ESMA report shows room for improvement regarding disclosures related to goodwill impairment
21 Jan 2013
The European Securities and Markets Authority (ESMA) has published a review of 2011 IFRS financial statements related to impairment testing of goodwill. The report shows that significant impairment losses of goodwill were limited to a handful of issuers. According to ESMA, this raises the question as to whether the level of impairment disclosed in 2011 financial reports appropriately reflects the difficult economic operating environment for companies. ESMA also finds that although the major disclosures related to goodwill impairment testing were generally provided, in many cases these were boilerplate and not entity-specific. ESMA expects issuers and their auditors to consider the findings of the review when preparing and auditing the 2012 IFRS financial statements.
ESMA decided to conduct the review of accounting practices related to the impairment of goodwill and other intangible assets because in connection with the financial crisis many market participants had expressed concerns about the reliability of goodwill impairment tests. Even Hans Hoogervorst, Chairman of the IASB, admitted in a speech given in June 2012: "In practice, these impairment tests do not always seem to be done with sufficient rigour. Often, share prices reflect the impairment before the company records it on the balance sheet. In other words, the impairment test comes too late."
ESMA itself found some common shortcomings in relation to the impairment testing of goodwill as evidenced in the twelfth extract of enforcement decisions published in October 2012, and has made impairment testing one of the enforcement priorities for 2012 financial statements.
The main objective of the review, which looked into the accounting practices of a sample of 235 European issuers with significant amounts of goodwill from 23 countries, was to provide an overview of the accounting practices related to the impairment of goodwill and other intangible assets, and evaluate the sufficiency of the related disclosures in the 2011 financial statements prepared in accordance with International Financial Reporting Standards (IFRSs).
The review showed that significant impairment losses of goodwill were limited to a handful of issuers with 5% of the issuers in the sample accounting for almost 75% of the goodwill impairment and again roughly three quarters of these 75% were reported by just three issuers. The review also showed that most of the issuers that disclosed the events and circumstances leading to recognition of impairment loss provided boilerplate explanations referring to "worsening economic outlook", "slowdown of the demand" or "competitive environment". Very few issuers provided specific information.
As a result of the review five areas of concern emerged:
- Key assumptions of the management - ESMA found that approximately 70% of the issuers focus insufficiently on disclosing the key assumptions used for cash flow forecasts other than discount rate and growth rate used in the impairment testing in detail and in a way useful to investors. ESMA urges issuers to disclose all key assumptions and discuss the approach management has adopted in determining them for impairment testing.
- Sensitivity analysis - ESMA has identified different practices with regard to disclosures on sensitivity analysis. ESMA also found that for issuers where the book value of their net assets exceeded their market capitalisation, only half presented a sensitivity analysis. ESMA would expect those issuers to be more transparent and disclose the sensitivity of the impairment calculation to changes in key assumptions.
- Determination of recoverable amount - ESMA would expect more weight to be given to external sources of information rather than entity-specific assumptions when determining fair value less costs to sell using discounted cash flows.
- Determination of growth rates - More than 15% of issuers disclosed a terminal growth rate in excess of 3%. In the current economic environment, using a long-term rate exceeding 3% seems ambitious and optimistic to ESMA and could lead to an overstated long-term growth rate.
- Disclosure of an average discount rate - Approximately 25% of issuers in the sample disclosed an average discount rate, rather than a specific discount rate on each material cash generating unit. ESMA urges issuers to use, and disclose, separate discount rates because by disclosing just a single average discount rate, issuers potentially obscure information that may be relevant to financial statement users.
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 financial statements. ESMA hopes this will lead to an improved rigour applied by issuers in the impairment test of goodwill and a better compliance with the requirements regarding impairment in IAS 36 Impairment of Assets.
In his June 2012 speech cited above, Hans Hoogervorst also indicated that the IASB might take "another look at goodwill" in the context of the post-implementation review of IFRS 3 Business Combinations.
Please click for access to the following documents on the ESMA website: