Tesco PLC – Annual report – 26 February 2022
Note 15 Impairment of non-current assets
Impairment losses and reversals
No impairment of goodwill was recognised in the current year (2021: £295m impairment of goodwill associated with Tesco Bank).
The table below summarises the Group’s pre-tax impairment losses and reversals on other non-current assets and investments in joint ventures and associates, with the former aggregated by segment due to the large number of individually immaterial store cash-generating units. This includes any losses recognised immediately prior to classifying an asset or disposal group as held for sale but excludes all impairments post classification as held for sale. There were no impairment losses or reversals in the year (2021: £nil) with respect to investments in joint ventures and associates and no impairments in other non-current assets and investments in joint ventures and associates in Tesco Bank (2021: £nil).
All impairment losses and reversals are classified as adjusting items (2021: £128m net reversal).
The net impairment loss in UK & ROI includes an impairment loss of £62m in the UK in respect of the Group obtaining control of The Tesco Sarum Limited Partnership (2021: £2m impairment loss in the UK & ROI in respect of the Group obtaining control of The Tesco Property (No. 2) Limited Partnership). Refer to Note 34 for further details.
The remaining other non-current assets impairment losses and reversals for the Group largely reflect normal fluctuations expected from store-level performance, property fair values and changes in discount rates, as well as any specific store closures.
Net carrying value of non-current assets
The net carrying values of other non-current assets and recoverable amounts of impaired other non-current assets for which an impairment loss has been recognised or reversed have been aggregated by segment due to the large number of individually immaterial store cash-generating units. The amounts below exclude assets or disposal groups classified as held for sale.
The Group treats each store as a separate cash-generating unit for impairment testing of other intangible assets, property, plant and equipment, right of use assets and investment property. The Group allocates goodwill to groups of cash-generating units, where each country represents a group of cash-generating units for the Group’s retail operations, as this represents the lowest level at which goodwill is monitored by management. Tesco Bank represents a separate cash-generating unit.
The recoverable amount of each store cash-generating unit is the higher of its value in use and its fair value less costs of disposal. The recoverable amount of a group of cash-generating units to which goodwill has been allocated is determined based on value in use calculations.
Head office and central assets such as distribution centres and associated costs are allocated to store cash-generating units based on level of use, estimated with reference to sales. Urban fulfilment centres and associated costs that are part of a store are included in the store cash–generating unit. Standalone customer fulfilment centres and associated costs are each treated as a separate cash-generating unit.
Value in use
Estimates for value in use calculations include discount rates, long-term growth rates, expected changes to future cash flows, including volumes and prices, and the probabilities assigned to cash flow scenarios. Estimates are based on past experience and expectations of future changes in the market, including the prevailing economic climate and global economy, competitor activity, market dynamics, changing customer behaviours, structural challenges facing retail and the resilience afforded by the Group’s operational scale.
Cash flow projections are based on the Group’s three-year internal forecasts, the results of which are reviewed by the Board. The forecasts are extrapolated to five years based on management’s expectations, and beyond five years based on estimated long-term average growth rates. Long-term growth rates for the Retail business are based on inflation forecasts by recognised bodies. Business unit level forecast growth is allocated to store-level cash-generating unit cash flows based on their relative current year actual sales performance, after adjusting for one-off cash flows affecting particular stores.
The Group applies an expected cash flow approach by probability-weighting different cash flow scenarios. The greatest probability weighting is applied to the cash flows derived from the three-year internal forecasts. Additional scenarios take account of the risks presented by macroeconomic downturns, global supply pressures and climate change, consistent with the viability statement scenarios (see the Longer term viability statement in the Strategic report) as well as an upside scenario.
Management estimates discount rates using pre-tax rates that reflect the market assessment as at the balance sheet date of the time value of money and the risks specific to the cash-generating units. The pre-tax discount rates are derived from the Group’s post-tax weighted average cost of capital, as adjusted for the specific risks relating to each geographical region. Risk-free rates are based on government bond rates in each geographical region and equity risk premia are based on forecasts by recognised bodies.
Tesco Bank goodwill
Tesco Bank value in use is calculated by discounting equity cash flows, defined as the excess above the regulatory requirement. Cash flow projections are based on the Bank’s three-year internal forecasts, approved by the Board. The forecasts are extrapolated to five years based on management’s expectations and beyond five years based on estimated long-term average growth rates. The long-term growth rate is based on inflation and GDP growth forecasts by recognised bodies. The discount rate is the cost of equity of Tesco Bank. Risk-free rates and equity risk premia are derived from recognised bodies.
Fair value less costs of disposal
Fair values of owned properties are determined with regard to the market rent for the stores or for alternative uses with investment yields appropriate to reflect the physical characteristics of the property, location, infrastructure, redevelopment potential and other factors. In some cases, fair values include residual valuations where stores may be viable for redevelopment. Fair values of leased properties are determined with regard to the discounted market rent for the property over the remaining period of the lease, reflecting the condition and location of the property and the local rental market, adjusted for a suitable void period. Fair values of the Group’s properties were determined with the assistance of independent professional valuers where appropriate. Costs of disposal are estimated based on past experience in each geographical region.
Investments in joint ventures and associates
The recoverable values of investments in joint ventures and associates are estimated taking into account forecast cash flows, equity valuations of comparable entities and/or recent transactions for comparable businesses.
Key assumptions and sensitivity
For value in use calculations, the key assumptions to which the recoverable amounts are most sensitive are discount rates, long-term growth rates, future cash flows (incorporating sales volumes, prices and costs) and probabilities assigned to cash flow scenarios. For fair value less costs of disposal calculations, the key assumption is property fair values.
The discount rates and long-term growth rates for each group of cash-generating units to which goodwill has been allocated are:
The discount rates and long-term growth rates for the Group’s portfolio of store cash-generating units, aggregated by segment due to the large number of individually immaterial store cash-generating units, are:
The Group has carried out sensitivity analyses on the reasonably possible changes in key assumptions in the impairment tests for (a) each group of cash-generating units to which goodwill has been allocated and (b) for its portfolio of store cash-generating units.
(a) With the exception of Tesco Bank goodwill, neither a reasonably possible of 1.0%pt increase in discount rates, a 5% decrease in future cash flows nor a of 1.0%pt decrease in long-term growth rates would indicate impairment in any group of cash-generating units to which goodwill has been allocated. Tesco Bank goodwill is not sensitive to a reasonably possible change in long-term growth rates, but is sensitive to a change in the discount rate and annual equity cash flows. An increase of 1.0%pt in the discount rate or a decrease in annual equity cash flows of 14.2% would reduce the year-end headroom of £212m to £nil.
(b) While there is not a significant risk of an adjustment to the carrying amount of any one store cash-generating unit that would be material to the Group as a whole in the next financial year, the table below summarises the reasonably possible changes in each key assumption and its impact on the impairment of the Group’s entire portfolio of store cash-generating units, presented in aggregate due to the large number of individually immaterial store cash-generating units:
The probability applied to each cash flow scenario differs by country, depending on the expected likelihood of each scenario occurring in each country. The base case represents the cash flows derived from the three-year internal forecasts and is assigned a weighted average probability of 64%. The impairment is not highly sensitive to the upside and climate change scenarios, both assigned 5% weighted average probabilities. The table below sets out the weighted average probability assigned to each of the remaining scenarios, to which the impairment is most sensitive, and shows the impact on impairment of a reasonably possible change in probability for each scenario, where the corresponding opposite change in probability is applied to the base case. The scenarios modelled differ to last year, consistent with the scenarios modelled for the viability statement.
Judgements and sources of estimation uncertainty (extract)
Key sources of estimation uncertainty (extracts)
Impairment of non-financial assets
The Group evaluates goodwill and non-current assets for impairment as set out in Note 15. The key assumptions and estimates to which the recoverable amounts are most sensitive, the methodology for calculating them and sensitivities are also disclosed in Note 15.
Impact of the war in Ukraine
In light of the war in Ukraine which commenced on 24 February 2022, the Group has considered whether any adjustments are required to reported amounts in the financial statements. The Group does not have any operations in Ukraine or Russia, but does have operations in Hungary and Slovakia, which border Ukraine. The Group is therefore not directly affected by trading restrictions or sanctions, but could be affected in future by possible wider macroeconomic consequences should the situation develop further. This could include an increase in domestic inflation from supply chain disruption, commodity shortages or commodity price increases affecting cash flows, or changes in market discount rates and valuations. Please refer to the Group Chief Executive’s review for details on how Tesco has responded to aid those affected by the crisis.
To the extent that there were observable indicators of change at the 26 February 2022 balance sheet date, these have been factored into the Group’s financial statements as at 26 February 2022, in particular: assessing the impact on discount rates and cash flow scenarios used in impairment testing of goodwill and non-current assets; incorporating the latest macroeconomic data into ECL calculations in Tesco Bank; and evaluating the effect on pension discount rate and plan asset fair values. In Central Europe, the Group considered whether there were any specific impairment indicators for stores in Hungary and Slovakia and concluded that there were not. Also in Central Europe, the Group established that it remained appropriate to continue to classify certain properties as held for sale. Finally, the Group decided that there are more than sufficient future taxable profits to continue to recognise deferred tax assets.
Sensitivities of reasonably possible changes in key inputs to impairment testing of goodwill and non-current assets, Tesco Bank ECL and pension obligations are given in Notes 15, 26 and 30 respectively.
The Group reviewed non-adjusting macroeconomic movements after the balance sheet date (for example discount rates, asset values and inflation impact from fuel price increases and/or supply chain disruption) and concluded that those movements were within the range of the Group’s existing sensitivities, hence no additional disclosures were required. The Group will continue to monitor the situation as it develops.