Biosensors International Group Case Study Analysis
Reallocation & Financial Statement Impact of Reallocation
If BIG had estimated that identifiable assets should be valued at $100 million higher, the goodwill would be reduced by $100 million. The impact of this reallocation on the financial statement of BIG is as follows;
- The intangible assets will increase &goodwill will decrease respectively by 100 million
- There will be an increase in amortization expense as the intangible assets are amortized over estimated useful lives over a straight-line basis
- In the income statement of the company for the year ended March 2012, other operating expenses will increase with the amount of amortization expense and profit of the year will reduce with the amount of amortization expense (if we ignore the effects of tax
- In the balance sheet of the company, under non-current assets the intangible asset will increase with $100 million increase in amortization and goodwill will reduce by $100 million, hence resulted in decreased total assets. On the equity side, the accumulated profit will reduce with the amount of amortization expense (ignoring the effect of tax), hence resulting in reduced total equity
Critical Assumptions in Impairment Test of Goodwill
Referring to Exhibit 8 provided in the case study, various assumptions have been made which are as follows;
- On the basis of the prior performance and expectation for the market development, the average growth rate was assumed to be 18%
- The terminal growth rate was assumed to be 2%
- The pre-tax discount rate was assumed to be 12%, reflecting business risk in correspondence to the geographical locations and business lifecycle(Anon., 2017).
Reasonability of Assumptions
Growth rate: 18%
There isa number of factors which thegrowth rate should be based on which includes; competitive factors & market growth as a whole. The growth rate is too high and seems to be highly optimistic,because of the fact that in DES Chinese market, the competition between local market rivals is rigorous or intense. The preference is given to local companies because of offering cheaper devices & their long term positive relationship with doctors & hospitals. The government of China requires healthcare hospitals for procuring high-value devices through competitive tenders in order to control the cost incur in healthcare, which in turn would reduce the prices.
Terminal growth rate: 2%
The reduction from an 18% growth rate to a 2% terminal value is sudden, thus does not reflect the cash flow’s growth for the forecasted period. The terminal growth rate should take into consideration the long-run market growth. In China, the increasing demand for DES is because of the disposal income, increased urbanization, & purchasing power of customers with the rapidly graying population together with the brisk growth in the medical device market in China. In China, the demographics are changing towards the increased prevalence of coronary disease and the aging population which augurs well for the DES market.
Discount rate: 12%
The adjustments in discount rate after comparing with other similar organization is necessary in order to reflect the business-specific risk in relation to the geographic location, business life-cycle and relevant industry. Other than Bio Japan, the discount rate of the company is lower than other companies, which implies that JWMS is low risk. Shortly, a 12 percent discount rate could be reasonable since the discount rate is higher than Bio Japan, which is a mature market and lower than the Indonesian market for BIT, which is an emerging market.
Use of Judgment & Estimates Affect Usefulness of Financial Statements
The use of estimates and judgments could help investors in predicting the performance of the firm in the future ahead. The informative disclosures could assist in narrowing the information asymmetry & help investors into their valuation through embedding suitable estimates. The management of the company could estimate the discount rate which ultimately helps investors in forecasting the cash flows as well as the operational performance of the company in their valuation.
On the other hand, the usefulness of financial statements could be reduced by using the accounting estimates as it enables more room for the management of earnings, for which the management could be incentivized to manage earnings (efficient vs opportunistic contracting), there is a possibility that management could manipulate such estimates or judgments. Additionally, there is no possibility that the assumptions or estimates used by management are free from error or completely neutral. Shortly, the usefulness of financial statements could be increased by the use of estimates and judgmentif they are used suitably & appropriately as management of the company has better knowledge and understanding of the financial information and the management is in a better position for making judgment estimates. Thus, the usefulness of the financial statement could be increased to the extent of the reliability of such estimates would not be missed or compromised (Ivana Mamic Sacer, 2015)................................
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