Discussion is underway about how to improve the process by which the success of acquisitions can be measured.
IFRS 3 Business Combinations is once again under the spotlight after the International Accounting Standards Board (IASB) published a Discussion Paper on possible improvements to the information companies report about acquisitions of businesses. The objective is to explore if changes to the accounting standard could make it easier for investors to assess how successful those acquisitions have been.
Impairment of goodwill
Under current rules, goodwill arising on acquisitions – purchased goodwill – is recognised and capitalised in accordance with IFRS 3 Business Combinations. In simple terms, purchased goodwill is measured as the difference between the amount of consideration transferred to acquire the business and the fair value of the separable net assets acquired.
Unlike many other intangibles, it is not amortised but is instead tested annually for impairment in line with IAS 36 Impairment of Assets. It is this impairment-only approach to the subsequent measurement of goodwill that is under the spotlight. “Some believe this is too little too late,” explains Sarah Dunn, a technical manager in ICAEW’s Financial Reporting Faculty.
The idea of a reintroduction of amortisation had been mooted – that is, the gradual write-down of goodwill over time, which was the requirement in IFRS Standards until 2004. However, the IASB’s preliminary conclusion is that it should retain the impairment-only approach, because there is no clear evidence that amortising goodwill would significantly improve the information that companies report to investors.
Meanwhile, better disclosures about acquisitions also falls under the remit of the Discussion Paper, following calls for better ways to gauge the performance of investments in relation to expectations, not least so investors can hold a company’s management to account for its acquisition decisions.
In response to this feedback, the IASB is suggesting changes to IFRS 3 that would require a company to disclose information about its objectives for an acquisition and, in subsequent periods, information about how that acquisition is performing against those objectives.
Investors have questioned how useful it is to recognise intangible assets acquired in a business combination separately from goodwill. On the one hand, the separation illustrates more fully what the company has purchased and helps investors to assess prospects for future cash flows. Separate recognition also results in intangible assets with finite useful lives being amortised rather than being included in goodwill, which is not amortised.
However, concerns have been raised about the complex, subjective and costly nature of valuing intangible assets, and how to set about estimating the carrying amounts of those intangible assets for which there is no active market, such as customer relationships and brands.
The IASB’s Discussion Paper, 'Business Combinations – Disclosures, Goodwill and Impairment', also contains further proposals, including suggestions of ways to reduce the cost of the impairment test for preparers. In anticipation of ICAEW formally submitting its response, Dunn says it welcomed further debate on the points the paper raised.
“Although the IASB is not proposing to change the impairment-only model, it is suggesting some simplifications to address concerns that the impairment test is too complex and costly. We welcome the discussion paper and agree that, as this project progresses, careful consideration should be given to the cost/benefit implications of any potential changes and to minimising disruption,” Dunn says.
The deadline for comments has been pushed back from 15 September until 31 December 2020 due to the COVID-19 pandemic.