Comment:
Investors weigh in on the goodwill amortization debate.
In the fall of 2019, the IASB and FASB began projects re-examining goodwill accounting, and specifically, the measurement of goodwill post-acquisition. Central to the considerations of such projects was the potential reintroduction of goodwill amortization after a 20-year hiatus. At the time, the IVSC Business Valuation Board decided to publish a three-part article series to explore certain fundamental questions in this area, aiming to inform financial statement preparers, reviewers, and users, and aid the capital market.
Kevin Prall is Technical Director to the IVSC’s Business Valuation Board.
More than two years later the debate continues. However, we now have our best view yet from the investor community on what they want, don’t want, and demand from the accounting standards setters in this area. The CFA Institute recently released the results from its investor survey. With 1,607 respondents collected from a random sample of CFA Charterholders, the feedback is clear.
CFA Survey Results:
Investors don’t want a reversion to amortization, they do want improved disclosures, and they demand a unified global approach.
Most investors surveyed believe goodwill is an asset that can have wasting and non-wasting elements, and that it doesn’t necessarily decrease in value over time (i.e., amortization). While investors recognise that the timeliness of goodwill impairments could be improved, 73% believe impairment still provides decision-useful information by confirming underperformance, 80% believe it helps hold management accountable, and 77% believe that elimination of impairment would result in a loss of information to investors. Most investors believe amortization does not allow for discernment of good vs. bad managers, distorts financial metrics, and does not provide decision-useful information for investment analysis. Also of note, 73% of investors are willing to bear the cost of impairment testing.
While investors clearly don’t want to revert to amortization, that doesn’t mean they are satisfied with the status quo. Investors want to see improved disclosures in areas such as:
- Valuation models and related estimates and assumptions;
- Quantitative information on acquisition performance over time, relative to original business objectives;
- Key common performance metrics used by management to monitor the acquisition;
- Quantitative and qualitative information on deal performance; and
- More information on how the board assessed the acquisition’s performance over time.
Finally, investors are overwhelming asking for a unified approach for goodwill from policymakers, with 94% believing the IASB and FASB should follow the same approach in the subsequent measurement of goodwill.
”The size of goodwill balances around the globe highlight why the debate about the subsequent measurement of goodwill must go beyond a discussion of accounting theory alone, as divergent solutions by the IASB and FASB will create significant comparability issues for investors. A majority of investors prefer retaining impairment only accounting, while improving disclosures over reverting to amortization. Amortization, even when done with impairment testing, will not improve financial reporting as it mutes impairment testing while increasing costs and simultaneously decreasing the decision-usefulness of financial statements. The IASB’s disclosure approach will allow investors to better evaluate acquisitions, and facilitate the market assessment of impairment testing, thereby improving financial reporting.
Sandra J. Peters, CFASenior Head, Global Financial Reporting Advocacy, CFA Institute
A Reflection on IVSC’s Perspective Papers:
Consistent with the CFA Institutes survey of investors, we agree that goodwill doesn’t necessarily decrease in value over time. In our first paper in the Perspectives Series, we explored whether goodwill is economically a wasting asset. We approached this question by first examining the components of goodwill to better assess their separate characteristics and patterns of value decline, or lack thereof. Second, we analysed the assumptions underlying deal models and the implicit assumptions regarding goodwill. Respectively, we found that 1) substantially all the components of goodwill do not decline in value in a consistent and predictable manner and 2) amortization of goodwill is not consistent with the economics of deal models and transaction pricing.
We also empathise with the CFA survey results that the timeliness of goodwill impairments could be improved. In the second paper we analysed the accounting framework to better understand why goodwill impairments in certain situations fail to be a leading indicator. However, our analysis also supported the survey results on how the impairment framework does provide decision-useful information, does hold management more accountable, and a move to amortize goodwill would severely reduce the information value of the goodwill impairment process and exacerbate the shortcomings of the test.
In our third and final article, we explored various options for enhancing the current framework and see significant overlap with respondents on specific ideas for improved disclosures on value creation. We agree that the initial recognition and valuation of goodwill and intangible assets disclosures should be enhanced, and impairment triggers should be more directly tied to those same KPIs, criteria, and disclosures made at the acquisition regarding the expected performance of the acquisition. The current acquisition accounting requirements generate an abundance of decision-useful information, yet public disclosures related to transactions are but a small fraction of that relied on by the preparers and reviewers of the financial statements.
”Enhanced KPIs and disclosures at acquisition would help set the guidelines for future impairment testing. The criteria for acquisition success, and alternatively impairment, should be defined and articulated to investors at the time of acquisition to the greatest extent possible. By defining the criteria for success and failure at the time of the acquisition, it will foster an impairment process that is more objective and transparent. As a result, impairment testing would require less judgment, and thus reduce the potential
IVSC Perspectives Paper: Enhancing the Goodwill Impairment Framework
moral hazard.
The Changing Landscape:
While the recent CFA survey results provide affirmation for many of the insights from the goodwill article series, much has changed over the last two years.
First, the markets and the accounting standard setters have recognised the ever-increasing importance of intangible value. Rising market values and increasing multiplies paid for acquisitions have been pervasive across industries, but those industries that rely most on intangible assets have seen the largest increases. The fervor has been no greater than in the SPAC market. Robust impairment testing will be critical to monitor if the assumptions underlying the lofty prices paid are realised in the future. The market trend has coincided with both the IASB and FASB seriously exploring options to better recognise the role of internally-generated intangible assets in enterprise value creation. The CFA Institute survey results are clearly consistent with such efforts.
The other mega trend is the continued emergence of ESG as a central C-suite issue focused on value creation, long term value, and financial resiliency/sustainability. While goodwill accounting and ESG may not initially seem to overlap, 80% of survey respondents believe the current impairment framework helps hold management accountable (i.e., governance).
The role of the current goodwill framework in promoting good governance is one of the few accounting standards that extends well beyond the accounting function. A recent survey by Ernst & Young LLP of 51 corporate and regional CFOs provides more insights on how CFOs strategically leverage this analysis across the organization. The survey found that most companies would perform the annual valuations even if the accounting requirement was removed. In addition, 75% of CFOs said they rely on the valuations to inform strategic decision-making and 63% use them to assess the health of individual business lines. As sustainability standards move forward at the International Sustainability Standards Board (ISSB) and elsewhere, everyone is trying to comprehend what value relevant ESG standards look like. When it comes to the G in ESG, the goodwill framework seems to be a pretty good example of promoting governance across accounting, finance, corporate development and the c-suite.