IAS 36 para 12(d), market capitalisation below net assets, impairment indicator, impairment of parent’s investment in subsidiaries.

ConvaTec Group Plc – Annual report – 31 December 2018

Industry: medical products

Industry: medical products

Chief Financial Officer’s review (extract)

Company only impairment of investment in subsidiaries

The company only financial statements of ConvaTec Group Plc can be found on pages 172 to 179. These accounts are presented as required by the Companies Act 2006 and prepared in accordance with FRS 101 (Financial Reporting Standard 101) Reduced Disclosure Framework. As part of the reorganisation of the Group in 2016, in preparation for the IPO, ConvaTec Group Plc acquired the entire share capital of Cidron Healthcare Limited (“CHL”). CHL owns the rest of the ConvaTec Group, with the exception of ConvaTec Management Holdings Limited. The acquisition by ConvaTec Group Plc of CHL was accounted for in the Company’s Financial Statements using merger accounting principles. The fair value of the shares acquired (representing the fair value of the Group on the date of the IPO) was recorded as the fair value of the investment held in CHL. The difference between the fair value and the nominal value of the shares acquired was taken to the merger reserve. The carrying value of the investment in CHL was established based on the Company’s IPO offer share price of £2.250.

The market share price of the Company at 31 December 2018 was £1.390, reflecting the market’s view of the current and future value of the Group. The fall in share price is, therefore, an indicator of possible impairment. We have, therefore, assessed the recoverable amount of the Company’s investment in CHL. The recoverable value has been determined using value in use. Value in use is the enterprise value, which has been calculated by applying a 12.1% discount rate to Board approved forecasts for the next five years, and then into perpetuity applying a long-term growth rate of 2%, less net debt to give an equity value. The outcome was benchmarked against the market capitalisation of the Group. As a result of this review, we have recognised an impairment charge of $1.616 billion which is offset by a transfer from the merger reserve to retained earnings, thus reducing the value of the investment to $3,887.4 million.

Determining the estimated recoverable amount of CHL is judgemental in nature and requires the use of certain estimated inputs that represent key sources of estimation uncertainty. It is reasonably possible that the estimations and assumptions used in determining the impairment as at 31 December 2018, including discount rate assumptions, may result, within the next financial year, in a material further impairment to the carrying amount of the investment value. The distributable reserves position of the Group is unaffected.

As at 31 December 2018, the retained surplus of ConvaTec Group Plc was $1,574.7 million (2017: $1,622.7 million) which is distributable.

Notes to the Company Financial Statements (extract)

Critical accounting judgements and key sources of estimation uncertainty

In the preparation of the Company’s Financial Statements in accordance with FRS 101, management are required to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the Financial Statements and the reported amounts of income and expenses for the periods presented.

The estimates and associated assumptions are based on historical experience and various other factors that are believed to be reasonable under the circumstances, the results of which form the basis of making the judgements about carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. The estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognised in the period in which the estimate is revised if the revision affects only that period, or in the period of the revision and future periods if the revision affects both current and future periods.

A key area of estimation uncertainty that has the most significant effect on the amounts recognised in the Financial Statements are the assumptions when determining the impairment of investment carrying values. Refer to Note 4 – Investment in Subsidiaries for details.

  1. Investments in Subsidiaries (extract)

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Foreign exchange represents the impact of translation to the Company’s chosen presentational currency of US dollar in accordance with IAS 21, The Effects of Changes in Foreign Exchange Rates.

The Company performed an assessment of the recoverable amount of the investments in subsidiaries at 31 December 2018 triggered by a decrease in the share price in October 2018 and the continued valuation of shares at the depressed value. The recoverable amount was determined with reference to IAS 36 methodology by assessing the value in use of the investments based on discounted cash flows. This resulted in an impairment of $1.616 billion. The impact on the retained earnings is offset by a transfer of the same amount from the merger reserve.

In undertaking the impairment review, the Company has considered both external and internal sources of information, and any observable indications that may suggest that the carrying value of shares in subsidiary undertakings may be impaired.

Future cash flows are determined using Board approved forecasts and strategic plans. These forecasts and strategic plans are based on specific assumptions during the five-year planning period with respect to revenue, results of operations, working capital, capital investments and other general assumptions for the projected period. The forecast assumptions, that derive the future cash flows, are based on the historical results of the Group combined with external market information and defined strategic initiatives. The recoverable amount has been estimated by the application of an appropriate discount rate to these future cash flows.

Determining the estimated recoverable amount is judgmental in nature and requires the use of certain estimated inputs that represent key sources of estimation uncertainty. It is reasonably possible that the estimations and assumptions used in determining the impairment as at 31 December 2018, including discount rate assumptions, may result, within the next financial year, in a material further impairment to the carrying amount of the investment value. If the discount rate were to increase by 0.5% the impairment would increase by $240 million.

 

 

 

 

 

 

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