The Stout Terminal Growth Rate Survey

The Stout Terminal Growth Rate Survey

March 01, 2015

U.S. and international accounting standards require goodwill and other indefinite-lived intangible assets to be tested for impairment at least annually at the reporting unit level. In Step 1 of such impairment testing, the Fair Value (including goodwill) of a reporting unit is measured and compared with its carrying amount.

Quoted market prices are considered the best indicator of a reporting unit’s Fair Value. However, quoted market prices are not available for many reporting units. In such a case, the reporting unit’s Fair Value is measured using one or more valuation techniques that rely on unobservable inputs that market participants would use to value the reporting unit.

The AICPA Accounting and Valuation Guide Testing Goodwill for Impairment (the “Guide”) illustrates three methods often used to measure the Fair Value of a reporting unit–the Discounted Cash Flow Method (an Income Approach), the Guideline Public Company method (a Market Approach), and the Guideline Company Transactions method (a Market Approach).

The Discounted Cash Flow Method is a multiple period discounting model in which the Fair Value of a reporting unit is determined based on the present value of its expected future economic benefits. Future economic benefits are comprised of two elements: a stream of benefits over a discrete projection period (often between three to 10 years) and a terminal value. In many cases, the terminal value represents over 50% of the total value measured for the reporting unit.

The terminal value represents the estimated value of a reporting unit at the end of the discrete projection period. The terminal value can be calculated using a financial formula or a market-derived multiple assuming a sale of the reporting unit at the end of the projection period. A terminal value generally reflects the value of the reporting unit’s future cash flows after the discrete projection period but does not imply a market participant would sell the business then.

The Gordon Growth Model is the financial formula generally used to determine a reporting unit’s terminal value. The Gordon Growth Model determines value by multiplying the terminal year’s projected cash flows by a capitalization factor, the formula of which is presented below:

Capitalization Factor= 1+g

g: constant growth rate k: cost of capital

Of the two factors, expected growth may be the most important since, conceptually, the expected return of an investment is equal to the sum of the cash flow yield of the investment plus the expected earnings growth rate.

In 2013, the European Securities and Markets Association (“ESMA”) published a report on its review of impairment of goodwill and other intangible assets in IFRS financial statements. ESMA sampled 235 issuers and found that approximately 70% of the sampled issuers failed to provide adequate disclosure of key assumptions used in cash flow forecasts for impairment testing.

A key issue identified by ESMA was the failure of issuers to use “realistic estimates of future growth rates that corresponds to forecasts of economic development.” ESMA found that more than 15% of issuers sampled disclosed terminal growth rates greater than 3%, the long-term expected nominal GDP growth rate for the Eurozone. ESMA described such assumptions as “ambitious and optimistic [which] may lead to an overstated long-term growth rate.” ESMA noted that IAS 36 required issuers to estimate terminal growth rates that “should not exceed long-term average growth rate for the products, industries or countries in which the issuer operates.” In its conclusion, “ESMA urge[d] issuers to provide realistic estimates of future growth rates that correspond to forecasts of economic development.”

ESMA’s observations led Stout to contemplate: “What was the range of terminal growth rates assumed by U.S. companies when testing goodwill for impairment?”

Stout searched the EDGAR database for all Forms 10-K filed with the Securities and Exchange Commission over the period beginning January 1, 2014 to December 31, 2014 by companies based in the United States. That search found 7,237 such filings. Of those filers, 2,904 reported goodwill on their balance sheets. Stout randomly selected 147 of these filings and reviewed each for disclosures of the terminal growth rate assumed when testing goodwill for impairment. The table below presents summary statistics regarding the balance of goodwill reported by all of the companies identified and the sample analyzed by Stout.

Similar to the ESMA study, Stout found almost two-thirds of the filers did not disclose key assumptions used to test goodwill for impairment. In approximately 15% of the Form 10-Ks analyzed, filers disclosed using qualitative analysis (sometimes referred to as Step 0) to determine that goodwill had not been impaired. About 8% of filers disclosed that they had used exit multiples to determine terminal values or only the market approach to determine a reporting unit’s Fair Value. Another 10% of the filings analyzed did disclose assumptions regarding the stable growth rate applied to determine terminal value.

The terminal growth rates that were disclosed ranged from 1.0% to 8.0% with a median terminal growth rate of 3.0%. The interquartile range of the terminal growth rates disclosed ranged from 2.75% to 4.50%. The 90th percentile terminal growth rate was 6.0%. In comparison, estimates of the long-range growth of the U.S. economy range from 4.0% to 5.0%, with real GDP expected to grow between 2.0% and 3.0% and inflation forecasted to range between 1.5% and 2.5%.

Based on this data, almost half of the issuers, which disclosed long-term growth rate assumptions used in their goodwill impairment testing, assumed growth rates greater than the expected nominal growth rate of the United States. Further, almost 20% of issuers sampled that disclosed growth rate assumptions used for goodwill impairment testing assumed growth rates greater than the expected real growth for the United States economy. We recognize that this sample is relatively small (only 14 issuers).

We believe our analysis of growth rates provides valuable insight as to the assumptions market participants are making about stable growth rates. In addition, we hope it provides incentive to issuers to disclose assumptions relied on when testing goodwill for impairment and provides additional information regarding market participants’ expectations.

The current survey focuses solely on the disclosures of growth rates assumed to calculate terminal value when using the DCF method to measure Fair Value for goodwill impairment testing. We recognize the survey could be expanded to other topics such as growth rates assumed for fairness opinions, stock based compensation, and intangible asset impairment testing, discount rates assumed for goodwill and intangible asset impairment testing, stock based compensation or fairness opinions, and royalty rates assumed when performing certain intangible asset impairment testing.


Lindsey Lee, CPA/ABV, CFA, ASA