The International Valuation Standards Council (IVSC) has published a series of papers (Perspectives Papers) on the concept of goodwill amortisation, and more specifically on its compatibility with business valuation principles.
The papers are intended to initiate and foster the debate, particularly in a context where the IASB and the FASB are considering changes to the accounting for goodwill, by raising some fundamental issues with the aim of informing financial statement preparers, reviewers, and users.
The first article in the series, Is Goodwill a Wasting Asset? was published in September 2019. The second article, What is the information value of the current impairment framework? was published in December 2019. Finally, the third and last paper, Opportunities for Enhancing the Goodwill Impairment Framework was published in June 2020.
The questions that the IVSC explores in this series of articles are the following
- Is goodwill a wasting asset with a readily determinable life, or an indefinite lived asset? (Part 1)
- What is the informational value of the current goodwill impairment process to users of financial statements and are there practical ways to improve the current test without adding significant cost or complexity? (Part 2)
- What are the wider impacts if goodwill were to be amortised – from accounting considerations to market reactions? (Part 3)
Part 3 – Opportunities for enhancing the goodwill impairment framework
The IVSC suggests potential options to significantly improve the information content of the goodwill impairment framework, while simultaneously reducing cost and complexity as compared to the current framework.
Potential solutions to mitigate or eliminate the effect of internally generated headroom could be to (i) recognise internally developed intangible assets and goodwill, or (ii) test at a lower level. Setting the granularity of the impairment test at the level of each separate acquisition is however considered cumbersome and may be impractical in the longer term as most of the acquired businesses are merged with legacy operations. The IVSC is therefore exploring more direct solutions to account for internally generated headroom:
Step-up Approach
The aim of this approach is to capture the internally generated headroom at the time of the acquisition. This is done either by determining the value of the unit under test and subtracting its carrying amount, or by determining the value of the entire Tested Unit Value and then subtracting the legacy business carrying amount and the purchase price. The IVSC proposes that any impairment be allocated solely and entirely to the goodwill acquired.
Direct value comparison
The incremental approach does not take into account the headroom generated by intangible assets created after the acquisition date. As these post-acquisition intangible assets are not recognised on the balance sheet, the amortisation of the acquired intangible assets creates an artificial headroom over time. A possible solution could be to include an adjustment to the carrying amount that takes into account the accumulated amortisation of the acquired assets after the acquisition and the related deferred taxes.
However, the IVSC considers that a more intuitive and less costly method to apply would be a direct value comparison. Under this approach, at each testing date, the value of the Tested Units would be compared to the static value of the Tested Units at acquisition. As long as the value of the Tested Units is greater than or equal to the value at acquisition, no impairment is recognised. The IVSC considers that direct comparison of value would reduce the overall costs and complexity of the impairment test as it would eliminate the need to determine the carrying amount of the Tested Units at each testing date.
The triggers for impairment testing should be more directly linked to the same key performance indicators, criteria and information provided at the time of acquisition regarding the expected performance of the acquisition:
Financial metrics
- deal metrics including EBITDA or the internal rate of return on a transaction, which can be compared to the company’s cost of capital to determine whether the transaction is likely to enhance the overall value of the company.
- Projected financial information such as revenue growth, expected margin expansion, capital expenditure, synergies and long-term growth and margin assumptions. Preparers and reviewers spend significant time developing and reviewing this data, which is only minimally disclosed to investors. Although preparers currently disclose little, if any, of this information, its systematic disclosure can provide investors with valuable information for assessing the value creation of transactions. However, the IVSC recognises that full disclosure of these measures could reveal competitive information.
- Key performance indicators which may be internal or sector-specific. IVSC considers that more disclosure of these KPIs that were used to assess the deal would provide investors with key insights with which to independently prepare financial models to assess intrinsic value.
The current Tested Unit structure is not very informative
Mandatory disclosure of key information about the units tested (i.e. is the acquisition included in an existing Tested Unit or tested as a standalone? If combined with legacy operations, what other assets and activities are included in this Tested Unit? their relative size or weight? the level of headroom existing in the Tested Unit…) would provide useful information for decision making in assessing various aspects of the transaction, including statements on expected synergies.
Information on goodwill
This would inform investors about how the company plans to create and sustain value creation beyond the life of the identified tangible and intangible assets.
The article suggests that the key performance indicators identified and communicated by management at the time of acquisition should form the basis of the impairment triggers. For example, in the periods immediately following the acquisition, actual performance should be compared to the forecast financial information determined at the time of the acquisition to see whether expectations have been met.
Where the goowill is impaired, the paper suggests that the cause of the impairments should be disclosed, together with the indicator that triggered the impairment test and details of how the indicator is below expectations.
In conclusion, the IVSC believes that the above suggestions represent viable options that not only significantly improve the information content of the goodwill impairment framework, but also simultaneously reduce the cost and complexity compared to the current framework.
While the IVSC does not recommend the exact information that should be disclosed at acquisition, whatever information is disclosed should form the basis of the impairment test triggers.
