The International Accounting Standards Board (IASB) has asked for users’ opinions on whether the amortisation of goodwill model should be reconsidered in its discussion paper, replacing the impairment-only model that currently applies for goodwill.
This feedback will help the IASB decide whether and how to develop detailed proposals based on the preliminary views in the Discussion Paper. The IASB discussed feedback on how an entity should subsequently account for goodwill, and the related disclosures an entity should be required to make. The IASB will consider the project’s direction at a future meeting and act accordingly.
Acquired businesses are often integrated soon after acquisition, which makes it hard to isolate the impact. Disclosures may be useful to users only for a limited time period. Some information may be commercially sensitive or forward looking, making its preparation even more challenging. Disclosure of forward-looking information may even create legal implications.
Currently IASB favours keeping the impairment testing model, as there is no compelling evidence to justify changing the accounting for goodwill again. But only eight out of 14 board members voted in favour of the impairment model. However, there are inherent limitations for both the impairment-only model and the amortisation model for goodwill.
The impairment model
Goodwill impairment testing is a time-consuming and costly exercise. It requires professional judgement and discretion from preparers, which introduces opportunities for managerial interpretation and bias.
The impairment test of goodwill allocates the goodwill to the group of assets that are expected to benefit from the merger or acquisition, then compares the carrying value to the recoverable amount. As a result, the size of any goodwill impairment depends on the recognition and measurement of the other assets in the cash-generating unit. In effect, goodwill is allowed to be overstated as long as other assets are understated by at least as much. This is why an acquisition can fail and goodwill may be lost, but no goodwill impairment is recognised.
Impairment losses are not always recognised on a timely basis and this may be attributed to two main factors: the shielding effect, as described above, and the over-optimistic assumptions contained in impairment testing, placed by management. An acquisition may perform poorly but no impairment loss will be recognised if goodwill is shielded. Impairment losses are often recognised too late, long after the events that caused the losses, and therefore don’t always provide users with relevant information.
On the other hand, the impairment-only model ensures that if losses have occurred, management will be held accountable for the acquisition decision, even if such information is delayed. Stakeholders can assess management’s stewardship. Holding management to account for the results of their decision making is one of the key objectives of financial reporting. A record of past goodwill impairments may help assess investment risks and the success of an acquisition strategy.
The amortisation model
Reintroducing amortisation could provide a single mechanism for reducing the carrying amount of acquired goodwill, thereby reducing the risk of potential overstatement. It would therefore reduce the frequency of impairment losses and decrease volatility in profit or loss.
The mere appearance of an impairment loss would hence become more relevant information to investors. It would also improve comparability between companies that grow organically, without acquisitions, and companies that grow through acquisitions. Non-amortisation of goodwill discriminates against companies that grow organically.
Users who favour reintroduction of amortisation suggest that goodwill is a wasting asset with a finite useful life. For example, the acquired workforce will leave or retire over time. Reintroducing amortisation will illustrate how goodwill is being consumed and how the benefits from the acquisition are realised.
Why favour the impairment approach
Even though impairment testing contains estimates, if the test is well applied, you can ensure that the combined assets, including goodwill, will not be carried at a higher value than their recoverable amount.
Although the impairment test contains unavoidable inherent limitations, it provides users with more useful and relevant information than the amortisation model. It holds management accountable for its acquisition decisions and, as per the conceptual framework, stewardship is now acknowledged as one of the two roles of financial reporting.
Goodwill has an indefinite useful life, as cost savings are expected to be recurring and knowledge and processes that generate future returns remain in the business.
Reintroducing amortisation would not save significant costs as the need for impairment testing will still remain. The underlying problem is to improve the way the impairment test is applied to ensure that impairments of goodwill are being properly recognised. Estimating the pattern in which goodwill diminishes would again require judgement.
Amortisation could reduce the likelihood of an impairment loss being recognised, as the carrying amount would be reduced, but this could further shield acquired goodwill against impairment losses, mislabelling some or all impairment losses as consumption.
Having an amortisation expense is quite arbitrary. It is difficult to estimate the useful economic life of goodwill and the pattern in which it diminishes. Having an arbitrary straight-line amortisation expense in profit or loss may lead to investors ignoring the expense. In such a case, how would the amortisation of goodwill significantly improve the relevance of information provided to investors? Imperfect impairments are better than unhelpful amortisation.
Evita Livera, BFP, FCA, Special Teaching Staff, Department of Accounting and Finance, University of Cyprus
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