Counterpoint: Recognition and subsequent measurement of goodwill

07 April 2016

There are questions that divide any room full of accountants. Threshold questions like the meaning of prudence, balance of recognition criteria for assets and liabilities, recycling from OCI (is it a parking lot or an elephant’s graveyard?), debt versus equity, etc. The accountants in the room might not be able to agree on one answer without using swords. We are planning a series of blogs on these questions, putting forth both sides of the argument in a verbal battle.

This week Guillaume Debout and Anna Schweizer from UK ACS see what arguments could be brought up for either side on goodwill: Is it an asset? And does the impairment-only approach work?

Pro impairment-only approach – by Guillaume Debout

Goodwill represents a payment made by an acquirer in anticipation of future economic benefits from assets that are not capable of being individually identified and separately recognised. As such it is a debit which should be taken either to the balance sheet (asset) or to the statement of comprehensive income, but cannot be recorded directly as a movement in equity as it does not involve a transaction with owners. The view is that if a rigorous and operational impairment test could be devised, more useful information would be provided to users of an entity’s financial statements by recording this debit on the asset side as “goodwill”, than by taking it to the income statement over a systematic period (and effectively “hiding” it in equity immediately or over time). The model in IAS 36 was seen as a sufficiently rigorous and operational impairment test (keeping in mind that the purpose of this week’s question is not to debate whether IAS 36 is “good enough” or whether accountants are doing a good job in applying it!).

Clearly an approach which relieves companies from the risk of having to book an impairment when things go wrong (as they frequently do following business combinations) would have the favour of management teams generally unwilling to disclose bad news to their investors, but it would reduce the level of information available for the readers of the financial statements. As a result, some investors support the impairment-only approach, as the current requirements help them to assess the stewardship of the management and to verify whether the results post combination are in line with expectations. The information provided by the impairment test of goodwill is usually considered useful (assuming the information is actually provided in line with the requirements of the standard and we all know this is not always the case but that is another problem).

This is in line with the Board’s discussions leading to the adoption of IFRS 3. The board felt that amortisation of goodwill over a systematic basis produces data that is meaningless, and perhaps even misleading, and thus fails to provide useful information. Under IAS 22 the rebuttable presumption was that this useful life of goodwill should not exceed twenty years from initial recognition. However, the useful life of acquired goodwill and the pattern in which it diminishes generally are not possible to predict, yet its amortisation depended on such predictions. The intention was to achieve an acceptable level of reliability in the form of representational faithfulness while striking some balance with what is practicable.

An amount amortised in any given period can be described at best as an arbitrary estimate of the consumption of acquired goodwill during that period. The Board remained doubtful about the usefulness of an amortisation charge that reflects the consumption of acquired goodwill, when the internally generated goodwill replacing it is not recognised.

Contra impairment-only approach – by Anna Schweizer

Where to start… *sigh*

Definition of an asset

The current debate around goodwill focuses on what to do with it once it’s on the balance sheet – however, shouldn’t the question rather be whether goodwill really is an asset that deserves to be recorded in the first place? The Conceptual Framework ED 2015 defines an asset as ‘a present economic resource controlled by the entity as a result of past events.’

Goodwill is the residual between the consideration paid for a business combination and the fair value of the (revalued) net assets acquired. Most acquirers assert that the purchase of a business leads to future economic benefits. But is this also true for goodwill itself? See more here.

Empirical evidence

Since the introduction of the impairment-only approach numerous studies have been performed. Amongst other things they have yielded the following:

  • Firms may delay necessary impairment. Even in countries with strict enforcement impairment decisions appear to be influenced by managerial and firm-level incentives, including preferences for smooth earnings (see more here).
  • Discretion in the reporting of goodwill impairment losses and big bath and smoothing strategies are influencing the decisions whether or not to impair goodwill and about the magnitude of the impairment (see more here).
  • Growth rate manipulation is a significant explanatory variable in avoiding or reducing the amount of the impairment write-off (see more here).

This fractional selection of academic work implies that the IAS 36 model is not ‘rigorous’.

Current IASB research project

The post implementation review of IFRS 3 reinforces some of these findings (see more here): The current impairment model is not effective in identifying impaired performance of areas of the business (cash-generating units) to which goodwill has been allocated. In particular, the reporting of accounting impairments is perceived as slow relative to the related economic impairment.

Some investors would prefer the re-introduction of the amortisation of goodwill, based on the following main reasons:

  • goodwill acquired in a business combination is supported and replaced by internally generated goodwill over time;
  • estimating the useful life of goodwill is possible and is no more difficult than estimating the useful life of other intangible assets;
  • goodwill has been paid for and so, sooner or later, it should have an impact on profit or loss;
  • amortising goodwill would decrease volatility in profit or loss when compared to an impairment model; and
  • amortising goodwill would reduce pressure on the identification of intangible assets.

Switzerland – the special case

Under the rules of SIX Swiss Exchange entities listed in Switzerland have an additional choice: Aside from US GAAP or IFRS they can apply Swiss GAAP FER. Under this standard goodwill can either be amortised over a maximum of 20 years or else offset against equity. At least two large listed entities who have recently switched to Swiss GAAP FER have chosen to offset their existing goodwill against equity when they changed their reporting standard. Would more entities make that choice if they had the chance?

Next steps?

The IASB and the FASB are assessing improvements to the impairment model and subsequent accounting for goodwill as part of the goodwill/impairment research project. Which one is the right way forward in your opinion?


Comments on the issue are as follow:
1. We have travelled so much in developing different guidelines on goodwill recognition and measurement and in doing so we reached to a major conclusion that internally generated goodwill should not be recognized.
2. In my opinion we should go for the amortization of goodwill on the basis of arguments given below.
3. Goodwill is the difference between the consideration paid and the portion of the fair value of subsidiary’s net assets acquired. Definitely the extra amount someone or parent company is paying is for the extra future economic benefits that will flow towards the entity and that’s why goodwill should be treated as an asset.
4. Generally those extra future economic benefits gradually fade out with the passage of time. And if those future economic benefits are not fading out this is not because of the contribution of original goodwill that we recognized at the time of subsidiary’s acquisition but because of internally generated goodwill created subsequent to acquisition.
5. In IAS 38, we have an understanding that an entity should not recognize the internally generated goodwill.
6. So if we agree with the argument that goodwill created on the date of acquisition is generally fades out with the passage of time, we should also reflect that in the financial statements by amortizing goodwill on some systematic basis.
7. As far as impairment of goodwill is concerned, when we are making calculations for the impairment testing of goodwill and comparing carrying amounts with the recoverable amounts we are in a way recognizing internally generated goodwill. This is because at the date of impairment testing the recoverable amount includes in it the effect of those extra future economic benefits which are arising not because of the extra amount we had paid in the name of goodwill at the date of acquisition but because of the internally generated goodwill we have created subsequent to acquisition.
8. So my concluding remarks are that goodwill should be amortized on some systematic basis over the period of time. However, if due to some objective evidence goodwill need to be tested for impairment, it should be tested and if require reduced accordingly.

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