Saturday, January 26, 2013

ESMA Calls for Improved Reporting of Goodwill Impairment

Based on a seminal review of IFRS-driven financial statements on the impairment of goodwill at 235 EU issuers, the European Securities and Markets Authority (ESMA) called for improved disclosure of goodwill impairment. ESMA questioned if the level of goodwill impairment disclosed in 2011 corporate financial statements properly reflected the difficult economic operating environment for most companies. While the major disclosures related to goodwill impairment testing were generally provided, conceded ESMA, in many cases these were  boilerplate and not entity-specific. ESMA expects issuers and their auditors to consider the findings of this review when preparing and auditing their IFRS financial statements. 

ESMA Chair  Steven Maijoor said that good quality financial information is key for investors in understanding the financial health of an issuer and, in turn, goodwill, and its impairment, are key components in making a realistic evaluation of firms.  In that respect ESMA’s review will help in providing a more harmonized approach to the disclosure of goodwill impairment under IFRS throughout the European Union

IFRS require recognition of goodwill in the consolidated financial statements of the acquiring company when the company pays a premium over the fair value of the identified assets and liabilities of the target company in a business combination.  After initial recognition, goodwill and intangible assets with indefinite useful lives are subject to annual impairment testing, but not to amortization.

According to IAS 36, when the carrying amount of an asset exceeds the recoverable amount, the asset is considered to be impaired and the company should reduce the carrying amount, and recognize an impairment loss.  Goodwill acquired in a business combination or intangible assets with indefinite useful lives have to be tested for impairment at least on an annual basis.  Goodwill impairment loss cannot be reverse

In order to improve the overall disclosure provided in this area, ESMA urged issuers to specify the key assumptions used in the impairment test and include sensitivity analyses with sufficient detail and transparency, especially in situations when indicators are present that impairment might have occurred. Companies should also determine the growth rates used to extrapolate cash flows projections based on budgets and forecasts; and disclose specific discount rates for each material cash-generating unit rather than average discount rates.

Disclosure on the sensitivity of key assumptions is an area where different practices were observed. ESMA noted that a considerable number of issuers provided very vague sensitivity analysis disclosures. Including a negative confirmation of impairment is wide-spread among issuers.  Disclosing such a confirmation might be helpful for the readers of the financial statements, said ESMA, but it can also cause some confusion, as an investor cannot determine either the amount of headroom or what management considers to be not a reasonably possible change.  As a result of these different practices, users of financial information do not always know why the sensitivity analysis was not provided. ESMA expects issuers to be more transparent and disclose the sensitivity of the impairment calculation to changes in key assumptions.

In addition, ESMA and national competent authorities responsible for IFRS enforcement will use the review’s findings as areas to focus their assessments on when reviewing 2012 IFRS-driven financial statements. These reviews will aim at improving the rigor applied by issuers in the impairment test of goodwill. Also important is monitoring the application and compliance with IAS 36 requirements on goodwill impairment, in particular with regard to the reasonableness of cash flows forecasts, the key assumptions used in the impairment test, and the sensitivity analyses provided.