1. Impairment

2. Impairment – Introduction to IAS 36
In this session, we will consider the requirements of IAS 16, ‘Property, Plant and Equipment’, IAS 23, ‘Borrowing Costs’, IAS 40 ‘Investment Property’, IAS 36 ‘Impairment of Assets’ and IAS 38 ‘Intangible Assets’.

3. Introduction Introduced in 2004 alongside IFRS 3, IAS 38
Modified previous version of IAS 36, changes required to reflect non-amortisation of goodwill in IFRS 3
Some changes to reflect a tightening up of the previous requirements to address areas of potential abuse
A “how to do it” standard
DCF projections

4. Impairment Scope of standard

5. Scope of standard
Applies to all non-financial assets (tangible and intangible) except Investment properties and oil and gas exploration costs
Assets held for disposal under IFRS 5 excluded
Deferred acquisition costs and intangible assets arising from insurers contractual rights under insurance contracts within scope of IFRS 4 – also excluded

6. Objectives of standard
The carrying values of non-financial assets do not exceed their recoverable amount
Impairment losses are recognised and measured on a consistent basis
Disclosures are given concerning the impact of impairment on an entity’s financial performance

7. Carrying value

8. Recoverable amount What is the recoverable amount?
The greatest value of the asset to the business in terms of cashflows that it can generate. I.e. It assumes managers are rational
This is the higher of value in use or fair value less costs to sell
Fair value less costs to sell – it is preferable to have an active market. If not, then need reliable estimators. If these cannot be obtained, use value in use alone.
Observable fair values unlikely to exist for many intangibles and some fixed assets

9. When are reviews required?
All assets – when there is an impairment indicator
Goodwill and indefinite lived intangible assets – annually
Intangible asset not yet ready for use – annually

10. What are possible impairment indicators?
External indicators
Internal indicators
Faster decline of the market value than would be expected as a result of the passage of time or normal use
Negative changes of technological, economic, legal and market environment
Increase in market interest rates or other market rates of return on investment
Carrying amount of the enterprise’s net assets > market capitalisation
Indication of the asset’s obsolescence or physical damage
Significant changes with an adverse effect on the enterprise have taken place during the period, or are expected to take place in the near future, in the extent to which, or manner in which, an asset is used or is expected to be used
Asset’s economic performance < to expectations
…the list is not exhaustive – other indicators may exist

11. Full test required under IAS?
In general – full test required
Short cut in certain circumstances where no change in allocation of fixed assets / goodwill and previous tests showed wide safety margin and no adverse change, therefore likelihood of impairment is remote
UK GAAP – first full year after acquisition was a cut- down test

12. How do we do a full test? Need to identify level at which to do test
Need to review fair value less costs to sell against carrying value – if the fair value less costs to sell can be reliably estimated and it exceeds carrying value – go no further
Otherwise – Value in use will be required

13. Measurement of fair value less costs to sell
Preferable to have an active market or reliable market indicators – fixed assets – yes unless specialised, intangibles and goodwill – unlikely.
Proceeds less direct costs of disposal of the asset itself
If CGU being sold, watch interaction with IFRS 5, ‘Non- current assets held for sale and discontinued operations’
If non-qualifying as IFRS 5 at the year end but being disposed of subsequently, using fair value less costs to sell (if lower than cost) may still be appropriate

14. Value in use Where practicable, estimate individually
Fixed assets for continuing use in business, tend to be interdependent
Goodwill by definition is not a separable asset and relates to a group of assets in a business unit
IAS 36 permits a degree of aggregation into the Cash Generating Unit (“CGU”) for Value in Use tests if goodwill can only be arbitrarily allocated

15. Calculation of value in use
Identify separate Cash Generating Units (CGUs)
Establish carrying values for the net assets of each CGU (including allocated goodwill)
Forecast the future cash flows of the CGU
and discount them to their present value
Compare the present value of the cash flows with the carrying values of the net assets of the CGU

16. Cash-generating units
Definition of CGU – the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets.
In an ideal world, a CGU is an individual asset
However can be aggregated to the level of creation of independent cashflows
Guidance on CGUs in mini-case studies in the standard
Independence (loss leaders, production allocation)
Retail (usually individual CGUs but material?)
Vertical integration (availability of external supply)

17. Allocating assets to CGUs
Directly attributable assets / liabilities
Not necessary to allocated assets/liabilities already tested for impairment (eg. working capital)
Allocation of central assets
Allocation of goodwill but see next slide…
GOLDEN RULES
Make sure you are comparing “apples” with “apples”
Do not allocate financing liabilities or tax (as they are excluded from VIU cashflows)
If allocate central assets exclude intra-group charges for the assets

18. Allocating goodwill to CGU’s
Goodwill is tested for impairment at the level at which management monitors goodwill
Can combine CGU’s for the purpose of this test if management does not monitor goodwill at individual CGU level
Goodwill must be allocated at least down to reportable segments
May involve two stages: Review at CGU level for assets excluding goodwill and then at combined CGU level for goodwill
Goodwill needs to be allocated to CGUs at the date of acquisition – disclose if not completed by year end

19. Calculation of value in use
Test separate Cash Generating Units (CGUs) (excl goodwill if not tested at this level)
Charge any impairments revealed at CGU level
If goodwill not tested at CGU level, aggregate CGUs into group of CGUs to which goodwill can be allocated
Compare the PV of the cash flows of combined CGU’s with the carrying values of the net assets of the CGU’s including goodwill

20. Value in use
Use forecasts based on “reasonable and supportable assumptions” consistent with most up to date budgets and plans but… growth rate and improvements assumptions are limited
Cashflows include:
Operating cashflows in relation to asset / CGU
Central overheads cashflows allocation (care!)
Disposal proceeds at end of useful lives
Capex to maintain standard of performance

21. Value in use “Reasonable and consistent…?”
Greater weight on external evidence
Management should examine causes of differences between previous forecasts and actual
Ensure consistent with past outcomes but…
…there is no Look-Back test as existed in FRS 11.

22. Value in use Transfer prices – adjust to market
Inflation – treat consistently
Constraints:
Long term growth – should not exceed long term average for product / territory
Forecasts should not exceed 5 years before defaulting to long-term growth rates
Must disclose and justify departures from this
No future reorganisation and capex (if ‘improving or enhancing’) unless restructuring provision has been made under IAS 37

23. Discount rate
Principle – “an estimate of the rate the market would use on an equally risky investment” – independent of way investment is financed
SUBJECTIVE AREA – options for determining rate
Use rate implicit in similar asset transactions
WACC for a listed company with similar risk profile
WACC for the entity adjusted for risks of CGU
Adjust the discount rate or the cashflows for risk and ensure inflation treated appropriately

24. Discount rate (cont) Pre-tax rate to discount pre-tax cashflows
Need to adjust post-tax rate (eg. observed WACC) for tax – not as easy as adjusting for 30% tax rate!
In practice –> assess impairment at post-tax level – if calculations indicate possible impairment then switch to pre-tax adjusting for any special factors that might distort relationship between pre and post-tax discount rates
Don’t forget this is an estimation / approximation – an art rather than a science

25. Recognition of impairment loss
Goodwill
Fixed assets / Intangibles
Write down pro rata after goodwill
No asset write down below NRV
Revalued assets – impairment against revaluation reserve
Write off first
Goodwill – write off completely before impairing other assets

26. Impairment on merged business
Unlike FRS 11 – no requirement under IFRS for internally- generated goodwill calculation as it was too difficult to apply in practice
UK GAAP – there are many practical difficulties
On merging the business, calculate the internally generated goodwill on the existing business
Add this internally generated goodwill to any future assets being tested for impairment at the IGU
Impairment allocated pro rata to actual and notional goodwill (with only actual impairment being charged)

27. Reversals of impairment
For assets other than goodwill – reverse when there is a change in assumptions underlying the cashflows, such as a change in economic conditions
Practically, looking for significant changes only
Should not exceed what the amortised cost would have been.
Goodwill impairments can never be reversed

28. Disclosures

29. Disclosures – War and Peace
Detailed disclosures for each class of assets impacted by impairments or reversals of impairments
Detailed disclosures of impairments by reportable segment
Discount rates used where impairment charged

30. Disclosure highlights
For CGUs with significant goodwill or indefinite life intangibles
For materially impaired CGU
Carrying amount of goodwill and indefinite life intangible assets
Basis for calculating recoverable amount (Fair Value less costs to sell or VIU)
If VIU  key cashflows assumptions (and basis for estimation), period of projections, terminal growth rate and discount rate
If Fair value less costs to sell  methodology and assumptions if not referenced to a market price
Sensitivity analysis for key assumptions if slight adjustment could result in impairment
Reason for impairment
Amount of impairment (or reversal)
Description of CGU
Basis for calculating recoverable amount (Fair Value less costs to sell or VIU)
If Fair Value less costs to sell, the basis used to determine value eg. active market
If VIU, the discount rate used and any previous VIU value

31. Impairment of assets – summary
Measurement
Recognition of loss
Review required
Carrying value
Goodwill / indef life intangible
Lower of
All assets
Equity or income statement
Recoverable amount
Depreciated cost or value
Higher of
When indicators exist
Each financial year
Value in use
Fair value less costs

32. Relationship with UK and US GAAP?

33. Impairment of assets IAS 36 FRS 11
Compare carrying value with higher of:
Fair value less costs to sell; and
value in use
Allocate
To goodwill
Pro-rata to all other tangible and intangible fixed assets
Reversals allowed for all assets except goodwill
No look-back tests
Disclosures – extensive!
Compare carrying value with lower of
Depreciated cost or value or recoverable amount
Recoverable amount is the higher of net realisable value or value in use
Allocate
To goodwill, then intangibles then pro-rata to all other tangible assets
Reversals restricted for all intangibles
Look-back tests required
Disclosure re long-term growth assumptions

34. US GAAP
Annual impairment review required for assets with indefinite useful lives and for goodwill
Impairment test for goodwill – two-stage
Compare recoverable amount of reporting unit with carrying amount (including goodwill)
If impairment indicated – full fair value exercise to calculate implied fair value of assets and therefore residual value of goodwill
Reversal of impairment to any asset – prohibited

35. US GAAP (continued) But watch…. US test two stage
Undiscounted cashflows under FAS 144 for definite-lived assets
Goodwill may be allocated to a different level

36. Impairment