Measuring recoverable amount
(paragraphs 18-57)
BCZ 9 In determining the principles that should govern the measurement of recoverable amount, IASC considered, as a first step, what an enterprise will do if it discovers that an asset is impaired. IASC concluded that, in such cases, an enterprise will either keep the asset or dispose of it. For example, if an enterprise discovers that the service potential of an asset has decreased:
(a) the enterprise may decide to sell the asset if the net proceeds from the sale would provide a higher return on investment than continuing use in operations; or
(b) the enterprise may decide to keep the asset and use it, even if its service potential is lower than originally expected. Some reasons may be that:
(i) the asset cannot be sold or disposed of immediately;
(ii) the asset can be sold only at a low price;
(iii) the asset's service potential can still be recovered but only with additional efforts or expenditure; or
(iv) the asset could still be profitable although not to the same extent as expected originally.
IASC concluded that the resulting decision from a rational enterprise is, in substance, an investment decision based on estimated net future cash flows expected from the asset.

BCZ 10 IASC then considered which of the following four alternatives for determining the recoverable amount of an asset would best reflect this conclusion:
(a) recoverable amount should be the sum of undiscounted future cash flows.
(b) recoverable amount should be the asset's fair value: more specifically, recoverable amount should be derived primarily from the asset's market value. If market value cannot be determined, then recoverable amount should be based on the asset's value in use as a proxy for market value.
(c) recoverable amount should be the asset's value in use.
(d) recoverable amount should be the higher of the asset's net selling price and value in use.*
Each of these alternatives is discussed below.
* In IFRS 5 Non-current Assets Held for Sale and Discontinued Operations, issued by the IASB in 2004, the term, 'net selling price' was replaced in IAS 36 by 'fair value less costs to sell'.

BCZ 11 It should be noted that fair value, net selling price and value in use all reflect a present value calculation (implicit or explicit) of estimated net future cash flows expected from an asset:
(a) fair value reflects the market's expectation of the present value of the future cash flows to be derived from the asset;
(b) net selling price reflects the market's expectation of the present value of the future cash flows to be derived from the asset, less the direct incremental costs to dispose of the asset; and
(c) value in use is the enterprise's estimate of the present value of the future cash flows to be derived from continuing use and disposal of the asset.
These bases all consider the time value of money and the risks that the amount and timing of the actual cash flows to be received from an asset might differ from estimates. Fair value and net selling price may differ from value in use because the market may not use the same assumptions as an individual enterprise.
Recoverable amount based on the sum of undiscounted cash flows

BCZ 12 Some argue that recoverable amount should be measured as the sum of undiscounted future cash flows from an asset. They argue that:
(a) historical cost accounting is not concerned with measuring the economic value of assets. Therefore, the time value of money should not be considered in estimating the amount that will be recovered from an asset.
(b) it is premature to use discounting techniques without further research and debates on:
(i) the role of discounting in the financial statements; and
(ii) how assets should be measured generally.
If financial statements include assets that are carried on a variety of different bases (historical cost, discounted amounts or other bases), this will be confusing for users.
(c) identifying an appropriate discount rate will often be difficult and subjective.
(d) discounting will increase the number of impairment losses recognised. This, coupled with the requirement for reversals of impairment losses, introduces a volatile element into the income statement. It will make it harder for users to understand the performance of an enterprise.
A minority of commentators on E55 Impairment of Assets supported this view.

BCZ 13 IASC rejected measurement of recoverable amount based on the sum of undiscounted cash flows because:
(a) the objective of the measurement of recoverable amount is to reflect an investment decision. Money has a time value, even when prices are stable. If future cash flows were not discounted, two assets giving rise to cash flows of the same amount but with different timings would show the same recoverable amount. However, their current market values would be different because all rational economic transactions take account of the time value of money.
(b) measurements that take into consideration the time value of money are more relevant to investors, other external users of financial statements and management for resource allocation decisions, regardless of the general measurement basis adopted in the financial statements.
(c) many enterprises were already familiar with the use of discounting techniques, particularly for supporting investment decisions.
(d) discounting was already required for other areas of financial statements that are based on expectations of future cash flows, such as long-term provisions and employee benefit obligations.
(e) users are better served if they are aware on a timely basis of assets that will not generate sufficient returns to cover, at least, the time value of money.
Recoverable amount based on fair value

BCZ 14 IAS 32 Financial Instruments: Disclosure and Presentation and a number of other International Accounting Standards define fair value as:
"... the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's length transaction..."
BCZ 15 International Accounting Standards include the following requirements or guidance for measuring fair value:
(a) for the purpose of revaluation of an item of property, plant or equipment to its fair value, IAS 16 Property, Plant and Equipment indicates that fair value is usually an asset's market value, normally determined by appraisal undertaken by professionally qualified valuers and, if no market exists, fair value is based on the asset's depreciated replacement cost.
(b) for the purpose of revaluation of an intangible asset to its fair value, IASC proposed in E60 Intangible Assets that fair value be determined by reference to market values obtained from an active market. E60 proposed a definition of an active market.*
(c) IASC proposed revisions to IAS 22 (see E61 Business Combinations) so that fair value would be determined without consideration of the acquirer's intentions for the future use of an asset.†
(d) IAS 39‡ indicates that if an active market exists, the fair value of a financial instrument is based on a quoted market price. If there is no active market, fair value is determined by using estimation techniques such as market values of similar types of financial instruments, discounted cash flow analysis and option pricing models.
* IASC approved an International Accounting Standard on intangible assets in 1998.

† IASC approved revisions to IAS 22 Business Combinations in 1998.

‡ The IASB's project to revise IAS 32 and IAS 39 in 2003 resulted in the relocation of the requirements on fair value measurement from IAS 32 to IAS 39.

BCZ 16 Some argue that the only appropriate measurement for the recoverable amount of an asset is fair value (based on observable market prices or, if no observable market prices exist, estimated considering prices for similar assets and the results of discounted future cash flow calculations). Proponents of fair value argue that:
(a) the purpose of measuring recoverable amount is to estimate a market value, not an enterprise-specific value. An enterprise's estimate of the present value of future cash flows is subjective and in some cases may be abused. Observable market prices that reflect the judgement of the market place are a more reliable measurement of the amounts that will be recovered from an asset. They reduce the use of management's judgement.
(b) if an asset is expected to generate greater net cash inflows for the enterprise than for other participants, the superior returns are almost always generated by internally generated goodwill stemming from the synergy of the business and its management team. For consistency with IASC's proposals in E60 that internally generated goodwill should not be recognised as an asset, these above-market cash flows should be excluded from assessments of an asset's recoverable amount.
(c) determining recoverable amount as the higher of net selling price and value in use is tantamount to determining two diverging measures whilst there should be only one measure to estimate recoverable amount.
A minority of commentators on E55 supported measuring recoverable amount at fair value (based on observable market prices or, if no observable market prices exist, estimated considering prices for similar assets and the results of discounted future cash flow calculations).

BCZ 17 IASC rejected the proposal that an asset's recoverable amount should be determined by reference to its fair value (based on observable market prices or, if no observable market prices exist, estimated considering prices for similar assets and the results of discounted future cash flow calculations). The reasons are the following:
(a) IASC believed that no preference should be given to the market's expectation of the recoverable amount of an asset (basis for fair value when market values are available and for net selling price) over a reasonable estimate performed by the individual enterprise that owns the asset (basis for fair value when market values are not available and for value in use). For example, an enterprise may have information about future cash flows that is superior to the information available in the market place. Also, an enterprise may plan to use an asset in a manner different from the market's view of the best use.
(b) market values are a way to estimate fair value but only if they reflect the fact that both parties, the acquirer and the seller, are willing to enter a transaction. If an enterprise can generate greater cash flows by using an asset than by selling it, it would be misleading to base recoverable amount on the market price of the asset because a rational enterprise would not be willing to sell the asset. Therefore, recoverable amount should not refer only to a transaction between two parties (which is unlikely to happen) but should also consider an asset's service potential from its use by the enterprise.
(c) IASC believed that in assessing the recoverable amount of an asset, it is the amount that an enterprise can expect to recover from that asset, including the effect of synergy with other assets, that is relevant.
The following two examples illustrate the proposal (rejected by IASC) that an enterprise should measure an asset's recoverable amount at its fair value (primarily based on observable market values if these values are available).

Example 1
10 years ago, an enterprise bought its headquarters building for 2,000. Since then, the real estate market has collapsed and the building's market value at balance sheet date is estimated to be 1,000. Disposal costs of the building would be negligible. The building's carrying amount at the balance sheet date is 1,500 and its remaining useful life is 30 years. The building meets all the enterprise's expectations and it is likely that these expectations will be met for the foreseeable future. As a consequence, the enterprise has no plans to move from its current headquarters. The value in use of the building cannot be determined because the building does not generate independent cash inflows. Therefore, the enterprise assesses the recoverable amount of the building's cash-generating unit, that is, the enterprise as a whole. That calculation shows that the building's cash-generating unit is not impaired.
Proponents of fair value (primarily based on observable market values if these values are available) would measure the recoverable amount of the building at its market value (1,000) and, hence, would recognise an impairment loss of 500 (1,500 less 1,000), even though calculations show that the building's cash-generating unit is not impaired.
IASC did not support this approach and believed that the building was not impaired. IASC believed that, in the situation described, the enterprise would not be willing to sell the building for 1,000 and that the assumption of a sale was not relevant.

Example 2
At the end of 20X0, an enterprise purchased a computer for 100 for general use in its operations. The computer is depreciated over 4 years on a straight-line basis. Residual value is estimated to be nil. At the end of 20X2, the carrying amount of the computer is 50. There is an active market for second-hand computers of this type. The market value of the computer is 30. The enterprise does not intend to replace the computer before the end of its useful life. The computer's cash-generating unit is not impaired.
Proponents of fair value (primarily based on observable market values if these values are available) would measure the recoverable amount of the computer at its market value (30) and, therefore, would recognise an impairment loss of 20 (50 less 30) even though the computer's cash-generating unit is not impaired.
IASC did not support this approach and believed that the computer was not impaired as long as:
(a) the enterprise was not committed to dispose of the computer before the end of its expected useful life; and
(b) the computer's cash-generating unit was not impaired.