The environment in which valuers, auditors and company directors have to assess the carrying value of assets, including intangibles, continues to be challenging given the fragility of the Australian and world economies. Significant judgement is required in determining appropriate cash flows and discount rates for valuation purposes. In these uncertain economic times the data available on which to base informed judgements can be scarce, difficult to verify and can change rapidly with markets being highly sensitive to economic data, and there being fewer merger and acquisition transactions occurring to benchmark against.
 
ASIC had previously identified asset impairment as an area of focus given the state of the economy. On 11 January 2010 ASIC advised that it had concerns about asset impairment from its review of financial statements as at 30 June 2009 and it will continue to be a focus of their monitoring of financial statements as at 31 December 2009. Furthermore, ASIC stated that further writedowns may be expected.

What should valuers, auditors and company directors focus on when preparing, reviewing or auditing asset valuations? The following is a summary of the key areas of a valuation that we believe should be the focus of preparers
and reviewers attention:

• The valuation should reflect the expectation of variations in the timing and quantum of cash flows. This can be achieved by building additional risk premium into the discount rate to reflect the uncertainty of the cash flows or by preparing a cash flow based on the weighted average possible cash flows. Both methods have their advantages and disadvantages however either method can be used as long as the risk and uncertainty is reflected in either the discount rate or the cash flow forecasts. A common error in valuations is double counting risk by adjusting cash flows and the discount rate.
  
  
• The discount rate should reflect all of the risks and uncertainties specific to the asset and its cash flows. This requires the risks and uncertainties to be identified and a premium quantified and allocated to the risk. The types of risks and uncertainties that should be considered include price risk, country risk, illiquidity, small entity risk, currency risk and where in the lifecycle is the asset or business.
  
  
• The assumptions used in a valuation must be credible and supported by verifiable data, preferably data which is external to the company. ASIC identified unrealistically optimistic discount rates and growth rates as a common issue. Relevant sources of data external to the entity may include central bank projections on interest rates, inflation and other key economic indicators prepared by economists and industry specific forecasts prepared by industry experts.
  
  
• A sensitivity analysis should be prepared on all valuations. This enables users to identify and assess the key assumptions that drive the valuation and the impact that a change in those assumptions could have on the valuation. This is particularly important when the valuation and the carrying value of the asset are close. ASIC has commented that there was a lack of disclosure in financial reports of sensitivity analysis.
  
  
• AASB 8 Operating Segments may change the operating segments previously identified by a company as the basis for identifying an operating segment has changed to align with the management information provided to the key decision maker/s in an entity. When goodwill has previously been allocated to a cash generating unit that is larger than the new operating segments to which it relates, the goodwill may have to be reallocated across the new operating segments. The valuation of goodwill must then be prepared on the cash flows from the relevant segment to which it has been allocated. This may result in impairment losses being recognised when the cash flows from an operating segment are less than those in the cash generating unit.

In these uncertain economic times a cautious but realistic approach to forecasting cash flows and determining discount rates should be adopted when valuing assets. The discounted cash flows should represent the weighted average of all the possible outcomes for the particular asset being valued.


Grant Sincock, Melbourne
gsincock@moorestephens.com.au