December saw the release of a significant proposal from the International Accounting Standards Board on accounting for mergers and acquisitions that will forever change the way the numbers look in annual reports.
These issues are being addressed as a part of phase one of the project on business combinations. That project has three exposure drafts that n
Everyone ready for the goodwill game?
December saw the release of a significant proposal from the International Accounting Standards Board on accounting for mergers and acquisitions that will forever change the way the numbers look in annual reports. These issues are being addressed as a part of phase one of the project on business combinations. That project has three exposure drafts that need to be considered by Australian companies and their boards of directors. The first of the three exposure drafts is one on business combinations. A core part of this element of the proposals presently open for public comment is the elimination of a contentious method for ac counting for mergers and acquisitions known as pooling of interests. This method of accounting is the financial reporting equivalent of Tarzan' s Grip: entities that have used it in the past stuck two sets of balance sheets together without any recognition of any value that might have increased or decreased as a result of the corporate elopement. The IASB explains in its basis for conclusions-a part of the exposure draft explaining the underlying logic behind a proposed accounting standard-that one of th e effects of pooling accounting is it results in a board of directors not being held accountable for the total amount invested on behalf of shareholders.
"The IASB' s [conceptual framework] notes that one of the objectives of financial statements is to show the accountability of management for the resources entrusted to it. The IASB observed that the pooling of interests method is an exception to the general principle that exchange transactions are accounted for at the fair values of the items exchanged," the basis for conclusions states.
" Because it ignores the values exchanged in the business combination, the information provided by applying the pooling of interests method fails to hold management accountable for the investment made and its subsequent performance."
Australian entities have not been permitted to account for mergers or acquisitions as poolings of interest. Companies in this country have been schooled in using acquisition accounting known as the purchase method. This method is quite unlike pooling in that inherent within it is an acknowledgment that companies might pay a premium that is well above the value of tangible assets to acquire another entity. The logic underlying the purchase method is the premium should be reflected in the financial statements rather than be buried elsewhere. Goodwill arises out of this accounting method and it is the visibility of goodwill that has caused a degree of angst among some in the business community because of the need to amortise it over a period not ex ceeding 20 years using the straight-line method. While this requirement is relatively simple and to some extent user-friendly because of this inherent ease of calculation it is argued in the business combinations exposure draft that whittling the goodwill away over a predetermined period possesses little information value to users. It does not offer any evidence of diminution of the value of assets a company owns or-more importantly-whether the cash generating units (CGU) are capable of bringing inflows into the business. Some commentators state investment analysts strip back goodwill in order to aid them in determining the level of sustainable earnings a business has. Doubts are then raised about the usefulness to these users of straight-line amortisati on over an arbitrary period for at least two reasons, if not more. The first is whether goodwill disappears in equal lumps as an economic reality. It could be argued that it does not always disappear in equal portions and the mere allocation of equal porti ons of the goodwill number as an expense contributes to the production of financial statements that mislead the market place. A second consideration that is just as relevant is whether goodwill dissipates over an arbitrarily selected period such as 20 years?
It might-hypothetically speaking-disappear more quickly because of the business decisions of one entity whereas it might not dissipate at all in the case of another. Members of the IASB acknowledge in the basis for conclusions that it is somewhat difficult to predict the useful life of goodwill and it is in this context amortisation over an arbitrary period is questionable. Those questions will be left behind corporate Australia and a new set of questions will become relevant when the international accounting standards dealing with this issue become law. The requirement for testing goodwill for impairment, which requires m ore work a calculation of a straight-line amortisation charge, means the bottom line is quarantined from goodwill write-downs in circumstances where all components of a business are doing well. Where a business is going through a tougher patch there may be a need to take a goodwill writedown because the overall value of parts of the business referred to above as a CGU. A part of the goodwill that has been bought will be allocated to each CGU and through estimations of future cash flows it may emerge that a unit needs to take a write down because it is not expected to do as well as in previous reporting periods. This goodwill impairment issue is only one of the critical elements Australian companies will face. The exposure draft will introduce the general concept of asset impairment that will require a better examination of the value of what sits in a company's financial statements. More detail will be provided regarding how intangible assets must be accounted for as a result of this proposed suite of accounting standards. Some companies may find internally generated intangible assets disappear from view. Other companies will face the opposite proposition. Things that were previously not considered assets suitable for recognition in a company' s accounts will be required to materialise. Some of the assets will have a short or finite life such as a patent. They will need to be amortised over that finite period of time. Others such as a brand name or television license could be around a tad longer and those assets will be subject to impairment testing unless something occurs that alters the indefinite nature of that asset. There is something boards of directors might need to consider with all of these reforms to merger and acquisition accounting. Amortisation of goodwill was previously seen as a deadweight around the neck of business because of the impact it had on the bottom line. One way accountants coped with this is they tried to recognise as many intangibles as possible in the accounts of a company to reduce the goodwill number that would need to be written off in equal lumps over time. The smaller the number the less havoc it wreaked on the bottom line. Non-amortisation could created another dilemma in the minds of some auditors and company accountants. The removal of amortisation could well lead to a reluctance of some to recognise particular intangibles that might have a short life, which would mean the entity would need to write it off more quickly. Could some companies see it as being to their advantage to hide what might otherwise be an identifiable intangible asset-something that should by rights be visible to users of accounts-in the line item "acquired goodwill" just so they don' t have to write this off? A reversal of past tendencies to recognise anything that could possibly move might take place. This does raise the spectre of non-compliance and a gaming of rules before a final standard is even introduced. Raising the potential for non-compliance and roguish behavior at a time when the standard is bein g developed may be seen by some accounting experts as inappropriate because they are busy trying to sell the IASB product and garner acceptance for the international reporting framework. This is, however, the proper time to test the concepts being thrown on the table for once the standards are introduced there is little that can be done to alter them domestically after they' ve been adopted here. We' ve subcontracted part of our legislative process to a group of people in London and it is our responsibility to ensure we understand what might come and raise concerns on a timely basis.
The purpose of this database is to provide a full-text record of all articles that have appeared in the CDJ since February 1997. It is aimed to assist in the research and reference process. The database has a full-text index and will enable articles to be easily retrieved.It should be noted that information contained in this database is in pre-publication format only - IT IS NOT THE FINAL PRINTED VERSION OF THE CDJ - therefore there might be slight discrepancies between the contents of this database and the printed CDJ.
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