With the adoption of IFRS 3 Business Combinations in 2004, the International Accounting Standards Board (IASB) abolished the amortization of goodwill and introduced an impairment-only approach. In the years after the adoption, however, the Board soon noticed a couple of problems. Firstly, the mandatory impairment test is both costly and subjective. Secondly, impairment losses on acquired goodwill are often recognized too late, due to the shielding of unrecognized headroom (excess of the recoverable amount over the carrying amount of a cash-generating unit or CGU), both at the acquisition date and subsequently. The above facts were the reason why the IASB has been considering including the requirements for impairment testing of goodwill, as well as the subsequent accounting thereof, in its post-implementation review (PIR) of the standard.
So, will you be able to amortize goodwill in the future again? Some of you might jump for joy when hearing this, while others won't...
Pros and cons of the reintroduction
The PIR revealed that investors have mixed views on whether goodwill should be amortized again or not. Those in favor of the amortization believe that goodwill acquired in a business combination is supported and replaced by internally generated goodwill over time. However, the IASB opposes the view that the timeline over which amortization should occur is impossible to determine and that the information value of amortization is very low for investors.
Investors in favor of the impairment-only approach, meanwhile, argue that the non-amortization of goodwill and the absence of impairment charges help them to verify whether an acquisition is working as expected. But it should be considered, as was highlighted by the IASB, that a company must burn through all of the headroom (unrecognized goodwill) before the acquired goodwill becomes visibly impaired. This means that the results of the impairment test will mostly be "too little, too late" and the balance sheet may thus give an overly optimistic representation of a company's financial health.
Mandatory annual impairment test
The PIR also revealed that the estimation of the value in use (VIU) to be performed as part of the impairment test is too costly and complex.
The main challenge for companies in relation to the impairment testing of goodwill is clearly the calculation of the VIU of an asset or CGU. This is due to the fact that companies are required by IAS 36 Impairment of Assets to use the pre-tax discount rate. However, the feedback from various stakeholders revealed that the pre-tax discount rate is firstly hard to understand and secondly does not provide useful information as it is mostly not observable and not used for valuation purposes. Therefore, in practice, impairment tests are often conducted on a post-tax basis with an additional iteration simply to derive a pre-tax discount rate when there are only observable post-tax discount rates. Therefore, stakeholders have requested a relief on the current requirements, i.e. permission to use post-tax inputs.
Another concern of companies was that future cash flows arising from capital expenditures for future enhancements are prohibited from being included in the projections used for the calculation of the VIU. This results in additional costs and complexity for companies as they need to exclude these cash flows from their financial budgets and/or forecasts. Such a separation between maintenance and expansionary capital expenditure, and having to assess the impact of subsequent cash flows, has turned out to be a huge challenge.
Stay tuned
Since 2015, the IASB has been discussing how to address all of these concerns. It finally decided in its June 2019 meeting on what to include in the project's forthcoming discussion paper (DP), which is planned to be published at the end of 2019.
Coming back to the question raised in the beginning of this article, chances are low that amortization of goodwill will be reintroduced, as eight out of fourteen Board members support an impairment-only approach. However, the pros and cons of both approaches will be included in the DP to get more background information. So you will have the chance to speak up and support your preferred approach!
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