Impairment Analysis: Bridging the gap between Appraisers and Auditors responsibilities
In recent times, the use of auditor-employed experts as part of the audit procedures has increased. This can be attributable to various factors including audit risk, expertise and skills required to test critical inputs that form part of the valuation exercise, Management or Management-employed appraiser’s expertise required to perform the valuation, etc.
Point in discussion is Standard on Auditing 620: Using the work of an auditor’s expert. While the SA 620 is effective for all audits beginning on or after April 1, 2010; the practical application/adoption of the same has seen increased interest and adoption more recently. However, the auditor has sole responsibility for the audit opinion expressed, and that responsibility is not reduced by the auditor’s use of the work of an expert. Further, the Valuation Standards Board has laid down stricter valuation guidelines and responsibilities to adhere to such standards and guidelines vests on the appraiser’s shoulders. Therefore, one can now witness that there is greater accountability and responsibility on both, the appraiser and auditor.
This article is focused to tackle practical challenges while performing audit review of valuation performed for impairment testing under Ind AS 36- Impairment of Assets. To make this document more relatable, the subject is presented in a FAQ format.
Most of us are aware that the objective of Ind AS 36 is to prescribe the procedures that an entity applies to ensure that its assets are carried at no more than their recoverable amount.”
Credentials and Experience
Question: Who is responsible for determination of Recoverable Amount? How to evaluate competencies, capabilities, and objectivity of Management-employed appraiser?
The Management of the entity (“Management”) is responsible for determination of Recoverable Amount. The Management shall either prepare these with the assistance of skilled personnel internally or employ an independent third-party appraiser for determination of Recoverable Amount. In either case, the person undertaking the impairment analysis should have the necessary qualification, experience, skills, and knowledge in the relevant field.
| Auditor’s Role | Appraiser’s Role |
|---|---|
For the auditor to express an opinion whether there exists an impairment loss; the auditor is required to review either the Management prepared analysis of Recoverable Amount or use work of an auditor’s expert. The auditor is required to verify and document reasonable and appropriate evidence in connection with the competencies, capabilities and objectivity of the person assisting in determination of Recoverable Amount. This is critical to stay compliant with Standard on Auditing 230: Audit Documentation (“SA 230”). Typically, this should incorporate the appraiser’s work experience relevant to financial reporting related valuation and check if they have the necessary qualification / license to practice in the jurisdiction. | The appraiser shall incorporate their valuation profile as part of or supplementary to the Valuation Report citing various types of engagements performed along with details of their professional qualifications / accreditation and licenses to perform valuation in the specific class of asset for financial reporting purposes. As best practice measures, the appraiser shall disclose their independence in the cover letter of the Valuation Report. |
Recoverable Amount
Question: What is Recoverable Amount under Ind AS 36? What are the valuation techniques/methods to determine FVLCOD and VIU?
If either of these amounts exceeds the asset’s carrying amount, the asset is not impaired, and it is not necessary to estimate the other amount.
To understand the two methods for determining the Recoverable Amount, let us look at various elements of each of these methods.
| Particulars | FVLCOD | VIU |
|---|---|---|
| Definition | FVLCOD = FV Less Cost of disposals Fair Value is defined as “the price that would be received to sell and asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.”1 Cost of disposals are incremental costs directly attributable to the disposal of an asset or CGU, excluding finance costs and income tax expenses.2 | Value in use is the present value of future cash flows expected to be derived from an asset or CGU.3 |
| Valuation techniques | Fair value is a market-based measurement. Therefore, it is measured using the assumptions that market participants would use when pricing the asset or CGU as at the measurement date. Example:
As a result, Fair Value could be determined using either of the generally accepted valuation techniques/approach depending on fair value hierarchy of inputs available. These approaches are:
Once the Fair value is determined using any of the commonly accepted valuation methods (example: discounted cash flow method, Guideline Public Company Method or Guideline Transaction Method), the cost of disposal is subtracted from the Fair Value to arrive at the Fair Value less Cost of Disposal. | VIU is an entity-specific measurement. The estimated future cash flows should be over a period of 5 years. Longer period needs to be justified with strong rationale. The estimates of future cash flows should include:
Future cash flows shall be estimated for the asset in its current condition and exclude cash flows expected to arise from:
|
Audit Review & Documentation Framework
Question: How can appraiser’s/valuer’s report assist auditors in obtaining reasonable and sufficient evidence as part of audit procedures?
A detailed and well-documented Valuation Report is fundamental to the audit procedures. However, here is a tabular presentation of certain key estimates that each appraiser can focus on documenting in their Valuation Report. This shall enable any independent reader of the Valuation Report to fully understand the analysis who has basic knowledge of valuation.
| Auditor’s Responsibility | How can Appraiser’s help bridge the gap? |
|---|---|
| Projections Reasonableness Testing | |
Auditor is required to understand, verify, and document the reasonableness of estimated future cash flow projections directly attributable to or allocated to the asset or CGU including various inputs and estimates in connection with:
| Projections are ultimately the responsibility on the Management. Appraiser can ensure that the Management provided Board approved projections for the purpose of impairment analysis. Further, appraiser shall document the sources of information in a separate section outlining various information/ data points that form part of the analysis and has been used in the value conclusion. This information can be provided by the Management based on their knowledge and experience in the industry, appraiser’s research from subscription-based platforms/database, industry reports or public domain and discussion with the Management. Few sources of information that assist an auditor in understanding and documenting Projections Reasonableness memo are:
This assists auditors in understanding the reliability and consistency of the inputs used and verify for the accuracy of the same. If possible, appraiser shall document their observations |
| Discount Rate – Selection of method and components | |
The auditors are required to check and comment on the selection, consistency and appropriateness of the inputs that form the discount rate. In practice, the most common method of determining the discount rate is the Weighted Average Cost of Capital using the CAPM. Typical inputs used to build the discount rate are:
| In summary, appraiser is required to document the method used for discount rate selection, various sources of input used in the discount rate conclusion and reason for selection of certain premia (quantitative or qualitative) that form part of the discount rate. Certain key elements that should be outlined by the appraiser either through their Valuation Report or through a supplementary documentation / communication are as under:
|
References & Standards
- Ind AS 113 – Fair Value Measurement
- Ind AS 36 – Impairment of Assets
- Ind AS 36 – Impairment of Assets