ICAEW.com works better with JavaScript enabled.

2020/21 Reporting Season: what we can learn from goodwill impairments trends

15 December 2020: A regular report into goodwill impairments has highlighted ongoing trends across Europe and the volatility of certain industries when faced with outside events.

"Graphs

Since 2013, Duff and Phelps has been monitoring goodwill impairment trends in Europe – it has been doing the same in the US for longer. This was, in part, a response to the financial crisis as data on impairments trends was in high demand. 

The firm’s 2020 European Goodwill Impairment Study, based on data up to December 2019, is about to be issued at a time when goodwill impairments are in the spotlight again. With the pandemic severely impacting economies across the world, uncertainty is high. In Europe, Brexit is piling on additional pressure.

“Impairment testing is really checking whether goodwill should still be on the balance sheet, or if there's a view that has been impaired in any way,” says Carla Nunes, a Duff & Phelps Managing Director in the Office of Professional and a co-author of the study. “It is really an accounting test to check whether the goodwill should still be carried on the balance sheet from when the acquisition occurred, or if not, how much of that should be written down? That leads on to the study around the level of impairment, which we've been running for a number of years now.”

Knowing goodwill impairments trends help investors and companies assess the performance of historic acquisitions and trends across industries and geographies. “This study captures those trends,” says Nunes. “How much companies are impairing their goodwill indicates how successful their acquisitions have been in the past.”

The report looks at the past five years to outline how trends have changed taking data from STOXX Europe 600 companies, which includes companies listed in 20 countries across the continent. In its 2018 report, the firm included analysis of several country-specific indices: the FTSE 100, DAX, CAC 40, FTSE MIB and IBEX 35.

“We bifurcate the study and focus between a country analysis and an industry analysis. From a country perspective, we look at the countries that have the most representation in the index. We actually analyse the trends for those companies and what might have caused those impairments.”

The Brexit vote in 2016 is a classic example of how outside events can affect goodwill impairments. The uncertainty the vote created resulted in impairments across a number of industries in the UK and other countries in Europe. 

“One event that caused the most amount of impairments historically in our database, was the Euro sovereign debt crisis. At that point, we saw a significant jump – we're talking about more than €70bn of aggregate goodwill impairment by the companies in the STOXX Europe 600. It tells you that big events like that can have a significant impact. You don't know if you're going to be able to generate the revenue growth and operating margins that you had anticipated originally. All of that creates pressure.”

In addition to geographical breakdowns, Duff & Phelps also looks at industry performance. Certain industries tend to be more volatile than others: in the 2018 study, consumer staples and financials and real estate had the highest aggregate goodwill impairments. 

“Currently the tech space and healthcare have lower goodwill impairments. Those industries are growing so much and so there's always this expectation that goodwill on the books is supported,” says Nunes.

In any given year, different industries might be more subject to impairment due to various economic and industry-specific factors. For example, recent regulations in the utilities sector encouraging green investments and renewable energy resulted in significant impairments. 

When it comes to impairment testing, James Palmer, a Managing Director in Duff & Phelps’ London office says that preparers need to be asking themselves questions about the wider environment and how it might impact their organisation. For example, when restrictions are likely to end, how fast the economy might recover, and how quickly a vaccine could be rolled out across the population. All of these things may affect earnings. Looking back at historical trends can help to assess those potential impacts. Whenever there's a lot of uncertainty, companies have more difficulty forecasting their earnings and cash flows, says Palmer. Additional tools and analytics can help to get to a reasonable result. “You may want to consider scenario analysis to more realistically reflect that there is a wider range of outcomes''.

In uncertain and volatile periods such as this, goodwill impairment models convey valuable information to investors about successful M&A activity. However, there is a view that it could be better; the IASB has issued a discussion paper to determine how goodwill impairment testing could be improved. 

There are different views on the issue of whether the impairment model is useful but in times of economic or other types of uncertainty, it does give relevant information to investors and analysts about how successful M&A activity has been in the past. 

With many factors causing uncertainty at the moment, it makes supporting robust forecasts into 2021 and beyond even more important. Alongside that, discount rates are also an important issue, Palmer explains. “The forecast is one big element of the impairment review and the discount rate is the other” 

Palmer and Nunes will be discussing all of the issues around goodwill impairments and the latest report at an ICAEW webinar that takes place on 15 December.

“Given the uncertainty created by issues such as Brexit and COVID-19 running towards the year end, the webinar aims to provide practical advice on impairment testing based on our experience,” comments Nunes.

Article series: 2020/21 Reporting Season

The above article is part of a series looking at the challenges of the corporate reporting season in 2020/21. The series aims to examine what shareholders, investors and other stakeholders want from corporate reporting at this difficult time.

See the series