Ravi Textiles: Goodwill Reallocation and Support for Value-in-Use Headroom

Rule. IAS 36.87 provides that if an entity reorganises its reporting structure in a way that changes the composition of the CGUs to which goodwill has been allocated, the goodwill is reallocated to the new CGUs. The reallocation is made on the basis of the relative carrying amounts of the new CGUs, unless a more reasonable basis is available. Goodwill is reallocated only to units expected to benefit from the synergies of the combination.

Application. The merger of Home Textiles and Kids Wear is a genuine reorganisation that changes the composition of CGUs, and the relative-carrying-amount method has been used. Two conditions must still be satisfied:

1. The new CGU must not be larger than the aggregation of the old CGUs for the goodwill already tested. Merging two units is permissible; sweeping part of a third CGU into the Consumer unit to shelter underperforming goodwill is not.
2. The synergies test must still hold - the reallocated goodwill must relate to the unit expected to benefit from the combination synergies. If part of the Home Textiles goodwill was supported by distribution synergies now transferred elsewhere, pro rata reallocation on carrying amounts could put goodwill in the wrong unit.

Timing. Reallocation is performed before the impairment test, so testing the Consumer CGU at 31 December 2025 on the new structure is correct, provided comparative impairment testing at the merger date did not already show a shortfall that should have been recognised then.

Error if conditions fail. Goodwill would be sitting in a CGU that does not benefit from it, artificially pooling a well-performing unit with a weak one and masking impairment. The correction is to reallocate on the more reasonable basis and retest, with a prior period adjustment only if the earlier allocation was itself wrong.

Assess the assumptions against IAS 36.30-57.

Headroom. Rs 15 million on a carrying amount of Rs 1,135 million is 1.3%. That is inside any reasonable estimation error for a five-year DCF. A 50 basis point rise in the 14% pre-tax discount rate, or a one-year delay in volumes, would more than eliminate it. Headroom of this size is not evidence of no impairment; it is evidence that the model determines the answer.

Volume growth of 18% versus industry 4%. IAS 36.33(b) requires the cash flow projections to be based on the most recent budgets approved by management and to reflect reasonable and supportable assumptions. Sustaining 18% for five years when the market grows at 4% implies a fourfold-plus share gain. Management must show contracts, capacity and customer commitments, not aspiration. If steady-state growth beyond the forecast period is 3%, the terminal value carries most of the Rs 1,150 million, and terminal value built on a five-year outperformance phase is doubly sensitive.

The 22% customer. A three-year contract expired in November 2025 and has not been renewed. This is a known post-year-end event bearing directly on the year-end projection. A model that continues to project revenue from that customer is inconsistent with the evidence and would breach IAS 36.34, which requires the model to reflect the current condition of the asset. At minimum, that customer's revenue must be removed and any replacement business supported by orders in hand.

Discount rate. 14% pre-tax must be a current market assessment of the risks specific to the CGU (IAS 36.55). If the customer loss materially increases risk, the rate must rise; management has not revised it.

Conclusion. The conclusion is not sustainable. Once the lost customer is removed, growth is normalised and the discount rate is adjusted for the additional risk, recoverable amount is likely to fall below Rs 1,135 million. A material impairment should be recognised, and the auditor should quantify the realistic write-down rather than accept the Rs 15 million headroom. The audit team should also document the sensitivity analysis showing the point at which headroom disappears.

Required disclosures - IAS 36.126-137.

1. The carrying amount of allocated goodwill and the impairment recognised during the period, by segment where applicable.
2. The recoverable amount of the CGU and whether it is value in use or fair value less costs of disposal.
3. The key assumptions used in the cash flow projections - volume growth, price and cost inflation, and the period covered - with management's basis for each.
4. The discount rate (14% pre-tax) and the terminal growth rate (3%), with a statement that the rate reflects current market assessments of the time value of money and CGU-specific risk.
5. The period of the projections and the reason for using more than five years if it does; where steady-state growth exceeds the long-run average, the justification and the period of higher growth.
6. Sensitivity: the amount by which the recoverable amount would have to fall for the CGU to equal its carrying amount (currently Rs 15 million), the change in a key assumption that would eliminate the headroom, and the impairment that would result. IAS 36.134(f) permits omission only if reasonably possible changes cannot cause the carrying amount to exceed recoverable amount - which cannot be claimed here.
7. The reorganisation and the basis of goodwill reallocation, with the amounts moved between units.
8. The loss of the 22% customer as a subsequent event or as a key assumption change, with its effect on the projections.

Audit evidence. Board-approved budgets reconciled to the model; the integrity of the model (formulas, consistency of cash flows, correct treatment of capital expenditure and working capital); inputs tested to order books, post-year-end actuals, industry reports and historical accuracy of prior forecasts; the discount rate benchmarked to comparable entities and the weighted average cost of capital; direct confirmation of customer renewals and correspondence with the lost customer; sensitivity analysis re-performed by the auditor; and a written representation from management that the forecasts are the most recent approved and that all material customer losses have been disclosed. Where the auditor concludes an impairment is required and management refuses, the difference should be quantified as an uncorrected misstatement and the opinion qualified if material.