Goodwill and Impairment (Agenda Paper 18)

Background

The Board is assessing whether it could improve the accounting for goodwill. The Board plans to publish a discussion paper in the second half of 2019, with a view to potentially amending IFRS 3 and IAS 36.

The staff plan to ask in the July 2019 Board meeting for permission to begin the balloting process for a Discussion Paper. The staff expect that the Discussion Paper (DP) will be ready for publication towards the end of 2019.

At this meeting the staff asked the Board to decide which preliminary views it wishes to express in the DP. The staff worked through six agenda papers (AP 18A-F) asking the Board to make decisions about preliminary views related to the topics covered in those papers. Because all of the topics have been discussed at previous meetings the staff have indicative decisions which they have used to summarise the package of (likely) preliminary views (AP 18G).

In this summary, we highlight the preliminary views being recommended by the staff for each of the six topics.

Better disclosures for business combinations (AP 18A)

This paper was discussed at the April and May 2019 meetings. At this meeting the staff are recommending that the Board confirm its preliminary views about improving the disclosure requirements in relation to business combinations.

Staff recommendations

The staff recommend that the Board propose

• (a) Three additional disclosure objectives so that the requirements in IFRS 3 are also to provide information about the strategic rationale for the business combination, to understand the amount and rationale for the total consideration paid and to evaluate the extent to which the key objectives of the combination are being achieved.
• (b) New requirements to disclose:
  • i. The strategic rationale for undertaking the business combination, such as how the acquisition links to the acquirer’s business strategy; and the main objectives of the business combination and the targets management expect to achieve.
  • ii. What measures the management plans to use, in future internal reporting, to assess the extent to which the key objectives of the business combination are being achieved;
  • iii. The amounts of those measures, in the acquisition year, the next two annual periods and then for as long as the entity concludes that this information is still necessary for users to fully assess whether the main objectives of the business combination are being achieved.
  • iv. If the entity no longer measures or assesses this information or the measures change, that fact and the reasons (the new measures if relevant).  
  • v. If an acquirer’s management does not assess the extent to which the key objectives of the business combination are being achieved, that fact and the reasons for not assessing.
  • vi. Information about synergies: a description of them, where they are expected, when they expect to achieve them and the amount (or range) of the synergies and the expected costs (or range) to achieve them.
  • vii. The amounts recognised at the acquisition date for each major class of identifiable assets acquired and liabilities assumed
  • viii. The acquiree’s amounts of revenue, operating profit or loss before acquisition-related transaction and integration costs, and cash flow from operating activities, since the acquisition date, included in the consolidated statement of comprehensive income and consolidated cash flow statement for the reporting period
• (c) Using a Chief Operating Decision Maker (CODM) approach for the measures the management plans to use, in future internal reporting, to assess the extent to which the key objectives of the business combination are being achieved (i.e. they are measures reported to the CODM).
• (d) Replacing IFRS 3: B64(q)(ii) with a requirement to provide additional information to allow users to understand the full-year effect of the business combination when a business combination occurs close to the end of the reporting period (or when a business is highly seasonal).

Board Discussions

The Vice-Chair sought clarification of how the CODM approach works, because there was no mention of them in relation to the key objectives, which refers to management. The staff confirmed that the key objectives relate to the information and monitoring that will be undertaken by the CODM. Feedback from the joint Global Preparers Forum (GPF) and Capital Markets Advisory Committee (CMAC) meeting was that removing the pro-forma information from the requirements is likely to elicit a strong response from investors. Board members wanted the questions to cover this specific point.

One Board member stressed that she sees the information being requested as a necessary part of the financial statements. One member was concerned that CODM focus might mean the information is at too high a level because users have perception of materiality that is lower than the CODM’s level of review. The questions in the consultation should try to draw out enough information to help the Board assess whether the proposal will lead to the right level of information. 

Board decisions

The Board decided:

• a) to include a preliminary view that the disclosure objectives and requirements to provide information about the strategic rationale for the business combination, to understand the amount and rationale for the total consideration paid and to evaluate the extent to which the key objectives of the combination are being achieved should be added to IFRS 3 (unanimous)
• b) to include a preliminary view that the disclosure requirements would use a CODM approach for the measures the management plans to use, in future internal reporting, to assess the extent to which the key objectives of the business combination are being achieved (i.e. they are measures reported to the CODM). (12:2)
• c) not to include a preliminary view that IFRS 3:B64(q)(ii) be replaced with a requirement to provide additional information to allow users to understand the full-year effect of the business combination when a business combination occurs close to the end of the reporting period (or when a business is highly seasonal) (5:9) but include it in the Discussion Paper as an idea that was considered but rejected, for stakeholders to comment upon. (13:1)

Reintroduction of amortisation of goodwill (AP 18B)

Analysis

In December 2017 the Board had decided tentatively not to reintroduce amortisation. This decision was based on the staff’s research which concluded there were no new arguments to support the reintroduction of amortisation of goodwill (see Agenda Paper 18B for the December 2017 Board meeting). At this meeting the staff will recommend that the Board confirm that decision.

Staff recommendation

The staff recommend that the Board confirm its preliminary view not to reintroduce amortisation.

Additional analysis

The staff are less sure about the Board’s likely decision. The staff have therefore included in AP 18G two sets of preliminary views, one confirming not reintroducing amortisation and one reintroducing amortisation.

To support the decision the staff have set out a summary of the arguments for the competing views.

In paragraph 42 of the paper the staff set out arguments offered in support of reintroducing amortisation. In summary they are:

• (a) Feedback from the post-implementation review (PIR) of IFRS 3 is that the impairment test is costly and complex, does not recognise impairment losses on a timely basis and provides only information of confirmatory value.
• (b) Feedback from the PIR of IFRS 3 suggests that the decision to change the subsequent accounting for goodwill from an amortisation model (with an impairment test) to an impairment-only approach might not meet a cost-benefit test if one was performed today.
• (c) Any loss of information to users of financial statements by reintroducing amortisation would be mitigated by the new disclosures the Board is considering (at this meeting).
• (d) The purpose of the subsequent accounting for goodwill should be to reduce the carrying amount of acquired goodwill.
• (e) The Board’s work on the ‘headroom approach’ has highlighted more clearly the shielding effect of unrecognised headroom, which could result in goodwill being overstated.
• (f) Retaining acquired goodwill on the statement of financial position may mislead users into thinking that the business combination continues to be a success in cases when it may actually have failed.
• (g) Amortisation would reduce the pressure on the impairment test.
• (h) Amortisation reduces the carrying amount of acquired goodwill and reduces the likelihood of an overstatement arising and thus is an appropriate response to the ‘too late’ issue.

Paragraph 43 of the paper summarises the arguments offered in support of an impairment-only approach. In summary they are:

• (a) The Board’s work has confirmed conclusions the Board reached in 2004 that it is not possible to measure the acquired goodwill directly post-acquisition, nor to amend the impairment test to target acquired goodwill in isolation;
• (b) The purpose of the impairment test should continue to be to ensure that the carrying amount of the assets (including goodwill) in a CGU does not exceed the recoverable amount of that CGU.
• (c) The carrying amount of acquired goodwill is recoverable from the cash flows of the cash-generating unit to which it contributes. It does not generate cash flows independently and the purpose of the impairment test is not to test the acquired goodwill directly;
• (d) The Board was aware of the shielding issue in 2004 when it developed IFRS 3 (and revised IAS 36), The feedback from the PIR and evidence obtained confirms the Board’s expectations.
• (e) Although, in principle, it would be appropriate to amortise acquired goodwill over its useful life, it is not possible to estimate the period or pattern of consumption in any reasonable way. Any amortisation expense would be arbitrary and will not provide useful information to users of financial statements. The information provided by the impairment-only approach is more useful for users (despite its limitations) than information provided by an amortisation model.
• (f) Other changes the Board is considering should reduce the cost and complexity of the impairment test.
• (g) An impairment test would still be necessary if amortisation was reintroduced.
• (h) The purpose of the test is not to determine whether a business combination has been a success or not.
• (i) Reintroducing amortisation does not solve the ‘too late’ issues allegedly caused by problems with the impairment test such as management optimism.

The staff make extensive references to the Australian Accounting Standards Board (AASB) Research Report Perspectives on IAS 36: a case for standard setting activity. (https://www.aasb.gov.au/admin/file/content102/c3/AASB_RR09_03-19Impairment_1552539258244.pdf) The report was written, under the direction of the AASB, by two staff members from Deloitte Australia. The report was discussed at a meeting of the Accounting Standards Advisory Forum (ASAF). The staff intend to summarise the ASAF meeting minutes and the AASB research for inclusion in the DP.

Board discussion

This paper was the most heavily debated paper during the session.

One Board member complimented the paper, but said he disagreed with the conclusion. He claimed that the PIR is the last chance to go back the original accounting of amortisation and that the Board should not hesitate to go back. He claims that impairments are only made when there is a change in CEO. He also claims that an impairment-only model is pro-cyclical and could accelerate a financial crisis.

The Chairman acknowledged that the previous Board was aware of the shielding factor but did not see it as being as big a problem. He thinks the analysis was eye-opening and has concluded that amortisation should be restored. He said that goodwill is a wasting asset and not showing wasting in the income statement is an informational deficiency. He thinks the income statement is inflated and that consumption sometimes gets labelled as impairment. It would allow more intangibles to be subsumed into goodwill because they can then be amortised, which will reduce costs. It is not perfect but gets rid of the problem of “too little too late.”

In response, a member thought the paper was balanced and that is how the Discussion Paper should be presented. He prefers not to express a view. He also thinks that a section should ask how people view goodwill—is it a wasting asset or an indefinite lived asset? This is important to seeing whether amortisation or impairment is the natural solution.

Other Board members supported the staff paper and its recommendations. One member said that he had spoken to a lot of investors—equity investors are polarised but that the vast majority are against amortisation; credit investors view goodwill amortisation or impairment as irrelevant them; and credit reference agencies (which rate smaller entities) focus on tangible net worth. The investors he spoke to seem to weigh in favour of not reintroducing amortisation. Personally he supported that view and also noted that the costs of maintaining goodwill are expensed.

Some members emphasised that the Board should have a compelling reason for changing. The evidence is not there to say it is broken and they therefore support the staff recommendation. The Vice-Chair questioned the foundations of the evidence of ‘too little too late’ and said that the existence of goodwill on a balance sheet was not evidence of failure. But the Board should also be wary of having a dream that is unachievable. It is the arbitrary nature if amortisation that swings her to an impairment-only model.

One of the members who supported the reintroduction of amortisation thought it was an appropriate response to the PIR and that they have new information to support that response and the Board has not identified a way to improve the test. Another member said that an impairment only model does not work and that the model “is broken.” He thinks the cash-generating unit (CGU) approach is a problem. Because goodwill is identified separately it supports reintroducing amortisation. Others disagreed, for varying reasons. One described goodwill as a “fake asset.” One thought the IASB was leading people into an ideal world rather than the real world.

One member said that views are clearly divided. The IFRS for SMEs Standard amortises goodwill and many members of the emerging economies group would prefer to keep amortisation. But they also support IFRS 3 and say that it is conceptually sound. The DP should seek feedback on amortisation rather than express a preference. Several Board members emphasised that this is about change management and the Board must have very clear communication. Acknowledging that there are split views the Board needs to be very disciplined and seek input on how to improve the model.

A staff member said that the objective of the subsequent measurement of goodwill needs to be as concise as possible.

The Chairman said that the Board should not be wishy-washy but should send a clear message that reflects the majority decision.

Board decision

The Board decided by a vote of 8 to 6 to confirm its preliminary view not to reintroduce amortisation and to retain an impairment-only model.

Presentation of total equity before goodwill subtotal (AP 18C)

In April 2019 some Board members said that a suggestion to require a sub-total on the statement of financial position highlighting tangible net worth should be investigated further. The Board discussed this again in May 2019 with the staff suggesting the Board consider requiring the disclosure of either total assets before goodwill, less total liabilities or total equity before goodwill either as a natural subtotal on the face of the Statement of Financial Position, in a footnote or as a “free-standing disclosure, on the face of the statement of financial position.”

The Board did not reach a consensus on this matter. Accordingly at this meeting the staff are asking the Board to either reach a preliminary view or indicate whether it should, instead, include a more open discussion in the DP.

Questions for the Board

Does the Board want to include a preliminary view in the Discussion Paper that a subtotal of total equity before goodwill be presented in the statement of financial position? If not, does the Board want to include in the Discussion Paper a brief discussion of the various presentations considered in this paper to obtain feedback from stakeholders with no preliminary view expressed?

Board discussion

The Chairman opened the discussion by saying that, in the light of the discussion about goodwill impairment, he was doubly motivated for this disclosure and that it would provide two views to investors. It was telling that the credit reference agencies look at total tangible net worth. 

A member responded saying he was not in favour. It gives the wrong impression and implies too much about the resulting equity number and implies that you should use the information including goodwill “at your peril.”

A member pointed out that the Board has already decided to separate goodwill from other intangible assets in the Primary Financial Statements project and this provides users with the ability to create their own sub-totals.

Another Board member wanted some other intangible assets such as non-contractual rights also separated.

Board decision

The Board decided by a vote of 11 to 3 to include a preliminary view in the Discussion Paper that a subtotal of total equity before goodwill be required to be disclosed.

Relief from mandatory annual impairment test (AP 18D)

The Board discussed this topic at its meeting In May 2019. At that meeting the Board indicated support for providing relief from mandatory annual impairment testing. Specifically, the tentative preliminary view was that the Board should propose removing the requirement to carry out an annual quantitative impairment test for goodwill and for intangible assets with indefinite useful lives or not yet available for use regardless of whether there is an indication of impairment. Instead such a test would be required only if there was an indication of impairment.

The paper includes some potential indicators the Board might want to consider adding into IAS 36, including some indicators used in the FASB’s Accounting Standards Codification.

Staff recommendation

The staff recommend that the Board confirm its preliminary view to remove the requirement to undertake a quantitative impairment test annually and instead move to an impairment-indicator approach. This would apply to goodwill and intangible assets with indefinite useful lives or not yet available for use.

Board discussion

The first Board member to speak said she wanted to understand what the cost savings are likely to be from not doing an annual test.

Several Board members expressed support for the change, because it would likely reduce costs significantly. They said that the Board should not force unnecessary tests onto entities. One member mentioned a Duff and Phelps study that entities that use the indicator test are more likely to recognise an impairment than those that do not use the expedient.

One member said that entities should be required to reach a positive conclusion that they do not need to do a test, rather than only reacting to indicators that become obvious. In other words, you need a basis for believing the amount is recoverable. A member noted that documentation to support the assessment was likely to be required.

Not all Board members supported moving away from a mandatory test, particularly given the decision not to reintroduce amortisation. Several members expressed concerns, with one describing impairment-only and removal of a mandatory test as ‘disastrous’. Another described the message as “atrocious.”  Another member was unconvinced that costs will be reduced significantly.

Another member reminded the Board that it was not making a firm proposal but was seeking feedback.

Board decision

The Board decided by 8 votes to 6 to confirm its preliminary view to remove the requirement to undertake a quantitative impairment test annually and instead move to an impairment-indicator approach. This would apply to goodwill and intangible assets with indefinite useful lives or not yet available for use.

Value in use—cash flows from a future restructuring or a future enhancement (AP 18E)

At its January 2018 meeting, the Board tentatively decided to consider removing the requirement for an entity to exclude from the calculation of value in use those cash flows that are expected to arise from a future restructuring or from a future enhancement. The staff state that the basis for the proposal is that the change would mean value-in-use would:

• (a) capture value from the potential of the asset or CGU rather than from the asset in its current use and condition;
• (b) adopt the same unit of account for value in use as is used for fair value less costs of disposal;
• (c) avoid applying a liability recognition criterion that is not pertinent to the measurement of an asset; and
• (d) avoid applying a rule perhaps intended to avoid unjustifiably optimistic assumptions. Preventing unjustifiably optimistic assumptions is more appropriately addressed by auditors or securities regulators.

When the Board reached its tentative decision, some Board members were concerned that simply removing the existing restriction could risk an increase in the use of unjustifiably optimistic inputs in estimating value in use. Others have expressed that concern in outreach and meetings with advisory groups. The staff are therefore proposing that the Board propose a threshold for including cash flows from future restructurings or enhancements. They would also require information about future uncommitted restructurings if the entity would otherwise have recognised an impairment from continuing to use the asset without those enhancements. 

Staff recommendation

The staff recommend that the Board:

• (a) confirm its preliminary view to remove the requirement to exclude from the calculation of value in use cash flows that are expected to arise from a future restructuring or enhancement; and
• (b) in response to concerns about unjustifiably optimistic cash flows estimates being used:
  • i. set a ‘more likely than not’ threshold for the inclusion of cash flow projections associated with future restructurings or future enhancements; and
  • ii. require qualitative disclosures about future restructurings to which an entity is not yet committed and future enhancements of an asset which are yet to occur?

Board discussion

A Board member said that he did not understand the threshold of more likely than not versus the level of commitment required by IAS 36. The staff clarified that entities have to meet the IAS 37 threshold, which is a high level of commitment.

Several members support proposing the change but not with a threshold. They also thought the proposed disclosure would be boilerplate. Some of the discussion was on a concern that the estimates should be based on reasonable and supportable information. A Board member pointed out that this is already the requirement in IAS 36.

Some members supporting the change were concerned that this is moving in the opposite direction in terms of the goodwill test, because it could reduce the likelihood of an impairment being recognised. One Board member, who did not support the change, thought it was a dangerous proposal and claimed that auditors could not challenge the assertions of management.

Board decision

The Board decided:

• a) By 12 votes to 2 to confirm its preliminary view to remove the requirement to exclude from the calculation of value in use cash flows that are expected to arise from a future restructuring or enhancement; and
• b) In response to concerns about unjustifiably optimistic cash flows estimates being used:
  • i) Not to set a ‘more likely than not’ threshold for the inclusion of cash flow projections associated with future restructurings or future enhancements, with only 2 members supporting this recommendation;
  • ii) Nor to require qualitative disclosures about future restructurings to which an entity is not yet committed and future enhancements of an asset which are yet to occur, with only 2 members supporting this recommendation.

Value in use—use of post-tax inputs (AP 18F)

When the Board discussed this paper in January 2018 it tentatively decided that DP include a preliminary view that the requirement to use pre-tax inputs and a pre-tax discount rate to calculate value in use be removed. The staff consider that the explicit requirement to use pre-tax cash flows complicates the measurement of value in use. This would be replaced with a requirement to use internally consistent assumptions about cash flows and discount rates when estimating value in use. The discount rates used would need to be disclosed.

Staff recommendation

The staff recommend that the Board:

• (a) confirm its preliminary view:
  • to remove references to pre-tax cash flows and discount rates;
  • require, instead, the use of internally consistent assumptions about cash flows and discount rates; and
  • require disclosure of the discount rates used.
• (b) include in the DP a brief discussion on whether there is a need for guidance on how to avoid ‘double counting’ of the tax cash flows, when the tax cash flows included in the measurement of deferred tax assets or deferred tax liabilities are also included in the recoverable amount of an asset.

Board discussion

One member said that he supported part (a) of the recommendations but that the Discussion Paper seemed to be large enough without adding a discussion about potential double counting. The immediate reaction of other Board members indicated agreement with this position and the Board went straight to a vote.

Board decision

The Board decided unanimously to:

• a) Confirm its preliminary view:
  • To remove references to pre-tax cash flows and discount rates;
  • Require, instead, the use of internally consistent assumptions about cash flows and discount rates; and
  • Require disclosure of the discount rates used.
• b) But not to include in the DP a brief discussion on whether there is a need for guidance on how to avoid ‘double counting’ of the tax cash flows, when the tax cash flows included in the measurement of deferred tax assets or deferred tax liabilities are also included in the recoverable amount of an asset.

Preliminary views (AP 18G)

This paper summarises the preliminary views anticipated by the staff on the basis of earlier Board discussions.

Question for the Board

Does the Board support incorporating the preliminary views in the DP?

Board discussion

The staff focused on the package in the paper that assumed the Board would support a continuation of the impairment-only model.

A Board member started the discussion by asking why they were being asked consider the package as a whole, having made decisions on individual items and what would happen if they do not support it. The Vice-Chair said it was to make sure Board members thought the package as a whole justified changing the requirements. She indicated that she had supported the package.

The Chairman said he does not like the overall package and that it will be difficult to sell. Most of the members who expressed concerns about the package had supported reintroducing amortisation, with one saying it was a “very poor package.” Several members expressed support for the overall package.

A member said that it was not about winners and losers, but communicating how the Board got to this position. The Board needed to show leadership. Others agreed and that the document should explain why the Board thinks the package is an appropriate response to the PIR. It should be clear to those responding to the Discussion Paper that if they indicate that they do not support amortisation that they at least understand the consequences.

One Board member said that she saw no benefit in voting or presenting this as a package because she thought that step will not help the discussion. Respondents will focus on individual decisions.

The Chairman decided that no vote was necessary.  

Board decision

No vote was taken.