An IASB discussion paper on goodwill and impairment reveals the problems investors have in assessing subsequent performance, says Adam Deller
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This article was first published in the July/August 2020 China edition of Accounting and Business magazine.
It may not be thought of as the traditional season of goodwill, but those of us working and living in the exciting bubble of financial reporting can expect to hear a lot about it in the coming months. In addition to the inevitable discussion over potential impairments linked to Covid-19, the International Accounting Standards Board (IASB) has released a discussion paper relating to the accounting for goodwill and impairment.
Accounting for goodwill is a topic that has never really disappeared from the IASB’s to-do list, and the discussion paper has arisen as the result of the post-implementation review of IFRS 3, Business Combinations, which examined whether the standard was working as intended. The discussion paper has two major areas: improving disclosures about acquisitions, and subsequent accounting for goodwill. This month, this column will focus on the proposals around the disclosures relating to acquisitions.
The IASB’s research revealed that many investors often have difficulty assessing the subsequent performance of an acquisition. They say it would be helpful to know what management’s objectives for acquiring the business were. In addition to that, they would like to see if these are being met.
Currently, users may get information about subsequent performance from the requirement in IFRS 3 to disclose the revenue and profit or loss from the acquired business from the acquisition date until the end of the period. In addition, the entity is required to present the revenue and profit or loss of the combined entity as though the acquisition date had been at the beginning of the annual reporting date.
There is no proposal to change this information, other than the consideration replacing profit or loss with ‘operating profit before acquisition-related costs and integration costs’. While operating profit isn’t currently defined, there is another IASB exposure draft that proposes a definition of the term, and the IASB believes this would be a useful figure for investors to see.
Investors may also get information about the success of the investment from the impairment test applied to goodwill, but this is likely to only provide limited information. A company not impairing goodwill does not necessarily mean that the acquisition has been a success. Likewise, recording an impairment could have arisen from external factors rather than disappointing performance from the acquisition.
The preliminary view of the IASB is that IFRS 3 should be amended to add disclosure requirements about the subsequent performance of an acquisition. This would help investors to hold management to account.
Currently, IFRS 3 requires a company to disclose the primary reason for an acquisition, but this is unlikely to be specific enough to give investors what they desire. The IASB proposes that this be replaced with the requirement to disclose the strategic rationale for undertaking an acquisition, and management’s objectives for the acquisition at the acquisition date.
In addition, the IASB is proposing a new requirement to disclose the metrics used to assess the performance of the acquisition. This is possibly the most contentious and interesting proposal in relation to these disclosures. These metrics could be financial or non-financial, but specific enough for it to be possible to verify whether the objectives are being met.
The information produced would not give management a free choice of disclosing what they want. They would be required to disclose whatever is used by the company’s decision-makers in monitoring the success of an acquisition. This information may differ from that provided by other companies, but comparability is not the major aim of this change. Rather, the reasoning would be to give the users more specific information about the acquisition.
In terms of which acquisitions this would relate to, the IASB proposes that this is done in a similar way to IFRS 8, Operating Segments, where the entity discloses all the ones monitored by the chief operating decision-maker.
Some responders stated that the performance of an acquisition may stop being monitored over time as it becomes integrated into the company. The proposal is that disclosures are made for as long as the metrics are being monitored. The firm can cease the disclosures when the performance is no longer monitored, as long as it discloses why they ceased monitoring the acquisition.
Similarly, some preparers stated that the metrics used may change over time. The IASB does not propose specifying any metrics to use, acknowledging that there is no such measure that should be utilised broadly by all companies. The metrics to be disclosed should be those that the company uses to monitor the performance. The IASB recognises that certain metrics may well become irrelevant over time, particularly if the company is reorganised. Companies will not be simply able to change the metrics they disclose each year but must explain why they have stopped using certain measures. Otherwise, companies could simply change the metrics used and use this to mask poor performance.
A large and obvious concern raised by preparers related to the release of commercially sensitive information. While there is clear validity in this, some investors have suggested that the information they need to understand the aims of the acquisition and hold management to account need not be overly detailed and precise. The IASB’s view is that commercial sensitivity is not a sufficient enough reason to prevent useful information from being disclosed.
This concern was particularly noted in one further proposal made by the IASB. This suggests that there should be additional disclosures in the year of acquisition relating to the synergies expected from combining the business. The proposal is that the company discloses a description of the expected synergies, when they are expected to be realised, the estimated amount of synergies and estimated costs to achieve these.
The IASB does not intend this to include detailed plans on how companies intend to realise the synergies, but recognises that this is another key way to determine the success or otherwise of an acquisition. Other concerns raised stated that such synergies are often difficult to quantify. It is the belief of the IASB that management will have already made such an estimate in determining the purchase price for an acquisition and obtaining shareholder approval. The proposal is that a range of values could be provided for the synergies, rather than a single specific amount.
Overall, these changes will be significant if implemented. It is hoped that they will not result in significant additional costs for preparers, as they are based on information that is already monitored by the company. If the proposals go ahead, it is very likely that the additional information will prove popular with users but less popular with preparers.
The comment period on the discussion paper has been extended to December 2020, and the IASB is particularly interested in hearing views on whether or not these proposals would lead to more useful information. It believes that the benefits of producing such information will outweigh any additional costs incurred in its production but it is looking to hear from investors, preparers and auditors to enable the project to move forwards.
Adam Deller is a financial reporting specialist and lecturer.
CPD technical article
"Commercial sensitivity is not a sufficient enough reason to prevent useful information from being disclosed"