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This paper looks at firms' disclosure of intangible assets in the Australian market after the enactment of the AASB 136 and AASB 138 in 2005. The focus is on 'higher user' firms and how they lost value of their assets between 2007 and 2008. The paper samples a few firms in order to analyze the disclosure of goodwill of distinct classes of intangible assets and their implicit effective life by examining the impairment expense as reflected in the income statement (Nigel 2006, p.1). The paper highlights some key uniformity in the disclosure practices of these firms, and tries to find out the determining factor of impairment of intangible assets as regulated by the new laws in the light of creative accounting.
This research is an analysis of asset losses by Australian firms due to impairment based on the annual reports of some of the ASX100 companies for the years 2007 and 2008 together with recent information on the firms. The concept of Enterprise value is used; the net asset values of the firms have been sourced from their annual reports and from Bloomberg. Enterprise value is defined as the total value of a firm, consisting of equity and debt assets plus its market value. Other important terms are goodwill, the residual cost of acquiring a business consisting of tangible and intangible assets and liabilities together with contingent liabilities. Accountants define asset impairment as a situation where the carrying value of an asset or a cash-generating unit (GNU) is more than its recoverable amount. This research takes into consideration important Australian accounting standards such as the AASB 3, 116, 136, and 138. In the exercise of allocating business costs between assets and liabilities, International Financial Reporting Standards (IFRS) are also taken into consideration.
Asset impairment policy in Australia
The Australian Accounting Standards Board (AASB) requires that whenever there is an indication of impairment that the Council will assess the situation and shall estimate the recoverable value of the assets. (Asset impairment policy 2008, p.1). The objective of the policy is to ensure continuous annual review of asset impairment as required by the Australian Accounting Standard AASB 136. This is in tandem with the legislative requirements of the Local government regulations of 1999. Part 3 of the asset impairment policy in Australia states that,
"Unless otherwise specified by these regulations, a council, council subsidiary or regional subsidiary must ensure that all accounting records, accounts and financial statements are prepared and maintained in accordance with all relevant Australian Accounting Standardsâ€¦.." (Mallala, 2008, p.2).
All non-current assets must be revalued by the Council, its subsidiary or a local subsidiary with regards to the Australian Accounting Standard AASB 116. The accounting standards in Australia require that if an asset is shows signs of impairment at minimum, several indications should be used to assess the situation. First, external sources of information are examined; this includes market conditions, legal, political, economic and technological trends in which the firm operates. Secondly, internal sources of information are used to evaluate the physical damage of the asset (or obsolescence). The important changes that have occurred, are occurring or that might occur in the future are noted. Such changes include the possibility of the asset not being obsolete and the finite usability of the asset rather than its indefinite usefulness. Thirdly, from an internal reporting perspective, other factors also affect the impairment of an asset. These include the actual funding required to operate, maintain or renew the asset may be significantly higher than budgeted. Thus if it occurs that an asset may be impaired, its residual useful life needs to be re-evaluated. This means that the amortization methods need to be reviewed and accordingly adjusted to reflect the applicable Accounting Standards to the asset. This should be done even if no impairment loss is recognized.
Another factor to consider is the 'value in use'. For non-profit making organisations, the future value of an asset is independent of its ability to generate cash flows. In this case, value in use is determined by calculating the 'depreciated replacement cost' of the asset. Depreciated replacement cost is simply the asset's current replacement cost less the accumulated depreciation; this is calculated to mirror the expired future economic value of the asset.
In the annual financial statements of firms, AASB 136 and 138 requires that they must be prepared in accordance with Australian International Financial Reporting Standards (AIFRS), the Australian version of the International Financial Reporting Standards (IFRS). Annually, firms are required to report to the Audit Committee responsible for monitoring asset impairment and those assets that are considered to be impaired are valued in accordance with the in use value method.
Intangible assets in 2007 and 2008 represented major parts of firms across various industries. The figures below show the aggregate value of intangible as at 30 June 2008 was valued at $75 billion, while that of Goodwill stood at $146 billion. The total value of $221 billion represented only 26% of net assets on the balance sheet; this result however is certainly not the representation of the entire market sector. Hence, to avoid obfuscation of results, this research focuses on 'high user' companies and investigates the disclosure practices of sampled Australian largest industrial firms and the decisions made by such companies with regards to impairment charges relative to their intangible asset portfolios.
In order to facilitate the progress of achieving this objective, a selection of industrial firms listed on the Australian Stock Exchange (ASX) that publicly released their annual reports from the years 2007 and 2008 was obtained from the companies' websites and from Bloomberg. The selection was further narrowed by highlighting companies that were: (a) larger part of their assets as intangible assets in 2007 and 2008; and (b) were affected by impairment of these assets as observed on their balance sheets. The samples together with more descriptive information on these companies are displayed using tables and figures.
A visual assessment of the data in figure-2 shows the enormity of the intangible assets held by the sampled Australian firms. These 'high user' firms accounted for about $97.5 billion in intangible assets (Brand finance, 2008, p.3).
The annual reports for 2007 and 2008 of the sample firms were reviewed, with a keen interest to the disclosures practices of the firms regarding intangible assets. To begin with, the disclosures are examined to establish whether they complied with the general requirements of the pertinent accounting standards. This is done to determine the uniformity and consistency of disclosure by the companies since the adoption of the AASB 138 in 2005. Next, goodwill is isolated from the net intangible assets and the impairment charges (if they exist) for 2008 were identified. The research utilizes secondary data from major research websites such as Brand finance, Bloomberg, and the ASX. The figures are obtained from such sites and analyzed using Excel and financial theory in the context of Australia.
Intangible assets of Australian ASX 100 firms
Intangible assets are key contributors to the market capitalization of the ASX 100. The 2008 global financial crisis came along with a surge in demand and a fall in share prices as some firms were blamed of escalating the situation with their poor financial reporting practices. More than $ 146 billion of goodwill was represented on the balance sheet of firms, but most of these assets had been speculated to be written down in 2008. The purpose of this research is to examine the summary and movements of intangible assets by the ASX 100 firms as disclosed by them. This is done to evaluate some of the firms that reduced their asset due to impairment and to examine the difference between enterprise value of intangible assets and their net balance sheet value. The findings are shown below.
Off Balance Sheet Intangible assets
The balance sheet in general is not a good representation of asset portfolio of Australian firms. About 49% of enterprise value as at 30th June 2008 is not reflected by balance sheets. Across the industries, intangible assets represent a larger part of the undisclosed value of the firms. However, the difference between tangible and intangibles varies significantly across the sectors as shown in the table below. At the top is the Media and Entertainment sector where only 12% of the enterprise value comprises of tangible assets while in the property sector, the enterprise value is less than the book value of tangible assets. The AASB recently released an article titled 'Initial Accounting for Internally Generated Intangible Assets'. In this article, AASB documented that all intangible assets should be treated the same, irrespective of whether they are internally generated or are acquired as in a business combination (AASB, 2008, p. 43).
The Australian Stock Exchange witnessed a decline in market capitalization of about 16 % between 2007 and 2008. During this period, less than 1% of intangible assets had been written-off as a result of impairment. This was surprisingly low given the slump in the stock market. An Australian firm, Valad Property Group wrote off the highest value of its reported intangible assets. The impairment charge was 31% of the carrying value of the assets. This was the highest impairment charge in terms of dollars. As the Australian economy continued to limp, experts suggested that significant impairments were imminent in the preceding financial year. Basing on the current share price at that time, a research conducted by Brand finance suggested that goodwill impairments would be about $ 50 billion.
In the opinion of this research, impairment reviews must be continuously conducted on individual companies so as to update the data on companies and to make use of more robust valuation techniques. In such a risky environment, company directors must employ the services of an independent audit firm so as to conduct these impairment reviews. This implies that the current auditing reports put their focus on intangible assets entirely on financial reporting. This should not be the case since in times of economic hardships; companies that tend to leverage their intangible assets effectively enjoy the highest yields in periods of economic recovery (AASB 2008, para.12).
Table-1: Significant Impairments Charges in 2008
The largest impairment charges are summarized in the table below.
of total intangibles
- Goodwill in Americas: $190m.
- Brands in Americas: $79m.
(Both of these are primarily from a decline in sales and cash flow expectations).
- Goodwill in AAP Wine business: $201m.
(Primarily from adverse exchange rates and
pressure on the Australian wine category in the
Hastings brand in the UK: $52m.
- Customer lists: $13m.
- Goodwill in Hastings, Alba and Advantage.
Operations in the UK: $277m.
- Impairment to goodwill in wagering segment
reflecting the changing competitive
environment, uncertainty in the regulatory
regime, and impact of challenges due to equine
- Goodwill impairment due to deteriorating economic conditions in to Fresh Dairy Division in NZ.
Software impairment due to restructuring.
Source: Brand finance, 2008, An evaluation of intangible asset disclosure in Australia
December2008, p. 14-15, viewed September 28, 2010, from: http://www.brandfinance.com/Uploads/pdfs/Australian%20Intangible%20Asset%20Review%20Dec08.pdf
Table-2: Companies with the highest impairment charges, a summary
Valad Property Group
Impairment of Intangible Assets and Goodwill
Financial Reporting Requirements in Australia
The main aim of AASB 136 is to ensure that firms carry assets below their recoverable amount. Thus, intangible assets including goodwill with an indefinite productive life must be reviewed and revalued regularly for impairment purposes. The same applies to amortization for the tangible assets with predetermined productive periods. In addition, whenever there is an indication of impairment, a review should be conducted to determine the possibility of impairment. The AASB 136 has defined various indications of impairment these are through; External sources of information showing that major undesirable changes have occurred, or are expected to occur, in the, market, economic, technological, political or legal environment. Also, significant unfavorable changes occurring with regard to the extent of which an asset is used, or the anticipation of such changes. These particular changes include factors like the asset becoming obsolete, plans to idle the asset, and a reduction in the usefulness period of the asset.
Other factors that might indicate impairment are an expected increase in the discounting rate when estimating the value of an asset, the carrying amount of an asset exceeding its market value and finally when internal auditing reports indicate that forecasted net cash flows from the asset are lower than the forecasted operating costs for that asset.
The aggregate findings of this research indicated that the decline in market capitalization of the ASX between 2007 and 2008 of about 15% was an indication of impairment most intangible assets. Surprisingly, impairment changes during this period only represented 1% of the carrying cost of intangibles assets (including goodwill). This is extremely low with regard to the deterioration in the Australian economy. This low value may be attributed to disclosure by firms especially those whose that have a large part of their assets as intangible assets.
Value at Risk of Future Impairments
The market conditions in the ASX have suffered significant declines since the global financial downtown. Most of these companies are yet to recover fully and it is anticipated that these adverse economic conditions will trigger more reviews so as to determine impairment.
Examples of Intangible Balances at Risk
This article also examines those companies that are vulnerable to impairment due to the current economic crisis. Some of these companies are listed below for illustration purposes; it does not mean that they are the most vulnerable. As stated
"Impairment losses for non-goodwill intangibles may be driven by many factors such as changes in general business conditions, changes in technology, declining market values, changing interest rates, or changes in how a company employs its assets" (Mulford & Comiskey, 2002 p. 223).
Figure-2: Enterprise Value by Sector
Value Characteristics of Intangible Assets
In order to effectively value intangible assets, an understanding of the attributes and function that these assets play in the value chain. The following characteristics are important when valuing intangible assets: intangible assets have no efficient markets; they are in real sense sold or bought as part of a business combination. This means that the market techniques for valuing intangible assets are rarely applicable; the relationship between investment and returns is non-linear. This means that the uses of cost valuation techniques are not very much applicable, save for replicable assets. Non-financial techniques regarding the measure of intangible assets tend to be poor. On the other hand, important valuation insights may be facilitated by obtaining information from sources such as intellectual property audits, marker research reports, and business plans. In addition, intangible assets do not diminish in value through continuous use; they have no rivalry, implying that simultaneous use of these assets is possible. This can lead to speedy growth and increased margins. The value of intangible assets is often affected by the value of other assets; this causes a complex interaction in the value chain. In order to clearly see clearly the relationship between intangible assets and other assets, value maps may be used in exploring these interactions. It may also be necessary to group complimentary intangible assets for purposes of valuation. The valuation report must also contain a precise definition of the type of asset being valued, especially where it has multiple rights. The use of terms such as 'brand' is too general, specific terms should include details such as patents and copyrights, trademarks and trade secrets.
Reversal of an impairment loss
During reporting dates, firms must assess whether there exists any indication of impairment loss for intangible assets (except goodwill) was reversed. An impairment loss realized for goodwill is irreversible. Where an indication of impairment loss is reversible, the tangible asset's reversible amount is assessed. In case an impairment loss is found to have been reversed, its increased carrying amount is always less its carrying amount less depreciation/amortization that would have been realized if no impairment loss had been realized. Watts (2003, p. 210) documented that a more stable balance sheet can be achieved since the valuation techniques for determining goodwill impairment are not in practically verifiable so as to avoid impairment (Watts, 2003, p. 220).
A reversal of an impairment loss is easily detected in the income statement, unless an asset is revalued amount complies with AASB 116 in which the reversal of the impairment is treated as an increased revaluation. After the reversal has occurred, the charge for depreciation or amortization is revised in future periods to apportion the assets adjusted carrying amount, minus its residual value. This is systematically done over the useful lifetime of the asset. With regard to a cash-generating unit, the reversal of an impairment loss is done by allocating the loss (except goodwill) on a pro rata basis. In the allocation of the reversal amount, the carrying amount of an asset must be kept above its recoverable amount. This is the same case for the asset's carrying amount, less depreciation/amortization, that would have been determined if no impairment loss been realized in previous periods.
Results & Discussion
The initial observation made was that, all the firms studied showed a consistent disclosure and reporting on intangible assets. This has been observed as follows;
The firms' annual reports contained clearly outlined accounting policies that define intangible assets and treatment of their impairment as well as their useful life, depreciation rate and methods. This was outlined in the audit notes along with a summary of the AASB policies.
The gross carrying amount of the assets and accumulated pay back at the beginning of the usefulness of the asset and at the end of the period were included for each individual asset class.
The amount of impairment losses recorded in the income statement for each individual asset class was also reported by the companies.
The reversal amounts of impairment losses, disposals, acquisitions and other revisions were also disclosed in the financial reports.
The disclosure of impairment of the sampled firms was consistent with the policies of AASB 136 and AASB 138 and is uniformly applied across the sectors. This is a clear evidence of a high degree of uniformity in financial reporting practices by the firms with regard to their presentation. As shown earlier in figure-2 above, goodwill represented 17 % of total assets in 2008 across the entire market. Goodwill is thus the most dominant intangible asset on the balance sheet. The ratio of goodwill to other intangible assets is 66:34. The dominance of
Goodwill on the balance sheet, this is in tandem with the US and UK (IFRS 3). This is an indication that adoption of IFRS is not achieving the aim of increasing the disclosure of other identifiable intangible assets. This can be attributed to several factors, both procedural and market such as; Overrated prices paid during times of economic optimism adding significant value to business combination values not directly attributable to particular assets; and the failure to allocate purchase price to various identifiable intangible assets, and undervaluing the already identified assets (Carlin, Finch & Ford, 2006, p.203).
Another important factor is related to firms' reluctance to attach value to intangibles that have definite useful lives and have to be amortized. In addition, lack of expertise on intangible assets by valuers leads to inappropriate pricing of these assets. This leads to improper valuation of goodwill despite the requirements of AASB 3's that firms' must disclose the type of the intangibles including goodwill and provide an explanation about their separate valuation. The growth in markets was an advantage for M&A overpayments and errors in the disclosure of intangibles. The economic downturn turned the tide, and the moribund demand demands thorough impairment reviews.
Disclosed intangible asset types
Companies describe intangible assets differently. In order to breakdown the reference
For ease of reference this paper classifies Intangible Assets in accordance with the illustrative examples as outlined in AASB 3, these are: "Marketing-related intangible assets, Customer-related intangible assets, Artistic-related intangible assets, Contract-based intangible assets, and Technology-based intangible assets." (AASB 3, para. BC 158). There seems to be no artistically related intangible asset in these categories. Thus, whenever descriptions are in sufficient, they are classified as 'other' (Godfrey & Koh 2001, p.44).
Arguably, it seems like the impairment choices made by firms are motivated by profitability. Current accounting and financial reporting standards utilize a plethora of assumptions and techniques, as used by managers and auditors in determining as to whether an intangible asset carrying value has been impaired. The key variables used by managers in the carrying out of this task includes the projected future cash flow that will be derived from the asset, the projected future disposal value of the intangible asset, and the assumed discount, growth and inflation rates in the environment of operation (Bismuth, 2006, p.10). The way decisions are made by managers in the exercise of their discretion eventually determines the impairment expenses and residual value of the asset. Whenever managers are in a position to determine values for the intangible assets, expenses, and profits of their companies, this exacerbates the risk that creative or hard line accounting options are used (Dean & Clarke, 2004, p.i-iv).
As indicated in above, intangible assets (excluding goodwill) represented 17% of total assets in 2008 across the entire market. With regard to the intangible value and the 2008 impairment expense, internally generated intangible assets constitute a larger part of the undisclosed value across the industries. Annual reports were not in general good sources of comprehensive information on the type and nature of internally generated intangible assets. In Australia, it is not compulsory for companies to disclose any of these resources. This is in spite of their significance to the current and future prosperity of the firm.
AASB moved to check this problem in 2002 by releasing a discussion paper that was way ahead of the public declarations of the AASB's correlates. In the document it is stated that:
"The manner by which an intangible item comes into existence is not relevant to the determination of whether the item can be identified as an asset. Therefore, intangible items of the same nature, irrespective of whether they are acquired in a business combination or internally generated (planned or unplanned), could be analyzed in the same way to determine whether they are assets." (AASB 2008, ch.2, para.56 ).
A new era in intangible asset disclosure dawned on Australian firms in 2005 when AASB 138 - Intangible Assets and AASB 136 - Impairment were introduced. Together, the two new accounting standards oversee the valuation and disclosure of intangible assets and the handling of their unavoidable impairment.
By examining a sample of intangible assets of firms in Australia listed on the ASX as for the years 2007 and 2008, it is evident that there is great degree of consistency and regularity in the disclosure of intangible assets by these firms. As shown in the research, goodwill represented 17 % of total assets in 2008 across the entire market. Goodwill is thus the most dominant intangible asset on the balance sheet. The ratio of goodwill to other intangible assets is 66:34. Goodwill on the balance sheet, this is in tandem with the US and UK. This is an indication that adoption of IFRS is not achieving the aim of increasing the disclosure of other identifiable intangible assets. This is partly attributable to the size and development of these firms; all of the firms in the sample are placed within the top 100 firms listed on the ASX. Information on these firms is provided in the annual reports which are in turn prepared using modern accounting policies regarding intangible assets and their impairment. The provided valuation of asset values, their acquisitions, impairment, and disposals cuts across significant intangible asset categories. The companies presented their disclosure in a manner designed to meet the expectation of the AASB 136 and 138.
Conceivably the most remarkable feature of the disclosure of intangible asset was the determination of their impairment loss between the years 2007 and 2008. Different analyses are used and summaries are provided using tables and figures as shown above. Closer examinations of the books maintained by these firms indicate that these firms are taking a very conservative or arguably creative approach towards the determination of impairment, with a goodwill impairment of only 1%. in as much as the approach taken by these firms lowers the impairment loss in the short run and boosts profits, what is less clear is the effect on asset book values created as a result of creative accounting. The approach leaves higher book values on the balance sheets. Due to economic uncertainties, changes in common business circumstances such as technological changes, diminishing market values, declining interest rates and a plethora of other intrinsic and extrinsic aspects will imply that the intangible assets with ultimately be impaired resulting in a considerable write-downs of these overrated assets. From the analysis it the sampled firms may be engaging in creative accounting by employing very 'conservative' techniques to impairment determination which is raising both profits and the assets book values in the short run. Perchance this deferment of impairment losses may manifest, and take scores of naive stockholders by storm.