Impairment – problems with cash flow estimates (revisited!)

We’ve previously looked here at the issue of allocating corporate costs to cash generating units for purposes of impairment testing.

On that previous occasion, we looked at a European example of an entity that didn’t allocate the costs of corporate officers to CGUs for purposes of determining cash flow estimates. In that case, the local enforcer disagreed with excluding the described cash flows, concluding that “the corporate costs were cash outflows that, according to IAS 36 paragraph 39(b), were necessarily incurred to generate the cash inflows from continuing use of the assets and could be allocated on a reasonable and consistent basis to the asset. In addition, in its internal management reports, the issuer had allocated all costs (including the costs of corporate officers) to CGUs.” It went on: “As the goodwill and other intangible and tangible assets were fully allocated to CGUs, and all estimated cash inflows were included in the cash flows projections, it was not reasonable to exclude from the CGU’s estimated cash flows any corporate level costs.”

This was my commentary on that occasion:

  • It’s very easy, in applying IAS 36, to get tangled up in the mechanics of slicing and dicing into CGIs and allocating cash flows and so forth, and to lose sight of what we like to call the “big picture.” Indeed, the standard often seems to be written in a way that encourages nothing less. IAS 36.102 addresses how corporate assets are tested for impairment by being allocated to cash-generating units or (if that’s not possible on a reasonable and consistent basis) to groups of CGUs. IAS 36.101 specifies that corporate assets don’t generate separate cash inflows. It doesn’t acknowledge though that they might generate separate cash outflows, and when it talks about adjusting the carrying amount of groups of CGUs to include allocated portions of carrying amounts of corporate assets, it pointedly requires comparing that adjusted carrying amount only “with the recoverable amount of the group of units” – that is, without adjusting the recoverable amount to include any outflows from the corporate assets. This seems to acknowledge that certain cash outflows might never be taken into account in the impairment testing model. Because this exclusion could easily undermine the aggregate effectiveness of the process, it appears it should be confined to outflows that indeed can’t be allocated to CGUs on any kind of reasonable and consistent basis. Plainly, this didn’t apply to the various salaries cited in the ESMA example, as a basis always exists for allocating salaries to the units which benefit from those individuals, and indeed, the issuer was already doing that for its internal purposes.

That seemed fairly clear to me then, but perhaps I was too confident, because the Canadian IFRS Discussion Group recently talked about this same issue, without reaching a complete unanimity of views. Some of the group members supported the view that senior officer salaries, costs of the board of directors and suchlike (stewardship costs, as the IDG labeled them) “are necessarily incurred by the entity to operate its business and generate cash inflows, and should be included in the cash outflows of the cash-generating unit when determining value in use.” But these members noted “that there could be practical challenges to allocate the stewardship costs on a reasonable and consistent basis…because certain stewardship costs could be incurred at a significantly higher level in order to manage and operate multiple cash-generating units of an entity. It was also questioned whether certain costs such as board of directorscosts, senior officer salaries or public company costs are truly directly attributable to the cash flows of a specific cash-generating unit because these costs would likely still exist even if the asset was sold.”

The bottom line was that “Preparers are encouraged to exercise care when analyzing the nature of stewardship costs to determine whether to include or exclude them in the value in use calculation of a cash-generating unit in order to capture the appropriate amount of cash flows in the model.” But all this of course suggests that the conclusion might plausibly go one way or the other, as long as some “care” is taken.

I would have said that preparers should be more than merely careful, if they’re crafting an argument to exclude such costs. Regarding the two points above – no doubt some arbitrariness may exist in allocating the costs on a reasonable and consistent basis (as it does in many aspects of developing estimates of future cash flows), but that doesn’t mean it can’t be done somehow. And on the second point – it doesn’t seem very relevant to me to argue that the stewardship costs would still exist even if the CGU was sold. An entity couldn’t manage and oversee its CGUs, or continue as a public issuer at all, without some degree of head office infrastructure. But the costs of that infrastructure have to be funded out of the entity’s operations one way or another. Therefore to carry out an overall impairment assessment process that simply ignores those costs seems to me an artificiality (even allowing that IAS 36 encompasses a fair degree of such artifice).

But I guess the group’s bottom line tells us that (for once?) I may be guilty of taking an overly hard line…!

The opinions expressed are solely those of the author

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