How Impairment of Cash-Generating Units Is Modeled Under IAS 36 Using Multi-Scenario Discounted Cash Flows

Impairment testing of Cash-Generating Units (CGUs) under IAS 36 – Impairment of Assets represents one of the most technically demanding areas in advanced financial reporting. When individual assets do not generate largely independent cash inflows, IFRS requires that they be grouped into CGUs and tested for recoverability whenever indicators of impairment arise—or annually in the case of goodwill and certain intangibles.

Modern practice goes beyond single-scenario modeling and increasingly incorporates multi-scenario discounted cash-flow (DCF) analyses, probability-weighted valuations, and sensitivity testing across assumptions such as growth rates, discount rates, pricing structures, regulatory shifts, and macroeconomic uncertainty. These models produce a recoverable amount that must be compared against the CGU’s carrying amount to determine whether impairment is required.

Because CGUs often include goodwill, brands, customer lists, and complex operational assets, the impairment process influences reported profit, equity balances, and comparability across reporting periods.

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IAS 36 requires CGU impairment testing when assets do not generate independent cash flows and must be evaluated as a combined unit.

Under IAS 36, a Cash-Generating Unit is the smallest group of assets that generates cash inflows largely independent from other assets. CGUs typically arise when assets operate together or contribute jointly to cash generation.

Examples include:

• Retail stores operating under a unified brand

• Manufacturing plants with integrated production lines

• Business divisions with shared distribution channels

• Technology platforms with interdependent modules

• Service portfolios that rely on centralized staff or infrastructure

CGU determination is a critical judgment. Too broad a CGU may mask impairment; too narrow a CGU may create artificial volatility.

IAS 36 requires impairment testing when indicators exist (e.g., declining margins, asset underperformance, regulatory changes). For CGUs containing goodwill or indefinite-life intangibles, testing is mandatory at least annually.

The recoverable amount is the higher of:

1. Value in Use (VIU) – Present value of future cash flows

2. Fair Value Less Costs of Disposal (FVLCD) – Market-based valuation

Multi-scenario DCF models are typically applied under VIU when observable market inputs are limited.

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Value-in-use calculations require multi-scenario modeling of future cash flows, growth assumptions, discount rates, and terminal values.

IAS 36 mandates that VIU be calculated using:

• Cash flows from continuing use of the CGU

• Cash flows from ultimate disposal (if any, excluding future restructurings not yet committed)

• Pre-tax discount rates reflecting current market assessments of the time value of money and risks specific to the CGU

In advanced practice, corporations build multi-scenario DCF models that weigh multiple potential outcomes:

• Base-case operational expectations

• Downside scenarios reflecting pricing pressure or demand declines

• Upside scenarios reflecting strategic expansion

• Inflation and cost-volatility cases

• Regulatory or technological disruption scenarios

Each scenario includes:

• Revenue projections

• Margin evolution

• Operating cost structures

• Capital expenditure requirements

• Working-capital behavior

• Terminal growth estimates (often conservative under IAS 36)

Probability-weighted cash flows improve accuracy when outcomes are uncertain. The weighted VIU is then compared to the carrying amount to determine impairment.

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Recoverable amount measurement requires careful selection of discount rates, risk adjustments, and scenario probabilities.

Discount rate selection is one of the most sensitive elements in CGU impairment testing. IAS 36 requires a pre-tax discount rate but allows entities to derive it from post-tax inputs if converted appropriately.

Key considerations:

• Weighted Average Cost of Capital (WACC) adjusted for CGU-specific risk

• Country risk premiums for multinational groups

• Leverage adjustments when capital structures differ from observable peers

• Inflation consistency between cash flows and discount rates

• Treatment of currency-specific risks in multi-currency CGUs

Probability weighting influences the overall recoverable amount. Typical structures include:

• Base case: 50–70%

• Downside: 20–40%

• Upside: 10–20%

The weighted scenarios generate a final recoverable amount that accounts for operational uncertainty.

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Key Modeling Elements in Multi-Scenario CGU Impairment Analysis

Element	Description
Scenario Design	Base, upside, downside, regulatory, macro-stress cases
Cash-Flow Horizon	Usually 5 years, extendable for long-life assets
Terminal Value	Conservative growth rate aligned with long-term GDP
Discount Rate	Pre-tax WACC adjusted for CGU-specific risks
Foreign Currency	Modeled in local currency with translation consistency
Probability Weighting	Applied to reflect realistic outcome distribution
Goodwill Allocation	Mandatory allocation of goodwill to CGUs for testing

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Journal entries reflect the impairment loss, allocation among assets, and reduction of goodwill when necessary.

When a CGU’s carrying amount exceeds its recoverable amount, IAS 36 requires the entity to recognize an impairment loss.

The allocation is:

1. First to goodwill, until written down to zero

2. Then pro-rata across other assets in the CGU (excluding certain exceptions such as inventory or deferred tax assets)

Recording the impairment loss:

• Debit: Impairment Loss (P&L)

• Credit: Goodwill (to the extent available)

• Credit: Property, Plant & Equipment / Intangibles (if further write-down is required)

If the recoverable amount increases in future periods, reversals are allowed under IFRS for assets other than goodwill. Goodwill impairment, however, is never reversed.

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Impairment testing affects profit volatility, equity movements, strategic decisions, and investor perception.

Impairment charges impact:

• Profit before tax – losses recognized immediately

• Equity – reduction through retained earnings

• Return on Assets (ROA) – lowered due to write-downs

• Capital allocation – influences management decisions on reinvestment or divestiture

• Debt covenants – impairment may affect leverage ratios

• Market perception – recurring impairments may signal structural issues

IAS 36 requires extensive disclosures when CGUs with significant carrying values or goodwill are tested, including:

• Key assumptions (growth rates, discount rates)

• Sensitivities to key inputs

• Description of scenario design

• Approach to probability weighting

• Explanation of why certain inputs are deemed reasonable

These disclosures help users understand how robust the impairment assessment is.

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Operational challenges include data quality, forecasting accuracy, allocation of shared costs, and governance over model assumptions.

Large organizations face practical challenges when implementing IAS 36 impairment testing, such as:

• Aligning internal forecasts with budgeting cycles

• Ensuring consistent allocation of corporate overhead to CGUs

• Modeling multi-currency exposures accurately

• Integrating risk assessments into discount rate calculations

• Documenting management judgment for auditors and regulators

• Maintaining audit trails for changes in assumptions

• Managing tension between operational optimism and IFRS conservatism

Automation and centralized modeling frameworks are increasingly used to standardize impairment testing across multiple CGUs and jurisdictions.

Accurate multi-scenario modeling ensures a realistic and transparent assessment of asset recoverability, maintains investor confidence, and supports sound corporate governance.

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