Wednesday, March 20, 2024

Navigating Impairment Testing Challenges (Part 2 of 2)

From Valuer’s Perspective: Understanding International Financial Reporting Standards 16 (Leases) (“IFRS 16”) and How It Affects Impairment Testing

The Misalignment:
Pre- and Post-IFRS 16 Discount Rate to Cashflow Forecast

• In our earlier post in Part 1, we discussed the difference between Pre- and Post-IFRS 16 discount rate. 
• In Part 2, we explain how IFRS 16 impacts the cash flow forecast and therefore matching the right discount rate to the cashflow forecast is important.

Impact of IFRS 16 on Cashflow Forecast

 

	Pre-IFRS 16	Post-IFRS 16
EBITDA	Lower EBITDA due to deduction of rental expenses.	Higher EBITDA arises from adding back non-cash flow item, specifically depreciation of Right-of-Use (“ROU”) assets.
WACC	Increase in WACC due to lower D/E ratio and higher re-levered beta. Debt only comprises bank loans, other borrowings and other finance lease liability.	Decrease in  WACC due to higher D/E ratio and lower re-levered beta as the company’s and industry’s capital structure are expected to be impacted by IFRS 16 in the similar way.
Enterprise Value	Lower enterprise value.	Higher enterprise value. The carrying amount of lease liabilities would then need to be deducted from enterprise value / value-in-use (“VIU”).

The Inconsistent Comparison:

Value-in-Use vs Carrying Value

• Inconsistency arises when the cashflow forecast are assessed on pre-IFRS 16 basis, and the VIU is then compared against post-IFRS 16 carrying amount as extracted from the statement of financial position.
• It is also important to note that the same carrying amount of lease liabilities would need to be deducted when determining carrying value of CGU and its VIU.

“Consistency is a Key Practice in Impairment Testing”

 

Impairment Testing: Post-IFRS 16

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!

View the infographic here:

Adrian Cheow
Executive Director & Practice Leader,
Deal Advisory
CFA, FCCA

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