As detailed in sections 27.11 to 27.13 of FRS 102, where one method shows the recoverable amount is in excess of the carrying amount, then the second method does not have to be completed. For example, if fair value less cost to sell indicates the recoverable amount is greater than the carrying amount, then the entity does not have to calculate the value in use.

If the value in use calculation indicates an impairment but the fair value less cost to sell method does not (or vice versa), then no impairment should be booked even where the entity has no intention of selling the asset. This is because the recoverable amount is defined to be the higher of the fair value less costs to sell and the value in use, and so only the higher figure is considered; the lower value, which may indicate an impairment, is not considered. The two methods are discussed in turn below:

Fair value less costs to sell

Sections 27.14 – 27.14A of FRS 102 provide guidance on determining fair value less costs to sell. Ideally, these figures should be based on an active market, or a binding sale agreement where this is available. However, there may not be active markets for all tangible and intangible fixed assets, or trade cash-generating units (CGUs).

In such instances, then the fair value can be based on recent transactions of identical nature. Where this is not possible valuation techniques should be used. One example of an appropriate valuation technique is a discounted cash flow model. Such a model should incorporate assumptions that market participants would use in estimating the asset’s fair value. The model should prioritise the use of market inputs and rely as little as possible on entity-determined inputs. A valuation technique would be expected to arrive at a reliable estimate of fair value if:

• It reasonably reflects how the market could be expected to price the asset; and
• The inputs to the valuation technique reasonably represent market expectations and measures of the risk of return factors inherent in the asset (Section 2A.3).

The model should utilise the models that are used by investors in assessing the fair value; models may vary based on sector, asset type or other factors. For example, hotels generally sell on a multiple of EBITDA, whereas discounted cash flows are usually used for manufacturing companies. The assumptions in whatever model should be based on the assumptions other market participants would use and should not be based on management's uncorroborated views or information not known by the market.

Where an active market does not exist but a valuation model is used, the advantage of using the fair value (less costs to sell) model above the value in use model is that that model can incorporate any future capital expenditures any third-party investor would incur to enhance the cash flows or restructuring that would be carried out. Under the value-in-use model, any future capital which enhances the level of performance above the current performance cannot be included in the cash flows.

Value in use

In reality, it is not always easy to determine the fair value so it is likely that entities will default to the value in-use model, which is defined as being the present value of future cash flows expected to be derived from an asset.

Value in use can be determined on an asset basis or where there is no independent cash flows from that asset, the smallest CGU which incorporates this asset. Value in-use calculations at the level of CGU will be required where the fair value less cost to sell cannot be determined or where this is below the carrying amount and:

1. goodwill is suspected of being impaired;
2. a CGU itself is suspected of being impaired; or
3. individual assets are suspected of being impaired and individual future cash flows cannot be identified for them.

Section 27.19 of FRS 102 makes it clear that future cash flows should only be estimated in its current condition. It cannot incorporate any future reconstructions not committed nor can it include cash outflows for purchasing fixed assets which enhance the cash flow generation possibilities for the entity. Therefore, in reality, the only capital expenditure that should be incorporated into the model is the cost of maintaining the current fixed assets at their current condition and any replacement expenditure on the assets making up a larger asset that requires replacement at various intervals and is depreciated over a shorter life than the main asset. In addition, it should incorporate normal repairs and maintenance costs for maintaining the assets.

Where an entity is committed to future reconstructions which will result in cost savings these may be included in the future cash flows.

The four steps to calculating value in use are:

1. divide the entity into CGUs where an asset does not have independent cash flows;
2. estimate the future pre-tax cash flows of the CGU under review;
3. identify an appropriate discount rate and discount the future cash flows; and
4. compare the carrying value with the value in use, along with the fair value less costs to sell, and recognise the impairment loss where applicable.