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Addressing Uncertainties In Goodwill Impairment Assessment

What are the cautionary measures to be exercised by management in their formulation of the goodwill impairment model?

Authored By

Ms Grace Lui


Valuation and Transaction Services


Ms Foong Yu Wen

Assistant Manager

Valuation and Transaction Services


Should management regard this global pandemic as a one-off extraordinary event to be disregarded entirely in their financial projections?

As a function of the widespread disruption to countries and societies resulting from the onset of COVID-19, most businesses continue to struggle to settle into the reality of a new normal alongside the macroeconomic impacts that are now inevitably ingrained into its very corporate fabric. The compounding effects of the pandemic upon the global economy can cause ripples throughout an organisation from its finance and liquidity, workforce availability, demand and supply of its revenue drivers, down to its operations and supply chain, impacting its operating expenses and costs of functioning. These ripples are due to deliver long sustaining impacts beyond the initial occurrence of the pandemic for an extended time period unknown and undeterminable.

The million dollar question thus exists: What are the cautionary measures to be exercised by management in their formulation of the goodwill impairment model? Should management regard this global pandemic as a one-off extraordinary event to be disregarded entirely in their financial projections?

While companies are still struggling to recover from the financial impacts from lock-downs in countries/ states and economic closures, we believe that evidence remains for companies to exercise prudency in their approach towards preparing a well-rounded goodwill impairment assessment.

At each reporting date, a company is required to perform impairment assessment on goodwill, intangible assets with indefinite life as well as intangible assets not used as of reporting date in accordance with FRS 36 Impairment of Assets, irrespective of whether any impairment indicators exist.

The key requirement is the measurement of the recoverable amount of the asset or cash-generating unit (CGU) against the respective assets’ carrying amount. The determination of the recoverable amount is achieved through the stringent documentation and measurement of, and relying on the higher of, the a) fair value less costs of disposal (FVLCD); and b) value in use (VIU):

Our avid investigation into the impact of a post-Covid landscape has provided evidence of financial impact on value determination of many commercial assets, on both the FVLCD and VIU fronts.

A. FVLCD key considerations:

In the estimation of fair value of tangible and intangible assets as a measure of an orderly transaction between market participants, reference should be made to observable transactions performed at arm’s length, where possible. Due in part to the economy having been cast into knee-deep uncertainty since the onset of the pandemic with stability of major financial markets yet to be achieved, big ticket transactions have mostly ground to a halt, with many observable transactions having been performed on a fire-sale basis, deviating from what would have been an orderly transaction.

When faced with the situation of unobservable inputs or limited data points, such reliance in itself will require greater investigation into the facts and circumstances of each transaction observed and available as at reporting date, before sound judgment can be applied to provide for adjustments, if required.

B. VIU key considerations:

The fundamental key inputs to developing financial models lay in carefully considered cash flow projections and appropriately-adjusted discount rates, supported by justifiable bases and assumptions provided for the explicit forecast period which accurately reflect the risks and uncertainty of the post-Covid economy as at the reporting date. Such discovery should be reflected in the cash flow projections with considerations made based on the industry, business and identifiable key operating drivers of the company or CGU.

A logical approach towards mitigating the risk of developing a cash flow projection model that does not reflect accurately the financial impact of the uncertain economic situation on the subject company, is to develop defined scenarios with alterations to critical variables affecting revenue and cost, based on defensible assumptions. Critical variables may include, but not limited to, market disruptive factors such as customers’ willingness to pay for the same unit of good or service, efficiency of distribution systems and supply chains, workforce availability, and the level of adoption of digital technology. A modest take towards integrating any outward economic disruptions into financial projections would be an estimation of the extent of uncertainty across scenarios, coupled with the corresponding theoretical execution time required for stabilisation of identified critical variables, and the critical analysis of how changes in such variables interplay with assumptions implied towards all other operational considerations.

Such defined scenario analysis should then allow for the identification of factors directly undermining liquidity or optimal functioning of the company, allowing for management to build their risk framework within the cash flows projections itself, thereby achieving a level of robustness while ensuring that the prospective financial information is defensible in itself. Probabilities applied to each defined scenario should provide perspective to the risks, concerns and circumstances if the company or CGU, casting visibility into key value drivers.
Where discount rates are concerned, arbitrary discount rate adjustments should be applied with caution, with additional consideration to be provided in arriving at adjusted inputs such as the capital structure of the company or CGU, which is known and expected as at the reporting date. A thorough review should be equally provided to other critical inputs including beta, cost of debt and cost of equity to reflect the increased risk for each defined scenario. A final analysis into the material differences between each of the defined scenarios based on the application of adjusted and non-adjusted discount rates should provide a supplementary review into the reasonableness of the various explicit cash flow projections prepared.

As a cautionary measure, a proactive dialogue should be formed with auditors early in order to obtain proper directives and the approach to be taken when dealing with the appropriate and substantiative assumptions used in the goodwill impairment evaluation process.

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