By Himanshu V. Kishnadwala
Chartered Accountant
Compiler’s Note: The impact of the Covid-19 pandemic was particularly adverse on the air travel, commercial aerospace and supporting industries. This has necessitated impairment testing of goodwill for companies that have invested in such entities. Given below is an illustration of such impairment evaluation and provision by one of the largest corporations in the US which had invested in such an entity and the reporting thereon by the Independent Auditor under Critical Audit Matters.
BERKSHIRE HATHWAY INC. (31ST DECEMBER, 2020)
From Notes to Consolidated Financial Statements
Significant accounting policies and practices
(b) Use of estimates in preparation of financial statements
We prepare our Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States (‘GAAP’) which require us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the balance sheet date and the reported amounts of revenues and expenses during the period. Our estimates of unpaid losses and loss adjustment expenses are subject to considerable estimation error due to the inherent uncertainty in projecting ultimate claim costs. In addition, estimates and assumptions associated with the amortisation of deferred charges on retroactive reinsurance contracts, determinations of fair values of certain financial instruments and evaluations of goodwill and identifiable intangible assets for impairment require considerable judgment. Actual results may differ from the estimates used in preparing our Consolidated Financial Statements.
The novel coronavirus (Covid-19) spread rapidly across the world in 2020 and was declared a pandemic by the World Health Organization. The government and private sector responses to contain its spread began to significantly affect our operating businesses in March. Covid-19 has since adversely affected nearly all of our operations, although the effects are varying significantly. The duration and extent of the effects over longer terms cannot be reasonably estimated at this time. The risks and uncertainties resulting from the pandemic that may affect our future earnings, cash flows and financial condition include the time necessary to distribute safe and effective vaccines and to vaccinate a significant number of people in the U.S. and throughout the world as well as the long-term effect from the pandemic on the demand for certain of our products and services. Accordingly, significant estimates used in the preparation of our financial statements including those associated with evaluations of certain long-lived assets, goodwill and other intangible assets for impairment, expected credit losses on amounts owed to us and the estimations of certain losses assumed under insurance and reinsurance contracts may be subject to significant adjustments in future periods.
Goodwill and other Intangible Assets (Extracts)
During 2020, we concluded it was necessary to re-evaluate goodwill and indefinite-lived intangible assets of certain of our reporting units for impairment due to the disruptions arising from the Covid-19 pandemic. We believed that the most significant of these disruptions related to the air travel and commercial aerospace and supporting industries. We recorded pre-tax goodwill impairment charges of approximately $10 billion and pre-tax indefinite-lived intangible asset impairment charges of $638 million in the second quarter of 2020. Approximately $10 billion of these charges related to Precision Castparts Corp. (‘PCC’), the largest business within Berkshire’s manufacturing segment. The carrying value of PCC-related goodwill and indefinite-lived intangible assets prior to the impairment charges was approximately $31 billion.
The impairment charges were determined based on discounted cash flow methods and reflected our assessments of the risks and uncertainties associated with the aerospace industry. Significant judgment is required in estimating the fair value of a reporting unit and in performing impairment tests. Due to the inherent uncertainty in forecasting cash flows and earnings, actual results in the future may vary significantly from the forecasts.
From Report of Independent Registered Public Accounting Firm
Critical Audit Matters
Goodwill and Indefinite-Lived Intangible Assets – Refer to Notes 1 and 13 to the Financial Statements
Critical Audit Matter Description
The Company’s evaluation of goodwill and indefinite-lived intangible assets for impairment involves the comparison of the fair value of each reporting unit or asset to its carrying value. The Company evaluates goodwill and indefinite-lived intangible assets for impairment at least annually. When evaluating goodwill and indefinite-lived intangible assets for impairment, the fair value of each reporting unit or asset is estimated. Significant judgment is required in estimating fair values and performing impairment tests. The Company primarily uses discounted projected future net earnings or net cash flows and multiples of earnings to estimate fair value, which requires management to make significant estimates and assumptions related to forecasts of future revenue, earnings before interest and taxes (‘EBIT’) and discount rates. Changes in these assumptions could have a significant impact on the fair value of reporting units and indefinite-lived intangible assets.
The Precision Castparts Corp. (‘PCC’) reporting unit reported approximately $31 billion of goodwill and indefinite-lived intangible assets as of 31st December, 2019. During the second quarter of 2020, the Company performed an interim re-evaluation of the goodwill and indefinite-lived intangible assets at the PCC reporting unit. This determination was made due to disruptions arising from the Covid-19 pandemic that had an adverse impact on the industries in which PCC operates. As a result of the re-evaluation, the Company recognised goodwill and indefinite-lived intangible asset impairment charges in the amount of approximately $10 billion, as the fair values of the PCC reporting unit and indefinite-lived intangible assets were less than their respective carrying values. As a result, PCC reported goodwill and indefinite-lived intangible assets of approximately $21 billion as of 31st December, 2020.
Given the significant judgments made by management to estimate the fair value of the PCC reporting unit and certain customer relationships with indefinite lives along with the difference between their fair values and carrying values, performing audit procedures to evaluate the reasonableness of management’s estimates and assumptions related to forecasts of future revenue and EBIT and the selection of the discount rate required a high degree of auditor judgment and an increased extent of effort, including the need to involve our fair value specialists.
How the Critical Audit Matter was addressed in the audit
Our audit procedures related to forecasts of future revenue and EBIT and the selection of the discount rate for the PCC reporting unit and certain customer relationships included the following, among others:
• We tested the effectiveness of controls over goodwill and indefinite-lived intangible assets, including those over the forecasts of future revenue and EBIT and the selection of the discount rate.
• We evaluated management’s ability to accurately forecast future revenue and EBIT by comparing prior year forecasts to actual results in the respective years.
• We evaluated the reasonableness of management’s current revenue and EBIT forecasts by comparing the forecasts to historical results and forecasted information included in analyst and industry reports and certain peer companies’ disclosures.
• With the assistance of our fair value specialists, we evaluated the valuation methodologies, the long-term growth rates and discount rate, including testing the underlying source information and the mathematical accuracy of the calculations, and developed a range of independent estimates and compared those to the long-term growth rates and discount rate selected by management.
