Australia is considering using the US approach to accounting for goodwill.
Accounting Standards Board is road testing this approach and Keith Alfredson and Adrian Murray* explain how it will work.
Statement of Financial Accounting Standards (FAS) 141 "Business Combinations" and FAS(142 "Goodwill and Other Intangible Assets" issued in July have radically changed accounting requirements for goodwill in the US. Goodwill is no longer amortised, but is tested at least annually for impairment. As a means of seeking input into its deliberations on the merit of the US impairment approach, the Australian Accounting Standards Board (AASB) has invited Australian entities to participate in field testing the US approach through the assistance of the AICD, Group of 100 and the Business Council of Australia. A US impairment model? There are several major differences between the accounting frameworks operating in the US and Australia which may have implications if the US impairment model were to be adopted in Australia. These differences include possible upward revaluations (prohibited in the US), greater recognition of internally generated intangibles and differences in the impairment testing of assets including amortised and non-amortised intangible assets.
Field testing of the US rules in an Australian context will provide insight into the implications of these differences and the cost and practicability of the US approach. The broader issue of international harmonisation also needs to be considered by the AASB in deciding whether to adopt these rules. In July this year the AASB issued ED 102 "International Convergence and Harmonisation Policy" proposing that the Board should ultimately accept the views of the International Accounting Standards Board (IASB), where such acceptance would lead to international convergence on an issue. While IASB rules presently require goodwill to be amortised, the IASB has commenced a project on Business Combinations which may lead to these rules being changed. The input of Australian entities field testing the US goodwill impairment model will provide valuable feedback for the AASB and IASB which may influence the final outcome. Hopefully, international convergence on this issue will emerge in due course.
Setting up for the model
1. Reclassify, where necessary, all goodwill and other intangible assets recognised from past business combinations accounted for using the purchase method, to conform with the new recognition criteria in FAS 141. The recognition criteria require an intangible asset to be recognised separately from goodwill only if it is separable or arises from contractual or other legal rights. Under these rules, entities are required to reclassify existing goodwill as separately recognised intangibles if those assets meet the legal/separable criteria. Separately recognised intangibles that do not meet the criteria are required to be reclassified to goodwill. FAS 141 provides an illustrative list of intangible assets that satisfy the recognition criteria, which includes trade names, customer lists, customer contracts and related customer relationships, non-contractual customer relationships and order and production backlog.
2. Establish "reporting units" (the level at which goodwill is tested for impairment). FAS 142 states that a reporting unit is an operating segment or, in certain circumstances, one level below an operating segment. A reporting unit will be a component of an enterprise that engages in business activities from which it may earn revenues and incur expenses, for which discrete financial information is available and whose operating results are regularly reviewed by higher level management.
3. Assign all assets (including goodwill) and liabilities to reporting units. Assets and liabilities are assigned to a reporting unit if they relate to the operations of the unit and would be considered in determining the fair value of that unit. Assets and liabilities relating to multiple reporting units (for example, corporate assets) are assigned using a reasonable method, for example on a pro-rata allocation basis. Goodwill is assigned to reporting units that are expected to benefit from the synergies of the business combination that gave rise to the goodwill, using a reasonable method.
Timing of tests
4. Goodwill is tested for impairment annually and when events or circumstances occur that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Annual tests are conducted at the same time every year for each reporting unit. Impairment tests conducted between annual tests do not remove the requirement for annual tests. Impairment testing, if required on other assets (including identifiable intangibles), is conducted before testing goodwill for impairment.
5. Determine the fair value of each reporting unit. Fair value is basically the market value of the reporting unit, and its determination will generally require some degree of professional judgment. [FAS 142.F1 defines fair value as "the amount at which an asset (or liability) could be bought (or incurred) or sold (or settled) in a current transaction between willing parties, that is, other than in a forced or liquidation sale".] Fair value determinations are allowed to be carried forward if the most recent valuation exceeded the carrying amount of the unit by a substantial margin, the assets and liabilities of the unit have not changed significantly and the likelihood that a current fair value determination would be less than the carrying value of the unit is remote.
6. Compare the fair value of the reporting unit against its carrying amount. If the fair value of the reporting unit exceeds its carrying amount, goodwill is assumed not to be impaired. It is only if the fair value is below the carrying amount that the extent of impairment (if any) is required to be measured, in accordance with the rules below.
7. Determine the fair value of all assets (excluding goodwill) and liabilities of the reporting unit, including any unrecognised internally generated intangible assets that would be recognised under acquisition accounting if the reporting unit were acquired at the date of the estimation. Determining fair value may present both a costly and complicated implementation issue. These measurements are only required for the purposes of goodwill impairment testing – entities are not permitted under FAS 142 to recognise or change the carrying value of any assets or liabilities as part of this process.
8. Derive the implied fair value of goodwill by subtracting the fair value of assets and liabilities determined under (7) from the fair value of the reporting unit determined under (5). This calculation will include the value of internally generated goodwill, which acts as a "buffer" against any impairment write-down.
9. Compare the carrying value of goodwill against its implied fair value. An impairment loss is recognised as an operating expense to the extent that the carrying amount of goodwill exceeds its implied fair value (except on initial adoption where any transitional write-down is recorded below the line as a change in accounting policy). The carrying value of goodwill is not permitted to be increased, nor can write-downs from previous periods be reversed.
* Keith Alfredson is the chairman, and Adrian Murray is a graduate intern at the Australian Accounting Standards Board. This article contains their views and does not necessarily represent the views of the AASB. The authors wish to acknowledge the help given by the staff of the AASB in preparation of this article, especially Robert Keys, senior project manager and Angus Thomson, technical director. Alfredson and Murray can be contacted on (03) 9617(7600 or at email@example.com
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