1. To calculate the VIU, we estimate the present amount of the future cash flows that we expect to derive from the asset or CGU. Value in use represents the future expected cash flows from the continuing use of an asset and its disposal, discounted to reflect the underlying risk and the time value of money concept.

Calculation of Value in Use

We determine value in use for each separate asset. Whenever this approach is not practical, we calculate for the smallest identifiable CGU that contains the asset. We must be able to identify and separate the cash flows relevant to the CGU.

Discount rate

Once we start with our value in use model, it is critical to determine the correct discount factor. The most proper discount rate is the one that the company can obtain to finance a separate asset with the same cash flows and risk patterns.

The discount factor should not be specific to the capital structure of the company. Therefore we use industry benchmarks by running comparative analysis against businesses operating in similar conditions.

In practice, the Weighted Average Cost of Capital (WACC) is the most common discount factor when we calculate the recoverable amount of an asset or CGU.

Pre-tax and post-tax

As of now, IAS 36 requires that we calculate the value in use with pre-tax cash flows and a pre-tax discount rate. However, observable market rates are usually post-tax. In such cases, tax cash flows for VIU calculations are not the same as the company expects to pay. Ideally, we should calculate tax payments as if the tax base of the asset or CGU is equal to its recoverable amount. Such would be a very complex calculation, so we assume the tax base is identical to the carrying value of the asset. In other words, we use accounting depreciation to calculate the income tax charge for the value in use.

It’s essential to be consistent in determining the carrying value of a CGU and the related cash flows. For practical reasons, the VIU often includes items relating to working capital and others. Therefore, we have to remember to include these items in the carrying value as well.

Keep in mind that as the discount factor already covers the inherent business risks and the time value of money concept, we exclude interest and dividends from the value in use calculation.

2. Common errors in impairment of goodwill

Error 1:

Not allocating goodwill acquired in a business combination to the acquirer's CGUs or group of CGUs that are expected to benefit from the synergies of combination

Error 2:

Allocating goodwill to CGUs at a lower level than at which goodwill is monitored for internal management purposes

Error 3:

Allocating goodwill to CGUs at a level higher than an operating segment before aggregation

Error 4:

Not allocating goodwill to an operation that has been disposed of

Error 5:

Not reallocating goodwill based on the relative approach to the units affected by a group reorganization

Error 6:

Not reallocating goodwill to the CGUs affected by a group reorganization

Error 7:

Only testing goodwill for impairment at the reporting date

Error 8:

Changing the date of impairment testing of goodwill

Error 9:

Not testing for impairment of goodwill in the first year