IASB mulls overhaul of goodwill accounting

The International Accounting Standards Board is considering changes in how to account for goodwill under International Financial Reporting Standards, perhaps reintroducing goodwill amortization.

IASB chairman Hans Hoogervorst discussed the board’s plans during a speech Wednesday in Tokyo at an event hosted by the Accounting Standards Board of Japan. He noted that when the IASB adopted the IFRS 3 Business Combinations standard in 2004, it abolished the amortization of goodwill, relying instead on an impairment-only approach. But the IASB now intends to include a question about the possible reintroduction of goodwill amortization in an upcoming discussion paper to get stakeholders’ views on the topic, although Hoogervorst warned that reintroduction is far from a foregone conclusion. He also spoke about the adoption of IFRS standards in Japan and other countries, saying he expects half the Tokyo market cap soon to be “IFRS-denominated.” But he acknowledged that many companies in Japan continue to use Japanese GAAP, where goodwill is still amortized.

“In Japanese GAAP, amortization of goodwill still exists,” said Hoogervorst. “Many Japanese stakeholders like the conservatism of goodwill amortization and it is one of the two IFRS modifications in Japanese Modified International Standards.”

IASB chairman Hans Hoogervorst speaking at an IFRS Foundation conference in Frankfurt, Germany
IASB chairman Hans Hoogervorst speaking at an IFRS Foundation conference in Frankfurt, Germany

The IASB has been reassessing its standards by doing post-implementation reviews, as the Financial Accounting Foundation does in the U.S. for standards from the Financial Accounting Standards Board that have been in place for a number of years to see if they have been achieving their intended purpose.

“As you know, the IASB has been discussing the issue of goodwill following the post-implementation review of IFRS 3,” said Hoogervorst. “Initially, the board did not intend to revisit the idea of re-introducing amortization of goodwill. We felt there was insufficient new evidence to merit investigating such an idea. However, the board decided in its July meeting to include a comprehensive analysis of the accounting for goodwill in our upcoming discussion paper, including a discussion of the possibility of re-introducing amortization.”

The IASB changed its mind because the post-implementation review identified a couple of problems with the impairment-only approach to goodwill, Hoogervorst acknowledged. “Some of these shortcomings were already known: the annual impairment test is both costly and subjective,” he added. “Often, the projections of future cash flows from cash-generating units tend to be on the rosy side. Impairment losses therefore tend to be identified too late, and when an impairment loss is finally booked, the resulting information has only weak confirmatory value for investors.”

The IASB’s staff did research to look for possible ways to make the impairment test more effective, showing how goodwill tends to be shielded by what staff members referred to as “headroom” of internally generated goodwill stemming from acquisitions.

“Our staff referred to this pre-acquisition—and therefore unrecognized—goodwill as ‘headroom,’” said Hoogervorst. “In practice, a company must burn through all of this headroom before the acquired goodwill becomes visibly impaired. Since the headroom can be quite substantial, our staff research made it clearer than ever before that it is almost inevitable that the results of the impairment test will be ‘too little, too late.’ Given that IFRS 3 relies completely on the impairment test to ensure that goodwill really exists, this is a far from satisfactory situation. The risk is that goodwill just keeps on accumulating over time even when the economics do not justify this. In such cases, the balance sheet may give an overly optimistic representation of a company’s financial health. Although sophisticated investors should be able to see through inflated goodwill numbers, others may not. For example, I was recently surprised to see how crude ‘book-to-value’ indicators seem to be commonly used in automated factor investing without making any adjustments for goodwill.”

That’s why he wants to go back to the IASB’s constituents and ask them how they feel about the issue, and he stressed that the IASB has not yet decided what to do.

“These are all good reasons for us to bring the question of re-introduction of amortization of goodwill back to our stakeholders in the form of a discussion paper,” said Hoogervorst. “Before Japan puts out the flags, however, let me warn you that it is far from a foregone conclusion that this discussion paper will lead to a re-introduction of amortization. After all, there were many good reasons why our predecessors on the board decided to get rid of it in 2004. The information value of amortization is very low as it is impossible to determine objectively the timeline over which amortization should occur. Goodwill is an asset with indefinite life and in some cases its value might not decrease over time. We also know that many investors will ignore amortization and will immediately add it back in their projections. Given our efforts to push back on non-GAAP measurements, this would not be a great development. Finally, any major accounting change needs to pass a clear cost-benefit analysis. It is not immediately clear that re-introduction of amortization would clear that hurdle.”

Hoogervorst also wants to raise awareness of the issue. “Whatever the outcome of this exercise will be, the discussion paper should serve to make our stakeholders better aware of the shortcomings of the impairment-only approach,” he said. “It may be that there is no better alternative, but in that case we should accept the current shortcomings of IFRS 3 with our eyes wide open. Should the discussion paper lead to better awareness of the possible pitfalls of current accounting for goodwill, this would in itself be a positive development.”

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