Investors saw some awe-inspiring numbers -- and not the good kind -- trotted out over the past two months of the corporate reporting season.
Among the big writedowns announced recently: Rio Tinto ($9.3 billion); BHP Billiton ($3.3 billion); NewsCorp ($2.8 billion); and Fairfax Media ($2.7 billion).
In total, $27 billion has been written down by the 50 biggest listed companies, according to analysis by accounting firm, KPMG, for the Australian Financial Review, and reported in the AFR today.
A writedown involves reducing the book value of an asset because it is overvalued compared to the market value. It usually occurs when a company publishes its financial statements.
There will be more writedowns, says Julie Garland McLellan, a corporate governance expert and director of manufacturing company Oldfields. “This is a non-cash item, so, unless you have debt attached to the asset, it doesn’t affect your company's solvency,” Garland McLellan says. “However, if you are buying assets and they are not worth what you paid for them, it is not something you want to continue to do.”
The corporate regulator, the Australian Securities and Investments Commission, is on the lookout for cheating over asset values this year. Stephen Whitchurch, an assurance partner at accounting firm, Pitcher Partners, says: “It is always an area of focus for auditors, but ASIC has flagged that it is one of the key items it will look at in reviewing this year’s annual reports. That is another reason you are seeing the writedowns.”
A difficult calculation
Writedowns are a valuable signal of a company's performance … and that of its directors. “It is very good practice for a board – before they do the audit – to go through the company’s assets and ask, what is the discounted cash flow valuation of this asset, and what is its tax value,” Garland McLellan says.
“If writedowns are continual and little ones, it is a sign that your board is awake. If they are big and occasional, it is a sign that something is wrong.”
But making the decision about when an asset is impaired, and must be written down, isn’t easy, says Whitchurch.
There are exceptions to Garland McLellan’s rule of thumb, he says. “You can’t generalise; it depends on the nature of the writedown. Some large miners might decide not to continue at project, and once they have made that decision, they write down the whole value.”
In some cases, the writedowns stem from acquisitions made during global financial crisis. “Companies can buy businesses at the height of the market, and when you assess that value later on, then the asset value goes down because of the operating conditions,” Whitchurch says.
Interpreting rules and obligations
The rules concerning asset values changed in 2005 when Australia adopted the international financial reporting standards (IFRS).
“Within those standards, there were methods proposed to calculate ‘fair value’ [of an asset], and discounted cash flow was adopted,” Whitchurch says. “There is complexity on the discount rate used, on the cash flows themselves and the time period, which is normally five years, and there is inherent difficulty predicting over that period.”
A director’s legal obligations are specific, says Murray Landis, a corporate governance partner at law firm, Middletons. “If there is a permanent diminution of value when you do the accounts, directors must report it to make sure the company’s accounts are ‘true and fair’ when they sign them off. That is the event that triggers the need to report.”
Complications arise for directors if a business or division is tracking badly, for example, losing revenue over a long period of time. This in itself is not an event that requires directors to report, says Landis. There must be a specific event that causes the impairment.
Whitchurch has a slightly different view. “Where operating cash flows reduce and they are a key driver of the calculation, you can anticipate that the fair value has reduced,” he says, but adds a warning. “Remember, we are looking at five years’ worth of projections that have to be built into the cash flow.”
No road back
The upshot is that directors must be very careful. Once a goodwill in a business is impaired, it cannot be revalued upwards, Whitchurch says, and cannot be put back on the books. “It is considered a newly-generated intangible asset.”
Directors are open to criticism for acting too quickly as well as too slowly. “Directors can be criticised for issuing announcement and then, if something doesn’t happen and you tell people too soon, they say you have jumped the gun.”
The time to worry is when the total value of a company's assets falls over time, Garland McLellan says. “If your assets overall are decreasing, it tells you your company is dying,” she says. “They should overall be going up. These are rules of thumb in business, and they are now called accounting practices.
“As a director you have to know what your company does, how it does it and what it is worth at the very least. You have to know enough about everything to know when to call in the experts.”