Navigating Impairment Testing Challenges (Part 1 of 2)
Understanding International Financial Reporting Standards 16 (Leases) (“IFRS 16”) and How It Affects Impairment Testing.
IFRS 16: Additions on the Statement of Financial Position
- Lease Liability:
Increases debt as all operating leases are converted to finance leases.
- Right-of-Use Asset:
Increases assets on initial recognition of present value of minimum lease period.
The Misunderstanding: Effect of IFRS16
- Capital Structure:
Higher debt changes the proportion of debt to equity in the capital structure i.e. increase the D/E ratio. However, be careful whether you are using total debt over total equity or net debt over equity. Most valuers use net debt.
- Beta:
Unlevered beta of peers may decrease because of the higher debt depending on whether the peer group has more debt than cash. Otherwise, there will not be a difference between the unlevered and levered beta.
A Real-Life Example
- As show in the table above, due to lease liabilities, the weight of debt and levered beta that are derived from comparable companies significantly rises and decreases respectively.
- This in turn decreases the Post-IFRS 16 WACC compared to the Pre-IFRS 16 WACC.
“Should I Use Pre- or Post-IFRS 16 WACC?”
“Post-IFRS 16 WACC is lower than the Pre-IFRS 16 WACC, so I should use Post-IFRS 16 WACC for all my Discounted Cash Flow (“DCF”) during impairment testing.”
It is tempting to do so, but the reality is not quite so. WACC reflects the riskiness of the cash flows in the DCF so if your cash flows reflect a Post-IFRS 16 situation, then you can use a Post-IFRS 16 WACC, provided the components in the DCF is consistent with a Post-IFRS 16 situation.
So, what are the differences between Pre- and Post-IFRS 16 during impairment testing for Value-in-Use? This is what we will share in our next post so stay tuned.
It is crucial to hire a professional valuer to properly assess the impairment testing of the cash-generating unit.
Otherwise, incorrect assessment may cause the financial performance of your company to take a hit on the financial year, which is a problem if your company is publicly listed.
Contact us to have a discussion and let us be your adviser to resolve your valuation-related issues today.
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Adrian Cheow
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Deal Advisory
CFA, FCCA
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