Top of ASIC Agenda – Impairment Assessments
As we roll past the 30 June 2018 financial year end, many companies will be turning their attention to the preparation of annual impairment assessments over their major assets. As in previous reporting periods, the Australian Securities and Investments Commission (ASIC) continues to have a significant focus on impairment testing and asset values.
Impairment is a tricky area involving a significant number of estimates and judgements and is an area that some companies continue to struggle with.
1. Key areas of focus
Impairment testing focuses on the comparison of recoverable amount vs the carrying amount. The recoverable amount is determined as the higher of fair value less costs to sell and value in use. These calculations carry a great deal of subjectivity and therefore the assumptions used need to be clearly understood, supported and disclosed.
Below are some common key assumption areas and what needs to be considered.
2. Cash flow forecasts
Forecasting future cash flows can seem like a crystal ball exercise, however reliable and supportable sources of information must be used when preparing cash flow forecasts including:
- Historical evidence of accurate budgeting and forecasting;
- Margin increases and growth rates, supported by sound plans which are considered reasonably achievable and supported by external evidence; and
- Consideration of economic, market and other factors outside of the control of the business.
Be careful not to base the forecast on the hopes and dreams for the business, but on the reality of the times ahead and any rough times you may face.
3. Discount rate
A discount rate is usually the most judgemental part of an impairment assessment and requires benchmarking and industry comparison.
Your discount rate calculation should consider:
- The rate expected to reflect the future value of money, adjusted for risks specific to the asset or cash generating unit (CGU);
- Discount rates must be pre-tax; and
- Discount rates may differ between assets or CGUs.
4. Appropriateness of the CGU
A CGU represents a group of assets for which the impairment assessment will be performed. At a minimum, a CGU should be no smaller than an operating segment of the business. For example, this should be the way in which management monitors the performance of the assets or business.
5. Terminal value
The use of a terminal value in an impairment assessment demonstrates when the present value of all future cash flows and future growth rates will be stable indefinitely.
A model is usually applied using growth rates, discount rates and normalised cash flows. These inputs are very subjective, and the calculations are often not well understood.
Terminal values often comprise the majority of the cashflow model, so it is essential to be prepared with well-supported assumptions.
Do not assume that the assumptions used last year will automatically be the same this year.
Where can it all go wrong?
Of the 54 inquiries made by ASIC over financial reports for 30 June 2017, 20 related to the impairment of assets.
In March 2018, following ASIC’s enquiry regarding the reasonableness and supportability of cash flow models used, Myer Limited was required to write down their assets by $515 million. Similarly subject to ASIC inquiries, AusTex Oil Limited and Wonhe Multimedia Commerce Limited wrote down assets by $6.17m and $5.4m respectively.
To avoid being in the ASIC spotlight, be diligent when preparing your 2018 impairment assessments. Ensure these are prepared in a timely manner to provide time for robust discussion and challenge. Consider seeking advice from PKF if you require an independent review.