Research PaperMarch, 2020Staff of the Accounting Standards Board of JapanStaff of the Hong Kong Institute of Certified Public AccountantsThe observations and views presented in this Research Paper are those of the ASBJ Staffand the HKICPA Staff and do not necessarily reflect views of the ASBJ or the HKICPA.Goodwill:
Improvements to Subsequent Accountingand an Update of the Quantitative StudyTABLE OF CONTENTSExecutive Summary…………………P. 3Introduction…………………P. 6PART 1: Quantitative study…………………P. 9PART 2: Scope and measurement basis for acquired goodwill…………………P. 19PART 3: Arguments for reintroducing amortisation in additionto impairment…………………P. 22PART 3A: ASBJ Staff view…………………P. 22PART 3B: HKICPA Staff view…………………P. 34PART 4: Amortisation period and method…………………P. 47PART 4A: ASBJ Staff view…………………P. 47PART 4B: HKICPA Staff view…………………P. 52Appendix A: Methodology of the quantitative study…………………P. 58Appendix B: Comparability between organic growth entitiesand acquisitive growth entities…………………P. 62Appendix C: Academic studies referenced by the ASBJ Staff…………………P. 65EXECUTIVE SUMMARYQuantitative study
1.The updated quantitative study in this Research Paper shows a steady increase in theamount of acquired goodwill presented in the financial statements. Consideringthis increasing trend, it is unlikely that the impairment-only model for acquiredgoodwill is working as intended. This has led to a “too little, too late” issue, whichhas been noted as a concern among some stakeholders.Scope of the Research Paper and the measurement basis for acquired goodwillScope of the Research Paper
2.The scope of this Research Paper is the subsequent accounting for acquired goodwill.Both the ASBJ Staff and the HKICPA Staff consider that acquired goodwill is a distinctunit of account independent from internally generated goodwill.Measurement basis for acquired goodwill
3.Acquired goodwill is an asset that should be measured at historical cost. Thehistorical cost should be updated to depict its consumption over time. Acquiredgoodwill should also be subject to the impairment test. When conducting theimpairment test, future cash flows would be discounted to determine therecoverable amount of the cash generating unit (‘CGU’).Arguments for reintroducing amortisation in addition to impairment
4.Both the ASBJ Staff and the HKICPA Staff think that acquired goodwill should beamortised over time on a systematic basis, and the CGU(s) to which acquiredgoodwill is attributed should be tested for impairment when there is an indication ofimpairment.ASBJ Staff view
5.The ASBJ Staff think acquired goodwill is a “wasting asset” (that is, an asset thatdiminishes in value over time) and, to faithfully represent this nature, financialstatements need to reflect the reduction in value.
6.As a result of this wasting nature and due to other factors, the ASBJ Staff proposethat acquired goodwill be amortised in addition to being tested for impairment.Impairment serves to signal the lack of recoverability of the carrying amount ofacquired goodwill and amortisation signals the consumption of acquired goodwill.Both are necessary.HKICPA Staff view
7.The HKICPA Staff consider that goodwill may be described as the difference betweenthe fair value of an entity and its identifiable net assets recognised under prevailingaccounting standards (book value), and term this “economic goodwill”. The valueof economic goodwill constantly changes over time. We think that acquiredgoodwill is a static snapshot of economic goodwill as of an acquisition date.
8.Over time, the amount recognised as acquired goodwill becomes increasingly lessreflective of the current fair value or current book value of the entity, and thereforemore meaningless as a balance sheet item.
9.The HKICPA Staff think that amortisation (with indicator-based impairment) betterreflects the nature of acquired goodwill than an impairment-only regime as:
(a) It better reflects the fact that acquired goodwill becomes increasingly lessrepresentative of the acquiree and the consolidated entity.(b) It provides a better opportunity to show how an acquisition is utilised.(c) It improves comparability between entities that grow organically and throughacquisitions.
10.The HKICPA Staff also think amortisation ensures that increasingly large goodwillbalances supported by the impairment-only model, which can contribute negativelyto management incentives and misrepresent risks, will be allocated to expense on atimely basis.Amortisation period and method
11.Both the ASBJ Staff and the HKICPA Staff think that acquired goodwill should beamortised using a single amortisation period for the entire acquired goodwill amountrecognised for each business combination, rather than disaggregating acquiredgoodwill into components and using different amortisation periods for eachcomponent.ASBJ Staff view
12.The ASBJ Staff think that the amortisation period should be based on the period thatmanagement expects to generate incremental cash inflows arising from theacquisition. In addition, the ASBJ Staff think that a maximum number of yearsshould be established by the standard-setter for the amortisation period to strike abalance between the provision of relevant information and the need to respond tothe concerns over the “too little, too late” issue.HKICPA Staff view
13.The HKICPA Staff think that:
(a) The amortisation period of acquired goodwill should be determined in terms ofthe expected utilisation of an acquisition. Entities should apply judgement todetermine what amortisation period and pattern is expected to best reflect theexpected utilisation of an acquisition.(b) The process of determining an amortisation period based on the principle ofreflecting expected utilisation of an acquisition will benefit both (a)
management, as it will be required to think critically about its post-acquisitionplans before acquisition date, and (b) users, as they will gain insight intomanagement’s expected timeline for an acquisition.INTRODUCTIONObjective of this Research PaperIN1The subsequent accounting for goodwill has been a subject of debate for manyyears. As of the issuance of this Research Paper (‘RP’), the InternationalAccounting Standards Board (‘IASB’) has an ongoing research project ongoodwill and impairment. The United States Financial Accounting StandardsBoard (‘FASB’) has also been undertaking a project on identifiable intangibleassets and subsequent accounting for goodwill.IN2The objective of this RP is to contribute relevant and timely analyses andarguments to the global research project, and to present the views of the staffof the Accounting Standards Board of Japan (‘ASBJ Staff’) and the staff of theHong Kong Institute of Certified Public Accountants (‘HKICPA Staff’).IN3This RP aims to accomplish the following:
(a) Share new findings from an updated quantitative study based on workpreviously conducted in 2016 by the European Financial Reporting AdvisoryGroup (‘EFRAG’) secretariat and the ASBJ Staff.(b) Analyse the existing requirements for goodwill under IFRS.(c) Explore alternative views on the subsequent accounting for goodwill.IN4This RP is a collaboration between the ASBJ Staff and the HKICPA Staff(collectively, ‘the Staffs’).Existing requirements and two concepts of goodwillIN5IFRS 3 Business Combinations defines goodwill as “An asset representing thefuture economic benefits arising from other assets acquired in a businesscombination that are not individually identified and separately recognised.”
IN6Applying IFRS 3, goodwill is initially recognised at the acquisition date as aresidual – the excess of the consideration transferred over the identifiable netassets acquired (ignoring non-controlling interest and step-acquisitions forsimplicity). Thereafter, goodwill is measured at historical cost and writtendown under the requirements of IAS 36 Impairment of Assets in the event ofimpairment. This approach may be referred to as the ”impairment-only”
approach.IN7What is defined as goodwill under IFRS 3 can be described as acquired goodwill(‘AGW’), and we shall label it as such in this RP.IN8There is additionally a concept of internally generated goodwill (‘IGGW‘), whichis clearly distinguished from AGW in this RP. This concept will be discussed inPart 3.History of the project on goodwillIN9The IASB issued IFRS 3 in 2004, superseding IAS 22 Business Combinations.This eliminated the pooling of interests method and mandated that all businesscombinations within the scope be accounted for using the acquisition method.IFRS 3 followed the issuance of FASB Statement No.141, Business Combinations,in 2001, and resulted in the convergence of U.S. GAAP and IFRS. This meantthat any entity paying consideration for an acquisition in excess of the fair valueof the acquiree’s identifiable net assets would be required to recognise theresidual difference as goodwill (which would be subsequently subject toimpairment).IN10 The IASB completed its Post-implementation Review (‘PIR’) of IFRS 3 in June
2015.Following the PIR, the IASB has undertaken a research project ongoodwill and impairment, with the aim of investigating how companies canprovide users with better information about business combinations at areasonable cost. In addition, the FASB published an Invitation to CommentIdentifiable Intangible Assets and Subsequent Accounting for Goodwill on July 9,2019, as part of its project on subsequent accounting for goodwill.IN11 One of the findings of the PIR is that stakeholders have mixed views on thesubsequent accounting for goodwill. In particular, while some stakeholderssupport the existing requirements (impairment-only), others support theamortisation of goodwill. Additionally, some stakeholders have expressed theview that goodwill impairment is not always recognised in a timely fashion (thisis known as the “too little, too late” issue), and some investors have stated thatdisclosures required by IFRS do not provide enough information to enable themto understand whether an acquired business is performing as expected. Somecompanies have also stated that the impairment test required for goodwillunder IAS 36 is costly and complex.Structure of this Research PaperIN12 Recognising the issues in the previous paragraph, the RP discusses thesubsequent accounting for goodwill. The structure of this RP is as follows:
(a) Quantitative studyThis part shows recent results of quantitative studies on goodwill andexplains that timely discussion about the subsequent accounting foracquired goodwill is still needed.(b) Scope of the RP and measurement basis for acquired goodwillThis part explains the scope of the RP and the measurement basis foracquired goodwill to provide context for later discussions.(c) Arguments for reintroducing amortisation in addition to impairmentThis part discusses the subsequent accounting for acquired goodwill,especially whether amortisation should be reintroduced.(d) Amortisation period and methodThis part discusses the amortisation period and the amortisation pattern.PART 1: QUANTITATIVE STUDYBackground information and summary of the study
1.1The objective of the quantitative study is to provide quantitative data andillustrate the trends in the amounts of goodwill and impairment in majorjurisdictions. The aim is to facilitate the technical and conceptual discussionsrelated to the subsequent accounting for goodwill by accounting standard settersaround the world.
1.2In 2016, the ASBJ Staff conducted a quantitative study on goodwill andimpairment together with the EFRAG secretariat, and as a result, issued ResearchPaper No. 2 Quantitative Study on Goodwill and Impairment in October 2016(‘Research Paper No. 2’)1. This quantitative study was conducted based on datafrom 2005 to 2014. Observing the results, the ASBJ expressed its view thatResearch Paper No. 2 implied that there was an increasing risk that impairmentof goodwill would have a significant impact on the financial position of an entitywhen it was recognised.
1.3The Staffs conducted updated quantitative studies on goodwill for the data from2014 to 2018 to show the recent trend in goodwill balances. The methodologyof this updated study is described in detail in Appendix A. The update of thestudy includes the following figures or ratios for stock market indices of theUnited States (the S&P 500 index), Europe (the S&P Europe 350 index), HongKong (the Hang Seng Composite index) and Japan (the Nikkei 225 index – forcompanies that apply IFRS)2:
(a) Total amount of goodwill(b) Amount of goodwill per company1 Please refer to the following website:
https://www.asb.or.jp/en/discussions/papers/2016-1003.html2 As mentioned in Appendix A, for the stock market index of Japan, the following companies that applyIFRS were included in the population considering that there were companies that have transitioned fromeither Japanese GAAP or U.S. GAAP to IFRS between 2014 and 2018:
(a) Regarding (a)-(e), companies that applied IFRS in 2018 were included in the population. For thefinancial figures for the periods in which the companies applied Japanese GAAP, no adjustmentswere made regarding the effects of amortisation charges.(b) Regarding (f) and (g), companies that applied IFRS throughout 2014-2018 were included in thepopulation.(c) Ratio of goodwill to net assets(d) Ratio of goodwill to market capitalisation(e) Number of companies that present high goodwill ratios(f) Amount of goodwill expensed(g) Intensity of goodwill expensed
1.4The study found that the amount of goodwill generally increased steadily overthe period of 2014 to 2018. Specifically:
(a) From 2014 to 2018, total goodwill and total goodwill per company tended toincrease steadily in all stock market indices.(b) A number of companies that constituted the stock market indices of theUnited States and Europe recognised goodwill that exceeded 100% of theirnet assets. For example in 2018, regarding the United States, 18.8% ofcompanies that constituted the stock market index had goodwill thatexceeded 100% of their net assets, while in Europe that number was 10.1%of companies. Some companies even recognised goodwill that exceeded100% of their market capitalisation, though the number of those companieswas relatively small.(c) The implied time to fully expense goodwill based on the impairment lossesrecognised from 2014 to 2018 resulted in 122 years for the stock market indexof the United States, 78 years for the stock market index of Europe, 64 yearsfor the stock market index of Hong Kong and 64 years for the stock marketindex of Japan.Results of the updated studyTotal amount of goodwill
1.5Figure 1.1 shows the trends in the total amount of goodwill from 2014 to 2018.
1.6From 2014 to 2018, total goodwill tended to increase for all stock market indices.Comparing the amounts in 2014 and in 2018 (Figure 1.2), total goodwill increasedby 45% for the stock market index of the United States, 26% for the stock marketindex of Europe,60%forthestockmarketindex of HongKong, and 74%for the stockmarket index ofJapan.Figure 1.1: Trends in the amount of total goodwill (inUSD billion)
United StatesEuropeHong KongJapanFigure 1.2: Trend of Figure 1.1 (The data of 2014are indexed as 100)
Amount of goodwill per company
1.7Figure 1.3 shows the trends in the amount of goodwill per company thatrecognised goodwill from 2014 to 2018.
1.8The amount of goodwill per company for the stock market indices of the UnitedStates and Europe was larger than that for the stock market indices of Japan andHong Kong. From 2014 to 2018, the amount of goodwill per company for thestock market indices of the United States, Europe and Japan increased steadilyyear by year.Ratio of goodwill to net assets3
1.9Figure 1.4 shows the trends in the ratio of goodwill to net assets. The objectiveof Figure 1.4 is to illustrate the significance of goodwill compared to the bookvalue of net assets.3 Net assets means the book value of equity.
4.9
5.4
6.1
6.5
7.1
4.5
4.7
5.1
5.3
5.7
0.4
0.5
0.5
0.6
0.6
1.9
1.8
2.4
2.6
3.2United StatesEuropeHong KongJapanFigure 1.3: Trends in the amount of goodwill percompany (that recognized goodwill) (in USD billion)
1.10The average ratio of goodwill to net assets from 2014 to 2018 was higher for thestock market indices of the United States and Europe. In addition, the ratiosteadily increased for the stock market indices of the United States and Japan.Figure 1.5 shows this increasing trend more clearly.
32.5%
35.3%
38.1%
39.1%
41.5%
27.1%
27.7%
29.3%
28.4%
29.7%
3.4%
3.9%
4.0%
3.7%
3.8%
11.6%
11.8%
15.1%
14.7%
16.9%United StatesEuropeHong KongJapanFigure 1.4: Trends in the ratio of the amount ofGoodwill to Net AssetsUnited StatesEuropeHong KongJapanFigure 1.5: The trend of Figure 1.4 (The data of2014 are indexed as 100)
Ratio of goodwill to market capitalisation4
1.11Similar to the trends in the ratio of goodwill to net assets, Figure 1.6 shows thetrends in the ratio of goodwill to market capitalisation.
1.12The average ratios of goodwill to market capitalisation in the stock market indicesof the United States and Europe were relatively high but were lower than theratio of goodwill to net assets in Figure 1.4. Figure 1.7 shows this trend byrescaling the figures of all market indices as 100 in 2014.4 Market capitalisation means market value of equity.
12.0%
13.2%
13.5%
12.4%
13.8%
16.7%
16.8%
18.0%
16.2%
19.9%
2.8%
3.7%
3.9%
3.1%
4.2%
9.1%
9.5%
11.9%
11.6%
15.0%United StatesEuropeHong KongJapanFigure 1.6: Trends in the ratio of the amountof Goodwill to the Market CapitalisationUnited StatesEuropeHong KongJapanFigure 1.7: The trend of Figure 1.6 (The data of2014 are indexed as 100)
Number of companies that present high goodwill ratios
1.13The following data shows the number of companies whose goodwill ratios (theratio of goodwill to net assets and the ratio of goodwill to market capitalisation)
are high. This shows the extent to which the amount of goodwill wasconcentrated in certain number of companies that constitute stock marketindices. Tables 1.8 and 1.9 show the number of companies that recognisedgoodwill that exceeded 50% and 100% of their net assets and their marketcapitalisation, respectively, from 2014 to 2018.Table 1.8: Trends in the number of companies that exceed certain ratios of theamount of Goodwill to Net Assets*Share: Ratio of the number of applicable companies to the number ofcompanies analysed.Table 1.9: Trends in the number of companies that exceed certain ratios of theamount of Goodwill to Market Capitalisation*Share: Ratio of the number of applicable companies to the number ofcompanies analysed.
1.14
18.8% of companies constituting the stock market index of the United States, andshareshareshareshareshareUS50%+
34.6%
37.0%
39.3%
41.1%
41.1%100%+
(71)(14.5%)
(73)(14.9%)
(83)(17.0%)
(82)(16.8%)
(92)(18.8%)
EUR50%+
32.4%
34.4%
34.7%
34.4%
33.8%100%+
(39)(11.3%)
(45)(13.0%)
(41)(11.8%)
(35)(10.1%)
(35)(10.1%)
HK50%+
2.8%
2.4%
3.9%
3.9%
3.9%100%+
(7)
(1.5%)
(8)
(1.7%)
(8)
(1.7%)
(6)
(1.3%)
(8)
(1.7%)
JPN50%+
6.5%
6.5%
9.7%
11.3%
8.1%100%+
(0)
(0.0%)
(1)
(1.6%)
(0)
(0.0%)
(0)
(0.0%)
(0)
(0.0%)
Stock MarketIndexThe numberof companiesanalysedshareshareshareshareshareUS50%+
2.0%
3.9%
3.3%
4.9%
8.0%100%+
(0)
(0.0%)
(2)
(0.4%)
(1)
(0.2%)
(2)
(0.4%)
(4)
(0.8%)
EUR50%+
6.9%
6.6%
6.1%
5.5%
11.0%100%+
(3)
(0.9%)
(3)
(0.9%)
(5)
(1.4%)
(3)
(0.9%)
(9)
(2.6%)
HK50%+
1.3%
2.4%
2.6%
2.6%
3.2%100%+
(2)
(0.4%)
(1)
(0.2%)
(4)
(0.9%)
(3)
(0.6%)
(6)
(1.3%)
JPN50%+
1.6%
1.6%
1.6%
3.2%
6.5%100%+
(1)
(1.6%)
(1)
(1.6%)
(1)
(1.6%)
(1)
(1.6%)
(1)
(1.6%)
Stock MarketIndexThe numberof companiesanalysed
10.1% of companies constituting the stock market index of Europe, recognisedgoodwill that exceeded 100% of their net assets in 2018. Some companieseven recognised goodwill that exceeded 100% of their market capitalisation.Amount of Goodwill Expensed
1.15Figure 1.10 shows the trends in the amount of goodwill expensed (that is,impairment losses) from 2014 to 2018.
1.16The impairment losses were relatively higher for the stock market indices of theUnited States and Europe, and were largest in 2018 for the stock market index ofthe United States.Intensity of Goodwill Expensed
1.17The intensity of goodwill expensed shows the extent of reductions of the goodwillbalance during the year. Figure 1.11 shows the trends in the ratio of the amountof goodwill expensed in the year to the amount of goodwill as of the previousyear-end5. For this analysis, the reductions do not include expenses or losses5 The intensity of goodwill expensed is calculated as follows:
The intensity of goodwill expensed=the amount of goodwill expensed in the yearthe balance of goodwill as of the previous year-endUnited StatesEuropeHong KongJapanFigure 1.10: Trends in the amount of Goodwillexpensed (in USD billion)
recognised from the disposal of businesses.
1.18The inverse of this ratio implies the time to fully expense goodwill. The inverseof the average of the ratios from 2014 to 2018 resulted in 122 years for the stockmarket index of the United States, 78 years for the stock market index of Europe,64 years for the stock market index of Hong Kong and 64 years for the stockmarket index of Japan.Does the “too little, too late” issue exist?
1.19As summarised in paragraph 1.4, the amount of acquired goodwill in thestatement of financial position tended to increase steadily over time. Inaddition, as mentioned in the previous paragraph, the implied average time tofully expense acquired goodwill for each stock market index largely exceeds 40years. We note that 40 years was the maximum amortisation period ofacquired goodwill prescribed in APB Opinion No.17 Intangible Assets, which wasapplied before U.S. GAAP were revised in 2001. We also note that 20 years wasthe maximum amortisation period prescribed in IAS 22, which was appliedbefore IFRS was revised in 2004.
1.20We observe that, together with the increasing trend of the amount of acquired
0.6%
0.6%
0.2%
0.3%
2.4%
1.1%
2.2%
1.3%
0.8%
1.0%
1.7%
1.3%
3.1%
0.9%
0.8%
1.6%
2.1%
1.4%
2.1%
0.6%United StatesEuropeHong KongJapanFigure 1.11: Trends in the intensity of Goodwill expensedgoodwill and the time to fully expense acquired goodwill, it is likely that the “toolittle, too late” issue exists with respect to the expensing of acquired goodwillunder the existing impairment-only model. If this is the case, it may bequestionable whether the existing impairment test is sufficiently “rigorous andoperational” to justify the non-amortisation of acquired goodwill6 and providerelevant information to users of financial statements.
1.21On the other hand, some have questioned our observation claiming that theincreasing trend in the amount of acquired goodwill does not justify the existenceof the “too little, too late” issue. For example, the growth in the economy andthe increase in M&A activity in recent years may have contributed to the increasein the amount of acquired goodwill.
1.22However, we do not think that such a claim undermines our observation inparagraph 1.20. This is because it would be difficult to define and obtain datathat represents the relationship between the growth in the economy or thefrequency of acquisitions and the amount of acquired goodwill. Under this dataconstraint, we conducted some rough data analyses but could not obtain anyclear implications from the analyses7. Accordingly, in the following parts, wewill discuss the subsequent accounting for acquired goodwill assuming that it islikely that the “too little, too late” issue exists.6 Please refer to paragraph 2.7.7 We conducted simplified quantitative data analyses by the following comparison, but we could notconfirm clear relationships.(a) A comparison between the amount of acquired goodwill and the stock price indices.(b) A comparison between the amount of acquired goodwill and GDPs.(c) A comparison between the amount of acquired goodwill and the number of M&A cases.The amount of acquired goodwill used in these analyses is based on the data of the companies that havebeen in the scope of analyses this time, and differs from the scope of the companies on whichcomparative data such as GDP is based. These analyses were conducted under such data constraints,and the implications of the results are extremely limited. More sophisticated analyses may producedifferent results.PART 2: SCOPE AND MEASUREMENT BASIS FOR ACQUIRED GOODWILLScope of this Research Paper
2.1As mentioned in the Introduction, we refer to what is recognised as goodwillunder IFRS 3 as acquired goodwill (AGW). This RP considers the subsequentaccounting for acquired goodwill.
2.2IFRS introduces another concept of goodwill, which is internally generatedgoodwill (IGGW). Paragraph 49 of IAS 38 Intangible Assets provides followingexplanation:
In some cases, expenditure is incurred to generate future economicbenefits, but it does not result in the creation of an intangible asset thatmeets the recognition criteria in this Standard. Such expenditure is oftendescribed as contributing to internally generated goodwill. Internallygenerated goodwill is not recognised as an asset because it is not anidentifiable resource (ie it is not separable nor does it arise fromcontractual or other legal rights) controlled by the entity that can bemeasured reliably at cost.
2.3When considering the accounting for AGW, it is relevant to assess the unit ofaccount. We think that AGW is a distinct unit of account that is independentfrom IGGW. This can be demonstrated by the fact that, under the existingrequirements:
(a) Only AGW is recognised as an asset. IGGW is not recognised, and under IFRSis dealt with separately in accordance with IAS 38. AGW can be recognisedgiven the existence of an exchange transaction to refer to for measurement,and it is a unique accounting construct.(b) AGW is a static concept measured at historical cost as mentioned later in thispart. It is not updated to track the changes attributable to IGGW8. Thecarrying amount of AGW is only updated when a cost allocation method is8 Some may note that the carrying amount of AGW can be supported by IGGW when performing theimpairment test (the “impairment shield” problem, discussed below); however, this is due to theinability to separate AGW and IGGW after a business combination and reflects a “best solution” for theimpairment model, which the Staffs do not think should be interpreted as affecting AGW’s unit ofaccount.applied (for example, impairment).(c) The Staffs think that, under the concept of historical cost accounting, theimpact of consideration transferred at the acquisition date (that gives rise toAGW) should be distinguished from the impact of expenditures subsequentto the business combination (that give rise to IGGW).Measurement basis for AGW - existing requirements
2.4AGW is measured at historical cost under the existing requirements. When aCash Generating Unit (‘CGU’) to which AGW is attributed is subsequently testedfor impairment, any impairment losses would first reduce the carrying amount ofAGW followed by the carrying amount of the other assets within the CGU.
2.5Paragraph BC131B of IAS 36 explains that, when introducing non-amortisation ofAGW, the IASB considered (a) straight-line amortisation with an impairment testwhen there is an indication of impairment, and (b) non-amortisation with animpairment test at least annually.
2.6In its considerations, the IASB noted the following (paragraph BC131E of IAS 36):
…the Board agreed that achieving an acceptable level of reliability in theform of representational faithfulness while striking some balance withwhat is practicable was the primary challenge it faced in deliberating thesubsequent accounting for goodwill. The Board observed that the usefullife of acquired goodwill and the pattern in which it diminishes generallyare not possible to predict, yet its amortisation depends on suchpredictions. As a result, the amount amortised in any given period can bedescribed as at best an arbitrary estimate of the consumption of acquiredgoodwill during that period. The Board acknowledged that if goodwill isan asset, in some sense it must be true that goodwill acquired in a businesscombination is being consumed and replaced by internally generatedgoodwill, provided that an entity is able to maintain the overall value ofgoodwill (by, for example, expending resources on advertising andcustomer service). …
2.7Ultimately, the IASB concluded on an approach of non-amortisation on the basisthat more useful information would be provided if a rigorous and operationalimpairment test could be devised (paragraph BC131G of IAS 36).Measurement basis for AGW - historical cost or current value?
2.8The IASB’s Conceptual Framework for Financial Reporting revised in March 2018(‘Conceptual Framework’) identifies historical cost and current value as the twocategories of measurement bases in IFRS. The Staffs consider historical cost,the measurement basis currently required, to be the more relevantmeasurement basis for AGW. This is because the entity’s business activitiesusually do not involve selling AGW (indeed AGW itself can’t be transferred),which is calculated as a residual from the costs incurred to achieve a businesscombination, and the entity retains it for use (paragraph 6.53 of the ConceptualFramework), and because AGW is used in combination with other economicresources to produce indirect cash flows for the entity (paragraphs 6.54-6.56 ofthe Conceptual Framework).
2.9Historical cost measurement does not reflect changes in values (paragraph 6.4 ofthe Conceptual Framework), but is updated over time to depict, for example, theconsumption of part or all of the economic resource that constitutes the asset,or the effect of events that cause part or all of the historical cost of the asset tobe no longer recoverable (paragraph 6.7 of the Conceptual Framework). Asconsidered in the development of IFRS 3 (please refer to paragraphs 2.5 and 2.6),amortisation is one way to depict such consumption of the asset.PART 3: ARGUMENTS FOR REINTRODUCING AMORTISATION IN ADDITIONTO IMPAIRMENT
3.1The Staffs support reintroducing amortisation in addition to impairment as asuperior method for the subsequent accounting for acquired goodwill.The Staffs propose an amortisation plus indicator-based impairment regime forAGW, under which AGW would be allocated to profit or loss on a systematic basisover its amortisation period. Amortisation reflects the utilisation of AGW.While amortisation would be a mandatory and prominent aspect of this regime,the Staffs also support retaining indicator-based impairment to reflect situationswhere there has been a substantive decline in the recoverable amount of theCGU(s) to which the AGW is assigned within the amortisation period.
3.2In the following paragraphs of Part 3 the Staffs explain this common view frombilateral perspectives, reflecting the Staffs’ respective ways of looking at thenature of acquired goodwill.PART 3A: ASBJ Staff viewWhat is the issue?
3.3The ASBJ Staff think that there are diverse views on the subsequent accountingfor AGW because there are diverse views on various issues related to AGW,including the disagreement on whether the “too little, too late” issue exists(considered in Part 1) and the disagreement on how to determine theamortisation period (considered in Part 4A). Part 3A discusses the followingthree issues mainly related to the nature of AGW:
(a) Stakeholders have different assumptions on the scope of "goodwill".Some stakeholders do not clearly distinguish goodwill arising from businesscombinations (AGW) from goodwill arising from expenditures made after thebusiness combinations (IGGW).(b) Stakeholders have different views on the nature of AGW.Stakeholders have different views on whether AGW is of a wasting nature.(c) Stakeholders have different views on how to reflect that nature in thesubsequent accounting for AGW.Among those who think that AGW is of a wasting nature, stakeholders havedifferent views on whether amortisation should be applied.The scope of “goodwill”
3.4When considering whether goodwill is of a wasting nature, an important startingpoint is the scope of “goodwill”. A lack of consensus on this point is likely tolead to differing views on the accounting for goodwill9.
3.5Some stakeholders do not clearly distinguish AGW from IGGW. Thesestakeholders typically are interested in assessing the value of an entity, andconsider goodwill to be one of its major contributors. They are more interestedin how goodwill contributes to the current value of an entity, and are lessinterested in whether goodwill has arisen from a business combination.
3.6In contrast, the ASBJ Staff consider that only AGW should be within the scope ofthe discussion, because it would result in providing relevant information aboutperformance subsequent to the business combination. In this regard, the ASBJStaff note that general purpose financial reports are not designed to show thevalue of an entity, but rather to provide useful information that is helpful for usersof financial statements to estimate the value of an entity10. The ASBJ Staff thinkthat this concept is not necessarily shared by such stakeholders in terms of whatkind of financial information should be provided. The success or failure of abusiness combination should be assessed by the profit earned after deducting itscost over the periods subsequent to the business combination. The ASBJ Staffthink that information about such profit is relevant to users of financialstatements. For this reason, the ASBJ Staff think that it is important to clearlydistinguish AGW from IGGW.9 This repeats the discussion in paragraph 2.3, but this is important for discussing the next issue of awasting nature of goodwill.10 Please refer to paragraph 1.7 of the Conceptual Framework.The nature of AGW - Is AGW a wasting asset?
3.7The excess of the consideration of the acquisition over the fair value of theidentifiable net assets is allocated to AGW. AGW arises from an exchange ofvalues that actually occurred, but by definition it has no physical substance, norcan it be separated from the entity. For these reasons, its condition cannot bedirectly observed, and stakeholders have different views and expectations onwhat would be its benefit and how long such benefit would last.The six components
3.8When developing IFRS 3, the IASB considered six components that couldpotentially form part of AGW (see Table 3.1) 11 . The IASB concluded thatComponents 1, 2 and 5 should not be subsumed into the amount initiallyrecognised as AGW.Table 3.1: The six potential components of AGW (quoted from related descriptions fromparagraphs BC313 and BC316 of IFRS 3)
Component 1The excess of the fair values over the book values of the acquiree’snet assets at the date of acquisition.Component 2The fair values of other net assets that the acquiree had notpreviously recognised.Component 3The fair value of the going concern element of the acquiree’s existingbusiness. The going concern element represents the ability of theestablished business to earn a higher rate of return on an assembledcollection of net assets than would be expected if those net assetshad to be acquired separately. That value stems from the synergiesof the net assets of the business, as well as from other benefits (suchas factors related to market imperfections, including the ability toearn monopoly profits and barriers to market entry – either legal orbecause of transactions costs – by potential competitors).The third component relates to the acquiree and reflects the excessassembled value of the acquiree’s net assets. It represents the pre-11 These six components were originally discussed in FASB’s Proposed Statement of Financial AccountingStandards: Business Combinations and Intangible Assets, issued September 7, 1999.existing goodwill that was either internally generated by theacquiree or acquired by it in prior business combinations.Component 4The fair value of the expected synergies and other benefits fromcombining the acquirer’s and acquiree’s net assets and businesses.Those synergies and other benefits are unique to each businesscombination, and different combinations would produce differentsynergies and, hence, different values.The fourth component relates to the acquiree and the acquirerjointly and reflects the excess assembled value that is created by thecombination – the synergies that are expected from combining thosebusinesses.Component 5Overvaluation of the consideration paid by the acquirer stemmingfrom errors in valuing the consideration tendered.Component 6Overpayment or underpayment by the acquirer.
3.9Under IFRS 3, Components 3, 4 and 6 are recognised as AGW, and Components 3and 4 collectively are referred to as “core goodwill”. Consistent with IFRS 3, thisRP focuses on Components 3 and 4 and discusses these Components in thefollowing paragraphs12. The ASBJ Staff would not discuss Component 6 becauseit would not be an asset from a conceptual standpoint but nonetheless would beconsidered to be of a wasting nature.13
3.10Examples of the Components 3 and 4 include the following:
Component 3(Going concern element)
Reputation, know-how, human resources12 The identification of these components is for discussion purposes and the ASBJ Staff understand thatit is not practically easy to separate these components. As noted later in paragraph 4.6, the FASBexplains in its exposure draft issued in 1999 that it abandoned the discernible-element approach, whichwould determine the amortisation period of AGW based on the multiple discernible elements of AGW,because the FASB found decomposing AGW into elements highly subjective.13 The IASB acknowledged that the sixth component is not an asset but conceptually is a loss (in the caseof overpayment) or a gain (in the case of underpayment) to the acquirer. Nevertheless, the IASBconcluded that in practice it is not possible to identify and reliably measure an overpayment at theacquisition date. Accordingly, the IASB decided to recognise the sixth component as part of acquiredgoodwill and to address the accounting for overpayments through subsequent impairment testing.Component 4(Synergies element)
Eliminating redundant work, creating new revenuestreams by combining know-how
3.11Figure 3.2 illustrates the relationship between the acquisition price andComponents 1-414. This example assumes the following:
(a) The total acquisition price was 135.(b) The book value of identifiable assets and liabilities that were previouslyrecognised by the acquiree was 73 and the fair value of such assets andliabilities was 80.(c) The fair value of identifiable assets and liabilities that were not previouslyrecognised by the acquiree was 15.(d) The value of the acquiree as a whole was 125, implying that the going concernelement was valued at 30.Figure 3.2: Relationship between the acquisition price and Components 1-414 This example assumes that the acquisition price does not include Components 5 and 6.
(4)Synergies element: 10
(3)Going concern element: 30
(1)Difference between fair valueand book value of assets andliabilities recognised by theacquiree: 7Book value of assets and liabilitiesrecognised by the acquiree: 73
(2)Fair value ofitems that werenot recognisedby the acquiree:
AGW: 40Going concern element
3.12The going concern element represents the ability to combine the identifiableitems of the acquiree to generate a return that exceeds the return that would begenerated by using those items individually. In other words, the going concernelement is the value inherent in the acquiree, and stems from the synergiesbetween identifiable items of the acquiree and from other benefits such as thoserelated to the ability to earn monopoly profits and legal or other barriers tomarket entry by potential competitors as described in Table 3.1.
3.13Some stakeholders claim that the going concern element may include the entity’sreputation with customers, technology and know-how, and an assembledworkforce. These stakeholders think that these factors are not of a wastingnature. In other words, the entity’s reputation with customers generates cashflows to the entity continuously, technology and know-how that supports thebusiness creates value continuously15, and the knowledge required to utilise theworkforce is maintained in the entity continuously.
3.14The ASBJ Staff take an opposing view, and think that the going concern elementis of a wasting nature for the following reasons:
(a) The ASBJ Staff think that it is difficult to differentiate the factors in paragraph
3.13 clearly, and difficult to quantify their value. This is because thosefactors interact with each other, and thus their value develops as a whole. Ifthose factors could be separated, they should already have been identifiedseparately as an identifiable asset. Thus, considering the going concernelement as a whole, AGW represents something that the acquirer is willingto pay to earn a return higher than the market expectation. These excessreturns will decrease over time assuming there is healthy competition.15 Perspectives Paper issued by International Valuation Standards Council (IVSC), “Business Valuation – IsGoodwill a Wasting Asset?” (https://www.ivsc.org/files/file/view/id/1599) claims that the going concerngoodwill comprises of reputation, future intangible value, and workforce, which are not wasting innature. Regarding future intangible value, the in-place assets such as workforce, knowhow andfoundational platform technology are leveraged for future ideation and technologies and continuouslycreate new intangible value. However, such assets seem to evolve over time to respond to the changesin the surrounding environment, which will likely make obsolete the original assets acquired at thebusiness combination. When assuming that what is acquired at the business combination isdistinguished from what is generated afterwards as mentioned in paragraph 3.6, it is unclear how suchassets can continue to create new value.Certain advantages over other entities due to legal or other economic reasonsmay continue indefinitely, but such cases are rare.(b) Even if it were possible to consider those individual factors as claimed inparagraph 3.13, the effects of the entity’s reputation with customers, and theeffects of technology and know-how would decrease as the surroundingenvironment changes and the workforce is replaced. Therefore,improvements or adjustments would be needed to ensure that those factorscontinue to be effective. In this way, the going concern element of AGWwould be replaced by updated reputation with customers or updatedtechnology and know-how. The ASBJ Staff think that these updated factorsform part of IGGW, which is distinct from the original AGW. Accordingly, theadvantages provided by the factors that were originally recognised as part ofAGW would not continue for long.Synergies element
3.15The synergies element represents synergies and other benefits expected fromcombining the net assets and businesses of both the acquirer and the acquiree.Those benefits include cost reduction through the use of economies of scale orgenerating incremental revenue such as by jointly producing better products orproviding better services.
3.16Some stakeholders think that factors such as higher margins due to costreduction or higher revenue from enhancing the business of the acquirer or theacquiree (or both) are the manifestation of the synergies element. Similar tothe going concern element, some argue that the synergies element is not of awasting nature because, when estimating the value of an entity, such factors areassumed to exist indefinitely16 in the estimated future cash flows.
3.17The ASBJ Staff take an opposing view, and think that, though the acquirer expectsto achieve higher margins or higher revenue as the manifestation of the synergieselement, the synergies element is of a wasting nature for two reasons. One isthat, if the synergies element is expected to generate excess returns, similar16 IVSC Perspectives Paper cited in footnote 15 claims that the synergies include higher margins throughrealising economies of scale (costs synergies) and higher revenue (revenue synergies). The paper statesthat synergies are implicitly assumed to exist indefinitely but it is not clear why such an assumptionshould be posed.behaviors aiming to achieve such excess returns would be enhanced in theindustry, and such excess returns would decrease over time assuming there ishealthy competition. This is similar to the discussion on the going concernelement. The other reason is that acquirers hold the view that many businesscombinations do not meet their expectations17 and that this may imply thatthere are many instances where the synergies element does not contribute toperformance subsequent to the business combination as expected.Goodwill as a whole
3.18As described above, the ASBJ Staff think that both the going concern element andthe synergies element are of a wasting nature, and that AGW is as a whole of awasting nature.
3.19Some stakeholders argue against this view from different perspectives withoutdistinguishing the going concern element from the synergies element. Thesestakeholders typically claim that, even if those elements are diminishing in nature,the period or pattern in which those elements diminish is not generally knownand that the elements may continue as long as the business is considered to bea going concern.The ASBJ Staff do not agree with this view because the question of how to17 There are following surveys available on the Internet and are mainly based on the responses fromentities that experience business combinations.Global PMI Partners, Success and Failure in M&A Execution – An Empirical Study,https://gpmip.com/success-and-failure-in-ma-execution-an-empirical-study/This study examines whether the value of the transaction is higher than the price actually paid for thetarget and concludes that the evolution of the market capitalisation of publicly listed companiesfollowing an acquisition generally points to a destruction of shareholder value.From Buying Growth to Building Value, The Boston Consulting Grouphttp://image-src.bcg.com/Images/BCG-From-Buying-Growth-to-Building-Value-Oct-2015_tcm9-
88324.pdfThe report states that companies can grow through acquisition, but that inexperienced acquirerstypically destroy value for their shareholders.The Survey on M&A by Deloitte Tohmatsu Consulting in 2013 (Japanese only)
https://www2.deloitte.com/content/dam/Deloitte/jp/Documents/about-deloitte/news-releases/jp-nr-nr20131008-2.pdf36% of companies that responded to the survey met their standards of M&A success. Most of thosestandards determine their M&A success based on whether they have achieved more than 80% of theirobjectives.Please also refer to footnote 36.estimate the diminishing period or pattern and the question of whether AGW isof a wasting nature are two separate issues. In addition, considering that anentity is required to estimate the period and the pattern in which the benefits ofproperty, plant and equipment (PPE) and intangible assets with a finite useful lifeare expected to be consumed, the ASBJ Staff expect that the same would applyto AGW. It may be true that more information is available in estimating thediminishing period and pattern for PPE or finite-lived intangible assets becausethose assets are exposed to physical wear and tear or may have legal limits onthe use of assets. However, their useful lives are defined in terms of the assets’expected utility to the entity18 and technical or commercial obsolescence areconsidered. In this regard, AGW is essentially no different from PPE orintangible assets. Accordingly, there is little justification that AGW should betreated otherwise.
3.20In relation to the wasting nature, academic studies have repeatedly shown thatreturns or rate of returns derived from accounting information, such as return onassets (ROA) or return on equity (ROE), tend to revert to their industry mean19.Some researchers in Japan have considered this tendency of mean reversion ofROA or ROE to be compatible with the argument that AGW is of a wasting nature.Palepu and Healy (2013) 20 noted the reason we can observe this tendency asfollows:
... rate of return on investment (ROEs) tend, over several years, to movefrom abnormal to normal levels – close to the cost of equity capital – asthe forces of competition come into play. Profit margins also tend toshift to normal levels, but for this statistic “normal” varies widely acrossfirms and industries, depending on the level of asset turn over andleverage. ...
3.21In addition, some academic studies have analysed to determine whether theentity’s performance has improved subsequent to business combinations.Some of these studies reported results that do not support the argument byobserving lower rates of return for several years subsequent to business18 IAS 16 Property, Plant and Equipment, paragraph 57.19 The ASBJ Staff reviewed academic papers mentioned in paragraphs C.1 to C.4 of Appendix C.20 Palepu, Krishna G. and Paul M. Healy (2013) Business Analysis and Valuation Using FinancialStatements, PART 2, 6-16, 5th edition, South-Western Cengage Learningcombinations at a statistically significant level21. The ASBJ Staff acknowledgethat those studies do not directly study the synergies element, but the ASBJ Staffobserve that combining the business and net assets of the acquirer and theacquiree do not necessarily lead to improved performance. This seems to implythat it is unlikely that there is positive support for the view that the synergieselement continue to exist.
3.22The ASBJ Staff note that, even if AGW is of a wasting nature and its valuediminishes over time, this does not necessarily mean that the estimated futurecash flows to the entity would decline over time. This is because cash flowsgenerated by the entity are reinvested. In other words, an entity has variousresources that contribute to its prospects for future cash flows, many of whichhave finite useful lives. The reduction in resources due to their consumptionusually results in the collection of other resources, which would be reinvested inthe entity’s business. This reinvestment cycle will continue as long as the entitylasts as a going concern.Some stakeholders claim that, if goodwill is of a wasting nature, there would bea large portion of cash flows that are unexplained after the entity’s finite-livedresources are consumed. However, the cash flows generated from the finite-lived resources originally acquired in a business combination will be reinvestedinto new finite-lived resources and additional cash flows will be generated fromthese new resources. Accordingly, future cash flows will continue to begenerated, far beyond the useful lives of the finite-lived resources originallyacquired in a business combination. This process allows the value of an entityto appear to be stable even if AGW is of a wasting nature.Accounting for acquired goodwill as a wasting assetWhether acquired goodwill should be amortised
3.23In the previous section, we concluded that AGW is of a wasting nature.
3.24One approach to depict the wasting nature of AGW in the financial statements isthe amortisation approach. This approach would allocate the cost of AGW21 Please refer to paragraph C.5 of Appendix C.over its useful life as expenses on a systematic basis, and the carrying amountafter amortisation would be tested for impairment22. The carrying amount ofAGW under the amortisation approach is not intended to directly reflect thecurrent value of AGW. Rather, amortisation would represent the consumptionof AGW, and amortisation would represent the decline in the benefitsrepresented by AGW.
3.25Another approach to depict the wasting nature of AGW in the financialstatements is the non-amortisation approach. Under this approach, it isassumed that it would not be a problem that entities may recognise IGGW up tothe initial historical cost of AGW. Accordingly, the carrying amount of AGWwould not be revised and thus expenses would not be recognised unless the totalvalue of AGW and IGGW becomes lower than the initial historical cost of AGW.Impairment losses should be recognised when the total value of AGW and IGGWbecomes lower than the initial historical cost of AGW.This non-amortisation approach focuses on the inseparability of AGW and IGGW.In other words, an entity cannot observe AGW separately from IGGW subsequentto the business combination; an entity can only observe the integrated unit ofAGW and IGGW. Accordingly, under this approach, as long as IGGWcompensates the wasting of AGW, an entity would report that the value ofgoodwill is maintained.
3.26Considering these two approaches, the ASBJ Staff support the amortisationapproach for the following reasons:
(a) The amortisation approach would not directly reflect the current value ofAGW in its carrying amount, but would allow an entity to represent itsdeclining trend over time separately from IGGW by reflecting theconsumption of AGW.(b) The ASBJ Staff think that the amortisation approach would reflect theconsumption of AGW, which forms part of investment of the businesscombination, in profit or loss in each period. This would result in expensingAGW in a timelier manner and would provide useful information about22 Please refer to footnote 8 regarding the unit of account that should be subject to impairment.financial performance subsequent to the business combination.(c) When the impairment test is conducted at the CGU level, the carrying amountof AGW is shielded by the acquirer’s IGGW before the business combinationand any IGGW of the combined business generated after the businesscombination23. This would obscure the impairment of AGW. As a result,when relying only on the impairment test, it is less likely that the wastingnature of AGW would be faithfully represented in the financial statements.In this regard, the amortisation would be applied regardless of such shielding,and the amortisation approach could avoid this disadvantage of the non-amortisation approach.(d) The non-amortisation approach would raise again the discussion of the scopeof the accounting discussed in paragraphs 3.4-3.6. In addition, the non-amortisation approach would effectively allow an entity to recognise IGGW,up to the initial historical cost of AGW, which results in treating IGGWdifferently, depending on whether it relates to AGW. The amortisationapproach could avoid this disadvantage of the non-amortisation approach.23 The IASB is aware of the issue of the so-called shielding effect and made efforts to improve theeffectiveness of the impairment test of goodwill, such as by developing an approach that could addressthe buffer created by the unrecognised headroom. However, the IASB did not continue the efforts dueto various reasons including the complexity of the developed approach.PART 3B: HKICPA Staff viewIntroduction
3.27Since the introduction of the impairment-only model, AGW balances have beenrising globally24. The HKICPA Staff think that such a trend, along with recenthigh-profile goodwill write-offs, gives rise to a number of questions about thenature of goodwill, its place on the balance sheet and its subsequent accounting.
3.28The HKICPA Staff think an amortisation plus impairment approach (which werefer to in short as an amortisation approach) for the subsequent accounting ofAGW is superior to the existing impairment-only approach. In this section, weexplain:
(a) The HKICPA Staff view on the nature of goodwill and its treatment underIFRS.(b) Why amortisation plus impairment is a better choice than impairment-only.The nature of goodwill and its treatment under IFRS
3.29It is challenging to come to consensus on the nature of goodwill due to the factthat it is not separately identifiable and cannot be directly measured. Variousattempts have been made to set out the components of goodwill, but none cometo a definitive list.25
3.30As discussed in Part 2, IFRS has two established accounting concepts for goodwill:
(a) acquired goodwill, or AGW, which IFRS 3 requires to be recognised as anasset; and (b) internally generated goodwill, or IGGW, which IAS 38 prohibitsfrom being recognised as an asset.
3.31For discussion purposes, the HKICPA Staff think that it is helpful to compare the24 Refer to Part 1 for an updated quantitative study on this phenomenon.25 In October 2015, IASB staff considered an approach to apply different accounting treatments for theseparate components of goodwill. In February 2016 (Agenda Paper 18B), that approach was excludedfrom deliberations on the basis that it would be extremely complex and subjective, and if there are anycomponents that can be accounted for separately then they’d presumably meet the IAS 38 criteria forseparate recognition. The IFRS 3 Basis for Conclusions acknowledges that goodwill may includecomponents such as a trained workforce, loyal customers (reputation), as well as market imperfectionsand barriers to entry, but a conclusive list of components was not provided.IFRS concepts of AGW and IGGW with goodwill in a broader sense, which weterm “economic goodwill” to provide a reference point independent of theaccounting regime.Economic goodwill
3.32The HKICPA Staff describe economic goodwill as follows:
Economic goodwill is the difference between the fair value of an entity and itsidentifiable net assets (book value) recognised under prevailing accountingstandards.
3.33The fair value of an entity refers to the market value or enterprise value of anentity as a whole. As the unit of account we refer to is the entity as a whole,this includes all elements that make up that whole including the ability to controlthe entity (control premium). There are various methods and a multitude ofinputs to determine a fair value for control of entity, which is an economic matterindependent of the given accounting regime. The HKICPA Staff consideracquisition price to be the best representation of the fair value of an entity at thetime of acquisition.
3.34Economic goodwill can be illustrated as such for an entity that has made no prioracquisitions (and hence has no AGW on its balance sheet):
3.35The purpose of goodwill in accountancy is to represent the divergence betweenwhat can be recognised and measured for financial reporting purposes(identifiable net assets, whose carrying amount is commonly referred to as “bookvalue26”), and what cannot (all components of the total fair value of an entity).
3.36A multitude of items and factors may contribute to the difference between anentity’s fair value and the book value of identifiable net assets27. The fact isthat financial reporting cannot identify, recognise and measure everycomponent that makes up the fair value of an entity (and indeed it is not thepurpose of general purpose financial reports to show the value of an entity, butrather to provide information to help users estimate the value). Hence, thereis a need for the concept of goodwill to act as a balancing amount.
3.37It should be noted that the concept behind our description of economic goodwillis considered in IAS 38.50, which when describing IGGW states “Differencesbetween the fair value of an entity and the carrying amount of its identifiable netassets at any time may capture a range of factors that affect the fair value of theentity.” However, IFRS does not directly define IGGW and the concept isprimarily used as a differentiator from AGW within the accounting framework.Acquired goodwill
3.38The relationship between economic goodwill and AGW is that AGW is a point-in-time “snapshot” of an acquiree’s economic goodwill as of the acquisition date ofa business combination 28 . AGW is the difference at the acquisition datebetween the identifiable net assets of the acquiree, and the acquirer’sestimation of fair value of the acquiree (the acquisition price).
3.39The concept of goodwill hence exists not only in the case of a business26 The HKICPA Staff use the term “book value” to represent the net amount recognised on the balancesheet of an entity under prevailing accounting standards. This amount may fluctuate from period toperiod due to the subsequent measurement of assets and liabilities, and recognition or derecognitionevents.27 In line with the IASB’s rationale for rejecting an approach that accounts for separate components ofgoodwill, HKICPA Staff do not think it is possible to attempt a definitive list of components so long asthose remain sufficiently unidentifiable and unmeasurable.28 The HKICPA Staff acknowledge AGW will be affected by any uplift in the book value of the acquiree’snet assets when they are fair valued under the acquisition method, and the fair value of any identifiablenet assets the acquiree had not previously recognised.combination, but so long as an entity’s fair value exceeds the book value of itsidentifiable net assets. The business combination simply provides a situation inwhich the economic goodwill of an acquiree can be measured as a balancingamount from the exchange transaction. The HKICPA Staff think the ability toobtain this residual measurement is one of the primary reasons recognition ofAGW is tenable under prevailing accounting standards.
3.40As a snapshot, AGW is a static and distinct historical accounting artefact.Barring the application of any subsequent accounting regime to update itscarrying amount, AGW cannot be re-measured after acquisition, nor can changesin AGW be directly tracked (hence why the impairment test depends on assessingthe recoverable amount of CGU(s)). This is in contrast to economic goodwill,which is dynamic and will vary in amount as the fair value of an entity fluctuatesfrom day to day, or the book value of the entity’s identifiable net assets changesfrom reporting period to reporting period.Why amortisation plus impairment is a better choice than impairment-only
3.41The HKICPA Staff are of the view that an amortisation regime (together withindicator-based impairment29) is the best approach to subsequently accountingfor AGW. There are two key points as to why:
(a) Amortisation better reflects the nature of AGW, in particular:
(i) It better reflects the fact that AGW becomes increasingly lessrepresentative of the acquiree and the consolidated entity.(ii) It provides a better opportunity for entities to show how anacquisition is utilised.(iii) It improves comparability between entities that grow organicallyand through acquisitions.(b) Amortisation ensures that increasingly large goodwill balances supported bythe impairment-only model, which may contribute negatively tomanagement incentives and misrepresent risks, will be allocated to expenseon a timely basis.29 Please refer to Part 4 for detailed discussion on our proposed method of amortisation plusimpairment.
3.42These points are addressed in turn.Key Point 1: Amortisation better reflects the nature of AGW.Better reflects how AGW becomes increasingly less representative of the acquireeand consolidated entity
3.43Goodwill is always a residual amount. It cannot be directly measured or directlyvalued because it is only the difference between an entity’s fair value and thebook value of its identifiable net assets, and would not exist as a concept withoutthose data points. In this sense, goodwill itself is not an item subject to“valuation”, and it could be said that goodwill is only a part of an asset (that assetbeing the entity as a whole) rather than a stand-alone asset itself.
3.44Over time, the amount recognised as AGW will become increasingly lessreflective of the current fair value or current book value of the entity, andtherefore increasingly meaningless as a balance sheet item. Unlike somethingsuch as a financial asset that can be measured at fair value, AGW cannot be re-measured and so cannot be updated to reflect any value creation.
3.45As such, a situation in which AGW has not yet been impaired does notdemonstrate that an acquisition has been a success, or even that it has metexpectations. The impairment test is asymmetric and cannot reflect increasesin value. As long as the fair value of its CGU(s) remains sufficient, AGW’scarrying amount will be supported (shielded) by IGGW and any otherunrecognised ‘headroom’, and hence economic goodwill, in the CGU30. This isbecause the impairment test compares a historical AGW balance against acurrent fair value, the latter which will reflect a dissimilar state of economicgoodwill from that at the acquisition date. Effectively, AGW becomes a ceilingfor the indirect recognition of IGGW. This can be referred to as the“impairment shield” issue.
3.46This impairment shield issue obscures the reality of goodwill, because what thefinancial statements purport to be an asset arising from a historical acquisitionmay be shielded from expense recognition by cash flows of an entity significantly30 Specifically, this will be the recoverable amount (higher of value in use and fair value less costs ofdisposal) of the CGU(s) to which AGW is assigned over the respective carrying amount. Though there aredifferences between value in use and fair value, the argument is the same.different from those of the entity that the asset was established for. Theconsolidated entity and its acquisition may continue to perform for years afterrecognising AGW. Over time, the acquisition may be integrated, and the overallentity enhanced and transformed in myriad ways to the point where theoriginally recognised AGW becomes largely meaningless. At such a point, e.g.years or decades after an acquisition, any impairment charge would be equallyas meaningless and also confusing, particularly if that acquisition had beensuccessfully monetised many years prior.
3.47Noting the above, the HKICPA Staff disagree with the argument made by someconstituents that AGW should not be amortised because it can be linked to andsupported by the cash flows used to value the acquisition (and is henceindefinitely lived or “non-wasting” in nature)31. Firstly, AGW simply cannot bedirectly measured (directly valued) and hence cannot be directly linked to anycash flows. As noted above, AGW acts more as a part of the asset of the overallentity rather than a stand-alone asset. Secondly, what is being assessed isacquired goodwill, which is a snapshot of economic goodwill, and hence a staticpicture of an historical amount. To assert that AGW is linked to or supportedby the entity’s cash flows becomes therefore even more tenuous, as AGWincreasingly bears no relation to the fair value of the entity and its cash flows towhich, some constituents argue, the AGW is supposed to relate.
3.48The HKICPA Staff think that amortisation plus impairment better reflects the factthat AGW becomes increasingly less representative of the economics of theunderlying entity than impairment-only. Amortisation ensures that thenecessary function of cost allocation will be applied in a systematic andunderstandable manner to an asset that becomes increasingly meaningless inrelation to its entity over time. This will help to resolve the issue that animpairment-only approach creates by enabling AGW balances to remain onbalance sheets irrespective of changes in the underlying entity, potentially to thepoint of those AGW balances being nonsensical.31 In particular, some constituents argue that AGW’s value is linked to the terminal value used to valuean acquisition, and that is subject to a perpetual growth assumption. These constituents argue that as aresult, goodwill is “non-wasting”, i.e. assumed to be an indefinite life asset, and therefore disagree withamortisation approaches. The HKICPA Staff disagree with this view for the reasons presented in this RP.Better opportunity to show how an acquisition is utilised
3.49One of the functions of accountancy is to represent the utilisation of economicresources over time. This is why there are concepts such as depreciation forproperty, plant and equipment, regardless of an entity’s expectation of increasesin economic value of those items. The purpose of such depreciation is not toshow a decline in the fair value of an item, which would be better representedby a current value measurement, but to show the utilisation of that item.
3.50AGW represents a part of the historical fair value of an entity at the acquisitiondate (although as noted in the section above this link cannot be directlymeasured). After the acquisition, if expectations are realised and the value ofthat acquisition is monetised, the cash flows associated with that acquisition willbe accounted for as income that increases assets (cash, accounts receivable, etc.)
and equity (retained earnings). If the AGW does not have an appropriate costallocation method applied to it, the entity effectively starts double counting cashflows (first as AGW, then again as income). Such a situation results in anartificial and accounting-driven inflation of assets and equity, and no informationwhatsoever on the utilisation of the amount paid for the acquisition.
3.51The HKICPA Staff think amortisation with impairment is preferable toimpairment-only because it provides a mechanism to show the utilisation ofAGW. Under amortisation, users will be able to see the timeframe in which anacquisition is expected to be utilised (via the amortisation period32), and be ableto observe a systematic cost allocation of AGW versus the income earned by theentity. This would better tie AGW to the performance of the acquisition. Forsuccessful acquisitions, this would provide a superior representation of themonetisation of the acquisition. For unsuccessful acquisitions, amortisationplus impairment would also reflect the destruction of value in a timelier manner.
3.52Amortisation is criticized by some constituents as an “artificial” charge. Somealso rightly note it is challenging to link the amount recognised as AGW to specificfuture benefits, given AGW can’t be directly measured or separately identified,and does not produce independent cash flows. The HKICPA Staff consider that32 Refer to Part 4 for discussion on amortisation period.this problem exists under both an amortisation and an impairment-only model,and will exist so long as AGW is recognised as an asset.
3.53Both amortisation and impairment of AGW are non-cash expenses, and as suchboth are “artificial” insofar as they are subsequent accounting mechanisms foraccounting purposes. The impairment model is an asymmetric mechanism toindirectly allocate AGW’s cost by reference to associated CGU(s) which cannotbe disentangled from IGGW. The HKICPA Staff consider that it is more artificialto let goodwill remain un-expensed over time (e.g. if an entity performs or ifAGW is otherwise shielded from impairment) to the point where, as noted in theprior section, it ceases to reflect any economic reality of the underlying firm.
3.54The HKICPA Staff propose retaining an indicator-based impairment test as part ofan amortisation approach. This would ensure that significant declines in valueof CGU(s) indicative of a failed acquisition would be recognised in early years,when the un-amortised amount of AGW is still of a substantial size. As such,impairment would still play a significant role in our approach, but that role wouldbe more relevant. This is because impairment tends to be most relevant in theearly years after an acquisition where the acquiree can be clearly distinguishedwithin the consolidated entity. The HKICPA Staff think that the current level ofinformation provided about management’s capital allocation decisions, and thesuccess or failure of acquisitions, will not deteriorate under an amortisation withimpairment approach. Our approach does not eliminate the recognition ofAGW as an asset or otherwise hide the acquisition’s performance. The HKICPAStaff think that concerns for additional insight into the performance ofacquisitions are best served by disclosures (including potential new disclosuresabout business combinations developed through the standard setting process33).Improves comparability between entities that grow organically and throughacquisitions
3.55When AGW is recognised as an asset, a problem that immediately arises is thatthe financial reporting of entities who primarily grow organically begins todiverge from that of entities who primarily grow through acquisitions. This isbecause some of what constitutes organic growth is required to be expensed (as33 The HKICPA Staff note that better disclosures for business combinations has been under considerationby the IASB and its staff.IGGW), whereas acquisitive growth allows for amounts not recognised as part ofidentifiable net assets to be capitalised as AGW. In this way, accounting isbiased towards entities depending on their growth strategy.
3.56Amortisation would ensure that AGW balances will eventually be expensed in asystematic manner, and this will serve to improve comparability between organicand acquisitive growth. This is illustrated in further detail in Appendix B.Key Point 2: Impairment-only supports increasingly large goodwill balances thatmay negatively incentivise management and misrepresent risks.
3.57As noted in Part 1, we acknowledge that there may be multiple reasons forincreasing goodwill balances. However, the HKICPA Staff think it is difficult todeny that an impairment-only model has contributed to such increases.Why does the impairment-only model allow for increasing goodwill balances?
3.58The absence of a regular amortisation charge will naturally result in highergoodwill balances so long as impairment is avoided. Problematically, thecurrent regime provides the opportunity to avoid recognising impairment. Thisis because AGW is tested for impairment by allocating it to cash generating units(CGU(s)) and testing those against their current recoverable amount. Thiscurrent recoverable amount will inevitably include IGGW and headroom, andhence changes in economic goodwill that both existed before, and was createdafter, the acquisition date. This is the impairment shield issue34.
3.59The impairment shield issue is exacerbated by a high level of managementjudgement in determining how the impairment test is performed, including theability to determine the level of CGU(s). Management can potentially allocategoodwill to a CGU that is sufficiently large (with sufficient headroom) such thata decline in the value of the operations that the AGW relates to is shielded bythe broader CGU35.34 This was acknowledged by the IASB in the development of IAS 36 (IAS 36.BC134-BC135).35 For example, a large multinational entity could purchase a relatively small subsidiary in one country,and then allocate the AGW of that subsidiary to a global business division. In doing so, the entity couldavoid recognising any impairment even if the subsidiary performed poorly, because that AGW would beshielded by the much larger recoverable amount of the global business division.What is the problem with increasing goodwill balances?
3.60The HKICPA Staff think that growing and un-expensed AGW balances may resultin distorted and weakened balance sheets, and lead to concerns about the roleaccountants are playing in allowing risks to develop without appropriaterepresentation. Consider the following:
(a) Current goodwill accounting is arguably pro-cyclical. An environment oflow interest rates, easy credit, and aggressive deal making may drive alarger number of acquisitions and higher acquisition prices. This in turnwill result in higher AGW balances. In such an environment, entities maythen avoid recognising any expense with regard to that AGW for anextended period of time as conditions remain positive and discount rates(used in the calculation of recoverable amount) low. However, wheneconomic conditions turn negative or interest rates rise, entities may startto experience “impairment shocks” and sudden large losses.(b) Increasing AGW creates situations where more of entities’ liabilities andequity are supporting a highly nebulous asset, which cannot be identified,separated, transferred or liquidated. This can result in managementleveraging against an increasingly more speculative asset side of thebalance sheet. Synergies, which some argue are a significant componentof AGW, don’t always manifest. Research from McKinsey & Company andBain & Company36 has found that nearly 70 percent of mergers assessedfailed to achieve expected revenue synergies, and two thirds of acquisitionsfail to create meaningful shareholder value.
3.61The HKICPA Staff are also concerned that the impairment-only regime mayexacerbate undesirable management incentives as follows:
(a) It may incentivise “big bath” accounting practices due to the subjectivenature of the impairment assessment and the impairment shield. Entities36 https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/where-mergers-go-wrong.https://www.bain.com/contentassets/a13fb5f396e348cc84699f4c7fe89d05/bsr_masteringmergerintegration.pdf.may elect to take a large impairment charge all at once (e.g. to coincidewith a change in management).(b) It may incentivise management to value acquisitions more highly, given thatany payment over identifiable net assets can be reflected as AGW andmanagement can ignore subsequent expense for a foreseeable future.(c) It may incentivise management to lever against an inflated and speculativeasset-side of the balance sheet.(d) To maximise financial reporting metrics, and given the market often viewsimpairment negatively, management may be incentivised to delayimpairment as long as possible.(e) Sticky AGW balances, resulting in inflated assets and equity and suppressedexpenses, can influence management’s decisions and affect the ability toproceed with certain corporate actions. For example, the ability to paydividends out of distributable reserves can be affected.
3.62The fact that some sophisticated stakeholders already make adjustments forgoodwill indicates that they view goodwill as it currently exists a speculativefinancial reporting item.How amortisation would improve this issue?
3.63Amortisation would help to address the issues noted above, as it would ensureAGW balances are brought down over the period the acquisition is utilised in asystematic manner. This would reduce the potential risks noted that are notcurrently being addressed by the impairment-only model. It would also help tomitigate the “impairment shield” problem and the ability of management toapply questionable judgement to impairment testing.
3.64The HKICPA Staff think that amortisation would improve management disciplineand better hold management accountable for acquisitions because it wouldrequire entities to consider the expected utilisation of the cost of theiracquisitions, and would not enable AGW to remain on balance sheet for undueamounts of time. This is unlike the current impairment model, which cancontribute to expense avoidance for a lengthy period of time. In this way, thenegative management incentives noted above would be alleviated.
3.65The HKICPA Staff disagree with the argument that amortisation of AGW wouldallow management to “hide” failed acquisitions. We are of the view thatamortisation, plus impairment, will improve transparency as it will ensure thereal economic cost of an acquisition is brought through the financial statementsin a timely and systematic manner.Goodwill and corporate stabilityA contribution to the HKICPA Staff by Professor Adam Leaver, Chair in Accountingand Society at Sheffield University Management School, United Kingdom.As noted in paragraph 3.50, the impairment-only model effectively ‘double counts’assets because (a) AGW values are a capitalised measure of the acquirer’s expectedfuture cash flows at the point of acquisition and (b) cash flows which then resultfrom that acquisition are accounted for as income that increases assets (cash,accounts receivable, etc.) or equity (retained earnings) without incurring anycorresponding costs or reductions to AGW. The benefits of an acquisition are, inother words, monetized first as AGW, then again as income. The resulting inflationof assets and equity that are an artefact of this accounting treatment may distortmanagerial incentives.First, CEOs may be incentivised to grow inorganically rather than organically. Thismay encourage amalgamations driven by financial engineering rather thanoperational efficiency motives. The resulting amalgamations may lead to increasedoperating inefficiencies at the aggregate. Worse, they may introduce ponzi-likedynamics if the disappointing operating outcome/cash flow performance of onemerger leads managers to seek a second merger for the asset uplift. In suchsituations, one poorly thought through merger may beget another.Second, given the option of either capitalising or distributing this double-countedincome many managers will choose to distribute. This may lead to an ‘acquire anddistribute’ strategy which may again displace other investment-led, productivity-focused sources of shareholder value creation. Remuneration structures tied toshareholder value measures or measures that underpin the creation of shareholdervalue may exacerbate this problem.Third, the benefits of double counting may encourage managers to over-estimatethe true economic value of corporate assets. Acquiring companies may thereforebe willing to pay a rising multiple of a target firm’s average annual income to acquireit. Paying higher multiples of average annual income may then have acorresponding effect on the goodwill booked.Fourth, the double counting of goodwill may have implications for corporatestability. If acquisitions are financed with large amounts of debt, and cash flowsfrom the acquisition fall below the level expected to justify AGW valuations, doublecounting goes into reverse. Falling cash flows may lead to real-time losses andthose real-time losses may lead to a goodwill impairment test. If the recoverablevalue of CGU assets are deemed to be lower than their carrying amount, that maylead to an impairment charge on top of the real-time losses. If firms are highlylevered, there may be inadequate equity redundancies to accommodate theoperating and impairment losses; or, firms will be forced to recapitalise throughshare issue at precisely the point that the market doesn’t want to buy shares.Firms may even be reluctant to impair their goodwill, despite weakening economicperformance – incentivising accounting fraud.In this sense goodwill accounting might be thought of as a form of leverage. Andthese processes might be thought of as ‘pro-cyclical’, echoing some of the problemswitnessed in financial firms during the 2007/8 crisis. Furthermore, this may erodethe decision-usefulness of accounts for investors if the logic of it is greater balancesheet volatility, which is difficult to predict.PART 4: AMORTISATION PERIOD AND METHOD
4.1The Staffs think that amortisation should be applied to the AGW arising fromeach individual business combination as a whole (that is, the AGW asset arisingfrom a particular acquisition should not be disaggregated into components withdifferent amortisation schedules). This is because AGW cannot be separatelyidentified or directly measured37 . In addition, management should make areasonable estimate of the amortisation period utilising reasonably availableinformation.
4.2The Staff’s respective proposals, based on their core arguments, are presentedbelow.PART 4A: ASBJ Staff viewUnit of amortisation
4.3As already discussed in paragraphs 3.23-3.26, the ASBJ Staff think that theamortisation approach should be applied to depict the wasting nature of theAGW in the financial statements. The ASBJ Staff do not think the amortisationapproach can be rejected merely because some consider it difficult to estimatethe amortisation period.
4.4As discussed in paragraphs 3.8-3.11, AGW can conceptually be analysed basedon several components, including the going concern element and the synergieselement. However, the ASBJ Staff think that a single amortisation period shouldbe used for AGW as a whole.
4.5The ASBJ Staff acknowledge that AGW itself is a residual of the consideration ofthe business combination after deducting the fair value of identifiable net assetsand do not generate independent cash flows. Accordingly, the ASBJ Staffunderstand that it is practically not easy to identify those individual components.Even if those components were to be individually identified, it would not be easyto quantify how those components contribute to the amortisation period37 If it were possible for components of AGW to be separately identified for amortisation, the Staffsthink that would presume such component should have been considered for recognition as an IAS 38intangible asset.because those components interact with each other.
4.6In the Proposed Statement of Financial Accounting Standards, BusinessCombinations and Intangible Assets published in 1999 (‘1999 Exposure Draft’),the FASB noted that it had considered the discernible-elements approach. Thisapproach assumes that goodwill is composed of multiple discernible elements,and identifies the useful life of each component and amortises AGW using aweighted average amortisation period of the discernible elements. No furtherconsideration was undertaken, as field testing found the approach to be highlysubjective.
4.7For this reason, that approach was not proposed in the 1999 Exposure Draft.Instead, the FASB proposed an amortisation period for the entire AGW based onmanagement estimates, up to a maximum of 20 years. Considering the historyof such discussions, the ASBJ Staff think that it is reasonable to apply a singleamortisation period to AGW as a whole, rather than to apply multipleamortisation periods to individual components.Possible approaches to determining the amortisation period
4.8Possible approaches to determining the amortisation period for AGW as a wholeinclude the following:
Approach 1: Require management to estimate the amortisation period, takinginto account the nature of AGW.Approach 2: As there is too much uncertainty in estimating the amortisationperiod, the accounting standard setter should determine theamortisation period (that is, “pick a number”).
4.9Approach 1 takes into account the fact that business combinations are diverseand that they can vary in nature. The ASBJ Staff think that what the acquirerexpects from goodwill and when the acquirer expects goodwill to become wasted(or alternatively, how long the acquirer expects goodwill to have an effect) varydepending on the business combination in question. In many cases, the ASBJStaff think that such expectation would be consistent with managementexpectation that future net cash inflows would increase due to the businesscombination, when incremental cash flows arising from reinvested assets areexcluded38. However, Approach 1 may be costly compared to Approach 2.
4.10Approach 2 ignores the different natures of AGW that arises from each businesscombination. Accordingly, this approach would treat AGWs with differenteconomics in the same manner, which may fail to represent the wasting of AGWin a timely manner and which may lead to false comparability. On the otherhand, the amortisation period for AGW has been controversial in theinternational debates, and some claim that a default period for the amortisationperiod should be considered as a viable alternative, given that addressing the“too little, too late” issue is of high priority. However, Approach 2 could only bejustified in the context of eliminating subjectivity inherent in estimating theamortisation period and in the context of addressing cost concerns.
4.11Regarding Approach 1 and Approach 2, the Agenda Paper “Possible approach foraddressing ‘too little, too late’ issue” (’ASBJ Paper’)39 which the ASBJ submittedto the Accounting Standards Advisory Forum in July 2017 discussed theamortisation period as follows:
(a) The ASBJ Paper basically supported Approach 1, with an amendment thatsets a cap on the amortisation period discussed below. In other words, theASBJ Paper argued that it was important to clarify the principle of theconcept of amortisation period, and in developing that principle, the viewsof users of financial statements on the amortisation period and informationprovided by amortisation should be emphasised. In addition, users offinancial statements who supported amortisation thought that informationbased on management’s estimate was useful. The ASBJ Paper suggested,as the essence of their views, that the amortisation period be “based on themanagement's estimate of the period in which the future net cash inflowswould increase due to the business combination." Though acknowledgingthe concerns over relying on management estimate, the ASBJ Paperemphasised more its advantage.(b) On the other hand, the ASBJ Paper did not provide a positive view on38 Paragraph 3.22 discusses that cash flows from reinvestment should not be considered whendiscussing the wasting nature of AGW.39 Please refer to following website:
https://www.asb.or.jp/en/discussions/papers/2017-0612-2.htmlApproach 2. In other words, for users of financial statements theinformation about amortisation period based on the management’sestimate was useful, whereas information based on the default amortisationperiod set by the accounting standard setter was unlikely to be useful, andwould not necessarily result in faithful representation because all AGWs areassumed to have the same amortisation period.
4.12The ASBJ Staff’s understanding is that the views of users of financial statementsare not significantly different from those expressed in 2017. In addition,management would be in the best position to estimate the amortisation periodbecause various information about the business combination is required toestimate the amortisation period. Accordingly, the ASBJ Staff think that thediscussion in the ASBJ Paper in the previous paragraph still holds, and Approach1 should be given priority, emphasising the views of users of financial statementswho consider the information based on the management’s estimate to be useful.Maximum amortisation period in applying Approach 1
4.13Setting a cap on the amortisation period would narrow management’s discretionbeyond the cap in estimating the amortisation period and might affect therelevance of information. The ASBJ Staff acknowledge that this is inconsistentwith the objective of Approach 1. However, assuming that there are growingconcerns over the “too little, too late” issue described in Part 1, such a measurewould likely be helpful to strike a balance between the provision of relevantinformation and the need to respond to such concerns. That is, setting such amaximum period would ensure that the amount of AGW decreases to zero withinthat maximum period, and is helpful to address the “too little, too late” issue.Accordingly, the ASBJ Staff think that it would be appropriate to set a maximumamortisation period.
4.14Although it was not easy to logically establish the appropriate maximum numberof years, the ASBJ Paper suggested 10 years. 10 years seemed to be acceptableto most stakeholders in light of (a) the maximum amortisation period set for theamortisation option provided for private companies under U.S. GAAP40, (b) theamortisation requirement under the IFRS for SMEs41, and (c) the results of some40 FASB Accounting Standards Codification Paragraph 350-20-35-63.41 Paragraph 19.23 (a) of IFRS for SMEs.academic studies.
4.15In this regard, the ASBJ Staff proposes a 10 year period similar to the ASBJ Paper.However, unlike the ASBJ Paper, the ASBJ Staff think that rebutting the maximumperiod of 10 years should not be permitted from the viewpoint of reachinginternational consensus. This is because (a) in international discussions so far,some have noted that it is unlikely to expect the effects of a businesscombination to continue more than 10 years, and (b) the amortisation optionprovided for private companies under U.S. GAAP and the amortisationrequirement under the IFRS for SMEs set 10 years as the maximum number ofyears and do not permit longer years (even as a rebuttable presumption). TheASBJ Staff also confirmed the results of academic studies that could beadditionally referenced (Please refer to Appendix C). As a result, the ASBJ Staffthink that setting the maximum amortisation period at 10 years will beacceptable to most stakeholders.Discussion of Approach 2
4.16As explained in Part 1, the amount of AGW has been increasing steadily over time,and this RP discusses the “too little, too late” issue assuming that this trend islikely to exist. In addition, as was observed during the recent discussions in theUnited States, stakeholders have serious concerns over the costs incurred inrelation to the subsequent accounting for AGW. Considering these situations,the ASBJ Staff think that some variation to Approach 2 is still worth considerationas the second best alternative to gain international consensus. In this case,considering the balance between eliminating subjectivity in estimating theamortisation period and ensuring a certain level of relevance, if the entity canjustify an amortisation period that is shorter than the default amortisation period,such amortisation period should be permitted.
4.17The ASBJ Staff consider that the discussion of the maximum amortisation periodin Approach 1 can also apply to the discussion to set the default period inApproach 2, considering that a variation to Approach 2 would permit anamortisation period shorter than the default period if the entity could justify it.Accordingly, the ASBJ Staff proposes that the default period in Approach 2 be 10years.PART 4B: HKICPA Staff viewAmortisation period
4.18One of our reasons for proposing amortisation of goodwill is to reflect theutilisation of AGW. As such, the HKICPA Staff think that the amortisation periodof AGW should be determined in terms of the expected utilisation of anacquisition42 . Entities should apply judgement to determine an amortisationperiod that reflects the entity’s expectations for utilisation of the acquiree,including the duration over which integration and monetisation of the acquireeis expected to take place as of the acquisition date.
4.19The HKICPA Staff view is that there are a variety of approaches and informationsources that can be used for determining the amortisation period for AGW in linewith this principle. When entering into an acquisition, it is good practice formanagement to analyse and have a business plan for the acquired entity post-acquisition. Questions that may be asked to inform the determination of theamortisation period include:
(a) What is the objective and strategic rationale of the acquisition? What arethe key business goals or priorities and their expected timeframe?(b) What are the most important sources of value from the acquisition, andhow and when will they be realised?(c) What are the financial results expected from the acquisition and when arethese expected? Is there an expected return on investment (considerationtransferred) based on forecast cash flows?(d) What is the integration plan for the acquisition? How long will theintegration process last? What are the key milestones for the integrationteam and when are they expected to be met?(e) Are there any limiting factors that would indicate a minimum or maximumamortisation period, for example any legal, compliance, or other similar42 The reader may note this is analogous to the principles in IAS 16 for determination of useful life.factors that impact the ability to fully integrate or operationalise anacquisition?
4.20We consider that much of this information should be able to be sourced frominternal reporting. Entities may also consider factors already noted inparagraph 90 of IAS 38 for determining the useful life of intangible assets.Determination of the amortisation period will require management judgement.However, the process of determining an amortisation period based on theprinciple of reflecting expected utilisation of an acquiree will benefit both (a)
management, as it will need to think critically about its post-acquisition plans,and (b) users, as they will gain more insight into management’s expectations foran acquisition. The HKICPA Staff note that this would be further enhanced bydisclosure of the significant judgements used in determining the amortisationperiod of AGW43.
4.21Setting such an approach based on the principle of expected utilisation of theacquisition also reflects our view that AGW is a historical snapshot of thedifference between fair value and book value as of the acquisition date. Beinga historical residual amount that cannot be directly measured, AGW is not subjectto valuation per se, and as an accounting construct does not have an “economiclife”.
4.22In addition to the principle above, we think that:
(a) There should not be a mandatory floor or ceiling for the amortisationperiod, as such a requirement would not be in line with the principle-basednature of IFRS and may fail to reflect an entity’s particular situation, industryand economic environment, which would diminish the value of theinformation provided to users. It may also incentivise entities to select thestandard period as a matter of operational convenience or to minimiseamortisation expense.(b) The HKICPA Staff nevertheless would support a rebuttable presumption thatthe amortisation period should not exceed a specified number of years (e.g.10 years). This is to avoid entities estimating an exceptionally long43 The need to disclose significant judgements would be captured by the disclosure requirements in IAS1 Presentation of Financial Statements.amortisation period that fails to reflect the nature of AGW and results insimilar concerns as already noted under the impairment-only approach.Determination of amortisation period for AGW - other possible approachesAt the International Forum of Accounting Standard Setters (IFASS) in October2019, participants suggested a number of approaches for determining theamortisation period. Among those, we noted a suggestion that an entitycould, in considering the synergies arising from the business combination andthe expected utilisation of the underlying acquired assets, apply a methodbased on the average useful lives of the identifiable underlying assets acquired.Another suggestion was to reference the industry or business life cycle of theentity.Amortisation method
4.23The HKICPA Staff view is that entities should be required to apply judgement todetermine what amortisation pattern is expected to best reflect the expectedutilisation of an acquisition.
4.24Analogising to the depreciation or amortisation requirements of IAS 16 or IAS 38,we may note that the cost allocation method used shall reflect the pattern inwhich an asset’s future economic benefits are expected to be utilised. TheHKICPA Staff think that, similar to IAS 16 and IAS 38, a variety of amortisationmethods may be used to allocate AGW on a systematic basis over its amortisationperiod. The method used should however reflect the expected utilisation of theacquiree, and be applied consistently from period to period. We think that,similar to IAS 38, entities should be required to use the straight-line method ifthe pattern of utilisation cannot otherwise be determined reliably.
4.25Entities could consider a variety of questions to help inform the amortisationmethod. The information used to determine the amortisation period shouldalso be considered when determining the amortisation method (e.g. expectedfinancial results, integration plan, key milestones, etc.).
4.26The HKICPA Staff think that the residual value of the AGW should be zero foramortisation purposes. AGW does not generate independent cash flows andcannot be transferred or disposed of. Additionally, AGW becomes increasinglyless representative of the acquiree and the consolidated entity over time.Applying amortisation – too difficult or too arbitrary?Some stakeholders argue that an amortisation approach for AGW is toodifficult and judgemental or too arbitrary to implement.The HKICPA Staff disagree, particularly when comparing an amortisationapproach to the existing impairment-only approach. The impairment-onlyregime is judgemental (e.g. in terms of allocation of AGW to CGU(s) andapplication of the impairment test) and operationally burdensome. Applyingdepreciation or amortisation, on the other hand, has been present inaccountancy at its most basic levels for much of modern history.Amortisation with indicator-based impairment will further reduce the burdenof an annual valuation process (which is complex and time-consuming and mayrequire costly engagement of external valuation firms).This RP presents a principle-based method by which to amortise AGW, andillustrates some of the methods and thought processes that could be used todetermine both the amortisation period and the amortisation method. TheHKICPA Staff think that determining an amortisation period and amortisationmethod based on expected utilisation of an acquisition is both practical andreasonable because entities should have basic answers to questions such as (1)
what are the objectives for the acquisition and the timeframe for meetingthem; (2) what are the financial expectations for the acquisition; and (3) whatis the integration plan for the acquisition. We furthermore consider thatmuch of this information should be based on internal reporting, and henceutilising that for external reporting will help minimise costs.Answers to such questions can help to inform a reasonable estimate of how anentity expects to utilise an acquiree. Judgement will certainly be required,however the use of judgement is present in many areas of IFRS and does notundermine the usefulness of the resulting information44.44 Paragraph 2.19 of the Conceptual Framework notes the use of reasonable estimates is an essentialpart of the preparation of financial information and does not undermine the usefulness of theAnswers to such questions will also help enforce management discipline andaccountability around acquisitions, which is something we think anamortisation regime supports in many respects. In order to determine anamortisation period and amortisation method, and disclose how those weredetermined, entities will need to consider and answer important questionsabout their acquisitions and post-acquisition plans. This will help furthersupport good practice and management stewardship.information if the estimates are clearly and accurately described and explained.AcknowledgementsThis RP was prepared by Atsushi Itabashi (ASBJ Staff) and Tiernan Ketchum (HKICPA Staff),with the advice of Atsushi Kogasaka (Chair of the ASBJ), Yasunobu Kawanishi (Vice chairof the ASBJ) and the HKICPA Financial Reporting Standards Committee, with the supportof Yukihiro Kajita and other staff of the ASBJ, and HKICPA staff Michelle Fisher, NormanChan, and Joni Kan.The HKICPA Staff greatly appreciate the support of Christina Ng (former Director,Standard Setting of the HKICPA), and Professor Adam Leaver, Chair in Accounting andSociety at Sheffield University Management School.Any possible errors remaining in this RP are the authors’ responsibility.Appendix A: METHODOLOGY OF THE QUANTITATIVE STUDYThe scope of companies analysedA1. The quantitative study collected data of more than 1,000 listed companies thatconstituted the following four major stock market indices in the United States,Europe, Hong Kong and Japan:
(a) the S&P 500 index of the United States (‘the stock market index of the UnitedStates’);
(b) the S&P Europe 350 index of Europe (‘the stock market index of Europe’);
(c) the Hang Seng Composite Index of Hong Kong (‘the stock market index ofHong Kong’) ; and(d) the Nikkei 225 index of Japan (‘the stock market index of Japan’).A2. Companies that have constituted the stock market indices as of the starting date ofthe study (July 2019) were included in the population, but the following adjustmentsshould be noted:
(a) Companies which had no net assets in any of the years between 2014 and2018 were excluded from the population;
(b) Companies with duplications (for example, a group and a listed subsidiarywithin the group) were excluded from the population45, except for companiesthat constituted the stock market index of Hong Kong because data to tracksuch group relationships were not available for Hong Kong; and(c) For the stock market index of Japan, only the following companies wereincluded in the population, considering that there were companies which havetransitioned from either Japanese GAAP or U.S. GAAP to IFRS during 2014-201846:
(i) Companies that applied IFRS in 2018 regarding the following figures:
Figure 1.1: Trends in the amount of total goodwill;
45 We identify such group relationships by the information provided by the Bloomberg database labelledas the “Ultimate Parent” under the category of “Company Overview”.46 The adjustments (a) and (b) were also considered to determine the companies included in thepopulation. Figure 1.2: The trend of Figure 1.1 (The data of 2014 are indexed as
100.)
Figure 1.3: Trends in the amount of goodwill per company (thatrecognised goodwill);
Figure 1.4: Trends in the ratio of the amount of Goodwill to NetAssets;
Figure 1.5: The trend of Figure 1.4 (The data of 2014 are indexed as
100.)
Figure 1.6: Trends in the ratio of the amount of Goodwill to theMarket Capitalisation;
Figure 1.7: The trend of Figure 1.6 (The data of 2014 are indexed as
100.)
Table 1.8: Trends in the number of companies that exceed certainratio of the amount of Goodwill to the Net Assets;
Table 1.9: Trends in the number of companies that exceed certainratio of the amount of Goodwill to the Market Capitalisation.For the financial figures for the periods in which the companies appliedJapanese GAAP, no adjustments were made regarding the effects ofamortisation charges.(ii) Companies that applied IFRS throughout 2014-2018 regarding thefollowing figures:
Figure 1.10: Trends in the amount of Goodwill expensed;
Figure 1.11: Trends in the intensity of Goodwill expensed.A3. With the adjustments mentioned in the previous paragraph, the number ofcompanies analysed for each stock market index was as follows:
Stock marketindexNumber ofcompaniesconstituting thestock market indexNumber ofcompanies analysedin the quantitativestudyNumber ofcompanies thatrecognised goodwillUnitedStatesEuropeHong KongJapan62*(29#)
59*(27#)
Total1,5611,3611,176* Number of companies that applied IFRS in 2018. The data ofapplicable companies are used for Figures 1.1 - 1.7 and for Tables 1.8and 1.9.# Number of companies that applied IFRS throughout 2014-2018. Thedata of applicable companies are used for Figures 1.10 and 1.11.A4. It should be noted that this sample is not a representative sample and should notbe used for statistical inference.Years coveredA5. We gathered data from 2014 to 2018.A6. Most companies had a year-end of 31 December. However, some companies hada year-end other than 31 December. For the stock market indices of the UnitedStates, Europe, Hong Kong and Japan, the financial data of those companies wereclassified in the year with the year-end that was closest to 31 December. Forexample, financial data of companies with the year-ends of 1 July 2018, 31December 2018 and 30 June 2019 were all presented as data for 2018.Data collectedA7. The following data were collected for each company analysed:
(a) Goodwill;
(b) Goodwill impairment;
(c) Net assets (that is, the book value of total equity); and(d) Market capitalisation (that is, the market value of total equity).A8. In this RP, all amounts were translated into U.S. dollars (USD) for the readers’convenience. A single exchange rate as of the end of June 2019 was used for thistranslation, as shown in the following table:
1 EUR = 1.13699 USD1 JPY = 0.00926 USD1 CNY = 0.14562 USD1 HKD = 0.12797 USD1 GBP = 1.26935 USD1 CHF = 1.02494 USD1 DKK = 0.15239 USD1 NOK = 0.11721 USD1 SEK = 0.10773 USDA9. The data of companies that constitute stock market indices were collected andanalysed using the Bloomberg database. However, the following adjustmentswere made:
(a) Regarding the stock market index of Japan, the Bloomberg data for ‘goodwillimpairment’ were replaced with the equivalent data from annual reports for allcompanies analysed if the data from two sources were inconsistent.(b) Regarding the stock market indices of the United States, Europe and HongKong, the Bloomberg data for ‘goodwill impairment’ were replaced with theequivalent data from annual reports for companies which decreased goodwillbalance by more than USD 1 billion compared to the previous year-end if thedata from two sources were inconsistent.(c) Other minor adjustments include using the data from annual reports in theyears for which the equivalent data are not available in the Bloombergdatabase because of a change of accounting period.Appendix B: COMPARABILITY BETWEEN ORGANIC GROWTH ENTITIES ANDACQUISITIVE GROWTH ENTITIESB1. The IFRS Conceptual Framework, when describing the qualitative characteristic ofcomparability, states that the faithful representation of similar economicphenomenon should possess some degree of comparability. The currentaccounting regime results in AGW being recognised as an asset only at the time ofa business combination. This creates deviations between entities that growthrough acquisitions versus those that grow organically.B2. To illustrate, consider the following example. Bank X has been mainly providinginvestment banking services. Management decides to set up a new wealthmanagement (‘WM’) division to expand and realise synergies by marketing someinvestment banking services to wealthy individuals. Management is consideringtwo options:
(a) Option A: Build-up a new WM division internally. This will cost $20m inexpenses, of which $5m are identifiable assets and $15m relates toexpenses that do not meet the recognition criteria in IAS 38 (and hencecontribute to IGGW).(b) Option B: Acquire an existing private bank in the market and integrate it asa new business division. This will also cost $20m, of which $5m will beallocated to identifiable net assets and $15m recognised as goodwill.B3. Management determines that it will take one year to fully establish the WMbusiness under both options. Assume that for purposes of our example, Bank Xwill be in substantially the same economic position after one year under eitheroption. Also assume that the fair value of each resulting iteration of Bank X will bethe same, and will be largely impacted by the costs used to build the WM business.We may illustrate how this will be accounted for under both options.Option A (organic growth):
B4. Bank X will expense $15m of costs that do not meet IAS 38 recognition criteria, andcapitalise $5m of other identifiable assets. At the end of the year, that expensewill reduce equity via retained earnings.DebitCreditExpense15m Cash20mOther Assets5mOverall effect•Cash of $5m is transformed into other assets•Decrease of assets (cash) by $15m•Expenses increase by $15m•Equity (retained earnings) decrease by $15mOption B (acquisitive growth):
B5. Bank X will capitalise $15m of AGW as required by IFRS 3, and capitalise $5m ofother identifiable assets. Assuming no impairment, there will be no impact toretained earnings. The cash has been transformed into other non-cash assets foraccounting purposes.DebitCreditAGW (Asset)
15m Cash20mOther Assets5mOverall effect•Cash of $20m is transformed into AGW and other assetsB6. The post-build up balance sheet position of Bank X will hence differ depending onthe option selected. Assume that Bank X started the year pre-build up with grossassets of $120m, split evenly between liabilities and equity. After the build-up, thebalance sheets (assuming no impairment and ignoring all other elements andtransactions for simplicity) would be as follows:
Option AOption BAssets105mLiabilities60mAssets120mLiabilities60mEquity45mEquity60mB7. The example above illustrates that current accounting regime leads to differences infinancial reporting depending on whether entities grow organically or throughacquisitions, even in cases where the cost of growth and economic substance of theentity after the growth is theoretically identical. This negatively impacts thequalitative characteristic of comparability. Some might argue that it is additionally‘unfair’ to entities that grow organically, given they are subject to a relatively lessbenign accounting model than acquisitive entities when it comes to accounting forgoodwill.B8. Introducing amortisation to the subsequent measurement of AGW would ensurethat AGW balances will eventually be expensed in a systematic manner, and willserve to improve comparability between organic and acquisitive growth.Appendix C: ACADEMIC STUDIES REFERENCED BY THE ASBJ STAFFAnalyses cited in the comment letter of the American Accounting Association regardingthe relevance of amortisationC.1 The comment letter of the Financial Accounting and Reporting Section of theAmerican Accounting Association in response to FASB’s Invitation to Comments,Identifiable Intangible Assets and Subsequent Accounting for Goodwill notes thatthere are some academic studies that suggests that the expected benefit ofgoodwill decays rapidly and that investors view goodwill as a wasting asset,including:
Bugeja, M., and N. Gallery. (2006). Is older goodwill value relevant? Accounting &Finance 46 (4): 519–535.The comment letter also notes that following studies examine more closely thelength of the amortisation period of goodwill and suggest that shorteramortisation periods better reflect the short-lived benefits of AGW:
Henning, S. L., and W. H. Shaw. (2003). Is the selection of the amortization periodfor goodwill a strategic choice? Review of Quantitative Finance and Accounting 20
(4): 315–333.Ojala, H. (2007). The value relevance of accounting goodwill – Does theabandonment of systematic amortisation make sense to investors? Finnish Journalof Business Economics 1: 9–34.C.2 The comment letter, on the other hand, notes following academic studies thatsuggest that amortisation would unlikely provide useful information.Jennings, R., M. LeClere, and R. B. Thompson. (2001). Goodwill amortization andthe usefulness of earnings. Financial Analysts Journal 57 (5): 20–28.Moehrle, S. R., J. A. Reynolds-Moehrle, and J. S. Wallace. (2001). How informativeare earnings numbers that exclude goodwill amortization? Accounting Horizons 15
(3): 243–255.Analyses regarding mean reversion of rate of returnsC.3 One of the most notable academic papers that presented this tendency of meanreversion is as follows:
Fama, E.F. and K.R.French (2000). Forecasting Profitability and Earnings, Journal ofBusiness, 73(2): 161-175In addition, the ASBJ Staff reviewed following academic papers when drafting theASBJ Paper:
Healy, P., Serafeim, G., Srinivasan, S. and Yu, G. (2011). Market competition,government efficiency, and profitability around the world. Working paper, HarvardBusiness School. Available at SSRN 1865878.Nissim, D. and Penman, S. H. (2001). Ratio analysis and equity valuation. Review ofAccounting Studies, 6: 109– 154.Obinata, T. (2013). Sustainability and mean reversion of profitability. Chuokeizai-sha, Inc. (the title of the book is not official translation but tentative one by theASBJ Staff.)
Palepu, K. G. And Healy, P. M. (2012). Business analysis and valuation 5th edition –International edition, Cengage learning.Palepu and Healy (2012) showed the empirical research results that excessoperating returns on equity diminished within five to ten years. Nissimand Penman (2001) explored the period of the mean reversion for decileportfolios formed on excess operating profit and found that excessoperating profit for the highest decile remained over 10 years.C.4 The ASBJ Staff additionally reviewed following papers and confirmed that there areno significant difference in the trend of mean reversion of rate of returns.Muramiya, K. (2010). Characteristic analysis of financial ratios that constituteresidual income model. In Sakurai, H. ed., Empirical analysis of enterprisevaluation, Section 9, 230-269, Chuokeizai-sha, Inc. (the titles of the paper and thebook are not official translations but tentative ones by the ASBJ Staff.)
Similar analyses to Nissim and Penman (2001) were conducted usingsamples of Japanese companies for fiscal years ending between January1977 and March 2007. Time series analyses for nine years wereconducted for residual earnings and residual operating income. The trendof mean reversion were observed.Sakurai, T. (2010). Persistence of residual income and enterprise valuation. InSakurai, H. ed., Empirical analysis of enterprise valuation, Section 10, 270-315,Chuokeizai-sha, Inc. (the titles of the paper and the book are not officialtranslations but tentative translations by the ASBJ Staff.)
The paper demonstrated that the adjustment speed of residual income peryear was 0.6271 for the sample Japanese companies for fiscal years endingbetween March 2002 and March 2007. Based on this, ROE is estimated tobe reduced to the cost of equity in about five years.Analyses regarding performance subsequent to business combinationsC.5 Following academic paper refers to several studies that analyses performancesubsequent to business combinations:
Obinata, T. (2012). The Origin of the Study of Accounting Standards, 364-365,Chuokeizai-sha, Inc. (the titles of the paper and the book are not officialtranslations but tentative translations by the ASBJ Staff.)
Studies that support improved performance referred to in Obinata (2012) include:
Healy, P.M., K.G.Palepu and R.S.Ruback (1992). Does Corporate PerformanceImprove after Mergers?, Journal of Financial Economics, 31(2): 135-175Bruner, R.E.(2001). Does M&A Pay? A Survey of Evidence for the Decision-Maker,working paper, University of VirginiaKallunki, J.-P., E. Pyykkӧ and Tl Laamanen (2009). Stock Market Valuation,Profitability and R&D Spending of the Firm: The Effect of Technology Mergers andAcquisitions, Journal of Business Finance & Accounting, 36(7-8): 838-862Studies that do not support improved performance referred to in Obinata (2012)
include:
Ghosh, A. (2001). Does Operating Performance Really Improve FollowingCorporate Acquisitions? Journal of Corporate Finance, 7(2): 151-178Ma, Q., D.A.Whidbee and A.W.Zhang (2011). Value, Valuation, and the Long-runPerformance of Merged Firms, Journal of Corporate Finance, 17(1): 1-17
Goodwill: Improvements to Subsequent Accounting and an Update of the Quantitative Study
下载原件Research PaperMarch, 2020Staff of the Accounting Standards Board of JapanStaff of the Hong Kong Institute of Certified Public AccountantsThe observations and views presented in this Research Paper are those of the ASBJ Staffand the HKICPA Staff and do not necessarily reflect views of the ASBJ or the HKICPA.Goodwill:
Improvements to Subsequent Accountingand an Update of the Quantitative StudyTABLE OF CONTENTSExecutive Summary…………………P. 3Introduction…………………P. 6PART 1: Quantitative study…………………P. 9PART 2: Scope and measurement basis for acquired goodwill…………………P. 19PART 3: Arguments for reintroducing amortisation in additionto impairment…………………P. 22PART 3A: ASBJ Staff view…………………P. 22PART 3B: HKICPA Staff view…………………P. 34PART 4: Amortisation period and method…………………P. 47PART 4A: ASBJ Staff view…………………P. 47PART 4B: HKICPA Staff view…………………P. 52Appendix A: Methodology of the quantitative study…………………P. 58Appendix B: Comparability between organic growth entitiesand acquisitive growth entities…………………P. 62Appendix C: Academic studies referenced by the ASBJ Staff…………………P. 65EXECUTIVE SUMMARYQuantitative study
1.The updated quantitative study in this Research Paper shows a steady increase in theamount of acquired goodwill presented in the financial statements. Consideringthis increasing trend, it is unlikely that the impairment-only model for acquiredgoodwill is working as intended. This has led to a “too little, too late” issue, whichhas been noted as a concern among some stakeholders.Scope of the Research Paper and the measurement basis for acquired goodwillScope of the Research Paper
2.The scope of this Research Paper is the subsequent accounting for acquired goodwill.Both the ASBJ Staff and the HKICPA Staff consider that acquired goodwill is a distinctunit of account independent from internally generated goodwill.Measurement basis for acquired goodwill
3.Acquired goodwill is an asset that should be measured at historical cost. Thehistorical cost should be updated to depict its consumption over time. Acquiredgoodwill should also be subject to the impairment test. When conducting theimpairment test, future cash flows would be discounted to determine therecoverable amount of the cash generating unit (‘CGU’).Arguments for reintroducing amortisation in addition to impairment
4.Both the ASBJ Staff and the HKICPA Staff think that acquired goodwill should beamortised over time on a systematic basis, and the CGU(s) to which acquiredgoodwill is attributed should be tested for impairment when there is an indication ofimpairment.ASBJ Staff view
5.The ASBJ Staff think acquired goodwill is a “wasting asset” (that is, an asset thatdiminishes in value over time) and, to faithfully represent this nature, financialstatements need to reflect the reduction in value.
6.As a result of this wasting nature and due to other factors, the ASBJ Staff proposethat acquired goodwill be amortised in addition to being tested for impairment.Impairment serves to signal the lack of recoverability of the carrying amount ofacquired goodwill and amortisation signals the consumption of acquired goodwill.Both are necessary.HKICPA Staff view
7.The HKICPA Staff consider that goodwill may be described as the difference betweenthe fair value of an entity and its identifiable net assets recognised under prevailingaccounting standards (book value), and term this “economic goodwill”. The valueof economic goodwill constantly changes over time. We think that acquiredgoodwill is a static snapshot of economic goodwill as of an acquisition date.
8.Over time, the amount recognised as acquired goodwill becomes increasingly lessreflective of the current fair value or current book value of the entity, and thereforemore meaningless as a balance sheet item.
9.The HKICPA Staff think that amortisation (with indicator-based impairment) betterreflects the nature of acquired goodwill than an impairment-only regime as:
(a) It better reflects the fact that acquired goodwill becomes increasingly lessrepresentative of the acquiree and the consolidated entity.(b) It provides a better opportunity to show how an acquisition is utilised.(c) It improves comparability between entities that grow organically and throughacquisitions.
10.The HKICPA Staff also think amortisation ensures that increasingly large goodwillbalances supported by the impairment-only model, which can contribute negativelyto management incentives and misrepresent risks, will be allocated to expense on atimely basis.Amortisation period and method
11.Both the ASBJ Staff and the HKICPA Staff think that acquired goodwill should beamortised using a single amortisation period for the entire acquired goodwill amountrecognised for each business combination, rather than disaggregating acquiredgoodwill into components and using different amortisation periods for eachcomponent.ASBJ Staff view
12.The ASBJ Staff think that the amortisation period should be based on the period thatmanagement expects to generate incremental cash inflows arising from theacquisition. In addition, the ASBJ Staff think that a maximum number of yearsshould be established by the standard-setter for the amortisation period to strike abalance between the provision of relevant information and the need to respond tothe concerns over the “too little, too late” issue.HKICPA Staff view
13.The HKICPA Staff think that:
(a) The amortisation period of acquired goodwill should be determined in terms ofthe expected utilisation of an acquisition. Entities should apply judgement todetermine what amortisation period and pattern is expected to best reflect theexpected utilisation of an acquisition.(b) The process of determining an amortisation period based on the principle ofreflecting expected utilisation of an acquisition will benefit both (a)
management, as it will be required to think critically about its post-acquisitionplans before acquisition date, and (b) users, as they will gain insight intomanagement’s expected timeline for an acquisition.INTRODUCTIONObjective of this Research PaperIN1The subsequent accounting for goodwill has been a subject of debate for manyyears. As of the issuance of this Research Paper (‘RP’), the InternationalAccounting Standards Board (‘IASB’) has an ongoing research project ongoodwill and impairment. The United States Financial Accounting StandardsBoard (‘FASB’) has also been undertaking a project on identifiable intangibleassets and subsequent accounting for goodwill.IN2The objective of this RP is to contribute relevant and timely analyses andarguments to the global research project, and to present the views of the staffof the Accounting Standards Board of Japan (‘ASBJ Staff’) and the staff of theHong Kong Institute of Certified Public Accountants (‘HKICPA Staff’).IN3This RP aims to accomplish the following:
(a) Share new findings from an updated quantitative study based on workpreviously conducted in 2016 by the European Financial Reporting AdvisoryGroup (‘EFRAG’) secretariat and the ASBJ Staff.(b) Analyse the existing requirements for goodwill under IFRS.(c) Explore alternative views on the subsequent accounting for goodwill.IN4This RP is a collaboration between the ASBJ Staff and the HKICPA Staff(collectively, ‘the Staffs’).Existing requirements and two concepts of goodwillIN5IFRS 3 Business Combinations defines goodwill as “An asset representing thefuture economic benefits arising from other assets acquired in a businesscombination that are not individually identified and separately recognised.”
IN6Applying IFRS 3, goodwill is initially recognised at the acquisition date as aresidual – the excess of the consideration transferred over the identifiable netassets acquired (ignoring non-controlling interest and step-acquisitions forsimplicity). Thereafter, goodwill is measured at historical cost and writtendown under the requirements of IAS 36 Impairment of Assets in the event ofimpairment. This approach may be referred to as the ”impairment-only”
approach.IN7What is defined as goodwill under IFRS 3 can be described as acquired goodwill(‘AGW’), and we shall label it as such in this RP.IN8There is additionally a concept of internally generated goodwill (‘IGGW‘), whichis clearly distinguished from AGW in this RP. This concept will be discussed inPart 3.History of the project on goodwillIN9The IASB issued IFRS 3 in 2004, superseding IAS 22 Business Combinations.This eliminated the pooling of interests method and mandated that all businesscombinations within the scope be accounted for using the acquisition method.IFRS 3 followed the issuance of FASB Statement No.141, Business Combinations,in 2001, and resulted in the convergence of U.S. GAAP and IFRS. This meantthat any entity paying consideration for an acquisition in excess of the fair valueof the acquiree’s identifiable net assets would be required to recognise theresidual difference as goodwill (which would be subsequently subject toimpairment).IN10 The IASB completed its Post-implementation Review (‘PIR’) of IFRS 3 in June
2015.Following the PIR, the IASB has undertaken a research project ongoodwill and impairment, with the aim of investigating how companies canprovide users with better information about business combinations at areasonable cost. In addition, the FASB published an Invitation to CommentIdentifiable Intangible Assets and Subsequent Accounting for Goodwill on July 9,2019, as part of its project on subsequent accounting for goodwill.IN11 One of the findings of the PIR is that stakeholders have mixed views on thesubsequent accounting for goodwill. In particular, while some stakeholderssupport the existing requirements (impairment-only), others support theamortisation of goodwill. Additionally, some stakeholders have expressed theview that goodwill impairment is not always recognised in a timely fashion (thisis known as the “too little, too late” issue), and some investors have stated thatdisclosures required by IFRS do not provide enough information to enable themto understand whether an acquired business is performing as expected. Somecompanies have also stated that the impairment test required for goodwillunder IAS 36 is costly and complex.Structure of this Research PaperIN12 Recognising the issues in the previous paragraph, the RP discusses thesubsequent accounting for goodwill. The structure of this RP is as follows:
(a) Quantitative studyThis part shows recent results of quantitative studies on goodwill andexplains that timely discussion about the subsequent accounting foracquired goodwill is still needed.(b) Scope of the RP and measurement basis for acquired goodwillThis part explains the scope of the RP and the measurement basis foracquired goodwill to provide context for later discussions.(c) Arguments for reintroducing amortisation in addition to impairmentThis part discusses the subsequent accounting for acquired goodwill,especially whether amortisation should be reintroduced.(d) Amortisation period and methodThis part discusses the amortisation period and the amortisation pattern.PART 1: QUANTITATIVE STUDYBackground information and summary of the study
1.1The objective of the quantitative study is to provide quantitative data andillustrate the trends in the amounts of goodwill and impairment in majorjurisdictions. The aim is to facilitate the technical and conceptual discussionsrelated to the subsequent accounting for goodwill by accounting standard settersaround the world.
1.2In 2016, the ASBJ Staff conducted a quantitative study on goodwill andimpairment together with the EFRAG secretariat, and as a result, issued ResearchPaper No. 2 Quantitative Study on Goodwill and Impairment in October 2016(‘Research Paper No. 2’)1. This quantitative study was conducted based on datafrom 2005 to 2014. Observing the results, the ASBJ expressed its view thatResearch Paper No. 2 implied that there was an increasing risk that impairmentof goodwill would have a significant impact on the financial position of an entitywhen it was recognised.
1.3The Staffs conducted updated quantitative studies on goodwill for the data from2014 to 2018 to show the recent trend in goodwill balances. The methodologyof this updated study is described in detail in Appendix A. The update of thestudy includes the following figures or ratios for stock market indices of theUnited States (the S&P 500 index), Europe (the S&P Europe 350 index), HongKong (the Hang Seng Composite index) and Japan (the Nikkei 225 index – forcompanies that apply IFRS)2:
(a) Total amount of goodwill(b) Amount of goodwill per company1 Please refer to the following website:
https://www.asb.or.jp/en/discussions/papers/2016-1003.html2 As mentioned in Appendix A, for the stock market index of Japan, the following companies that applyIFRS were included in the population considering that there were companies that have transitioned fromeither Japanese GAAP or U.S. GAAP to IFRS between 2014 and 2018:
(a) Regarding (a)-(e), companies that applied IFRS in 2018 were included in the population. For thefinancial figures for the periods in which the companies applied Japanese GAAP, no adjustmentswere made regarding the effects of amortisation charges.(b) Regarding (f) and (g), companies that applied IFRS throughout 2014-2018 were included in thepopulation.(c) Ratio of goodwill to net assets(d) Ratio of goodwill to market capitalisation(e) Number of companies that present high goodwill ratios(f) Amount of goodwill expensed(g) Intensity of goodwill expensed
1.4The study found that the amount of goodwill generally increased steadily overthe period of 2014 to 2018. Specifically:
(a) From 2014 to 2018, total goodwill and total goodwill per company tended toincrease steadily in all stock market indices.(b) A number of companies that constituted the stock market indices of theUnited States and Europe recognised goodwill that exceeded 100% of theirnet assets. For example in 2018, regarding the United States, 18.8% ofcompanies that constituted the stock market index had goodwill thatexceeded 100% of their net assets, while in Europe that number was 10.1%of companies. Some companies even recognised goodwill that exceeded100% of their market capitalisation, though the number of those companieswas relatively small.(c) The implied time to fully expense goodwill based on the impairment lossesrecognised from 2014 to 2018 resulted in 122 years for the stock market indexof the United States, 78 years for the stock market index of Europe, 64 yearsfor the stock market index of Hong Kong and 64 years for the stock marketindex of Japan.Results of the updated studyTotal amount of goodwill
1.5Figure 1.1 shows the trends in the total amount of goodwill from 2014 to 2018.
1.6From 2014 to 2018, total goodwill tended to increase for all stock market indices.Comparing the amounts in 2014 and in 2018 (Figure 1.2), total goodwill increasedby 45% for the stock market index of the United States, 26% for the stock marketindex of Europe,60%forthestockmarketindex of HongKong, and 74%for the stockmarket index ofJapan.Figure 1.1: Trends in the amount of total goodwill (inUSD billion)
United StatesEuropeHong KongJapanFigure 1.2: Trend of Figure 1.1 (The data of 2014are indexed as 100)
Amount of goodwill per company
1.7Figure 1.3 shows the trends in the amount of goodwill per company thatrecognised goodwill from 2014 to 2018.
1.8The amount of goodwill per company for the stock market indices of the UnitedStates and Europe was larger than that for the stock market indices of Japan andHong Kong. From 2014 to 2018, the amount of goodwill per company for thestock market indices of the United States, Europe and Japan increased steadilyyear by year.Ratio of goodwill to net assets3
1.9Figure 1.4 shows the trends in the ratio of goodwill to net assets. The objectiveof Figure 1.4 is to illustrate the significance of goodwill compared to the bookvalue of net assets.3 Net assets means the book value of equity.
4.9
5.4
6.1
6.5
7.1
4.5
4.7
5.1
5.3
5.7
0.4
0.5
0.5
0.6
0.6
1.9
1.8
2.4
2.6
3.2United StatesEuropeHong KongJapanFigure 1.3: Trends in the amount of goodwill percompany (that recognized goodwill) (in USD billion)
1.10The average ratio of goodwill to net assets from 2014 to 2018 was higher for thestock market indices of the United States and Europe. In addition, the ratiosteadily increased for the stock market indices of the United States and Japan.Figure 1.5 shows this increasing trend more clearly.
32.5%
35.3%
38.1%
39.1%
41.5%
27.1%
27.7%
29.3%
28.4%
29.7%
3.4%
3.9%
4.0%
3.7%
3.8%
11.6%
11.8%
15.1%
14.7%
16.9%United StatesEuropeHong KongJapanFigure 1.4: Trends in the ratio of the amount ofGoodwill to Net AssetsUnited StatesEuropeHong KongJapanFigure 1.5: The trend of Figure 1.4 (The data of2014 are indexed as 100)
Ratio of goodwill to market capitalisation4
1.11Similar to the trends in the ratio of goodwill to net assets, Figure 1.6 shows thetrends in the ratio of goodwill to market capitalisation.
1.12The average ratios of goodwill to market capitalisation in the stock market indicesof the United States and Europe were relatively high but were lower than theratio of goodwill to net assets in Figure 1.4. Figure 1.7 shows this trend byrescaling the figures of all market indices as 100 in 2014.4 Market capitalisation means market value of equity.
12.0%
13.2%
13.5%
12.4%
13.8%
16.7%
16.8%
18.0%
16.2%
19.9%
2.8%
3.7%
3.9%
3.1%
4.2%
9.1%
9.5%
11.9%
11.6%
15.0%United StatesEuropeHong KongJapanFigure 1.6: Trends in the ratio of the amountof Goodwill to the Market CapitalisationUnited StatesEuropeHong KongJapanFigure 1.7: The trend of Figure 1.6 (The data of2014 are indexed as 100)
Number of companies that present high goodwill ratios
1.13The following data shows the number of companies whose goodwill ratios (theratio of goodwill to net assets and the ratio of goodwill to market capitalisation)
are high. This shows the extent to which the amount of goodwill wasconcentrated in certain number of companies that constitute stock marketindices. Tables 1.8 and 1.9 show the number of companies that recognisedgoodwill that exceeded 50% and 100% of their net assets and their marketcapitalisation, respectively, from 2014 to 2018.Table 1.8: Trends in the number of companies that exceed certain ratios of theamount of Goodwill to Net Assets*Share: Ratio of the number of applicable companies to the number ofcompanies analysed.Table 1.9: Trends in the number of companies that exceed certain ratios of theamount of Goodwill to Market Capitalisation*Share: Ratio of the number of applicable companies to the number ofcompanies analysed.
1.14
18.8% of companies constituting the stock market index of the United States, andshareshareshareshareshareUS50%+
34.6%
37.0%
39.3%
41.1%
41.1%100%+
(71)(14.5%)
(73)(14.9%)
(83)(17.0%)
(82)(16.8%)
(92)(18.8%)
EUR50%+
32.4%
34.4%
34.7%
34.4%
33.8%100%+
(39)(11.3%)
(45)(13.0%)
(41)(11.8%)
(35)(10.1%)
(35)(10.1%)
HK50%+
2.8%
2.4%
3.9%
3.9%
3.9%100%+
(7)
(1.5%)
(8)
(1.7%)
(8)
(1.7%)
(6)
(1.3%)
(8)
(1.7%)
JPN50%+
6.5%
6.5%
9.7%
11.3%
8.1%100%+
(0)
(0.0%)
(1)
(1.6%)
(0)
(0.0%)
(0)
(0.0%)
(0)
(0.0%)
Stock MarketIndexThe numberof companiesanalysedshareshareshareshareshareUS50%+
2.0%
3.9%
3.3%
4.9%
8.0%100%+
(0)
(0.0%)
(2)
(0.4%)
(1)
(0.2%)
(2)
(0.4%)
(4)
(0.8%)
EUR50%+
6.9%
6.6%
6.1%
5.5%
11.0%100%+
(3)
(0.9%)
(3)
(0.9%)
(5)
(1.4%)
(3)
(0.9%)
(9)
(2.6%)
HK50%+
1.3%
2.4%
2.6%
2.6%
3.2%100%+
(2)
(0.4%)
(1)
(0.2%)
(4)
(0.9%)
(3)
(0.6%)
(6)
(1.3%)
JPN50%+
1.6%
1.6%
1.6%
3.2%
6.5%100%+
(1)
(1.6%)
(1)
(1.6%)
(1)
(1.6%)
(1)
(1.6%)
(1)
(1.6%)
Stock MarketIndexThe numberof companiesanalysed
10.1% of companies constituting the stock market index of Europe, recognisedgoodwill that exceeded 100% of their net assets in 2018. Some companieseven recognised goodwill that exceeded 100% of their market capitalisation.Amount of Goodwill Expensed
1.15Figure 1.10 shows the trends in the amount of goodwill expensed (that is,impairment losses) from 2014 to 2018.
1.16The impairment losses were relatively higher for the stock market indices of theUnited States and Europe, and were largest in 2018 for the stock market index ofthe United States.Intensity of Goodwill Expensed
1.17The intensity of goodwill expensed shows the extent of reductions of the goodwillbalance during the year. Figure 1.11 shows the trends in the ratio of the amountof goodwill expensed in the year to the amount of goodwill as of the previousyear-end5. For this analysis, the reductions do not include expenses or losses5 The intensity of goodwill expensed is calculated as follows:
The intensity of goodwill expensed=the amount of goodwill expensed in the yearthe balance of goodwill as of the previous year-endUnited StatesEuropeHong KongJapanFigure 1.10: Trends in the amount of Goodwillexpensed (in USD billion)
recognised from the disposal of businesses.
1.18The inverse of this ratio implies the time to fully expense goodwill. The inverseof the average of the ratios from 2014 to 2018 resulted in 122 years for the stockmarket index of the United States, 78 years for the stock market index of Europe,64 years for the stock market index of Hong Kong and 64 years for the stockmarket index of Japan.Does the “too little, too late” issue exist?
1.19As summarised in paragraph 1.4, the amount of acquired goodwill in thestatement of financial position tended to increase steadily over time. Inaddition, as mentioned in the previous paragraph, the implied average time tofully expense acquired goodwill for each stock market index largely exceeds 40years. We note that 40 years was the maximum amortisation period ofacquired goodwill prescribed in APB Opinion No.17 Intangible Assets, which wasapplied before U.S. GAAP were revised in 2001. We also note that 20 years wasthe maximum amortisation period prescribed in IAS 22, which was appliedbefore IFRS was revised in 2004.
1.20We observe that, together with the increasing trend of the amount of acquired
0.6%
0.6%
0.2%
0.3%
2.4%
1.1%
2.2%
1.3%
0.8%
1.0%
1.7%
1.3%
3.1%
0.9%
0.8%
1.6%
2.1%
1.4%
2.1%
0.6%United StatesEuropeHong KongJapanFigure 1.11: Trends in the intensity of Goodwill expensedgoodwill and the time to fully expense acquired goodwill, it is likely that the “toolittle, too late” issue exists with respect to the expensing of acquired goodwillunder the existing impairment-only model. If this is the case, it may bequestionable whether the existing impairment test is sufficiently “rigorous andoperational” to justify the non-amortisation of acquired goodwill6 and providerelevant information to users of financial statements.
1.21On the other hand, some have questioned our observation claiming that theincreasing trend in the amount of acquired goodwill does not justify the existenceof the “too little, too late” issue. For example, the growth in the economy andthe increase in M&A activity in recent years may have contributed to the increasein the amount of acquired goodwill.
1.22However, we do not think that such a claim undermines our observation inparagraph 1.20. This is because it would be difficult to define and obtain datathat represents the relationship between the growth in the economy or thefrequency of acquisitions and the amount of acquired goodwill. Under this dataconstraint, we conducted some rough data analyses but could not obtain anyclear implications from the analyses7. Accordingly, in the following parts, wewill discuss the subsequent accounting for acquired goodwill assuming that it islikely that the “too little, too late” issue exists.6 Please refer to paragraph 2.7.7 We conducted simplified quantitative data analyses by the following comparison, but we could notconfirm clear relationships.(a) A comparison between the amount of acquired goodwill and the stock price indices.(b) A comparison between the amount of acquired goodwill and GDPs.(c) A comparison between the amount of acquired goodwill and the number of M&A cases.The amount of acquired goodwill used in these analyses is based on the data of the companies that havebeen in the scope of analyses this time, and differs from the scope of the companies on whichcomparative data such as GDP is based. These analyses were conducted under such data constraints,and the implications of the results are extremely limited. More sophisticated analyses may producedifferent results.PART 2: SCOPE AND MEASUREMENT BASIS FOR ACQUIRED GOODWILLScope of this Research Paper
2.1As mentioned in the Introduction, we refer to what is recognised as goodwillunder IFRS 3 as acquired goodwill (AGW). This RP considers the subsequentaccounting for acquired goodwill.
2.2IFRS introduces another concept of goodwill, which is internally generatedgoodwill (IGGW). Paragraph 49 of IAS 38 Intangible Assets provides followingexplanation:
In some cases, expenditure is incurred to generate future economicbenefits, but it does not result in the creation of an intangible asset thatmeets the recognition criteria in this Standard. Such expenditure is oftendescribed as contributing to internally generated goodwill. Internallygenerated goodwill is not recognised as an asset because it is not anidentifiable resource (ie it is not separable nor does it arise fromcontractual or other legal rights) controlled by the entity that can bemeasured reliably at cost.
2.3When considering the accounting for AGW, it is relevant to assess the unit ofaccount. We think that AGW is a distinct unit of account that is independentfrom IGGW. This can be demonstrated by the fact that, under the existingrequirements:
(a) Only AGW is recognised as an asset. IGGW is not recognised, and under IFRSis dealt with separately in accordance with IAS 38. AGW can be recognisedgiven the existence of an exchange transaction to refer to for measurement,and it is a unique accounting construct.(b) AGW is a static concept measured at historical cost as mentioned later in thispart. It is not updated to track the changes attributable to IGGW8. Thecarrying amount of AGW is only updated when a cost allocation method is8 Some may note that the carrying amount of AGW can be supported by IGGW when performing theimpairment test (the “impairment shield” problem, discussed below); however, this is due to theinability to separate AGW and IGGW after a business combination and reflects a “best solution” for theimpairment model, which the Staffs do not think should be interpreted as affecting AGW’s unit ofaccount.applied (for example, impairment).(c) The Staffs think that, under the concept of historical cost accounting, theimpact of consideration transferred at the acquisition date (that gives rise toAGW) should be distinguished from the impact of expenditures subsequentto the business combination (that give rise to IGGW).Measurement basis for AGW - existing requirements
2.4AGW is measured at historical cost under the existing requirements. When aCash Generating Unit (‘CGU’) to which AGW is attributed is subsequently testedfor impairment, any impairment losses would first reduce the carrying amount ofAGW followed by the carrying amount of the other assets within the CGU.
2.5Paragraph BC131B of IAS 36 explains that, when introducing non-amortisation ofAGW, the IASB considered (a) straight-line amortisation with an impairment testwhen there is an indication of impairment, and (b) non-amortisation with animpairment test at least annually.
2.6In its considerations, the IASB noted the following (paragraph BC131E of IAS 36):
…the Board agreed that achieving an acceptable level of reliability in theform of representational faithfulness while striking some balance withwhat is practicable was the primary challenge it faced in deliberating thesubsequent accounting for goodwill. The Board observed that the usefullife of acquired goodwill and the pattern in which it diminishes generallyare not possible to predict, yet its amortisation depends on suchpredictions. As a result, the amount amortised in any given period can bedescribed as at best an arbitrary estimate of the consumption of acquiredgoodwill during that period. The Board acknowledged that if goodwill isan asset, in some sense it must be true that goodwill acquired in a businesscombination is being consumed and replaced by internally generatedgoodwill, provided that an entity is able to maintain the overall value ofgoodwill (by, for example, expending resources on advertising andcustomer service). …
2.7Ultimately, the IASB concluded on an approach of non-amortisation on the basisthat more useful information would be provided if a rigorous and operationalimpairment test could be devised (paragraph BC131G of IAS 36).Measurement basis for AGW - historical cost or current value?
2.8The IASB’s Conceptual Framework for Financial Reporting revised in March 2018(‘Conceptual Framework’) identifies historical cost and current value as the twocategories of measurement bases in IFRS. The Staffs consider historical cost,the measurement basis currently required, to be the more relevantmeasurement basis for AGW. This is because the entity’s business activitiesusually do not involve selling AGW (indeed AGW itself can’t be transferred),which is calculated as a residual from the costs incurred to achieve a businesscombination, and the entity retains it for use (paragraph 6.53 of the ConceptualFramework), and because AGW is used in combination with other economicresources to produce indirect cash flows for the entity (paragraphs 6.54-6.56 ofthe Conceptual Framework).
2.9Historical cost measurement does not reflect changes in values (paragraph 6.4 ofthe Conceptual Framework), but is updated over time to depict, for example, theconsumption of part or all of the economic resource that constitutes the asset,or the effect of events that cause part or all of the historical cost of the asset tobe no longer recoverable (paragraph 6.7 of the Conceptual Framework). Asconsidered in the development of IFRS 3 (please refer to paragraphs 2.5 and 2.6),amortisation is one way to depict such consumption of the asset.PART 3: ARGUMENTS FOR REINTRODUCING AMORTISATION IN ADDITIONTO IMPAIRMENT
3.1The Staffs support reintroducing amortisation in addition to impairment as asuperior method for the subsequent accounting for acquired goodwill.The Staffs propose an amortisation plus indicator-based impairment regime forAGW, under which AGW would be allocated to profit or loss on a systematic basisover its amortisation period. Amortisation reflects the utilisation of AGW.While amortisation would be a mandatory and prominent aspect of this regime,the Staffs also support retaining indicator-based impairment to reflect situationswhere there has been a substantive decline in the recoverable amount of theCGU(s) to which the AGW is assigned within the amortisation period.
3.2In the following paragraphs of Part 3 the Staffs explain this common view frombilateral perspectives, reflecting the Staffs’ respective ways of looking at thenature of acquired goodwill.PART 3A: ASBJ Staff viewWhat is the issue?
3.3The ASBJ Staff think that there are diverse views on the subsequent accountingfor AGW because there are diverse views on various issues related to AGW,including the disagreement on whether the “too little, too late” issue exists(considered in Part 1) and the disagreement on how to determine theamortisation period (considered in Part 4A). Part 3A discusses the followingthree issues mainly related to the nature of AGW:
(a) Stakeholders have different assumptions on the scope of "goodwill".Some stakeholders do not clearly distinguish goodwill arising from businesscombinations (AGW) from goodwill arising from expenditures made after thebusiness combinations (IGGW).(b) Stakeholders have different views on the nature of AGW.Stakeholders have different views on whether AGW is of a wasting nature.(c) Stakeholders have different views on how to reflect that nature in thesubsequent accounting for AGW.Among those who think that AGW is of a wasting nature, stakeholders havedifferent views on whether amortisation should be applied.The scope of “goodwill”
3.4When considering whether goodwill is of a wasting nature, an important startingpoint is the scope of “goodwill”. A lack of consensus on this point is likely tolead to differing views on the accounting for goodwill9.
3.5Some stakeholders do not clearly distinguish AGW from IGGW. Thesestakeholders typically are interested in assessing the value of an entity, andconsider goodwill to be one of its major contributors. They are more interestedin how goodwill contributes to the current value of an entity, and are lessinterested in whether goodwill has arisen from a business combination.
3.6In contrast, the ASBJ Staff consider that only AGW should be within the scope ofthe discussion, because it would result in providing relevant information aboutperformance subsequent to the business combination. In this regard, the ASBJStaff note that general purpose financial reports are not designed to show thevalue of an entity, but rather to provide useful information that is helpful for usersof financial statements to estimate the value of an entity10. The ASBJ Staff thinkthat this concept is not necessarily shared by such stakeholders in terms of whatkind of financial information should be provided. The success or failure of abusiness combination should be assessed by the profit earned after deducting itscost over the periods subsequent to the business combination. The ASBJ Staffthink that information about such profit is relevant to users of financialstatements. For this reason, the ASBJ Staff think that it is important to clearlydistinguish AGW from IGGW.9 This repeats the discussion in paragraph 2.3, but this is important for discussing the next issue of awasting nature of goodwill.10 Please refer to paragraph 1.7 of the Conceptual Framework.The nature of AGW - Is AGW a wasting asset?
3.7The excess of the consideration of the acquisition over the fair value of theidentifiable net assets is allocated to AGW. AGW arises from an exchange ofvalues that actually occurred, but by definition it has no physical substance, norcan it be separated from the entity. For these reasons, its condition cannot bedirectly observed, and stakeholders have different views and expectations onwhat would be its benefit and how long such benefit would last.The six components
3.8When developing IFRS 3, the IASB considered six components that couldpotentially form part of AGW (see Table 3.1) 11 . The IASB concluded thatComponents 1, 2 and 5 should not be subsumed into the amount initiallyrecognised as AGW.Table 3.1: The six potential components of AGW (quoted from related descriptions fromparagraphs BC313 and BC316 of IFRS 3)
Component 1The excess of the fair values over the book values of the acquiree’snet assets at the date of acquisition.Component 2The fair values of other net assets that the acquiree had notpreviously recognised.Component 3The fair value of the going concern element of the acquiree’s existingbusiness. The going concern element represents the ability of theestablished business to earn a higher rate of return on an assembledcollection of net assets than would be expected if those net assetshad to be acquired separately. That value stems from the synergiesof the net assets of the business, as well as from other benefits (suchas factors related to market imperfections, including the ability toearn monopoly profits and barriers to market entry – either legal orbecause of transactions costs – by potential competitors).The third component relates to the acquiree and reflects the excessassembled value of the acquiree’s net assets. It represents the pre-11 These six components were originally discussed in FASB’s Proposed Statement of Financial AccountingStandards: Business Combinations and Intangible Assets, issued September 7, 1999.existing goodwill that was either internally generated by theacquiree or acquired by it in prior business combinations.Component 4The fair value of the expected synergies and other benefits fromcombining the acquirer’s and acquiree’s net assets and businesses.Those synergies and other benefits are unique to each businesscombination, and different combinations would produce differentsynergies and, hence, different values.The fourth component relates to the acquiree and the acquirerjointly and reflects the excess assembled value that is created by thecombination – the synergies that are expected from combining thosebusinesses.Component 5Overvaluation of the consideration paid by the acquirer stemmingfrom errors in valuing the consideration tendered.Component 6Overpayment or underpayment by the acquirer.
3.9Under IFRS 3, Components 3, 4 and 6 are recognised as AGW, and Components 3and 4 collectively are referred to as “core goodwill”. Consistent with IFRS 3, thisRP focuses on Components 3 and 4 and discusses these Components in thefollowing paragraphs12. The ASBJ Staff would not discuss Component 6 becauseit would not be an asset from a conceptual standpoint but nonetheless would beconsidered to be of a wasting nature.13
3.10Examples of the Components 3 and 4 include the following:
Component 3(Going concern element)
Reputation, know-how, human resources12 The identification of these components is for discussion purposes and the ASBJ Staff understand thatit is not practically easy to separate these components. As noted later in paragraph 4.6, the FASBexplains in its exposure draft issued in 1999 that it abandoned the discernible-element approach, whichwould determine the amortisation period of AGW based on the multiple discernible elements of AGW,because the FASB found decomposing AGW into elements highly subjective.13 The IASB acknowledged that the sixth component is not an asset but conceptually is a loss (in the caseof overpayment) or a gain (in the case of underpayment) to the acquirer. Nevertheless, the IASBconcluded that in practice it is not possible to identify and reliably measure an overpayment at theacquisition date. Accordingly, the IASB decided to recognise the sixth component as part of acquiredgoodwill and to address the accounting for overpayments through subsequent impairment testing.Component 4(Synergies element)
Eliminating redundant work, creating new revenuestreams by combining know-how
3.11Figure 3.2 illustrates the relationship between the acquisition price andComponents 1-414. This example assumes the following:
(a) The total acquisition price was 135.(b) The book value of identifiable assets and liabilities that were previouslyrecognised by the acquiree was 73 and the fair value of such assets andliabilities was 80.(c) The fair value of identifiable assets and liabilities that were not previouslyrecognised by the acquiree was 15.(d) The value of the acquiree as a whole was 125, implying that the going concernelement was valued at 30.Figure 3.2: Relationship between the acquisition price and Components 1-414 This example assumes that the acquisition price does not include Components 5 and 6.
(4)Synergies element: 10
(3)Going concern element: 30
(1)Difference between fair valueand book value of assets andliabilities recognised by theacquiree: 7Book value of assets and liabilitiesrecognised by the acquiree: 73
(2)Fair value ofitems that werenot recognisedby the acquiree:
AGW: 40Going concern element
3.12The going concern element represents the ability to combine the identifiableitems of the acquiree to generate a return that exceeds the return that would begenerated by using those items individually. In other words, the going concernelement is the value inherent in the acquiree, and stems from the synergiesbetween identifiable items of the acquiree and from other benefits such as thoserelated to the ability to earn monopoly profits and legal or other barriers tomarket entry by potential competitors as described in Table 3.1.
3.13Some stakeholders claim that the going concern element may include the entity’sreputation with customers, technology and know-how, and an assembledworkforce. These stakeholders think that these factors are not of a wastingnature. In other words, the entity’s reputation with customers generates cashflows to the entity continuously, technology and know-how that supports thebusiness creates value continuously15, and the knowledge required to utilise theworkforce is maintained in the entity continuously.
3.14The ASBJ Staff take an opposing view, and think that the going concern elementis of a wasting nature for the following reasons:
(a) The ASBJ Staff think that it is difficult to differentiate the factors in paragraph
3.13 clearly, and difficult to quantify their value. This is because thosefactors interact with each other, and thus their value develops as a whole. Ifthose factors could be separated, they should already have been identifiedseparately as an identifiable asset. Thus, considering the going concernelement as a whole, AGW represents something that the acquirer is willingto pay to earn a return higher than the market expectation. These excessreturns will decrease over time assuming there is healthy competition.15 Perspectives Paper issued by International Valuation Standards Council (IVSC), “Business Valuation – IsGoodwill a Wasting Asset?” (https://www.ivsc.org/files/file/view/id/1599) claims that the going concerngoodwill comprises of reputation, future intangible value, and workforce, which are not wasting innature. Regarding future intangible value, the in-place assets such as workforce, knowhow andfoundational platform technology are leveraged for future ideation and technologies and continuouslycreate new intangible value. However, such assets seem to evolve over time to respond to the changesin the surrounding environment, which will likely make obsolete the original assets acquired at thebusiness combination. When assuming that what is acquired at the business combination isdistinguished from what is generated afterwards as mentioned in paragraph 3.6, it is unclear how suchassets can continue to create new value.Certain advantages over other entities due to legal or other economic reasonsmay continue indefinitely, but such cases are rare.(b) Even if it were possible to consider those individual factors as claimed inparagraph 3.13, the effects of the entity’s reputation with customers, and theeffects of technology and know-how would decrease as the surroundingenvironment changes and the workforce is replaced. Therefore,improvements or adjustments would be needed to ensure that those factorscontinue to be effective. In this way, the going concern element of AGWwould be replaced by updated reputation with customers or updatedtechnology and know-how. The ASBJ Staff think that these updated factorsform part of IGGW, which is distinct from the original AGW. Accordingly, theadvantages provided by the factors that were originally recognised as part ofAGW would not continue for long.Synergies element
3.15The synergies element represents synergies and other benefits expected fromcombining the net assets and businesses of both the acquirer and the acquiree.Those benefits include cost reduction through the use of economies of scale orgenerating incremental revenue such as by jointly producing better products orproviding better services.
3.16Some stakeholders think that factors such as higher margins due to costreduction or higher revenue from enhancing the business of the acquirer or theacquiree (or both) are the manifestation of the synergies element. Similar tothe going concern element, some argue that the synergies element is not of awasting nature because, when estimating the value of an entity, such factors areassumed to exist indefinitely16 in the estimated future cash flows.
3.17The ASBJ Staff take an opposing view, and think that, though the acquirer expectsto achieve higher margins or higher revenue as the manifestation of the synergieselement, the synergies element is of a wasting nature for two reasons. One isthat, if the synergies element is expected to generate excess returns, similar16 IVSC Perspectives Paper cited in footnote 15 claims that the synergies include higher margins throughrealising economies of scale (costs synergies) and higher revenue (revenue synergies). The paper statesthat synergies are implicitly assumed to exist indefinitely but it is not clear why such an assumptionshould be posed.behaviors aiming to achieve such excess returns would be enhanced in theindustry, and such excess returns would decrease over time assuming there ishealthy competition. This is similar to the discussion on the going concernelement. The other reason is that acquirers hold the view that many businesscombinations do not meet their expectations17 and that this may imply thatthere are many instances where the synergies element does not contribute toperformance subsequent to the business combination as expected.Goodwill as a whole
3.18As described above, the ASBJ Staff think that both the going concern element andthe synergies element are of a wasting nature, and that AGW is as a whole of awasting nature.
3.19Some stakeholders argue against this view from different perspectives withoutdistinguishing the going concern element from the synergies element. Thesestakeholders typically claim that, even if those elements are diminishing in nature,the period or pattern in which those elements diminish is not generally knownand that the elements may continue as long as the business is considered to bea going concern.The ASBJ Staff do not agree with this view because the question of how to17 There are following surveys available on the Internet and are mainly based on the responses fromentities that experience business combinations.Global PMI Partners, Success and Failure in M&A Execution – An Empirical Study,https://gpmip.com/success-and-failure-in-ma-execution-an-empirical-study/This study examines whether the value of the transaction is higher than the price actually paid for thetarget and concludes that the evolution of the market capitalisation of publicly listed companiesfollowing an acquisition generally points to a destruction of shareholder value.From Buying Growth to Building Value, The Boston Consulting Grouphttp://image-src.bcg.com/Images/BCG-From-Buying-Growth-to-Building-Value-Oct-2015_tcm9-
88324.pdfThe report states that companies can grow through acquisition, but that inexperienced acquirerstypically destroy value for their shareholders.The Survey on M&A by Deloitte Tohmatsu Consulting in 2013 (Japanese only)
https://www2.deloitte.com/content/dam/Deloitte/jp/Documents/about-deloitte/news-releases/jp-nr-nr20131008-2.pdf36% of companies that responded to the survey met their standards of M&A success. Most of thosestandards determine their M&A success based on whether they have achieved more than 80% of theirobjectives.Please also refer to footnote 36.estimate the diminishing period or pattern and the question of whether AGW isof a wasting nature are two separate issues. In addition, considering that anentity is required to estimate the period and the pattern in which the benefits ofproperty, plant and equipment (PPE) and intangible assets with a finite useful lifeare expected to be consumed, the ASBJ Staff expect that the same would applyto AGW. It may be true that more information is available in estimating thediminishing period and pattern for PPE or finite-lived intangible assets becausethose assets are exposed to physical wear and tear or may have legal limits onthe use of assets. However, their useful lives are defined in terms of the assets’expected utility to the entity18 and technical or commercial obsolescence areconsidered. In this regard, AGW is essentially no different from PPE orintangible assets. Accordingly, there is little justification that AGW should betreated otherwise.
3.20In relation to the wasting nature, academic studies have repeatedly shown thatreturns or rate of returns derived from accounting information, such as return onassets (ROA) or return on equity (ROE), tend to revert to their industry mean19.Some researchers in Japan have considered this tendency of mean reversion ofROA or ROE to be compatible with the argument that AGW is of a wasting nature.Palepu and Healy (2013) 20 noted the reason we can observe this tendency asfollows:
... rate of return on investment (ROEs) tend, over several years, to movefrom abnormal to normal levels – close to the cost of equity capital – asthe forces of competition come into play. Profit margins also tend toshift to normal levels, but for this statistic “normal” varies widely acrossfirms and industries, depending on the level of asset turn over andleverage. ...
3.21In addition, some academic studies have analysed to determine whether theentity’s performance has improved subsequent to business combinations.Some of these studies reported results that do not support the argument byobserving lower rates of return for several years subsequent to business18 IAS 16 Property, Plant and Equipment, paragraph 57.19 The ASBJ Staff reviewed academic papers mentioned in paragraphs C.1 to C.4 of Appendix C.20 Palepu, Krishna G. and Paul M. Healy (2013) Business Analysis and Valuation Using FinancialStatements, PART 2, 6-16, 5th edition, South-Western Cengage Learningcombinations at a statistically significant level21. The ASBJ Staff acknowledgethat those studies do not directly study the synergies element, but the ASBJ Staffobserve that combining the business and net assets of the acquirer and theacquiree do not necessarily lead to improved performance. This seems to implythat it is unlikely that there is positive support for the view that the synergieselement continue to exist.
3.22The ASBJ Staff note that, even if AGW is of a wasting nature and its valuediminishes over time, this does not necessarily mean that the estimated futurecash flows to the entity would decline over time. This is because cash flowsgenerated by the entity are reinvested. In other words, an entity has variousresources that contribute to its prospects for future cash flows, many of whichhave finite useful lives. The reduction in resources due to their consumptionusually results in the collection of other resources, which would be reinvested inthe entity’s business. This reinvestment cycle will continue as long as the entitylasts as a going concern.Some stakeholders claim that, if goodwill is of a wasting nature, there would bea large portion of cash flows that are unexplained after the entity’s finite-livedresources are consumed. However, the cash flows generated from the finite-lived resources originally acquired in a business combination will be reinvestedinto new finite-lived resources and additional cash flows will be generated fromthese new resources. Accordingly, future cash flows will continue to begenerated, far beyond the useful lives of the finite-lived resources originallyacquired in a business combination. This process allows the value of an entityto appear to be stable even if AGW is of a wasting nature.Accounting for acquired goodwill as a wasting assetWhether acquired goodwill should be amortised
3.23In the previous section, we concluded that AGW is of a wasting nature.
3.24One approach to depict the wasting nature of AGW in the financial statements isthe amortisation approach. This approach would allocate the cost of AGW21 Please refer to paragraph C.5 of Appendix C.over its useful life as expenses on a systematic basis, and the carrying amountafter amortisation would be tested for impairment22. The carrying amount ofAGW under the amortisation approach is not intended to directly reflect thecurrent value of AGW. Rather, amortisation would represent the consumptionof AGW, and amortisation would represent the decline in the benefitsrepresented by AGW.
3.25Another approach to depict the wasting nature of AGW in the financialstatements is the non-amortisation approach. Under this approach, it isassumed that it would not be a problem that entities may recognise IGGW up tothe initial historical cost of AGW. Accordingly, the carrying amount of AGWwould not be revised and thus expenses would not be recognised unless the totalvalue of AGW and IGGW becomes lower than the initial historical cost of AGW.Impairment losses should be recognised when the total value of AGW and IGGWbecomes lower than the initial historical cost of AGW.This non-amortisation approach focuses on the inseparability of AGW and IGGW.In other words, an entity cannot observe AGW separately from IGGW subsequentto the business combination; an entity can only observe the integrated unit ofAGW and IGGW. Accordingly, under this approach, as long as IGGWcompensates the wasting of AGW, an entity would report that the value ofgoodwill is maintained.
3.26Considering these two approaches, the ASBJ Staff support the amortisationapproach for the following reasons:
(a) The amortisation approach would not directly reflect the current value ofAGW in its carrying amount, but would allow an entity to represent itsdeclining trend over time separately from IGGW by reflecting theconsumption of AGW.(b) The ASBJ Staff think that the amortisation approach would reflect theconsumption of AGW, which forms part of investment of the businesscombination, in profit or loss in each period. This would result in expensingAGW in a timelier manner and would provide useful information about22 Please refer to footnote 8 regarding the unit of account that should be subject to impairment.financial performance subsequent to the business combination.(c) When the impairment test is conducted at the CGU level, the carrying amountof AGW is shielded by the acquirer’s IGGW before the business combinationand any IGGW of the combined business generated after the businesscombination23. This would obscure the impairment of AGW. As a result,when relying only on the impairment test, it is less likely that the wastingnature of AGW would be faithfully represented in the financial statements.In this regard, the amortisation would be applied regardless of such shielding,and the amortisation approach could avoid this disadvantage of the non-amortisation approach.(d) The non-amortisation approach would raise again the discussion of the scopeof the accounting discussed in paragraphs 3.4-3.6. In addition, the non-amortisation approach would effectively allow an entity to recognise IGGW,up to the initial historical cost of AGW, which results in treating IGGWdifferently, depending on whether it relates to AGW. The amortisationapproach could avoid this disadvantage of the non-amortisation approach.23 The IASB is aware of the issue of the so-called shielding effect and made efforts to improve theeffectiveness of the impairment test of goodwill, such as by developing an approach that could addressthe buffer created by the unrecognised headroom. However, the IASB did not continue the efforts dueto various reasons including the complexity of the developed approach.PART 3B: HKICPA Staff viewIntroduction
3.27Since the introduction of the impairment-only model, AGW balances have beenrising globally24. The HKICPA Staff think that such a trend, along with recenthigh-profile goodwill write-offs, gives rise to a number of questions about thenature of goodwill, its place on the balance sheet and its subsequent accounting.
3.28The HKICPA Staff think an amortisation plus impairment approach (which werefer to in short as an amortisation approach) for the subsequent accounting ofAGW is superior to the existing impairment-only approach. In this section, weexplain:
(a) The HKICPA Staff view on the nature of goodwill and its treatment underIFRS.(b) Why amortisation plus impairment is a better choice than impairment-only.The nature of goodwill and its treatment under IFRS
3.29It is challenging to come to consensus on the nature of goodwill due to the factthat it is not separately identifiable and cannot be directly measured. Variousattempts have been made to set out the components of goodwill, but none cometo a definitive list.25
3.30As discussed in Part 2, IFRS has two established accounting concepts for goodwill:
(a) acquired goodwill, or AGW, which IFRS 3 requires to be recognised as anasset; and (b) internally generated goodwill, or IGGW, which IAS 38 prohibitsfrom being recognised as an asset.
3.31For discussion purposes, the HKICPA Staff think that it is helpful to compare the24 Refer to Part 1 for an updated quantitative study on this phenomenon.25 In October 2015, IASB staff considered an approach to apply different accounting treatments for theseparate components of goodwill. In February 2016 (Agenda Paper 18B), that approach was excludedfrom deliberations on the basis that it would be extremely complex and subjective, and if there are anycomponents that can be accounted for separately then they’d presumably meet the IAS 38 criteria forseparate recognition. The IFRS 3 Basis for Conclusions acknowledges that goodwill may includecomponents such as a trained workforce, loyal customers (reputation), as well as market imperfectionsand barriers to entry, but a conclusive list of components was not provided.IFRS concepts of AGW and IGGW with goodwill in a broader sense, which weterm “economic goodwill” to provide a reference point independent of theaccounting regime.Economic goodwill
3.32The HKICPA Staff describe economic goodwill as follows:
Economic goodwill is the difference between the fair value of an entity and itsidentifiable net assets (book value) recognised under prevailing accountingstandards.
3.33The fair value of an entity refers to the market value or enterprise value of anentity as a whole. As the unit of account we refer to is the entity as a whole,this includes all elements that make up that whole including the ability to controlthe entity (control premium). There are various methods and a multitude ofinputs to determine a fair value for control of entity, which is an economic matterindependent of the given accounting regime. The HKICPA Staff consideracquisition price to be the best representation of the fair value of an entity at thetime of acquisition.
3.34Economic goodwill can be illustrated as such for an entity that has made no prioracquisitions (and hence has no AGW on its balance sheet):
3.35The purpose of goodwill in accountancy is to represent the divergence betweenwhat can be recognised and measured for financial reporting purposes(identifiable net assets, whose carrying amount is commonly referred to as “bookvalue26”), and what cannot (all components of the total fair value of an entity).
3.36A multitude of items and factors may contribute to the difference between anentity’s fair value and the book value of identifiable net assets27. The fact isthat financial reporting cannot identify, recognise and measure everycomponent that makes up the fair value of an entity (and indeed it is not thepurpose of general purpose financial reports to show the value of an entity, butrather to provide information to help users estimate the value). Hence, thereis a need for the concept of goodwill to act as a balancing amount.
3.37It should be noted that the concept behind our description of economic goodwillis considered in IAS 38.50, which when describing IGGW states “Differencesbetween the fair value of an entity and the carrying amount of its identifiable netassets at any time may capture a range of factors that affect the fair value of theentity.” However, IFRS does not directly define IGGW and the concept isprimarily used as a differentiator from AGW within the accounting framework.Acquired goodwill
3.38The relationship between economic goodwill and AGW is that AGW is a point-in-time “snapshot” of an acquiree’s economic goodwill as of the acquisition date ofa business combination 28 . AGW is the difference at the acquisition datebetween the identifiable net assets of the acquiree, and the acquirer’sestimation of fair value of the acquiree (the acquisition price).
3.39The concept of goodwill hence exists not only in the case of a business26 The HKICPA Staff use the term “book value” to represent the net amount recognised on the balancesheet of an entity under prevailing accounting standards. This amount may fluctuate from period toperiod due to the subsequent measurement of assets and liabilities, and recognition or derecognitionevents.27 In line with the IASB’s rationale for rejecting an approach that accounts for separate components ofgoodwill, HKICPA Staff do not think it is possible to attempt a definitive list of components so long asthose remain sufficiently unidentifiable and unmeasurable.28 The HKICPA Staff acknowledge AGW will be affected by any uplift in the book value of the acquiree’snet assets when they are fair valued under the acquisition method, and the fair value of any identifiablenet assets the acquiree had not previously recognised.combination, but so long as an entity’s fair value exceeds the book value of itsidentifiable net assets. The business combination simply provides a situation inwhich the economic goodwill of an acquiree can be measured as a balancingamount from the exchange transaction. The HKICPA Staff think the ability toobtain this residual measurement is one of the primary reasons recognition ofAGW is tenable under prevailing accounting standards.
3.40As a snapshot, AGW is a static and distinct historical accounting artefact.Barring the application of any subsequent accounting regime to update itscarrying amount, AGW cannot be re-measured after acquisition, nor can changesin AGW be directly tracked (hence why the impairment test depends on assessingthe recoverable amount of CGU(s)). This is in contrast to economic goodwill,which is dynamic and will vary in amount as the fair value of an entity fluctuatesfrom day to day, or the book value of the entity’s identifiable net assets changesfrom reporting period to reporting period.Why amortisation plus impairment is a better choice than impairment-only
3.41The HKICPA Staff are of the view that an amortisation regime (together withindicator-based impairment29) is the best approach to subsequently accountingfor AGW. There are two key points as to why:
(a) Amortisation better reflects the nature of AGW, in particular:
(i) It better reflects the fact that AGW becomes increasingly lessrepresentative of the acquiree and the consolidated entity.(ii) It provides a better opportunity for entities to show how anacquisition is utilised.(iii) It improves comparability between entities that grow organicallyand through acquisitions.(b) Amortisation ensures that increasingly large goodwill balances supported bythe impairment-only model, which may contribute negatively tomanagement incentives and misrepresent risks, will be allocated to expenseon a timely basis.29 Please refer to Part 4 for detailed discussion on our proposed method of amortisation plusimpairment.
3.42These points are addressed in turn.Key Point 1: Amortisation better reflects the nature of AGW.Better reflects how AGW becomes increasingly less representative of the acquireeand consolidated entity
3.43Goodwill is always a residual amount. It cannot be directly measured or directlyvalued because it is only the difference between an entity’s fair value and thebook value of its identifiable net assets, and would not exist as a concept withoutthose data points. In this sense, goodwill itself is not an item subject to“valuation”, and it could be said that goodwill is only a part of an asset (that assetbeing the entity as a whole) rather than a stand-alone asset itself.
3.44Over time, the amount recognised as AGW will become increasingly lessreflective of the current fair value or current book value of the entity, andtherefore increasingly meaningless as a balance sheet item. Unlike somethingsuch as a financial asset that can be measured at fair value, AGW cannot be re-measured and so cannot be updated to reflect any value creation.
3.45As such, a situation in which AGW has not yet been impaired does notdemonstrate that an acquisition has been a success, or even that it has metexpectations. The impairment test is asymmetric and cannot reflect increasesin value. As long as the fair value of its CGU(s) remains sufficient, AGW’scarrying amount will be supported (shielded) by IGGW and any otherunrecognised ‘headroom’, and hence economic goodwill, in the CGU30. This isbecause the impairment test compares a historical AGW balance against acurrent fair value, the latter which will reflect a dissimilar state of economicgoodwill from that at the acquisition date. Effectively, AGW becomes a ceilingfor the indirect recognition of IGGW. This can be referred to as the“impairment shield” issue.
3.46This impairment shield issue obscures the reality of goodwill, because what thefinancial statements purport to be an asset arising from a historical acquisitionmay be shielded from expense recognition by cash flows of an entity significantly30 Specifically, this will be the recoverable amount (higher of value in use and fair value less costs ofdisposal) of the CGU(s) to which AGW is assigned over the respective carrying amount. Though there aredifferences between value in use and fair value, the argument is the same.different from those of the entity that the asset was established for. Theconsolidated entity and its acquisition may continue to perform for years afterrecognising AGW. Over time, the acquisition may be integrated, and the overallentity enhanced and transformed in myriad ways to the point where theoriginally recognised AGW becomes largely meaningless. At such a point, e.g.years or decades after an acquisition, any impairment charge would be equallyas meaningless and also confusing, particularly if that acquisition had beensuccessfully monetised many years prior.
3.47Noting the above, the HKICPA Staff disagree with the argument made by someconstituents that AGW should not be amortised because it can be linked to andsupported by the cash flows used to value the acquisition (and is henceindefinitely lived or “non-wasting” in nature)31. Firstly, AGW simply cannot bedirectly measured (directly valued) and hence cannot be directly linked to anycash flows. As noted above, AGW acts more as a part of the asset of the overallentity rather than a stand-alone asset. Secondly, what is being assessed isacquired goodwill, which is a snapshot of economic goodwill, and hence a staticpicture of an historical amount. To assert that AGW is linked to or supportedby the entity’s cash flows becomes therefore even more tenuous, as AGWincreasingly bears no relation to the fair value of the entity and its cash flows towhich, some constituents argue, the AGW is supposed to relate.
3.48The HKICPA Staff think that amortisation plus impairment better reflects the factthat AGW becomes increasingly less representative of the economics of theunderlying entity than impairment-only. Amortisation ensures that thenecessary function of cost allocation will be applied in a systematic andunderstandable manner to an asset that becomes increasingly meaningless inrelation to its entity over time. This will help to resolve the issue that animpairment-only approach creates by enabling AGW balances to remain onbalance sheets irrespective of changes in the underlying entity, potentially to thepoint of those AGW balances being nonsensical.31 In particular, some constituents argue that AGW’s value is linked to the terminal value used to valuean acquisition, and that is subject to a perpetual growth assumption. These constituents argue that as aresult, goodwill is “non-wasting”, i.e. assumed to be an indefinite life asset, and therefore disagree withamortisation approaches. The HKICPA Staff disagree with this view for the reasons presented in this RP.Better opportunity to show how an acquisition is utilised
3.49One of the functions of accountancy is to represent the utilisation of economicresources over time. This is why there are concepts such as depreciation forproperty, plant and equipment, regardless of an entity’s expectation of increasesin economic value of those items. The purpose of such depreciation is not toshow a decline in the fair value of an item, which would be better representedby a current value measurement, but to show the utilisation of that item.
3.50AGW represents a part of the historical fair value of an entity at the acquisitiondate (although as noted in the section above this link cannot be directlymeasured). After the acquisition, if expectations are realised and the value ofthat acquisition is monetised, the cash flows associated with that acquisition willbe accounted for as income that increases assets (cash, accounts receivable, etc.)
and equity (retained earnings). If the AGW does not have an appropriate costallocation method applied to it, the entity effectively starts double counting cashflows (first as AGW, then again as income). Such a situation results in anartificial and accounting-driven inflation of assets and equity, and no informationwhatsoever on the utilisation of the amount paid for the acquisition.
3.51The HKICPA Staff think amortisation with impairment is preferable toimpairment-only because it provides a mechanism to show the utilisation ofAGW. Under amortisation, users will be able to see the timeframe in which anacquisition is expected to be utilised (via the amortisation period32), and be ableto observe a systematic cost allocation of AGW versus the income earned by theentity. This would better tie AGW to the performance of the acquisition. Forsuccessful acquisitions, this would provide a superior representation of themonetisation of the acquisition. For unsuccessful acquisitions, amortisationplus impairment would also reflect the destruction of value in a timelier manner.
3.52Amortisation is criticized by some constituents as an “artificial” charge. Somealso rightly note it is challenging to link the amount recognised as AGW to specificfuture benefits, given AGW can’t be directly measured or separately identified,and does not produce independent cash flows. The HKICPA Staff consider that32 Refer to Part 4 for discussion on amortisation period.this problem exists under both an amortisation and an impairment-only model,and will exist so long as AGW is recognised as an asset.
3.53Both amortisation and impairment of AGW are non-cash expenses, and as suchboth are “artificial” insofar as they are subsequent accounting mechanisms foraccounting purposes. The impairment model is an asymmetric mechanism toindirectly allocate AGW’s cost by reference to associated CGU(s) which cannotbe disentangled from IGGW. The HKICPA Staff consider that it is more artificialto let goodwill remain un-expensed over time (e.g. if an entity performs or ifAGW is otherwise shielded from impairment) to the point where, as noted in theprior section, it ceases to reflect any economic reality of the underlying firm.
3.54The HKICPA Staff propose retaining an indicator-based impairment test as part ofan amortisation approach. This would ensure that significant declines in valueof CGU(s) indicative of a failed acquisition would be recognised in early years,when the un-amortised amount of AGW is still of a substantial size. As such,impairment would still play a significant role in our approach, but that role wouldbe more relevant. This is because impairment tends to be most relevant in theearly years after an acquisition where the acquiree can be clearly distinguishedwithin the consolidated entity. The HKICPA Staff think that the current level ofinformation provided about management’s capital allocation decisions, and thesuccess or failure of acquisitions, will not deteriorate under an amortisation withimpairment approach. Our approach does not eliminate the recognition ofAGW as an asset or otherwise hide the acquisition’s performance. The HKICPAStaff think that concerns for additional insight into the performance ofacquisitions are best served by disclosures (including potential new disclosuresabout business combinations developed through the standard setting process33).Improves comparability between entities that grow organically and throughacquisitions
3.55When AGW is recognised as an asset, a problem that immediately arises is thatthe financial reporting of entities who primarily grow organically begins todiverge from that of entities who primarily grow through acquisitions. This isbecause some of what constitutes organic growth is required to be expensed (as33 The HKICPA Staff note that better disclosures for business combinations has been under considerationby the IASB and its staff.IGGW), whereas acquisitive growth allows for amounts not recognised as part ofidentifiable net assets to be capitalised as AGW. In this way, accounting isbiased towards entities depending on their growth strategy.
3.56Amortisation would ensure that AGW balances will eventually be expensed in asystematic manner, and this will serve to improve comparability between organicand acquisitive growth. This is illustrated in further detail in Appendix B.Key Point 2: Impairment-only supports increasingly large goodwill balances thatmay negatively incentivise management and misrepresent risks.
3.57As noted in Part 1, we acknowledge that there may be multiple reasons forincreasing goodwill balances. However, the HKICPA Staff think it is difficult todeny that an impairment-only model has contributed to such increases.Why does the impairment-only model allow for increasing goodwill balances?
3.58The absence of a regular amortisation charge will naturally result in highergoodwill balances so long as impairment is avoided. Problematically, thecurrent regime provides the opportunity to avoid recognising impairment. Thisis because AGW is tested for impairment by allocating it to cash generating units(CGU(s)) and testing those against their current recoverable amount. Thiscurrent recoverable amount will inevitably include IGGW and headroom, andhence changes in economic goodwill that both existed before, and was createdafter, the acquisition date. This is the impairment shield issue34.
3.59The impairment shield issue is exacerbated by a high level of managementjudgement in determining how the impairment test is performed, including theability to determine the level of CGU(s). Management can potentially allocategoodwill to a CGU that is sufficiently large (with sufficient headroom) such thata decline in the value of the operations that the AGW relates to is shielded bythe broader CGU35.34 This was acknowledged by the IASB in the development of IAS 36 (IAS 36.BC134-BC135).35 For example, a large multinational entity could purchase a relatively small subsidiary in one country,and then allocate the AGW of that subsidiary to a global business division. In doing so, the entity couldavoid recognising any impairment even if the subsidiary performed poorly, because that AGW would beshielded by the much larger recoverable amount of the global business division.What is the problem with increasing goodwill balances?
3.60The HKICPA Staff think that growing and un-expensed AGW balances may resultin distorted and weakened balance sheets, and lead to concerns about the roleaccountants are playing in allowing risks to develop without appropriaterepresentation. Consider the following:
(a) Current goodwill accounting is arguably pro-cyclical. An environment oflow interest rates, easy credit, and aggressive deal making may drive alarger number of acquisitions and higher acquisition prices. This in turnwill result in higher AGW balances. In such an environment, entities maythen avoid recognising any expense with regard to that AGW for anextended period of time as conditions remain positive and discount rates(used in the calculation of recoverable amount) low. However, wheneconomic conditions turn negative or interest rates rise, entities may startto experience “impairment shocks” and sudden large losses.(b) Increasing AGW creates situations where more of entities’ liabilities andequity are supporting a highly nebulous asset, which cannot be identified,separated, transferred or liquidated. This can result in managementleveraging against an increasingly more speculative asset side of thebalance sheet. Synergies, which some argue are a significant componentof AGW, don’t always manifest. Research from McKinsey & Company andBain & Company36 has found that nearly 70 percent of mergers assessedfailed to achieve expected revenue synergies, and two thirds of acquisitionsfail to create meaningful shareholder value.
3.61The HKICPA Staff are also concerned that the impairment-only regime mayexacerbate undesirable management incentives as follows:
(a) It may incentivise “big bath” accounting practices due to the subjectivenature of the impairment assessment and the impairment shield. Entities36 https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/where-mergers-go-wrong.https://www.bain.com/contentassets/a13fb5f396e348cc84699f4c7fe89d05/bsr_masteringmergerintegration.pdf.may elect to take a large impairment charge all at once (e.g. to coincidewith a change in management).(b) It may incentivise management to value acquisitions more highly, given thatany payment over identifiable net assets can be reflected as AGW andmanagement can ignore subsequent expense for a foreseeable future.(c) It may incentivise management to lever against an inflated and speculativeasset-side of the balance sheet.(d) To maximise financial reporting metrics, and given the market often viewsimpairment negatively, management may be incentivised to delayimpairment as long as possible.(e) Sticky AGW balances, resulting in inflated assets and equity and suppressedexpenses, can influence management’s decisions and affect the ability toproceed with certain corporate actions. For example, the ability to paydividends out of distributable reserves can be affected.
3.62The fact that some sophisticated stakeholders already make adjustments forgoodwill indicates that they view goodwill as it currently exists a speculativefinancial reporting item.How amortisation would improve this issue?
3.63Amortisation would help to address the issues noted above, as it would ensureAGW balances are brought down over the period the acquisition is utilised in asystematic manner. This would reduce the potential risks noted that are notcurrently being addressed by the impairment-only model. It would also help tomitigate the “impairment shield” problem and the ability of management toapply questionable judgement to impairment testing.
3.64The HKICPA Staff think that amortisation would improve management disciplineand better hold management accountable for acquisitions because it wouldrequire entities to consider the expected utilisation of the cost of theiracquisitions, and would not enable AGW to remain on balance sheet for undueamounts of time. This is unlike the current impairment model, which cancontribute to expense avoidance for a lengthy period of time. In this way, thenegative management incentives noted above would be alleviated.
3.65The HKICPA Staff disagree with the argument that amortisation of AGW wouldallow management to “hide” failed acquisitions. We are of the view thatamortisation, plus impairment, will improve transparency as it will ensure thereal economic cost of an acquisition is brought through the financial statementsin a timely and systematic manner.Goodwill and corporate stabilityA contribution to the HKICPA Staff by Professor Adam Leaver, Chair in Accountingand Society at Sheffield University Management School, United Kingdom.As noted in paragraph 3.50, the impairment-only model effectively ‘double counts’assets because (a) AGW values are a capitalised measure of the acquirer’s expectedfuture cash flows at the point of acquisition and (b) cash flows which then resultfrom that acquisition are accounted for as income that increases assets (cash,accounts receivable, etc.) or equity (retained earnings) without incurring anycorresponding costs or reductions to AGW. The benefits of an acquisition are, inother words, monetized first as AGW, then again as income. The resulting inflationof assets and equity that are an artefact of this accounting treatment may distortmanagerial incentives.First, CEOs may be incentivised to grow inorganically rather than organically. Thismay encourage amalgamations driven by financial engineering rather thanoperational efficiency motives. The resulting amalgamations may lead to increasedoperating inefficiencies at the aggregate. Worse, they may introduce ponzi-likedynamics if the disappointing operating outcome/cash flow performance of onemerger leads managers to seek a second merger for the asset uplift. In suchsituations, one poorly thought through merger may beget another.Second, given the option of either capitalising or distributing this double-countedincome many managers will choose to distribute. This may lead to an ‘acquire anddistribute’ strategy which may again displace other investment-led, productivity-focused sources of shareholder value creation. Remuneration structures tied toshareholder value measures or measures that underpin the creation of shareholdervalue may exacerbate this problem.Third, the benefits of double counting may encourage managers to over-estimatethe true economic value of corporate assets. Acquiring companies may thereforebe willing to pay a rising multiple of a target firm’s average annual income to acquireit. Paying higher multiples of average annual income may then have acorresponding effect on the goodwill booked.Fourth, the double counting of goodwill may have implications for corporatestability. If acquisitions are financed with large amounts of debt, and cash flowsfrom the acquisition fall below the level expected to justify AGW valuations, doublecounting goes into reverse. Falling cash flows may lead to real-time losses andthose real-time losses may lead to a goodwill impairment test. If the recoverablevalue of CGU assets are deemed to be lower than their carrying amount, that maylead to an impairment charge on top of the real-time losses. If firms are highlylevered, there may be inadequate equity redundancies to accommodate theoperating and impairment losses; or, firms will be forced to recapitalise throughshare issue at precisely the point that the market doesn’t want to buy shares.Firms may even be reluctant to impair their goodwill, despite weakening economicperformance – incentivising accounting fraud.In this sense goodwill accounting might be thought of as a form of leverage. Andthese processes might be thought of as ‘pro-cyclical’, echoing some of the problemswitnessed in financial firms during the 2007/8 crisis. Furthermore, this may erodethe decision-usefulness of accounts for investors if the logic of it is greater balancesheet volatility, which is difficult to predict.PART 4: AMORTISATION PERIOD AND METHOD
4.1The Staffs think that amortisation should be applied to the AGW arising fromeach individual business combination as a whole (that is, the AGW asset arisingfrom a particular acquisition should not be disaggregated into components withdifferent amortisation schedules). This is because AGW cannot be separatelyidentified or directly measured37 . In addition, management should make areasonable estimate of the amortisation period utilising reasonably availableinformation.
4.2The Staff’s respective proposals, based on their core arguments, are presentedbelow.PART 4A: ASBJ Staff viewUnit of amortisation
4.3As already discussed in paragraphs 3.23-3.26, the ASBJ Staff think that theamortisation approach should be applied to depict the wasting nature of theAGW in the financial statements. The ASBJ Staff do not think the amortisationapproach can be rejected merely because some consider it difficult to estimatethe amortisation period.
4.4As discussed in paragraphs 3.8-3.11, AGW can conceptually be analysed basedon several components, including the going concern element and the synergieselement. However, the ASBJ Staff think that a single amortisation period shouldbe used for AGW as a whole.
4.5The ASBJ Staff acknowledge that AGW itself is a residual of the consideration ofthe business combination after deducting the fair value of identifiable net assetsand do not generate independent cash flows. Accordingly, the ASBJ Staffunderstand that it is practically not easy to identify those individual components.Even if those components were to be individually identified, it would not be easyto quantify how those components contribute to the amortisation period37 If it were possible for components of AGW to be separately identified for amortisation, the Staffsthink that would presume such component should have been considered for recognition as an IAS 38intangible asset.because those components interact with each other.
4.6In the Proposed Statement of Financial Accounting Standards, BusinessCombinations and Intangible Assets published in 1999 (‘1999 Exposure Draft’),the FASB noted that it had considered the discernible-elements approach. Thisapproach assumes that goodwill is composed of multiple discernible elements,and identifies the useful life of each component and amortises AGW using aweighted average amortisation period of the discernible elements. No furtherconsideration was undertaken, as field testing found the approach to be highlysubjective.
4.7For this reason, that approach was not proposed in the 1999 Exposure Draft.Instead, the FASB proposed an amortisation period for the entire AGW based onmanagement estimates, up to a maximum of 20 years. Considering the historyof such discussions, the ASBJ Staff think that it is reasonable to apply a singleamortisation period to AGW as a whole, rather than to apply multipleamortisation periods to individual components.Possible approaches to determining the amortisation period
4.8Possible approaches to determining the amortisation period for AGW as a wholeinclude the following:
Approach 1: Require management to estimate the amortisation period, takinginto account the nature of AGW.Approach 2: As there is too much uncertainty in estimating the amortisationperiod, the accounting standard setter should determine theamortisation period (that is, “pick a number”).
4.9Approach 1 takes into account the fact that business combinations are diverseand that they can vary in nature. The ASBJ Staff think that what the acquirerexpects from goodwill and when the acquirer expects goodwill to become wasted(or alternatively, how long the acquirer expects goodwill to have an effect) varydepending on the business combination in question. In many cases, the ASBJStaff think that such expectation would be consistent with managementexpectation that future net cash inflows would increase due to the businesscombination, when incremental cash flows arising from reinvested assets areexcluded38. However, Approach 1 may be costly compared to Approach 2.
4.10Approach 2 ignores the different natures of AGW that arises from each businesscombination. Accordingly, this approach would treat AGWs with differenteconomics in the same manner, which may fail to represent the wasting of AGWin a timely manner and which may lead to false comparability. On the otherhand, the amortisation period for AGW has been controversial in theinternational debates, and some claim that a default period for the amortisationperiod should be considered as a viable alternative, given that addressing the“too little, too late” issue is of high priority. However, Approach 2 could only bejustified in the context of eliminating subjectivity inherent in estimating theamortisation period and in the context of addressing cost concerns.
4.11Regarding Approach 1 and Approach 2, the Agenda Paper “Possible approach foraddressing ‘too little, too late’ issue” (’ASBJ Paper’)39 which the ASBJ submittedto the Accounting Standards Advisory Forum in July 2017 discussed theamortisation period as follows:
(a) The ASBJ Paper basically supported Approach 1, with an amendment thatsets a cap on the amortisation period discussed below. In other words, theASBJ Paper argued that it was important to clarify the principle of theconcept of amortisation period, and in developing that principle, the viewsof users of financial statements on the amortisation period and informationprovided by amortisation should be emphasised. In addition, users offinancial statements who supported amortisation thought that informationbased on management’s estimate was useful. The ASBJ Paper suggested,as the essence of their views, that the amortisation period be “based on themanagement's estimate of the period in which the future net cash inflowswould increase due to the business combination." Though acknowledgingthe concerns over relying on management estimate, the ASBJ Paperemphasised more its advantage.(b) On the other hand, the ASBJ Paper did not provide a positive view on38 Paragraph 3.22 discusses that cash flows from reinvestment should not be considered whendiscussing the wasting nature of AGW.39 Please refer to following website:
https://www.asb.or.jp/en/discussions/papers/2017-0612-2.htmlApproach 2. In other words, for users of financial statements theinformation about amortisation period based on the management’sestimate was useful, whereas information based on the default amortisationperiod set by the accounting standard setter was unlikely to be useful, andwould not necessarily result in faithful representation because all AGWs areassumed to have the same amortisation period.
4.12The ASBJ Staff’s understanding is that the views of users of financial statementsare not significantly different from those expressed in 2017. In addition,management would be in the best position to estimate the amortisation periodbecause various information about the business combination is required toestimate the amortisation period. Accordingly, the ASBJ Staff think that thediscussion in the ASBJ Paper in the previous paragraph still holds, and Approach1 should be given priority, emphasising the views of users of financial statementswho consider the information based on the management’s estimate to be useful.Maximum amortisation period in applying Approach 1
4.13Setting a cap on the amortisation period would narrow management’s discretionbeyond the cap in estimating the amortisation period and might affect therelevance of information. The ASBJ Staff acknowledge that this is inconsistentwith the objective of Approach 1. However, assuming that there are growingconcerns over the “too little, too late” issue described in Part 1, such a measurewould likely be helpful to strike a balance between the provision of relevantinformation and the need to respond to such concerns. That is, setting such amaximum period would ensure that the amount of AGW decreases to zero withinthat maximum period, and is helpful to address the “too little, too late” issue.Accordingly, the ASBJ Staff think that it would be appropriate to set a maximumamortisation period.
4.14Although it was not easy to logically establish the appropriate maximum numberof years, the ASBJ Paper suggested 10 years. 10 years seemed to be acceptableto most stakeholders in light of (a) the maximum amortisation period set for theamortisation option provided for private companies under U.S. GAAP40, (b) theamortisation requirement under the IFRS for SMEs41, and (c) the results of some40 FASB Accounting Standards Codification Paragraph 350-20-35-63.41 Paragraph 19.23 (a) of IFRS for SMEs.academic studies.
4.15In this regard, the ASBJ Staff proposes a 10 year period similar to the ASBJ Paper.However, unlike the ASBJ Paper, the ASBJ Staff think that rebutting the maximumperiod of 10 years should not be permitted from the viewpoint of reachinginternational consensus. This is because (a) in international discussions so far,some have noted that it is unlikely to expect the effects of a businesscombination to continue more than 10 years, and (b) the amortisation optionprovided for private companies under U.S. GAAP and the amortisationrequirement under the IFRS for SMEs set 10 years as the maximum number ofyears and do not permit longer years (even as a rebuttable presumption). TheASBJ Staff also confirmed the results of academic studies that could beadditionally referenced (Please refer to Appendix C). As a result, the ASBJ Staffthink that setting the maximum amortisation period at 10 years will beacceptable to most stakeholders.Discussion of Approach 2
4.16As explained in Part 1, the amount of AGW has been increasing steadily over time,and this RP discusses the “too little, too late” issue assuming that this trend islikely to exist. In addition, as was observed during the recent discussions in theUnited States, stakeholders have serious concerns over the costs incurred inrelation to the subsequent accounting for AGW. Considering these situations,the ASBJ Staff think that some variation to Approach 2 is still worth considerationas the second best alternative to gain international consensus. In this case,considering the balance between eliminating subjectivity in estimating theamortisation period and ensuring a certain level of relevance, if the entity canjustify an amortisation period that is shorter than the default amortisation period,such amortisation period should be permitted.
4.17The ASBJ Staff consider that the discussion of the maximum amortisation periodin Approach 1 can also apply to the discussion to set the default period inApproach 2, considering that a variation to Approach 2 would permit anamortisation period shorter than the default period if the entity could justify it.Accordingly, the ASBJ Staff proposes that the default period in Approach 2 be 10years.PART 4B: HKICPA Staff viewAmortisation period
4.18One of our reasons for proposing amortisation of goodwill is to reflect theutilisation of AGW. As such, the HKICPA Staff think that the amortisation periodof AGW should be determined in terms of the expected utilisation of anacquisition42 . Entities should apply judgement to determine an amortisationperiod that reflects the entity’s expectations for utilisation of the acquiree,including the duration over which integration and monetisation of the acquireeis expected to take place as of the acquisition date.
4.19The HKICPA Staff view is that there are a variety of approaches and informationsources that can be used for determining the amortisation period for AGW in linewith this principle. When entering into an acquisition, it is good practice formanagement to analyse and have a business plan for the acquired entity post-acquisition. Questions that may be asked to inform the determination of theamortisation period include:
(a) What is the objective and strategic rationale of the acquisition? What arethe key business goals or priorities and their expected timeframe?(b) What are the most important sources of value from the acquisition, andhow and when will they be realised?(c) What are the financial results expected from the acquisition and when arethese expected? Is there an expected return on investment (considerationtransferred) based on forecast cash flows?(d) What is the integration plan for the acquisition? How long will theintegration process last? What are the key milestones for the integrationteam and when are they expected to be met?(e) Are there any limiting factors that would indicate a minimum or maximumamortisation period, for example any legal, compliance, or other similar42 The reader may note this is analogous to the principles in IAS 16 for determination of useful life.factors that impact the ability to fully integrate or operationalise anacquisition?
4.20We consider that much of this information should be able to be sourced frominternal reporting. Entities may also consider factors already noted inparagraph 90 of IAS 38 for determining the useful life of intangible assets.Determination of the amortisation period will require management judgement.However, the process of determining an amortisation period based on theprinciple of reflecting expected utilisation of an acquiree will benefit both (a)
management, as it will need to think critically about its post-acquisition plans,and (b) users, as they will gain more insight into management’s expectations foran acquisition. The HKICPA Staff note that this would be further enhanced bydisclosure of the significant judgements used in determining the amortisationperiod of AGW43.
4.21Setting such an approach based on the principle of expected utilisation of theacquisition also reflects our view that AGW is a historical snapshot of thedifference between fair value and book value as of the acquisition date. Beinga historical residual amount that cannot be directly measured, AGW is not subjectto valuation per se, and as an accounting construct does not have an “economiclife”.
4.22In addition to the principle above, we think that:
(a) There should not be a mandatory floor or ceiling for the amortisationperiod, as such a requirement would not be in line with the principle-basednature of IFRS and may fail to reflect an entity’s particular situation, industryand economic environment, which would diminish the value of theinformation provided to users. It may also incentivise entities to select thestandard period as a matter of operational convenience or to minimiseamortisation expense.(b) The HKICPA Staff nevertheless would support a rebuttable presumption thatthe amortisation period should not exceed a specified number of years (e.g.10 years). This is to avoid entities estimating an exceptionally long43 The need to disclose significant judgements would be captured by the disclosure requirements in IAS1 Presentation of Financial Statements.amortisation period that fails to reflect the nature of AGW and results insimilar concerns as already noted under the impairment-only approach.Determination of amortisation period for AGW - other possible approachesAt the International Forum of Accounting Standard Setters (IFASS) in October2019, participants suggested a number of approaches for determining theamortisation period. Among those, we noted a suggestion that an entitycould, in considering the synergies arising from the business combination andthe expected utilisation of the underlying acquired assets, apply a methodbased on the average useful lives of the identifiable underlying assets acquired.Another suggestion was to reference the industry or business life cycle of theentity.Amortisation method
4.23The HKICPA Staff view is that entities should be required to apply judgement todetermine what amortisation pattern is expected to best reflect the expectedutilisation of an acquisition.
4.24Analogising to the depreciation or amortisation requirements of IAS 16 or IAS 38,we may note that the cost allocation method used shall reflect the pattern inwhich an asset’s future economic benefits are expected to be utilised. TheHKICPA Staff think that, similar to IAS 16 and IAS 38, a variety of amortisationmethods may be used to allocate AGW on a systematic basis over its amortisationperiod. The method used should however reflect the expected utilisation of theacquiree, and be applied consistently from period to period. We think that,similar to IAS 38, entities should be required to use the straight-line method ifthe pattern of utilisation cannot otherwise be determined reliably.
4.25Entities could consider a variety of questions to help inform the amortisationmethod. The information used to determine the amortisation period shouldalso be considered when determining the amortisation method (e.g. expectedfinancial results, integration plan, key milestones, etc.).
4.26The HKICPA Staff think that the residual value of the AGW should be zero foramortisation purposes. AGW does not generate independent cash flows andcannot be transferred or disposed of. Additionally, AGW becomes increasinglyless representative of the acquiree and the consolidated entity over time.Applying amortisation – too difficult or too arbitrary?Some stakeholders argue that an amortisation approach for AGW is toodifficult and judgemental or too arbitrary to implement.The HKICPA Staff disagree, particularly when comparing an amortisationapproach to the existing impairment-only approach. The impairment-onlyregime is judgemental (e.g. in terms of allocation of AGW to CGU(s) andapplication of the impairment test) and operationally burdensome. Applyingdepreciation or amortisation, on the other hand, has been present inaccountancy at its most basic levels for much of modern history.Amortisation with indicator-based impairment will further reduce the burdenof an annual valuation process (which is complex and time-consuming and mayrequire costly engagement of external valuation firms).This RP presents a principle-based method by which to amortise AGW, andillustrates some of the methods and thought processes that could be used todetermine both the amortisation period and the amortisation method. TheHKICPA Staff think that determining an amortisation period and amortisationmethod based on expected utilisation of an acquisition is both practical andreasonable because entities should have basic answers to questions such as (1)
what are the objectives for the acquisition and the timeframe for meetingthem; (2) what are the financial expectations for the acquisition; and (3) whatis the integration plan for the acquisition. We furthermore consider thatmuch of this information should be based on internal reporting, and henceutilising that for external reporting will help minimise costs.Answers to such questions can help to inform a reasonable estimate of how anentity expects to utilise an acquiree. Judgement will certainly be required,however the use of judgement is present in many areas of IFRS and does notundermine the usefulness of the resulting information44.44 Paragraph 2.19 of the Conceptual Framework notes the use of reasonable estimates is an essentialpart of the preparation of financial information and does not undermine the usefulness of theAnswers to such questions will also help enforce management discipline andaccountability around acquisitions, which is something we think anamortisation regime supports in many respects. In order to determine anamortisation period and amortisation method, and disclose how those weredetermined, entities will need to consider and answer important questionsabout their acquisitions and post-acquisition plans. This will help furthersupport good practice and management stewardship.information if the estimates are clearly and accurately described and explained.AcknowledgementsThis RP was prepared by Atsushi Itabashi (ASBJ Staff) and Tiernan Ketchum (HKICPA Staff),with the advice of Atsushi Kogasaka (Chair of the ASBJ), Yasunobu Kawanishi (Vice chairof the ASBJ) and the HKICPA Financial Reporting Standards Committee, with the supportof Yukihiro Kajita and other staff of the ASBJ, and HKICPA staff Michelle Fisher, NormanChan, and Joni Kan.The HKICPA Staff greatly appreciate the support of Christina Ng (former Director,Standard Setting of the HKICPA), and Professor Adam Leaver, Chair in Accounting andSociety at Sheffield University Management School.Any possible errors remaining in this RP are the authors’ responsibility.Appendix A: METHODOLOGY OF THE QUANTITATIVE STUDYThe scope of companies analysedA1. The quantitative study collected data of more than 1,000 listed companies thatconstituted the following four major stock market indices in the United States,Europe, Hong Kong and Japan:
(a) the S&P 500 index of the United States (‘the stock market index of the UnitedStates’);
(b) the S&P Europe 350 index of Europe (‘the stock market index of Europe’);
(c) the Hang Seng Composite Index of Hong Kong (‘the stock market index ofHong Kong’) ; and(d) the Nikkei 225 index of Japan (‘the stock market index of Japan’).A2. Companies that have constituted the stock market indices as of the starting date ofthe study (July 2019) were included in the population, but the following adjustmentsshould be noted:
(a) Companies which had no net assets in any of the years between 2014 and2018 were excluded from the population;
(b) Companies with duplications (for example, a group and a listed subsidiarywithin the group) were excluded from the population45, except for companiesthat constituted the stock market index of Hong Kong because data to tracksuch group relationships were not available for Hong Kong; and(c) For the stock market index of Japan, only the following companies wereincluded in the population, considering that there were companies which havetransitioned from either Japanese GAAP or U.S. GAAP to IFRS during 2014-201846:
(i) Companies that applied IFRS in 2018 regarding the following figures:
Figure 1.1: Trends in the amount of total goodwill;
45 We identify such group relationships by the information provided by the Bloomberg database labelledas the “Ultimate Parent” under the category of “Company Overview”.46 The adjustments (a) and (b) were also considered to determine the companies included in thepopulation. Figure 1.2: The trend of Figure 1.1 (The data of 2014 are indexed as
100.)
Figure 1.3: Trends in the amount of goodwill per company (thatrecognised goodwill);
Figure 1.4: Trends in the ratio of the amount of Goodwill to NetAssets;
Figure 1.5: The trend of Figure 1.4 (The data of 2014 are indexed as
100.)
Figure 1.6: Trends in the ratio of the amount of Goodwill to theMarket Capitalisation;
Figure 1.7: The trend of Figure 1.6 (The data of 2014 are indexed as
100.)
Table 1.8: Trends in the number of companies that exceed certainratio of the amount of Goodwill to the Net Assets;
Table 1.9: Trends in the number of companies that exceed certainratio of the amount of Goodwill to the Market Capitalisation.For the financial figures for the periods in which the companies appliedJapanese GAAP, no adjustments were made regarding the effects ofamortisation charges.(ii) Companies that applied IFRS throughout 2014-2018 regarding thefollowing figures:
Figure 1.10: Trends in the amount of Goodwill expensed;
Figure 1.11: Trends in the intensity of Goodwill expensed.A3. With the adjustments mentioned in the previous paragraph, the number ofcompanies analysed for each stock market index was as follows:
Stock marketindexNumber ofcompaniesconstituting thestock market indexNumber ofcompanies analysedin the quantitativestudyNumber ofcompanies thatrecognised goodwillUnitedStatesEuropeHong KongJapan62*(29#)
59*(27#)
Total1,5611,3611,176* Number of companies that applied IFRS in 2018. The data ofapplicable companies are used for Figures 1.1 - 1.7 and for Tables 1.8and 1.9.# Number of companies that applied IFRS throughout 2014-2018. Thedata of applicable companies are used for Figures 1.10 and 1.11.A4. It should be noted that this sample is not a representative sample and should notbe used for statistical inference.Years coveredA5. We gathered data from 2014 to 2018.A6. Most companies had a year-end of 31 December. However, some companies hada year-end other than 31 December. For the stock market indices of the UnitedStates, Europe, Hong Kong and Japan, the financial data of those companies wereclassified in the year with the year-end that was closest to 31 December. Forexample, financial data of companies with the year-ends of 1 July 2018, 31December 2018 and 30 June 2019 were all presented as data for 2018.Data collectedA7. The following data were collected for each company analysed:
(a) Goodwill;
(b) Goodwill impairment;
(c) Net assets (that is, the book value of total equity); and(d) Market capitalisation (that is, the market value of total equity).A8. In this RP, all amounts were translated into U.S. dollars (USD) for the readers’convenience. A single exchange rate as of the end of June 2019 was used for thistranslation, as shown in the following table:
1 EUR = 1.13699 USD1 JPY = 0.00926 USD1 CNY = 0.14562 USD1 HKD = 0.12797 USD1 GBP = 1.26935 USD1 CHF = 1.02494 USD1 DKK = 0.15239 USD1 NOK = 0.11721 USD1 SEK = 0.10773 USDA9. The data of companies that constitute stock market indices were collected andanalysed using the Bloomberg database. However, the following adjustmentswere made:
(a) Regarding the stock market index of Japan, the Bloomberg data for ‘goodwillimpairment’ were replaced with the equivalent data from annual reports for allcompanies analysed if the data from two sources were inconsistent.(b) Regarding the stock market indices of the United States, Europe and HongKong, the Bloomberg data for ‘goodwill impairment’ were replaced with theequivalent data from annual reports for companies which decreased goodwillbalance by more than USD 1 billion compared to the previous year-end if thedata from two sources were inconsistent.(c) Other minor adjustments include using the data from annual reports in theyears for which the equivalent data are not available in the Bloombergdatabase because of a change of accounting period.Appendix B: COMPARABILITY BETWEEN ORGANIC GROWTH ENTITIES ANDACQUISITIVE GROWTH ENTITIESB1. The IFRS Conceptual Framework, when describing the qualitative characteristic ofcomparability, states that the faithful representation of similar economicphenomenon should possess some degree of comparability. The currentaccounting regime results in AGW being recognised as an asset only at the time ofa business combination. This creates deviations between entities that growthrough acquisitions versus those that grow organically.B2. To illustrate, consider the following example. Bank X has been mainly providinginvestment banking services. Management decides to set up a new wealthmanagement (‘WM’) division to expand and realise synergies by marketing someinvestment banking services to wealthy individuals. Management is consideringtwo options:
(a) Option A: Build-up a new WM division internally. This will cost $20m inexpenses, of which $5m are identifiable assets and $15m relates toexpenses that do not meet the recognition criteria in IAS 38 (and hencecontribute to IGGW).(b) Option B: Acquire an existing private bank in the market and integrate it asa new business division. This will also cost $20m, of which $5m will beallocated to identifiable net assets and $15m recognised as goodwill.B3. Management determines that it will take one year to fully establish the WMbusiness under both options. Assume that for purposes of our example, Bank Xwill be in substantially the same economic position after one year under eitheroption. Also assume that the fair value of each resulting iteration of Bank X will bethe same, and will be largely impacted by the costs used to build the WM business.We may illustrate how this will be accounted for under both options.Option A (organic growth):
B4. Bank X will expense $15m of costs that do not meet IAS 38 recognition criteria, andcapitalise $5m of other identifiable assets. At the end of the year, that expensewill reduce equity via retained earnings.DebitCreditExpense15m Cash20mOther Assets5mOverall effect•Cash of $5m is transformed into other assets•Decrease of assets (cash) by $15m•Expenses increase by $15m•Equity (retained earnings) decrease by $15mOption B (acquisitive growth):
B5. Bank X will capitalise $15m of AGW as required by IFRS 3, and capitalise $5m ofother identifiable assets. Assuming no impairment, there will be no impact toretained earnings. The cash has been transformed into other non-cash assets foraccounting purposes.DebitCreditAGW (Asset)
15m Cash20mOther Assets5mOverall effect•Cash of $20m is transformed into AGW and other assetsB6. The post-build up balance sheet position of Bank X will hence differ depending onthe option selected. Assume that Bank X started the year pre-build up with grossassets of $120m, split evenly between liabilities and equity. After the build-up, thebalance sheets (assuming no impairment and ignoring all other elements andtransactions for simplicity) would be as follows:
Option AOption BAssets105mLiabilities60mAssets120mLiabilities60mEquity45mEquity60mB7. The example above illustrates that current accounting regime leads to differences infinancial reporting depending on whether entities grow organically or throughacquisitions, even in cases where the cost of growth and economic substance of theentity after the growth is theoretically identical. This negatively impacts thequalitative characteristic of comparability. Some might argue that it is additionally‘unfair’ to entities that grow organically, given they are subject to a relatively lessbenign accounting model than acquisitive entities when it comes to accounting forgoodwill.B8. Introducing amortisation to the subsequent measurement of AGW would ensurethat AGW balances will eventually be expensed in a systematic manner, and willserve to improve comparability between organic and acquisitive growth.Appendix C: ACADEMIC STUDIES REFERENCED BY THE ASBJ STAFFAnalyses cited in the comment letter of the American Accounting Association regardingthe relevance of amortisationC.1 The comment letter of the Financial Accounting and Reporting Section of theAmerican Accounting Association in response to FASB’s Invitation to Comments,Identifiable Intangible Assets and Subsequent Accounting for Goodwill notes thatthere are some academic studies that suggests that the expected benefit ofgoodwill decays rapidly and that investors view goodwill as a wasting asset,including:
Bugeja, M., and N. Gallery. (2006). Is older goodwill value relevant? Accounting &Finance 46 (4): 519–535.The comment letter also notes that following studies examine more closely thelength of the amortisation period of goodwill and suggest that shorteramortisation periods better reflect the short-lived benefits of AGW:
Henning, S. L., and W. H. Shaw. (2003). Is the selection of the amortization periodfor goodwill a strategic choice? Review of Quantitative Finance and Accounting 20
(4): 315–333.Ojala, H. (2007). The value relevance of accounting goodwill – Does theabandonment of systematic amortisation make sense to investors? Finnish Journalof Business Economics 1: 9–34.C.2 The comment letter, on the other hand, notes following academic studies thatsuggest that amortisation would unlikely provide useful information.Jennings, R., M. LeClere, and R. B. Thompson. (2001). Goodwill amortization andthe usefulness of earnings. Financial Analysts Journal 57 (5): 20–28.Moehrle, S. R., J. A. Reynolds-Moehrle, and J. S. Wallace. (2001). How informativeare earnings numbers that exclude goodwill amortization? Accounting Horizons 15
(3): 243–255.Analyses regarding mean reversion of rate of returnsC.3 One of the most notable academic papers that presented this tendency of meanreversion is as follows:
Fama, E.F. and K.R.French (2000). Forecasting Profitability and Earnings, Journal ofBusiness, 73(2): 161-175In addition, the ASBJ Staff reviewed following academic papers when drafting theASBJ Paper:
Healy, P., Serafeim, G., Srinivasan, S. and Yu, G. (2011). Market competition,government efficiency, and profitability around the world. Working paper, HarvardBusiness School. Available at SSRN 1865878.Nissim, D. and Penman, S. H. (2001). Ratio analysis and equity valuation. Review ofAccounting Studies, 6: 109– 154.Obinata, T. (2013). Sustainability and mean reversion of profitability. Chuokeizai-sha, Inc. (the title of the book is not official translation but tentative one by theASBJ Staff.)
Palepu, K. G. And Healy, P. M. (2012). Business analysis and valuation 5th edition –International edition, Cengage learning.Palepu and Healy (2012) showed the empirical research results that excessoperating returns on equity diminished within five to ten years. Nissimand Penman (2001) explored the period of the mean reversion for decileportfolios formed on excess operating profit and found that excessoperating profit for the highest decile remained over 10 years.C.4 The ASBJ Staff additionally reviewed following papers and confirmed that there areno significant difference in the trend of mean reversion of rate of returns.Muramiya, K. (2010). Characteristic analysis of financial ratios that constituteresidual income model. In Sakurai, H. ed., Empirical analysis of enterprisevaluation, Section 9, 230-269, Chuokeizai-sha, Inc. (the titles of the paper and thebook are not official translations but tentative ones by the ASBJ Staff.)
Similar analyses to Nissim and Penman (2001) were conducted usingsamples of Japanese companies for fiscal years ending between January1977 and March 2007. Time series analyses for nine years wereconducted for residual earnings and residual operating income. The trendof mean reversion were observed.Sakurai, T. (2010). Persistence of residual income and enterprise valuation. InSakurai, H. ed., Empirical analysis of enterprise valuation, Section 10, 270-315,Chuokeizai-sha, Inc. (the titles of the paper and the book are not officialtranslations but tentative translations by the ASBJ Staff.)
The paper demonstrated that the adjustment speed of residual income peryear was 0.6271 for the sample Japanese companies for fiscal years endingbetween March 2002 and March 2007. Based on this, ROE is estimated tobe reduced to the cost of equity in about five years.Analyses regarding performance subsequent to business combinationsC.5 Following academic paper refers to several studies that analyses performancesubsequent to business combinations:
Obinata, T. (2012). The Origin of the Study of Accounting Standards, 364-365,Chuokeizai-sha, Inc. (the titles of the paper and the book are not officialtranslations but tentative translations by the ASBJ Staff.)
Studies that support improved performance referred to in Obinata (2012) include:
Healy, P.M., K.G.Palepu and R.S.Ruback (1992). Does Corporate PerformanceImprove after Mergers?, Journal of Financial Economics, 31(2): 135-175Bruner, R.E.(2001). Does M&A Pay? A Survey of Evidence for the Decision-Maker,working paper, University of VirginiaKallunki, J.-P., E. Pyykkӧ and Tl Laamanen (2009). Stock Market Valuation,Profitability and R&D Spending of the Firm: The Effect of Technology Mergers andAcquisitions, Journal of Business Finance & Accounting, 36(7-8): 838-862Studies that do not support improved performance referred to in Obinata (2012)
include:
Ghosh, A. (2001). Does Operating Performance Really Improve FollowingCorporate Acquisitions? Journal of Corporate Finance, 7(2): 151-178Ma, Q., D.A.Whidbee and A.W.Zhang (2011). Value, Valuation, and the Long-runPerformance of Merged Firms, Journal of Corporate Finance, 17(1): 1-17