By Tim KotrlikManager - Audit and Assurance
4 August 2020
Forecasting the future is often not straight forward, and even more so given the heightened present uncertainty, with the COVID-19 pandemic, and the measures taken to combat (e.g. business closures, travel restrictions) having a substantial impact on businesses across the world.
Asset values continue to be a key focus area for financial reporting regulators – and the negative impact of COVID-19 will mean that previously unaffected businesses will need to consider their asset values for the first time.
As always, goodwill or other indefinite-lived assets will need to be tested for impairment on at least an annual basis. AASB 136 Impairment of Assets also requires that other non-financial assets (e.g. property, plant & equipment, investment properties, biological assets) be tested for impairment when there is an indication of impairment at the reporting date.
Indicators of impairment include significant changes which have an adverse effect on the company, either during the reporting period or that will take place in the near future, in the market or economic environment in which the company operates. Accordingly, if a company has been negatively impacted by the COVID-19 pandemic – for example, temporarily scaling down operations, seeing declines in demand, or reduced prices/margins – then this likely qualifies as an indication of impairment.
If an indication of impairment exists, companies will need to estimate the recoverable amount of the asset, being the higher of its fair value less costs of disposal and its value in use.
Value in use is the future cash flows expected to be derived from an asset (or a group of assets called a cash-generating unit), discounted to present value. The discounted cash flows need to reflect expectations about possible variations in the amount or timing of those future cash flows (i.e. the assumptions and cash flow forecasts used to test for impairment should be updated to reflect the potential impact of COVID-19 – noting that past results may not be an accurate predictor of future outcomes in this environment).
AASB 136 prescribes two approaches to project cash flows:
- The traditional approach
- Uses a single cash flow projection, or most likely cash flow
- Cash flows are not adjusted for risk
- Risk, including any risk associated with the impact of COVID-19, is reflected in determining the discount rate (i.e. the discount rate may be significantly higher than in prior years, even though interest rates have fallen)
- Uses multiple, probability-weighted cash flow projections
- Uncertainty about the future cash flows, including any uncertainty arising from the impact of COVID-19, is reflected in the different probability-weighted cash flow projections used, not in the discount rate
Whichever approach is adopted, it’s important to note that the rate used to discount cash flows should not reflect risks for which the future cash flow estimates have already been adjusted, and vice versa. Otherwise, the effect of some assumptions will be double counted.
Please reach out to your local PKF office if you require any support, guidance or additional insights.