30. Impairment testing of goodwill

30. IMPAIRMENT TESTING OF GOODWILL
   
General principles
 
Goodwill acquired in business combinations is allocated to cash-generating units (CGU), which are the reportable service line segments in segment reporting. In July 2016 the CGU structure in IT-services changed due the alignment of the operating structure with the new strategy, and goodwill was reallocated to the new CGUs based on the relative net present values of businesses transferred to the new CGUs. As a result, the goodwill in Managed Services and Industry Products was totally allocated to Technology Services and Modernization and Industry Solutions respectively. The goodwill in Consulting and System Integration was allocated to Technology Services and Modernization, Business Consulting and Implementation and Industry Solutions. There was no changes to goodwill in Product Development Services due to the alignment of the operating structure.
 
The recoverable amounts of all CGUs are determined based on value-in-use calculations. The cash flow projections covering the initial four-year period have been based on financial forecasts approved by senior management supported by industry growth forecasts obtained from external sources. The growth rates used to extrapolate the cash flows for the subsequent one-year period vary between 1% and 10%, which reflect the management’s estimate of the industry’s long-term average growth rate. Subsequent to the five-year projection period the growth rate used is 2%, which does not exceed the expectations of growth in real terms.
 
Forecasted profit margins are based on actual performance in prior years adjusted for expected efficiency improvements.
 
The discount rate applied to cash flow projections is the weighted average pre-tax cost of capital. The discount rate is based on normalized weighted average of 30-year government bond rates in the countries where the CGUs operate. The bond rates are adjusted for the general market risk and the business risk of the CGUs. The pre-tax discount rates for the CGUs vary between 7% and 12% (between 7% and 13%).
 
Carrying amount of goodwill allocated to CGUs and segments
 
The total goodwill at 31 December 2016 was EUR 409.7 million. The increase compared to 31 December 2015 is EUR 24.8 million. Goodwill increased EUR 26.3 milllion due to the acquisitions and decreased EUR 1.5 million due to currency effects.
 
All CGUs contain goodwill that may be considered significant in comparison with the Group’s total carrying amount of goodwill. Every CGU represent business operations providing services to selected customers in their market segments.
 
In CGU Technology Services and Modernization the carrying amount of goodwill allocated to the CGU at 31 December 2016 was EUR 168.9 million. The recoverable amount of the CGU has been calculated in accordance with the general principles described above. The growth rate for the initial four-year period varies between 1% and 2% and EBITDA margin between 16% and 18%. The growth rate used to extrapolate the cash flows for the subsequent one-year period is 1%. The discount rate applied to the cash flow projections is 7.2%.
   
In CGU Business Consulting and Implementation the carrying amount of goodwill allocated to the CGU at 31 December 2016 was EUR 25.4 million. The recoverable amount of the CGU has been calculated in accordance with the general principles described above. The growth rate for the initial four-year period varies between 10% and 11% and EBITDA margin between 6% and 12%. The growth rate used to extrapolate the cash flows for the subsequent one-year period is 10%. The discount rate applied to the cash flow projections is 7.3%.
 
In CGU Industry Solutions the carrying amount of goodwill allocated to the CGU at 31 December 2016 was EUR 155.6 million. The recoverable amount of the CGU has been calculated in accordance with the general principles described above. The growth rate for the initial four-year period varies between 7% and 12% and EBITDA margin between 14% and 18%. The growth rate used to extrapolate the cash flows for the subsequent one-year period is 8%. The discount rate applied to the cash flow projections is 7.9%.
   
In CGU Product Development Services the carrying amount of goodwill allocated to the CGU at 31 December 2016 was EUR 59.8 million. The recoverable amount of the CGU has been calculated in accordance with the general principles described above. The growth rate for the initial four-year period varies between 4% and 8% and EBITDA margin between 10% and 12%. The growth rate used to extrapolate the cash flows for the subsequent one-year period is 5%. The discount rate applied to the cash flow projections is 12.3%.
 
As a result of the impairment testing no impairment was identified. Value-in-use calculation for each CGU is sensitive to changes in growth assumptions, EBIT margin assumptions and interest rates. The recoverable amount in Product Development Services, EUR 116 million, is EUR 40 million above the carrying amount. The recoverable amount of CGU Product Development Services would equal its carrying amount if the key assumptions were to change as follows:
   
Change in annual growth rate (%-units) n/a
Change in EBIT margin (%-units) -3
Change in interest rates (%-units) +6
   
   
In the other CGUs the surplus between the recoverable amount and the carrying amount is substantial, and any likely change in the three parameters isolated would not result in the recoverable amount being equal to the carrying amount.
   
The carrying amounts of goodwill allocated to the CGUs are disclosed below:
   
Carrying amount of goodwill
   
EUR million 31 Dec 2016
Technology Services and Modernization 168.9
Business Consulting and Implementation 25.4
Industry Solutions 155.6
Product Development Services 59.8
Total 409.7