Recoverable Amount

Definition of Recoverable Amount

The recoverable amount of an asset is an accounting concept that represents the higher of the asset’s net realizable value (NRV) and its value in use (VIU). This value is essential for determining whether an asset has been impaired. It ensures that the recorded value of the asset does not exceed the amount that is recoverable through its use or sale.

Key Components:

Net Realizable Value (NRV): NRV is the estimated selling price of an asset in the ordinary course of business, less any costs necessary to complete the sale.
Value in Use (VIU): VIU refers to the present value of future cash flows expected to be derived from an asset.

An asset is considered impaired if its carrying amount exceeds its recoverable amount. In such cases, companies are required to write down the asset to its recoverable amount.

Examples of Recoverable Amount Usage

Example 1: Machinery in a Manufacturing Plant

A company owns a piece of machinery used in production. The carrying amount of the machinery is $100,000. The NRV is calculated to be $80,000, while the VIU, based on forecasted cash flows from using the machinery, is determined to be $90,000. The recoverable amount of the machinery would be the higher of the NRV ($80,000) and the VIU ($90,000). Thus, the recoverable amount is $90,000. If the carrying amount is greater than $90,000, an impairment loss must be recognized.

Example 2: Real Estate Property

A real estate company owns a property with a book value of $500,000. Its current sale price (NRV) is estimated to be $450,000. Based on future rental income projections, the VIU is calculated to be $475,000. The recoverable amount here is the higher of $450,000 (NRV) and $475,000 (VIU). Thus, the recoverable amount is $475,000. If the property’s carrying amount exceeds this, the company must record an impairment loss.

Frequently Asked Questions (FAQs)

What happens if the recoverable amount is less than the carrying amount?

If the recoverable amount is less than the carrying amount, the asset is considered impaired, and the carrying amount should be reduced to the recoverable amount. This reduction is recognized as an impairment loss in the income statement.

How often should recoverable amounts be assessed?

Recoverable amounts should be assessed whenever there is an indication that an asset may be impaired. Additionally, certain assets like goodwill and intangible assets with indefinite useful lives must be tested for impairment at least annually.

Can the recoverable amount change over time?

Yes, the recoverable amount can change due to variations in market conditions, operational performance, or other factors that affect an asset’s value. Companies must reassess the recoverable amount when new information indicates that it might have changed significantly.

What is the impact of an impairment loss on financial statements?

An impairment loss reduces the carrying amount of the asset on the balance sheet and is also recognized as an expense in the income statement, thereby reducing net income for the period.

Are there specific accounting standards that provide guidance on recoverable amounts?

Yes, International Financial Reporting Standards (IFRS) such as IAS 36 “Impairment of Assets” and US Generally Accepted Accounting Principles (GAAP) provide guidance on determining recoverable amounts and handling asset impairments.

Net Realizable Value (NRV): The estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.
Value in Use (VIU): The present value of the future cash flows expected to be derived from an asset or cash-generating unit.
Impairment Loss: The amount by which the carrying amount of an asset exceeds its recoverable amount.
Carrying Amount: The amount at which an asset is recognized in the balance sheet under accrual accounting standards.
Present Value (PV): The current value of future cash flows, discounted at a specific rate that reflects the time value of money.

Online References

Suggested Books for Further Studies

“Financial Accounting and Reporting” by Barry Elliott and Jamie Elliott
“Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
“Wiley IFRS 2021: Interpretation and Application of IFRS Standards” by PKF International Ltd
“International Financial Statement Analysis” by Thomas R. Robinson, Elaine Henry, Wendy L. Pirie, Michael A. Broihahn

Accounting Basics: “Recoverable Amount” Fundamentals Quiz

### What represents the recoverable amount of an asset? - [ ] The lower of its net realizable value and value in use. - [x] The higher of its net realizable value and value in use. - [ ] Only its net realizable value. - [ ] Only its value in use. > **Explanation:** The recoverable amount is deemed to be the higher of an asset's net realizable value (NRV) and its value in use (VIU). ### What does net realizable value (NRV) represent? - [ ] The initial cost minus accumulated depreciation. - [x] The estimated selling price less costs to sell. - [ ] The amount the asset is insured for. - [ ] The future expected cash flows discounted to present value. > **Explanation:** NRV is the estimated selling price in the ordinary course of business, less any costs to make the sale. ### Which of the following would not typically necessitate an impairment review? - [x] Routine repairs and maintenance. - [ ] Significant adverse changes in technology that affect the asset. - [ ] A decrease in market value of the asset. - [ ] Evidence of physical damage to the asset. > **Explanation:** Routine repairs and maintenance do not typically necessitate an impairment review as they are part of normal operational procedures. ### Why might an asset's carrying amount be reduced? - [ ] To increase depreciation expenses. - [x] Because its carrying amount exceeds the recoverable amount. - [ ] To reduce taxable income. - [ ] Because the market demands it. > **Explanation:** An asset's carrying amount is reduced through an impairment loss when it exceeds the asset's recoverable amount. ### What is value in use (VIU)? - [ ] The resale price of the asset. - [ ] The historical cost of the asset. - [x] The present value of future cash flows expected from the asset. - [ ] The estimated selling price minus costs to sell. > **Explanation:** VIU is the present value of future cash flows expected to be derived from an asset or cash-generating unit. ### How is impairment loss reflected on financial statements? - [x] As an expense in the income statement. - [ ] As a reduction in liabilities. - [ ] As an extraordinary gain. - [ ] It is not reflected on financial statements. > **Explanation:** Impairment loss is an expense in the income statement, reducing the net income for the period. ### When should an impairment test be conducted? - [ ] Only during annual financial audits. - [ ] Every three years. - [x] Whenever there is an indication that an asset may be impaired. - [ ] Only when dictated by management. > **Explanation:** Impairment tests should be conducted whenever there are indications that an asset may be impaired, in addition to specific annual tests for certain assets. ### What results if the recoverable amount is greater than the carrying amount? - [ ] An impairment loss. - [ ] Deferred tax liability. - [ ] No adjustment is needed. - [x] No impairment loss and potentially a reversal if previously impaired. > **Explanation:** If the recoverable amount exceeds the carrying amount, no impairment loss is recorded and, if there was a previous impairment, a reversal may be possible subject to accounting standards. ### Which standard provides detailed guidance on impairment of assets? - [x] IAS 36 under IFRS. - [ ] IAS 2 under IFRS. - [ ] ASC 606 under US GAAP. - [ ] ASC 210 under US GAAP. > **Explanation:** IAS 36 under IFRS provides detailed guidance on the impairment of assets. ### What is the primary goal of calculating the recoverable amount? - [ ] To ensure the financial statements are conservative. - [x] To determine if an asset has been impaired and needs to be written down. - [ ] To estimate future sales performance. - [ ] To allocate costs to different departments. > **Explanation:** The primary goal is to determine if an asset has been impaired and needs to be written down to its recoverable amount.

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