A little while ago Wesfarmers Ltd (ASX: WES) announced a review of the company’s department stores. Following that review and in anticipation of an upcoming results release, Wesfarmers’ also impairment-tested a number of its businesses, and announced the results of those tests this morning:

  • Department store Target will wear a $1.1 billion to $1.3 billion pre-tax non-cash impairment
  • Coal miner Curragh will take a $600 million to $850 million pre-tax non-cash impairment
  • Restructuring (cash) costs of $145 million for Target, in addition to an estimated Earnings Before Interest and Tax (EBIT) loss of $50 million as a result of high clearance activity

What are ‘Non-cash’, ‘pre-tax’, impairments?

First, non-cash means that the company doesn’t have to pay any money as a result of the impairment. Thanks to tougher trading conditions, Target and Curragh no longer make as much money as they used to, therefore the value of the businesses have fallen. As a result, Wesfarmers must lower the value of these assets on its balance sheet, which is recorded as a loss on the profit statement since the reduction in value must be accounted for – the money can’t just disappear into thin air.

Second, pre-tax means that the loss can be used to offset tax, reducing the ‘after-tax’ impact of the earnings. The after tax impact will be between $1.08 billion and $1.28 billion for Target, and $420 million to $600 million for Curragh.

Even though these impairments will substantially reduce the group’s statutory profit for the year, it won’t have any effect on the actual cash that the business makes – which is a consolation for shareholders. Dividends are unlikely to be affected.

What’s the catch?

However, ‘non-cash’ impairments reflect actual cash spent (on acquiring a business) in previous reporting periods that was, with the benefit of hindsight, wasted. Target faces tough trading conditions in a competitive part of the market, as witnessed by the impairments and the restructuring expenses. The coal business also faces tough conditions, it isn’t a huge contributor to earnings, but these write-downs are still significant.

On the plus side, Kmart and other parts of the Wesfarmers business, such as the supermarkets, have been performing strongly and management noted that there has been a substantial increase in the value of other Coles Group assets since acquisition, which accounting rules do not permit the company to recognise. These value increases more than outweigh the declines at Target.

Today was a tough announcement for shareholders, but their eyes should be on the future. Wesfarmers’ has a solid record of capital allocation, and I would continue to feel confident backing management’s decisions going forward.

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Motley Fool contributor Sean O'Neill has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.