Chapter 06 - Consolidation and Audit of Intangible Assets and Impairment

Objective: Enhance relevance, reliability, and comparability of information about business combinations.

Components:

1. Recognition and measurement principles for acquired assets and liabilities.

2. Determination of goodwill.

3. Required disclosures.

Business Definition: An integrated set of activities and assets managed to provide returns to investors, owners, members, or participants in the form of dividends, lower costs, or other economic benefits.

Business Combination Definition (IFRS 3):

A business combination is a transaction or event where an acquirer gains control over one or more businesses.

Key Elements of a Business (IFRS 3.B7):

1. Inputs: Economic resources creating outputs through processes (e.g., non-current assets, intellectual property).

2. Process: System, standard, protocol, convention, or rule applied to inputs (e.g., strategic management, operational processes).

3. Output: Result of inputs and applied processes.

Acquisition Method is used for all business combinations (IFRS 3.4).

Steps in Applying the Acquisition Method:

1. Identify the Acquirer: Determine the entity obtaining control.

2. Determine Acquisition Date: Date of effective control.

3. Recognize and Measure: Assets, liabilities, and non-controlling interest at fair value.

4. Goodwill or Gain: Recognize goodwill or gain from a bargain purchase.

Equation: Consideration paid + previous Interest + NCI – Net equity at FV = Goodwill

With indication:

• At the end of each reporting period, assess if there is any indication of asset impairment.

• If there is an indication, estimate the recoverable amount of the asset.

Without indication:

• Test intangible asset with indefinite useful life or not yet available for use annually.

• Compare the carrying amount of the asset with its recoverable amount.

• Perform the impairment test at the same time every year.

• Asset's value decline beyond expectations

• Changes in technology, market, economy, or legal environment

• Impact of market interest rates on discount rate and asset's value

• Carrying amount exceeding market capitalization

• Obsolescence or physical damage

• Adverse changes within the entity:

  • Asset becoming idle

  • Plans to discontinue or restructure operations

  • Intent to dispose of the asset early

  • Reassessment of useful life as finite

• Worse-than-expected economic performance of the asset

• Evidence from internal reporting:

  • Increased cash needs for acquisition and maintenance

  • Lower operating profit

Impairment Testing (IAS 36.8)

• Carrying amount exceeding recoverable amount indicates asset impairment

• Recoverable amount is higher of Fair Value Less Costs of Disposal (FVLCOD) and Value in Use (based on DCF models)

• FVLCOD is the amount from selling an asset or CGU in an arm's length transaction, deducting disposal costs.

• Value in Use: Present value of future cash flows from the asset or cash-generating unit

• Fair Value usually higher than Value in Use (as a rule of thumb)

• CGU is the smallest identifiable group of assets generating cash inflows largely independent of other assets.

• CGU can be an individual asset, a group of assets, or a collection of assets and liabilities.

Key Audit Checks - Cash Flows

The cash flow projections should match the life of the asset

• Finite life asset = finite life projection

• Indefinite life asset or business = perpetuity or other terminal value

Assumptions should be internally consistent

• Is there investment in PP&E and working capital to support any projected growth in revenue?

Assumptions in cash flows and discount rate should be consistent

• Do they both include inflation? Tax?

• Does the risk free rate cover the same period as the projections?

Key Audit Checks - Terminal Value

1. Need for a terminal value:

   • Required when cash flow projections don't cover the entire life of the asset

2. Two common approaches for terminal value: a) Cash flows into perpetuity b) Application of an exit multiple

3. Considerations:

   • Cash flows into perpetuity suitable for indefinite life assets or businesses

   • Exit multiple based on achievable multiple of cash flows/revenues/profits on sale

Key Points - Terminal Value

1. Period Covered:

   • Determine if appropriate for finite or infinite period

2. Multiple-based:

   • Assess if supported by market data

3. Extension of Cash Flows:

   • Consider if cash flows are in a steady state

   • Is the growth assumption supportable

   • Is the implied multiple supported by market data