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 2 – Information Value of the Current Impairment Test : Leading or Lagging Indicator ?
As concluded in the first Perspective Paper, goodwill is a non-wasting asset.
Although the existing goodwill impairment framework provides financial users with a range of valuable information (both quantitative and qualitative), impairments do not appear to consistently serve as a leading indicator of future cash flows and returns.
This 2nd IVSC paper examines four potential reasons for the main criticism that impairment testing often fails to identify impairments in a timely manner, or at all :
- Impairment Shielding: the purchased business and related goodwill are in most cases embedded in an existing Cash Generating Unit (CGU). Therefore, the acquired goodwill is only impaired once the internally created goodwill has been exhausted. In the event of a business downturn, the internally created goodwill creates a buffer that protect the impairment of the acquired goodwill;
- Artificial headroom resulting from the amortisation of certain acquired intangible assets while new intangibles are not recognised on the balance sheet. Amortisation of intangible assets has a greater tendency to shield impairments as time passes, thus leading to decreased information value of goodwill.
- A review of the impairment triggers cited in the accounting standards shows them to be overely broad and mainly focused on external market and industry conditions. In some cases, such as share prices, the triggers themselves are a lagging indicator;
- Behavioural considerations – reluctance to implement impairment tests. Experience shows that goodwill impairments are usually accompanied by a change in management, overall strategy and/or a decision to restructure or sell all or part of an acquired business. The individuals responsible for conducting and overseeing the goodwill impairment process are also, in most cases, part of the investment evaluation and decision process. As such, these individuals may have an inherent bias, thus raising a potential conflict of interest.
In the third article of the Perspectives Papers series, the IVSC then discusses some practical solutions to improve the current goodwill impairment framework.
