In principle, yes as that would be one way of looking at it. In...

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    In principle, yes as that would be one way of looking at it.

    In practice, however, it becomes a bit more complicated than this.

    It may well be that the new CFO, Millar and the new external advisers to the Board will adopt a more conservative estimating position for determining impairment than currently exists but until then the principles outline din Note 13 apply.

    Even if change occurs however, it might still be that impairment does not occur this time round. Rather the instruments for determining impairment may all have their values changed, with the sensitivity analysis then reapplied, without it necessarily resulting in impairment at this time. In this regard, the Note 13 values, ranges and discounting factors could all be changed resulting in a quicker shift towards impairment even if actual impairment does not then happen to follow on from the updated analysis then performed.

    SGH’s approach to impairment therefore does not adopt the type of principle that you have outlined although with new accountants in place, this could well be looked at.

    SGH’s actual methodology towards accounting for impairment of Goodwill is outlined in several Notes to its 2015 Annual Report.

    In it, they have broken down by reference to a number of different CGUs (Cash Generating Units) – AU/PIL. AU/GL, UK/PIL, UK/GL, SGS. Any one or more of these CGUs could be impacted for any number of reasons without necessarily impacting on any of the other CGUs. In context what this means is that impairment to one or more CGUs whilst sounding bad may not necessarily prove to be the case especially if the at risk goodwill is limited.

    By doing this, SGH have certainly tried to shift the boundary posts for assessing when (or if) goodwill risks by aligning those risks specifically at the CGU level. Profit could therefore drop significantly on account of the non-SGS CGUs failing to perform as forecast, yet this may not materially affect goodwill or impairment provided that SGS holds up. But if not, then, yes, impairment would follow through.

    Considered in another way, if SGS is performing thereabouts, even if it drops down to ½ F16 forecast rates, this still may not result in any impairment occurring. If however, any of the other CGUs literally break down in a functioning sense, even by <¼ sense, then impairment of one or more of those units could quickly follow, not because profit has dropped by that much but because performance has.

    Outside of SGS which has $1.0B in goodwill on the Balance Sheet, the other CGUs have a combined $150M in currently carried goodwill. Hence, the greater impact risk is through SGS rather than through the other CGUs even though the operational risk could be far greater in the other CGUs than in SGS.

    As Note 13 states:

    • The recoverable amount of goodwill and indefinite life intangibles allocated to each of the CGUs has been determined based on a value in use calculation as required by AASB 136 Impairment of Assets. This uses financial budgets and cash flow projections approved by senior management covering a five year period.
    • The value in use is compared to the net carrying amount of the CGU. If the calculated value in use exceeds the net carrying amount, no impairment loss is recorded.
    For example, the allocated impairment criteria across the various CGUs is:
    Column 1 Column 2 Column 3 Column 4 Column 5 Column 6
    0 CGU
    Nominal Growth Rate**
    Discount Rate
    DISC R to = Recoverable Value
    2014 NGR Rate
    2014 DISCR
    1 AU/PIL
    5%
    9.25%

    7.7%
    9.1%
    2 AU/GL
    8%
    9.25%

    9.12%
    9.1%
    3 UK/PIL
    5%
    9.25%

    6.8%
    9.1%
    4 UK/GL
    8%
    9.25%

    6.8%
    9.1%
    5 SGS
    2.25%
    10.45%
    12%


    6 Total





    ** Applied to F16, based on the F17 – F20 period.

    Refer Note 2a (Impairment of Goodwill):
    Determining whether goodwill is impaired requires an estimation of the value in use of the cash generating units to which goodwill has been allocated. The value in use calculation requires management to estimate the future cash flows expected to arise from the cash-generating unit and a suitable discount rate in order to calculate present value. Where the actual future cash flows are less than expected, a material impairment loss may arise.

    Then refer Note 13:
    Goodwill and indefinite life intangibles acquired through business combinations have been allocated to individual cash generating units (“CGUs”) in both the Australian and UK business for the purposes of impairment testing being the Personal Injury Law (“PIL”) division, General Law (“GL”) division and SGS.

    The recoverable amount of goodwill and indefinite life intangibles allocated to each of the CGUs has been determined based on a value in use calculation as required by AASB 136 Impairment of Assets. This uses financial budgets and cash flow projections approved by senior management covering a five year period.

    The value in use is compared to the net carrying amount of the CGU. If the calculated value in use exceeds the net carrying amount, no impairment loss is recorded.

    Then there is the following, also from Note 13:
    The Group performed its annual impairment test in June of 2015. The Group is sensitive to the recovery of fees in its legal business, and the velocity of the resolution of those files. In performing the value-in-use calculations for each CGU, the group has applied post-tax discount rates to discount the forecast future post-tax cash flows.

    The key assumptions used in the estimation of the recoverable amount are set out below:

    • Average fees recoverable for legal matters;
    • Average file velocity for legal matters; and
    • Cost of capital and discount rate used.
    Note 13 then goes on to point out that:
    The recoverable amount of the ….. CGU has been determined based on a value in use calculation using cash flow projections from the financial forecasts approved by senior management covering a five year period. …. The growth rates beyond the 5 year period have been determined with reference to forecast inflation rates, population and industry growth rates.

    In relation to SGS specifically, Note 13 states:
    The recoverable amount of Slater and Gordon Solutions (“SGS”) CGU, £756m as at 30 June 2015, has been determined based on a value in use calculation using cash flow projections from the financial forecasts approved by senior management covering a five year period.

    Based on the provisional accounting the estimated recoverable amount of the SGS CGU exceeded its carrying amount by approximately £123m at 30 June 2015.

    The projected cash flows have been based on financial forecasts by senior management for the periods FY16 to FY18 with a 2.25% nominal growth rate applied to periods post FY18. This long term growth rate for the SGS CGU has been based on the long term economic growth rate. This differs to the long term growth rate assumption applied to the other UK CGU’s as SGS was only acquired on 29 May 2015.

    A key driver of performance which may impact an impairment of the SGS CGU is the rate of resolution of personal injury claims (“velocity of matters”). Personal injury claims represent a very large proportion of the SGS business and if the velocity of matters slows, cash flow will be detrimentally impacted and this may impair goodwill.

    A sensitivity analysis has been conducted to measure the extent to which velocity would need to be reduced before goodwill was impaired. The sensitivity analysis conducted on the average velocity of personal injury claims within the SGS CGU indicated a negative movement of up to 60% in the settlement period for matters would not cause an impairment to the SGS CGU.

    To therefore comment:
    * Goodwill could be impaired even if profit does not drop by $100m, to use your example.
    * Goodwill could be impaired elsewhere even if SGS holds up.
    * Conversely, if the other CGUs hold up, but SGS fails to do so, then goodwill could also be impaired.
    * The goodwill impairment risk to SGS, at its maximum is $1.0B, but then closer to $150M for all of the remaining CBUs.
    * SGS impairment risk could arise from several quarters including (*) further refinement of the provisional accounting outcome, (*) further adjusting the nominal growth rate, (*) change in the velocity of matters, and (*) impact on the average velocity of matters.
    * If for example, the average velocity is 180 days to average resolution, then the outward shift could be to 288 days before risk of impairment arises.
    * According to the PSD Presentation from 24 June, 70% of matters within the Portal are settled within 6 – 9 months whilst the remaining 30% take from 9 – 24 months in order to settle.
    * If these values were to move out by 60% on average, within individual categories and weighted across the board, then problems would arise.
 
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