Sustainable Valuations

Impairment testing requires careful professional judgement. As this case study highlights, when assessing the value of potentially impaired assets, the devil is in the detail. Using a construction SME, we guide you through the key steps required to apply a value-in-use (VIU) approach under IAS 36 / FRS 102.

Introducing Construction BV

This stylised case concerns a regional Dutch construction firm (“Construction BV”) generating approximately €100m in annual revenue, with cash flows driven largely by long-term fixed-price contracts. The company has accumulated goodwill from prior acquisitions, resulting in a total cash-generating unit (CGU) carrying amount of €25m.

Impairment trigger

Construction BV’s management faces a combination of pressures that led to a revision of its medium-term forecasts:

  1. sustained input cost inflation (labour and materials),
  2. margin compression on existing fixed-price contracts,
  3. lower expected profitability over the next few years.

These developments constitute an impairment trigger. IAS 36 requires entities to assess at each reporting date whether there is any indication that assets may be impaired and, where such indicators exist, to estimate the recoverable amount. The revision of management forecasts therefore triggers an impairment test for the reporting period.

ESG linkage (illustrative)

In the construction sector, margin pressures are increasingly reinforced by environmental and sustainability-related factors, such as higher costs for lower-carbon building materials and tighter environmental permitting requirements. Where such factors lead to revised forecasts or reduced expected profitability, they can act as indirect impairment indicators under IAS 36 and FRS 102, even where no single regulatory breach has occurred.

Base case DCF: value-in-use calculation

Having established the impairment trigger, the next step is to estimate the recoverable amount. This is done using a value-in-use (VIU) model, defined as the present value of expected future cash flows from the relevant CGU — i.e. Construction BV.

Cash-flow projections reflect management’s best estimates, while the discount rate is determined using market benchmarks for comparable assets, in accordance with IAS 36.30–33 and IAS 36.55–57.

Under these base-case assumptions, the VIU of Construction BV is €26.77m, marginally exceeding the CGU carrying amount of €25.00m. Assets remain recoverable, but only under tight and carefully documented assumptions.

Management assumptions — base case

AssumptionBase case (indicative)
Explicit forecast period3 years
Revenue growth2% per year
EBITDA margin~4%
Capex~2.5% of revenue
Net working capital~5% of revenue
Pre-tax discount rate (WACC)~9.0%
Terminal growth rate~1.0%

Assessment 1: Base case versus carrying amount

Carrying amount — CGU inputs

ComponentEUR m
Goodwill7.00
Other intangibles3.00
Net working capital adjustments (optional)0.00
Other CGU assets / liabilities15.00
Total carrying amount (CGU)25.00

Recoverable amount — base case

EUR m
Value in use (base case)26.77

Headroom — base case

EUR m
Headroom (base case)+1.77

Assessment 2: Reasonably possible downside scenario

Given the limited headroom, additional analysis is required. IAS 36 places particular emphasis on assessing whether reasonably possible changes in key assumptions could result in an impairment (IAS 36.134(f)).

For Construction BV, the downside scenario reflects a situation in which contract volumes decline and cost pressure persists for longer than expected. There is also a sustainability dimension: the firm may lose contracts to greener competitors (revenue impact) and struggle to switch to cost-effective lower-carbon materials (margin impact).

Downside scenario — assumptions

VariableDownside assumption
Revenue~5% below base case
EBITDA margin–0.75 percentage points
Recovery period2 years

The downside affects cash flows only. The discount rate is not increased and terminal assumptions remain unchanged, avoiding double-counting of risk in line with IAS 36.

Downside scenario — outcome

EUR m
Value in use (downside)23.77
Headroom / (impairment)–1.23

Under this scenario, the recoverable amount falls below the carrying amount by €1.23m. Accordingly, an impairment would be required if this downside scenario were assessed as the most likely outcome at the reporting date.

Even where no impairment is ultimately recognised, such a result cannot be ignored. Additional explanation and justification would be required in the financial statements.

Assessment 3: Sensitivity to key valuation assumptions

Where VIU outcomes straddle the carrying amount, further sensitivity analysis is prudent. Two key valuation assumptions are stress-tested: the discount rate and the terminal growth rate.

Sensitivity assumptions

Sensitivity variableChange
Discount rate+100 basis points
Terminal growth–50 basis points

Sensitivity results

EUR mStarting pointWACC +100 bpsTerminal growth –50 bps
VIU — base case26.7723.3125.26
VIU — downside case23.7720.6922.43

A relatively modest increase in the discount rate places the CGU below water, even under base-case assumptions. A small reduction in terminal growth almost fully erodes base-case headroom.

Where headroom is limited, IAS 36 requires disclosure of both the amount of headroom and the key assumptions for which a reasonably possible change would result in an impairment. In practice, this often includes the discount rate and terminal growth assumptions.

What would be impaired?

If an impairment were recognised, IAS 36 requires the loss to be allocated first to goodwill, and then to other CGU assets on a pro-rata basis, subject to asset-specific floors. For Construction BV, the €7m goodwill balance would therefore be the first asset adjusted.

Six practical considerations for SME impairment tests

The Construction BV case highlights several recurring themes in SME impairment testing:

  1. Forecast discipline
    Forecasts must reflect current conditions, not hoped-for recoveries. Construction firms are particularly exposed due to long-term contracts.
  2. Operational risk versus valuation mechanics
    In SME cases, impairment risk typically stems from cash-flow deterioration rather than changes in valuation parameters.
  3. CGU definition
    Defining the CGU too broadly can mask impairment; defining it too narrowly can exaggerate volatility. This judgement is often scrutinised by auditors.
  4. Disclosure risk
    Where headroom is limited, disclosure quality becomes as important as the numerical outcome.
  5. Sustainability-related drivers
    Environmental regulation and sustainability requirements increasingly affect sectors such as construction. Where these impacts are reasonably foreseeable, they should be reflected in forecasts and considered in impairment testing — not treated as “non-financial” issues.
  6. When external support becomes sensible
    In many cases accountants can perform impairment tests internally. The key question is when assumptions become sufficiently tight or contested that independent challenge is prudent.

Final thoughts

Impairment testing is not about predicting the future. It is about demonstrating that carrying values remain recoverable under reasonable and supportable assumptions.

As the Construction BV case shows, even modest changes in cash-flow assumptions can flip the conclusion. This is why impairment testing remains one of the most judgement-heavy areas of financial reporting — and one where careful modelling and independent challenge can materially reduce professional risk.

This case study is illustrative, based on typical SME conditions and rounded figures. It does not represent any specific company.

Leave a Reply

Your email address will not be published. Required fields are marked *