The pressure is on: Impairment test according to IFRS & HGB

The problem exists for both HGB and IFRS preparers but is exacerbated in IFRS financial statements due to the regulations applicable there. Under HGB, goodwill resulting from an M&A acquisition is amortized over its useful life, whereby the carrying amounts and thus also the potential for impairment losses are reduced “naturally” over time. Under IFRS, on the other hand, an impairment test only must be carried out at least once a year, while goodwill is not amortized (“impairment-only approach”). This basic concept will probably not change in the future, despite the heated debate about the reintroduction of amortization. However, some specific modifications are currently being considered (for details see here​). 

​Since the introduction of the impairment-only approach, it has been observed in the past that listed German companies have only written down goodwill to a limited extent. However, due to the deterioration in the overall economic situation, goodwill impairments have increased significantly in 2023 compared to the previous two years, as shown in our analysis of the IFRS consolidated financial statements of German companies below:

In 2023, impairment losses resulted from an increase in the interest rate level, among other things. Even though interest rates did not increase further in 2024, it remains at a high level compared to previous reporting periods. In conjunction with the deterioration in the economic outlook and thus a trend towards a worsening of growth and profitability prospects in the business plans of some companies, it is possible that goodwill impairments will continue to increase in 2024, both in absolute terms and relative to goodwill balances, at least on a sector-specific basis. In particular, companies with previously quite optimistic business plans and low excess coverage of the carrying amount (so-called “headroom”) now have a particularly high risk of “catching up” on write-downs that were not recognized in the past due to more optimistic planning. 

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How companies can deal with this constellation, which is also generally reflected in HGB accounting, is shown below. 

The goodwill impairment test in accordance with IFRS is governed by IAS 36, which generally requires a company to be segmented into cash-generating units (CGUs). In practice, the CGU regularly comprises all assets and liabilities that are necessary for the operating business, whereas those of a financing nature are not included in the CGU. The goodwill resulting from business combinations is then allocated to the individual CGUs in consideration of the expected synergies. The impairment test in accordance with IAS 36 is based on a comparison of the carrying amount of the CGU with the recoverable amount, which corresponds to the higher of the two value concepts “value in use” and “fair value less cost of disposal”. 

If, in economically calm phases, the determination of one of the two values is usually sufficient to demonstrate that there is no impairment, a more complex determination of both values may be necessary in times of crisis. Unlike the fair value, the value in use includes genuine synergies specific to the company; however, future restructuring as well as improving or enhancing investments may not be included here (at least according to the current legal status). This is particularly important in the context of the current transformational environment. Accordingly, such measures are not suitable for increasing the value in use. 

When deriving the discount rate, the so-called “market-participant view” must be applied for both value concepts, according to which all components of the WACC generally used are determined on the basis of a group of comparable companies (so-called “peer group”) and not on the basis of the actual financing structure of the CGU. The recoverable amount determined using the WACC approach corresponds approximately to a so-called “entity value” of the CGU, i.e. a value before taking net financial debt into account. 

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The impairment test in accordance with HGB is based on the purchased legal entity as the valuation object for both the annual and consolidated financial statements. This is mandatory for the annual financial statements, as no goodwill is recognized here (at least in the classic case of a share deal), but rather the investment in the subsidiary, which is also not amortized. For the consolidated financial statements in accordance with HGB, DRS 23 recommends allocating goodwill to individual business segments, but also permits the investment as a reference basis. An equity value is then determined for each subsidiary in accordance with the requirements of IDW RS HFA 10 and compared with the carrying amount of the investment in the annual financial statements or, in the simplest approach, with the carrying amount of the net assets of the subsidiary plus goodwill in the consolidated financial statements. 

In contrast to the approach under IAS 36, the derivation of the cost of capital is based on the specific debt structure of the valuation object (at market values) and not on that of the peer group. It is also possible to take synergies between the subsidiary to be valued and other subsidiaries or the reporting company itself into account in the valuation. The company value to be compared with the investment's book value to be tested is a so-called “equity value”, i.e. the company value after taking net financial debt into account. 

An impairment test for goodwill in the consolidated financial statements in accordance with the HGB must always be carried out if there are indications that an impairment is likely to be permanent. For the investment in the annual financial statements, there is an option to write it down either only if the impairment is expected to be permanent or also if the impairment is only temporary. 

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Despite all the differences in detail, the impairment tests under IFRS and HGB have one thing in common: in practice, the valuation is often based on a discounted cash flow approach. Here, expected future cash flows are derived based on integrated (CGU-specific) business plan and discounted to the valuation date using a suitable discount rate. Following the detailed planning phase, which regularly covers between 3 and 5 years, the terminal value is calculated using an assumption about the long-term growth factor. 

This results in two key components for the valuation: 

Depending on the sector and company, expectations for the future and therefore the business plans included in the numerator may currently be more pessimistic than in previous reporting periods. The optimism that still largely existed in 2023 has increasingly faded in some sectors over the course of 2024 and the deteriorating economic outlook is leading to more conservative earnings prospects. Possible approaches regarding the key parameters for the valuation in connection with declining earnings prospects are presented below: 

In the subsequent accounting of a company acquisition in the form of a share deal, a fundamental distinction must be made between the testing of investment book values in the HGB separate financial statements and the impairment test in the IFRS consolidated financial statements. 

Although both impairment test concepts are often based on a discounted cash flow approach, they differ, in part significantly, in their design, implementation and relevant premises. The following table provides an aggregated overview of the main differences between the two impairment test concepts: 

Regardless of the accounting system used, there is currently a trend towards more frequent and higher write-downs. After the rise in interest rates was already reflected in valuation models last year, a more pessimistic expectation of future business development is likely to be added in 2024, depending on the sector. Sound (integrated) corporate planning and careful derivation of expected future cash flows are therefore essential.​