Audit Procedures for Impairment in the FRC Audit Inspections 2022

Impairment

Conducting robust testing in audit procedures for impairment involves deconstructing the models, assumptions, and data used by management.

Findings were raised for 6 of the 7 largest UK audit firms to address relating to impairment with the FRC’s audit inspection reports. This demonstrates how consistently complex it is to audit this significantly judgemental area.

Impairment assessments are a feature of audits of all sizes. All audit firms can glean valuable insights from these inspection results. They can, and should, take the best practices discussed here to improve quality.

General Impairment Assessments

Auditors must thoroughly consider impairment indicators through detailed searches and evaluating the results of other testing. Challenging the appropriateness of revenue and EBTIDA multiples and the reasonableness of forecasts is an important part of testing impairment.

Evidence is key. Look-back tests can provide perspective on the prior accuracy of management judgements. Ensure you are unpicking the various layers of impairment assessments to audit the different elements as well as assessing impairment at a macro level.

Goodwill

Determining Cash Generating Units (CGUs) precedes detailed goodwill impairment evaluation. Essential procedures include challenging management’s CGU

determination as well as the cash flow forecasts and sales assumptions at a CGU level.

Future growth rates are impossible to conclusively evidence, but short-term growth should more strongly correlate to recent results. Sensitivity analysis and look-back procedures allow auditors to critically review the overall goodwill assessment and the assumptions within.

Incorporate challenge of management in all areas of the audit of goodwill impairment assessments.

Other Impairment Areas

The recoverability of assets such as receivables may be heavily impacted by external events. The cashflow impact must be incorporated in impairment modelling. When auditing illiquid investments, it is important to involve experts to develop independent models to assess management’s models.

Ensure your overall engagement team has the appropriate skills to audit impairment assessments.

Next steps

Complexities auditing impairment are common and all audit firms should be targeting quality improvements in this area. Tackling this area as early in the audit process as possible provides additional time to assess the models used, challenge management’s assumptions, and validate the accuracy of data and inputs to supporting evidence.

The various impairment takeaways to support your firm’s methodology improvements, or your next impairment audit test, are available in our detailed guide. Quick reference cheat-sheets to help you implement these tips quickly and easily are included. Find these 21 tips for auditing estimates in the free guide – a sample of impairment tips is included below.

Cheat sheet preview

IMPAIRMENT:

General Impairment Assessments

• Perform a detailed and extensive search for potential impairment indicators, including consideration of the results of other audit testing.
• Consider and challenge the appropriateness of revenue and EBITDA multiples and assess the reasonableness of revenue and EBITDA forecasts used in the impairment assessment.
• Corroborate the forecast growth rates and identification of impairment indicators to external evidence, as well as use look-back procedures.
• Perform an extensive sensitivity analysis over each assumption in the valuation of a financial asset to mitigate the risk of potential impairment.

Going Concern and Viability Assessments

• Perform a clear evaluation of management’s going concern assessment, in particular the impact of the principal and strategic risks on the forecast liquidity and covenant headroom.

Goodwill

• Evidence the challenge of management’s short-term growth rates, if there is significantly lower growth recorded in recent actual results.
• Consider the impact of the sensitivity of the goodwill impairment to changes in management’s forecast scenarios and evidence adequately.

Other Impairment Areas

• Obtain sufficient evidence and challenge management’s valuation estimates and cash flow assumptions for acquired assets.
• Use firm experts to develop independent models to assess the integrity of management’s models when valuing illiquid investments.