- What is Impairment Testing?
An impairment test is an accounting practice and analysis that is undertaken to determine if the goodwill and intangible assets acquired as part of an acquisition of an entity is impaired or has lost its value. Intangible assets such as lease arrangement, customer list, trade name etc. acquired by companies change throughout the life of the asset, and for the financial statements to reflect and represent the true value of assets, an impairment test must be undertaken annually. Goodwill, in particular, can represent a significant portion of the company’s net asset value, and in the absence of an annual analysis, the balance sheet could well be overstated.
- What is the scope of IAS 36?
Impairment of assets (including goodwill) is governed by the accounting standard IAS 36, which applies to all assets, except for those that have their own rules for impairment (for instance, employee remuneration IAS 19, and stocks IAS 2).
IAS 36 ‘Impairment of Assets’ sets out the requirement to ensure that the assets of a reporting entity are carried at amounts that do not exceed their recoverable amounts. According to IAS 36, the recoverable amount of an asset is the amount higher of its fair value less costs to sell (FVLCS) and its value in use (VIU).
- What are the terms FVLCS and VIU?
FVLCS is defined as an amount obtainable in an arm’s length transaction between a willing buyer and seller, as defined under IFRS 13 Fair Value Measurement. VIU is based on an estimate of the future cash flows the entity expects to generate from the use of the asset or associated Cash Generating Units (CGUs).
If the carrying amount of an asset exceeds its recoverable amount, the asset must be impaired. IAS 36 then requires the asset to be written down to its recoverable amount and the impairment loss to be recognised.
- How often does an impairment test for goodwill need to be carried out?
As per IAS 36, intangible assets with indefinite useful life, intangibles not yet ready for their intended use, and goodwill acquired in a business combination, must be tested for impairment at least annually, irrespective of whether there is any indication of impairment. This implies that any company with goodwill on its balance sheet (acquired in a business combination/ acquisition) will need to get an impairment test conducted at the end of each reporting period/ annually, which is a statutory audit requirement.
- What are indicators of impairment?
Indicators as defined in IAS 36 comprise external sources such as market value declines, negative changes in technology/ markets, increase in interest rates, etc. while internal sources include worse performance than expected, plans to discontinue operations, obsolescence, to name a few. There could be significant events, such as Covid-19, which could also serve as triggering events for an impairment test, depending on the event’s impact on operations.
- At what level should goodwill be tested?
Goodwill is generally allocated to the CGUs that are expected to benefit from a business combination in which the goodwill arose. Therefore, goodwill is tested for impairment at the level of a CGU, or a group of CGUs, as it does not generate cash flows independently. This requirement means that the CGU or the group of CGUs will need to be tested annually for impairment
- What are elements in determining the recoverable value of an asset/ CGU?
The major basis of estimating VIU or FVLCS are cash flow projections, discount rates, and adjustments to incorporate uncertainty, variability, and other factors that must be reflected in the pricing of asset or CGU. IAS 36 allows these adjustments to be reflected either by adjusting the discount rate or by adjusting the cash flows (including assumptions for the long-term growth). Given the high uncertainty in the backdrop of Covid-19, an adjustment in the cash flows is often preferable as it involves more explicit consideration of possible future outcomes.
- How is impairment of goodwill reflected in the company’s financial statements?
An impairment loss is recognised when the recoverable amount is lower than the carrying amount of the CGU. The impairment loss is recognised as an expense in the income statement, with the corresponding downward adjustment of the goodwill/ intangible/ other asset in the balance sheet.
- What are the challenges in undertaking the goodwill impairment test?
The process of undertaking an impairment test involves assessing the company’s cash flow projections, which are based on future events which are difficult to predict, and management plans which may or may not occur as planned. There are significant assumptions with substantial valuer’s judgement involved in such impairment tests which can make the process time-consuming and complex. Therefore, it is important for companies to have an expert valuation firm to guide and assist with their impairment test process.
- Why should I engage a professional firm to undertake an impairment test?
Are the costs justified? Undertaking an impairment test of goodwill is a requirement under IAS 36, and given that it involves a valuation of the CGU to which goodwill has been allocated, companies often rely on experts to assist them with the impairment test as part of the financial reporting process. Since the impairment test is reviewed by the company’s statutory auditors, they prefer to have an independent expert valuer’s view on any potential impairment or otherwise.
A professional valuer provides an independent, unbiased and objective opinion on the value of a CGU, in line with the requirements of IAS 36. The technical considerations as laid down by the accounting standards are an important aspect that must be considered. It also brings to the table a different perspective, based on the experience of the valuer across different sectors. Consequently, the benefits of getting a professional opinion on the impairment test far outweighs the associated costs.
- Does PKF have the experience of undertaking impairment tests in the sector that my company operates in?
As an impairment test involves the valuation of a company/ CGU, we have the experience in undertaking impairment reviews across a wide range of sectors across UAE and the wider Middle East. At PKF UAE, we are sector agnostic, and have valued companies across various industries such as manufacturing, retail, healthcare, financial services, logistics, food and beverage, amongst several others. Our technical competence in choice of the right valuation methodology, critical thought process, and analytical skills have placed PKF amongst the top valuation firms in the UAE. We have a large client base, with many sharing their experiences of working with us. You may refer to the Client Testimonial section on this website to see what our clients have to say.
PKF UAE has a team of highly experienced professionals with many years of expertise, offering a wide range of advisory services across sectors. We would be happy to discuss any of your requirements. Please feel free to get in touch with us on difc@pkfuae.com or at www.pkfuae.com.
