Auditors are facing greater scrutiny over the valuation of
goodwill as the incidence of goodwill impairment charges escalates
in the UK.

Nick Rea, a partner in the Pricewater-houseCoopers UK (PwC)
market and value advisory practice, told The Accountant
impairment disclosures will be a key area of focus for auditors
this year.

“We are looking now at some transactions that were conducted at
the time when the markets were much higher and that’s led to large
amounts of goodwill,” he said.

“PwC, along with all the other accounting firms, are looking at
this issue as part of the year-end audits as a key area where the
companies need to make very robust calculations. It’s probably a
more difficult task now than it has been in previous years.”

Goodwill is the term used to describe intangible assets that
cannot be valued separately, such as the value of brand and client
base.

Companies are required to stress test the value of goodwill for
each of their cash generating units each year. These business units
are broken up into the way management reports on business
performance, for example by product type or geography.

IAS 36 Impairment of Assets requires companies to disclose the
key assumptions and the approach taken to make those assumptions
when using valuation models to check that goodwill does not need to
be written down.

The standard also requires more detailed quantified and
narrative disclosures when a “reasonably possible change” in a key
assumption would have caused a material goodwill impairment loss to
arise.

IAS 1 Presentation of Financial Statements requires companies to
provide additional information about key assumptions and other key
sources of estimation uncertainty that have a “significant risk” of
causing a material goodwill impairment loss within the next
financial year.

Rea said the area of valuation where companies will need to take
extra caution is discounted cash flow valuations, which needs to be
supported by benchmarking.

“Given the market conditions that we’re facing now I think it is
even more important that the assumptions that are in the
value-and-use calculation are verified and validated against the
market data,” he added.

“What you will see with stock markets coming down so far is
saying something about expected growth and profitability for
companies.”

The valuations expert said impairment charges of goodwill have
been on the rise and this trend is likely to continue well into
2009 as companies with December 2008 year-ends have their accounts
audited.

“The valuation practice will be helping our audit teams on
reviewing this balance, as we have in previous years… I suspect the
other firms are doing the same,” Rea explained.

A visible approach

The Financial Reporting Review Panel (FRRP), a watchdog that
reviews the annual accounts and reporting of companies to ensure
they comply with UK laws, this year will investigate the impairment
disclosures of 30 companies.

In an unusual move, the panel will warn companies before these
reviews to encourage “reporting of the highest standard and not to
catch people out”.

FRRP chairman Bill Knight explained that the adequacy of
impairment disclosures, their extent and clarity, and the
assumptions on which they are based, are of key interest to users
of accounts prepared during a severe economic downturn.

“It is not the panel’s aim or practice to catch people out. We
think it fair to inform the companies concerned of our approach,”
he said.

Last October, the Financial Reporting Council published a review
of the information disclosed by 32 listed companies on their
testing for impairment of goodwill in 2007 accounts.

It found that 53 percent of companies only provide boilerplate
disclosures while less than 20 percent provide information that is
company specific and very useful.

The report said that narrative reporting on the way in which key
assumptions are identified and quantified tended to be vague and in
many cases consisted of generalised statements.

Only a minority of the companies surveyed provided information
by cash generating unit, even where significant amounts of goodwill
had been allocated to more than one cash generating unit.

Arvind Hickman