What is the issue?
Entities are likely to
record impairments for the first time under the new standards at June
2008. The changes to market conditions have meant that impairment test
triggers are all around us. The market has changed since entities last
prepared financial statements. For some entities, market capitalisation is
less than net assets as transactions occurred in a different environment with
higher equity prices. There is now greater uncertainty in the economic
environment due to higher inflation and the credit squeeze. Higher
interest rates mean that the cost of capital is up.
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Who does it impact?
Entities that identify triggers that indicate their assets may be impaired (ie, due to increased interest rates or a significant decline in the asset’s value). These entities must conduct an impairment test.
Why is it important to be aware of now?
Determining impairment should not be a ‘last minute’ task. All entities should focus now on whether they are likely to have an impairment at 30 June. Early identification of potential asset impairment might allow management to implement a profit improvement strategy, such as a restructure, and avoid an impairment charge.
What do impacted entities need to do?
Determine whether impairment exists by comparing either the fair value or value in use of assets (or a group of assets) with the asset’s (or a group of assets’) carrying amount. In more buoyant times entities have pointed to prices in the market (fair value). However, with roller coaster market prices we expect to see more entities turn to the value in use method at June 2008 to determine the recoverable amount of assets.
Determining the value in use of an asset involves estimating expected cash inflows and outflows from continuing use of the asset and applying the appropriate discount rate to its future cash flows. If necessary, entities will need to change their forecasts to reflect downturns in economic prospects.
Without such an adjustment entities may get an error in their impairment calculations. Entities’ cash flows should be checked for reasonableness when compared to market expectations for the sector/entity. Entities with commodity price exposure and currency exposure will need to freshen up their assumptions.
Don’t miss equity accounted investments in associates and joint ventures from impairment testing.
PwC insight: What management should watch out for
- Be careful that you’re really doing a value in use test.
Some tests purport to be value in use, but which are not. For example, the benefit of future reorganisations or future enhancements, such as additions of capital, should not be included in cash inflows. Although these don’t qualify for a value in use test, they are permitted when calculating the recoverable amount based on fair value less costs to sell if other market participants would do the same.
- Make sure that your value in use test makes sense when compared with market data.
Management should be prepared to explain how and why the valuation implied by its forecasts (based on value in use) are reasonable when compared with market data. Market data is based on the fair value test, which is the price that an entity could obtain for its assets in an arms length transaction. It should also explain benchmark data. For instance, multiples implied by quoted comparable companies, implied multiples from comparable transactions, and share price trends of the entity or similar listed entities.
- Impairment disclosure requirements are onerous and securities regulators will expect full compliance.
Tick all the boxes to ensure that your entity’s disclosure requirements are met. In particular, start collecting data early to ensure that your entity meets the disclosure requirements for cash generating units with goodwill and/or intangible assets. Often these disclosure requirements can be significant.
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