Impairment Made Easy: When Financial Assets Go Bad

7 Aug

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As a Chartered Business Accountant in Practice, you work with clients who rely on you to prepare financial statements that reflect their true financial position. One area that often needs close attention is financial assets. When customers cannot pay, when loans become doubtful, or when investments lose value, you need to recognise an impairment loss.

This article explains how to apply impairment under Section 11 of the IFRS for SMEs Standard. We look at what the standard says in paragraphs 11.21 to 11.26 and give you practical examples to help you apply it in your own work.

What Is Impairment?

Impairment is a reduction in the value of a financial asset. It happens when there is real evidence that your client will not receive the full amount that was expected. This may be because the customer is in financial difficulty, the borrower has defaulted on a loan, or the value of an investment has dropped permanently.

Impairment does not happen because of general concerns or market noise. It happens because of clear and specific evidence.

When Must You Assess for Impairment?

At the end of each reporting period, you must check whether any financial assets measured at cost or amortised cost are impaired.

This includes:

Trade receivables or debtors
Loans to employees, directors, or other businesses
Investments in shares that are not measured at fair value

You must do this every year. You cannot wait until something becomes a legal dispute.

Signs That a Financial Asset Might Be Impaired

The standard gives examples of what counts as objective evidence. These include:

The customer or borrower is in serious financial difficulty
There has been a breach of contract, such as missed interest or capital payments
Your client has given easier terms that they would not normally offer, such as payment holidays or waiving interest
It is likely that the customer or borrower will go into liquidation or restructure
There is evidence that expected future cash flows will be less than what was first expected, such as poor economic conditions in the client’s industry

You do not need all of these signs. One clear and proven sign is enough to recognise an impairment.

Step-by-Step: How to Apply Impairment

Step 1: Look at Each Financial Asset

You must look at each significant asset on its own. This includes larger loans and all shares or equity investments. For trade receivables, you may group them based on risk level or how long they have been outstanding.

Step 2: Check for Evidence of Impairment

Ask yourself some basic questions:

Has the customer or borrower paid late?
Have they asked for longer payment terms?
Are they still operating normally?
Is there any news about business problems?

If there is evidence that they may not pay the full amount, you must assess for impairment.

Step 3: Calculate the Impairment Loss

The way you calculate the impairment depends on how the asset is measured.

A. If the Asset Is Measured at Amortised Cost

This applies to most loans and long-term receivables.

You must estimate how much your client now expects to receive. Then you discount that amount using the original interest rate that was applied when the asset was first recorded.

The difference between the asset's carrying amount and the discounted expected cash flows is the impairment loss.

Example: Your client loaned R100,000 to a supplier at 10 percent interest. Due to the supplier’s financial problems, only R60,000 is expected to be repaid in three years. Discounting R60,000 at 10 percent gives a present value of around R45,000. Your client must now recognise an impairment loss of R55,000.

B. If the Asset Is Measured at Cost

This applies to some investments in shares or instruments where fair value is not available.

You must estimate how much the investment is worth now. If the company has closed or is under liquidation, the value may be zero. The impairment loss is the difference between the recorded value and the estimated recoverable value.

Step 4: Record the Impairment

Once the loss is calculated, your client must record the impairment loss in profit or loss. The carrying value of the asset must be reduced accordingly. This ensures that the financial statements reflect a fair and accurate position.

Step 5: Consider Reversals in Future Periods

If things improve in a future year, and there is clear evidence that the asset has regained value, the impairment can be reversed. The reversal must be based on new information that confirms that the situation has changed. You cannot reverse more than what was written down, and you must not reverse based on hope or short-term market recovery.

Practical Examples from Everyday Practice

Example 1: Debtor Has Not Paid for 8 Months

A customer owes R12,000. The invoice is 8 months overdue. The business owner says the customer is struggling. You estimate that only R5,000 will be recovered.

Action: Record an impairment loss of R7,000.

Example 2: Loan to Director with No Repayments

A director borrowed R100,000 three years ago. No payments have been made. The director is now unemployed and cannot repay.

Action: If there is no reasonable chance of repayment, the full amount must be impaired.

Example 3: Investment in a Private Company

Your client invested R50,000 in a small start-up. The company shut down and has no assets to repay investors.

Action: Record a full impairment of R50,000.

Why Impairment Matters

Impairment is about being realistic. It helps financial statements reflect the value that is likely to be collected. As a Business Accountant in Practice, you help your clients avoid overstating assets or profits. You also protect your own professional standing by applying the standard correctly.

Final Thought

Impairment is not about complex models. It is about good judgment based on real evidence. If you can see that an asset is unlikely to be fully recovered, it is your job to measure the loss and account for it.

Apply these five steps every year:

Review each financial asset.
Look for signs of loss or doubt.
Estimate the recoverable amount.
Record the loss in profit or loss.
Reverse it only if the facts have changed.

Getting this right gives your client better information and strengthens the value of your work.

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