Impairment testing: Australian regulator releases information sheet for Directors

One of the key areas that regulators (and Auditors) focus on is the overstatement of the assets presented on an entity’s balance sheet.

An ‘asset’ by definition are items that are expected to produce economic returns, being positive net cash flows from either their sale and/or use in the business.

For certain assets that are used in the business, impairment testing requires an entity to first:

1. Group them into appropriate cash-generating-units (‘CGUs’, as defined), and then
2. Undertake detailed discounted cash flow modelling, itself requiring the use of multiple (and often significant) judgements and estimates with respect to the timing and amount of cash inflows and outflows, and the inputs to the discount rate used to discount them.

The financial reporting standard that prescribes when and how impairment testing is to be undertaken (NZ IAS 36 Impairment of Assets) is an involved and detailed standard.

In (re)drawing necessary attention to this area of financial reporting, the Australian regular (ASIC) has recently published an information sheet (INFO 203 - Impairment of non-financial assets: Materials for directors) that underscores directors’ responsibilities in this area.

The guidance in the information sheet is equally applicable to all New Zealand entities that prepare Tier 1 and 2 general purpose financial statements in accordance with NZ IFRS or PBE IPSAS.

Areas addressed by the information sheet

The information sheet is broken down into the following areas, providing useful reminders, explanatory information, and expectations of the regulator on Audit Committees, Directors etc.

• What impairment testing is.
• Why impairment testing is important.
• The types of assets included.
• How impairment testing is performed.
• The role of directors and audit committees and reliance on Management’s work, including considerations of:
  • Whether assets are material.
  • The level of expertise of Management and staff in the area of impairment.
  • The appropriate use of external experts, and
  • How the performance of the company and the environment in which it operates may affect the recoverability of the value of assets through operating activities or the sale of those assets.
• The matters that may be considered in assessing the impairment of non-financial assets, including:
  • The need for impairment testing.
  • The process for assessing impairment.
  • Common issues with impairment calculations, including (but not limited to):
    • Not determining appropriate CGUs (i.e., at a too high a level).
    • Not applying different discount rates to CGUs with different risks and/or geographies.
    • Unreasonable, overly optimistic assumptions about future cash flows (i.e., not taking into account past actual results, forecasting accuracy, future economic and market conditions), including using terminal growth rates that exceed the long-term average growth rate.
    • Not cross-checking (sense checking) valuations against alternate valuation methods.
    • Not providing sufficient disclosures.
• Questions that may be asked of external auditors.

Need help?

Navigating an entity’s impairment testing is an area that requires a high degree of skill, care, and knowledge.

Please contact our Financial Reporting Advisory team for assistance in navigating the requirements of NZ IAS 36.

Please contact our Deal Advisory team for assistance impairment test modelling.