Question

What are some of the complexities and key issues involved in impairment testing. In your analysis, you can refer to one or more publications issued by the ‘Big 4’ firms.

Answer 1

Issues with assessing assets often come from a handful of areas within the testing process itself.

The first question that raises is At what level should I test for impairment? The answer being which assets is being tested and it's dependencies on other seets to generate cash inflows.This might be based on geographical, customer or product location of the unit.

Moreover it is important to understand the difference between the fair value and value in use models.

Fair value ensures what an investor will pay for the asset while value in use will determine what the asset will generate for the business internally.

Another issue is to select the appropriate discount rate .Many companies are using CAPM AND Weighted Average Cost of Capital. A discount rate should not be selected in isolation.

The risk inherent in your cash flow should also be considered to arrive at the discount rate.Discount rate should reflect gearing and incremental borrowing rates current in the market which may be different to company's actual gearing and interest charges.

Tax is also a complexity added in the impairment test .A common mistake is to include inconsistent tax assumptions in the model.A company might be wrongly discounting pre cash flows with a post tax rate and vice versa. Another common error is inclusion of benefits of prior years tax losses.

There are various other issues like:-

A) Check out the integrity of your model - your impairment test is only good as your model

B) Consider the impact of foreign currencies that a company transacts in

C) Make sure you disclose key assumptions and possible alternative outcomes

D) Compare the results of your model with other market approaches

As the technology and economy is changing dynamically another issue is to make sure that impairment testing model is up to date and meeting the requirements of current economic state.which sometimes becomes hard to be done.