully, when the end of its life does eventually come, the list will still be sellable (assuming it was looked after properly), for at least as much as it cost. Otherwise, it would need to be impaired.

Note: IAS is occasionally interpreted to mean that revenue and expenses are considered. This is not correct. IAS 36 focuses on cash flow, and only cash flow.

The previously capitalized cost of the item after accumulated depreciation.

RA is defined as the higher of the CGU's fair value less cost of disposal and value-in-use.

Fair value may be, as outlined in IFRS 13, determined using a market, cost or income approach as discussed in more detail on this link.

However, given that cash flows must be estimated to determine value-in-use, the income approach is the preferable way to determine fair value. If this approach yields inadequate results, the market approach utilizing level 2.b inputs (e.g. prices at auction for comparable items) comes in second. Finally, as it is the most operationally challenging and (since it requires adjusting replacement cost to reflect, for example, obsolescence or wear and tear) practically as subjective as the income approach, the cost approach is used only as a last resort.

VIU is determined by estimating future cash flows, most commonly on the basis of internally generated sales forecasts, budgets or similar information. The cash flows are then weighted for probability and discounted using a risk free rate (if the weighting also reflects systemic risk) or a risk free rate adjusted for systemic risk.

The procedure is identical to the procedure used in determining fair value using an income approach and level 3 inputs. However, as the fair value estimate must reflect the perspective of a market participant the result may be, as discussed further down on this page, significantly different.

If CA > RA, the CGU is impaired and written down to the higher of FVLCOD or VIU.

US GAAP uses a two-step test that first compares the A/AG's CA to its RA (ΣCF), then to its FV.

As outlined in ASC 360-10-35-17, an entity tests an asset (asset group) for recoverability by comparing its carrying amount (net book value) with its recoverable amount.

An asset group is defined as: the unit of accounting for a long-lived asset or assets to be held and used, which represents the lowest level for which identifiable cash flows are largely independent of the cash flows of other groups of assets and liabilities.

Thus, the guidance is applicable to both groups of assets as well as individual assets, provided the individual assets have their own identifiable cash flows.

Interestingly, ASC 350-30-05-4 specifies that intangible assets with indefinite lives are to be tested for impairment (at minimum once per annum). This requirement applies even if they do not generate any identifiable cash flows and thus do not meet the definition of are not asset or asset group ¯\_(ツ)_/¯

For example, an entity acquires a customer list it intends to use for a product still under development. Or, the list could be to market a current product. Or, the list could be a current product that will that will continue to be sold, in various versions and updates, for the foreseeable future. Or, it could be for a variety of products that will continue to be sold for as long as the company continues to do business.

It makes no difference that the item generates no identifiable cash flow. It is intangible. It has an indefinite life. It must be tested for impairment. At least one every year.

However, even if the asset (asset group) fails the first step of the test, it will not be impaired unless its carrying amount exceeds its fair value.

Costs of disposal are also deducted but only if the entity intends to dispose of the asset or group (ASC 360-10-35-38).

The previously capitalized cost of the item after accumulated depreciation.

RA is the sum of the undiscounted cash flows expected to result from the use and eventual disposal of the A/AG.

If CA > RA, the A/AG's CA is not recoverable so it fails the test. However, ASC 360-10-35-17 (edited) also states: an impairment loss shall be measured as the amount by which the carrying amount of a long-lived asset (asset group) exceeds its fair value. Thus, the A/AG's CA (which is not recoverable because CA > ΣCF) is compared to fair value. Only if CA > FV is the A/AG impaired and written down to FV.

This procedure, colloquially known as the two-step test, is supposedly easier to apply than IFRS's (also colloquially known as) higher of test (above).

The most challenging aspect of evaluating an item is estimating the expected future cash flows the item will (probably) generate over the reminder of its useful life. Once this is complete, determine fair value can be as simple as (assuming the income approach and level 3 inputs, which is a safe assumption considering all the effort that went into estimating the cash flows) dividing those cash flows by (1+i)ⁿ, where the i does not even need to be estimated, but can be the risk free rate.

So, by requiring a test that first compares ΣCF to CA, US GAAP does nothing lessen an accountant’s workload.

It does, however, result in (marginally) fewer impairments (compared to IFRS), which appears to be the FASB's way of throwing a bone to one key stakeholder group: the corporate executives that hate impairments more than practically anything else.

However, as both approach fair value in the same way, these differences disappear in practice.

The key issue, IFRS 13 and ASC 820 are converged standards which provide virtually identical guidance on determining fair value each, for example, allowing fair value to be determined using an income approach and level 3 inputs.

But wait, says the attentive reader. IFRS also considers value-in-use, not just fair value.

True, but calculating VIU involves: 1. estimating expected future cash flows, which may be estimated on the basis of management forecasts or sales projections. 2. adjusting those cash flows for probability (a.k.a. risk). 3. discounting those risk-adjusted cash flows to present value using a risk-free rate or risk free rate adjusted for systemic risk if applicable.

Calculating fair value using the income approach and level 3 inputs involves: 1. estimating expected future cash flows, which may be estimated on the basis of management forecasts or sales projections. 2. adjusting those cash flows for probability (a.k.a. risk). 3. discounting those risk-adjusted cash flows to present value using a risk-free rate (method 1) or risk free rate adjusted for systemic risk (method 2).

See the difference?

Well, there is one.

VIU is based on projections utilizing reasonable and supportable assumptions that represent management's best estimate of the range of economic conditions that will exist with greater weight given to external evidence.

FV-IA-L3 is based on projections utilizing reasonable and supportable assumptions that represent management’s best estimate of the range of economic conditions that will exist to reflect the perspective of a market participant that holds the asset.

Is there a difference between giving greater weight to external evidence and reflecting the perspective of a market participant?

Hard to say, but certainly more likely than not (more on this below).

True, IFRS compares fair value less cost of disposal to value-in-use, while US GAAP only considers fair value.

But, invariably, FVLCD > VIU, so it makes no practical difference.

Why is fair value always higher than value-in-use?

As with practically every generalization, exceptions exist.

Except for the generalization that recognizing an impairment is always a thankless task.

This generalization is always true.

For example, one impairment test trigger a significant decline in a CGU's value.

Assuming the entity is using the CGU effectively, its VIU will most likely be higher than its FVLCD.

Not that it would make any difference. In the real world, no one ever devotes the time and effort necessary to check the current market prices of the, for example, 500 machines comprising a production line again and again at the end of each period just to fulfill a criterion that was evidently added to the guidance by a board member considering the issue academically rather than practically.

Interestingly, a significant decrease in the market price of a long-lived asset (asset group) is only a triggering event in ASC 360-10-35-21.a. IAS 36.12.a does discuss an observable indication that the asset’s value has declined during the period significantly more than would be expected as a result of the passage of time or normal use but does not explicitly require assessing market prices.

Similarly, if an entity reassesses the useful life of an asset from finite to indefinite (and vice versa in US GAAP), it does not necessarily mean the asset is impaired.

And so on.

VIU reflects how the entity is currently using the cash-generating unit. Since it is having to test it for impairment, evidently, not particularly well.

As noted above, most generalizations have exceptions.

For example, if an impairment test is triggered by a decline in an item's market price, or a reassessment of its useful life, or a change in discount rates, or even a technological, market, economic, legal regulatory or other adverse external change, the result could be that the continued use of the cash-generating unit would generate more cash than selling it off in pieces.

But, this is not the real point.

The point is, if, in a US GAAP context, fair value were determined using an income approach and level 3 inputs, it could easily reflect a market participant’s view that includes considering the synergies a particular company brings to the asset group and thus yield a higher fair value than if the group were broken up and sold off in pieces.

But, be that as it may, when a cash-generating unit or asset group actually does become impaired, a value that reflects its best possible alternative use is always higher than a value that reflects its current use.

This generalization is always true.

Specifically, VIU is determined using a present value technique reflecting management's best estimate giving more weight to external evidence. But giving weight to external evidence does nothing to change the fact that CGU will continue to be used in the same, evidently crappy, way it has been.

Fair value, regardless of approach, reflects the view a market participant would take in evaluating the CGU. Presumably, this view does not reflect the cash the CGU will generate if used by the entity currently using it, but how much cash it would bring if bought by some other entity and used (as a whole or chopped up into parts) in the most effective manner possible.

This is true if fair value is determined using an income approach and level 3 inputs on the basis of management’s best estimate, since it must still must reflect the view of a market participant evaluating the CGU. It is true if fair value is determined using the cost approach and level 2.b inputs since replacement cost (even when adjusted for wear and tear and obsolescence) also reflects the external value of the CGU. It is certainly true if fair value is determined using the market approach and level 2.b inputs since, for example, the prices of comparable items bring at auction absolutely reflects their actual, intrinsic value.

The point is, since fair value reflects an items best possible alternative use, even if the accountant doing the measurement was half asleep, fair value will still be higher than value-in-use even after, for example, auction fees were deducted.

The only minor difference, since IAS 36 always assumes FVLCOD while US GAAP only considers disposal costs if the entity plans to dispose (ASC 360-10-35-38), the impairment charge, unless no disposal costs are expected to be incurred, will be (marginally) higher for a retained CGU not measured at VIU.

On the other hand, since IFRS allows impairment charges to be reversed (except for goodwill), entities do not generally object to the slightly larger hit to reported earnings.

Similarly, while not identical, the what and when to test are also very close.

In IFRS, the item tested for impairment is the cash-generating unit (CGU). In US GAAP, it is the asset group (AG). However, both IFRS and US GAAP define the CGU | AG as the lowest organization level where net cash flow may be determined (IAS 36.6 | ASC 360-10-35-23). Both also have similar guidance for when otherwise separable CGUs | AGs may be combined.

Otherwise separatable CGUs | AGs may be combined only if economically inseparable. For example, the disposal or elimination of a lossmaking CGU | AG would lead to the loss of a profit generating CGU | AG or CGUs | AGs.

The best example is provided by IAS 36.68 which, if summarized, would be: an entity provides public transit in three cities. As each city generates discrete inflows and outflows, the CGUs | AGs are city A, city B and city C.

Cities A and B pass the impairment test but city C fails. City C is impaired. However, it the results of cities A, B and C are summed, the aggregate ABC would pass the test. The impairment is still recognized and allocated to city C.

However, if the entity had entered into a contract with the county requiring a minimum level of service to A, B and C and curtailing or eliminating C would cause a loss of A and B, then the CGU | AG is ABC.

The guidance in ASC 360-10-35-23 leads to the same result even if the ASC does not include a similarly colorful example.

When it comes to goodwill, under IFRS it is tested at the group of CGU level while under US GAAP at the reporting unit (RU) level. However, as goodwill must be assigned to the group of CGUs | RU when it is first recognized (IAS 36.80 | ASC 350-20-35-41), the only palpable difference, IFRS does not explicitly define what a group of CGUs comprises while US GAAP does define the RU.

While explained in some detail (ASC 350-20-35-33 to 38), a reporting unit is simply a segment's segment.

Specifically, it has all the exigent features of a segment except rather than reporting the entity's chief decision maker it reports to a segment's chief decision maker.

However, not all entities have RUs. In this case, the segment is treated as an RU for goodwill testing and impairment purposes.

IAS 36.80.b provides comparable guidance specifying that a group of CGUs cannot be larger than a segment.

IAS 36.100 to 103 also acknowledge that some components of an entity (such as a corporate headwaters or joint service center) cannot be evaluated for impairment since they have no identify separate from the entity so cannot be identifiable CGUs (ASC 360-10-35-24 and 25, while not nearly as detailed, reach the same conclusion).

Somewhat less logically, IAS 36.10.a also specifies that an intangible asset with an indefinite life is to be tested for impairment (at minimum once per annum). This requirement applies even if it does not generate any identifiable cash flows and thus do not meet the definition of cash-generating unit. Fortunately, ASC 350-30-05-4 provides comparable guidance so the appraoch under US GAAP is the same.

Other than for some intangible assets, an impairment test is performed if (IAS 36.9 to 17 | 360-10-35-21):

As outlined in IAS 36.10.a, an intangible assets with indefinite useful lives is tested for impairment at least annually. It may be tested at any time during the year, provided the test is performed regularly (e.g. the first week in August). Different intangible assets may also be tested at different times (though this is rarely done). IAS 36.96 provides equivalent guidance for goodwill..

ASC 350-20-35-28 likewise specifies an annual impairment test for goodwill and also allows it to be performed at any time provided it is performed regularly. Likewise ASC 350-30-35-18 requires annual testing of intangible assets with unlimited lives, but does not discuss timing. In practice, most entities test all their intangible assets, including goodwill, at the same time unless there is a pressing need to apply the guidance differently.

An items market value has significantly (unexpected) declined.
A significant adverse external change (technological, market, economic, legal, regulatory, etc.) has occurred.
A significant adverse internal change to the item (obsolescence, physical damage, etc.).
A significant change in company’s operations (i.e. asset idling, disposal, restructuring, etc.) has occurred.
The return on the item is below budget, cash flow below expectations, current period losses projected.
The item's useful life is reassessed as finite rather than indefinite (or vice versa).

ASC 350-30-35-10: An intangible asset that initially is deemed to have a finite useful life shall cease being amortized if it is subsequently determined to have an indefinite useful life, for example, due to a change in legal requirements. If an intangible asset that is being amortized is subsequently determined to have an indefinite useful life, the asset shall be tested for impairment in accordance with paragraphs 350-30-35-18 through 35-20.

ASC 350-30-35-17: If an intangible asset that is not being amortized is subsequently determined to have a finite useful life, the asset shall be tested for impairment in accordance with paragraphs 350-30-35-18 through 35-19. That intangible asset shall then be amortized prospectively over its estimated remaining useful life and accounted for in the same manner as other intangible assets that are subject to amortization.

Cost of acquiring the asset has risen significantly above budget (US GAAP only)

Carrying amount of the net assets of the entity is more than its market capitalization (IFRS only)

A significant increase in the market rates used to calculate the asset’s value-in-use (IFRS only)

In addition, intangible assets with an indefinite useful life (IAS 36.10.a | ASC 350-30-35-18) and goodwill (IAS 36.10.b | ASC 350-20-05-4A) are tested (assessed) annually.

ASC 350-30-35-18A and ASC 350-20-35-3A allow an annual assessment (a.k.a. step zero when applied to goodwill) to see if a full test is necessary. However, a full annual test is not disallowed.

IAS 36 does not include the same option, so an annual test is necessary under IFRS.

On the other hand, IAS 36.89 outlines that an intangible assets with an indefinite life may be tested as part o CGUs (provided the CGUs are tested annually). Under ASC 350-30-35-18 intangible assets with an indefinite life are assessed or tested separately.

An assessment of whether any of the above circumstances has occurred shall be performed annually. However, a test shall be performed immediately if one of these circumstances occurred during the period.

Note: the assessment may be performed at any time during the period, provided it is performed regularly. It need not be performed as at the end of the fiscal year.

While the guidance may be comparable, the way companies apply it is not.

Impairment under IFRS (usually) and US GAAP is measured by reference to fair value.

IAS 36 specifies (in various paragraphs) that recoverable amount is the higher of fair value less cost to dispose and value-in-use.

RA is practically always FVLCD because FVLCD is practically always higher than VIU.

Because IAS 36 specifies that an impairment loss is the amount by which the carrying amount (CA) of an asset or a cash-generating unit (CGU) exceeds its recoverable amount (RA), where RA is the higher of the CGU's fair value less costs of disposal (FVLCOD) and value-in-use (VIU), most entities begin with VIU. This not only is because VIU is determined using internal data, making it somewhat easier to calculate, but also because, in most situations, FVLCOD > VIU. Thus, if the CGU passes VIU > CA, there is no need for FVLCOD > CA. If it fails, for a little extra effort, FVLCOD usually makes the hit to earnings smaller and more palatable.

IAS 36 discusses value-in-use which is estimated by evaluating estimated future net cash inflows adjusted for probability and discounted using a risk-adjusted discount rate (provided systemic risk is included in the cash flow probabilities, which is generally the case).

IFRS 13 outlines three approaches to fair value: market, cost and income.

Back to front, the income approach is estimated by evaluating estimated future net cash inflows adjusted for probability and discounted using a risk-adjusted discount rate (provided systemic risk is included in the cash flow probabilities, which is generally the case).

The difference between VIU and FV-IA? As explained in IAS 36.33.a, the inputs (a.k.a. cash flow projections) reflect reasonable and supportable assumptions representing management’s best estimate of expected range of economic conditions giving greater weight to external evidence. In contrast, as explained in IFRS 13.89 entity shall develop unobservable inputs using the best information available in the circumstances, which might include its own data (presumably compiled by management). The entity may thus begin with its own data, but it would then adjust it if reasonably available information indicates that other market participants would use different data or there is something particular to the entity that is not available to other market participants (e.g. an entity-specific synergy). It need not, however, undertake exhaustive efforts to obtain information about market participant assumptions.

So what is the difference to giving greater weight to external evidence and adjusting data if other market participants would use different data?

Since VIU reflects how the entity will use the CGU, while FV-IA-L3 reflects a market participants view, presumably the view that some other entity could use the CGU more effectively, it is practically always the case that FV-IA-L3 > VIU.

The only problem, since FV-IA-L3 might include an entity's own data (presumably compiled by its management) and since management is often motivated to compile data that will minimize impairment charges, if FV-IA-L3 is significantly higher than VIU, auditors will likely be skeptical and extra diligent in evaluating of the data actually reflects market participant view.

Consequently, in practice, the differences between VIU and FV-IA-L3 tend to be relatively small.

however, IFRS 13 also allows an entity to use both the market and cost approaches as the inputs into both these apr4aoches will be the same (level 2.b. prices for similar items bought or sold on markets that are not active) they are objectively verifiable so not open to auditor scrutiny, merely double checking.

But, as a rule they will still reflect the best possible alternative use rather than (as does VIU, the entity' own, presumably crappy, use.

Note: when using the cost approach, adjusting the values for wear, tear, obsolescence, etc. is necessary but these adjustments are still more readily verifiable than management’s cash flow projections. This also implies, using the market approach (considering data such as recent prices at auction) is commonly the most effortless way to determine FVLCOD.

Why?

VIU reflects how the entity doing the testing is currently using the cash-generating unit. Since it is having to test for impairment, presumably, it is not using it particularly well.

As with practically every generalization, exceptions exist.

Except for the generalization that recognizing an impairment is always a thankless task.

This generalization is always true.

For example, one impairment test trigger a significant decline in a CGU's value.

Assuming the entity is using the CGU effectively, its VIU will most likely be higher than its FVLCD.

Similarly, if an entity reassesses the useful life of an asset from finite to indefinite (and vice versa in US GAAP), it does not necessarily mean the asset is impaired.

And so on.

However, fair value may be determined using any one of three approaches: market, cost and income. These approaches may even be combined, particularly when measuring something as complex as a group of cash-generating units | reporting unit. While entities should choose the approached yielding the most accurate result, the IFRS 13 | ASC 820 gives practitioners a surprising degree of flexibility when it comes to selecting the actual methodology.

For example, entity A elects to measure the fair value a production line using the market approach and level 2.b inputs. Entity B (a direct competitor) uses the cost approach and level 2.b inputs to measure its production line for its competing product. Entity C (another competitor) combines the income and cost approaches. Entity D (a third competitor) deems the income approach and level 3 inputs most appropriate.

A ≠ B ≠ C ≠ D even though the item being impaired is practically the same.

But, the difference is not caused by the guidance but by IFRS and US GAAP each allowing an entity to tailor its approach to its situation like a suit from Savile Row or, for the hip and cool, Quadrilatero della Moda.

However, A, B, C and D did use the same appraoch, A ≈ B ≈ C ≈ D or perhaps A ≅ B ≅ C ≅ D.

In the academically perfect world, A = B = C = D. In the real world, no two entities will ever get an identical result. If they did, it would appear just as suspicious as if the result was 1,500,000 not 1,512,284.41.

Even if the results were mathematically identical, highly unlikely but theoretically possible, entities are encouraged to avoid boiler plate disclosures, so each would should write its disclosure in its own style, so the best one can should hope for is congruency.

More broadly, this is the drawback of principles based accounting. On the one hand, allowing practitioners to apply professional judgment allows them to pick the approach that, in their judgment, leads to the optimal result. On the other, since practitioners usually apply their judgment independently, there is no guarantee two practitioners at two entities facing a comparable problem will use a comparable approach leading to a comparable solution.

This divergence in practice is somewhat mitigated by the auditor where the four largest firms tend to approach similar problems in a similar fashion. However, the inherent flexibility of the guidance makes it practically impossible for an auditor to disagree with an approach fully consistent with the guidance as written simply because it yields a different that another fully consistent approach applied by a different practitioner.

Also, marginally more entities report impairments under IFRS than under US GAAP.

Unlike the IFRS higher of test, the US GAAP two step test has somewhat heavier trigger pull, particularly if the expected life of the asset group being tested is long.

Technically, IAS 36 does not outline a "test" per se. Instead, it specifies that a cash-generating unit is impaired if its carrying amount exceeds its recoverable amount. But, since RA is defined as the higher of value-in-use and fair value less cost of disposal, entities will invariably try VIU first (above). Only if VIU results in an impairment, will they try fair value, which usually results in a smaller charge.

ASC 360-10-35-17 outline two steps. In the first step (to see if an asset's (or group's) carrying amount is recoverable) the CA is compared to the undiscounted sum of cash flows. If ΣCF > CA, the CA is recoverable and the asset (group) is not impaired. If ΣCF < CA, the CA is then compared to fair value. Only if FV < CA, is the asset (group) impaired and written down to FV.

Since ΣCF (above) is invariably higher than Σ$ \frac{CF}{(1+i)^n} $ (above), the same company could pass US GAAP, but fail IFRS.

As a result, relatively fewer companies record impairments under US GAAP than IFRS.

Note: this observation is based on our client base which is not a representative sample. Nevertheless, the same propensity has be implicitly observed in various studies including: link, link, link.

Cash-generating unit | asset (group)

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Intangible asset with indefinite life

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Goodwill

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