In summary

• IASB issued a discussion paper on potential changes to the accounting for goodwill
• Preliminary view of the Board is to NOT re-introduce the amortization model
• Instead it proposes to end mandatory annual impairment testing and simplify the impairment model
• Further disclosure requirements are proposed to track performance of an acquired company after acquisition date
• The comment period for the discussion paper ended on 31 December 2020. The discussion paper feedback is expected in March 2021

Following feedback received in a post-implementation review on IFRS 3 ‘Business Combinations’, IASB is exploring whether companies can, at a reasonable cost, provide investors with more useful information about the acquisitions those companies make.

To that extend, the Board has issued a discussion paper on which stakeholders can provide their input. The main focus in that paper is on improving disclosures around acquisitions in financial reporting and on the current methodology of goodwill accounting.

In this article we will look at the most important feedback from that post-implementation review and proposals from the IASB in response to this feedback, in its discussion paper.

Feedback from the post-implementation review

Based on feedback received from investors, preparers, auditors and regulators, the IASB concluded that there were broadly two high-priority focus areas in the implemented standard on business combinations that needed further investigation:

1. The effectiveness and complexity of testing goodwill for impairment

As could be expected, many preparers of financial statements think that the goodwill impairment test is complex, time-consuming and expensive. They also believe that there is too much judgement involved, especially in determining value in use (VIU) and allocating goodwill to the cash-generating units (CGU’s).

The clarity that is provided to investors by applying the impairment methodology does not justify its complexity and cost, in the view of these respondents.

2. Subsequent accounting for goodwill

Does the current practice of testing goodwill for impairment suffice, or should we move to amortizing goodwill in combination with indication-based impairment testing?

Some investors think that keeping the original goodwill amount intact is useful for relating the price paid to what was acquired and for calculating the return on invested capital. The absence of impairment charges is considered to be a good indication of the success of an acquisition.

Others believe that goodwill that arises with an acquisition is replaced by internally generated goodwill over time. These respondents support a change to amortization of (externally generated) goodwill, as further discussed below.

On a closely related topic, some feedback indicated that current disclosure requirements in IFRS 3 do not suffice to properly track the performance of an acquired company in the post-acquisition period.

Proposals from the Board

To address the points made regarding effectiveness and complexity of goodwill impairment testing, the Board’s preliminary conclusions are the following:

• It cannot design a different impairment test for cash-generating units containing goodwill that is significantly more effective than the impairment test in IAS 36 at recognizing impairment losses on goodwill on a timely basis and at a reasonable cost.
• Instead, it should develop proposals intended to reduce the cost and complexity of performing the impairment test by providing relief from the obligatory annual quantitative impairment test if there is no indication that an impairment may have occurred.
• The Board will make proposals that should simplify the calculation of Value in Use, in case an impairment test is to be performed.

On the topic of goodwill accounting subsequent to an acquisition, the main conclusion of the Board is that it should not re-introduce the amortization of goodwill. We will take a closer look at the Board’s considerations in the next paragraph.

In order to improve the tracking of post-acquisition performance, the Board is proposing to enhance the disclosure objectives and requirements in IFRS 3 to improve the information provided to investors about an acquisition and its subsequent performance. The main proposals includes adding disclosures around:

• The strategic rationale for undertaking an acquisition and the objectives that management had for the acquisition at the acquisition date.
• The subsequent performance of an acquisition that is based on the internal information and metrics the company’s management uses to monitor and measure the acquisition’s progress against the objectives of the acquisition.

Goodwill accounting: impairment or amortization

One of the more persistent discussions in the accounting world is that of amortization – or not – of goodwill that arises on acquisitions. Under Dutch GAAP for example, such goodwill is still being amortized whereas companies reporting under IFRS or US GAAP are testing goodwill for impairment annually, without amortization.

As said above, supporters of amortization claim that goodwill generated in a business combination is gradually being replaced by internally generated goodwill. Some claim that by not amortizing goodwill, it gets overstated which makes it difficult to assess management’s performance.

Besides these conceptual arguments, there are other, more practical considerations. The most important one is that impairment testing does not meet the objectives from the Board, as impairment charges are recognized too late, impairment testing does not provide enough meaningful information to investors and is costly and complex to execute.

Those who favor the impairment model over amortizing often argue that amortization periods often are arbitrary and that an amortization charge in the income statement therefore is meaningless. Some claim that goodwill is not even a wasting asset with a finite useful life so should not be amortized. The information that is provided in the impairment testing method can be meaningful, at least more so than an arbitrary amortization charge, according this group of stakeholders.

The IASB is of the view that it can’t change a methodology every few years and only if the foreseen benefits would outweigh the related cost and disruption. Having said that, Board members can be found in both the amortization- and in the impairment camp. Only a narrow majority led to the Board’s preliminary view to maintain the impairment model as the subsequent accounting method for goodwill.

Next steps

After a lengthy post-implementation process that started in early 2015, the IASB issued a Discussion Paper in March 2020. The response period to this DP, stretched further due to COVID-19, ended by 31 December 2020.

The Board will share respondent’s feedback by end of March 2021. Based on this feedback, the Board will decide whether and how to develop detailed proposals in the next stage of the project.

It will be hard to find common ground between supporters of amortization and those that favor impairment testing. The IASB will try to avoid divergence from USGAAP on such an important topic and it is the Board’s objective not change its methodologies every other year in the first place.

Therefore, I would be surprised if the Board changes its preliminary view stated in the Discussion Paper with regards to the goodwill accounting methodology. However, there may be some changes to the additional disclosure requirements as a result of respondents’ push-back.