Key considerations for year-end impairment testing

Increasing interest rates, rising inflationary pressures fuelled by global conflict, and economic uncertainty has placed unprecedented pressures on businesses.

As a result, we are seeing increased risk that the recoverable amount of assets/CGUs is below their carrying amount - or any existing headroom is significantly reduced. Our clients are being questioned by their auditors whether existing impairment processes are sufficiently robust and reliable to capture the changing forecasts, assumptions, and sensitivities. Companies are also questioning the amount of effort that is involved in the process, in particular for parts of the business where they consider an impairment unlikely.

Impairment has therefore become the accounting hot-topic of the season. Companies have been flagging a significantly increased level of audit scrutiny, and impairment is a FRC area of focus for the 2024/25 cycle of annual reviews due to the risks related to the current economic environment.

In this blog, we have posed a number of critical questions for you to consider covering different aspects of the impairment process to help you identify the likely challenges you may face, considering the current volatile economic conditions.

• Do you take a risk-based approach? – or is a lot of time spent on detailed testing and documentation for parts of the business you are confident won’t be materially impaired?
• How do you identify triggering events? For instance, do you have a policy that determines the potential impairment triggers. And how often is this policy updated to stay relevant with the market? Does this policy include quantitative as well as qualitative factors?
• What are the key drivers impacting your testing? Have you identified inputs such as WACC, growth rates or margins that would significantly impact the outcome of impairment testing. Are these drivers constantly monitored? What sources do you consider to help estimate this inputs? Do those sources include external and internal data points?
• How are your CGUs defined? Is this at an asset level or a higher level? Particularly, is the grouping of assets into CGUs appropriate?
• Is the recoverable amount of CGU based on value in use (VIU) or fair value less costs of disposal (FVLCD)? Have you reconsidered whether the current basis of determining recoverable amount is appropriate at year end? For example, if you are expecting to restructure your business.
• How do you allocate central overheads and corporate assets to CGUs? Is this policy appropriate reflecting your group at the reporting date?
• Do you monitor your CGUs for potential changes to business and / or other events that may lead to a change in identification of CGUs?
• How do you consider inflationary, country or CGU specific risks especially in a complex portfolio of multi-national CGUs?
• At what level is testing performed? Do you perform a detailed test whenever there is an impairment indicator? Or do you have a high-level test before you consider detailed testing. Does your testing differentiate different categories of testing such as existing versus newly acquired intangibles?

• How agile is your cash flow model? Is your model robust and reliable to capture and reflect the changing assumptions, estimates and sensitivities? For example, are the terminal values assumptions still valid?
• How do you update discount rates? Does this correlate to the market risk free rates or do you consider other adjustments such as market premiums, where appropriate. Do you rely on recent valuations without considering further adjustments?
•  How do you assess forecasting risk? Do you adjust your cash flow forecast or incorporate this risk into the alpha factor?
• How do you determine disclosure requirements? Have you considered enhanced sensitivity analysis for major sources of uncertainty? How have you analysed future potential impairment risks to protect your business from those risks by applying scenario analysis and sensitivities to the key judgements?
• What are your sources of benchmarking to validate your assumptions and other inputs? How have you considered that the sources are appropriate for your specific impairment requirements?
• How have you considered the connectivity between your impairment model and your climate / sustainability commitments? i.e., Are the climate commitments in the first half of the annual report reflected in the forecasts used for impairment in the back half of the annual report?
• Have you considered knock on impacts? For instance, does an impairment charge result in triggering financial covenants for your borrowings? For CGUs at risk, how do you perform reasonableness checks for the recoverable amounts and document the support for key judgements?

• Consider whether the current level of documentation would meet the increased scrutiny given current risk. For instance, are you documenting new assumptions, justification, and the internal board approvals?
• How often do you communicate with your auditors? For instance, how early are you producing your disclosures and sharing them with your auditors to avoid any last-minute surprises.
• Timing of internal signoffs versus auditor communication. Best practice would be to have these as aligned as possible to avoid any potential delays to and obtain auditors buy-in.

• Understand your current impairment process and suggest process improvements to bring efficiencies aligned to your business objectives and the requirements of IAS 36.
• Prepare/review technical accounting papers to support your approach and documentation of impairment testing.
• Review and provide support in enhancing your disclosures, where necessary, keeping in mind the accounting requirements and overall connectivity within your financial statements.
• Support with undertaking impairment testing on behalf of the company, and the provision of key inputs such as discount rates.

If you would like to discuss potential solutions to these challenges, please do not hesitate to contact KPMG’s On Call Accounting team