AC3103 Seminar 19:

Biosensors International Group (BIG)

Valuation and Impairment Testing of Intangibles

Team 8:
Cassandra Leo
Samantha Chua
Ke Jiaxin
Lew Shi Hui
Yvon Teo
Tan Zhi Yun
Summary
• BIG operates in three segments
1. Critical care segment
2. Interventional cardiology segment
3. Licensing revenue segment 95% of revenue

• Large part of BIG’s profits is associated with its DES technology

• BIG set up strategic partnership to establish JWMS in 2003 (Own 50%)
• In 2011, BIG acquired rest of 50% of JWMS with cash and stock deal
of US$478 million
• Rationale for acquisition:
1. China is the fastest growing DES markets
2. New healthcare reform in China would lower costs and
increase demand for stent treatments
3. Ageing population and increasing prevalence of coronary diseases
in China
• Factors limiting growth:
• Local companies offer cheaper devices and had good long
term relationships with hospitals and doctors.
• Foreign companies create local manufacturing and training
centers, expand their sales force, and engage in M&A as well
• Chinese government require hospitals to provide competitive
tender, with expected price reduction of 15-20% in mid-2010s
• Post-acquisition Financial Statements and Analysis
• BIG added US$156 million to its intangible assets and US$608
million to its goodwill
• The two items constituted 62% of BIG’s total assets in 2012, as
compared to 4% the year before.
• What the two items represented, how they were accounted for
and how they should be interpreted
Q1. Intangibles from the Acquisition of
JWMS
Types of intangibles Amount (US$)
Patents 18,825,000
Customer Relationships 135,128,000
Land use rights 1,841,000
Goodwill 607,670,000

From Exhibit 8 (Page 19 & 20): Additions via business combinations

Q2. Summary of Accounting
Treatment
Accounting Treatment Relevant IFRS

Initial Recognition: IFRS 3.32 Business Combinations

● At cost, being excess of Recognise goodwill as of the acquisition date measured as the
consideration transferred excess of (a) over (b) below:
and amount recognised
for NCI over net (a) the aggregate of:
identifiable assets (i) value of consideration transferred (Fair Value)
(ii) the amount of any non-controlling interest
(iii) in a business combination achieved in stages the FV of
previously held equity interest at acquisition date

(b) the net of the acquisition-date amounts of the identifiable

assets
acquired and the liabilities assumed measured in accordance
with
this IFRS.
Accounting Treatment Relevant IFRS

Initial Recognition: IFRS 3.34 Business Combinations

● If consideration is lower than FV of net If the difference is negative, the resulting gain is a
assets acquired, difference is bargain purchase to be recognised in P/L at
recognised in P/L acquisition date

Subsequent Measurement: IAS 36.96 Impairment of Assets

● Cost less accumulated impairment Goodwill should be tested for impairment annually
losses
● Determines whether goodwill is IAS 36.80 Impairment of Assets
impaired at least on an annual basis For impairment testing, goodwill acquired in a business
● Goodwill allocated to cash combination shall, from the acquisition date, be
generating units (CGU) expected to allocated to each of the acquirer’s CGUs, that are
benefit from synergies of combination expected to benefit from the synergies of combination
Accounting Treatment Relevant IFRS

Subsequent Measurement: IAS 36.90 Impairment of Assets

● Impairment is determined for goodwill Test for impairment by comparing the carrying
by assessing recoverable amount of amount of the CGU, including goodwill, with the
each CGU to which the goodwill recoverable amount
relates
● If recoverable amount < carrying
amount, impairment loss recognised in
P/L
● Impairment losses recognised for IAS 36.124 Impairment of Assets
goodwill not reversed in subsequent An impairment loss recognised for goodwill shall not be
periods reversed in a subsequent period
Accounting Treatment Relevant IFRS

Derecognition: IAS 36.86 Impairment of Assets

● When part of a CGU is disposed of, If goodwill has been allocated to a CGU and the entity
associated goodwill forms part of disposes of an operation within that unit, the goodwill
carrying amount in determining associated with the operation disposed of shall be:
gain/loss on disposal
● Measured on the basis of relative (a) included in the carrying amount of the operation
values of operation disposed of and when
portion of CGU retained determining the gain or loss on disposal; and

(b) measured on the basis of the relative values of the

operation disposed of and the portion of the CGU
retained
Q2. Summary of Accounting
Treatment
Other Intangible Assets (Patents, Customer Relationships, Land Use Rights)

Accounting Treatment Relevant IFRS

Initial Recognition: IFRS 3.8 Business Combinations

● At cost Measure the identifiable assets acquired and the
● Fair value at acquisition date liabilities assumed at their acquisition-date fair values

Subsequent Measurement: IAS 38.74 Intangible Assets

● Cost less accumulated amortisation Cost model: After initial recognition, an intangible asset
and impairment losses shall be carried at its cost less any accumulated
amortisation and any accumulated impairment
losses
 Other Intangible Assets (Patents, Customer Relationships, Land Use Rights)

Accounting Treatment Relevant IFRS

Subsequent Measurement: IAS 36.9 Impairment of Assets

● Assessed for impairment whenever there is An entity shall assess at the end of each reporting
indication that intangible asset may be period whether there is any indication that an asset
impaired may be impaired.

● Amortisation is on a straight line basis IAS 38.97 Intangible Assets

over estimated useful lives The cost less residual value of intangible asset with
○ Patents-5 years finite useful life should be amortised on a systematic
○ Customer relationships-10 years basis over that life, reflecting the pattern of benefits
○ Land use rights-30 & 46 years
Other Intangible Assets (Patents, Customer Relationships, Land Use Rights)

Accounting Treatment Relevant IFRS

Subsequent Measurement: IAS 38.104 Intangible Assets

● Amortisation period and method reviewed at Amortisation period should be reviewed at
least at each balance sheet date least at each financial year end

Derecognition: IAS 38.113 Intangible Assets

● Gain/losses measured as difference between Gain/loss arising from the derecognition of an
net disposal proceeds and carrying amount, intangible asset shall be determined as the
recognised in income statement difference between the net disposal
proceeds and the carrying amount of the
asset. It shall be recognised in profit or loss
when the asset is derecognised
Q3. Definition and Recognition of
Assets
Discuss if the accounting treatment for each category of
intangible is consistent with the IFRS conceptual framework with
regard to the definition and recognition of assets.

1. Patents
2. Customer Relationships
3. Land use rights
4. Goodwill arising from consolidation
Q3. Definition of intangible assets
Identifiability
An asset is identifiable if it either:
a) is separable, ie is capable of being separated or divided from the entity and sold, transferred,
licensed, rented or exchanged, either individually or together with a related contract, identifiable
asset or liability, regardless of whether the entity intends to do so; OR
b) arises from contractual or other legal rights, regardless of whether those rights are transferable
or separable from the entity or from other rights and obligations.
Control
An entity must have power to obtain future economic benefits flowing from the underlying resource &
restrict others from accessing those benefits.
Future economic benefit
May include revenue from the sale of products or services, cost savings, or other benefits resulting
from the use of the asset by the entity.
Q3. Recognition of intangible
assets
An intangible asset shall be recognised if, and only if:
(a) it is probable that the expected future economic benefits that are attributable to the asset
will flow to the entity; AND
(b) the cost of the asset can be measured reliably.
Q3. Consistency with IFRS Patents
Definition
Identifiability: Rights to patent arises from contractual or other legal rights.
Control: Gives BIG power to obtain future economic benefits & restrict others from accessing those
benefits. (protected by law)
Future economic benefit: Ownership of patent can attract financial backing and attract investments
in the firm.

Recognition
(a) Future economic benefits are probable due to the growing demand for DES-based medical
stent treatments.
(b) Costs of patents can be measured reliably. (at purchase cost)

Accounting treatment for patents is consistent with IFRS.

Q3. Consistency with IFRS Land Use Rights

Definition
Identifiability: Rights to land use arises from contractual or legal rights.
Control: Gives BIG control over land use & restricts others’ usage.
Future economic benefit: Gives BIG the right to use the land to carry out economic activities that
will bring about future economic benefits.

Recognition
(a) Future economic benefits are probable
(b) Cost of land use rights can be measured reliably

Accounting treatment for land use rights is consistent with IFRS.

Q3. Consistency with IFRS Customer
Relationship
Definition s
Identifiability: Customer relationships can arise from contractual rights.
Control: BIG has not much control over customer relationships, since external factors may affect
customer relationships.
Future economic benefit: Established customer relationships increase revenue from the sale of
products, as long as firm has strong customer relationships & customer loyalty.

Recognition
(a) Future economic benefits are probable - JWMS has a strong Chinese distribution network and
BIG is likely to enjoy good long-term relationships with these existing customers via the
expansion of its sales force by acquiring JWMS
(b) Difficult to measure costs of customer relationships reliably (especially for non-contractual
relationships)

Accounting treatment for customer relationships is questionable.

Q3. Consistency with IFRS Goodwill
Definition
Identifiability: Arises from contractual rights (from acquisition of another firm)
Control: Goodwill arising from acquisition such as reputation gives BIG power to obtain future
economic benefits & restricts others from accessing those benefits. (control over entity/acquiree)
Future economic benefit: Goodwill arising from acquisition such as increase in BIG’s reputation in
the China market as well as the ability to tap on JWMS’ distribution network and manufacturing
capability to introduce Biosensor product lines in China. (can generate future cash flows)
Recognition
(a) Future economic benefits are probable - JWMS is the 3rd largest, which is likely to increase
future sales & revenue for BIG
(b) Costs can be measured reliably - goodwill is initially measured at cost, being the excess of the
consideration transferred and the amount of non-controlling interest over the net identifiable
assets acquired and liabilities assumed.

Accounting treatment for goodwill is consistent with IFRS.

Q4.
BIG had estimated that the intangible assets should be
valued at US$ 100 million higher, thus reducing the
goodwill recognized on the date of acquisition. Discuss
the potential financial statement impact(s) of this
allocation.
Q4. Financial statement impact(s) of
reallocation
• Increase intangible assets by US$ 100m
• Decrease goodwill by US$ 100m

• Intangible assets are amortised over a straight-line basis over

their respective estimated useful lives
• Amortisation expense will increase

• No impairment of goodwill attributable to JWMS recognized for the year

(Page 21)
• No adjustment needed for impairment of goodwill
Income statement for the year ended 31 March 2012
2012
Other operating expenses Increase Amortisation expense amount
Profit for the year Decrease Amortisation expense amount
(ignore tax effects)
Balance Sheets as at 31 March 2012 (US$)
2012
Non-current Assets
Intangible assets Increase $100m net of increase in amortisation
Goodwill Decrease $100m
Total Assets Decrease Amortisation expense amount

Equity
Accumulated profits/ (losses) Decrease Amortisation expense amount
(ignore tax effects)
Total Equity Decrease
Future financial statement impacts:
● Future income becomes more predictable
● Amortisation can be calculated
● Goodwill impairment is subjective and requires more estimates

Management have less flexibility to manage earnings. Less goodwill to manage

earnings by manipulation of impairment on goodwill.
Q5. Impairment testing for goodwill

Critical Assumptions (Exhibit 8)

• Average growth rate of 18%, based on past performance and its expectations
of market development
• Terminal growth rate of 2%
• Pre-tax discount rate of 12%, which reflects business specific risks relating to
the Biomedical industry, business life-cycle and geographical locations
Q6. Reasonableness of assumptions
Growth rate: 18% growth rate for JWMS for the next five years
• The growth rate should be based on future industry outlook, including market growth and
competitive factors.
• Evidence of increased demand for DES in China
However, 18% may be too high an assumption:
• Intense competition in the DES market in China with strong local competitors
• Local companies are preferred (tend to offer cheaper devices, long term relationship with
hospital and doctors)
• Chinese government is controlling healthcare costs through requiring hospitals to procure high
value devices through competitive tenders. Analysts predict this would lower prices by 15-20%
by mid 2010s.

→ These events put pressure on JWMS’ margins hence a 18% growth rate year on year
seems too optimistic.
Growth rate: 18% growth rate for JWMS for the next five years
• Overall Asia Pacific interventional cardiology market was expected to grow at a strong average
12% per year through 2017 with most of the growth from China and India.
• Frost and Sullivan predicted China’s coronary stent market to expand at a 2007-2014
compound annual growth rate of 24% (with DES used in 95% of the cases).

→ A number closer to 12% should be chosen as opposed to 24% since the 24% projection is
only until 2014, 2 years from now as opposed to the 5 years forecast period used by
Biosensors.
Terminal growth rate: 2% for JWMS beyond 5 years
• Terminal growth rate should reflect the market growth in the long run and JWMS’ ability to
exploit the market growth
• Increasing demand for DES in China due to increasing urbanization, disposable income and
consumer purchasing power with a rapidly graying population, together with a brisk growth in
the country’s medical device market.
• Reasonable terminal growth rate given ageing population and increasing prevalence of
coronary diseases in China

• However, the drop from 18% to 2% after the 5 year forecast period is sudden and might not truly
reflect the growth of cash flows from JWMS.
Discount rate: 12% pre-tax discount rate
• Compare with other similar firms and adjust the discount rate to reflect business specific risks
relating to the relevant industry, business life-cycle and geographical location
• 12% is lower than all other CGUs other than Bio Japan, implying that JWMS is relatively low risk
• Lack of information about other CGUs to assess risk
• Could be reasonable since 12% is a higher discount rate than Bio Japan, which is a more
mature market and a lower discount rate than Indonesia market for BIT, which is an emerging
market.
Other factors
• None of the goodwill impairment for the year was for JWMS
• Consider that goodwill and intangible assets account for 62% of total assets for BIG
• However, JWMS only contributed 2% of the group’s profit for the year.
• A possible red flag to question the reasonableness of the various assumptions for goodwill
impairment
Q6. Impairment of goodwill
• Goodwill is determined by purchase consideration less net identifiable
assets acquired and liabilities, usually representing future economic
benefits due to synergies
• Generally impaired when there is overpayment and goodwill is overstated

From BIG’s Notes to Financial Statements:

• Impairment for goodwill is determined by assessing the recoverable
amount of each cash-generating unit (or group of cash-generating
units) to which the goodwill relates
• When recoverable amount is less than carrying amount, an impairment
loss is recognised in profit or loss
• Impairment is not reversible
Q7. Usefulness of Financial Statements
• Discuss how the use of judgements and estimates affect the
usefulness of financial statements.

Conceptual Framework:
The objective of financial reporting is to provide financial
information that is useful to existing and potential investors, lenders
and other creditors in making decisions about providing resources
to the entity.
 Q7 Qualitative Characteristics
Qualitative characteristics of useful information:
1.Fundamental qualitative characteristics
2.Enhancing qualitative characteristics
Decision Usefulness

Fundamental Characteristics
Relevance Reliability

Comparability Verifiability Timeliness Understandability

Enhancing Characteristics
Relevance
• Relevant financial information makes a difference to the
decision made by users
• Predictive value, confirmatory value or both

Reliability/ Faithful representation

• Complete
• Neutral
• Free from error
Q7. Usefulness of Financial Statements
Arguments for increased usefulness
• Management has information advantage and can better assist investors in
their prediction of future firm performance
• Informative disclosures by management can help narrow information asymmetry
and help investors by incorporating appropriate estimates into their valuations of the
firm → more relevance since greater predictive value

Example: Estimation of discount rate

• Management is in the best position to estimate the discount rate as it incorporates
current expectations of market development and business specific risks relating
to the relevant industry, business life-cycle and geographical location
• Such information disclosures provide more relevant information to investors
• Estimate of discount rate aids investors in accurately forecasting firm’s
operating performance and cash flows in their valuation of the firm
Arguments for decreased usefulness
• Use of accounting estimates may reduce usefulness as it allows more room
for earnings management
• Management may have incentives to manage earnings (opportunistic Vs efficient
contracting), hence they may manipulate such judgements and estimates
• Estimates and assumptions used by managers may not always be
completely neutral or free from error→ decreased reliability

Example: Overstatement of estimated useful life of intangible assets

• Overstating estimated useful life of IA results in lower amortization
expense incurred, overstating profits
• May result in subsequent losses in the future when IA are assessed as impaired
• Reduce usefulness of accounting information since the useful life estimate does
not reflect the true and complete economic usefulness of the asset
Arguments for decreased usefulness
Example: Overstatement of growth rates used for value-in-use calculations in Goodwill
impairment testing
• Overstating growth rates used to forecast operating performance and cash flows
may overstate recoverable amount of each cash-generating unit to which the
goodwill relates
• Goodwill may be unreliably assessed as not impaired, overstating profits
• Unreliable estimates reduce the usefulness of accounting information
since information on goodwill impairment is not neutral or free from error
• Information is also not relevant as it does not provide predictive value for investors
Conclusion
The use of management judgements and estimates will increase the
usefulness of financial statements if they are appropriately used since
management have a better understanding of the financial information of the
firm and are in a better position to make such judgment estimates.

However, there is a trade-off against relevance and reliability since the use of
such estimates also create wider room for management to engage in
earnings management.

Hence such estimates increase usefulness to the extent that the reliability of
such estimates are not compromised.