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Is the impairment standard beyond repair?
August, 16th 2007
The standard (AS-28) seems to provide guidance primarily from the perspective of a manufacturing company, even though close to half of Indias GDP is contributed by the service sector.


In A Midsummer Nights Dream the Bard describes, through Hermia, how nature compensates impairment: Dark night, that from the eye his function takes, the ear more quick of apprehension makes; wherein it doth impair the seeing sense, it pays the hearing double recompense.

Such mercies, however, dont seem to hold true with the accounting standard on impairment (AS-28), issued by the ICAI (Institute of Chartered Accountants of India). Goodwill impairment in practice is still a distant reality due to the lack of guidance on its implementation, frets Mr Paul Alvares, a senior professional in a member firm of Ernst & Young Global. If the Institute intends that the standard on impairment, especially on goodwill, should be i mplemented in spirit, it should issue guidance to this standard, which should address questions and practical implementation problems being faced by industry. Else, this standard will just remain a standard in theory, he adds, during a recent interaction with Business Line.

While that should leave one wondering if an effective guidance can make good for the impairment in the standard, it should help starters to know that the word impair means make worse or damage. His health was impaired by overwork, reads an example on . Impairment is the amount by which stated capital is reduced by distributions and losses, defines .

Impairment in colloquial sense would mean an excess value, which may not be recoverable, explains Mr Alvares. It could mean excess value of any asset. Impairment relating to fixed assets and goodwill has separate accounting guidance. This is because of the number of assumptions involved in its evaluation and also the longer timeframe involved. In India, the accounting standard Impairment of Assets, AS-28, was introduced in 2002 to provide guidance on measurement, accounting and disclosure aspects of impairment.

Excerpts from an interview:

Has AS-28 achieved its objective?

Strange as it may sound, there are very few companies in India where one finds impairment adjustments on financial statements. Does it mean that the assets of Indian companies are fairly valued? And we all know the answer. Is it possible that though goodwill under Indian GAAP is shown multiple times higher than its IFRS equivalent (because of book value rather than fair value approach) no impairment adjustment is required? Thus the effectiveness of AS-28 is open to many a question, even as it is being implemented on paper than in spirit.

What do you think could be the reasons?

AS-28 is complex and this theoretical complexity is not supported by any practical implementation guidance, which makes its level of application across corporates far from desired. Professionals who have faced these situations would agree that when it comes to actually testing goodwill for impairment, there are a number of practical issues that one faces which do not have answers in AS-28.

Issues, such as?

One of the biggest issues is the lack of guidance on goodwill impairment for the service industry. The standard seems to provide guidance primarily from the perspective of a manufacturing company, even though close to half of Indias GDP is contributed by the service sector. Acquisitions in the service industry like in BPOs or IT companies are done at dizzy multiples, which generate huge goodwill on the balance sheets of these companies.

In many cases, goodwill may be the largest item on the asset side of the balance sheet of these companies. How does one evaluate goodwill impairment in the case of such companies? How does one determine a cash-generating unit in such companies? The fixed assets in service industries may not be directly relevant to income-generation and hence the guidance suggested by AS-28 of loading goodwill on fixed assets/cash generating units fails completely, because unlike in a manufacturing company, fixed assets in a service company only provide support and are not income-generating.

Is impairment beyond repair, or what can be the way forward?

Corporate India as a whole may not be geared yet to support an exercise like goodwill impairment. Even at the cost of being different from global practices, the ICAI should insist on goodwill on consolidation to be amortised over a defined period like say 20-30 years, considering the earning time span which these acquisitions could be anticipating. This would ensure that the assets of Indian corporates as a whole are not overstated.

Are there other questions too that come up when the service industry tries to implement the standard?

The standard is completely silent in the case of goodwill arising on multiple acquisitions. Deals today, especially in software and BPOs, are done for a whole business. For example, a software company may have three verticals and the company acquiring it may acquire all the verticals. How does one allocate goodwill to those verticals? What happens if one of the verticals is sold later? There could probably be two scenarios emerging.

One, where the company contends that the goodwill be allocated on proportionate basis (on a convenient parameter) and written off to the extent the vertical is sold off. Contrary position, which a company could also take, is that the future cash generations of the continuing verticals is able to cover even the goodwill on the vertical sold. Either of these scenarios could have huge implications on the profit of these companies and companies could follow the convenience approach, due to lack of guidance.

How critical is projection of profits and cash flows in the evaluation of impairment in AS-28?

The entire fulcrum of the standard is on projections. Cash flow projections would decide whether there would be an impairment provision or not. Therefore, it is the most important aspect of the implementation. AS-28 requires assets to be evaluated against future cash flows. In India, where even many listed companies may not be having a formal budgeting process, can we reasonably expect companies to be able to project their earnings over the life of the assets? One wonders whether most of these would be paper projections without any basis. Which gives rise to the question as to whether this accounting standard is being implemented on paper?

What difficulties can arise when making projections?

There are many, but the key issue is the period over which the future cash flows are to be considered. Imagine a company that has multiple plants and each plant was set up in different years, due to which their balance useful lives would be different. How would one project the cash flows in this case, where the future cash flows are a sum of the cash flows of various plants having different estimated useful lives? Can companies in India reliably forecast cash flows at the plant level and that too for the balance useful life of each plant? Also, over what period does one forecast cash flows? Is the period the estimated useful life as per Schedule XIV to the Companies Act, 1956, or can the cash flows go beyond the estimated useful life?


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