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Goodwill and impairment

Date recorded:

Cover paper - Agenda paper 18

The Board continued its discussions on the goodwill and impairment research project. The Staff discussed the following topics in this meeting:

  • Removing the requirement to use pre-tax inputs when calculating value in use (VIU): AP 18A
  • Removing the requirement to exclude cash flows relating to uncommitted future restructurings and asset enhancements when calculating VIU: AP 18B

The Staff plan to discuss the following at the next meeting: (a) ways to simplify the identification and separation of intangible assets acquired in a business combination from goodwill; and (b) whether the next consultative document should be a discussion paper or an exposure draft.

Value in use: what tax attribute should be reflected in value in use? Agenda Paper 18B

Background

In this paper, the Staff analysed whether the Board should consider removing the requirement to use pre-tax inputs in calculating VIU.

Staff analysis

Stakeholders have consistently pointed out that calculating VIU on a pre-tax basis and disclosing the pre-tax discount rate is not useful. This is because the current value of an asset is regarded and understood as a post-tax measure and the related valuations are done on a post-tax basis in order to reflect the net return to an investor. Disclosing a pre-tax discount rate is merely a mechanical exercise of reverse-engineering an existing post-tax result. As such, it is a meaningless figure to many stakeholders.

The Board’s predecessor, the IASC, required the use of pre-tax inputs because it was concerned that using post-tax inputs without specifying the basis for computing the future tax cash flows (i.e. the tax attribute) would cause double counting. This is because IAS 12 already requires an entity to recognise a deferred tax asset or liability on the future tax consequences of an entity’s assets and liabilities. If the VIU is also calculated on a post-tax basis, the tax effect would be reflected twice in an entity’s financial statements. Although the problem could potentially be resolved by stipulating what tax attribute the VIU should reflect, the IASC believed that the ensuing calculations would be complex and burdensome.

In the paper, the Staff used a numerical example to illustrate how such a calculation could be done. Nevertheless, they acknowledged that any serious consideration of this approach would require an extensive analysis of the interaction between IAS 36 and IAS 12 and hence would not meet the simplification objective of the research project.

Staff recommendation

In light of the above, the Staff recommended that the Board remove the requirement in IAS 36 to use pre-tax inputs when calculating VIU, but to require an entity to:

  1. use internally consistent assumptions about cash flows and discount rate (i.e. pre-tax cash flows with pre-tax discount rate and vice versa); and
  2. disclose the discount rate(s) actually used.

This would make the VIU calculation consistent with that of fair value and the Staff’s proposal to remove the requirement in IAS 41 to use pre-tax discount rates when determining the fair value of a biological asset (see AP 12B to this month’s Board meeting).

Discussion

The Board agreed with the Staff recommendation without much discussion. The Chair observed that the benefits of removing ‘fake accuracy’ resulting from reverse engineering a pre-tax discount rate outweighs the conceptual concerns of double counting.

Value in use: cash flows from a future restructuring or a future enhancement – Agenda Paper 18B

Background

In this paper, the Staff analysed whether the Board should consider removing the requirement to exclude cash flows relating to uncommitted future restructurings and asset enhancements when calculating VIU.

Staff analysis

IAS 36 requires VIU to be calculated based on the estimated future cash flows arising from the asset’s current condition. As such, cash flows relating to uncommitted future restructurings and enhancing an asset’s performance are required to be excluded from the VIU calculation. This concept was reaffirmed by the Board in 2004 when it revised IAS 36.

The Staff, however, thought that inherent in the current condition of a typical asset within the scope of IAS 36 is the potential to restructure or enhance the asset. A market participant would be willing to pay for (or would ask to be paid for) this potential when buying (or selling) the asset. The Staff believed that such a currently existing potential should be factored into the VIU calculation to be consistent with determining the fair value of an asset.

Furthermore, the Staff believed that removing this requirement would have the following benefits. It would:

  1. dispel the perception that the cash flow composition of VIU is linked to the recognition requirements of IAS 37. Some people think that the prohibition to include cash flows from an uncommitted restructuring in the VIU calculation is due to IAS 37’s prohibition of recognising a provision for such a restructuring. The Staff did not think this is a valid view because many cash flows included in a VIU calculation are not recognised as liabilities.
  2. avoid creating a rule to exclude particular cash flows because they may be prone to overly optimistic assumptions. Some people argue that cash flows from uncommitted restructurings and asset enhancements are subject to significant uncertainties and are thus more prone to management manipulation. The Staff acknowledged these concerns but believe them to be an issue of compliance rather than accounting.

Staff recommendation

In light of the above, the Staff recommended that the Board remove the requirement in IAS 36 to exclude cash flows relating to uncommitted future restructurings and asset enhancements when calculating VIU.

Discussion

The Board agreed to explore removing the requirement to exclude cash flows relating to uncommitted future restructurings and asset enhancements when calculating VIU in the next consultative document together with the pros and cons of the removal. Depending on whether an exposure draft or a discussion paper will be issued, the Board may have to redeliberate this matter with further analysis.

Although the Board was generally supportive of removing the exclusion, many Board members were concerned that this will open the door to management opportunism. Some members suggested putting parameters around what types of uncommitted restructurings can be included in the cash flows, e.g. based on probability or including only those that appear in a budget approved by the CODM or high-level management.

There was no firm conclusion on this though and several Board members said putting in constraints would actually make the VIU calculation more complex. They also noted that there are sufficient existing safeguards in IAS 36 about the reasonableness of cash flows to curb malpractice. If these are not working in practice then it is an issue of enforcement and not of standard-setting.

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