Many people have strong views about whether the International Accounting Standards Board (Board) should reintroduce amortisation of goodwill. But I can’t get excited about that as a topic for standard setting now, for two reasons:
- I think the arguments for amortisation (with impairment) and the arguments for impairment-only are quite finely balanced. I’m not sure which one I would go for if we had a blank sheet of paper and didn’t have to worry about whether to change from the status quo. But we don’t have a blank sheet of paper, we have a standard that has been place since 2008. Any change in treatment now would cause cost and disruption.
- As far as I know, no significant new information or arguments have become available since the Board adopted the impairment-only approach in 2008. Nor do I see any sign that many people are changing their views on this controversial topic or that any lasting consensus could emerge. Without new information or arguments and with no lasting new consensus, the only driver of a change in approach might be a change in the mix of views around the Board table because of a change in Board membership. And with no lasting consensus, there is a high risk that many people will find they don’t like any new treatment and will then put pressure on the Board to change yet again in a few years.
I won’t discuss here the arguments for and against amortisation. The Board’s discussion paper Business Combinations—Disclosures, Goodwill and Impairment (2020) set out the arguments well. Instead, I discuss below:
- a lesson from history
- what is goodwill?
- is goodwill just a consolidation adjustment?
- is acquired goodwill distinct from internally generated goodwill?
- what about immediate write-off?
- my conclusions
A lesson from history
In the mid 1990s, 3 different treatments for goodwill were in common use:
- In some countries, goodwill was amortised over a short period of about to 5 or 10 years.
- In some countries, goodwill was amortised over a long period of up to 40 years.
- In some countries, goodwill was written off directly against equity immediately on acquisition.
At the time, people in each of those 3 categories argued vociferously that they were at a competitive disadvantage against both of the other groups.
I conclude from those discussions that:
- all possible treatments of goodwill have disadvantages.
- everyone seems to be most aware of the disadvantages of whatever treatment they are currently using—and largely blind to the disadvantages of all other treatments.
- if the accounting for goodwill changes from treatment A to treatment B, many people who previously hated treatment A may suddenly find that they hate treatment B as much as they previously hated treatment A.
So it could be very dangerous for a standard setter to change treatment without being very sure that proponents of the change will, in fact, like the change as much as they expect today.
What is goodwill?
People often describe goodwill as a residual. That is not quite right. When an entity acquires a business, it doesn’t just acquire the assets (and take on the liabilities) that it will recognise immediately after the acquisition, it also acquires a collection of other rights. This collection of rights isn’t itself a residual, even though we do measure it as a residual and even though there are some unavoidable imperfections in how we measure it.
Paragraphs BC313-BC317 of the Basis for Conclusions on IFRS 3 Business Combinations list 6 components of the item recognised and labelled as goodwill, including some components that give rise to measurement imperfections. Many of those things might be assets that the entity acquired but does not recognise separately (component 2 listed in paragraph BC313). Also, synergies might exist between recognised and/or unrecognised assets and the separate measurement of those assets might not capture the effect of those synergies (components 3 and 4 listed in paragraph BC313).
IFRS 3 defines goodwill as ‘an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognised’. That definition is on the right lines but it is not quite accurate, perhaps because the definition predates the revised Conceptual Framework for Financial Reporting (issued in 2018). The asset does not ‘represent the future economic benefits’; it is a right (or set of rights) and that right (or set of rights) has the potential to produce economic benefits.
The Board and the US Financial Accounting Standards Board (FASB) concluded in 2004 that the collection of rights labelled as goodwill (and measured as a residual) is an asset. Paragraphs BC318-BC323 of the Basis for Conclusions on IFRS 3 explain why the Boards reached that conclusion.
Although I know not everyone agrees with that conclusion, I do agree that that this collection of rights is clearly an asset (or, most likely, several assets). When an entity has a functioning business, it has some rights beyond the (other) assets that it recognises separately as assets. The owner of the business controls those rights. Those rights have the potential to produce economic benefits.
We attach the label ‘goodwill’ to those rights. ‘Goodwill’ may not be a particularly good name for the collection of rights it labels. The name probably makes many people think mainly of some sort of warm and pleasant feeling in, above all, the minds of customers, though perhaps also in the minds of others, such as employees, suppliers, regulators and maybe even the general public. The name probably doesn’t fit very well for some other components of goodwill, such as rights to benefit from processes or from synergies. Perhaps finding a label more informative than ‘goodwill’ might smooth progress on the controversial topic of how to account for this item.
Is goodwill just a consolidation adjustment?
Some people view goodwill as just a consolidation adjustment creating a bridge between (1) the cost of investment shown in an acquirer’s individual financial statements and (2) the assets and liabilities recognised separately in the acquirer’s consolidated financial statements.
I don’t accept that view. Although goodwill arises most commonly in consolidated financial statements, that isn’t the only place where it can arise. When an entity acquires an unincorporated business, the acquirer recognises the goodwill in its unconsolidated financial statements. The 2 situations are virtually identical:
- When an unincorporated business is acquired, the (collection of assets labelled) goodwill is an asset of the acquirer and sits in the acquirer. The acquirer recognises that goodwill in its own unconsolidated financial statements (and also in its consolidated financial statements, if it prepares them).
- When an incorporated entity containing a business is acquired, the (collection of assets labelled) goodwill is an asset of the acquired entity and sits in the acquired entity. Thus, the acquirer recognises that goodwill in its consolidated financial statements only.
Acquisitions of unincorporated businesses are not particularly common, but do occur. I saw one in practice many years ago when an audit client of mine, an engineering consultancy, acquired an unincorporated one-man engineering business. Thinking about what happens in the special case of an unincorporated business helps show what is going on when an incorporated entity is acquired.
Is acquired goodwill distinct from internally generated goodwill?
A common argument is the following: goodwill acquired in a business combination has a limited life. After the acquisition, the total value of goodwill may not have declined (and may well have gone up, if the acquisition was a success). Nevertheless, the acquired goodwill is being consumed over time and is being progressively replaced by new goodwill generated internally. Therefore, the acquired goodwill should be amortised as it is being consumed. Because we don’t recognise internally generated goodwill, the acquirer should not recognise the new goodwill that replaces the acquired goodwill. If the acquirer does not amortise the acquired goodwill, the acquirer is implicitly recognising internally generated goodwill, replacing the acquired goodwill already consumed.
That argument is entirely logical—if you accept the premiss that acquired goodwill is distinct from internally generated goodwill. Until a few years ago, I used to accept that premiss, and hence the whole of the argument in the preceding paragraph. Moreover, I always used to think that argument was the strongest argument for amortisation. However, I no longer accept the premiss. In consequence, I no longer view the argument as valid.
I now think that acquired goodwill is not distinguishable from internally generated goodwill in the same business—certainly not in practice, and perhaps not even in principle. If acquired goodwill were economically distinct from goodwill subsequently generated internally in the same business, it would be possible at any date after the acquisition to separate the rights labelled as ‘goodwill’ cleanly into 3 buckets:
- rights acquired in the business combination;
- enhancements to those acquired rights; and
- entirely new rights created or acquired after the business combination.
However, it is not possible to make a clean separation of that kind. If any rights acquired were sufficiently distinct to permit such a clean separation, they should probably have been recognised in the business combination separately as identifiable assets. Taken as a whole, the set of rights labelled as ‘goodwill’ is not frozen separately at the date of acquisition. It continues to exist and develop organically over time. The distinction between acquired goodwill and internally generated goodwill is purely an accounting construct and does not depict any distinction that exists in the real world.
What we recognise is just goodwill, it is not ‘acquired goodwill’. If goodwill was entirely generated internally, it is not recognised as an asset. If goodwill is acquired in a business combination, it is recognised at that time and measured then as a residual. Subsequently:
- goodwill is measured at that initial residual amount, less impairment losses (if any). That amount is goodwill, it is not ‘acquired goodwill’.
- subsequent expenditure on maintaining or enhancing that goodwill is recognised as an expense.
Although I no longer view acquired goodwill as distinguishable from internally generated goodwill, I don’t see my current view as an argument for aligning the treatment of ‘acquired goodwill’ and ‘internally generated goodwill’. Alignment could be achieved only:
- by recognising ‘internally generated goodwill’—that treatment would, in effect, place a value on the entity, something which would go beyond the objective of financial statements.
- or by immediate write-off of ‘acquired goodwill’—I discuss below why I do not support that approach.
What about immediate write-off?
As I mentioned above, some countries used to permit or require goodwill to be written off directly against equity immediately on acquisition. A few people have suggested that the Board should require immediate write-off. They argue that this is the only way to make the treatment of acquired goodwill comparable with the treatment of internally generated goodwill.
To my mind, immediate write-off lacks all credibility, for the following reasons:
- when an entity buys a business, it typically acquires more than just the separately recognised assets and so must pay more than the fair value of those separately recognised assets. In general, the entity’s management thinks the acquisition price it has negotiated is no more than the fair value of the acquired business as a whole. Recognising a loss at the time of the acquisition is inconsistent with management’s view of the value of the business it has acquired, and is inconsistent with accounting for the acquisition of other assets.
- preparers would undoubtedly portray any loss recognised at the time of acquisition as not depicting the substance of the transaction.
- it seems unlikely that users of financial statements would typically view any loss recognised at the time of acquisition as a real economic loss. (In some circumstances, users may suspect that management has misjudged and overpaid, incurring some economic loss at the time of the acquisition. Nevertheless, their estimate of the amount of the overpayment is likely to be more or less than any loss recognised in the financial statements).
- immediate write-off would reduce pressure on management to show continuing accountability for the full price paid. No impairment loss would be recognised unless the value in use of the cash generating unit(s) fell below the carrying amount of the separately recognised assets.
- even immediate write-off would not create full comparability between acquired goodwill and internally generated goodwill. Entities incur expenses in generating goodwill internally and maintaining it and they recognise those expenses in profit or loss. In contrast, immediate write-off would lead to the cost of goodwill being recognised, but presented in some manner showing that preparers don’t view it as a ‘real’ expense.
Goodwill is an asset—a collection of rights—and not just a consolidation adjustment. It is not a residual, though we measure it as a residual and there are unavoidable imperfections in measuring it. ‘Goodwill’ may not be a good name for the collection of rights it labels. ‘Acquired goodwill’ is not economically distinct from goodwill subsequently generated internally in the same business. Immediate write-off of goodwill would lack all credibility.
I can’t get excited about goodwill because I don’t think there is a good case for standard setting today. There are no new arguments and information. There is no sign that any lasting consensus could emerge. Changing the treatment of goodwill would cause disruption and cost, and there is no sign that any change in approach would lead to demonstrably better information for users of financial statements. Determining what new approach to adopt would use resources (of the Board and stakeholders) that could be used more beneficially on other standard setting topics.
Any change now from the existing approach would probably reflect a change in the mix of views on the Board, rather than being driven by new information or arguments. And so any change now would risk setting off new rounds of standard setting next time the mix of views on the Board changes, or once stakeholders implement any new approach and realise that it also has drawbacks.