Impairment testing under IAS 36: practical guidance

Building an impairment test that reflects the business, holds up to audit and tells the reader something useful

-- IAS 36 makes sure assets are not carried above the amount the business can recover from them. Goodwill, indefinite life intangibles and intangibles not yet available for use must be tested every year; other assets are tested when there is an indication of impairment. - Most impairment tests are decided by three judgements: how the cash-generating units are defined, how realistic the cash flow forecasts are, and what discount rate is used. Small changes in any of them can move the outcome by tens of millions of dirhams. - Auditors focus on whether forecasts are management-approved budgets, past performance and market evidence, and whether the discount rate reflects the risks of the specific unit rather than the group as a whole. - In the [UAE](https://www.claemirates.com/locations), corporate tax means that if you model value in use on a post-tax basis, the cash flows and the discount rate must both be post-tax, and the pre-tax rate that IAS 36 requires you to disclose must be derived from that model, not estimated with a simple gross-up. - The best impairment tests are prepared in the fourth quarter, using the same forecasts management uses to run the business, with sensitivities that show the reader how close the decision really was."

Why impairment testing matters more than ever

Impairment testing sits at the point where accounting meets the business plan. It asks a simple question: if this group of assets were to be used for the rest of its life, or sold today, would it generate at least as much as its carrying amount? If not, the shortfall is written off.

For many UAE groups, the question has become harder to answer. Acquisitions made during periods of strong growth have left significant goodwill on balance sheets. Interest rates have remained above pre-2022 levels, which has kept discount rates higher than many older forecasts assumed. Some sectors, such as hospitality and retail, face new supply and changing customer patterns, while others, such as construction, depend heavily on a small number of large projects. Against that background, an impairment test built by rolling forward last year's spreadsheet is unlikely to survive the audit.

It is also one of the most visible judgements in the financial statements. Regulators across many markets have repeatedly listed impairment of non-financial assets among their enforcement priorities, typically because the disclosures do not explain the key assumptions or show how sensitive the result is to them.

When to test: indicators versus annual testing

IAS 36 sets two triggers. Goodwill, intangible assets with an indefinite useful life and intangible assets not yet available for use must be tested every year, whether or not there is any sign of impairment. The test can be performed at any time during the year, provided it is done at the same time each year. Different CGUs or assets can be tested at different dates, but an intangible first recognised in the year, or a CGU with goodwill from a business combination in the year, must be tested before the year end (paragraphs 10 and 96). All other assets within scope, including property, plant and equipment, right-of-use assets and finite life intangibles, are tested only when there is an indication that they may be impaired. That indicator review must be performed at every reporting date.

The indicator review is where many entities fall short. It is often a single sentence in a year end memo stating that "no indicators were identified", with no evidence that anyone looked. A better approach is to work through a structured checklist and record the answer to each question.

An indicator does not mean that an impairment exists. It means a test is required. Equally, if an indicator exists but the test shows enough headroom, the entity should still consider whether the asset's remaining useful life, depreciation method or residual value needs to be revised.

Cash-generating units and allocating goodwill

Many assets do not generate cash inflows on their own. A hotel's elevators, kitchens and furniture produce cash only together with the building and the brand. IAS 36 therefore requires assets to be grouped into cash-generating units (CGUs): the smallest identifiable group of assets that generates cash inflows largely independent of the cash inflows from other assets.

The phrase "largely independent" is the key. If a group's three hotels share a reservation system but each sells rooms to its own guests at its own rates, each hotel is likely to be a separate CGU. If, at group level, a manufacturer’s plant sells all its output to a sister company at an internal price, the plant is unlikely to be a CGU on its own unless an active market exists for its output. If one does, the plant is a CGU even though its output is used internally, and its cash inflows are based on management’s best estimate of arm’s-length prices (paragraphs 70-71). Defining CGUs too broadly hides impairment, because profitable units absorb the losses of weak ones. Auditors will compare the CGU definition with the way management monitors the business (paragraph 69) and use segment reporting as a cross-check, though segments are not themselves the test. CGUs should also be identified consistently from period to period unless a change is justified (paragraph 72).

Goodwill does not generate cash flows independently, so it is allocated to the CGUs or groups of CGUs that are expected to benefit from the business combination. The allocation must be done at the lowest level at which goodwill is monitored for internal management purposes and cannot be larger than an operating segment before aggregation (paragraph 80; IFRS 8 paragraph 5). Where goodwill was never properly allocated after an acquisition, the first impairment test is often the moment the problem surfaces.

Corporate assets, such as a head office building or a shared IT platform, need the same treatment. They are allocated to CGUs on a reasonable and consistent basis where possible. Where that is not possible, the CGU is first tested without the corporate asset. The corporate asset is then tested at the level of the smallest group of CGUs to which it can be allocated on a reasonable and consistent basis (paragraph 102).

Recoverable amount: value in use or fair value less costs of disposal

The recoverable amount is the higher of two measures. If either one exceeds the carrying amount, there is no impairment and the other does not need to be calculated.

In practice, most operating businesses use value in use, because it relies on internal forecasts that already exist. Where fair value less costs of disposal is the basis, IAS 36 also requires disclosure of the fair value hierarchy level, the valuation technique and the key assumptions, including the discount rate if a present value technique is used (paragraphs 130(f) and 134(e)). Fair value less costs of disposal becomes more useful where there is good market evidence, or where management plans significant changes that a buyer would also make, since uncommitted restructurings and enhancements cannot be reflected in value in use under the current requirements..

The IASB has proposed targeted changes to IAS 36 (Exposure Draft ED/2024/1), including removing the requirement to use pre-tax cash flows and a pre-tax discount rate in value in use, and removing the exclusion of cash flows from uncommitted restructurings and enhancements. At the time of writing these have not been finalised.

Cash flow forecasts that survive an audit

The forecast is where most of the value in an impairment test comes from, and where auditors spend most of their time. IAS 36 requires cash flow projections to be based on reasonable and supportable assumptions, giving greater weight to external evidence. They should be based on the most recent budgets approved by management and cover a maximum of five years unless a longer period can be justified. Beyond the forecast period, cash flows are extrapolated using a steady or declining growth rate, unless an increasing rate can be justified. That rate should not exceed the long-term average growth rate for the products, industries or country concerned unless a higher rate can be justified (paragraph 33(c))

Five questions tend to decide whether a forecast is accepted.

1. Is it consistent with the forecast management uses to run the business? A forecast prepared only for the impairment test, and more optimistic than the budget used to set bonuses and bank covenants, will be challenged unless the differences can be explained. The standard asks for management’s best estimate, so budgets set to be deliberately stretching or deliberately conservative also need adjusting
2. How accurate have past forecasts been? Auditors will compare last year's forecast for this year with actual results. A history of missing budgets by, say, 20% requires either an explanation or a revised forecast that is better supported by evidence (paragraph 34).
3. Do the assumptions match external evidence? Occupancy and room rates for a hotel, order books for a contractor and market growth for a retailer can all be checked against market data.
4. Does the terminal year make sense? The terminal value often represents more than two thirds of value in use. The final forecast year must reflect a sustainable, normalised level of performance, including maintenance capital expenditure at a level that keeps the assets in their current condition.
5. Are tax and working capital treated consistently? IAS 36 measures value in use using pre-tax cash flows and a pre-tax rate. Many entities model post-tax cash flows as a practical route, which in principle gives the same answer. If you do, the tax cash flows should reflect the entity’s expected UAE corporate tax position (generally 9% on taxable income above AED 375,000, subject to free zone status, the 75% limit on using tax losses and any top-up tax) and the discount rate must be post-tax. Working capital movements should follow the revenue profile.

A terminal growth rate deserves particular care. For a UAE business, a long-term growth rate in line with expected long-term inflation and real economic growth is usually defensible. A rate that simply continues the forecast period’s growth into perpetuity is generally hard to defend.

The discount rate

The discount rate should reflect current market assessments of the time value of money and the risks specific to the asset or CGU for which the cash flows have not already been adjusted. In practice, most entities start with a weighted average cost of capital, built from a risk-free rate, an equity risk premium, a beta from comparable listed companies, a cost of debt and a target capital structure.

Three issues come up repeatedly in UAE impairment tests. First, the risk-free rate and country risk premium must match the currency of the cash flows. Because the dirham is pegged to the US dollar, many valuers start from US treasury yields and add a country risk premium. Whatever the approach, the inputs must reflect market conditions at the test date, the cash flows must be on the same currency and inflation basis as the rate, and country risk must not be counted in both the cash flows and the rate. Changes in method should be explained rather than avoided. Second, a single group discount rate is rarely appropriate for every CGU. A hotel, a contracting unit and a facilities management business carry different risks and should have different rates. Third, risks must not be double counted. “If the cash flows have already been adjusted for a risk, for example through probability-weighted scenarios, adding a further premium to the discount rate for the same risk double counts it and understates value in use (paragraph 56).

IAS 36 requires value in use to be measured using pre-tax cash flows and a pre-tax discount rate (paragraphs 50(b) and 55). Because market inputs are usually observed post-tax, many entities model post-tax cash flows at a post-tax rate and then derive the pre-tax rate that gives the same value in use. The Basis for Conclusions accepts that the two approaches should give the same answer in principle, but the pre-tax rate must be calculated, not approximated, and it is the rate that is disclosed (paragraph 134(d)(v)).

Practical example: Abu Dhabi Co's hotel unit

Abu Dhabi Co acquired a resort hotel business several years ago. The hotel is a separate CGU, and goodwill from the acquisition is allocated to it. At 31 December 2025, the carrying amount of the CGU is as follows.

Occupancy fell during 2025 as two new resorts opened nearby, and the hotel missed its budget by 15%. Management uses value in use. Its forecast assumes occupancy recovers gradually from 64% in 2025 to 72% by 2028 and then stays flat, and average daily rate grows by 3% a year. These assumptions sit at or below the competitive set, are supported by tourism authority arrivals data and the confirmed supply pipeline, and treat the two new resorts as permanent competition. The 2025 shortfall was traced to a slower ramp-up of corporate bookings than budgeted, and the 2026 forecast was rebuilt from 2025 actuals rather than from the original budget. Cash flows grow faster than revenue because most of the hotel’s costs are fixed. The forecast includes no benefit from any uncommitted refurbishment. Its forecast assumes occupancy recovers gradually as the new supply is absorbed, supported by tourism authority arrivals data and back-tested against 2025 actuals. The management-approved budget for 2026 and the strategic plan for 2027 to 2030 give the following post-tax cash flows, after maintenance capital expenditure and UAE corporate tax at 9%. The post-tax discount rate is 9.5%, and the terminal growth rate is 2.5%. Management models value in use on a post-tax basis. The equivalent pre-tax rate that gives the same value in use is derived iteratively and is about 10.2%; a simple gross-up (9.5% ÷ 0.91) would give 10.4%. The 10.2% is the rate disclosed.

Note: this is illustrative and ignores tax shields. Real tax cash flows would shift it, which is the point of deriving it rather than grossing up.

The terminal value is calculated as the 2030 cash flow grown by 2.5%, divided by the difference between the discount rate and the growth rate. That gives AED 124.5 million at the end of 2030, or AED 79.1 million in present value terms. Adding the present value of the five forecast years, AED 28.9 million, gives a value in use of AED 108.0 million. A broker’s indicative valuation, net of estimated costs of disposal, suggests a fair value less costs of disposal of about AED 104 million. This is lower than value in use, so value in use of AED 108.0 million is the recoverable amount, being the higher of the two (paragraph 18).

The carrying amount of AED 120.0 million exceeds the recoverable amount of AED 108.0 million by AED 12.0 million. The impairment loss is allocated first to goodwill, and only then to the other assets of the CGU pro rata to their carrying amounts. No individual asset can be reduced below the highest of its fair value less costs of disposal, its value in use and zero.

The journal entry at 31 December 2025 is a debit of AED 12,000,000 to impairment loss in profit or loss and a credit of AED 12,000,000 to accumulated impairment of goodwill. No deferred tax arises on the goodwill impairment. IAS 12 does not allow a deferred tax liability on the initial recognition of goodwill (paragraph 15(a)), and the same applies to later reductions in it (paragraph 21B). This assumes the goodwill is not deductible for tax; if it is, deferred tax would need to be considered.. The impairment of goodwill is not reversed in later periods, even if the hotel's performance recovers.

How close was the call?

After the impairment, the CGU's carrying amount equals its recoverable amount, so there is no headroom left. Any adverse movement in a key assumption would lead to a further impairment. This is the kind of analysis that supports the sensitivity disclosure required