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Goodwill Impairment Review

IAS36, ASC 350, Ind AS 36, AS 28: Value in Use and Fair Value Less Costs to Sell 

Financial reporting requirements related to impairment testing can be complex.  Testing may include annual tests and “triggered” tests, specific assets or asset groups, direct fair value write-downs or a multistep testing process, and other considerations unique to impairment accounting.

Goodwill impairment reviews entail the annual determination of the value in use or fair value less costs sell of cash-generating units.

In accordance with IAS 36, “Impairment of Assets,” goodwill and indefinite-lived intangible assets are not amortized but are tested annually for impairment (impairment reviews may also be initiated by triggering events or changes in circumstances which indicate that the carrying amount of goodwill may not be recoverable).

IAS 36 states that an impairment loss shall be recognized for a CGU if, and only if, the recoverable amount (defined as the higher of fair value less costs to sell and value in use) of the unit is less than the carrying amount of the unit. A CGU is defined in IAS 36 as “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.”

Value in use is defined in IAS 36 as “the present value of the future cash flows expected to be derived from an asset or cash-generating unit.”

Fair value less costs to sell is defined in IAS 36 as “the amount obtainable from the sale of an asset or CGU in an arm’s length transaction between knowledgeable, willing parties, less the costs of disposal.”

IAS 36 specifies use of a pre-tax discount rate (the WACC).  However, in practice the cost of equity component of the WACC cannot be calculated on a pre-tax basis as a pre-tax "market risk premium" (specifically, a pre-tax "return on the market") cannot be observed.  Grossing up the cost of equity at the effective tax rate only gives the correct result if there is no cash flow growth and no deferred tax.

An approximation of “value in use” therefore involves discounting the post-tax cash flows at the post-tax WACC.  The correct “value in use” can be achieved by adjusting this approximation for the cash flows related to deferred tax.  However, as this involves a complex iterative calculation, a practical first step is to determine the approximation via the post-tax methodology and make a judgment as to whether the result gives sufficient headroom over the carrying value to infer there is only a remote likelihood of impairment on a pre-tax basis.

If sufficient headroom exists to infer there is no impairment and there are disclosure requirements for a pre-tax discount rate, it seems reasonable to use the pre-tax cash flows and iterate on the pre-tax discount rate required to provide the same result as the approximation of value in use determined via the post-tax methodology.

Per the Financial Accounting Standards Board, goodwill and intangible assets with indefinite useful lives must be tested at least annually for impairment under ASC Topic 350, Intangibles – Goodwill and Other.

When the fair value of an asset is less than current book value, ASC 350 may define the difference as impairment and require the asset owner to write off that difference as an impairment charge.

Fair value, as defined in FASB ASC Topic 820, Fair Value Measurements and Disclosures, is “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.”  FASB ASC Topic 820 provides several key principles of fair value measurement:

  • Fair value should reflect an exit price, the price that would be accepted to sell the asset.
  • The hypothetical transaction is assumed to be an orderly transaction, not a forced sale.
  • The asset (liability) is transferred in an exchange between market participants.
  • Fair value should reflect the perspective of a market participant that holds the asset or owes the liability; thus, it would reflect its highest and best use.
  • The hypothetical transaction is assumed to occur in the principal or most advantageous market.
  • Fair value should not reflect any adjustment for transaction costs, but it may include transportation costs in certain circumstances.
  • The highest and best use determines the premise of value, either in-use (in combination with other assets as installed or otherwise configured) or in-exchange (stand-alone).

As per AS 28, “Impairment of Assets,” an enterprise should assess at each balance sheet date whether there is any indication that an asset may be impaired. If any such indication exists, the enterprise should estimate the recoverable amount of the asset. This Standard defines recoverable amount as the higher of an asset’s net selling price and value in use. The best evidence of an asset’s net selling price is a price in a binding sale agreement in an arm’s length transaction, adjusted for incremental costs that would be directly attributable to the disposal of the asset, whereas the value in use is estimated by discounting (with an appropriate discount rate) the future cash flows. If the recoverable amount of an asset is less than its carrying amount, the carrying amount of the asset should be reduced to its recoverable amount. That reduction is an impairment loss.

What We Do
Our services related to impairment testing include:

  • Assisting clients in the overall impairment test planning process
  • Estimating fair values for reporting units
  • Assigning acquired assets and assumed liabilities to reporting units based on their relation to the operations of the reporting unit/cash-generating unit
  • Assigning goodwill to reporting units/CGUs based on the benefits of the combination to the respective reporting units/CGUs
  • Converting projected cash flows into fair value estimates, consistent with market participant assumptions

Why American Appraisal?
American Appraisal provides assistance to many companies during their annual goodwill (and indefinite-lived intangible asset) impairment reviews.  American Appraisal consultants, both in India and across our network of global offices, have access to extensive databases, which keeps us in constant touch with market evidence related to discount rates and discount rate inputs, comparable transactions and selling costs for use in:

  • Value-in-use analysis
  • Fair value less costs to sell calculations
  • Sensitivity analysis

We have played a key role in both complex and more straightforward IAS 36 financial reporting engagements in recent years, including:

  • A number of assessments for IT companies in India
  • A number of assessments for renewable energy companies in India
  • An assessment of an Australian-listed entity

American Appraisal consultants are active in:

  • the International Valuation Standards Council
  • the Appraisal Issues Task Force
  • the FASB’s Valuation Resources Group
  • the Appraisal Foundation
  • the American Society of Appraisers
  • the American Institute of CPAs

This involvement ensures our knowledge of current financial reporting standards, practices and procedures.

Goodwill impairment review calculations performed by American Appraisal result in:

  • Independent, objective and supportable fair value opinions
  • Clear, comprehensive valuation reports