The year 2022 was marked by a number of economic factors:
- The war in Ukraine
- Rising oil prices
- Inflation
- Rising interest rates
- The energy crisis
These factors are all potential indicators of impairment within the meaning of IAS 36. For the record, IAS 36 on ‘impairment of assets’ stipulates that ‘an entity must assess at each reporting date whether there is any indication that an asset may be impaired’. To assess this potential impairment, the entity must consider both internal and external sources of information. Among these external sources, the standard identifies, for example, the possibility of “significant changes, having a negative effect on the entity […] in the […] economic […] or market environment in which the entity operates ’ but also the situation where ‘the carrying amount of the entity’s net assets exceeds its market capitalisation’[1].
SORGEM Evaluation has supported several clients in carrying out these impairment tests.
As part of this support, we have taken particular care not to assume automatic links, without further analysis, between cyclical factors and a potential decline in the value of companies’ assets, particularly as a deterioration in the short-term economic outlook does not necessarily have an impact in the medium to long term and therefore does not necessarily have a significant impact on the value of assets valued over an indefinite life. This impact is further smoothed out by the fact that the terminal value often accounts for a significant proportion of the valuation of assets with an indefinite useful life[2], thereby further limiting the impact of non-normative factors on the first few months or years of the business plan.
Furthermore, we have considered the impact of these events on the discount rates used in impairment tests. All the parameters required to calculate the discount rate are affected: risk-free rate, equity market premium, the company’s beta, cost of debt, etc.
With regard to risk premiums, it is particularly important in this context to align the premiums used in the discount rates with the projected cash flows in order to avoid a double penalty: cash flows revised significantly downwards, and market-based risk premiums applied to scenarios where future cash flows have not been sufficiently adjusted.
In all cases, we have encouraged companies to consider whether the effects of these cyclical factors were one-off or likely to persist over time. In this regard, assumptions regarding the end of the crisis or even probabilistic scenarios have been defined and may be regularly updated to anticipate any risk of impairment.
[1] IAS 36, available at www.focusifrs.com
[2] The weighting of the terminal value is often greater than 50 per cent of the asset’s total value. This weighting decreases as the time horizon lengthens (i.e. the greater the number of years required to reach a normative cash flow, the lower the weighting of the terminal value).
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