Market Cap Versus Book Value – An SEC Comment Letter Sequence

One of the more complex issues companies deal with when performing goodwill impairment tests is what to do when a company’s market capitalization is less than its book value.  Does this mean an impairment automatically exists?  Is it an indicator of impairment?  How should this be dealt with in the impairment analysis?

Here is an SEC comment that raised this question for ArcelorMittal, a steel company:

We note the company’s net book value significantly exceeds its market capitalization. We also note this trend has persisted for a considerable period of time and the degree to which net book value exceeds market capitalization has substantially increased. Given that declines in market capitalization may indicate potential asset impairments, please explain if and how this factor has impacted your asset impairment assessments. Please more fully explain and address the following:

Explain how you determine your cash generating units for impairment testing of property, plant and equipment;

Explain how you determine and assess the reasonableness of the useful lives of property, plant and equipment;

Explain how you determine your groups of cash generating units for impairment testing of goodwill;

Since recoverable amounts appear to exceed market capitalization, explain how you determine the material assumptions underlying your impairment analyses and how you determine each material assumption is reasonable and supportable; and

Explain how you assess the reasonableness of your fair value estimates, including if and how you reconcile your fair value estimates to your market capitalization.

ArcelorMittal is a foreign private issuer and prepares its financial statements in accordance with IFRS as adopted by the IASB.  While the goodwill impairment test in IFRS is a bit different from the test under US GAAP, the company’s response is an interesting and thorough analysis of this issue.

The company’s response is too lengthy to include in this post so here is a link to the response.

Not to provide spoilers, but the next letter in the process is the SEC’s closing letter.

Thanks to Alyson Clabaugh of Intelligize for spotting this example, and as always, your thoughts and comments are welcome!

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