TL;DR:

IAS 36 impairment testing reveals whether your assets are genuinely worth what you’ve recorded. In this complete guide, you’ll discover when testing’s mandatory, how to choose between fair value and value-in-use calculations, and why cash-generating unit boundaries matter more than you think. Real EUR examples show the math behind loss recognition, while practical checklists and common pitfalls keep you audit-ready. Stop guessing about impairment and start testing with confidence.

IAS 36 Impairment Testing: Complete Step-by-Step Guide

INTRODUCTION

Imagine discovering that your company’s assets are worth significantly less than what’s shown on the balance sheet. You’re not alone—this gap happens more often than you’d think, and it’s exactly why IAS 36 impairment testing exists.

Your organization reports assets at specific values each year. But markets change, technology advances, and business conditions shift. That’s where IAS 36 impairment testing comes in. It’s the process that ensures your assets aren’t overstated on financial statements.

If you’re an accountant, finance manager, or business leader responsible for financial accuracy, understanding IAS 36 is non-negotiable. This guide walks you through everything from identifying when testing’s needed to calculating losses and reporting them properly. You’ll learn the practical steps that professionals use, see real numeric examples, and discover where companies typically stumble.

Let’s dig into what makes IAS 36 work and how to implement it correctly.

IAS 36 Impairment Testing Explained Simply

What Is Asset Impairment Under IAS 36?

Asset impairment happens when the carrying amount of an asset exceeds what you can actually recover from it. In simpler terms, your balance sheet shows the asset’s worth at one value, but its real market value is lower.

IAS 36 is the International Financial Reporting Standard (IFRS) that governs how companies identify, measure, and report these situations. It applies to property, plant, equipment, goodwill, and intangible assets—but excludes inventories, deferred tax assets, and financial assets.

Why Impairment Testing Matters in Financial Reporting

Accurate financial reporting depends on reliable asset values. Stakeholders—investors, lenders, regulators—rely on your balance sheet to make decisions. If assets are overstated, you’re painting a false picture of company health.

According to the Financial Reporting Council (FRC), for the third consecutive year (up to 2024/25), impairment was the issue most frequently raised with companies. This shows how critical proper testing is to maintaining credibility and compliance.

When Does IAS 36 Require Impairment Testing?

The rule is straightforward: test when indicators suggest impairment might exist. But there’s one exception—goodwill and indefinite-life intangibles require annual testing regardless of indicators.

External Indicators of Impairment

These come from outside your organization and signal that conditions have changed:

Market value declines: Observable drop in the asset’s market price or fair value of similar assets. If comparable properties or equipment sell for less, your asset might be worth less too.

Technological obsolescence: New technology makes current assets outdated. Think older manufacturing equipment when automation becomes standard.

Legal or regulatory changes: New regulations increase compliance costs or restrict asset use. Environmental rules might limit operations or require expensive modifications.

Economic downturns: Broader economic slowdown affects demand and profitability. Rising interest rates increase financing costs and reduce future cash flow values.

Interest rate increases: Higher discount rates reduce present value of future cash flows, directly impacting asset values.

Internal Indicators of Impairment

These originate within your organization:

Physical damage: Asset deterioration, obsolescence, or partial disposal reduces its ability to generate cash.

Asset underperformance: The asset generates less cash than expected, signaling its economic benefits are diminishing.

Corporate restructuring: Plans to discontinue operations, consolidate divisions, or sell assets signal reduced future benefits.

Management decisions: Your team decides to exit a market, close a facility, or stop using an asset as intended.

Worse-than-expected performance: Actual results consistently fall short of projections, indicating overestimation of future benefits.

How to Calculate Recoverable Amount

The recoverable amount is the higher of two values: fair value less costs of disposal (FVLCD) or value in use (VIU). Whichever is higher becomes your benchmark for comparison.

Fair Value Less Costs of Disposal

FVLCD starts with the asset’s fair value—the price you’d receive selling it in an arm’s-length transaction. Fair value comes from three sources:

Observable market prices: The best option. If similar assets trade regularly, use those market data points directly.

Comparable transactions: Recent sales of similar assets provide reliable pricing benchmarks.

Market-based inputs: If direct markets are thin, use pricing models based on comparable market data.

Then subtract direct costs to sell. These include commissions, legal fees, and removal costs—but not financing or restructuring costs.

Value in Use Explained

Value in use (VIU) takes a different approach. It’s based on the cash flows the asset will generate over its remaining useful life, discounted back to present value.

Why? Because the asset’s real worth depends on the cash it produces, not just market prices. A specialized piece of equipment might have low resale value but high VIU because it generates valuable production.

Estimating Future Cash Flows

Your cash flow projections should be realistic and defensible. Here’s what to include:

Use management-approved budgets: Start with your formal planning documents, not optimistic best-case scenarios.

Project 5 years typically: Most companies forecast five years of specific cash flows, then estimate a terminal value for remaining life.

Include working capital changes: Account for changes in receivables, inventory, and payables—these affect actual cash available.

Exclude financing cash flows: Don’t include loan repayment or interest; those belong on the financing side of your statement.

Exclude restructuring cash flows: Until you’ve formally committed to restructuring, don’t include those costs or savings.

Use conservative growth rates: Terminal value growth typically matches long-term economic growth (2-3% in developed economies).

Choosing an Appropriate Discount Rate

The discount rate reflects two things: time value of money and risks specific to the asset. Most companies use a pre-tax discount rate that:

Matches the asset’s risk profile: Higher-risk assets need higher discount rates. A manufacturing facility carries less risk than speculative technology development.

Reflects current market conditions: Update your rate assessment annually. Rising interest rates increase discount rates; declining rates do the opposite.

Aligns with long-term risk-free rates: Use government bond yields as your baseline, then add a risk premium.

Avoids WACC mismatches: Your discount rate should reflect asset-specific risks, not company-wide cost of capital.

Recognizing and Measuring an Impairment Loss

When carrying amount exceeds recoverable amount, you’ve got an impairment loss. This gets charged to profit or loss on your income statement.

Impairment Calculation Formula

The formula is simple: Impairment Loss = Carrying Amount – Recoverable Amount

But the real work happens in estimating that recoverable amount accurately.

Step-by-Step Numeric Example

Let’s walk through a real scenario. Assume you have manufacturing equipment with:

• Carrying amount: EUR 120,000
• Estimated FVLCD: EUR 85,000
• Calculated VIU: EUR 95,000

Step 1: Determine recoverable amount. Recoverable amount is the higher of FVLCD (EUR 85,000) and VIU (EUR 95,000), so it’s EUR 95,000.

Step 2: Compare to carrying amount. Your carrying amount is EUR 120,000, which exceeds the recoverable amount.

Step 3: Calculate the loss. EUR 120,000 – EUR 95,000 = EUR 25,000 impairment loss.

Step 4: Recognize in profit or loss. You record EUR 25,000 as an impairment charge on your income statement and reduce the asset’s book value to EUR 95,000.

This straightforward example shows how the process works. Real situations get more complex with multiple assets, cash-generating units, and goodwill allocations, but the principle stays the same.

Allocating Loss to Assets

When you test a cash-generating unit rather than individual assets, you need to allocate the loss across multiple assets. The allocation follows a specific hierarchy:

First, reduce goodwill to zero: Goodwill absorbs losses first.

Then allocate pro-rata to other assets: Distribute remaining loss proportionally based on carrying amounts of other assets in the unit.

Never reduce assets below recoverable amount: You can’t push any individual asset below its own recoverable amount.

Cash-Generating Units and Goodwill Testing

Not all assets generate cash independently. That’s why IAS 36 uses the concept of cash-generating units for impairment testing.

Identifying a Cash-Generating Unit

A cash-generating unit (CGU) is the smallest identifiable group of assets that generates independent cash inflows. The key word is “independent”—the cash flows must be largely independent of other assets’ cash flows.

How do you identify your CGUs? Start with how your business operates:

Divisional structure: If you run separate operating divisions, each might be its own CGU.

Product lines: Different products might generate independent revenues and cash flows.

Geographic markets: You might have distinct operations in different regions.

Manufacturing facilities: A plant that sells products independently could be a single CGU.

But here’s where companies often stumble. Making CGU boundaries too narrow risks missing important synergies between assets. Make them too broad, and you dilute impairment signals. Your CGU definition should match how you monitor and make operational decisions.

Impairment of Goodwill

Goodwill can only be tested at the CGU level—never individually. Here’s why: goodwill represents synergies from combining assets, so it only makes sense to test it with the related assets.

When testing for goodwill impairment:

Compare the CGU’s carrying amount (including goodwill) to its recoverable amount. If carrying amount exceeds recoverable amount, you’ve got an impairment.

Allocate the loss first to goodwill: Goodwill gets written down first to eliminate the excess.

Then allocate remaining loss to other assets: If the impairment exceeds goodwill, the remainder spreads across other assets using the pro-rata method.

Corporate Asset Allocation

Corporate assets (head office facilities, shared IT systems, insurance) don’t generate independent cash flows. When testing for impairment:

Allocate corporate assets to related CGUs: Spread corporate costs proportionally across the units that benefit.

Test each CGU including its allocated corporate assets: This ensures corporate overhead is factored into recoverable amount calculations.

This approach prevents understatement of impairment by ignoring the costs of shared infrastructure.

Reversal of Impairment Losses Under IAS 36

The good news: impairment losses aren’t permanent. If conditions improve, you can reverse them (with one important exception).

Reversal for Individual Assets

For individual assets (not goodwill), reversal is allowed if conditions improve. The reversal:

Cannot exceed the original depreciated cost: You can’t restore the asset to more than its original carrying amount before impairment.

Gets charged to profit or loss: Just like the original loss, reversals flow through income statement.

Requires clear evidence of improvement: Asset performance, market conditions, or economic circumstances must genuinely improve.

Common scenarios for reversals include:

• Market conditions improve after temporary downturn
• Asset performance exceeds recent expectations
• Technology becomes valuable again (surprisingly rare)
• Legal or regulatory barriers are removed

Reversal for Cash-Generating Units

CGU reversals follow the same principle but apply to the unit as a whole. Your evidence should show the recoverable amount has increased since the last impairment.

Note this critical rule: goodwill impairment losses are never reversed. Once you’ve written down goodwill, it stays down.

Disclosure Requirements and Reporting Impact

IAS 36 requires specific disclosures about impairment testing. These aren’t optional—regulators and auditors look for them.

For assets with impairment losses, disclose:

Events that triggered testing: External market changes, internal performance issues, or restructuring announcements.

Amounts recognized: The specific loss amounts and affected asset classes.

Methods used: Whether you used FVLCD, VIU, or both in measuring recoverable amount.

Key assumptions: Discount rates, growth rates, and cash flow projection periods.

Sensitivity analysis: Show how changes in key assumptions (±1% changes in discount rate, for example) would affect your conclusions.

The purpose of these disclosures is transparency. Financial statement users need to understand your judgments and assumptions. If assumptions are aggressive or ambiguous, they’ll question your estimates.

Common Pitfalls in Impairment Testing

Most errors fall into a few recurring categories. Here’s what to watch for.

Practical Challenges

Incorrect CGU boundaries: Setting boundaries too narrow or too broad creates inconsistent testing. Your boundaries should align with how you monitor performance and make decisions—not accounting convenience.

Unrealistic cash flow projections: Using best-case scenarios, including restructuring savings not yet committed, or applying growth rates higher than long-term economic growth are all common mistakes.

Wrong discount rate: Using WACC when you should use asset-specific rates, or failing to update rates when market conditions change, leads to incorrect recoverable amounts.

Poor sensitivity analysis: Checking only one assumption or using tiny sensitivity ranges misses meaningful risks.

Inadequate documentation: Failing to document your methodology, sources, and key judgments creates audit risk and makes reversals difficult to support later.

Best Practice Safeguards

Use a structured testing process: Develop a formal checklist covering indicators, CGU definition, cash flow development, rate selection, and documentation.

Involve multiple disciplines: Bring together accountants, operational managers, and valuation specialists. Different perspectives catch errors.

Update assumptions annually: Market conditions, interest rates, and business performance change. Don’t simply repeat prior-year assumptions.

Perform sensitivity analysis thoroughly: Test multiple assumptions and varying ranges. Show how results change under different conditions.

Document everything: Record your CGU decisions, cash flow sources, discount rate calculations, and any changes from prior years.

Get external validation: Consider third-party valuations for significant assets or goodwill. It costs money upfront but prevents costly restatements.

IAS 36 Practical Checklist for Compliance

Use this checklist when conducting impairment testing:

PRELIMINARY ASSESSMENT

• [ ] Identify all assets and goodwill requiring review
• [ ] Assess external indicators (market, technology, legal, economic)
• [ ] Assess internal indicators (damage, performance, restructuring)
• [ ] Determine if testing is required (indicators present, or goodwill/indefinite intangibles regardless)
• [ ] Define cash-generating units based on operational structure

RECOVERABLE AMOUNT CALCULATION

• [ ] Gather current market data for FVLCD assessment
• [ ] Project 5-year cash flows using approved budgets
• [ ] Calculate terminal value using reasonable growth rates
• [ ] Select appropriate pre-tax discount rate reflecting asset risks
• [ ] Calculate VIU using projected cash flows and discount rate
• [ ] Determine recoverable amount as higher of FVLCD and VIU

IMPAIRMENT MEASUREMENT

• [ ] Compare carrying amount to recoverable amount
• [ ] Calculate impairment loss if carrying amount exceeds recoverable amount
• [ ] Allocate loss to goodwill first, then other assets pro-rata
• [ ] Record loss to profit or loss
• [ ] Update asset carrying amounts to recoverable amounts

REVERSAL ASSESSMENT (if applicable)

• [ ] Assess whether conditions have improved since impairment
• [ ] Calculate reversal amount not exceeding original depreciated cost
• [ ] Confirm goodwill reversals aren’t recorded (never allowed)
• [ ] Record reversal to profit or loss

DISCLOSURES

• [ ] Document triggering events for testing
• [ ] Record impairment loss amounts and affected asset classes
• [ ] Describe valuation methods (FVLCD, VIU, or both)
• [ ] List key assumptions (discount rates, growth rates, projection periods)
• [ ] Perform and document sensitivity analysis results
• [ ] Prepare notes to financial statements covering all required disclosures

Key Definitions and Core Concepts

Carrying Amount

The amount at which an asset is recognized on the balance sheet after deducting accumulated depreciation and accumulated impairment losses. This is the net book value.

Recoverable Amount

The higher of fair value less costs of disposal and value in use. It represents what you can actually recover from the asset through use or sale.

Impairment Loss

The amount by which carrying amount exceeds recoverable amount. It measures the reduction needed to bring asset value in line with actual economic reality.

How Often Should You Perform Impairment Testing?

The testing frequency depends on the asset type:

Goodwill and indefinite-life intangible assets: Annual testing required regardless of indicators. This is non-negotiable.

Other intangible assets not yet available for use: Annual testing required until the asset becomes available for use.

All other assets: Test only when indicators exist at the reporting date. If no indicators, no testing needed.

This tiered approach recognizes that goodwill carries higher impairment risk due to its nature it can’t be depreciated and represents acquisition synergies that can disappear quickly.

Maximize Your IAS 36 Compliance with Expert Guidance

Impairment testing isn’t just a compliance box to check. It’s about presenting accurate financial statements that stakeholders can trust. When done properly, it strengthens your credibility with investors, lenders, and regulators.

The complexity of IAS 36 defining CGUs, estimating cash flows, selecting discount rates, documenting assumptions—deserves professional attention. Many organizations benefit from support in this area.

Our IAS 36 Impairment Basics guide covers foundational concepts, while our IAS 36 advisory services team helps navigate complex testing scenarios, goodwill allocations, and disclosure requirements. Whether you’re dealing with a first-time testing situation or refining your existing process, having the right guidance makes the difference.

Take the next step: reach out to discuss your specific impairment testing challenges and how we can help ensure your financial reporting reflects economic reality.

Final Thoughts on Protecting Your Asset Values

IAS 36 impairment testing protects both your organization and the stakeholders who rely on your financial statements. Getting it right requires understanding the standard’s principles, applying them consistently, and documenting your decisions carefully.

The companies that handle impairment testing best treat it not as a compliance obligation but as a valuable management tool. Regular testing reveals when business conditions have changed and assets need revaluation. This forward-looking perspective prevents surprise write-downs later.

Start with a clear process. Develop consistent CGU definitions aligned with your operational structure. Use realistic, documented cash flow projections. Select discount rates that reflect current market conditions and asset-specific risks. Perform meaningful sensitivity analysis. And document everything thoroughly.

Your balance sheet should tell an accurate story. When you master IAS 36 impairment testing, it will.