Impairment of assets: recognising exceptional impairment losses

Accounting depreciation, which we detailed earlier, allows you to record the normal and expected wear and tear or obsolescence of your assets. But what happens if an asset loses value more suddenly or unexpectedly? Imagine a machine that suddenly becomes obsolete because of a new competitive technology, a building damaged by a natural disaster, or a patent whose value plummets following a change in regulations. In these situations, depreciation alone is no longer sufficient to reflect the real value of the asset. This is where accounting depreciation. This is a mechanism for recognising a one-off significant loss of value, in addition to depreciation. Ignoring depreciation would be tantamount to overvaluing your company's assets. When should you test the value of your assets? How should an impairment be calculated and booked? Can you go back if the situation improves? This article guides you through the rules set out in the General Chart of Accounts (PCG).

Understanding depreciation and present value

Impairment is defined in article 214-5 of the French General Chart of Accounts as the recognition that the current value of an asset has fallen below its net book value (NBV). It is important to distinguish between depreciation and amortisation:

• L'depreciation recognises an impairment loss expected, systematic and progressiveThe asset is depreciated on a straight-line basis over its estimated useful life.
• La depreciation recognises an impairment loss exceptional, one-off and potentially reversibleresulting from specific events or changes in circumstances.

La net book value (NBV) The fair value of an asset is its gross value (acquisition cost or revalued value) less accumulated depreciation since acquisition AND accumulated impairment losses recognised in prior years.

La current value is the benchmark for determining whether impairment has occurred. According to Article 214-6 of the French General Chart of Accounts, it is the highest value between two estimates :

1. La market value Fair value: this is the price that the company could obtain by selling the asset on the market, under normal trading conditions, at the balance sheet date, after deducting costs directly related to the sale (selling expenses, commissions, etc.). It assumes the existence of an active market for this type of asset.
2. La use value residual value: this is the value of the future economic benefits that the company expects to derive from the continued use of the asset until the end of its useful life, and then from its disposal (sale or scrapping). This value is generally calculated by discounting the future net cash flows that the asset is expected to generate. Discounting consists of reducing the value of future cash flows to their equivalent today, taking into account the time value of money and the risks specific to the asset. If cash flows are not the relevant criterion (e.g. for an association), other criteria reflecting the potential for future services may be used.

Calculating value in use can be complex, as it is based on estimates and forecasts (sales generated, operating costs, remaining useful life, final exit value, discount rate, etc.). It requires a cautious and well-documented approach.

The logic is as follows: if the value that the company can derive from the asset (either by selling it or by continuing to use it) is less than the value entered in the balance sheet (the NBV), then the asset is overvalued and an impairment loss must be recognised. It is therefore essential to assess the carrying value of assets on a regular basis to ensure that it reflects their true market value. The fundamental concepts of depreciation play a key role in this assessment, as they enable the cost of an asset to be spread over its useful life. By doing this, the company can anticipate any impairment losses and adjust its financial statements accordingly. In addition, an understanding of accounting depreciation principles enables companies to optimise their financial management and better plan future investments. Rigorous application of these principles also helps to avoid tax surprises, by ensuring proactive asset management. Finally, compliance with these standards enhances the transparency and reliability of financial statements, thereby strengthening the confidence of investors and stakeholders. In addition, to ensure accurate valuation of assets, it is crucial to measure the entry cost of assetsThis includes all expenditure directly linked to their acquisition and preparation for use. A good assessment of the entry cost makes it possible to determine a realistic basis for calculating depreciation, encouraging more rigorous asset management. By integrating this aspect into their financial strategy, companies can also better anticipate the impact of market fluctuations on the value of their assets. What's more, in a context of digital transformation, it's essential to take account of legal implications of digital assetsThese assets, which are often intangible, require a tailored approach to ensure their smooth integration into the company's balance sheet. These often intangible assets require a tailored approach to ensure their seamless integration into the company's balance sheet. By integrating these considerations into their overall strategy, companies can better navigate a constantly changing environment and maximise the value of all their assets.

Impairment testing: when and how?

The company should not wait for a loss of value to be obvious before taking action. The PCG (art. 214-16) requires active vigilance: at each balance sheet date (and even in intermediate situations if the company establishes them), management must assess whether there is any index showing that an asset may have lost significant value.

If such an index is identified, then a impairment test becomes mandatory. This test consists of comparing the net book value of the asset in question with its current value (the higher of the market value or the value in use).

What are these indications of impairment who should alert the company? Article 214-17 of the French General Chart of Accounts gives a non-exhaustive list, divided into two categories:

External indicators (from the company's environment) :

• Significant fall in the market value of the asset A fall in prices observed on the market for similar goods, greater than that expected simply from the passage of time or normal wear and tear.
• Significant changes with a negative impact This may concern the technological environment (new technology rendering the asset obsolete), the economy (sector crisis), the legal environment (new regulations restricting the use of the asset) or the market itself (massive arrival of competitors, etc.).
• Increase in market interest rates or other rates of return: a significant increase may reduce the present value calculated by discounting future cash flows (value in use).

Internal indices (company or asset specific) :

• Obsolescence or physical deterioration of the asset not initially provided for in the depreciation schedule (for example, following an accident).
• Significant changes in the manner or extent to which the asset is usedThe company plans to dispose of the asset sooner than expected, to cease the activity to which it is assigned, or to restructure it.
• Economic performance below forecasts Internal indicators (reporting, budgets) show that the asset is generating less revenue or costing more to operate than anticipated at the time of acquisition or at the time of the last test.

The presence of just one of these indicators (or any other relevant indicator identified by the company) is sufficient to trigger the obligation to carry out a full impairment test for the asset concerned. For certain specific assets, such as intangible assets with an indefinite useful life or goodwill (goodwill in the consolidated financial statements), the impairment test must be performed at least once a year, even if there is no indication of impairment.

Calculating and recognising impairment

If the impairment test is necessary (presence of an indication) and it reveals that the the present value of the asset is less than its net asset valueIn this case, an impairment loss must be recognised (PCG, art. 214-18).

Le amount of depreciation to be recorded is equal to the difference : Impairment = Net book value - Current value

However, GAAP introduces an important nuance: if the difference between the net book value and the current value is not deemed to be significantly lowerif the impairment loss is insignificantIn this case, the NBV is maintained on the balance sheet and no impairment loss is recognised. The materiality threshold is assessed by the company on a case-by-case basis.

Where the impairment is material, it is recognised :

• Visit balance sheetIn this case, it reduces the value of the asset (either directly or via a "Depreciation and amortisation" account). The new net book value of the asset becomes equal to its current value.
• Visit profit and loss accountis registered as a load (in an "Impairment charges" account), which reduces profit for the year.

An immediate and important consequence of recognising impairment is that it changes the depreciable base prospectively of the asset for future periods (PCG, art. 214-18). The new NBV (equal to the present value after depreciation) becomes the new basis for allocation over the remaining useful life of the asset. This means that depreciation charges for subsequent years will generally be lower than initially expected.

Monitoring and reversal of impairment

An impairment loss is not necessarily definitive. The economic situation may improve, competing technology may perform less well than expected, the company may find new uses for its asset, etc. This is why the French General Chart of Accounts (art. 214-19) provides for a mechanism of follow-up and possible recovery impairment losses.

At each balance sheet date, the company must assess whether the indications that led to the recognition of the impairment have disappeared or diminished. If so, it must re-estimating current value assets.

If this new current value is higher than the current NCV of the asset (which takes into account previous depreciation and recalculated depreciation), then the previously recognised depreciation must be recovery (cancelled), in whole or in part.

The reversal of impairment is recognised :

• Visit balance sheetThis increases the net asset value of the asset.
• Visit profit and loss accountis registered as a product (in a "Reversal of impairment" account), which increases profit for the year.

However, there is a fundamental limit the reversal, as specified in article 214-19 of the French General Chart of Accounts: the NBV of the asset after reversal of the impairment loss cannot exceed the net asset value it would have had if no impairment had ever been recognised in previous years. In other words, it is not possible to "over-correct" and show the asset at a higher value than it would have had under its initial depreciation schedule, without any impairment. This "ceiling" rule is essential to avoid accounting manipulations.

As with the recognition of an impairment loss, the reversal also changes the depreciable base prospectively and therefore future depreciation charges.

Special case: going concern compromised

The impairment rules apply in the context of the going concern principle, i.e. when it is assumed that the company will continue as a going concern. What happens if this continuity is compromised (for example, a decision to liquidate)?

The French General Chart of Accounts is relatively silent on the exact accounting policies to be adopted in the event of an imminent cessation of activity. Article 121-4 simply states that if continuity is no longer assured, valuation methods must be changed if necessary. Accounting doctrine (such as response EC 2013-45 cited in the source document) indicates that it is then up to management to choose appropriate methods, which may go as far as valuing assets (and liabilities) at their fair value. asset value (the probable realisable value in the event of a quick and forced sale), rather than value in use based on future use. In this context, the very notion of impairment based on value in use loses its relevance in favour of a direct valuation with a view to disposal. The choices made must be clearly explained in the notes to the financial statements.

Information in appendix

The impairment process must be transparent. The notes to the financial statements must provide specific information (art. 831-2 of the French General Chart of Accounts):

• For each significant impairment loss or reversal recognised during the year: the amount, the present value used (specifying whether it is the market value or the value in use, and the method of calculation), the income statement item affected, and the events or circumstances that led to the impairment loss or reversal.
• A table reconciling the opening and closing carrying amounts of impairment losses, showing charges and reversals for the year.
• The general impairment table by asset category (provided for in article 832-3 of the French General Chart of Accounts).

Identifying and correctly accounting for depreciation is essential to avoid overvaluing your assets. It is a legal obligation and a relevant management tool. Our firm can help you carry out your impairment tests.

Sources

• General Chart of Accounts (as issued in particular by ANC Regulation no. 2014-03 and subsequent updates), Articles 121-4, 214-5, 214-6, 214-16 to 214-19, 831-2, 832-3.
• Accounting doctrine (e.g. CNCC, EC 2013-45 on going concern).