M&As: how can information reported be improved?

2 December 2020: The IASB has extended its consultation on ways to help investors hold companies to account for acquisitions and on goodwill accounting to 31 December 2020.

There is still time to contribute to the discussion, prompted by the IASB, on possible improvements to the information companies report on acquisitions of businesses – to help investors and others gauge how successful those acquisitions have been. The IASB is also seeking feedback on how companies should account for goodwill arising from such acquisitions.

The problem arises when acquisitions fail to live up to expectations in years after they are agreed. Investors need to know how well an acquired entity is performing to test management decision-making, amongst other things.

The upshot is that in its discussion paper the IASB is suggesting changes to IFRS Standards 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.

On top of that, the IASB is also thinking about whether to change how a company accounts for goodwill. Companies must test goodwill for impairment annually, but is this test effective? What would a better test look like? Should the IASB reintroduce amortisation of goodwill alongside the impairment test?

The current model – the impairment-only approach – provides relevant information to investors, but it tests a broader set of assets than just goodwill. The IASB has reached the preliminary conclusion that there is no alternative impairment test that can target goodwill better and at reasonable cost and that the impairment-only approach should be retained. However, the IASB is interested in further feedback.

The IASB’s technical team points out that this whole discussion is a response to the post-implementation review of IFRS 3 – the standard that relates to M&As. This review is a part of the IASB’s process following publication of a new standard. Its purpose is simply to understand how well a standard is performing, whether it works as intended and, importantly, whether it has improved financial reporting. The IASB has been through that process for IFRS 3 and this project is in response to the feedback it received. 

What the IASB heard during that review, says its technical team, was that investors feel they do not get enough information about the performance of acquisitions. There was also feedback about goodwill itself as well as intangible assets acquired in an acquisition. 

Although, through this process, the IASB has reached the preliminary view that it should retain the impairment-only approach for goodwill, how does it propose to address concerns that the impairment-only model leads to write-downs that are too little and too late?

The IASB identified two underlying reasons that could cause that ‘too little too late’ problem. The first one was management overoptimism when estimating future cashflows. IAS 36 – the standard for accounting for impairments - already contains a lot of requirements for calculating cashflow projections, points out the IASB’s technical team. That is why the IASB’s preliminary view is that if there is still a problem with cashflow forecasts being too optimistic, it is an implementation problem and is better dealt with by auditors and regulators than through additional standard-setting.

The other issue is shielding. This is where there is “headroom” in another part of the business with which the acquisition is being combined. That headroom, often the result of internally generated goodwill that is not recognised on the balance sheet, might prevent an entity from impairing acquired goodwill, even when an acquisition has not performed as well as expected. The IASB has spent a significant amount of time exploring two approaches to address this issue but neither of them was particularly well supported, and neither of them have therefore been pursued.

The IASB has attempted to address some parts of the ‘too little, too late’ problem, however. In particular, the IASB’s preliminary views for additional disclosures about the subsequent performance of acquisitions is an attempt to provide more timely information about acquisitions than the impairment test can.

When asked whether some of the proposed disclosures on post-acquisition performance would be better suited to the front end of the accounts rather than in the notes to the financial statements, the IASB’s technical team agreed that this is a question often raised by stakeholders. 

However, having considered this alternative approach, the IASB technical team says the main reason this information is required in the financial statements rather than in management commentary is that the IASB wants to ensure that users of the financial statements get the information they say they need. 

The team explains further that the IASB has a practice statement on management commentary, but that the practice statement is not mandatory, and therefore the IASB doesn’t have any tools available to require companies to disclose this information in management commentary. Therefore, the only option available to the IASB is to require the disclosure of that information in the financial statements.

So, what should the profession do? The main way of contributing is to submit comments to the IASB. The deadline, having now been extended to the end of the year, allows members to respond to several questions, and the IASB welcomes comments on all these.

Find out more about the Business Combinations—Disclosures, Goodwill and Impairment consultation and submit comments here.