For most companies, when taking on the transition to IFRS 16 ‘Leases’, the standard has been reviewed in isolation. However, with IFRS 16 bringing on ‘right of use’ (‘ROU’) assets, a question that we are being asked is how you factor these ROU assets into your impairment assessment under IAS 36 ‘Impairment of Assets’.

The initial step of an IAS 36 impairment exercise is to determine which assets should be assessed for impairment in their own right. For an asset to be individually assessed for impairment it needs to generate independent cash flows. ROU assets are not specifically referenced in IAS 36 so it is unclear as to whether or not these assets would generate independent cash flows. Considering the nature of the asset that is being brought on balance sheet, the ROU asset reflects an entity’s ability to use an underlying leased asset to generate cash flows. A judgement will need to be made here and for the purposes of this article we are considering how the ROU asset should be treated if it does not generate cash flows in its own right

Where an asset does not generate cash flows in its own right, IAS 36 requires that the asset is allocated to a Cash Generating Unit (‘CGU’), being ‘the smallest group of assets that generate cash inflow that are largely independent of each other’. Identifying the CGU’s for a business can be time consuming and complexFor the purposes of this exercise, we have not considered how companies will identify an appropriate CGU.

IAS 36 (para 24.27) requires that ‘the carrying value of each CGU containing the assets and goodwill being reviewed should be compared with the higher of its value in use (‘ViU’) and fair value less costs of disposal (‘FVLCTD’). The initial question that companies will need to answer is whether they can sell an ROU asset (i.e. if there is a ‘FVLCTD’). If the decision is that you can sell an ROU asset (which we consider unlikely), the FVLCTD can be included within an assessment of the wider CGU FVLCTD. Otherwise, the value in use should be determined. 

Which balances and cash flows should be included in the assessment?

Most companies looking at performing an assessment of ViU incorporating IFRS 16 are asking how the ROU asset and lease payments are included in the calculation of the carrying value of the CGU. As the aim of the impairment test is to assess whether the ROU asset is impaired, the ROU asset would need to be included in the carrying value of the CGU. When considering how to treat the lease liability, IAS 36 (para 75) states that ‘the carrying amount of a cash-generating unit shall be determined on a basis consistent with the way the recoverable amount of the cash-generating unit is determined.’

In determining the recoverable amount of the CGU, IAS 36 (para 50) requires that estimates of future cash flows (that would be used in a ViU calculation) shall not include:

a)     Cash inflows or outflows from financing activities; or

b)     Income tax receipts of payments

Financing activities include lease arrangements and therefore in estimating the future cash flows for the ViU calculation all associated payments should be removed. Returning to how to treat the lease liability; if the lease payments are not part of the cash flows used to determine the recoverable amount of the CGU, the lease liability should not form part of the carrying value of the CGU. Therefore in summary:

·        Include the ROU asset as part of the carrying value of the CGU;

·        Exclude the lease liability from the carrying value of the CGU; and

·        Exclude the associated lease payments from the estimate of future cash flows used as part of the ViU assessment.

What about discount rates?

Following on from the first question about which balances and cash flows should be included, the second question is what discount rate I should use. 

When assessing the ViU of an individual asset or CGU, the estimate of future cash flows need to be present valued using an appropriate discount rate.

Again looking at the guidance within IAS 36 (para 55) states that:

The discount rate (rates) shall be a pre-tax rate (rates) that reflect(s) current market assessments of: 

  (a) the time value of money; and 

  (b) the risks specific to the asset for which the future cash flow estimates have not been adjusted. 

Paragraphs 56 and 57, provides further detail that an appropriate rate would be:

A rate that reflects current market assessments of the time value of money and the risks specific to the asset is the return that investors would require if they were to choose an investment that would generate cash flows of amounts, timing and risk profile equivalent to those that the entity expects to derive from the asset. This rate is estimated from the rate implicit in current market transactions for similar assets or from the weighted average cost of capital of a listed entity that has a single asset (or a portfolio of assets) similar in terms of service potential and risks to the asset under review....(para 56)

When an asset-specific rate is not directly available from the market, an entity uses surrogates to estimate the discount rate (para 57).

Having the guidance is helpful, however the next question is what does this mean in practice?

If assessing an ROU asset separately for impairment, an appropriate discount rate may be the rate implicit in the lease or the incremental borrowing rate (as both of these rates would be a good proxy for the return that an investor would expect). Any rate that is used needs to be a ‘current’ market related rate at the time the assessment is performed and it may be that the rates used (e.g. rate implicit in the lease) may change from inception.

When including the ROU as part of a CGU, the discount rate would be the return that would be expected from that specific CGU (from a market participant perspective). In this situation, using the rate implicit in the lease or incremental borrowing rate would not be appropriate. Any existing rates determined for CGU’s (for example an entity specific weighted average cost of capital) may need to be adjusted for the addition of the ROU asset, with an assessment made for how a market participant would assess the change.


On your initial review of IFRS 16, you may have considered it a relatively straight forward accounting standard to implement, however the closer we move to its adoption date, we are identifying many areas where this seemingly simple standard is making our lives more challenging. Understanding the implications to your impairment analysis and process is only one example of where IFRS 16 impacts your wider financial reporting. We are already helping a number of companies answer these types of questions, so if you need support, we are here.  


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