Goodwill impairment testing under cash-flow uncertainty
Sofia Packaging Group prepares consolidated statements under IFRS. It carries goodwill of BGN 4,500,000 allocated to the Corrugated CGU. The CGU's carrying amount, including goodwill, is BGN 18,000,000 at 31 December 2025. Management prepared a five-year plan: free cash flow of BGN 2,100,000 in 2026, growing 3% per year. The pre-tax discount rate used is 9%, and the terminal growth rate is 1.5%. A recent energy-price shock has raised input costs; the budget was approved before the shock and assumes stable margins. The auditors note that the CGU's actual 2025 free cash flow was BGN 1,750,000, that a key customer representing 22% of volume has given notice, and that the discount rate was derived from a peer group with materially lower leverage. The finance team argues no impairment is needed because undiscounted future cash flows exceed the carrying amount.
1. Critique the impairment test as prepared and identify the specific IAS 36 deficiencies, without computing a final impairment figure.
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Several deficiencies arise under IAS 36:
- Cash flow projections must be based on the most recent budgets approved by management, adjusted for the effects of events after approval (IAS 36.33). The energy shock and the 22% customer loss are known post-budget events that must be reflected; using pre-shock margins overstates cash flows.
- The customer loss is a triggering indicator and also affects the projections. A customer at 22% of volume is not a trivial sensitivity; the plan should model the lost contribution explicitly rather than hold margins constant.
- The discount rate must reflect the specific risks of the CGU (IAS 36.55). Using a peer group with materially lower leverage understates the entity's cost of equity and debt weighting. The rate should be a pre-tax rate consistent with the pre-tax cash flows; if the cash flows are pre-tax, the rate must be pre-tax, and the 9% figure needs a documented derivation.
- The undiscounted-cash-flow argument is not an IAS 36 concept. IAS 36 compares the recoverable amount (higher of fair value less costs of disposal and value in use) with the carrying amount. Undiscounted flows are irrelevant.
- Terminal growth of 1.5% must be justified and should not exceed the long-term growth rate for the market or product; with a declining customer base, a positive terminal growth assumption needs support.
- Consistency of cash flows and discount rate: the five-year plan should exclude financing cash flows and tax at the rate used in the discount rate, and working capital and capex must be consistent with the growth assumed.
2. The audit partner asks for a defensible value-in-use estimate. Set out the computation structure and explain the sensitivities that must be disclosed.
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Structure the value in use as the present value of the five-year free cash flows plus the present value of the terminal value, discounted at a pre-tax rate consistent with the flows.
Using the stated inputs: year 1 = 2,100,000 / 1.09 = 1,926,606; year 2 = 2,163,000 / 1.1881 = 1,820,555; year 3 = 2,227,890 / 1.2950 = 1,720,378; year 4 = 2,294,727 / 1.4116 = 1,625,617; year 5 = 2,363,569 / 1.5386 = 1,536,180. Sum of years 1-5 = BGN 8,629,336. Terminal value at end of year 5 = 2,363,569 x 1.015 / (0.09 - 0.015) = 2,399,022 / 0.075 = BGN 31,986,960; discounted = 31,986,960 / 1.5386 = BGN 20,790,000 approximately. Total value in use roughly BGN 29,420,000, which exceeds the BGN 18,000,000 carrying amount.
But the inputs are unreliable: the 2,100,000 base is above the 1,750,000 actual, the customer loss is unmodelled, and 9% may be too low. Sensitivities to disclose and document: (a) a 10% reduction in projected cash flows; (b) a 1 percentage-point increase in the discount rate; (c) zero or negative terminal growth; (d) full loss of the 22% customer. Re-run each and record the headroom. IAS 36.134 requires disclosure of the key assumptions, the approach to determining values, the discount rate, and the amount by which recoverable amount exceeds carrying amount, plus the value assigned to key assumptions and the period over which cash flows were projected. The conclusion should be that, on corrected cash flows, headroom is thin and the test must be redone before sign-off.