Recoverable Amount: Definition, Formula and Example
There are a number of ways to estimate the value of a held asset, but the most common is the recoverable amount. This method of valuation has existed in accounting for many years and is the best way to estimate value.
Let's look a bit more in-depth into what a recoverable amount is, and how you use it.
Here’s What We’ll Cover:
Recoverable Amount Definition
The recoverable amount is the higher value between the estimated net sales price and the value for use. To expand further, two scenarios are considered. First, the anticipated return on selling the asset, minus costs to sell. Second, what present and future cash flow do the asset produce when it is in use. When calculated, the higher of these two values is the recoverable amount. This applies to both tangible and intangible assets.
This amount is relevant in accounting as it helps in determining impairment loss. Impairment losses occur when assets have a lower value than their recoverable amounts. If the recoverable amount is greater than the current market value, then no impairment occurs. However, if the recoverable amount is less than the current market value then an impairment loss occurs. This is important to figure out for tax assets.
For example, let's imagine a company holds an asset with a carrying value of $50,000. This includes the current value and considers the original cost and costs of disposal. Now say the recoverable amount is only $45,000. This means the company would report an impairment loss of $5,000 on financial statements. You should calculate this for any individual assets that may hold an impairment loss.
Recoverable Amount Formula and Example
Let's look at a very basic example for one of the more common types of individual assets. Imagine your business owns a widget-producing machine and you want to find the recoverable amount.
To calculate this value, first determine the net sales price. The net sales price is the total revenue from the asset minus any direct or indirect costs associated with the sale of that asset.
Let's say your widget-producing machine holds a market value of $50,000. The costs associated with selling that machine amount to $10,000. This would include costs to broker a sale, transport costs, or any other expense incurred to sell. That would mean the net sale price, or fair value less cost to sell (FVLCTS) is $40,000.
Next, find the value for use. Value for use is the future cash flow projections generated by the asset. Account for all future periods during the expected lifetime of the machine. Let's say this machine can reasonably expect to run for another five years. In that five year span, estimated cash flow projections are as follows:
Year 1: $8000
Year 2: $7200
Year 3: $6480
Year 4: $5832
Year 5: $5248
This gives an estimated cash flow projection of $32760.
Now, we compare the cost of use ($32760) to the FVLCTS ($40,000). We can see that the cost to sell would be the higher value. Therefore, our recoverable amount in this example is $40,000. Do use a depreciation method in determining value to sell.
To take things a step further, let's say this same machine has a carrying amount of $50,000. This means you would have an impairment loss of $10,000 on your financial statements.
The same types of calculations are valid for intangible assets, as well as other cash generating units such as an investment property. Anytime you suspect asset impairment, it's critical to determine this for all financial assets.
Whenever impaired assets exist, it's important to understand the recoverable amount. Income statements and all other financial statements need to be accurate.
To determine impairment loss on your portfolio of assets, there are three basic steps:
- Find the carrying value of the asset owned.
- Find the fair market value for the asset, and subtract the cost to sell. The average cost of similar assets sold tends to present fair market value.
- Calculate the future cash flow projections for the expected life of the asset.
- Compare the sale value and the projected cash flow values. The recoverable amount is the greater of the two.
- If the carrying value is higher than the recoverable amount, this shows asset impairment. The impairment loss is the difference between these values.
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