German Commercial Code (HGB) and IFRS Impairment Testing

Importance of Impairment Testing for Companies

On average, the fair value of a European, publicly listed company is more than twice as high as its book value. Put more precisely, investors attribute a value to companies that is 2.5 times as high as the reported equity. When a company is acquired, this difference between the market value and the book value is reported in goodwill on the balance sheet of the acquiring company. The goodwill at many companies has become the most important balance sheet position in recent years due to strong M&A activities/corporate acquisitions. If, for example, General Electric, the largest company in the world, were to write off its reported goodwill, this would mean a loss of more than 70% of its equity. The recoverability of the equity investment is as important for the individual financial statements as the goodwill is for consolidated financial statements. The steadily growing importance of goodwill is known to auditing firms and the German Financial Reporting Enforcement Panel [DPR]. Consequently, these positions are frequently one of the focal points of an audit. The experienced advisors at FAS AG will safely guide you through the entire impairment test process.

Structuring of the Impairment Test

Impairment tests are to be carried out in accordance with the German Commercial Code [Handelsgesetzbuch, HGB] and IFRS. IAS 36 governs the procedure of an impairment test for international accounting. Accordingly, goodwill is checked for impairment on the level of the operating segments, and this is done at least once a year. Simply put, this is the structure according to which the management controls the company.

The asset impairment test takes place on the basis of smaller units, so-called cash generating units (CGUs). This is only necessary if there is an indication of an impairment (triggering event). An important factor in connection with this is that an early warning system is installed for these triggering events. This makes it possible to prevent non-recognition of these indicators, leading to a necessary impairment not being reported. Often, such processes are already present in the company, but not sufficiently documented.

The legal structuring rather than the internal reporting is relevant for an equity investment valuation under the German Commercial Code [Handelsgesetzbuch, HGB] or specifically IDW RS HFA 10. See also the graphic above. Both tests roughly follow a corporate valuation despite some different specifics, with the equity value being relevant for the finances in accordance with the German Commercial Code [Handelsgesetzbuch, HGB] and the enterprise value assuming this position in accordance with IFRS.

It is important overall that the IFRS and HGB tests can be reconciled – otherwise, appropriate comments must be made by the auditors or the DPR. We will support you in the structuring of various impairment tests and help to generate the necessary documentation in the corporation.

Course of Impairment Test

After specification of the CGU structure for the impairment test, the actual test process is always identical.  

Relevant Valuation Data

A discounted cash flow method is usually used for later valuation. The business plan required for this is already available at least in part at most companies. We can help you with development of a business plan, extend a one-year budget beyond this period, or extend a pure income statement plan to include the balance sheet and the cash flow statement. Likewise, we will be glad to check the plausibility of your plans for you. Furthermore, we will also calculate the weighted capital costs and coordinate them with your auditor.

Calculation of the Carrying Amount

In the determination of the book value or carrying amount, it is necessary to consider the equivalence principle in particular. Accordingly, it should be remembered that the calculation is supposed to match the amount from the cash flow – otherwise, an illegitimate impairment may take place. Since the recoverable amount in its various forms represents an enterprise value, this must be compared with the operating net assets.

Calculation of the Recoverable Amount

The recoverable amount of the CGUs matches the higher amount from the fair value or the value in use. Both values are results of a discounted cash flow model. The calculation is specified by the amount of the underlying cash flows. The value in use must be adjusted for restructuring effects, for example; the fair value may only include those planning components that an average market participant would use.

Determination of impairment

Ultimately, the recoverable amount and the carrying value of the CGUs are always compared, hopefully with no impairment being discovered. Apart from the CGU structure, asset impairment tests and goodwill impairment tests are largely identical. Something else takes place, by contrast, in the calculation for the equity investment valuation under the German Commercial Code [Handelsgesetzbuch, HGB]. These values can usually be simply transferred, however.

Final Documentation of the Results

After the completion of the impairment test, the advisors at FAS AG will prepare reasonable documentation for you. It will meet the requirements of your auditor and pass any later audits by the German Financial Reporting Enforcement Panel [Deutsche Prüfstelle für Rechnungslegung, DPR].

 Dirk Spalthoff Member of the Board/Partner