The objective of IAS 36 is to ensure that the Company's assets are carried at no more than their recoverable amount. An asset is carried at more than its recoverable amount if its carrying amount exceeds the amounts to be recovered through use or sales of the asset. If the carrying amount > recoverable amount, the asset have to be impaired.
IAS 36 is considered extremely for financial statement users. Let's illustrate a scenario where no Company does not apply IAS 36 appropriately.
Company ABC have recorded a few machineries in its accounting books for the year ended 31 Dec 2008. However, due to excessive usage of the machineries & improper maintenance, the machineries are at the end of its life cycle with approximately nil value. Company ABC is going to scrap off the machineries in one month time. However, in the book, the Machineries have a net book value of US$1million.
A few investors are in the process of taking over Company ABC. While reviewing the Company ABC's financial statement, they are more than happy to find out that the Company has US$1million worth of machineries on hand. As such, they are willing to pay another US$1million on top of the initial offer price!
If IAS 36 has been applied appropriately, the Company should have impaired the Machineries to its recoverable amount. Investors would not have paid another US$1mil for the end-of-life machineries. Hence, it is important to carry out proper impairment testing for significant assets on the Company's books.