This article was first published in the April 2016 UK edition of Accounting and Business magazine.

Accounting for goodwill has been the gift that goes on giving for those who like an argument. Everything from the accounting principles to balance sheet values has been subject to controversy. 

I’ve seen goodwill written off immediately after the transaction, flattering return on equity for acquisitive companies. Later, fully amortised, it created spectacular annual charges for acquirers at the height of the dotcom bubble. Then IFRS 3, Business Combinations, came along, splitting acquired intangibles into those with a finite life, which are amortised, and goodwill, which is carried at acquisition cost and tested for impairment annually.

The post-implementation review (PIR) of IFRS 3, by the International Accounting Standards Board (IASB), has reopened the debate. As an agenda paper for the February board meeting said: ‘Stakeholders have always had opposing and strongly held views on accounting for goodwill… and the feedback during the PIR did not provide evidence that this diversity of views has decreased.’ 

IFRS 3 was one of the successes of the IFRS/US GAAP convergence programme, which lends transatlantic support to its preservation. With no consensus on changes to the standard, nothing substantial is likely to happen. But the arguments, in particular over whether to amortise goodwill, have not gone away. 

Those in favour say that all intangible assets erode and that impairment tests involve subjective inputs that are too easy for management to manipulate. A French analyst I know describes DCF (discounted cashflow) valuations as ‘Dis-moi Combien il te Faut’, or ‘tell me how much you need’.

Those against say that when management pays – or overpays – for an acquisition it should be held to account by testing the carrying value for impairment. Amortisation whittles down the valuation indiscriminately, so the cost slips under the radar. Indeed, preparers invite analysts to disregard it in ‘adjusted’ profits. 

Assuming we are stuck with a hybrid treatment of acquired intangibles, other improvements could be made to tackle concerns on both sides. First, impairment tests should be more timely – triggered by an indicator that value has dropped – and the valuation techniques more transparent. This would build on the information we already get in the notes to the accounts and the auditor’s report. 

For example, in Reckitt Benckiser’s annual report for 2014, auditor PwC says: ‘We challenged management on the appropriateness of its sensitivity calculations and also applied our own sensitivity analysis to the forecast cashflows and long-term growth rates.’

Second, analysts should beware of ignoring the amortisation of intangibles with a finite life. As with the depreciation of tangible assets, it represents investment that needs to be replenished. 

Third, and most important, management needs to justify the amount paid for the acquisition. This includes clarity on what the full costs were: for the equity, assumed net debt, fees and restructuring charge. The last of these is related to promised synergies, on which progress should be clearly reported. In the end, shareholders are more interested in return on investment than in the fine lines between different types of intangibles.

Jane Fuller is a fellow of CFA UK and serves on the Audit and Assurance Council of the Financial Reporting Council.