It’s the hope that kills you. That’s a phrase that English football fans have become increasingly familiar with over the years. It’s a phrase that both the fictional American coach Ted Lasso (eponymous star of the Apple TV show) and the very real American Mrs Deller hate.
Many of us have previously known what it is to have our hopes raised, that maybe this year will be our year, only for things to end in glorious (or not so glorious) failure. It would be easier to not get our hopes up and save ourselves the pain.
It may not feel as important, but many of us working in financial reporting can know what that is, particularly with the ongoing business combinations project. This was the subject of my first article for this magazine, over seven years ago (which also began with a reference about English football).
The exposure draft still aims to improve the reporting on goodwill, but the ambitions have been scaled back
Back in those heady days of optimism, the research project was ambitiously called ‘Goodwill and impairment’. Through its many iterations, the aims of trying to solve the potential problem of goodwill impairment being ‘too little, too late’ have proved to be complex at every turn. Attempts to provide improved calculations to negate a shielding effect have been sidelined and the amortisation calculation shelved.
Despite what it sounds like, the project itself has not been shelved. Far from it, it has moved to the exposure draft (ED) stage and is now open for comments (until 15 July). The ED still aims to improve the reporting on goodwill, but it’s reasonable to think that the ambitions have been scaled back somewhat. The project is now called ‘Business Combinations – Disclosures, Goodwill and Impairment’, which certainly gives hints about the direction in which it is heading.
Thresholds
The first part of the ED proposed amendments to IFRS 3, Business Combinations, intended to improve information that is disclosed about acquisitions. The primary focus of these disclosures is to give more information on the performance of strategic acquisitions.
There are a few judgmental items over such disclosures. The first is what constitutes a strategic acquisition. A qualitative threshold would be where an acquisition results in a new major line of business or geographical location, like the language used in IFRS 5, Non-current Assets Held for Sale and Discontinued Operations, when establishing if an item qualifies as a discontinued operation.
A quantitative threshold is where any of the revenue, operating profit or assets exceed 10% of the acquiree’s corresponding amounts, consistent with IFRS 8, Operating Segments.
Placing the onus on the company to select what is disclosed of course introduces the risk of bias or omission
For new strategic acquisitions, information about acquisition-date key objectives and targets should be disclosed with subsequent disclosure about the extent to which these are being met.
Management information
This information bring us to the second area of judgment, which is what information should be disclosed. Rather than giving specific items to be disclosed, the proposed disclosures would be based on the information management used to review the strategic acquisition.
The International Accounting Standards Board (IASB) believes that no one set of information would be useful across all entities, so they would disclose the information that is reviewed by key management personnel.
While this lack of prescriptive information does make sense, placing the onus on the company to select what is disclosed of course introduces the risk of bias or omission. This risk is further heightened by a proposed exemption in the plans, which will mean that companies will be exempt from disclosing information that may prejudice some of these targets.
As companies may already be reluctant to disclose this type of information, the presence of the exemption opens up a wider possibility that this is used to provide limited or boilerplate information. The IASB proposes to provide further guidance on how the exemption should be applied.
Impairment test
Key to the risk of goodwill being impaired ‘too little, too late’ is the nature of the impairment calculation itself and the potential management over-optimism. Drawn from IAS 36, Impairment of Assets, the impairment calculation compares the carrying amount of the asset with its recoverable amount, being the higher of fair value less costs to sell and value in use. As goodwill doesn’t generate cash on its own, it is tested together with a group of assets called a cash-generating unit (CGU).
The problem of ‘too little, too late’ is unlikely to be remedied
One change is that entities will be required to disclose which of the reportable segments the CGU containing goodwill is included in. Users could at least then see the performance of that reportable segment when assessing the reasonableness of management’s assumptions.
Value in use
The final major proposed change is to the value-in-use calculation. This should be based on the cashflow projections (generally not exceeding five years) on the most recent budgets/forecasts provided by management.
This is similar to existing requirements but the need to exclude cashflows from uncommitted future restructuring or enhancement has been removed. This is aimed at bringing the calculation more in line with the information actually used by management.
Overall, the project does seem to be rolling towards requiring some additional disclosures, with the decision of what to disclose potentially lying with the entity itself. Including this could definitely be of some benefit to users, but sadly the problem of ‘too little, too late’ is unlikely to be remedied by these. Sometimes it really is the hope that kills you.
Watch and learn
Watch Adam Deller’s series of videos explaining the fundamentals of IFRS Standards
