Goodwill is an asset arising from a business combination when a company obtains control over a business paying an acquisition purchase price that is greater than the value assigned to the identifiable net assets of the acquired business. Although it is recognized as an asset that represents future economic benefits arising from an acquisition, goodwill is not separable from other assets of the business unlike identifiable assets. Under IFRS, goodwill is not subject to amortization but is instead subject to an annual (or more frequent) impairment test when there are indications of potential impairment.
In the wake of the financial crisis, a noteworthy trend has emerged in the realm of corporate finance with an exponential growth of accumulated goodwill balances. Specifically, within the S&P 500, the total goodwill balance has more than doubled, soaring from USD 1.6 trillion in 2008 to USD 3.7 trillion in 2021. This surge is not exclusive to the United States, as a parallel pattern is evident in the European Union, where the total reported goodwill from 1,477 listed companies witnessed a nearly 50% increase, climbing from EUR 1.1 trillion in 2013 to EUR 1.6 trillion in 2019. This observation calls for a careful examination of the factors driving the persistent growth in goodwill, whether such balances align with the economic realities and whether these reported values are supportable.
The matter has also been the focus area of regulators currently. Notably, the International Forum of Independent Audit Regulators (“IFIAR”) and the European Securities and Markets Authority (“ESMA”) are actively working to enhance the stringency of global and European practices, respectively. In the U.S., the Securities and Exchange Commission (“SEC”) and the Public Company Accounting Oversight Board (“PCAOB”) has remained steadfast in their focus on this critical and highly subjective accounting estimates.
As the landscape of financial reporting evolves, addressing the challenges associated with goodwill impairment becomes imperative. By acknowledging and scrutinizing these concerns, stakeholders can contribute to fostering a more transparent and reliable reporting outcome.
Key Concerns
International Organization of Securities Commissions (“IOSCO”), being an international body that brings together securities regulators from around the world, collaborates with standard-setting bodies such as the IASB to promote consistency and transparency in financial reporting.
In addition to IASB’s initiatives towards proposed amendments to IAS 36 and IFRS 3, there is a call for the IASB to explore opportunities to enhance the impairment tests themselves. IOSCO is actively monitoring how issuers, audit committees, and
external auditors address the challenge of “too little, too late.” Moreover, it is crucial for the IASB to consider how anticipated changes in standards will address and mitigate this problem.
Under IFRS, goodwill impairment occurs when the recoverable amount of a cash- generating unit (CGU) or a group of CGUs, to which goodwill is allocated, falls below its’ carrying amount. The recoverable amount is determined as higher of the fair value less costs of disposal and its value in use. However, the intricacies lie in the inherent subjectivity of these assessments, relying heavily on significant management judgments and estimates.
Key Focus Areas
• Identifiable Intangible Assets and providing the entity- specific disclosure of the factors that make up the Goodwill
• The “Close Call” Scenario
• Key audit matter
• Audit approach
• Improvement in Communication between TCWG, Management and Auditors
• The Dilemma of “Too Little, Too Late”
• Challenges in Management’s Assumptions
• Enhanced Disclosure
IASB Initiatives in Response to Stakeholder Concerns
In March 2020, the IASB issued the Discussion Paper Business Combination – Disclosures, Goodwill and Impairment (the Discussion Paper) which outlined issues identified through the Post-Implementation Review of IFRS 3 Business Combinations (PIR of IFRS 3) and provided the IASB’s preliminary views on how to address these issues.
IASB is in process of developing an exposure draft that would propose amendments to IFRS 3 and IAS 36.
Feedback and Recommendations
The IOSCO has published feedback from stakeholders and recommendations for standard setters that will be useful as they pursue initiatives to enhance business combination disclosures and related matters of impairment testing.
- Identifiable Intangible Assets and providing the entity-specific disclosure
- Challenges in Management’s Assumptions
- Addressing the Dilemma of “Too Little, Too Late” and the “Close call” Scenario through enhanced disclosures
- Improvement in Communication between TCWG, Management and Auditors
- Audit approach and Key audit matter
Uniqus Point of View
Embracing a commitment to transparency not only aligns with regulatory principles but also serves to empower investors with the information necessary for prudent decision-making in the dynamic landscape of financial markets. This could help investors to more effectively hold management to account for its acquisition and subsequent reporting decisions. Providing greater transparency and improved disclosures regarding the following aspects would be beneficial for investors and other stakeholders:
- Initial Recognition – On initial recognition disclose how the acquired business is (or is not) incorporated into the existing business; how the results of performance and cash flows of the acquired business are included in each operating segment or CGU of the acquirer; and the future cash flows (including synergies), weighted average cost of capital (WACC) and growth rates for each business segment or CGU as assumed at the time of the acquisition.
- Subsequent Assessment – For periods subsequent to the acquisition, disclose aforementioned information to help investors confirm the subsequent performance of the business combination and identify the indication of goodwill impairment.
- Valuation Models and Related Estimates and Assumptions – Granular disclosures on the valuation models employed along with greater transparency on the related inputs and outputs.
- Sensitivity analysis – Information regarding the sensitivity to change of the significant estimates and assumptions.
- Performance of Acquisitions – Quantitative information on how an acquisition performs including TCWG’s assessment, and disclosure of the key common performance metrics that management is using to monitor the performance of the acquisition.
While financial statement users would benefit from the disclosure of entity-specific factors that make up the goodwill recognized in a business combination and subsequent changes to these factors, reporting entities may face challenges in empirically identifying and verifying the items and amounts of synergies within
the combined business. Additionally, information regarding goodwill is often commercially sensitive and the potential public disclosure of such details may, in some cases, lead to competitive disadvantages for the reporting entity.
Conversely, disclosing information about the performance of an acquisition might be more effectively addressed as a mandated aspect of management disclosure as disclosure in financial statements would pose challenges in the context of its acceptability under the existing accounting standards.
The publication of the IOSCO’s recommendations on accounting for goodwill marks a significant development in the ongoing effort to refine financial reporting standards and is a step toward achieving greater transparency and reliability in financial reporting along with benefiting the global investment community.
In conclusion, the success of these recommendations lies not only in their theoretical soundness but also in their practical applicability. Achieving an equilibrium between the potential risks of boilerplate disclosure against divulging sensitive information poses a delicate challenge for standard setters, requiring careful navigation of the fine line between providing meaningful insights for financial statement users and safeguarding sensitive information of reporting entities.
