IAS 36, paras 130-134 disclosures, impairment in the year, FVLCD and VIU, sensitivities by scenario, retail

Tesco PLC – Annual report – 27 February 2021

Industry: retail

Note 15 Impairment of non-current assets

Impairment losses and reversals

An impairment of £295m was recognised on the goodwill associated with Tesco Bank (2020: £nil). This impairment arises due to an increase in the cost of equity used to discount cash flows and a reduction in cash flows arising from the economic impact of the pandemic. No other goodwill impairment losses were recognised by the Group (2020: £nil).

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. Impairment losses and reversals comparatives have been re-presented in order to show the Group’s Thailand, Malaysia and Poland businesses as discontinued operations. There were no impairment losses or reversals in the year (2020: £nil) with respect to other non-current assets and investments in joint ventures and associates in Tesco Bank.

(a) Of the £85m other non-current assets net impairment reversal for the Group (2020: £302m loss), a net reversal of £81m (2020: £302m loss) has been classified within exceptional items, of which a net reversal of £119m (2020: £251m loss) related to the UK & ROI, a net reversal of £5m (2020: £28m reversal) related to Central Europe and a net loss of £43m (2020: £79m loss) related to discontinued operations.

(a) Refer to previous table for footnote.

(b) Comparatives have been re-presented to present Thailand, Malaysia and Poland as discontinued operations. Refer to Note 7 for further details.

The net impairment reversal in UK & ROI includes an impairment loss of £32m in the UK in respect of the Group obtaining control of The Tesco Property (No. 2) Limited Partnership (2020: £287m impairment loss in the UK & ROI in respect of the Group obtaining control of The Tesco Atrato Limited Partnership). Refer to Note 33 for further details.

Immediately preceding their recognition as held for sale in H1 2020/21, an impairment review was carried out on the Group’s Thailand, Malaysia and Poland operations. There were no significant changes in relation to the Malaysia and Thailand operations between the 2020 year end and reclassification as held for sale, and expected proceeds exceeded the carrying value, so no impairment was required. The Poland disposal involves both a corporate sale and the separate sale of the remaining property assets. Expected proceeds for the corporate sale exceeded the carrying value so no impairment was required. The recoverable amount of the remaining property assets is based on fair value less costs of disposal on an asset by asset basis, such that some assets are impaired while others have an impairment reversal. This results in a net impairment charge of £43m, recognised in discontinued operations – exceptional. See Note 7 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.

(a) Goodwill of £4,271m (2020: £4,840m) consists of UK £3,789m (2020: £3,793m), ROI £2m (2020: £3m) and Tesco Bank £480m (2020: £775m) included within continuing operations and £nil (2020: Thailand £193m and Malaysia £76m) in discontinued operations.

(b) The carrying value of the Group’s investments include: Trent Hypermarket Private Limited £53m (2020: £59m) and Tesco Underwriting Limited £93m (2020: £87m).

(c) Due to the individual nature of each property, fair values are classified as Level 3 within the fair value hierarchy.

(a)-(c) Refer to previous table for footnotes.

(d) Refer to Note 1 for further details regarding the prior year restatement.

Impairment methodology

Cash-generating units

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. Refer to Note 1 for further details. 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 from the current financial year due to the evolution of the online channel that these centres support, rather than being allocated to the stores in their vicinity.

Value in use

Retail

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.

In the current year, 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 Brexit, COVID-19, a macroeconomic downturn 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. In the current year the risks associated with Brexit and COVID-19 are reflected in the probability-weighted cash flow scenarios, and hence the discount rate is no longer adjusted for these risks.

Tesco Bank goodwill

Tesco Bank value in use is calculated by discounting equity cash flows, defined as the excess above the regulatory requirement. Tesco Bank applies an expected cash flow approach, using the internal three-year forecasts, approved by the Board, as well as stressed scenarios in line with those used to measure expected credit losses (refer to Note 25) to form a probability-weighted cash flow. 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

Key assumptions

For value in use calculations, the key assumptions to which the recoverable amounts are most sensitive are discount rates, long-term growth rates, the impact on cash generated from operations from year one sales growth (incorporating sales and costs, as well as volumes and prices) 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:

Sensitivity

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, which has been impaired in the current year, neither a reasonably possible one percentage point increase in discount rates, a one percentage point decrease in year one sales growth nor a one percentage point decrease in long-term growth rates would indicate impairment (or further impairment) in any group of cash-generating units to which goodwill has been allocated.

The table below summarises the reasonably possible changes in key assumptions to which Tesco Bank goodwill is most sensitive and their impact on impairment in the current year:

(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 in the current year 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 60%. The impairment is not highly sensitive to the upside and climate change scenarios, assigned 5% and 4% weighted average probabilities respectively. 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.