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ACCA Research Report No. 92

Andrews, 2006

Executive summary

This report assesses the extent of asset impairment losses disclosed by companies listed on the FTSE 350 index, within the context of Financial Reporting Standard 11, Impairment of Fixed Assets and Goodwill (FRS 11) (ASB 1998), using published financial reports available in 2004.

FRS 11 was introduced by the Accounting Standards Board in 1998. The aim of FRS 11 is to ensure that the book value of fixed assets is not stated at more than those assets’ recoverable amount. In the context of FRS 11, ‘recoverable amount’ is the higher of net realisable value or value in use. If the situation arises where an asset or group of assets is valued in the financial statements at more than its recoverable amount, then the asset or group of assets is considered impaired. FRS 11 states that once there is some indicator that the asset or group of assets is impaired, that asset must be written down to its recoverable amount, with the charge being taken through the profit and loss account.

For some companies, this has resulted in the reporting of large impairment losses and the impact upon reported performance has been significant. A large proportion of impairment losses relate to goodwill and other intangible assets. This raises the question of how to value intangible assets within financial statements, when the valuation is based on a wide range of future expectations, both financial and non-financial, that are subject to dramatic fluctuation.

The aims of this research were:

• to identify those companies that have reported impairment losses under FRS 11
• to assess the extent of asset impairment
• to determine the reasons disclosed by companies for the impairment of assets, the valuation basis used for that impairment and the extent of disclosure
• to analyse the types of test of impairment used in practice and their frequency
• to investigate the effect asset impairment has on the financial statements in terms of key financial indicators.

The key findings of this research are:

• more than one in five companies listed on the FTSE 350 have reported an impairment loss
• impairment losses were present in 26 out of 29 sectors
• the media sector had the highest incidence of companies that reported impairment losses
• the telecom sector had the highest value of reported impairment losses
• the total amount of impairment losses disclosed by the sample companies was £20,126m
• goodwill was the most frequently impaired asset, with 40% of all impairments relating to goodwill
• goodwill was the largest asset in terms of value of impairment loss
• 58 out of 79 companies (73%) reported an impairment of goodwill
• 62% of companies in the sample did not disclose a specific accounting policy note about how the impairment loss is calculated
• 40% of companies in the sample did not disclose a reason for the impairment loss
• the extent of narrative disclosure in relation to the impairment loss increased in line with the amount of the impairment loss
• the average discount rate in use by companies that disclosed a rate was 10.9%, ranging from a low of 3% to a high of 32.2%
• the impact of impairment losses on turnover was not significant for 78% of companies in the sample
• the impact of impairment losses upon reported book value of fixed assets was not significant for 72% of companies in the sample
• overall, the reported impairment losses had a significant impact upon reported profits.

We conclude that loss-making companies are more adversely affected by impairment losses than profitable companies. In the sample cases, the impairment loss was often a significant component of the reported overall loss.

Overall, in the reports sampled, the numerical disclosures of impairment losses are evident, but the narrative disclosures are often inconsistent and disappointing as explanations of the indicators of impairment or as justification of the impairment loss.

A minority of reports give very detailed information about the impairment loss. The reports of those companies with the highest impairment losses give the most detail about why the impairment loss arose. Many reports in the sample, however, fail to give any reason or background to the impairment loss, even though the impairment loss is often a significant amount.

With the transition to international reporting standards in the UK from January 2005, asset impairment will continue to be an area of interest to users, companies, regulators and other groups. Although FRS 11 is now effectively replaced by its international counterpart, International Accounting Standard 36 (IAS 36), both standards share many common features concerning the recognition and measurement of impairment loss. Nonetheless, there are some significant differences between the UK and the international regulatory environment in the area of impairment review and goodwill. Importantly, International Financial Reporting Standard 3 Business Combinations allows goodwill to have an indefinite useful life and be subject to annual impairment reviews in accordance with IAS 36 Impairment of Assets, irrespective of whether there are any indications of impairment. This differs significantly from the UK regulation under FRS 10 Goodwill and Intangible Assets and FRS 11 Impairment of Fixed Assets and Goodwill, which generally require goodwill to have a finite useful life of 20 years or less and be subject to an impairment review only if there are indicators of impairment after the year of acquisition. The finite useful life of 20 years under the UK regulation may be dispensed with only in exceptional, justifiable circumstances. As a result of the UK regulation, the majority of companies in this sample have selected 20 years as the finite lifespan for goodwill and have amortised the asset over its finite life. The amortisation of goodwill over a useful life of 20 years often results in a significant charge to the profit and loss account. Under the new international regulatory environment, goodwill is permitted to have an indefinite useful life and be subject to annual impairment reviews. Some companies may change their accounting policies and dispense with an annual amortisation charge in favour of an annual impairment review of goodwill. Consequently, the issue arises of whether, under international regulations, companies will disclose more impairment losses.

What is clear from this report, within the context of FRS 11, is that disclosures in the sampled reports about how companies have arrived at the impairment loss are inconsistent. Measurement may have taken place to value the asset, but the way in which the figure is determined is reported inconsistently in the financial statements. Impairment reviews have the potential to offer a useful assessment of the future expectations of the company, and the use of forward-looking budgeted cash flows to arrive at an asset valuation is potentially very useful as an information tool for shareholders and other interested groups. Any future standard on impairment could improve the disclosure to include a clear cause of impairment, stated unambiguously in the annual report with supporting calculations.

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