Impairment of an indefinite-life intangible: two specialists and a four-day deadline
Arden Biotech plc, a listed drug developer with a 31 December 2025 year end, carries an indefinite-life IPR&D intangible of $140m that is subject to an annual impairment test. Management's valuation specialist produced a discounted cash flow model using a 9.5% discount rate, 4.5% terminal growth and probability-weighted peak sales of $900m. Your firm's valuations expert reviewed the model and considers the discount rate 200 to 300 basis points too low and the terminal growth above long-run GDP growth; a 250bp increase in the discount rate reduces the recoverable amount by $45m and a 1% reduction in terminal growth reduces it by $22m. Materiality is $18m. The audit team has not documented an evaluation of either specialist's competence or objectivity, and has not challenged the assumptions. The engagement partner has known the CFO for 15 years; the CFO supplied a bank's letter describing the assumptions as market consistent. The audit report is due in four business days and the engagement quality reviewer has not yet seen the file.
1. Evaluate whether sufficient appropriate audit evidence has been obtained over the impairment assessment, referring to the use of management's expert and the auditor's expert.
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Not on the current file. The audit evidence over a $140m indefinite-life intangible depends on the quality of the impairment model and on the auditor's evaluation of both specialists.
For management's expert, the valuation specialist, the team must evaluate competence, capabilities and objectivity, understand the instructions given, and assess whether the assumptions are reasonable. The bank's market consistent letter is not evidence of reasonableness: the bank may have a commercial interest, and a comfort letter is not an audit opinion or a valuation.
For the auditor's expert, ISA 620 requires the team to assess competence, capabilities and objectivity, agree the scope of work, and evaluate whether the work is adequate and supports the conclusions. That evaluation must be documented, and it has not been.
The sensitivity analysis is decisive. A 250bp increase in the discount rate reduces the value by $45m, and a 1% lower terminal growth reduces it by $22m, each well above the $18m materiality. The expert's view that the rate is 200 to 300bp too low therefore implies a plausible misstatement of tens of millions. The team should challenge the WACC build-up, including peer betas, the size premium and country risk, the terminal growth against long-run inflation and GDP, and the probability weighting of peak sales. Independent sensitivity and a range of reasonably possible outcomes should be documented. Until then, the team does not have sufficient appropriate evidence and cannot sign.
2. Determine the effect on the audit opinion if management refuses to adjust, and explain how you would decide between qualification and an adverse opinion.
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If management refuses to adjust, the auditor should quantify the misstatement. Using the expert's midpoint, the discount rate is around 250bp too low, implying the recoverable amount is overstated by roughly $45m; the terminal growth adds a further $22m of possible overstatement. Against materiality of $18m, even the lower end of the range is material.
The opinion then depends on pervasiveness. If the misstatement is confined to the IPR&D intangible and the resulting impairment charge, a qualified opinion is likely. But note that the asset is $140m and the possible impairment is a large fraction of it; if the impairment also affects reported profit, deferred tax, covenants or key performance indicators, the effect may be pervasive and an adverse opinion may be appropriate. The auditor should also check whether there are indicators that the asset should be tested more frequently, and whether the $140m carrying amount is supportable at all under a reasonable range.
If management refuses to provide the model, the underlying data or access to its specialist, that is a scope limitation and may lead to a qualified opinion or a disclaimer. If management provides the information but disagrees on the conclusion, that is a disagreement, not a limitation. Distinguish the two in the report and document the range of outcomes considered.
3. Address the engagement partner's relationship with the CFO and the documentation and quality review issues that must be resolved before signing.
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Three governance issues need to be resolved before the report is signed.
The partner's 15-year relationship with the CFO is a familiarity threat. It does not automatically disqualify the partner, but it must be evaluated and, given the disagreement over a major judgement, the firm should consider replacing the engagement partner or requiring an independent partner review of the impairment conclusion.
The missing documentation is a quality management issue. ISA 230 requires documentation of significant judgements and conclusions before the report is dated. The absence of any evaluation of the specialists' competence and objectivity is a gap that must be closed, not back-filled after signing. The engagement quality reviewer has not seen the file; for a listed entity an engagement quality control review is required, and the reviewer must evaluate the significant judgements, including the impairment, before the report is released.
Practical steps: brief the engagement quality reviewer immediately, document the evaluation of both specialists, consult the firm's technical or valuations team, and if the evidence still does not support the carrying amount, propose an adjustment and, if refused, modify the opinion. If the partner's objectivity cannot be supported, the firm should reassign the engagement. The report date should be deferred if the file cannot be completed.