Learning Outcomes
After reading this article, you will understand when and how to identify impairment of inventory and non-current assets under IAS 36. You will be able to explain common indicators of impairment, describe the process for impairment testing, outline appropriate audit procedures, and discuss how to obtain and assess audit evidence related to impairment. You should be able to apply these concepts to ACCA-style scenarios and articulate the reporting implications if impairment is not addressed accurately.
ACCA Audit and Assurance (AA) Syllabus
For ACCA Audit and Assurance (AA), you are required to understand the identification and testing of impairment for inventory and non-current assets. Focus your revision on:
- Recognising impairment indicators for inventory and non-current assets as required by IAS 36.
- Explaining and performing audit procedures for identifying and testing for impairment.
- Understanding how to obtain sufficient and appropriate audit evidence relating to impairment and its valuation.
- Assessing management’s process for impairment review and evaluating audit risks in this area.
- Reporting and disclosure requirements if impairment is identified or omitted in the financial statements.
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- What objective evidence might indicate that an item of property, plant and equipment is impaired as per IAS 36? List at least three examples.
- How should inventory be valued when its expected selling price is lower than cost? Briefly explain the required accounting treatment.
- Describe two substantive audit procedures an auditor should perform to obtain evidence for an impairment review.
- What should an auditor do if management refuses to recognise a material impairment loss?
Introduction
Impairment occurs when the carrying amount of inventory or a non-current asset exceeds the amount expected to be recovered through use or sale. IAS 36 requires entities to review assets at each reporting date for indicators of impairment. If indicators exist, an impairment test must be performed.
Key Term: Impairment
The reduction in the recoverable amount of an asset below its carrying value, requiring the asset to be written down in the accounts.
Impairment risks are significant because unrecognised impairment can lead to overstated assets, incorrect profits, and non-compliance with IFRS.
Why impairment matters
Inventory and non-current assets make up a large proportion of many entities’ statements of financial position. Their value often relies on judgements and estimates. Changes in technology, market demand, or business conditions can reduce asset values with little advance warning. For the auditor, this area presents inherent risk of material misstatement due to its subjectivity and potential for management bias.
Indicators of Impairment
IAS 36 specifies both external and internal indicators that assets may be impaired. At each reporting date, management and auditors should consider these factors for inventory and non-current assets.
External indicators
- Significant decline in market value.
- Adverse changes in economic or legal environment.
- Increases in interest rates, making the asset’s carrying value less recoverable.
- Evidence of obsolescence, such as new technology or reduced customer demand.
- For inventory: reduction in expected selling prices or increased competition.
Internal indicators
- Physical damage to an asset, such as fire or flood.
- Asset is idle, underperforming, or part of a restructuring.
- Evidence from internal reporting of declining economic performance.
- For inventory: slow-moving items or damaged goods.
Key Term: Recoverable Amount
The higher of an asset’s fair value less costs to sell and its value in use.
Worked Example 1.1
An electronics retailer holds large stockpiles of last year’s tablet model as new technology was recently released. Most units remain unsold and must now be discounted. Are there impairment indicators?
Answer:
Yes. The release of new technology and unsold stock are objective evidence of impaired value. Inventory should be valued at the lower of cost and net realisable value.
Inventory Impairment: Audit Approach
IAS 2 requires inventory to be measured at the lower of cost and net realisable value (NRV). NRV is the estimated selling price less costs to complete and sell.
Key Term: Net Realisable Value (NRV)
The estimated selling price in the ordinary course of business less estimated costs of completion and selling.
If NRV falls below cost, the inventory must be written down to NRV and the loss recognised in profit or loss.
Testing inventory for impairment
- Review aged inventory listings for slow-moving, old, or obsolete items.
- Inspect for evidence of damage or deterioration.
- Compare cost to recent selling prices (review post year-end sales invoices).
- Discuss with management the basis for NRV estimates for inventory.
- Consider market conditions and price trends.
Key Term: Obsolescence
Inventory is considered obsolete when it is no longer usable or saleable due to age, style, or technological change.Key Term: Write-down
A reduction in the carrying amount of inventory or asset to reflect a decrease in value.
Worked Example 1.2
A clothing retailer’s year-end inventory includes 300 units of last season's coats priced at $50 each, but current selling price is $30 per unit. Cost to sell is $2 per coat. What is the correct carrying value?
Answer:
NRV per coat is $30 - $2 = $28, which is below the cost of $50. Inventory should be written down to $28 × 300 = $8,400.
Non-Current Asset Impairment: Audit Approach
Non-current assets (property, plant, equipment, and intangibles) must be tested for impairment if there are indicators. IAS 36 requires an impairment test whenever such signs are present.
Impairment testing process
- Identify impairment indicators (see above).
- Calculate the recoverable amount (higher of fair value less costs to sell and value in use).
- Compare recoverable amount with carrying amount.
- If recoverable amount < carrying amount, recognise an impairment loss.
For cash-generating units (CGUs)
When an asset does not generate independent cash flows, impairment is assessed at the CGU level.
Key Term: Cash-Generating Unit (CGU)
The smallest identifiable group of assets that generates independent cash inflows.
Testing for impairment (audit procedures)
- Review asset registers for items not in use, damaged, or idle.
- Investigate major write-offs or losses post year-end.
- Inspect board minutes for planned closures or restructuring.
- Compare carrying values to recent valuations and market prices.
- Assess reasonableness of management’s forecasts and assumptions (discount rates, growth estimates).
- Evaluate adequacy and accuracy of supporting calculations.
Worked Example 1.3
A factory machine is idle following major client loss. Management’s discounted cash flow (value in use) is $20,000. The asset’s carrying amount is $35,000, and fair value less costs to sell is $18,000.
Answer:
The recoverable amount is $20,000 (higher of $20,000 value in use and $18,000 fair value less costs to sell). The machine should be written down from $35,000 to $20,000, recording a $15,000 impairment loss.
Exam Warning
A common error is to ignore impairment indicators at the planning stage and fail to identify assets needing review. If indicators exist, the impairment test and necessary write-downs must be considered. Incomplete procedures in this area can lead to audit failure.
Audit Evidence for Impairment
Auditors must obtain sufficient and appropriate evidence regarding:
- The existence of impairment indicators.
- The determination of recoverable amounts and NRV.
- The calculation and recognition of impairment losses.
Key evidence sources include:
- Management’s impairment reviews and calculations.
- Board minutes discussing asset utilisation or restructuring.
- Post year-end sales data for inventory NRV.
- Third-party valuations for large non-current assets.
- Contracts or correspondence showing loss of significant customers.
Professional scepticism is needed—challenge management's assumptions about future cash flows, discount rates, or inventory demand.
Revision Tip
In exam scenarios, always tie impairment risk to a specific financial statement assertion (valuation for both inventory and non-current assets, or completeness for impairment losses). State clearly which assertion is at risk in your answer.
Reporting and Disclosure
If an impairment loss is identified, it must be recognised immediately in profit or loss. Adequate disclosure is required for the amount of the loss and reasons for impairment.
If management refuses to recognise a material impairment loss, the auditor must consider a modified audit opinion due to material misstatement. This may result in a qualified or adverse opinion, depending on materiality and pervasiveness.
Summary
Entities must review inventory and non-current assets at each reporting date for impairment indicators. If indicators are present, impairment testing under IAS 36 is required, with inventory valued at lower of cost and NRV, and non-current assets tested against recoverable amount. The auditor must design and perform appropriate procedures to identify possible impairment, verify calculations, and obtain sufficient evidence. Any recognised impairment loss must be properly accounted for and disclosed, and a failure to do so can impact the auditor’s report.
Key Point Checklist
This article has covered the following key knowledge points:
- Define impairment and list both external and internal indicators for inventory and non-current assets.
- Explain how to test inventory for impairment and how to calculate write-downs to NRV.
- Describe impairment testing and recoverable amounts for non-current assets under IAS 36.
- Identify audit risks arising from impairment and plan substantive procedures to obtain evidence.
- Assess management assumptions used in impairment testing and evaluate reasonableness.
- State the reporting and audit opinion implications where impairment is not recognised or disclosed.
Key Terms and Concepts
- Impairment
- Recoverable Amount
- Net Realisable Value (NRV)
- Obsolescence
- Write-down
- Cash-Generating Unit (CGU)