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

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.