CASE 4.1 ASSET IMPAIRMENTS IN THE RECESSION OF 2008-2009 Required 1. Evaluate the five general valuation rules discussed at the beginning of the case. Is it useful to have those different valuation methods? Explain. 2. Why are the impairment rules for goodwill different than for other assets? Explain. 3. Evaluate the recoverability test used in U.S. GAAP. 4. Are the differences between IFRS and U.S. GAAP significant? Explain. 5. Compare the three IFRS disclosures in Exhibits 1, 2, and 3. How subjective are the impairment calculations? Which assumptions needed to compute impairment are the most subjective? Which are least subjective? Explain. 6. Compare the two U.S. GAAP disclosures, using the same criteria as in question 5. 7. Which of the five disclosures is most informative? Which is least informative? Why? 8. Which disclosures are most informative, the IFRS disclosures, the U.S. GAAP disclosures, or are the differences more company specific? Explain. 0 HIBIT 1 STLE IMPAIRMENT TE, 2008 NUAL REPORT SECTION FOUR FINANCIAL REPORTING-IFRS 14.1 Impairment charge during the period Nestl Waters Home and Office Delivery business in Europe Goodwill related to the 2003 acquisition of Powwow has been allocated for the impairment test to the Cash Generating Unit (CGU) defined as the Nestl Waters Home and Office Delivery (HOD) business in Europe. As at 31 December 2008, the carrying amounts of all goodwill items allocated to this CGU and expressed in various European currencies represent an equivalent of CHF 836 million before 2008 impairment (2007: CHF 1119 million). According to IFRS requirements an annual impairment test was conducted in the second half of the year. Following further deterioration of the business in various countries since the last impairment test and the foreseen disposal of the Italian and UK HOD operations, the present value of future cash flows was revised downwards. As the recoverable amount of the CGU was lower than its carrying amount, an impairment of goodwill amounting to CHF 442 million has been recognised in 2008 (2007: CHF 210 million). The recoverable amount of the CGU has been determined based upon a value-in-use calculation. Deflated cash flow projections covering the next 50 years, discounted at a weighted average rate of 6.2%, were used in this calculation. The cash flows for the first five years were based upon financial plans approved by Group Management; years six to ten were based upon Group Management's best expectations. Cash flows were assumed to be flat for years eleven to 50. Cash flows have been adjusted to reflect the specific business risks. Main assumptions, based on past experiences and current initiatives, were the following: - Sales: annual growth between 1.5 and 8.3% for the first three years and between 2.2 and 2.3% in the six years afterwards. - EBIT margin evolution: consistent with sales growth and enhanced cost management and efficiency, with a higher growth during the first three years and then steadily improving ten basis points per year over the following years. 14.2 Yearly impairment tests Goodwill impairment reviews have been conducted for more than 200 goodwill items allocated to some 50 Cash Generating Units (CGUS). There are no significant carrying values of goodwill that are allocated across multiple CGUS. Detailed results of the impairment tests are presented below for the three significant goodwill items, representing more than 50% of the net book value at 31 December 2008. For the purpose of the tests, they have been allocated to the following CGUS: PetCare, Infant Nutrition and Ice Cream USA. PetCare Goodwill related to the 2001 acquisition of Ralston Purina has been allocated for the impairment test to the CGU of the product category PetCare on a worldwide basis. As at 31 December 2008, the carrying amounts, expressed in various currencies, represent an equivalent of CHF 9888 million (2007: CHF 10 618 million) for the goodwill and CHF 29 million (2007: CHF 29 million) for the intangible assets with indefinite useful life. The recoverable amount of the CGU is higher than its carrying amount. The recoverable amount has been determined based upon a value-in-use calculation. Deflated cash flow projections covering the next 50 years, discounted at a weighted average rate of 6.7%, were used in this calculation. The cash flows for the first five years were based upon financial plans approved by Group Management; years six to ten were based upon Group Management's best expectations, (continued) CASE 4.1 ASSET IMPAIRMENTS IN THE RECESSION OF 2008-2009 which are consistent with the Group's approved strategy for this period. Cash flows were assumed to be flat for years eleven to 50, although Group Management expects continuing growth. Cash flows have been adjusted to reflect the specific business risks. Main assumptions, based on past experiences and current initiatives, were the following: - Sales: annual growth between 3.9 and 7.9% for North America and between 3 and 4.5% for Europe over the first ten-year period. EBIT margin evolution: steadily improving margin over the period, in a range of 10-30 basis points per year for North America and 10-60 basis points per year for Europe, consistent with sales growth and portfolio rationalisation. Assumptions used in the calculation are consistent with the expected long-term average growth rate of the PetCare business in the regions concerned. The key sensitivity for the impairment test is the growth in sales and EBIT margin. Assuming no sales growth and no improvement in EBIT margin over the entire period would not result in the carrying amount exceeding the recoverable amount. An increase of 100 basis points in the discount rate assumption would not change the conclusions of the impairment test. Infant Nutrition Goodwill and intangible assets with indefinite useful life related to the 2007 acquisition of Gerber have been allocated for the impairment test to the CGU of the Infant Nutrition businesses on a worldwide basis. As at 31 December 2008, the carrying amounts, expressed in various currencies, represent an equivalent of CHF 3963 million (2007: CHF 4227 million) for the goodwill and CHF 1405 million (2007: CHF 1497 million) for the intangible assets with indefinite useful life. The recoverable amount of the CGU is higher than its carrying amount. The recoverable amount has been determined based upon a value-in-use calculation. Deflated cash flow projections covering the next 50 years, discounted at a weighted average rate of 8%, were used in this calculation. The cash flows for the first five years were based upon financial plans approved by Group Management; years six to ten were based upon Group Management's best expectations, which are consistent with the Group's approved strategy for this period. Cash flows were assumed to be flat after, although Group Management expects continuing growth. Cash flows have been adjusted to reflect the specific business risks. Main assumptions were the following: - Sales: annual growth between 2 and 5% for North America and between 5.2 and 5.7% for the rest of the world over the first five-year period. EBIT margin evolution: steadily improving margin over the period, in a range of 10-50 basis points per year for North America and in a range of 60-90 basis points per year for the rest of the world. The key sensitivity for the impairment test is the growth in sales and EBIT margin. Assuming no sales growth and no improvement in EBIT margin over the entire period would not result in the carrying amount exceeding the recoverable amount. An increase of 100 basis points in the discount rate assumption would not change the conclusions of the impairment test. Ice Cream USA Goodwill and intangible assets with indefinite useful life related to the Group's Ice cream businesses in the USA (Nestl Ice Cream Company and Dreyer's) has been allocated for the EXHIBIT 1- continued 251 NESTL IMPAIRMENT NOTE, 2008 ANNUAL REPORT (continued) 2 HIBIT 1- tinued STLE IMPAIRMENT TE, 2008 QUAL REPORT SECTION FOUR FINANCIAL REPORTING-IFRS impairment test to the Ice Cream USA CGU. As at 31 December 2008, the carrying amounts, expressed in USD, represent an equivalent of CHF 3096 million (2007: CHF 3301 million) for the goodwill and CHF 76 million (2007: CHF 81 million) for the intangible assets with indefinite useful life. The recoverable amount of the CGU is higher than its carrying amount. The recoverable amount has been determined based upon a value-in-use calculation. Deflated cash flow projections covering the next 50 years, discounted at 6.4%, were used in this calculation. The cash flows for the first five years were based upon financial plans approved by Group Management; years six to ten were based upon Group Management's best expectations, which are consistent with the Group's approved strategy for this period. Cash flows were assumed to be flat for years eleven to 50, although Group Management expects continuing growth. Cash flows have been adjusted to reflect the specific business risks. Main assumptions, based on past experiences and current initiatives, were the following: - Sales: annual growth between 2 and 5% over the first ten-year period. - EBIT margin evolution: steadily improving margin over the period, in a range of 70-270 basis points per year, which is consistent with strong sales growth and enhanced cost management and efficiency. The key sensitivity for the impairment test is the growth in sales and EBIT margin. Limiting annual growth to only 4% until 2017 and 0% thereafter would not result in the carrying amount exceeding the recoverable amount. Reaching 80% of the expectations in terms of EBIT evolution would not result in the carrying amount exceeding the recoverable amount. An increase of 100 basis points in the discount rate assumption would not change the conclusions of the impairment test. 2 TCH GOODWILL ENT Goodwill is allocated to the Group's cash-generating units (CGUS), which correspond to the profit centers for the segment