One of the fundamental principles of accounting is that the financial statement should be prepared on a basis that is understandable and presents a true and fair view of the subject matter of the accounts and the financial situation of the accounting entity. With regard to the regular recognition of wear and tear of non-current assets through accounting depreciation (depreciation reserves), non-current assets may remain neglected in this respect and the accounting entity may not work with this area of accounting any further, or does not take into account and evaluate other facts that may indicate the grounds for impairment of assets recorded in the accounting. Asset impairment may also occur due to external and internal influences, as we discuss below. Thus, an entity should reflect in its accounting the impact of all known or potential effects, i.e. regularly assess the utility value and actual value of an asset and, if impairment is identified, reflect this in its accounting.

One of the latest Interpretations of the National Accounting Council (hereinafter the NAC) [1], I-45 Impairment of Tangible and Intangible Non-current Assets – Testing and Recognition, addresses this very issue, which we would like to present to our readers in this article and we would like to answer the questions of when and how an accounting entity tests non-current assets for impairment or how any impairment or changes in the value of an asset should be captured in the accounting.

It should be noted that even before this Interpretation, an accounting entity was required to test individual assets and assess, whether their value recorded in the accounting records (accounting value) corresponded to reality. The interpretation of the NAC only additionally helps with the actual application in practice, so it is not a “revolutionary” novelty in the accounting and obligations on the part of the accounting entity.

Under article 25 paragraph 3 of Act No. 563/1991 Coll., on Accounting (hereinafter the “AA”), accounting entities are obliged to take into account any risks and possible losses related to the impairment of an owned asset as of the end of the balance sheet date, regardless of the profit or loss achieved in the current period. This is done, among other things, by means of regular inventory-taking, in which accounting units determine the actual condition of assets and any reasons for recording impairment.

Impairment of assets is also treated in the Czech Accounting Standard for Entrepreneurs No. 005, entitled Provisions, which states that provisions for depreciated non-current assets, the use value of which is in practice reduced by wear and tear, are made in cases where their utility value determined in an inventory is significantly lower than their valuation in the accounting records after deduction of depreciation reserves, and such lowering of value cannot be considered definitive (permanent).

To that end, an entity should assess whether there is any indication that an asset is impaired at least annually, but always as of balance sheet date or another date, at which the financial statement is prepared. Indications can be both external and internal. External indications include a decline in the market value of an asset, technological or legislative changes, market developments representing the loss of a significant customer or the entry of a competitor into the market. Internal indications refer to deterioration or obsolescence of the asset, changes in the use or efficiency of the asset.

If, on the basis of the above indications, there is a presumption that a non-current asset is impaired, the entity determines the amount of impairment for the assets concerned by using the recoverable amount, which is determined to be the higher of the following:

1. fair value of the asset minus the costs to sell it; and
2. value in use, which represents the discounted net operating cash flows that an asset or group of assets generates.

If the recoverable amount is lower than the residual value of the asset, the entity is obliged to reduce the accounting (residual) value of the non-current asset by the difference through a provision
for non-current assets. Under article 56 paragraph 4 of Decree No. 500/2002 Coll., which implements certain provisions of the Accounting Act, the accounting entity shall make a corresponding adjustment to the depreciation plan for the asset, so that future depreciation reflects the fact that the residual cost of the asset has decreased. The entity also assesses the possibility of adjusting the residual value of the asset that is taken into account in depreciation.

If the assumption of impairment of the tested asset ceases to exist, the accounting entity decides to redetermine the recoverable amount of the asset. If that amount exceeds the residual value of the asset, the entity derecognises a provision, but only up to the maximum amount that the asset would have had, if no impairment loss had been recognised in the past. At the same time, the entity shall consider adjusting the depreciation plan for the given asset, so that subsequent depreciation reflects the fact that the residual cost of the asset has increased.

The interpretation itself describes the issue in more detail, including assumptions, conclusions and justifications, which can be viewed on the NAC website – www.nur.cz in the Approved Interpretations section. 

If you are dealing with accounting cases related to the impairment of non-current assets, if you are planning to adopt interpretations in your accounting policies, or if this represents a change in your current approach and you would like to consult us about it, please do not hesitate to contact us, as we are among the experts who are involved in the development of individual interpretations of the NAC. 

[1] The National Accounting Council is an independent professional institution dedicated to promoting professional competence in the development of the accounting professions and methodology. The main mission of the NAC is to cooperate with the Finance Ministry, other governmental, legislative and other institutions on the development of legislation and related standards focusing on accounting and cooperation in the development of accounting professions.