IAS 36 CGU Identification: Allocation & Testing

The cash-generating unit is the single most consequential judgement in IAS 36 Impairment of Assets. It sets the level at which recoverable amount is measured, the level at which goodwill is tested, and ultimately whether an impairment is recognised at all. Draw the boundary too widely and loss-making operations shelter behind profitable neighbours; draw it too narrowly and you may allocate goodwill you cannot support. (For readers arriving on terminology: the standard is IAS 36, an International Accounting Standard. There is no IFRS 36 — the number is sometimes miscited, but the impairment rules on CGUs, goodwill and recoverable amount all live in IAS 36.) This guide walks the full chain, from identifying a unit through to allocating an impairment loss with real journals, and shows exactly where the audit challenges land. For the wider mechanics of the test itself, start with our IAS 36 impairment hub and the sister note on value-in-use, WACC and terminal value.

How do you identify a cash-generating unit under IAS 36?

A cash-generating unit is the smallest identifiable group of assets that generates cash inflows largely independent of the cash inflows from other assets or groups of assets (IAS 36.6). The decisive test is independence of cash inflows — not how management organises reporting lines, cost centres or legal entities. You identify a CGU by asking, for the asset or group under review, whether there is an active market for its output and whether the cash it brings in stands on its own; if it does, that is the boundary (IAS 36.68–70).

IAS 36.66 requires an entity that cannot estimate the recoverable amount of an individual asset to fall back to the CGU to which the asset belongs, because most assets do not generate cash on their own. Two anchoring rules keep the exercise disciplined. First, if an active market exists for the output of an asset or group of assets, that asset or group is a CGU even where the output is used internally (IAS 36.70) — for example an in-house power station selling notionally to the rest of the group. Second, CGUs must be identified consistently from period to period for the same asset or type of asset, unless a change is justified (IAS 36.72). A quiet re-drawing of unit boundaries the year a loss would otherwise crystallise is exactly what auditors hunt for.

How assets are used and monitored is persuasive but not determinative. IAS 36.69 directs preparers to consider, among other things, how management monitors the entity's operations (by product line, business, location) and how it makes decisions about continuing or disposing of assets. A retail chain typically has a CGU at the individual store level, because each store attracts its own customers and takes its own till receipts independently of the store down the road; a telecoms operator often has a CGU at national-network level, because the network's interconnected infrastructure generates cash jointly and no single mast produces independent inflows. The table shows how the same principle resolves differently across industries.

How is goodwill allocated to CGUs, and at what level is it tested?

Goodwill acquired in a business combination is allocated, from the acquisition date, to each of the acquirer's CGUs or groups of CGUs expected to benefit from the synergies of the combination (IAS 36.80). Goodwill does not generate cash flows independently and is often not recoverable at the level of a single asset, so IAS 36 never tests it in isolation — it is tested as part of the unit or group of units it was allocated to. This is the structural reason a CGU containing goodwill can be impaired even when every tangible asset within it would individually pass.

IAS 36.80 caps the size of the allocation unit: each unit or group of units to which goodwill is allocated must represent the lowest level within the entity at which goodwill is monitored for internal management purposes, and must not be larger than an operating segment as defined by IFRS 8 before aggregation. Where the initial allocation cannot be completed before the end of the annual period in which the combination occurred, it must be completed before the end of the first annual period beginning after the acquisition date (IAS 36.84). If goodwill relates to a CGU but has not been allocated to that unit, the unit is tested for impairment, when there is an indicator, by comparing its carrying amount (excluding goodwill) with its recoverable amount (IAS 36.88).

Two mechanical points routinely trip preparers up. When an entity disposes of an operation within a CGU to which goodwill has been allocated, the goodwill associated with that operation is included in the carrying amount of the operation on disposal and measured on a relative-value basis unless a better method exists (IAS 36.86). And when an entity reorganises its reporting structure in a way that changes the composition of CGUs to which goodwill has been allocated, the goodwill is reallocated to the affected units using a relative-value approach (IAS 36.87). Both events are red flags for auditors because they move goodwill across the impairment perimeter.

IAS 36.90 then sets the frequency: a CGU to which goodwill has been allocated must be tested for impairment at least annually, and whenever there is an indication that the unit may be impaired, by comparing the carrying amount of the unit (including the goodwill) with its recoverable amount. The annual test may be performed at any time during the year provided it is performed at the same time each year, and different CGUs may be tested at different times (IAS 36.96). Recoverable amount is the higher of fair value less costs of disposal and value in use (IAS 36.18) — the same measurement covered in our value-in-use guide.

How is an impairment loss allocated across the assets of a CGU?

An impairment loss is recognised for a CGU only when its recoverable amount is less than its carrying amount, and the loss is allocated in a fixed order (IAS 36.104): first to reduce the carrying amount of any goodwill allocated to the unit, and then to the other assets of the unit pro rata on the basis of their carrying amounts. Goodwill absorbs the first blow in full before any other asset is touched. This ordering, combined with the ban on reversing goodwill impairments (IAS 36.124), is what makes goodwill the most fragile line on the balance sheet.

There is a floor. IAS 36.105 prohibits reducing the carrying amount of any individual asset below the highest of its fair value less costs of disposal (if measurable), its value in use (if determinable), and zero. Any loss that would otherwise fall on such an asset is reallocated pro rata to the other assets of the unit. The worked example below runs the full allocation for a single CGU that fails its annual goodwill test.

Here the CU28m loss is fully absorbed by goodwill, so step 2 never triggers and no other asset is written down. The journal entry is straightforward:

Now vary the facts: suppose recoverable amount were CU55m, giving a CU45m loss. Goodwill absorbs its full CU30m first, leaving CU15m to spread pro rata across the brand, plant and other assets in proportion to their carrying amounts (20:40:10, i.e. CU70m total), subject to the IAS 36.105 floor. That allocates CU4.29m to the brand, CU8.57m to the plant and CU2.14m to other assets. If, say, the plant's own fair value less costs of disposal were CU34m, it could not be written below that figure and the CU2.57m excess would be reallocated to the brand and other assets. The journal becomes:

The goodwill portion can never be reversed in a later period (IAS 36.124); the amounts allocated to the brand, plant and other assets may be reversed if recoverable amount recovers, but only up to the depreciated carrying amount that would have existed had no impairment been recognised (IAS 36.117).

What do auditors challenge on CGU identification and goodwill allocation?

Auditors treat CGU identification and the goodwill impairment test as a significant risk, almost always involving significant judgements and accounting estimates. That routes the work through ISA 540 (Revised) Auditing Accounting Estimates and Related Disclosures and ISA 500 Audit Evidence, supported by the auditor's obligation under ISA 315 (Revised 2019) to understand how management identifies units and monitors goodwill. Three findings recur.

In each case the auditor also stress-tests the cash-flow assumptions feeding value in use — growth rates, margins and discount rate — and performs the retrospective review of prior estimates required by ISA 540.9, comparing last year's forecasts with actual outcomes. Persistent optimism (forecasts that never materialise) is strong evidence of management bias and drives an expanded, more sceptical impairment audit.

Case study: Vodafone's country-level CGUs and the FY2019 write-down

Vodafone Group Plc is a clean illustration of how a telecoms group draws CGU boundaries and how goodwill impairment then flows through profit or loss. In its Annual Report for the year ended 31 March 2019, Vodafone tested goodwill at the level of groups of CGUs corresponding to its country operations, consistent with IAS 36.80. Country operations were the lowest level at which goodwill was monitored internally and were no larger than its operating segments. Following weaker performance in certain markets, the Group recognised impairment losses of approximately €3.5 billion for the year, principally against the goodwill and assets of its Spain and Romania operations.

Frequently asked questions

Is it IAS 36 or IFRS 36? It is IAS 36 Impairment of Assets. There is no IFRS 36. Cash-generating units, goodwill allocation and the impairment test all sit within IAS 36, an International Accounting Standard carried into the IFRS body of standards.

What is a cash-generating unit? The smallest identifiable group of assets that generates cash inflows largely independent of the cash inflows from other assets or groups (IAS 36.6). Independence of cash inflows — not reporting structure — is the test.

How is goodwill allocated to CGUs? To each CGU or group of CGUs expected to benefit from the synergies of the combination, at the lowest level goodwill is internally monitored and no larger than an operating segment (IAS 36.80), completed by the end of the first annual period after acquisition (IAS 36.84).

In what order is an impairment loss allocated within a CGU? Goodwill first, then the other assets pro rata on carrying amount (IAS 36.104), with no asset written below the higher of its fair value less costs of disposal, value in use, or zero (IAS 36.105).

How often is a goodwill CGU tested? At least annually, at a consistent point in the year, and whenever an impairment indicator exists (IAS 36.90, 96).

Can a goodwill impairment be reversed? No — IAS 36.124 prohibits it. Impairments of other CGU assets may be reversed up to the depreciated-cost ceiling (IAS 36.117).

Can a CGU be larger than an operating segment? No. The unit or group of units to which goodwill is allocated for testing must not be larger than an operating segment before aggregation under IFRS 8 (IAS 36.80).

About the author

Usman Qureshi is a Chartered Certified Accountant (ACCA) working in audit and advisory. He writes the IFRS, FRS 102 and US GAAP guides published on this site. Membership is listed on the ACCA public register.