Impairment test

What it means

An impairment test compares the carrying amount of an asset with what the business can still recover from it through sale or use. If the carrying amount is higher, the asset is impaired and the difference is recognised so that the balance sheet does not show more than the asset is really worth.

Under Slovak rules a temporary decline in value is recognised through an impairment allowance, which can be reversed if the situation improves. A permanent decline is dealt with by a write-down. International standards (IFRS) have more detailed rules and the concept of recoverable amount.

Under IFRS the recoverable amount is the higher of two figures: fair value less costs of disposal and value in use, meaning the present value of the future cash flows the asset will generate. Slovak rules apply a similar logic of comparing with a reduced value.

How it works in practice

The test is carried out when there are indications of impairment, such as falling sales, technological obsolescence of a machine, damage to an asset, the loss of a key customer or a significant drop in market prices. For goodwill and some intangible assets, IFRS require the test every year.

Value in use is often determined with a discounted cash flow method similar to a DCF valuation. Assumptions about future revenue, costs and the discount rate must be justified and documented, because the auditor will examine them.

In the everyday accounts of small companies, impairment testing concerns mostly inventory, receivables and fixed assets. For slow-moving goods, for example, their carrying amount must be compared with the expected selling price less selling costs, and any shortfall recognised.

What to watch out for

Impairment allowances on assets are generally not tax-deductible, except for certain allowances on receivables that meet statutory conditions. This creates a difference between accounting and taxable profit and, for larger companies, deferred tax that must be calculated correctly.

Impairment must not be ignored just because it would worsen the result. The prudence principle in asset valuation requires known risks and losses to be recognised, and an auditor will flag overstated assets in the audit opinion.