Brentwood Precision Ltd: revaluation decrease or impairment?
Brentwood Precision Ltd reports under IFRS with a 31 December year end. Its factory was revalued on 31 December 20X3, creating a £600,000 surplus in other comprehensive income; no transfer to retained earnings has been made and depreciation is charged on the revalued amount. At 31 December 20X5 the factory's carrying amount is £2,400,000 before the annual valuation; the valuer reports a fair value of £1,550,000 and disposal costs of £50,000. The regional property market has softened, and the finance director wants to charge the whole movement to profit or loss, arguing that IAS 36 applies whenever fair value falls. Separately, a packaging machine with largely independent cash flows has a carrying amount of £420,000, a value in use of £350,000 and a firm sale offer of £405,000 less £25,000 selling costs. Finally, the coatings cash-generating unit carries £1,800,000 in total, being goodwill £300,000, property, plant and equipment £1,200,000 and other intangibles £300,000; its value in use is £1,350,000 and its fair value less costs to sell is £1,400,000.
1. How should the fall in the factory's value be accounted for, and is IAS 36 the relevant standard?
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Brentwood uses the revaluation model for this class, so a fall in fair value in a softening market is first dealt with under IAS 16 as a revaluation decrease, not as an impairment.
Movement: carrying amount £2,400,000 less fair value £1,550,000 = £850,000 decrease. Under IAS 16 that decrease is charged against the existing revaluation surplus for that asset in other comprehensive income to the extent a surplus remains, with any excess to profit or loss:
- £600,000 debited to the revaluation reserve (OCI)
- £250,000 charged to profit or loss
The £50,000 disposal cost is a distractor: IAS 16 revalues to fair value, not fair value less costs to sell. Costs to sell belong to the IAS 36 recoverable amount calculation.
IAS 36 becomes relevant only if the revalued carrying amount of £1,550,000 still exceeds the asset's recoverable amount, which requires a separate impairment indicator and a value in use calculation at the level of the asset or its cash-generating unit. The regional price movement is already captured in the valuation, so there is no automatic second write-down.
A further practical point: the company should have been transferring the excess depreciation on the revalued amount to retained earnings each year, which would have reduced the remaining surplus and increased the amount hitting profit or loss.
2. Calculate the impairment of the packaging machine and explain the rule you applied.
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Recoverable amount is the higher of fair value less costs to sell and value in use:
- Fair value less costs to sell = 405,000 − 25,000 = £380,000
- Value in use = £350,000
- Recoverable amount = £380,000
Impairment loss = 420,000 − 380,000 = £40,000, charged to profit or loss (the machine has no revaluation surplus attached).
Why the higher amount: IAS 36 presumes that an entity will not sell an asset for less than its value in use if it can avoid doing so, so the greater of the two is the best evidence of the amount recoverable. Choosing the lower figure would overstate the loss. The firm sale offer is strong, verifiable evidence of fair value less costs to sell; value in use is a management estimate and is not automatically preferred simply because it is more conservative.
Presentation: the loss is recognised in profit or loss, disclosed in the notes with the events and circumstances that led to it, and the revised carrying amount of £380,000 is depreciated over the asset's remaining useful life. Because the machine is not revalued, the impairment may be reversed in a later period if the recoverable amount rises, but not above the depreciated original cost.
3. Calculate the impairment of the coatings cash-generating unit and show how it is allocated.
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Step 1 - recoverable amount: higher of value in use £1,350,000 and fair value less costs to sell £1,400,000 = £1,400,000.
Step 2 - impairment: 1,800,000 − 1,400,000 = £400,000.
Step 3 - allocation. IAS 36 requires the loss to be allocated first to any goodwill, then to the other assets pro rata to their carrying amounts:
| Asset | Carrying amount | Allocation | Revised |
|---|---|---|---|
| Goodwill | 300,000 | 300,000 | 0 |
| PPE | 1,200,000 | 1,200/1,500 × 100,000 = 80,000 | 1,120,000 |
| Other intangibles | 300,000 | 300/1,500 × 100,000 = 20,000 | 280,000 |
| Total | 1,800,000 | 400,000 | 1,400,000 |
The pro rata allocation cannot reduce any asset below the higher of its own fair value less costs to sell, value in use (if determinable) or zero; no such floor is breached here.
Two follow-ups examiners like: the goodwill write-off of £300,000 is not reversible in future periods, whereas the £100,000 allocated to PPE and intangibles may be reversed if the recoverable amount recovers. Also, testing the CGU first is required because the individual assets do not generate independent cash flows.