HSBC 2009 Annual Report Download - page 64

HSBC HOLDINGS PLC
Report of the Directors: Operating and Financial Review (continued)
Critical accounting policies
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level of interest rates, portfolio seasoning, account
management policies and practices, changes in laws
and regulations, and other factors that can affect
customer payment patterns. Different factors are
applied in different regions and countries to reflect
the variation in economic conditions, laws and
regulations. The assumptions underlying this
judgement are highly subjective. The methodology
and the assumptions used in calculating impairment
losses are reviewed regularly in the light of
differences between loss estimates and actual loss
experience. For example, roll rates, loss rates and the
expected timing of future recoveries are regularly
benchmarked against actual outcomes to ensure they
remain appropriate.
The total amount of the Group’s impairment
allowances on homogeneous groups of loans is
inherently uncertain because it is highly sensitive to
changes in economic and credit conditions across a
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$1.3 billion at
31 December 2009 (2008: US$1.6 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 2p on the Financial Statements. Note 22 on
the Financial Statements lists the Group’s cash
generating units (‘CGU’s) by geographical region
and global business. Total goodwill for the Group
amounted to US$23 billion as at 31 December 2009
(2008: US$22 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 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 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 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.
During 2009, no impairment of goodwill was
identified (2008: US$10.6 billion). In addition to
the annual impairment test which was performed as
at 1 July 2009, HSBC reviewed the current and
expected performance of the CGUs as at
31 December 2009 and determined that there was no
indication of potential impairment of the goodwill
allocated to them. However, in the event of a
significant deterioration in economic and credit
conditions compared with those 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.