Understanding impairment

John Price explains why it is crucial that directors challenge and understand the asset values in company financial reports.

The Australian Securities and Investments Commission (ASIC) wants directors to think carefully about asset impairment and the carrying amounts of non-financial assets in their company’s financial reports.

In focusing on impairment of non-financial assets, ASIC is mindful to avoid matters that could not be reasonably known or foreseen at the time that financial reports are completed. 

However, while we seek to avoid judging matters with the benefit of hindsight we do expect preparers, directors and auditors to be realistic and have regard to reasonably foreseeable circumstances regarding impairment at the time of the financial report.

ASIC Information Sheet 203 Impairment of non-financial assets: Materials for directors is a resource to help directors consider impairment and the adequacy of impairment work. It is not technical or a checklist, but provides questions directors can ask management. Directors’ reliance on management will depend on:

• Materiality of the assets.
• The expertise of management and staff.
• The use of external experts.
• How the company’s performance may affect asset values.

Impairment testing

Where there are indicators of asset impairment, a company must determine whether their carrying amount exceeds their recoverable amount. This must also be made for unamortised intangibles, such as goodwill, even without indicators.

An asset’s recoverable amount is the higher of its fair value less the costs of disposal and value in use.  Recoverable amount is assessed by the cash generating unit (CGU). This is the smallest identifiable group of assets that generates cash inflows that are largely independent of other assets’ cash inflows. CGUs should not be larger than operating segments.

On impairment management directors should consider:

• If market capitalisation is less than reported net assets.
• If performance of any CGU has declined in recent years, since year-end, or is projected to decline.
• If past forecasts were not met.
• If there are significant changes in the business or its environment now or in the future.

Impairment processes

Directors may consider whether:

• The company has a culture and incentives supporting realistic assessments of the business and its assets.
• Management shows sufficient scepticism on asset values.
• Management, staff and any experts have sufficient qualifications, experience, expertise, time, and knowledge of business prospects.
• Historical cash flows have been tested for reliability and key assumptions benchmarked against appropriate sources.
• There are strong internal controls over the impairment process, including supervision and review.
• The work has been adequately documented.

Common issues

In our experience, common issues with companies’ impairment calculations include:

• Cash flows and assumptions are not reasonable and reliable, having regard to historical cash flows, economic and market conditions, and funding costs.
• Value in use calculations not meeting constraints on using increasing cash flows after five years, and excluding restructurings and improvements to asset performance.
• Cash flows are not matched to carrying amounts of all assets that generate those cash flows, such as inventories, receivables and tax balances.
• Similar discount rates are used for different CGUs, even though the risks are different and the CGUs are located in different countries.
• CGUs are identified at too high a level.

External auditors

Directors should get familiar with any auditor concerns and likewise alert the auditor to their concerns.  The auditor should have appropriate experience and expertise, which may mean using their own experts.  The auditor should also understand the business, apply professional scepticism to challenge cash flows and assumptions and be given time to undertake their review.