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The Certainty of a CGU-Specific WACC - Estimating Complications of Applying a Company-Wide Discount Rate

Jonsson, Axel LU and Jönsson, Oskar LU (2014) BUSN69 20141
Department of Business Administration
Abstract
Purpose: (1) Determine whether there is an inconsistency between the disclosed WACC and the
WACC applied in CGU’s for internal impairment tests, with respect to IAS 36. (2) Determine to
what extent companies apply a company-wide WACC internally in all CGU’s, when conducting
impairment tests in accordance with IAS 36. (3) Describe and analyse the incentives for
companies to apply a company-wide WACC in all CGU’s, and what effect this could have on
impairment tests.

Methodology: In this paper we used both an inductive and a deductive perspective. The survey
we distributed, and the review of annual reports, examined the application of discount rates in
practice, through a descriptive manner. We also applied case studies through a... (More)
Purpose: (1) Determine whether there is an inconsistency between the disclosed WACC and the
WACC applied in CGU’s for internal impairment tests, with respect to IAS 36. (2) Determine to
what extent companies apply a company-wide WACC internally in all CGU’s, when conducting
impairment tests in accordance with IAS 36. (3) Describe and analyse the incentives for
companies to apply a company-wide WACC in all CGU’s, and what effect this could have on
impairment tests.

Methodology: In this paper we used both an inductive and a deductive perspective. The survey
we distributed, and the review of annual reports, examined the application of discount rates in
practice, through a descriptive manner. We also applied case studies through a normative
perspective, in order to analyse and prescribe how companies should operate in accordance with
best practice.

Theoretical perspectives: The literature review concerned calculations of WACC for CGU’s
and how disclosure policy could affect the cost of capital. This was extended by a review of the
positive accounting theory, in order to analyse whether companies had incentives to act
opportunistic by applying a company-wide WACC. We also added the institutional theory,
which allowed us to analyse if WACC disclosures were affected by decoupling or institutional
factors.

Empirical foundation: We gathered data from the annual reports of 118 Swedish listed
companies, regarding their application of discount rates within CGU’s. We also distributed a
survey that targeted CFO’s from 40 of these 118 companies. This survey provided internal
information and arguments regarding companies’ application of WACC. Four case studies,
modelled by data gathered from a database held by Stern School of Business in New York,
exemplified and analysed best practice in IAS 36.

Conclusions: We concluded that a majority of the companies in this paper disclosed a companywide
WACC, and that this was consistent with the WACC the companies applied internally.
Companies that applied a company-wide WACC often considered their CGU’s to have the same
risk. However, the arguments of some of these risk assessments could be questioned. It does not
appear that companies apply a company-wide WACC to affect the impairment test, and we see
no general reluctance towards the use of a CGU-specific WACC. However, companies appear to
have difficulties of establishing CGU-specific WACC, which seems to have a negative effect on
the degree of application. (Less)
Please use this url to cite or link to this publication:
author
Jonsson, Axel LU and Jönsson, Oskar LU
supervisor
organization
course
BUSN69 20141
year
type
H1 - Master's Degree (One Year)
subject
keywords
WACC, cash generating units, impairment test, IAS 36, disclosures
language
English
id
4463546
date added to LUP
2014-06-26 13:50:19
date last changed
2014-06-26 13:50:19
@misc{4463546,
  abstract     = {{Purpose: (1) Determine whether there is an inconsistency between the disclosed WACC and the
WACC applied in CGU’s for internal impairment tests, with respect to IAS 36. (2) Determine to
what extent companies apply a company-wide WACC internally in all CGU’s, when conducting
impairment tests in accordance with IAS 36. (3) Describe and analyse the incentives for
companies to apply a company-wide WACC in all CGU’s, and what effect this could have on
impairment tests.

Methodology: In this paper we used both an inductive and a deductive perspective. The survey
we distributed, and the review of annual reports, examined the application of discount rates in
practice, through a descriptive manner. We also applied case studies through a normative
perspective, in order to analyse and prescribe how companies should operate in accordance with
best practice.

Theoretical perspectives: The literature review concerned calculations of WACC for CGU’s
and how disclosure policy could affect the cost of capital. This was extended by a review of the
positive accounting theory, in order to analyse whether companies had incentives to act
opportunistic by applying a company-wide WACC. We also added the institutional theory,
which allowed us to analyse if WACC disclosures were affected by decoupling or institutional
factors.

Empirical foundation: We gathered data from the annual reports of 118 Swedish listed
companies, regarding their application of discount rates within CGU’s. We also distributed a
survey that targeted CFO’s from 40 of these 118 companies. This survey provided internal
information and arguments regarding companies’ application of WACC. Four case studies,
modelled by data gathered from a database held by Stern School of Business in New York,
exemplified and analysed best practice in IAS 36.

Conclusions: We concluded that a majority of the companies in this paper disclosed a companywide
WACC, and that this was consistent with the WACC the companies applied internally.
Companies that applied a company-wide WACC often considered their CGU’s to have the same
risk. However, the arguments of some of these risk assessments could be questioned. It does not
appear that companies apply a company-wide WACC to affect the impairment test, and we see
no general reluctance towards the use of a CGU-specific WACC. However, companies appear to
have difficulties of establishing CGU-specific WACC, which seems to have a negative effect on
the degree of application.}},
  author       = {{Jonsson, Axel and Jönsson, Oskar}},
  language     = {{eng}},
  note         = {{Student Paper}},
  title        = {{The Certainty of a CGU-Specific WACC - Estimating Complications of Applying a Company-Wide Discount Rate}},
  year         = {{2014}},
}