IASB Discussion Paper DP/2020/1 Business Combinations-Disclosures, Goodwill and Impairment

Page 1 of 16Our Ref.: C/FRSCSent electronically through the IASB Website (www.ifrs.org)

23 December 2020Mr Hans HoogervorstInternational Accounting Standards BoardColumbus Building7 Westferry CircusCanary WharfLondon E14 4HDUnited KingdomDear Hans,IASB Discussion Paper DP/2020/1Business Combinations-Disclosures, Goodwill and ImpairmentThe Hong Kong Institute of Certified Public Accountants (HKICPA) is the only bodyauthorised by law to set and promulgate standards relating to financial reporting, auditingand ethics for professional accountants in Hong Kong. We are grateful for the opportunityto provide our views and the views of our stakeholders on this Discussion Paper (DP).The HKICPA appreciates the IASB’s initiative and efforts to explore ways to provideinvestors with more useful information about the acquisitions made by companies andimprove the accounting of goodwill. The HKICPA has been actively engaged with thistopic, and in March 2020 the staff of the HKICPA, with the staff of the AccountingStandards Board of Japan, published a joint Research Paper Goodwill: Improvementsto Subsequent Accounting and an Update of the Quantitative Study (RP). The RP, inorder to contribute relevant and timely analyses to the global project, shares findings ona quantitative study and explores views on the subsequent accounting for goodwill. TheHKICPA recommends that the IASB refer to the RP in full as an integral part of ourcomments on the DP.The HKICPA has carefully reviewed the DP and performed outreach with localstakeholders to broaden awareness of the proposals and seek feedback. We providedetailed comments in the Appendix, with primary points including:

The DP tends to concentrate on a disclosure-based solution to the prevailingaccounting issues, which we consider may not fully address the issues surroundingthe accounting for goodwill. We think that it may be beneficial to explore thefundamental accounting of goodwill more robustly.The HKICPA supports an amortisation plus indicator-based impairment approach aswe outlined in our RP, which is supported by a slight majority of our stakeholders.We have noted a variety of arguments for both the amortisation plus impairmentmodel and the current impairment-only model from practical, cost-benefit, usefulness,and conceptual perspectives. This is detailed in the Appendix.The HKICPA generally supports the IASB’s intention to enhance the disclosureobjectives and requirements in IFRS 3, and thereby improve the information providedto users about an acquisition and its subsequent performance. Nevertheless, wenoted diverse views from different types of stakeholders. Many of our stakeholdersvoiced concerns that some of the proposed new disclosure requirements aresubjective and would likely lead to boilerplate disclosures, while some of thePage 2 of 16proposed new disclosures may be considered commercially sensitive and may raisequantification difficulties and give rise to audit challenges. Additionally, the proposedpro forma information disclosures may raise significant challenges for preparers andauditors. The HKICPA recommends that the IASB perform sufficient furtherconsultation and outreach on this aspect including hosting a consultation groupcomprising both investors and preparers to enable direct communication and toobtain further clarity over the respective needs and concerns. We also recommendthe IASB carefully consider the extent of the disclosures, together with the exampledisclosures and suggestions shared by our stakeholders as summarised inparagraphs 8 and 12 of the Appendix.Specifically, among the disclosure proposals, the HKICPA disagrees with theproposal for disclosures that analogises to the management approach and sharessimilar views with our stakeholders that the resulting disclosures would be ofinsufficient quality. We recommend that the IASB carefully reconsider the costs andbenefits of this proposal.The HKICPA and the majority of our stakeholders do not think the IASB’s proposalof presenting total equity excluding goodwill would improve financial reporting.We found the proposed removal of the restriction on including cash flows relating touncommitted future restructurings and asset enhancements in estimating value inuse lacking conceptual basis, and that the proposal would increase the risk of overlyoptimistic inputs, aggravating the ‘too little, too late’ problem. These concerns areshared by some of our stakeholders and we recommend that if the IASB were topursue this proposal, it should provide a conceptual basis for such a change andinclude more specific criteria on when such cash flows could be included. On theother hand, we and a majority of our stakeholders support the IASB’s proposal toallow companies to use post-tax cash flows and post-tax discount rates in estimatingvalue in use.Our detailed responses to the questions raised in this DP are in the Appendix.If you have any questions regarding the matters raised in this letter, please contact me(ceciliakwei@hkicpa.org.hk) or Tiernan Ketchum (tiernanketchum@hkicpa.org.hk),Deputy Director of the Standard Setting Department.Sincerely,Cecilia KweiDirector, Standard Setting DepartmentPage 3 of 16Work undertaken by HKICPA in forming its viewsThe Hong Kong Institute of Certified Public Accountants:

(i)

issued an Invitation to Comment on DP/2020/1 on 23 March 2020 to its membersand other stakeholders;

(ii)

met with representatives from Hong Kong's financial reporting, securities andlisting regulatory bodies;

(iii)

sought input from its Business Combinations and Reporting Entity AdvisoryPanel, Financial Reporting Valuation Advisory Panel, and Small and MediumPractitioners Technical Issues Working Group, which are mainly comprised oftechnical and industry experts from large as well as small and mediumaccounting firms (collectively, Practitioners);

(iv)

held a public roundtable discussion on 6 October 2020, comprising investors,analysts, preparers, academics and practitioners, with IASB Board member andstaff participation; and(v)

developed its views through its Financial Reporting Standards Committee,having reflected on its stakeholder views. The Committee comprises academics,preparer representatives from various industry sectors, regulators, as well astechnical and industry experts from small, medium and large accounting firms.This submission outlines the HKICPA's views and summarises our stakeholders'comments on the DP/2020/1. You may access our stakeholder responses to theDP/2020/1 here:

https://www.hkicpa.org.hk/en/Standards-and-regulation/Standards/Our-views/pcd/financial-reporting-submissions/2020Detailed comments on IASB DP/2020/1Improving disclosures about acquisitionsQuestion 2(a) and (b)—Proposed disclosuresQuestions 4 and 5—Other improvements to IFRS 3 disclosuresStakeholders’ views

1.Most stakeholders supported the IASB’s proposals on improved disclosures.Nonetheless, some practitioners from small and medium firms disagreed with theproposed additional disclosures as they are seen to significantly increase auditdifficulties and complexity. These practitioners considered that the existingdisclosures under IFRS 3 Business Combinations and IFRS 8 Operating Segmentsprovide sufficient information to users, and the disclosure requirements under IFRS12 Disclosure of Interests in Other Entities do not require specific disclosures formaterial subsidiaries, hence these practitioners questioned why additionaldisclosures are required for acquisitions (i.e. acquisition of subsidiaries).

2.Some stakeholders commented that certain proposed disclosures are quantitativein nature but may not be easily quantified, for example, non-monetary elements ofsynergies (i.e. management integration) and management or cultural metrics usedfor monitoring the achievement of acquisition objectives. These proposeddisclosures may be practically difficult, particularly for smaller companies, as theyoften do not perform such a comprehensive analysis before or after acquisitions. Apractitioner suggested that the IASB provide more guidance on how to quantifythese disclosures, for example, the estimated amount or range of amounts ofsynergies.

3.Some stakeholders commented that the proposed disclosure of the strategicAppendixPage 4 of 16rationale and objectives of an acquisition could be generic and boilerplate, andprovide limited useful information to users.

4.Practitioners generally expressed their concerns that the proposed new disclosurerequirements would result in increased difficulty and complexity for audit becauseof their qualitative and subjective nature, particularly around the verification of themetrics used by management for monitoring purposes, and the expected synergies.Nonetheless, some of these practitioners considered that they should be able toovercome the majority of these difficulties because much of the informationdisclosed is likely to be broad and not difficult to reconcile to other supportinginformation, particularly for listed companies that already prepare circulars for majortransactions with similar disclosures.

5.Some users expressed concerns that given the proposed metrics disclosures haveto be made in the first two years after the acquisition if the acquisition is monitoredby the management, disclosing such short-term information may be detrimental tothe long-term value of a company. Instead of focusing on narrowly detailed metrics,users often focus broadly on whether the transaction is ultimately successful (thiswould be reflected in the share price of the company), and whether there will bemajor issues/risks in that transaction. Hence, the proposed metrics disclosureswould provide limited useful information.

6.Preparers commented that significant cost and effort would be involved for them tocomply with the additional disclosures, and this may not justify the benefits of theresulting information. For example, the proposed metrics disclosures may requiresome preparers to develop further metrics to monitor the performance of theacquiree for disclosure purposes. It was acknowledged however that this maybeneficially encourage some preparers to monitor the performance of the acquireemore robustly, rather than only focus on goodwill impairment.

7.A group of banking industry preparers and a practitioner expressed concern aboutthe proposed requirements to disclose the cash flows from operating activities ofan acquired business after the acquisition date, and of the combined business ona pro forma basis for the current reporting period. They considered that there maybe challenges to disclose information in the current reporting period on a pro formabasis since the businesses have already been combined and information about theacquired business before the acquisition may not be available. The separate cashflows of the acquired entity may need to be derived from assumptions andestimations and hence may not be sufficiently reliable or useful. There will alsolikely be significant challenges in auditing such pro forma information.

8.This group of banking industry preparers also made the following suggestions tothe IASB regarding the pro forma disclosures:

provide further guidance to address the difficulties and challenges faced bystakeholders in preparing the pro forma information required as described inparagraphs 2.74-2.75 of the DP in order to better align the practices amongcompanies; in particular, how to prepare the pro forma information when thecompanies are not able to obtain relevant financial information of the acquiredbusiness before acquisition;

replace the term “profit or loss” with the term “operating profit [or loss] beforeacquisition-related transaction and integration costs” for the pro formainformation; anddefine “integration costs” as mentioned in paragraph 2.80 of the DP to facilitateconsistent application.Page 5 of 16

9.Additionally, this group of banking industry preparers understood the need for theproposed disclosures, but suggested that the IASB allow sufficient flexibility forvoluntary disclosures in the initial phase.

10.A small group of practitioners from small and medium firms recommended that theIASB consider the related cost and practicability in applying these proposeddisclosure requirements to all companies, and suggested that the IASB requiresuch proposed disclosures only for listed companies or material transactions,perhaps through the application of criteria around the size of the transactions.

11.Many practitioners, some preparers including a group of banking industry preparersand an academic commented that the IASB should consider whether the proposeddisclosures that may involve forward-looking assumptions (e.g. expected synergies)

should be provided in or outside of the financial statements given their nature (i.e.qualitative, not based on historical information and not prepared in accordance withfinancial reporting framework). Some consider it more appropriate to include themas part of management commentary rather than in the financial statements.

12.Example disclosures suggested by some stakeholders for the IASB’s considerationinclude:

removing the proposed metrics disclosures and instead providing moreflexibility to companies by, e.g. requiring an explanation of the key risks orsubsequent events that affect the performance of the acquiree after theacquisition;

requiring an explanation of the potential decline in future prospects of theacquiree, and whether unexpected changes may happen in the future;

requiring a qualitative and quantitative explanation of the businessmodel/strategic plan to achieve the expected synergies;

requiring explanations on how the disclosed information is being calculated,for example, how to calculate the expected synergies from an acquisition andhow it is linked to the goodwill balance;

requiring disclosures of the basis for valuation of the acquiree (i.e. method andapproach adopted, market research and analysis performed), to provideinvestors with a better understanding of what went into the acquisition price(which by extension can help users better understand the composition ofgoodwill);

requiring disclosures of earn-out and contingency information to facilitate thevaluation; andrequiring disclosures of the sensitivity analysis of the assumptions used inimpairment testing, the headroom related to goodwill (i.e. by how much therecoverable amount exceeds the carrying amount of the cash-generating unit(CGU)), and the profitability of the CGU(s), so as to provide more timely insightto users as to whether there would be potential goodwill impairment losses.HKICPA analysis and recommendation

13.The HKICPA appreciates and generally agrees with the IASB’s proposal to have aprimary objective to provide investors with better information about acquisitions.However, a majority of our stakeholders have raised concerns about the proposeddisclosures, including that they are either too generic in nature (i.e. strategicrationale and objectives of acquisitions) which may lead to boilerplate disclosuresand hence not be useful to users; or are too specific (i.e. metrics used bymanagement to monitor the performance of the acquiree and the amount ofexpected synergies), to the extent that such information may be consideredPage 6 of 16commercially sensitive or that management may not be able to quantify them on areasonable basis further giving rise to audit challenges.

14.The HKICPA acknowledges the explanation as summarised in paragraphs 2.72-

2.86 of the DP why the IASB’s preliminary view is to retain the disclosurerequirements for pro forma information. However, disclosures of pro formainformation have raised significant challenges for preparers and auditors giveninformation before the acquisition date may not be available to the latter.Furthermore, it is not clear whether pro forma information should take into accountsynergies as well as wider integration benefits and costs that would have beenreaped or incurred had the acquisition taken place at the start of the reporting period,and whether preparers could make a reasonable quantification of such amountsand the ability of auditors to audit such amounts.

15.Accordingly, the HKICPA recommends that the IASB consider whether the currentrequirement to disclose pro forma revenue and profit or loss of the combined entityis achieving the disclosure objectives of IFRS 3 as originally envisaged by the IASB,as well as what and how much value they are providing to users of the financialstatements, before deciding on their retention and/or introducing additionaldisclosures on pro forma cash flows from operating activities of the combined entity.If the IASB considers pursuing the proposed pro forma disclosures, the IASB shouldprovide specific guidance for companies about how to prepare such information,and consider the suggestions shared by our stakeholders in paragraph 8 above.

16.The HKICPA recommends that the IASB set up a working group comprisinginvestors and preparers to enable direct communication between these two groupsfor them to understand each other’s respective needs and the ability to provideinformation, before reconsidering the nature and extent of the proposed disclosurerequirements. We also recommend that the IASB consider the examples ofadditional disclosures as suggested by our stakeholders in paragraph 12 above.

17.On replacing ‘profit or loss’ with ‘operating profit [or loss] before… integration costs’,the term ‘operating profit’ is not defined in IFRS. The IASB should refer to the projecton primary financial statements to ensure consistency in definition or the descriptionof the term. Furthermore, we suggest that the IASB define the term ‘integrationcosts’ to ensure consistency in application.Question 2(c)—Proposed basis for disclosuresStakeholders’ views

18.Many stakeholders questioned the DP’s proposed basis for disclosures that makesanalogy to the management approach used for segment reporting under IFRS 8.

19.According to paragraph 80 of IAS 36 Impairment of Assets, goodwill is allocated toa CGU or groups of CGU(s) which represents the lowest level within the companyat which the goodwill is monitored for internal management purposes (with that levelnot being larger than an operating segment). In light of this, some practitionersraised concerns that in situations where goodwill is managed internally at a lowerlevel than the operating segment, such information may not be provided to the chiefoperating decision maker (CODM) and thus would not be presented in the financialstatements.

20.In addition, some practitioners commented that the CODM may be able todetermine what information will be disclosed in the financial statements throughselective reporting practices, and this could increase the challenges for auditingPage 7 of 16purposes. For example, it is difficult for auditors to assess whether the CODM is areasonable person to make such a decision as not to monitor a significantacquisition, and thus not to disclose the related information. It is suggested that theIASB provide application guidance on how to perform such an assessment.

21.It was observed that investors have generally not been satisfied with the “eyes ofmanagement” approach used for disclosures under IFRS 8. The overall quality ofdisclosures based on such a management approach is unsatisfactory in practice,and it allows significant opportunities for manipulation by management through thecreation of internal information specifically to feed into disclosures for externalreporting purposes. For example, management may prepare separate internalreporting to effectively hide certain information and avoid disclosure in the financialstatements.

22.Nonetheless, a few stakeholders who did support the IASB’s proposal consideredthat the proposed approach is easy for management and is entity/business specific.These stakeholders consider that going beyond the proposed level of disclosuresmay be costly to perform and lead to excessive disclosures.

23.One practitioner from a small and medium firm considered that further informationcould be disclosed as a supplement, if necessary, if that additional information isrelevant to an understanding of the financial statements that is not presentedelsewhere as required by paragraph 112 of IAS 1 Presentation of FinancialStatements.HKICPA analysis and recommendation

24.The HKICPA acknowledges the IASB’s reasons for using a management approachas the basis for disclosures; nevertheless, we share similar views with ourstakeholders that the overall quality of disclosures based on such an approach isunsatisfactory in practice, and increases the opportunities for managementmanipulation of information disclosed in the financial statements, potentially leadingto insufficient and not useful information. We recommend that the IASB considerthe pros and cons of using such a management approach before pursuing it.Question 2(d)—Commercial sensitivitiesQuestion 2(e)—Constraints on proposed disclosuresStakeholders’ viewsCommercial sensitivities

25.Many stakeholders, particularly preparers, expressed concerns about the sensitivityof the required disclosures, particularly the estimated amount or range of amountsof synergies expected from the acquisitions, and the metrics used by managementfor monitoring the acquiree’s subsequent performance. Some stakeholderscommented that useful information is often commercially sensitive, but thatsensitivity should not be a valid reason for not making such disclosures. The extentof disclosures should be carefully considered to balance between generic andoverly specific/sensitive disclosures.

26.A practitioner from a small and medium firm commented that there could bediversity in the interpretation of “commercial sensitivity”, and this flexibility couldencourage companies to use sensitivity as an excuse not to make the requireddisclosures. This practitioner suggested that the IASB define “commercialsensitivity” and provide application guidance on how to consider whetherinformation disclosed is commercially sensitive.Page 8 of 16Constraints on proposed disclosures

27.A few practitioners from small and medium firms pointed out that detailedinformation related to the objectives of the acquisitions along with targets isnecessarily forward-looking information, given forward-looking assumptions areused to estimate the future cash flows and quantify the expected synergies arisingfrom the acquisitions. As such, they disagreed with the notion in paragraphs 2.29-

2.32 of the DP that such information was not forward-looking.HKICPA analysis and recommendation

28.The HKICPA understands the concerns shared by some of our stakeholders thatthe proposed required disclosures are commercially sensitive and forward-lookingin nature, for example, the amounts of expected synergies. Nevertheless, we agreethat these are not sufficient constraints for not providing useful information to users.We suggest that the IASB consider the extent of disclosures to balance betweenadequacy and necessity, the sensitivity of the information disclosed, and whether itis more appropriate to include certain of the proposed disclosures as part ofmanagement commentary rather than in the financial statements.Question 3—Disclosure objectivesStakeholders’ views

29.Stakeholders generally supported the IASB’s proposal but considered thatincorporating the disclosure objectives may not be sufficient or useful. The followingcomments were noted:

Information disclosed would still be subject to the judgement of the preparersregarding what is relevant information.Although IFRS 15 Revenue from Contracts with Customers and IFRS 16Leases have included disclosure objectives, it has been observed thatpreparers may not look at the objectives carefully and may only provide thedisclosures specified in the Standards. Hence, such an approach may not beeffective in practice.

30.A few practitioners recommended that the IASB consider incorporating specificrequirements on how to meet those objectives and to provide meaningfulinformation to users. On the other hand, a practitioner from a large accounting firmsuggested that the IASB follow the objective of its Disclosure Initiative project, andset disclosure requirements that are principle-based and could be appliedappropriately across different industries, rather than requiring disclosures ofspecific information for all companies.HKICPA analysis and recommendation

31.The HKICPA is generally supportive of the proposals in the DP and supports ourstakeholders’ suggestion on incorporating specified disclosures in the Standards.We recommend that the IASB provide examples of specific disclosures that wouldbe applicable to most of the companies to meet the disclosure objectives, similar tothe requirements specified in paragraphs 52-60 of IFRS 16 on how to meet thedisclosure objectives for lessees, so as to provide more meaningful information tousers. The HKICPA considers that more specific disclosure objectives andrequirements could facilitate compliance by smaller companies and increasecomparability across entities.Page 9 of 16Goodwill impairment and amortisationQuestion 6—Effectiveness of impairment testStakeholders’ views

32.Some stakeholders suggested that the current impairment-only model is generallyeffective. Those who took this view generally considered that in cases where themodel has failed to perform well, improvements would likely come through morerobust application and control.

33.A stakeholder commented that the IASB should consider further what theimpairment test is fundamentally testing, given that the model does not test goodwilldirectly. This stakeholder suggested that if the impairment model only ever tests aCGU(s), the underlying issues about impairment of goodwill may not be resolved.HKICPA analysis and recommendation

34.The HKICPA supports an amortisation plus impairment approach, which we expandon in our comments to the DP’s Question 7.

35.The DP notes the IASB identified two broad reasons for the concerns thatimpairment losses are not recognised on a timely basis, including managementover-optimism and the impairment shield. We agree that these two reasons arerelevant; in particular, we think the impairment shield issue is significant.

36.We would however posit that in addition to management over-optimism, an issuemore broadly is the combination of the ability for management to exercise significantjudgement over the model and the incentives that exist to avoid impairment. Asdiscussed in our RP, we consider that the impairment-only regime may contributeto various incentives for delaying impairment (e.g. to maximize financial reportingmetrics).

37.An example of the judgement referred to above would be the ability for managementto allocate goodwill to a sufficiently large CGU such that a decline in value isshielded by the broader CGU. If the IASB elects to retain an impairment-only model,we would suggest that areas such as this be scrutinized for potential improvements.A key potential improvement would be with regard to determining whether therequirements around allocating goodwill to CGUs can be refined to prevent casesof management shielding operations within overly large CGUs, which we considera relevant issue of the existing requirements.Question 7—Amortisation of goodwillStakeholders’ views

38.Overall, our stakeholders’ views on the accounting for goodwill have been mixed,with a small majority favouring amortisation.

39.Among stakeholders more supportive of amortisation, key messages include:

The DP is heavily focused on a disclosure-based solution, and appears torelegate the accounting of goodwill to be a secondary issue. The IASB shouldfirstly consider the fundamental nature of goodwill and address the conceptualaccounting issues. Additionally, some considered that the DP attempts toPage 10 of 16preemptively discard a variety of historical arguments about goodwill. However,quality of argument should matter over novelty, and some of the “well-known”

arguments are worth considering in more detail.Goodwill does become less representative of the underlying entity over time.This is because goodwill is “static” and it only represents a snapshot ofacquired/external goodwill as of a historical acquisition date. Overtime, whatgoodwill is ostensibly supposed to represent is commingled with (non-recognised) internally generated goodwill. Amortisation better reflects this fact.Acquired goodwill is wasting because it is static. There will inevitably be churn.Furthermore, the argument that goodwill is not wasting on the basis that thevalue or going-concern element of an entity is valued and projected intoperpetuity is inappropriate because that argument is not looking at acquiredgoodwill, but rather is looking at overall economic goodwill.There is a significant bias in financial reporting between acquisitive andorganic growth. Current goodwill accounting exacerbates this issue andcontributes to skewing management incentives.Amortisation of goodwill can better reflect the consumption of an acquisition.When an entity is acquired, the goodwill amount in part reflects expectationsfor future cash flows. When those cash flows are realised, it is logical torecognise a corresponding expense through goodwill amortisation to reflectthe consumption. This also addresses the double counting issue that arises ifthis expense is not taken (double counting cash flows first as acquired goodwill,then as income if expectations are realised and the value of an acquisition ismonetised).Many of the issues that arise with goodwill accounting do so as a result of therecognition of acquired (external) goodwill and non-recognition of internallygenerated goodwill. Theoretically, there are three possible ways to resolvethese issues:

oDo not recognise external goodwill as an asset.oRecognise external goodwill as an asset and apply amortisation.oMove to a full revaluation model including external and internal goodwill.It is operationally and practically easier to amortise goodwill. Hence in theabsence of rationale otherwise, it is better to amortise than to haveimpairment-only. A significant amount of time and resources are devoted tothe goodwill impairment process, the amount of which may be disproportionateto the value that it provides to users of financial statements.The impairment test is highly subjective and allows management ampleopportunity to delay impairment.

40.Among stakeholders more supportive of impairment, key messages include:

The impairment model may not be perfect for investors, but it does at leastprovide confirmatory information in the form of impairment expense, andallows users to monitor the goodwill balance over time. Amortisation does notprovide useful information, and results in the goodwill balance disappearingover time.Some members of the valuation community argue generally that goodwill is anon-wasting asset on the basis that valuations are done on a terminal valuebasis that assumes perpetual cash flows.oHowever, this argument was disputed by some of our stakeholders on thebasis that it is assessing the wrong type of goodwill. The argumentassesses total or economic goodwill, whereas what is recognised underIFRS 3 is external goodwill, the latter being a static accounting concept.The impairment model can be and is still effective when implemented properly,and most entities in Hong Kong do robustly implement the test. Instances of“too little too late” are an implementation issue. Additionally, it may notPage 11 of 16necessarily be a problem that goodwill balances are increasing globally, asthis may simply reflect increased acquisition activity.An amortisation charge would be inappropriate in the event that an acquisitionhas not failed or otherwise destroyed value.Amortisation could hide impairment and fail to hold management to accountfor acquisitions, because as the carrying amount of goodwill is amortised theamount which would be compared against the recoverable value shrinks.HKICPA analysis and recommendation

41.In March 2020, the staff of the HKICPA, with the staff of the Accounting StandardsBoard of Japan, published a joint Research Paper (RP) Improvements toSubsequent Accounting and an Update of the Quantitative Study. The RP presentsthe joint view of the staff involved that goodwill should be amortised, and that theCGU(s) to which goodwill is attributed should be tested for impairment when thereis an indication of impairment (an amortisation plus impairment approach). TheHKICPA recommends that the IASB refer to the RP in full as an integral part of ourcomments on the DP.1

42.The HKICPA observes that the DP in general concentrates on disclosures andimprovements to the existing framework. Ideally, we would suggest the IASB toconsider a more fundamental review of the accounting for goodwill, including theinitial recognition of acquired goodwill, the status of goodwill as an asset, and therelationship between acquired goodwill and internally generated goodwill. We echoa comment noted from one of our stakeholders above that many of the issues withgoodwill arise from the recognition of acquired goodwill and non-recognition ofinternally generated goodwill.

43.We nevertheless appreciate that this would be a broad undertaking and potentiallybeyond the project’s scope. As such, and as we do in the RP, we focus ourcomments on the accounting for acquired goodwill under the existing recognitionframework.Question 7(a)(b)(c) – reintroducing amortisation

44.The HKICPA takes the view that amortisation plus impairment is preferable to animpairment-only approach.

45.In Part 3B of the RP, we analyse the nature of goodwill and compare acquiredgoodwill with economic goodwill. We then argue how amortisation is a preferableapproach to subsequent measurement as it better reflects the nature of goodwilland addresses the issue of increasingly large goodwill balances as seen under thecurrent impairment-only model.

46.The RP defines the concept of “economic goodwill” as the difference between thefair value of an entity and its identifiable net assets recognised under prevailingaccounting standards. As such, we note that goodwill is only an amount that is usedto represent the divergence between what can be recognised and measured forfinancial reporting purposes and what cannot.

47.The relationship between economic goodwill and acquired goodwill is that the latteris a point-in-time snapshot of an acquiree’s economic goodwill as of the acquisitiondate. As a snapshot, acquired goodwill is a distinct and static concept. This is in1 https://www.hkicpa.org.hk/-/media/HKICPA-Website/New-HKICPA/Standards-and-regulation/SSD/07_Major-projects/goodwill/rp_goodwill20.pdfPage 12 of 16contrast to economic goodwill, which is dynamic, as its amount would vary as thefair value or recognised identifiable net assets of an entity changes from time totime.

48.Key points as to why amortisation of acquired goodwill is preferable include:

Amortisation better reflects the nature of acquired goodwill, in particular:

oIt better reflects the fact that acquired goodwill becomes increasingly lessrepresentative of the acquiree and of the overall consolidated entity.oIt provides a better opportunity to show how an acquisition is utilised.oIt improves comparability between entities that grow organically andthrough acquisitions.Amortisation helps ensure that the increasingly large goodwill balances asseen under the current impairment-only model will be allocated to expense ona timely basis.

49.Details of these points are presented in Part 3B of our RP. Rather than reproducethem here, we recommend that the IASB review the RP in full.Question 7(d) – acquired goodwill as distinct from internally generated goodwill

50.The DP asks whether respondents view acquired goodwill as distinct fromsubsequent internally generated goodwill. As noted in Part 3B of the RP, we thinkthat acquired goodwill is a distinct unit of account and independent from other formsof goodwill. This is because only acquired goodwill is permitted to be recognised asan asset, and the distinction is a key reason why many issues with goodwillaccounting arise (e.g. the impairment shield, lack of comparability between typesof growth, and a static acquired goodwill figure). Although acquired goodwill can beshielded by subsequent internally generated goodwill, it cannot be remeasuredfrom its original amount.

51.We observe that this question may be relevant to arguments which posit thatgoodwill is a non-wasting asset because valuations are done on a basis that reflectsa perpetual growth assumption of cash flows. We agree with our stakeholderfeedback noted above that this argument is inappropriate because it is not lookingat acquired goodwill, but rather at overall economic goodwill.

52.Acquired goodwill is always a residual amount. It cannot be directly measured ordirectly valued because it is only a difference between an entity’s fair value andidentifiable net assets recognised under accounting standards at a point in time. Inthis sense, acquired goodwill is not an item subject to valuation, unlike the entity asa whole. Goodwill is simply a residual amount due to the inability of accountingstandards to fully identify, recognise and measure every component that makes upthe fair value of an entity. It can be further said that goodwill is only a part of anasset (that asset being the entity as a whole) rather than a stand-alone asset itself.

53.An argument that acquired goodwill is not wasting because an entity is valued undera perpetual growth assumption, in our view, inappropriately conflates acquiredgoodwill and economic goodwill, and hence ignores that what is recognised in thefinancial statements (acquired goodwill) is a static amount representing a historicalsnapshot of economic goodwill.Question 7(e) – adjustment of performance measures under amortisation or impairment

54.With regard to this question, we believe it is important to keep in mind that acquiredgoodwill is not an effective item for assessing an acquisition’s performance or thePage 13 of 16success of an acquisition. The DP notes this in a number of instances. Whenassessing the subsequent accounting of goodwill, we would recommend that theIASB focus on the nature of acquired goodwill and its position within the accountingframework.Question 7(f) – amortisation period and pattern

55.The HKICPA discusses its views on the amortisation period and method in Part 4Bof the RP. The HKICPA considers that the amortisation period can be determinedin terms of the expected utilisation of an acquisition. This could be informed byfactors such as management’s expected integration and monetisation of theacquisition (e.g. acquisition plan and timeframe of expected financial results).

56.Much of the information that the DP proposes as disclosures can be used to informthe determination of an amortisation period. For example, the metrics thatmanagement uses to monitor the objectives of an acquisition, combined withinformation about the extent to which those metrics are being met, can be key inputsfor determining the expected utilisation/monetisation period of an acquisition. Weconsider this strengthens the case for amortisation approach, as (1) informationthat the DP proposes as useful will be represented through the amortisationmechanism (e.g. information about objectives for an acquisition and the timeframein which those are met), and (2) management will be able to access the requisiteinformation at little additional cost.

57.We do not think that there should be a mandatory floor or ceiling for the amortisationperiod, as that may fail to reflect an entity’s particular situation, industry andeconomic environment. We nevertheless would support a rebuttable presumptionthat the amortisation period should not exceed a specified number of years.

58.With regard to the amortisation pattern, we similarly think that entities should berequired to apply judgement to determine what pattern is expected to best reflectthe expected utilisation of an acquisition. We think that entities should leverage onthe information used to determine the amortisation period when determining theamortisation method. Consistent assumptions and judgements should be appliedfor both the amortisation period and method. We think that the residual value ofgoodwill should be zero for amortisation purposes.

59.We do not believe that determining an amortisation approach for goodwill is overlydifficult, judgemental or arbitrary. Our RP suggests a principle-based approach toamortisation can be used to determine both the amortisation period and methodusing reasonably available information. We think that some arguments thatamortisation can only be arbitrary go back to a fundamentally differentunderstanding of what acquired goodwill represents as compared to economicgoodwill. As noted above, we think that acquired goodwill needs to be considereddistinctly from other forms of goodwill.Other topicsQuestion 8—Presentation of total equity excluding goodwillStakeholders’ views

60.Stakeholders generally disagreed with the IASB’s proposal of presenting totalequity excluding goodwill on the balance sheet. These stakeholders noted that theproposed figure can already be easily computed, thus separate presentation wouldPage 14 of 16not provide significant improvements to financial reporting. Stakeholders alsocommented that the proposal may raise the question of why goodwill is beinghighlighted as such, and what this may imply (e.g. whether goodwill is an asset).

61.A smaller selection of stakeholders stated that although the figure is trivial tocompute, such presentation may be beneficial in that it could highlight the fact thatgoodwill is different from other assets, and help reduce the comparability issueconcerning organic versus acquisitive growth entities.HKICPA analysis and recommendation

62.The HKICPA agrees with our stakeholders who consider that the IASB’s proposalwould not significantly improve financial reporting given the ease with which thefigure can be computed, and overall we note that the fundamental issues withgoodwill accounting cannot be resolved through changes in presentation. We alsonote that the existence of this proposal is indicative of the fact that goodwill has arather unique nature as an asset. As noted elsewhere in this comment letter, werecommend the IASB consider the fundamental accounting of goodwill.Question 9—Relief from an annual impairment testStakeholders’ views

63.Most of our stakeholders considered that removing the mandatory annualimpairment test for goodwill, while retaining an impairment-only model, mayincrease the chance that impairment losses could be concealed or otherwise notrecognised in a timely manner.

64.On the other hand, a few stakeholders welcomed the proposal because theprovision of such relief would make the accounting treatment of goodwill moreconsistent with other assets that are not assessed annually for impairment.HKICPA analysis and recommendation

65.The HKICPA, in line with our RP, supports an amortisation approach for goodwillincluding testing for impairment when there is an indication of impairment. However,if the IASB retains an impairment-only approach, we believe that the annualimpairment should be retained as an indicator-based approach would make theimpairment assessment less robust. Were the IASB to decide to pursue the removalof the annual impairment test and retain an impairment-only model, we wouldrecommend that the IASB revisit the indicators for impairment to ensure thoseindicators are sufficiently clear and precise.Question 10—Simplifying value in use estimatesStakeholders’ views

66.A majority of our stakeholders welcomed allowing the use of post-tax cash flowsand the post-tax discount rates in estimating value in use (VIU), on the basis thatthey are commonly used in practice. One stakeholder however commented thatallowing the use of post-tax cash flows and discount rates would not be very helpfuland may introduce complexity, as the process of determining post-tax cash flowsand discount rates can require complex adjustments.

67.Some stakeholders expressed concern on allowing the inclusion of cash flowsrelated to future uncommitted restructurings, or improving or enhancing the asset’sPage 15 of 16performance. Including cash flows from a future uncommitted restructuring may notbe conceptually sound, as this would use forward-looking information. It may alsoincrease the risk that management’s inputs are too optimistic or aggressive, andcontribute to challenges for auditors.HKICPA analysis and recommendation

68.The HKICPA is generally supportive of the proposals in the DP and supports ourmajority stakeholders’ view to permit the use of post-tax cash flows and the post-tax discount rates in estimating VIU, since they are commonly used in practice bypreparers.

69.With regard to the proposal to remove the restriction on including cash flows froma future uncommitted restructuring or from improving or enhancing an asset’sperformance, we do not believe that this is consistent with the concept of VIU thatrequires an assessment of cash flows from an asset’s current condition. The DP at

4.38(c) describes the proposal as being consistent with how fair value is determined.We question whether this alignment of VIU and fair value less costs of disposal isappropriate and if pursued, whether there is a need to retain these two ‘separate’concepts.

70.If the IASB decides to pursue this route, we recommend that the IASB establish aconceptual basis for the proposal and that it includes more specific criteria on whensuch cash flows could be included in the VIU calculation. For example, at whatstage of a planned but uncommitted restructuring should these cash flows beincluded, what kind of qualitative indicators should be considered and disclosed, aswell as other guidance to promote consistency and to reduce unintendedconsequences (e.g. reporting entities including inappropriate cash flows in theircalculation resulting in a delayed recognition of impairment).Question 11— Simplification of impairment testStakeholders’ views

71.Stakeholders generally agreed with the IASB’s preliminary view not to simplify theimpairment test further, as it would be challenging to do so without sacrificing itsquality.HKICPA analysis and recommendation

72.The HKICPA acknowledges that the impairment test may not be simplified furtherin general without challenges. However, we would recommend that the IASBconsider adding guidance on identifying CGUs and on allocating goodwill to CGUs.This is an issue that is frequently encountered in practice, and as noted inparagraph 37 of this comment letter, we consider that management shieldingoperations within overly large CGUs is a relevant issue of the existing requirements.Question 12—Recognising acquired intangible assets separately from goodwillStakeholders’ views

73.Stakeholders generally supported the IASB’s preliminary view not to change thecurrent recognition criteria for intangible assets because it is complex and difficultto distinguish certain intangible assets (e.g. customer lists) from goodwill. Somestakeholders also noted that certain intangible assets are often nebulous to valueand can be difficult to distinguish from the rest of the company. Commingling somePage 16 of 16identifiable intangibles with goodwill could result in a loss of useful information.Furthermore, broadening the scope of what is allowed into goodwill would onlymake the goodwill impairment process more challenging and exacerbate the ‘toolittle, too late’ issue.HKICPA analysis and recommendation

74.The HKICPA is supportive of the IASB’s preliminary view to retain the currentrecognition requirements in IFRS 3 and IAS 38, and not develop a proposal to allowcertain intangible assets to be included in goodwill. This is the case regardless ofwhether goodwill is amortised.Question 13—Convergence with US GAAPStakeholders’ views

75.A stakeholder noted the importance of convergence with US GAAP especially fordual-listed companies with listings in Hong Kong and in the US. The stakeholdernoted that a divergence in goodwill accounting between IFRS and US GAAP couldresult in materially different balance sheets for the same company listed on differentstock exchanges.HKICPA analysis and recommendation

76.The HKICPA believes that convergence is good but it should not come at theexpense of IFRS stakeholders. We would recommend that the IASB monitor theUS Financial Accounting Standards Board’s progress on their equivalent projectand provide its constituents with the reasons and an effects analysis of any potentialGAAP differences if there were to be a divergence in views.~ End ~