Madelie Olivey CA(SA)
The ED, issued in March 2024, marked a decade-long review process which began in 2014. The IASB is proposing improvements to disclosure requirements for acquisitions and some targeted amendments to the requirements in IAS 36 relating to the calculation of value in use, the allocation of goodwill to cash-generating units and the disclosure requirements.
Enhanced disclosures
The IASB suggests new requirements for disclosing information about acquisitions, emphasising the need for clarity on the performance of strategic acquisitions. Companies would need to disclose management’s objectives and targets at the time of acquisition and subsequently report on the extent to which those targets have been met.
These disclosures are designed to help investors understand whether an acquisition has been successful. The IASB decided to require disclosures about performance for only ‘strategic’ acquisitions after considering whether investors need this information for all acquisitions.
- Qualitative thresholds − the acquisition results in a company entering a new major line of business or geographical location, or
- Quantitative thresholds − any one of revenue, operating profit and assets of the acquired business constitutes at least 10% of the acquirer’s corresponding amounts.
These thresholds build on other requirements, for example how regulators identify particularly important acquisitions.
The proposed disclosures regarding the performance of a strategic acquisition would be based on information management would review regarding the strategic acquisition rather than a list of specified information.
The IASB also proposes other amendments to IFRS 3. For example, IFRS 3 could require reporting entities to disclose quantitative information about expected synergies in the year of acquisition if such information is not commercially sensitive or subjected to litigation risk.
By disclosing this information, a question arises about whether this information is auditable, and if so, whether the cost of producing such information outweighs its perceived benefit.
Measuring synergies would be subjective especially where the acquired company is integrated in the business operations of the acquirer.
Changes to the impairment test
Goodwill, which does not generate cash flows independently, is therefore tested for impairment together with other assets as part of a group of assets called Cash-Generating Unit (CGU).
The IASB’s review revealed that impairment losses on goodwill are often recognised too late and that the impairment test itself is complex and costly.
Despite debates about reintroducing the amortisation of goodwill, in November 2022, the IASB voted to retain the impairment-only approach for goodwill accounting, citing the insufficient evidence that amortisation would significantly improve financial reporting.
The IASB performed a root cause analysis of why impairment loss calculations are not effective, and found that management over-optimism, and almost inevitable, some level of shielding in headroom leads to ineffective impairment loss calculations.
When an entity tests the combined business for impairment, a reduction in the recoverable amount of the combined business is first absorbed by this headroom and an impairment of acquired goodwill can be masked.
The IASB considered whether it could redesign the impairment test in IAS 36 that would be significantly more effective at recognising impairment losses on goodwill on a timely basis and at a reasonable cost.
The board decided that it could not resolve the limitations of the impairment test and set about resolving what appears to be a measurement issue, by proposing enhanced disclosures to those already in IAS 36.
To address the issue of shielding, the IASB proposes to clarify how to allocate goodwill to cash-generating units. The proposed clarification emphasises the importance of maintaining the link between how goodwill is tested for impairment and how an entity is organised for internal reporting purposes, and to avoid an entity allocating goodwill at the operating segment level by default. I believe that whilst the additional guidance is helpful, it is not enough to resolve the issue of shielding.
To respond to concerns about the cost and complexity of the impairment test, the IASB proposes changing the calculation of value in use by removing the restriction on including cash flows from uncommitted future restructuring or asset enhancement, as well as removing the requirement to calculate value in use on a pre-tax basis.
The rules regarding pre-tax and post-tax cash flows are welcome, and understandably, removing these restrictions around cash flows would bring inputs used in the impairment test closer to the information used by management resulting in investors receiving more relevant information.
On the other hand, including information about events that the entity is not committed to, could again create an opportunity for manipulation increasing the level of shielding available within the impairment test.
This seems to be a fine balance that the IASB is negotiating; whether the board is successful in its endeavours is yet to be determined.
Where to go to from here?
The proposal regarding additional disclosures in the notes to the financial statements should make it possible to assess the success of a business combination for a foreseeable period after the acquisition date.
It is yet to be determined what an appropriate time period would be until such information becomes irrelevant. While disclosure should not be a tool to solve what is essentially a measurement issue, a perfect answer for goodwill accounting is not possible today and it will not be possible in the future.
The IASB’s proposal is in many areas unsatisfactory, but a stable compromise of enhanced disclosure is more appropriate than to repeatedly question the fundamental aspects of the IFRS framework.
Ultimately, accounting is a language that does not live from being conceptually perfect, but from being generally accepted and 'understandable' and providing reliable and useful information to stakeholders.
