KPMG Ingles Nic 36

CORPORATE FINANCE
Praktische Umsetzung des IFRS

Impairment Test nach IAS 36
WP/StB Dr. Marc Castedello, Partner KPMG Mnchen
Vortrag LMU Mnchen, 1. Februar 2006
ADVISORY
2006 KPMG Deutsche Treuhand-Gesellschaft AG, the German member firm of KPMG International, a Swiss cooperative.
All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International.
Agenda
1. Concept of impairment test

2. Level of impairment test
3. Carrying amount of CGUs
4. Valuation approaches for recoverable amount
5. Fair value less cost to sell
6. Value in use
7. Comparison value in use and fair value
8. Example
2006 KPMG Deutsche Treuhand-Gesellschaft Aktiengesellschaft Wirtschaftsprfungsgesellschaft, the German member firm of KPMG International, a Swiss cooperative.
All rights reserved. The KPMG logo and name are trademarks of KPMG International.

Accounting for business combinations
PPA IFRS 3
Determination
of acquisition
cost
Purchase
price
allocation
1. IDENTIFICATION
Impairment preparation
Definition of
cash generating
units
Allocation
of assets
and liabilities
2. ANALYSIS
Impairment Test IAS 36

Goodwill
allocation
Impairment
test
3. VALUATION
z Identification of all
z Determination of
z Determination of fair
tangible assets with

expected deviation
between fair value and
book value
z Identification of intangible
assets and contingent
liabilities
z Those intangible assets
which do not meet the
relevant accounting
criteria are part of
goodwill
valuation methods for the

assets
z Determination of
valuation assumptions
(e.g. useful live) for the
assets
z Gathering of data for the
valuation
value of identified assets

and liabilities/contingent
liabilities
z Calculation of deferred
taxes
z Determination of the
remaining goodwill

Recoverable amount
Assets have to be carried at no more than their recoverable amount:
CGU
asset
carrying amount
>
CGU
asset
recoverable amount
Recoverable amount is the greater of . . .

Value in use
Fair value less costs to sell
Present value of the future cash flows expected z The amount obtainable from the sale of an asset
or CGU in an arms length transaction between
to be derived from an asset or CGU
knowledgeable, willing parties, less costs of
z Reflecting the internal perspective of
disposal
accounting company
z Reflecting the external perspective of market in
which the company is operating
z
If either fair value less costs to sell or value in use exceeds the assets
carrying amount, it is not necessary to estimate the other amount

Cash generating unit
A cash-generation unit is the smallest identifiable group of assets that generates cash
inflows that are largely independent of the cash inflows from other assets or group of
assets.
CGU
CGUs without allocated goodwill
CGUs with allocated goodwill
assets
goodwill
IAS 36.69:
IAS 36.81:
an entity considers various factors

including how management monitors the
entity's operations () or how management
makes decisions about continuing or
disposing of the entity's assets and
operations.
the lowest level within the entity at which

the goodwill is monitored for internal
management purposes

Impairment test of intangible assets (without goodwill)
z Most important assets that have to be tested for impairment are intangible assets like
brands, customer relationship, technology, patents etc.

z Fair value of this assets has been assessed on their individual level of each single asset,
because independent cash inflows are no prerequisite to determine fair value
z Characteristic of these assets is, that they regularly do not produce any independent cash
inflows, but create the latter in combination with other assets
z From a value in use perspective these assets have to be tested on a CGU level
but
z According to IAS 36.22 they can be tested on a individual level for impairment as long as
their fair value can be determined individually and the latter is higher as their carrying
amount
z Important simplification for many intangible assets, because methodology of PPA process
can be used as well for impairment test

Impairment test of assets (without goodwill)
individual asset
Can fair
value less costs to
sell be determined for
individual asset?
Fair value
less costs to sell
>
carrying amount
Yes
no impairment
No
No
Impairment test
on individual
asset level
Yes
individual asset
Asset generates
largely independent
cash flows?
Yes
Value in use
>
carrying amount
Yes
no impairment
No
No
CGU
Impairment
test on
CGU level
Fair value
less costs to sell
>
carrying amount
Yes
no impairment
impairment
CGU
No
Value in use
>
carrying amount
No
impairment
Yes
no impairment
Source: IDW RS HFA 16

Impairment test of assets (without goodwill)
Practical problem:
z IAS 36 is focussing on cash-inflows. Thus, cash-outflows can be dependent from cash-
outflow for other assets

z Therefore, a cash-flow statement on CGU-level is no prerequisite
z Example: Retail Group
Customers market a
Customers market b
Cash-inflows
Cash-inflows
Market a
Market b
Each market basically builds a CGU!

but:
Cash-outflows
Logistic centre
1) expansion in new geographical

markets
2 key account management
Procurement

Impairment test of goodwill (I)
Goodwill does not generate cash flows independently from other assets or group of assets
z
IAS 36.80: For purpose of impairment testing, goodwill is

allocated to CGUs or groups of CGUs, that are expected
to benefit from the synergies of the combination.
IAS 36.82: One has to take into account how
management monitors the operations. Therefore, the
development of additional reporting system is typically
not necessary
IAS 36.80b: The CGU shall not be larger than a
segment based on either the entitys primary or the
entitys secondary reporting format determined in
accordance with IAS 14 Segment Reporting (IAS 36.80)
IAS 36.81: In terms of a methodology no certain rule of
allocation exists (non-arbitrary, IAS 36.81). Goodwill can
even be assigned to units, which have not been
acquired in the particular transaction
z
z
Goodwill does not necessarily reflect synergies, but

value drivers that fail to meet the identification criteria
of IAS 38.
Management are the people who decide about the
acquisition (and not the local management of the units).
Decision can only be based on existing reporting
system.
In practice, tendency to test on segment level
Possible allocation measures
relative cash flows of CGUs
relative EBIT/EBITDA of CGUs
relative fair values of assigned intangibles to CGUs
A business combination leads to one goodwill, even though a SPA comprises different values
for different legal entities. A goodwill cannot lead to a badwill for a single CGU and a higher
goodwill for the remaining CGUs

Impairment test of goodwill (II)
Group
Segments (IAS14)
Strategic
business units
Operative
business units
Profit centre
Legal entities
Quelle: IFRS-Praxis
3. Carrying amount of CGUs

Principles of allocation
Overall principle
(IAS 36.75)
The carrying amount of a CGU shall be determined on a basis consistent with the way the
recoverable amount of the CGU is determined.
There is just one carrying amount, which is independent how the recoverable amount is
determined
Recognised liabilities
(IAS 36.76b)
Basically, no financing activities are considered
Working Capital
(IAS 36.88)
For practical reasons allocation is accepted. In practise due to overall principle and cash
flow determination very common.
Pensions
The recoverable amount should be determined without any consideration of pension costs
at all. Consequently, pensions must be deducted in the carrying amount. Alternatively,
recoverable amount can be reduced by pensions liability, which correspondingly has to be
considered in the carrying amount
Tax assets
Assets and liabilities in connection with taxes like deferred tax assets and liabilities and
current tax asset and liability are not considered
Minority interests
The goodwill does not comprise the minority interest. Due to the fact that recoverable
amount includes minority interest the carrying amount has to be grossed up
10
4. Value categories for recoverable amount

Value in use and fair value less cots to sell
Recoverable
amount
Value in use
Fair value less cost to sell
Valuation
perspective
Assessment of asset/CGU in its current condition

within the company
Assessment of asset / CGU from the perspective

of a hypothetical buyer less cost of disposal
Valuation
approaches
Income approach only (see also IDW RS HFA 16

Tz. 20)
After the IDW RS HFA 16 Tz. 20 hierarchy:

1. market approach
2. income approach
Composition of
estimates of
future cash flows
z true synergy effect between CGUs / assets
z no true synergy effects between CGU / assets
z no improvements or enhancements
z cash flow from financing & taxes on income
z no future restructuring
z no cash flows from financing and taxes on
income
Cost of capital
WACC
z market participant tax rate
z existing capital structure of CGU(s)
WACC
z market participant tax rate
z market-based capital structure
11
4. Valuation approaches for recoverable amount

Value in use and fair value less costs to sell
Net selling price
reflects the markets
expectation of the
present value of future
cash flows (IAS 36
BCZ 11(b))
US-GAAP comparison
Market approach
Level 1
active markets
1. Binding sale
agreement
(IAS 36.25)
Level 2
quoted prices
2. Market price on active

markets (IAS 36.26)
Level 3
observ. market
inputs
3. Best information available (IAS 36.27)

Analogy method: recent
transactions for similar
assets (IAS 36.27)
Fair Value
Hierarchy
FASB
Level 4
not directly observ.
market inputs
Discounted cash flow

method (IAS 36 BCZ 16)
Level 5
entity inputs
Income approach
Value in use
Value in use is the enterprises estimate

of the present value of the future cash
flows (IAS 36 BCZ 11 (c))
12
5. Fair value less costs to sell

Market approach
z
Market approach is usually not applicable for single assets, but for CGUs
Multiples reflect current market transactions to indicators that drive the profitability of the asset
Indicators might be revenue, market shares, operating profit, cash-flow
However, observable market prices are often difficult to be transferred to fair value in terms of IFRS 3
Market approach
Do buyer specific
synergies increase
fair value?
Determination of multiples based

on comparable transactions
Market capitalisation of
comparable company that equals
CGU
What about
analysts
estimations?
Synergies
Premium
Has a control
premium to be added
in order to reflect fair
value?
Historic
Transaction
Price
Sales / EBIT
Sales / EBIT
Market
Capitalisation
Multiple
13

Income approach
z
The relevant cash flows are determined on the basis of cash flow forecasts for the CGU
In practise, typically managements estimation of cash flows is used, but IAS 36 requires to focus on
market expectations, which means the use of external rather than internal figures
The cash flow projection has to be consistent with the determination of the carrying amount
One has to bear in mind that the valuation object is not an enterprise, but a bundle of assets
Basically, the cash flows can be calculated as follows:

assets of CGU
Cash flow CGU = EBITCGU (1 - t) - ICCGU
financial assets
where
EBITCGU = Earnings before Interest and Taxes of CGU
receivables
short term accruals
inventories
payables
= Corporate tax rate
ICCGU
= Change of Invested Capital of CGU
The tax rules of the country in which the cash flows are generated have to be applied
The costs for disposal have to be deducted. Depending on the size of the transaction a range of 0,5 to
3,0 % seems to be reasonable
14

Income approach cost of capital
z
For all methods of the income approach: The relevant cash flows have to be discounted to present value
For asset valuation, the entity value has to be determined, because the asset is - unlike legal entities in
case of enterprise valuations - not a legal subject with own financing activities
However, financing is a decision on the level of the investor. But how are single assets or CGUs typically
financed by a hypothetical buyer? Practical answer: Long lived assets and CGUs are typically financed
by equity and debt. For practical reasons the WACC is applied. Working capital is usually debt financed.
WACC = [re * E/(D+E) + rd * D/(D+E) * (1-t) ]
Equity rate of return of

the asset/CGU
corroborated from peer
group companies
Capital structure of
companies typically
operating these assets
Corresponding tax rate

to taxation of cash flow
15

Valuation summary
z
The standard requires to base fair value on the best information available if neither a binding sales
agreement nor an active market for the asset is existing
This does not mean that the standard wants the final judgement to be based on one single valuation
approach (market versus income)
This seems to be consistent with the Fair Value Measurement Project under US-GAAP
However, the practical problem arises how to rank a market value e.g. based on comparable
transactions and a DCF value after it is unlikely that they result in the same value
One possible solution might be taking an weighted or unweighted average, but finally the conclusion is
based on professional judgement!
Carrying amount
EBITDA-multiples
Market Capitalisation
DCF-value
10
20
30
40
16
6. Value in use
Basis for cash flows
z
Cash flow projections shall be based on the following (IAS 36.33):
The most recent financial forecast approved by management
The period covered by the forecast shall be no more than 5 years unless a longer period can be
justified
Beyond this period, the projections of the forecast shall be extrapolated
The growth rate shall not exceed the long term average growth rate of relevant products, industries
and markets unless a higher rate can be justified
N This seems to make the value in use look like the more attractive approach that can be summarized
as follows: An impairment is the penalty for expression of a lack of creativity in terms of
forecasting [Schildbach, T., WPG 10/2005, page 558]
BUT (IAS 36.34):
z
Management assesses the reasonableness of the assumptions on which its current cash flow
projections are based by examining the causes of differences between past cash flow projections and
actual cash flows.
Management shall ensure that the assumptions on which its current cash flow projections are based are
consistent with past actual outcomes, provided the effects of subsequent events or circumstances that
did not exist when those actual cash flows were generated make this appropriate.
17
6. Value in use
Estimates for future cash flows
Closer look makes the approach looking much less attractive, as cash flows
z Shall include company specific expectations and factors like synergies between the object
to be valued and other assets
z Shall not include cash inflows/outflows from
a future restructuring to which the entity is not yet committed
much stricter than IDW S1 / HFA 10
improving or enhancing the assets (CGUs) performance
what is improvement or enhancement of a CGU?
Topical issue in
practice, but often
neglected
financing activities
income tax receipts or payments (IAS 36.44 and IAS 36.50)
Technical problem
for discount rate
18
6. Value in use
Discount rate
z
z
z
z
z
z
z
z
z
The discount rate shall be a pre-tax rate (IAS 36.55)

Problem: The calculation of a pre-tax discount rate on basis of the CAPM requires a market risk premium on a pre-tax
basis which is not available
Pragmatic solution:
The value in use is calculated with an after-tax WACC
In order to meet the equivalence criteria the cash flow must also be determined after-tax
The resulting value is the value in use
The calculation includes the TAB in line with the calculation of the fair value less costs to sell (IAS 36.BCZ85)
To determine the pre-tax WACC, the cash flow has to be adjusted by income taxes
Following the assumption that a pre-tax valuation equals a post-tax valuation, the pre-tax WACC should be determined
via goal-seeker
In principle, value in use should be an enterprise-specific measure determined in accordance with the enterprises own view
of the best use of that asset. Logically, the discount rate should be based on the enterprises own assessment both of the time
value of money and of the risks specific to the future cash flows from the asset. However, IASC believed that such a rate
could not be verified objectively.
Therefore, IAS 36 requires that the enterprise should make its own estimate of future cash flows but that the discount rate
should reflect, as far as possible, the markets assessment of the time value of money. Similarly, the discount rate
should reflect the premium that the market would require from uncertain future cash flows based on the distribution
estimated by the enterprise.
19
7. Comparison value in use and fair value less cost to sell

Discount rates
Parameter of
WACC
Value in use
Fair Value less cost to sell
Cost of equity
z Peer Group (Beta derivation)
z Peer Group (Beta derivation)
z Base rate of business plan currency
z Base rate of business plan currency
(differention)
z Levered Beta reflects capital structure of
CGU/company
z Market risk premium (depending on cash flow
origination)
z individual risk discounts premium in terms of
cash flow projection of management
(differention)
z Levered beta reflects target structure of peer
group
z Market risk premium (depending on cash flow
origination)
Cost of debt
z Financing costs of CGU
z Financing costs of peer group
Long-term
growth rate
z As enhancement / improvement of
z Long-term market growth rate
Taxes
z Consideration of taxes (after tax WACC)
z Consideration of taxes (after tax WACC)
z Taxes reflect country specific marginal rate of
z Taxes reflects country specific marginal rate
tax (weighted)
z After tax cash flows (same tax rate)
z Adjustment of after tax WACC into pre tax
of tax (weighted)
z After tax cash flow applying same tax rate
z Capital structure from CGU/company
z Capital structure from peer group
assets /CGU must not be taken into

consideration, long term growth limited,
sometimes even zero or negative (IAS 36.36)
Capital structure
20

Potential advantages of the fair value less cost to sell
Value in use
Fair value less cost to

sell
Elimination of synergies
Elimination of future cash inflows or

outflows expected to arise from future
restructurings or from improving or
enhancing asset's performance
Harmonisation with fair value according

to US GAAP
Reduction of complexity as the

business plan does not have to be
adjusted by effects from restructuring
and extension of capital investments
21

Typical approach for goodwill impairment test
Determination fair value less
cost to sell
no
Carrying amount >

yes
Determination
value in use
Fair value less cost to sell >

value in use
yes
no
impairment
impairment based on Fair

value less cost to sell
no
Carrying amount >

value in use
no
yes
Impairment based on value in

use
22
8. Example: Fair value less cost to sell

Financials cash generating unit
t=0
Plan Results
t=1
t=2
t=3
t=4 ff.
(sustained growth)
2,0%
Sales turnover
3.000,00
3.100,00
3.200,00
3.264,00
Operating costs
1.740,00
1.798,00
1.856,00
1.893,12
EBITDA
1.260,00
1.302,00
1.344,00
1.370,88
42,0%
42,0%
42,0%
42,0%
195,00
213,00
230,00
235,00
1.065,00
1.089,00
1.114,00
1.135,88
35,5%
35,1%
34,8%
34,8%
EBITDA - Margin
EBIT
EBIT- Margin
Interest
0,00
0,00
0,00
0,00
1.065,00
1.089,00
1.114,00
1.135,88
319,50
326,70
334,20
340,76
745,50
762,30
779,80
795,12
100,00
100,00
100,00
100,00
100,00
Fixed assets
3.800,00
4.000,00
4.500,00
4.700,00
4.700,00
Current assets
1.000,00
1.300,00
1.600,00
1.700,00
1.763,00
EBT
Tax
30%
EAT
Allocated items for CGU

Goodwill
Tax assets
Net Assets
4.270,00
4.480,00
4.690,00
4.950,00
5.013,00
630,00
920,00
1.510,00
1.550,00
1.550,00
No allocation of these
assets according to
IAS 36
Pension claims
Interest accrued liabilites
Other
23

Impairment test (1/2)
t=0
EBIT
Adjusted tax on profits
NOPLAT
+Amortisation
-/+ Capital expenditures
-/+ Investment working capital
-/+ Investment other assets
Free cash flow
30%
WACC
Terminal growth
Present value of cash flows
Sum of cash flows
Fair Value
Disposal costs
Fair Value less cost to sell
Carrying Amount
Impairment indication
2%
t=1
t=2
t=3
t=4 ff.
1.065,00
319,50
745,50
195,00
-395,00
-10,00
0,00
535,50
1.089,00
326,70
762,30
213,00
-713,00
290,00
0,00
552,30
1.114,00
334,20
779,80
230,00
-430,00
-60,00
0,00
519,80
1.135,88
340,76
795,12
235,00
-235,00
-63,00
0,00
732,12
7,3%
7,3%
7,3%
499,07
479,71
420,76
7,3%
2,0%
11.181,62
12.581,16
0,00
12.581,16
251,62
12.329,54
4.270,00
- No -
24

WACC - Derivation
Cost of Equity
8,5%
Cost of debt
5,0%
Average capital structure of market participants

Market value debt capital
Market value total capital
Standard business tax rate
Tax Shield
WACC
80,0%
80
100
30,0%
1,2%
7,30%
25
Example: Value in use

Financials cash generating Unit
t=0
t=1
t=2
t=3
t=4 ff.
Plan Results
0,0%
Sales
3.000,00
3.000,00
3.000,00
3.000,00
Operating costs
1.740,00
1.740,00
1.740,00
1.740,00
EBITDA
1.260,00
1.260,00
1.260,00
1.260,00
42,0%
42,0%
42,0%
42,0%
195,00
195,00
195,00
195,00
1.065,00
1.065,00
1.065,00
1.065,00
35,5%
35,5%
35,5%
35,5%
EBITDA - Margin
Depreciation
EBIT
EBIT- Margin
Interest
0,00
0,00
0,00
0,00
1.065,00
1.065,00
1.065,00
1.065,00
319,50
319,50
319,50
319,50
745,50
745,50
745,50
745,50
100,00
100,00
100,00
100,00
100,00
Fixed assets
3.800,00
3.800,00
3.800,00
3.800,00
3.800,00
Current assets
1.000,00
1.250,00
1.550,00
1.650,00
1.713,00
EBT
Tax
30%
EAT
Allocated item for CGU

Goodwill
Taxed assets
Net Assets
4.270,00
4.270,00
3.980,00
4.040,00
4.103,00
630,00
880,00
1.470,00
1.510,00
1.510,00
Pension claims
Interest accrued liabilities
Other
Assumption:
No sustainable
growth due to
limitation of
investment on
replacement
Elimination of
enhancement and
improvement
including operating
consequences
26

t=0
EBIT
NOPLAT
+Amortisation
-/+ Capital expenditures
-/+ Investment working capital
-/+ Investment other assets
Free Cash flow
30%
WACC
Terminal growth
Sum of cash flows
Value in use
9.346,12
0,00
9.346,12
Carrying Amount
4.270,00
Impairment indication
t=1
t=2
t=3
t=4 ff.
1.065,00
319,50
745,50
195,00
-195,00
0,00
0,00
745,50
1.065,00
319,50
745,50
195,00
-195,00
290,00
0,00
1.035,50
1.065,00
319,50
745,50
195,00
-195,00
-60,00
0,00
685,50
1.065,00
319,50
745,50
195,00
-195,00
-63,00
0,00
682,50
7,6%
7,6%
7,6%
692,84
894,39
550,26
7,6%
0,0%
7.208,62
- No -
27

WACC - Derivation
Costs of equity
8,5%
Cost of debt
5,0%
Capital structure CGU

Market value debt capital
Market value total capital
Standard business tax rate
Tax Shield
WACC
60,0%
60
100
30,0%
0,9%
7,60%
28

Determination of the real pre-tax discount rate
t=0
EBIT
NOPLAT
+Amortisation
-/+ Capital expenditure
-/+ Invested working capital
-/+ Invested assets
Free cash flow from tax
0%
WACC from tax

Terminal growth
Sum of cash flows
Value in use
t=1
t=2
t=3
t=4 ff.
1.065,00
0,00
1.065,00
195,00
-195,00
0,00
0,00
1.065,00
1.065,00
0,00
1.065,00
195,00
-195,00
290,00
0,00
1.355,00
1.065,00
0,00
1.065,00
195,00
-195,00
-60,00
0,00
1.005,00
1.065,00
0,00
1.065,00
195,00
-195,00
-63,00
0,00
1.002,00
11,1%
11,1%
11,1%
958,32
1.097,15
732,24
11,1%
0,0%
6.558,41
Operating
result pretaxation
9.346,12
0,00
9.346,12
9.346,12
Pre-tax rate by
iterative
computation acc.
IAS 36 BCZ 85
29

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CORPORATE FINANCE

Praktische Umsetzung des IFRS

1. Concept of impairment test

1. Concept of impairment test

Impairment Test IAS 36

tangible assets with

valuation methods for the

value of identified assets

1. Concept of impairment test

Recoverable amount is the greater of . . .

Fair value less costs to sell

1. Concept of impairment test

CGUs without allocated goodwill

CGUs with allocated goodwill

an entity considers various factors

the lowest level within the entity at which

2. Level of impairment test

brands, customer relationship, technology, patents etc.

2. Level of impairment test

2. Level of impairment test

outflow for other assets

Each market basically builds a CGU!

1) expansion in new geographical

2. Level of impairment test

IAS 36.80: For purpose of impairment testing, goodwill is

Goodwill does not necessarily reflect synergies, but

In practice, tendency to test on segment level

Possible allocation measures

relative cash flows of CGUs

relative EBIT/EBITDA of CGUs

relative fair values of assigned intangibles to CGUs

2. Level of impairment test

3. Carrying amount of CGUs

Basically, no financing activities are considered

4. Value categories for recoverable amount

Fair value less cost to sell

Assessment of asset/CGU in its current condition

Assessment of asset / CGU from the perspective

Income approach only (see also IDW RS HFA 16

After the IDW RS HFA 16 Tz. 20 hierarchy:

z true synergy effect between CGUs / assets

z no true synergy effects between CGU / assets

z cash flow from financing & taxes on income

4. Valuation approaches for recoverable amount

Fair value less cost to sell

2. Market price on active

3. Best information available (IAS 36.27)

Discounted cash flow

Value in use is the enterprises estimate

5. Fair value less costs to sell

Indicators might be revenue, market shares, operating profit, cash-flow

Determination of multiples based

5. Fair value less costs to sell

Basically, the cash flows can be calculated as follows:

Cash flow CGU = EBITCGU (1 - t) - ICCGU

short term accruals

= Corporate tax rate

= Change of Invested Capital of CGU

5. Fair value less costs to sell

WACC = [re * E/(D+E) + rd * D/(D+E) * (1-t) ]

Equity rate of return of

Corresponding tax rate

5. Fair value less costs to sell