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IAS 36 Impairment Testsfor Valuation Professionals

May 18, 2009 – NYSSCPA BV Conference

*connectedthinking

PricewaterhouseCoopersDecember 2008IFRS – Impairment Tests under IAS 36

Slide 2

Relevance of IFRS is continouing to increase

U.S. Transition to IFRS only delayed to economic crisisOngoing convergence initiatives between FASB and IASBSubsidiaries of European and many Asian companies already need to provide IFRS reporting to parent companiesIFRS is literally moving closer:

2012 Mexico adopting IFRS2013 Canada adopting IFRS

• IAS 36 Impairment Testing is an area with limited convergence • Subtle differences in terminology and the standard’s

requirement’s proved to create confusion in practice

Section heading goes here

PricewaterhouseCoopersMay 7, 2009IFRS – Impairment Tests under IAS 36

Slide 3

Agenda

1. Introduction to the Standard2. Carrying Amount and Recoverable Amount 3. Timing4. Cash Generating Units5. Testing Sequence 6. Goodwill Allocation7. Impairment Losses and Reversals8. Questions & Answers


Slide 4

Long-lived tangible assets

Intangible assets assets with indefinite

useful life

Goodwill

US GAAP

Intangible assetswith definite useful life

SFAS 144

SFAS 142

IAS 36 Impairment Test – Brief Comparison to US GAAP

Introduction

IFRS

IAS 36

IAS 36

IAS 36

Accounting standards set the valuation framework!

Trigger based Test

Annual Impairment Test, as well as Trigger based


Slide 5

Differences in IFRS and US GAAP

Selected Differences• Value concepts (fair value vs. recoverable amount: higher of fair value less

costs to sell and value in use)• Goodwill impairment test methodology (one-step vs. two-step approach)• Asset impairment test methodology (discounted vs. undiscounted cash

flows)• Reversals of impairment losses obligatory under IFRS (except goodwill);

under US GAAP prohibited• Additional triggering event under IFRS: increase in market interest rates• Minority interest: IFRS grossing up approach; US GAAP fair value of

controlling interests

Introduction


Slide 6

Recoverable Amount

higher of an asset’s or CGU’sor group of CGUs’

Fair Value less Costs to Sell Value in Use

1) Best evidence: arm´s length transaction less disposal cost

2) Otherwise: market price less cost of disposal (provided active market)

3) Otherwise: best information available to reflect amount an entity could obtain (unforced transaction) (IAS 36.25pp)

“[…] an asset’svalue in use reflects how the market would

price the cash flows that management expects to derive from that asset.” (IAS 36.BC 60)

Carrying Amount vs.

“External (market) value” “Internal value (from use) for the entity”

OverviewProcedure of Impairment Test under IFRS

Carrying Amount and Recoverable Amount


Slide 7

Carrying Amount for CGUOverview

Net working capital

Allocated share of corporate assets+

Carrying amount of a CGU=

Allocated goodwill* +

The carrying amount of a CGU shall be determined consistent with the way the recoverable amount of the CGU is determined! (IAS 36.75)

Directly attributable assets (tangibles and intangibles)+

- Attributable liabilities where applicable

* The carrying amount of goodwill needs to be grossed up on a 100% basis to include the goodwill attributable to the minority interest. (IAS 36.92). Relevant for goodwill bearing CGUs only.

1 vs.Carrying Amount and Recoverable Amount


Slide 8

Practice Issue Determination of Carrying Amount of CGU

Issue:Within a CGU there is a non-operating building rented to third parties. Rental payments are not included in the CGU‘s financial projections.


Should the carrying amount of the CGU exclude this building?


Slide 9

Fair Value less Costs to SellValue Concept

2

vs.

Fair Value „The amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm‘s length transaction.“

Source: IFRS 3 Appendix A, Similar: SFAS 142. 23; SFAS 144. 22

Hypothetical Buyer

„Willing Buyer – Willing Seller“ Concept

Stand-Alone Valuation

Key Elements:

Valuation Hierarchy

Market-based Measurement



Slide 10

Fair Value less Costs to SellFair Value Hierarchy

2

vs.

“Prices from previous transactions provide empirical evidence for the indicated value of an intangible asset”

Price in a binding sales agreementin an arm’s length transaction

Current bid price,if an active market exists

Value estimate using best information available

to reflect the amount to be obtained from disposal,

considering comparable transactions

Source: IAS 36.25-27

Multiples

DCF



Slide 11

Fair Value less Costs to SellEstimating Costs to Sell

2

vs.Carrying Amount and Recoverable Amount

Practical Advice: For goodwill test typically 1 to 2% of EV applied

Costs of removing the asset (e.g. legal, transaction)

Costs to bring an asset into condition for its sale

Costs, which are already recognised as liabilities

Costs of reorganising a business

• Costs to sell

• No costs to sell

Termination benefits for employees


Slide 12

3

vs.

Value in UseValue Concept

Value in use „The present value of the future cash flows expected to be derived from the continuing use an asset or CGU and its disposal at the end of its economic useful lifetime.“

Source: IAS 36.31/ A.19

Internal value – consider entity-specific synergies

Excluding cash flows related to;• Restructuring (if not provided for under IAS 37)• Enhancement Capex (Maintenance o.k.)• Financing activities

Key elements:

Independent of entiy’s financing/capital structure


Pre-tax notion – exclude tax cash flows


Slide 13

Value in UseTechnical Issue - Pre-tax vs. Post-tax calculation

• ‘Grossing-up’ or omitting tax-shield of debt sometimes applied by valuation practitioners

• However, pre-tax cost of equity can not be derived from capital market data (e.g. CAPM)

• Discounting post-tax cash flows at post-tax discount rate should lead to the same result as discounting pre-tax cash flows with pre-tax discount rate (IAS 36.BCZ85)

• For disclosure purposes: A two-step iterative calculation process can be used to convert the post-tax discount rate into an implicit pre-tax rate



Slide 14

Value in UseSelected Technical Issues

Deferred taxes• Area is still evolving – treatment might be inconsistent in

practice• Discuss early with client and his auditor to avoid suprises• Food for thought:

- Deferred are not subject to IAS 36 test- DTA related to pre-existing NOLs could be easily excluded

from carrying amount- Ignoring all deferred taxes, especially DTL subsequent to

purchase accounting for non-taxable stock deal might inappropriately trigger impairment



Slide 15

Overview“Frequency” of Impairment Testing

• tested in year of acquisition• thereafter annually Indefinite lived intangibles

Goodwill

Intangibles not yet available for use

• tested in year of acquisition • thereafter annually at the same time every period

• tested annually

Test always to be performed if there is a triggering event!

Timing

Special treatment regarding …

Source: IAS 36.10, IAS 38.108


Slide 16

OverviewImpairment Indicators (“Triggering Events”)

• Faster decline of market value than expected from normal use

• Negative changes of technological, economic, legal and market environment

• Increase in market interest rates or other market rates of return on investment

• Net assets exceed an entity’s market capitalisation

• Indication of the asset’s obsolescence or physical damage

• Significant strategic or operational changes with an adverse effect on the enterprise (e.g. technology loss of customer, )

• Performance is worse than expected

External Indicators Internal Indicators

Timing

Source: IAS 36.12


Slide 17

GoodwillImpairment Test

Cash-generating Unit (CGU)

Group of CGUs

OverviewAsset and Goodwill Impairment Test

AssetImpairment Test

Hierarchy Levels for

Impairment Testing

Individual Asset

Cash-generating Unit (CGU)

Group of CGUs

Corporate Assets(IAS 36.102 (b))

“If there is any indication that an asset may be impaired, recoverable amount

shall be estimated for the individual asset.”

“If it is not possible to estimate the recoverable amount of the individual asset, […] determine the recoverable amount of the cash-generating unit to

which an asset belongs.”

Cash Generating Units


Slide 18


OverviewCGU Structure

Top-down approach

Goodwill “... the lowest level within the entity at which goodwill is monitored for internal management purposes ...”and not be larger than an IFRS 8 operating segment (IAS 36.81)

“A cash-generating unit is 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.” (IAS 36.6)

...

Assets

Bottom-up approach

Segment 1

Segment4Division 1 Division 2 Division 3 Region 1

Entity

… … … …Entity’s asset base

BU 3

BU 2

BU 1

Region 2

Region 1

Region 2

Segment 2 Segment 3

Country 2Country 1


Slide 19

Store 2

OverviewDetermination Goodwill CGU Structure – Example Retailer

Austria Poland

C&C(Metro, Makro)

Store 3

Store 1

Metro Group

Germany

Goodwill Impairment Test on the Level of Group of CGUs

Asset Impairment Test on CGU Level

RealExtra

Kaufhof AdlerMedia MarktSaturn

...

Others

Top-down approach

Bottom-up approach



Slide 20

Corporate Assets

• Corporate assets are assets that contribute to several cash-generating units (e.g. headquarters, R&D center)

• For corporate assets, it may not be possible to test the assets on an individual basis or test them as part of a single CGU.

• For these assets:1) Test the CGUs excluding the corporate assets2) Identify the smallest group of CGUs to which a portion of

the corporate asset can be allocated reasonably3) Compare the carrying amount of the group of CGUs

including the corporate asset (or portion thereof) to the recoverable amount of the group of units.



Slide 21

Practice Issue Determination of Carrying Amount of CGU

Issue:Certain corporate assets have been appropriately allocated to a CGU. In the financial projections of the CGU, corporate charges have been reflected. They relate to payments to the ultimate parent company, being the legal owner of the corporate assets.In performing the impairment test, all corporate charges have been excluded to determine VIU and FVLCS.


Is it appropriate to exclude all corporate charges when determiningVIU and FVLCS?


Slide 22

Valuation Issues

Minority Interests (NCIs)• Carrying amount of goodwill needs to be grossed up to a

100% basis, to include the goodwill attributable to the minority interest. (IAS 36.92)

• Any impairment loss is proportionally allocated between parent company and minorities with the portion attributable to parent being recognised as goodwill impairment loss

Control Premium• Typically not applied in EU for IFRS purposes, since prices on

active markets are of higher priority to other estimates, control premium might be difficult to defend



Slide 23

Consider in Carrying Amount

VIUdeterminable?

TriggerLevel 1

IntangibleDefinite useful life?

Ready for use?

VIU >Carrying Amount

FVLCTS >Carrying Amount

Impairment

NoImpairment

No Impairment

Test

FVLCTSdeterminable?

Yes

Yes

Yes

Yes

No

Yes

Yes

No

No

No

No

Tier 1 – Individual Asset Tier 3 – Goodwill CGU

No

AnnualIP-Test?

TriggerLevel 3/4

FVLCTS / VIUCGU(s) >

Carrying Amount incl.Goodwill

NoImpairment

Impairment

YesYes

NoYes

Tier 2 – Asset CGU

TriggerLevel 2 ?No

Impairment

NoImpairment

Yes

Yes

NoNo

Assigned to CGU?

Corporate Asset

FVLCTS / VIUCGU >

Carrying Amount

VIUdeterminable?


Slide 24

Practice IssueCorporate Trade Name

Issue:A corporate trade name accounted for according to IFRS 3/IAS 38 with indefinite life has been considered a corporate asset.The trade name has been allocated to 10 individual CGUs.Due to the indefinite life the trade name is to be tested for impairment on an annual basis.


Do we need to perform an impairment test for all 10 CGUs ?


Slide 25

OverviewGoodwill Allocation - Acquisition

CGU 2

CGU 1

Entity

CGU 3

CGU n

...

Goodwill

EBIT/EBITDA?

Net Revenue?

Net Income?

… ?

Assets in CGU?

Goodwill Allocation

Detailed analysis of …

Expected synergies

Going-concern element

Approximation by a reasonable

allocation key

If detailed analysis not applicable

Goodwill shall be allocated to each CGU / group of CGUs that are expected to benefit from the synergies (external synergies and going concern element) of the combination! (IAS 36.80)


Slide 26

OverviewGoodwill Allocation – First Time Adopters

First time adopters electing not to apply IFRS 3 retrospectively have to allocate US GAAP goodwill to CGU and test goodwill for impairment as of the date of transition (IFRS 1 B2 (iii))

CGU 2

CGU 1

Entity

CGU 3

CGU n

...

Goodwill

EBIT/EBITDA?

Net Revenue?

Net Income?

… ?

Assets in CGU?

Goodwill Allocation

Detailed analysis of …

Expected synergies

Going-concern element

Approximation by a reasonable

allocation key

If detailed analysis not applicable


Slide 27

OverviewTreatment of Impairment Losses

Initial recognition of impairment loss involves:• First any goodwill in CGU is impaired• Any remaining impairment loss is allocated pro-rata to

long-lived assets• No reduction of individual assets below the highest of (a)

the asset’s FVLCS, (b) the asset’s VIU and (c) zero• Reversal of any revaluation reserve, then through P&L• Adjustment of depreciation/ amortisation charge

Impairment Losses and Reversals


Slide 28

OverviewTreatment of Impairment Losses

Impairment losses reversed:• Only where estimates have changed• Up to carrying amount had no impairment been charged• Accounting for reversal corresponding to accounting for

impairment loss• No reversal of goodwill impairment

Impairment Losses and Reversals


Slide 29

Financial assets classified as • Subsidiaries• Associates• Joint ventures

Intangible assets, including goodwill

Property, plant and equipment • Inventories (IAS 2)• Assets arising from construction contracts

(IAS 11)• Assets arising from employee benefits

(IAS 19)• Deferred tax assets (IAS 12)• Financial assets within the scope of IAS 39• Investment property measured at fair value

(IAS 40)• Biological assets (IAS 41)• Insurance contracts (IFRS 4) • Non-current assets classified as held for

sale (IFRS 5)

IAS 36 Excluded from scope of IAS 36

Scope of IAS 36

Appendix

Source: IAS 36.2-5


Slide 30

Picture

Presenter

Georg Gollnow

+1 646 471 [email protected]

Appendix

© 2008 PricewaterhouseCoopers L.L.P. PricewaterhouseCoopers refers to the U.S. firm of PricewaterhouseCoopers L.L.P. and other members of the worldwide PricewaterhouseCoopers organization. All rights of use and reproduction reserved. PwC

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