Auditing a client's impairment review
The evidence an auditor needs for a client's impairment review: when one is required, recoverable amount, value-in-use cash flows and carrying amounts.
By Achekam · · 5 min read · For Accountants & audit firms in South Africa, Nigeria, Kenya
An impairment review is management telling you what its assets are worth based on what it expects to happen next. The forecast that supports it was usually prepared by the same people whose results would suffer from a write-down. Little in the review can be vouched to an invoice, and the outcome often turns on a growth rate or a discount rate that could reasonably be a little higher or lower.
That makes it one of the areas where audit evidence is hardest to pin down, and one where reviewers and regulators look closely. This article covers what evidence the auditor should obtain for an impairment review and a value-in-use calculation, and how to keep the challenge proportionate on smaller audits.
When an impairment review is needed
The IFRS Foundation states the core principle of IAS 36: an asset must not be carried in the financial statements at more than the highest amount to be recovered through its use or sale. If the carrying amount exceeds the recoverable amount, the asset is impaired, and the carrying amount is reduced to the recoverable amount with an impairment loss recognised.
Some assets need a recoverable amount every year. Under IAS 36, that applies to intangible assets with indefinite useful lives, intangible assets not yet available for use, and goodwill acquired in a business combination. For other assets, the recoverable amount is assessed only when there is an indication that the asset may be impaired.
So the first audit question is whether the client has correctly identified when a review is needed. Look for indications the client may have overlooked:
- assets idle, damaged or due to be replaced;
- a business unit making losses or below budget;
- a market that has turned, such as falling prices for the client's products;
- net assets above the business's market value, where one is available.
If an indication exists and no review was done, that is a finding before any calculation is tested.
Recoverable amount: the higher of two measures
Under IAS 36, recoverable amount is the higher of fair value less costs to sell and value in use. The IFRS Foundation describes value in use as the expected future cash flows the asset will produce in its current condition, discounted to present value at an appropriate rate.
It is worth knowing that the IFRS Foundation's summary uses "fair value less costs to sell", while its history refers to disclosures where recoverable amount is based on "fair value less costs of disposal". The client's policy and disclosures should use the terminology of the version of the standard that applies.
Because recoverable amount is the higher of the two, a client only needs one measure above carrying amount to avoid an impairment. If the client relies on fair value, test that; if it relies on value in use, test that. The auditor does not need to audit both if one is clearly sufficient.
Value in use against budgets and actual results
ACCA's article on examining evidence gives, as evidence for an impairment review based on value in use, a value-in-use calculation annotated to show that the cash flows have been compared with budgets and with actual cash flows to judge whether they are reasonable.
That annotation is the heart of the work. For each significant input:
- Cash flow forecasts. Agree to board-approved budgets. Then compare last year's budget with what actually happened. A client that missed its budget by a wide margin last year needs a strong reason to expect this year's to be met.
- Growth beyond the budget period. Compare with the business's own history and with the economic outlook for its market.
- Asset condition. Value in use reflects the asset in its current condition, so forecasts should not include cash flows from future improvements or expansions not yet undertaken.
- Discount rate. Understand how it was derived and whether it reflects the risks of the cash flows.
- Sensitivity. Ask how much each key input would have to change to remove the headroom. If a small change does it, disclosure and scepticism both need to rise.
Carrying amounts agreed to the asset register
ACCA also lists a schedule comparing carrying value with recoverable amount, with carrying value agreed to the non-current asset register. It sounds basic and is often missed. The carrying amount in the review must:
- agree to the asset register and the trial balance;
- include all the assets in the cash-generating unit, including allocated goodwill;
- be at the same date as the review.
A review that compares a correct recoverable amount with the wrong carrying amount proves nothing. See auditing property, plant and equipment for the register work.
Recording the work and any adjustment in Achekam
Each work item in Achekam lists the procedures to perform and the documents required. A step is marked done only with a written response and its documents, or set aside with a reason, and steps are never deleted. For an impairment review, that means the comparison of forecasts with budgets, the actual results check and the sensitivity analysis each need a written response and their supporting files before they count as done.
The asset and goodwill lines in the lead schedules are built from the engagement's trial balance with each figure traceable to its lines. If the team concludes an impairment is needed or is overstated, staff record an audit adjustment on the line with a reason, and raise a finding from the working paper that is later closed or withdrawn.
Scepticism about forecasts
The IAASB states that ISA 540 (Revised) fosters a more independent and challenging sceptical mindset in auditors when auditing accounting estimates. Impairment reviews are where that mindset earns its keep. Signs that need more challenge:
- forecasts that show a sharp recovery from the current year with no specific cause;
- a discount rate lower than last year without a clear reason;
- assumptions that differ from those used elsewhere, for example in going concern forecasts or bank covenant projections;
- headroom that is consistently just enough, year after year.
Our guide to auditing accounting estimates covers the general approach, including evaluating management's point estimate and range.
ACCA's technical article on examining evidence sets out the evidence expected for impairment reviews and other judgemental areas, and is a good reference for structuring the working paper.
At planning on your next audit with goodwill or a loss-making unit, ask for last year's budget alongside this year's forecast. The comparison is the quickest evidence of how much weight the forecast can bear.
General guidance only, not advice on your own circumstances. Tax and payroll rules change: check the current position with the authority or your adviser.
