Goodwill impairment test issue

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edith
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Goodwill impairment test issue

Post by edith »

My company acquired a subsidiary.
I now need to prepare goodwill impairment test.
The fair value of building inside the subsidiary has been estimated and be applied in my consolidation financial statements.

Now in the estimation of recoverable amount...

Thank you.
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Marek Muc
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Re: Goodwill impairment test issue

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...and the question is? :)
edith
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Re: Goodwill impairment test issue

Post by edith »

My company acquired a subsidiary.
I now need to prepare goodwill impairment test.
The fair value of building inside the subsidiary has been estimated and be applied in my consolidation financial statements.

Now in the estimation of recoverable amount of the cash generating unit,
do I need to consider the fair depreciation schedule of this building, in the Discount Cash Flows? Or capital allowance instead in the Discounted Cash Flows.

A easier way, should the carrying amount of CGU ignore the revaluation surplus of this building?
edith
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Re: Goodwill impairment test issue

Post by edith »

A friend tells me that on PPA completion date PPE assets have been estimated on fair value basis (in order to workout goodwill), so on subsequent goodwill impairment test, the CGU Carrying Amount should be based on that fair values and subsequent depreciation, while the DCF (for VIU and Fair Value of CGU Recoverable Amount) should not consider fair value adjustment on the depreciation schedule.

I think that under this practice the Carrying Amount and Recoverable Amount are not on consistent basis. Am I correct?

Then the solution will then be, I think,
A) kick out the PPE surplus from the CGU Carrying Amount formula; or
B) DCF's depreciation schedule considers the PPA completion date's deemed cost (that Fair Values worked out on completion date) and subsequent deprecition up to impairment date.

Am I correct?
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Marek Muc
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Re: Goodwill impairment test issue

Post by Marek Muc »

you need to test for impairment the carrying amount of CGU as shown in your consolidated balance sheet, i.e. including fair value adjustments recognised as a result of business combination accounting (or PPA)

Depreciation is a non-cash expense and it doesn't impact future cash flows (DCF) and hence recoverable amount, so I'm not sure what your doubts are with this
JRSB
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Re: Goodwill impairment test issue

Post by JRSB »

needs more detail to comment really., what is the building used for, what is the accounting policy applied to that property, etc
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Marek Muc
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Re: Goodwill impairment test issue

Post by Marek Muc »

I think that irrespective of the accounting policy for this building you don't deduct its depreciation from future cash flows...
edith
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Re: Goodwill impairment test issue

Post by edith »

The formula of free cash flow is as follows:

https://www.cfainstitute.org/en/members ... Tax%20rate)%20%2B%20Net%20borrowing.

FCFF = EBITDA x (1 – Tax rate) + Dep x (Tax rate) – FCInv – WCInv.

I.e.Depr does not disappear in the cash flow formula.
This is the generally accepted formula here.

To me, recoverable amount on goodwill impairment test date (on recent fiscal year end) considering PPE acquisition revalued cost from equity acquirer's angle (based on fair value adjustment arising from PPA completion date), is a way to reflect the consistent basis with carrying amount (which has also considered the same revalued cost). This is what I learnt and what my auditor close friends told me.

To me, the same asset may involve two carrying amounts, which are different between acquirer's angle and acquiree's angle (e.g a building purchased by acquiree 20 years ago will have smaller carrying amount on recent fiscal year end date, while the same building whose company shares purchased by acquirer several months ago will have larger carrying amount on the same fiscal year end date, on acquirer's consolidated balance sheet and thus larger depreciation on its consolidated income statement).

Now my friends have two opposite views. One side thinks that Carrying Amount should consider the above PPA fair value adjustment but Recoverable Amount should not (due to tax law requiring me depreciation schedules based on PPE tax base (no step-up adjustment)). Another side thinks that revalued PPE fair value adjustment should appear/disappear at both Carrying Amount and Recoverable Amount).

Thanks for your agreeing with me that goodwill impairment test on recent fiscal year end should consider the PPE acquisition cost from acquirer's angle (based on fair value adjustment arising from PPA date) on both Carrying Amount and Recoverable Amount.

So do you also agree if 'both' Carrying Amount and Recoverable Amount do not consider PPE acquisition revalued cost (based on fair value adjustment arising from PPA date)?

(This looks to be more simple way to settle the dispute between my friends)
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Marek Muc
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Re: Goodwill impairment test issue

Post by Marek Muc »

Free cash flows aren't impacted by depreciation expense.

See this Investopedia article:

https://www.investopedia.com/terms/f/freecashflow.asp
There are two main approaches to calculating FCF. The first approach uses cash flow from operating activities as the starting point, and then makes adjustments for interest expense, the tax shield on interest expense, and any capital expenditures (CapEx) undertaken that year. The second approach uses earnings before interest and taxes (EBIT) as the starting point, then adjusts for income taxes, non-cash expenses such as depreciation and amortization, changes in working capital, and CapEx. In both cases, the resulting numbers should be identical, but one approach may be preferred over the other depending on what financial information is available.
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Marek Muc
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Re: Goodwill impairment test issue

Post by Marek Muc »

Ps. The formula that you provided uses depreciation instead of actual CapEx, which is wrong IMO
edith
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Re: Goodwill impairment test issue

Post by edith »

You are so nice to give another formula. But the formula I gave you have been approved by our company auditor. So don't worry. This is not the issue we are discussing. FCFF formula the CFA proposes is the same as what our auditor proposes.
edith
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Re: Goodwill impairment test issue

Post by edith »

FCFF = EBIT x (1 – Tax rate) + Dep – Capex – Change in Working Capital = EBITDA x (1 – Tax rate) + Dep x(Tax rate) – Capex – Change in Working Capital. This formula has been applied among CFA experts, valuers and auditor in my city for these years. So don't worry. Thanks again.

From IFRS angle, is there restriction forbidding taking out fair value adjustments from both sides (carrying amount and recoverable amount)?
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Marek Muc
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Re: Goodwill impairment test issue

Post by Marek Muc »

You didn't add capex in the previous post...

Anyway, depreciation charge won't impact your future cash flows (apart from tax payments), I'm sure CFAs are aware of that ;)

IFRSs don't give you precise formulas to use, read more about IFRS requirements in the knowledge base (follow the internal links there):

https://ifrscommunity.com/knowledge-bas ... of-ias-36/
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Marek Muc
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Re: Goodwill impairment test issue

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PS. Note that you are adding back depreciation charge in your formula
FCFF = EBIT x (1 – Tax rate) + Dep – Capex – Change in Working Capital
JRSB
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Re: Goodwill impairment test issue

Post by JRSB »

Marek Muc wrote: 18 Jan 2023, 14:01 I think that irrespective of the accounting policy for this building you don't deduct its depreciation from future cash flows...
agree but trying to work out what the building is and how it might impact tests at CGU level
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