Setting objectives for the Board’s follow up work (Agenda paper 18)

Background

Stakeholder feedback to the Board from the Post-implementation review of IFRS 3 Business Combinations and IAS 36 Impairment of assets was that accounting for intangible assets acquired in a business combination and acquired goodwill do not always produce useful financial information and that there is insufficient information to help investors understand the subsequent performance of the acquired business. Consequently, the Board undertook to a research project to investigate the following four areas:

• Whether there are new conceptual arguments or information which will support the amortisation of goodwill?
• Could some identifiable intangible assets acquired in a business combination be included within goodwill?
• Could information be provided on a timelier basis to users through disclosures without imposing costs that exceed benefits?
• Can the application of the requirements of IAS 36 Impairment of assets be improved by simplifying the test of impairment without making it less robust and making the test more effective at timely recognition of goodwill?

In seeking to respond to the above four areas, the Board had reached initial preferences. Subsequently, the Board assessed how on particular area of change would contribute to meeting one or more of the objectives of the research project, attempted to identify a balanced package of possible changes in response to the stakeholder feedback  and explored the form and content of the consultation document.

Key learnings

The key learnings from the research work of the stakeholder concerns are set out below:

• Intangible assets acquired in a business combination
• Acquired goodwill
• Accounting for goodwill
• Impairment testing of goodwill

Intangible assets acquired in a business combination

 A number of different views were presented by investors and preparers in different areas, some of the key views included:

• Investors had mixed views about the usefulness of information provided by recognising all identifiable intangible assets acquired in a business combination.
• Some investors thought that recognising fair value of identifiable assets acquired and liabilities assumed in a business combination does not provide useful information.
• Prepares had mixed views relating to the cost and complexity of involved in identifying and measuring intangible assets.
• Many investors supported recognising some but not all identifiable assets acquired in a business combination.
• There were concerns about comparability between financial statements of those entities that grow with acquisitions and those that grow without acquisitions.

Acquired goodwill

The concerns raised by investors were in relation to whether goodwill is an asset and should be amortised, the effectiveness of testing of goodwill for impairment and the costs and complexity of the performing the impairment test.

Accounting for goodwill

The research undertaken thus far has not provided new evidence to change the existing conclusions that goodwill is an asset and should not be amortised. However, it did provide insight into stakeholder concerns. Two of the concerns were that goodwill is measured as a residual rather than on the basis of the economic resources or rights that constitute goodwill; and any overpayments are subsumed in the measurement of goodwill. The Board concluded that there was no easier method to measure goodwill and acknowledged the latter concern aforementioned.

The concern around whether acquired goodwill should be amortised, in part, relates to the unit of account for goodwill.  The Board indicated that internally generated goodwill and acquired goodwill are considered as one unit of account and where synergies are potentially expected for an indefinite period, it would generally not be possible to predict a useful life.

Impairment testing of goodwill

The research thus far has provided some evidence to question the Board’s conclusion that an annual quantitative impairment test would provide sufficient rigour in testing of the carrying amount of goodwill for impairment. The key findings from the research project include the following:

• The impairment testing model only provides useful information if an impairment loss is recognised or close to being recognised.
• As goodwill is currently tested for impairment as part of a unit, the focus on the test is whether the carrying amount of the net assets of the unit (including goodwill) is overstated.
• The impairment test would not identify any overpayments and an impairment of goodwill could be masked by existing unrecognised headroom within the cash generating unit goodwill has been allocated to.
• Some members of Accounting Standards Advisory Forum (ASAF) and other consultative bodies were concerned about the rebuttable presumption that all of a decrease in headroom should be attributed to acquired goodwill.

Possible objectives

In response to the stakeholder engagement and research findings, the staff have suggested possible objectives for follow-up work. These are laid out below:

• Objective A – better disclosures that would enable investors to assess whether a business combination is a good investment and performs as expected after combination.
• Objective B – targeted changes to value in use calculation.
• Objective C – change the impairment model to focus on whether the carrying amount of goodwill is recoverable.
• Objective D – retain the current impairment model and simplify the requirements for goodwill. This objective would reconsider requiring an entity to perform an impairment test of goodwill only where there are possible indicators of impairment, whether amortisation of goodwill should be reintroduced and consider if immediate write-off of goodwill on initial recognition would be appropriate.
• Objective E – remove the accounting differences between internally-generated intangible assets and intangible assets acquired in a business combination.

Staff recommendation

No staff recommendations were made in this paper. The paper discussed what objectives the Board might seek to achieve in follow up work from the Board’s Goodwill and Impairment research project and asked the Board which objectives to pursue.

Discussion

A Board member questioned which information is really useful for users of financial statements and that their initial understanding was that investors were focused on impairment. The focus for future objectives needs to meet the needs of investors and especially in the area of impairment where there is a significant cost. If users were concerned about other areas that could be satisfied by disclosures, then this would have to be factored into approach adopted for the impairment of goodwill. 

In response to the questions asked, the staff clarified below:

• One group of investors was not concerned about goodwill amortisation and believed that impairment testing did not target goodwill.
• Another group of investors focused on stewardship of management but it was not clear whether these investors understand the outcome of the goodwill impairment test. In particular, whether the impairment test provides information about whether the acquisition was a good or bad investment decision (which is one area about which they were seeking further information).
• In some circumstances (i.e. if the subsidiary acquired was a separate segment) the impairment test may provide helpful information. However, when the subsidiary is integrated into the existing business, the impairment test might not provide this information.
• Additionally, the staff indicated that goodwill could have an indefinite useful life but not an infinite life. In some instances, management could have an indication of who long synergies would last and therefore, there could be a charge against the synergies for the amount paid. A challenge to this is that management may not always consider how long the synergies from a business combination may last.

Objective A – Better disclosures

There were a number of views expressed with regard to Objective A, with some Board members viewing the objective of better disclosures as critical. This was on the basis of investors’ feedback regarding the non-availability of financial information for periods after a business combination. The Board discussion encompassed the following:

• The principles from the Conceptual Framework and the objective of general purpose financial statements should be considered when setting the objectives for follow-on work. In particular, information around how company acquisitions create shareholder value and hold management accountable for stewardship was important for investors. As investors were not currently obtaining enough information, more attention was needed in relation to disclosures.
• Providing better disclosures under Objective A could potentially also decrease the cost of other alternatives (i.e. Objectives B–E).
• Qualitative and quantitative disclosures could be improved by disclosure of expected synergies and actual synergies (i.e. has the acquired business met the improved performance as expected?). Disclosures could also be improved to describe the evidence the company has to support the carrying value of goodwill recognised.
• Disclosures are necessary, however in the instance of multiple acquisitions where each transaction has individual facts, there may be a large volume of disclosures required which are onerous. Therefore, in this instance, amortisation of goodwill could be also be useful.
• The requirements to meet Objective A could potentially be viewed separately to other areas of this project.

Further to the above, a Board member discussed that additional information about the acquired subsidiary, such as disclosure of within its own segment or contribution to the business could be useful. The Board member indicated that these disclosures should not be prescriptive as there could be degrees of integration and independence of the acquired entity after the business combination.

Another Board member thought that additional work on disclosures would be relevant, although this may be more costly. The Board member also believed there needed to be a discussion with constituents, in particular in areas of:

• The impairment test could not be improved in a cost effective way and therefore, if this objective is continued, there may be some drawbacks
• Amortisation could potentially be considered further however this only gives an end point to recognition of goodwill
• Whether an immediate write off is appropriate

Objective B—targeted changes to the value in use calculation

One Board member was cautious about Objective B, in particular, that the impairment test was in relation to the asset in its current condition and not in a future condition. Another Board member identified that there is tension between companies that experience organic growth compared to those that achieve growth by acquisition, and that the comparability of the financial statements between these entities is reduced.

Objective C—change in impairment testing model to focus on recoverability of goodwill

This objective brought about diverse views, in particular:

• The impairment testing model provided a useful, but weak signal, about the performance of the business. However, this information was only provided at the time of impairment whereas users are requesting this information on an ongoing basis. A number of other Board members concurred with this view and that by the time the impairment test had been undertaken or an impairment loss recognised, this information was too late for investors. 
• A change in the current impairment testing model would not bring more information than what is available currently.
• The headroom approach would have a benefit exceeding the cost.
• Pursuing an impairment testing model at the lowest possible levels of units without aggregation would conflict with the require requirements of IFRS 8 Operating Segments.

Objective D—retain the current impairment testing model and simplify requirements for goodwill

Retaining the current impairment testing model and simplifying the requirements for goodwill under Objective D received mixed views from the Board.  In particular, the following key views were expressed:

• One Board member discussed that better information was needed in relation to the success of acquisitions and how this interlinked with the impairment of goodwill. The Board member believed that there was still some further thought required in relation to the impairment testing model and either the model needed to be improved, or the test could be simplified.
• Another Board member supported Objective D, however was uncertain around how the impairment test could be simplified.
• One Board member did not agree with Objective D and believed the focus should be on how to improve the accounting for goodwill rather than simplifying the accounting for goodwill. If simplification does occur, this Board member believed that the usefulness of information would decrease.
• Another Board member did not think the amortisation of goodwill should be re-introduced and did not agree with immediate write off of goodwill even though this would be a simpler approach.
• One Board member discussed that the impairment test is in relation to the cash generating unit, but not specifically goodwill. The information around whether the cash generating unit was smaller or greater than the value in use was still helpful. This Board member also indicated that in looking the concepts of amortisation vs impairment, if neither approach worked well, it would be preferable to adopt the option that provided the most information in the least costly manner. It was further clarified that if amortisation of goodwill was reintroduced, this approach would still include impairment.
• A Board member expressed the view that goodwill was a conditional asset, and to retain the balance sheet’s integrity, it was not appropriate to continue to recognise goodwill if it was impaired. This Board member indicated that goodwill amortisation may provide helpful information to the users on the basis that when a business is acquired, management may have an indication of how long additional earnings power from synergies of the acquired business will last. Therefore, allocating an expense to meet extra earnings following a business combination could be useful to some investors.
• One Board member thought the concept of a cash-generating unit could be a problem as companies integrate and move assets around following an acquisition. However, this Board member discussed that there could be a possibility to simplify the asset impairment test on the periphery.
• One Board member approached the discussion from the perspective of the Conceptual Framework, namely starting from the premise that goodwill is an asset. The current accounting model is intended to measure acquired goodwill and to provide subsequent measurement of goodwill. At the time of IFRS 3 implementation, it was acknowledged that there may be a trade-off between faithful presentation and relevance.
• This Board member said that the headroom approach could be a possible solution, however if this approach is found to be not helpful, there may be a need to consider non-recognition of goodwill (i.e. goodwill write-off). The Board member acknowledged that writing off goodwill does not bring information in itself.
• This Board member did not support improving the impairment test at a lower level as this makes tracking the business combination difficult.

Objective E—differences between internally-generated intangible assets and those for intangible assets

Most Board members viewed that Objective E was a project in its own right and required further discussion. One Board member did not think it was appropriate to align internally generated intangible assets and those acquired in a business combination as proposed by Objective E. Another Board member indicated that Objective E should not be written off as it had arisen on application of the requirements of IFRS 3. This Board member referred to research undertaken that highlighted differences in the relevance of net income for entities that undergone business combinations compared to those that did not.

One Board member thought that they could include all objectives for follow-on work, however they needed to agree on the form and content of the consultation paper. The seriousness of the problems would need to be prioritised in terms of what is important to stakeholders. The staff responded that the focus that on discussion paper would be driven from what the Board considered regarding the objectives.

As part of the discussion, the staff clarified on the following items:

• The focus on Objective E was not put internally-generated intangible assets on balance sheet but to focus on differences on the differences between internally-generated intangible assets and intangible assets acquired in a business combination
• The carrying value of cash generating units could potentially be at the segment level which would result in cost savings and play more prominence on the line item of goodwill
• Testing for impairment of cash-generating units that include goodwill are typically tested at an operating segment level, however operating segments themselves do not require an impairment test

One Board member expressed a view that different elements are interlinked and potentially the way forward was to offer a package of different proposals and obtain stakeholder feedback in this regard

Decision

The Board voted on the objectives that they would like to achieve for follow on work. This vote was undertaken in the context of the research undertaken so far and views of investors that the current impairment testing model provided useful information too late.

All 14 Board members agreed with staff recommendation to pursue the objective of identifying better disclosures that would enable investors to assess more effectively whether a business combination is a good investment and the acquired business is performed as expected (Objective A).

12 of 14 Board members agreed with the staff recommendation to pursue changes to the value in use calculations (Objective B).

5 of the 14 Board members wished to pursue the objective of changing the impairment testing model to focus on assessing whether the carrying amount of acquired goodwill is recoverable (Objective C).

Where the Board decided not to pursue Objective C;

• 4 of the 14 Board members would consider requiring an entity to immediately write-off goodwill on initial recognition
• 8 of the 14 Board members would consider reintroducing amortisation of goodwill (if immediate write-off of goodwill on initial recognition was not considered)
• 10 of the 14 Board members would reconsider pursuing possible relief from the mandatory annual quantitative impairment testing

11 of the 14 Board members agreed with the staff recommendation to not pursue the objective of removing the differences between accounting requirements for internally-generated intangible assets and those for intangible assets acquired in a business combination (Objective E).