The Bruce Column — ESMA backs up its impairment warning

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23 Jan, 2013

European securities regulator ESMA has issued some tough research findings to back up its previous warnings on levels of goodwill impairment. Robert Bruce, our resident columnist, looks at the evidence.

Back in November last year, the European Securities and Markets Authority (ESMA) told companies that goodwill impairment was one of the priorities they should be focussing on in their report and accounts this year.

At that point the ESMA Chairman, Stephen Maijoor, said that: ‘The market value of many listed companies has fallen below their book value, a situation potentially indicating impairment and thus the need for an impairment test. ESMA considers that particular attention has to be paid to the valuation of goodwill and intangible assets with indefinite life spans, whenever significant amounts are recognised in the financial statements’.

Now ESMA has issued a more specific warning about the levels of goodwill impairment. In November it was a simple warning. Now it has backed it up with its own research.

It has issued a review of the accounting practices of over 200 companies across Europe which had significant amounts of goodwill. And the results bear out the earlier worries that impairment was not being carried out to anything like the extent that ESMA would consider to be healthy. The figures are quite remarkable. The report shows that: ‘Significant impairment losses of goodwill were limited to a handful of issuers’. In effect 5% of the issuers in the sample accounted for almost 75% of the goodwill impairment and roughly three-quarters of these 75% were reported by just 3 issuers.

Backed up by these findings ESMA has returned to the fray with ever more urgency. Reflecting on the research ESMA says: ‘This therefore raises the question as to whether the level of impairment disclosed in 2011 financial reports appropriately reflects the difficult economic operating environment for companies’.

And in a further warning it notes that although the major disclosures related to goodwill impairment testing were generally provided, ‘in many cases these were of the boilerplate variety and not entity-specific’. Small wonder that in its report it concludes that ‘the quality of narrative information could be improved when describing the events and circumstances which led to the recognition of impairment’.

Amongst the boilerplate ESMA complains about were the use of ‘worsening economic outlook’, ‘slowdown of the demand’, and ‘competitive environment’. In a nutshell companies need to be more realistic in reflecting the realities and more specific in describing what they have done and why they have done it.

ESMA emphasises the importance of improving the overall disclosure provided. And in particular it recommends that issuers: ‘Better specify the key assumptions used in the impairment test; include sensitivity analyses with sufficient detail and transparency, especially in situations when indicators are present that impairment might have occurred; 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’.

All of this can be highly judgmental. The use of cash flow forecasts is not a precise science even in good times, and at the moment it is particularly challenging. And caution is advisable around growth forecasts and discount rates.

As Maijoor said in conclusion: ‘Good quality financial information is key for investors in understanding the financial health of an issuer in whom they hold assets or in who they may wish to invest. 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 harmonised approach to the disclosure of goodwill impairment under IFRS throughout the European Union’.

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