The accounting rules under IAS 36 Impairment of Assets are intended to provide a uniform approach to accounting for impairment. However, there are many areas of IAS 36 that are open to interpretation. This led KPMG to examine how companies are going about meeting the requirements of International Financial Reporting Standards (IFRS) and how they are interpreting and applying certain aspects of the impairment statement. This culminated in the Cost of Capital and Impairment Testing Study for South Africa.
Just over one-third of companies surveyed recognised some form of impairment during the 2010 financial year, being either goodwill or asset impairment. This shows that while South Africa continues to recover from recession, many companies are still performing below expectation or have seen deterioration in business. Half of companies who participated in the survey performed an impairment test as a result of a trigger event.
This points to the fact that even though the financial crisis occurred in 2008/9, several companies are still experiencing adverse economic events which have prompted an impairment test.
The standard on impairment testing allows for two types of valuation method to be performed. The higher of the two must be used to determine whether an impairment of the asset or goodwill has taken place. This gives companies the latitude to select which valuation approach they wish to use. When deciding on which valuation method to select, they must understand the requirements and implications of each method.
Most companies chose the value in use method, as companies assume that a market-based approach would lead to lower values than a value in use approach. This suggests that companies still feel that market-based methods of valuation will undervalue their assets or goodwill.
It would appear that there is a fair amount of consistency in how companies determine their cost of capital, with the vast majority using the capital asset pricing model. The average cost of equity from respondents was 13.5%, which was obtained from impairment tests performed during 2010. Given that discount rates need to be determined at the unit level, the average cost of equity appears low and suggests that companies are using the capital asset pricing model without further adjustment. This is of concern, given that the empirical record of the pure capital asset pricing model, which is based on the risk-free rate and beta only, is poor.
Less than half of companies indicated that they would prepare a different discount rate for businesses within their groups if the risks of the business being tested for impairment were different from the risks of the rest of the group.