HSBC 2008 Annual Report Download - page 65

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large number of geographical areas. Economic and
credit conditions within geographical areas are
influenced by many factors with a high degree of
interdependency so that there is no single factor to
which the Group’s loan impairment allowances as
a whole are sensitive. However, HSBC’s loan
impairment allowances are particularly sensitive to
general economic and credit conditions in North
America. For example, a 10 per cent increase in
impairment allowances on collectively assessed
loans and advances in North America would increase
loan impairment allowances by US$1.6 billion at
31 December 2008 (2007: US$1.2 billion). It is
possible that the outcomes within the next financial
year could be different from the assumptions built
into the models, resulting in a material adjustment to
the carrying amount of loans and advances.
Goodwill impairment
HSBC’s accounting policy for goodwill is described
in Note 2(p) on the Financial Statements. Note 22
on the Financial Statements lists the Group’s cash
generating units (‘CGUs’) by geographical region
and global business. Total goodwill for the Group
amounted to US$22 billion as at 31 December 2008
(2007: US$34 billion).
The process of identifying and evaluating
goodwill impairment is inherently uncertain because
it requires significant management judgement in
making a series of estimations, the results of which
are highly sensitive to the assumptions used. The
review of goodwill impairment represents
management’s best estimate of the factors below:
• the future cash flows of the CGUs are sensitive
to the cash flows projected for the periods for
which detailed forecasts are available, and to
assumptions regarding the long-term pattern of
sustainable cash flows thereafter. Forecasts are
compared with actual performance and
verifiable economic data in future years;
however, the cash flow forecasts necessarily and
appropriately reflect management’s view of
future business prospects at the time of the
assessment; and
• the discount rate used to discount the future
expected cash flows is based on the cost of
capital assigned to an individual CGU, and can
have a significant effect on the CGU’s
valuation. The cost of capital percentage is
generally derived from a Capital Asset Pricing
Model, which incorporates inputs reflecting a
number of financial and economic variables,
including the risk-free interest rate in the
country concerned and a premium to reflect the
inherent risk of the business being evaluated.
These variables are subject to fluctuations in
external market rates and economic conditions
outside of management’s control and are
therefore established on the basis of significant
management judgement and are subject to
uncertainty.
When this exercise demonstrates that the
expected cash flows of a CGU have declined and/or
that its cost of capital has increased, the effect is to
reduce the CGU’s estimated recoverable amount. If
this results in an estimated recoverable amount that
is lower than the carrying value of the CGU, a
charge for impairment of goodwill will be
recognised in HSBC’s income statement for the year.
The accuracy of forecast cash flows is subject to
a high degree of uncertainty in volatile market
conditions. In such market conditions, management
retests goodwill for impairment more frequently than
annually to ensure that the assumptions on which the
cash flow forecasts are based continue to reflect
current market conditions and management’s best
estimate of future business prospects.
Given the extraordinary market events
experienced globally during the second half of 2008,
HSBC performed an additional impairment test on
all the CGUs within the Group as at 31 December
2008. As a result, HSBC recognised an impairment
charge of US$10.6 billion on Personal Financial
Services – North America as at 31 December 2008
(2007: nil). Management concluded that the
recoverable amount of the other CGUs to which
goodwill has been allocated exceeded their carrying
value. However, in the event of further significant
deterioration in the economic and credit conditions
beyond the levels already reflected by management
in the cash flow forecasts for the CGUs, a material
adjustment to a CGU’s recoverable amount may
occur which may result in the recognition of an
impairment charge in the income statement.
Note 22 on the Financial Statements includes
details of the CGUs with significant balances of
goodwill, states the key assumptions used to assess
the goodwill in each of those CGUs for impairment,
and provides a discussion of the sensitivity of the
carrying value of goodwill to changes in key
assumptions.
Valuation of financial instruments
HSBC’s accounting policy for determining the
fair value of financial instruments is described in
Note 2d on the Financial Statements.