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BusinessDictionary.com (n.d.) defines asset impairment as "a technique which involves comparing the total profit estimations from a capital asset, usually over a minimum period of 20 years, to the asset's book value; and as a result the difference-gain or loss-is posted". Asset impairment is aimed at describing the measures that an entity takes in ensuring that an asset is carried only at the recoverable amount. According to IAS 36, an asset is carried at a value greater than its recoverable amount if its carrying amount surpasses the amount to be recovered through use or sale of the asset. For the purposes of goodwill, the standard explains that detailed calculations made in a preceding period of the recoverable amount of cash generating unit(s) to which goodwill has been allocated are used in impairment. Within the first two years of their compliance to IFRS (International Financial Reporting Standards), 50 large scale goodwill extensive Australian firms- among them Hyundai disclosed the existence of goodwill in their financial reports and hence decreased the value of their capital assets by way of impairment. The purpose of this paper is to explore the extent of their compliance with the goodwill accounting and reporting disclosure requirements under AASB 136 over the first two years (2007 & 2008) of their IFRS adoption.
Investigating the goodwill reporting practices adopted by a sample of 50 large Australian listed firms, which unveiled the presence of goodwill in each of the first two years (2007 and 2008) in which they produced financial statements in line with IFRS. These firms were a representative or a subset of the Australian listed firm population. This research seeks to employ a comparative technique in which the requirements under AASB 136 and the contents of a firm's impairment testing disclosure are grouped into a dichotomy of comply or non-comply categorization. The technical accuracy and quality of these goodwill disclosures together with an evaluation of support of disparity in these over a given period of time offers an evidentiary basis for investigation.
The past has witnessed significant changes and turmoil in the practice and domain of goodwill accounting. Carlin and Finch, (2008) postulate that goodwill accounting has faced numerous challenges over time; among which includes the use of forceful expense deferral amortization methods; immediate post-acquisition write-offs, development allocations and extreme in-process study; and unnecessary disagreements relating to inappropriate use of pooling of interests approach to acquisition accounting in order to avoid goodwill recognition. In considering the present preferences on the part of standard setters for impairment testing for goodwill, it is valuable to adopt formulations for goodwill reporting based on the IFRS.
Carlin and Finch, (2008) in Ernst & Young, (2001) postulate that a variety of technical articles published in Australia during the approval of the issuance of SFAS 141 & 142 questioned whether the failure of the Australian regulatory regime to immediately move to an impairment-based regime similar to that in existence in the USA might damage the capability of Australian quartered businesses to efficiently compete on price on internationally raced acquisition transactions. In spite of various domestic lobbying efforts, it was perhaps a must given the prominence accorded to international harmonization, that the USA shift to an impairment establishment coupled with the existence of a similar approach to goodwill accounting under the IFRS regime which was being promoted by the IASB, would joggle countries such as Australia which had maintained their own indigenous reporting standards into contemplation of their own course of action. Carlin and Finch, (2008) highlight four major reasons behind Australia's adoption of the new regime (in accounting). These include:
The proliferation of an all encircling relevant accounting standard concerned with intangibles, whether identifiable or not, as dictated in AASB 138 - Intangible Assets Resisting compliance with IFRS 263
The persistence of the compulsory use of purchase accounting to corporate acquisition transactions - as per AASB 3 - Business Combinations.
The prohibition on the identification of internally created goodwill, and in addition, the setback of write-downs on purchased goodwill as postulated in AASB 136.
The neglect of the traditional amortisation and recognition approach to accounting for goodwill and the substitution of this rubric with an impairment regime, as per AASB 136, according to which purchased goodwill may be held at cost indefinitely until impaired, with impairment costs being charged against earnings, pp. 264
Despite the fact that many of these firms were resisting compliance to this new regime, as they felt it would reduce their competitiveness in the global market, these reasons attracted numerous comments from auditors. With now a new and easily understandable accounting architecture, an inspection of the requirements of AASB 136 illustrates a "foundation of massive complexity" (Carlin and Finch, 2008, pp. 264). The existing goodwill should be associated with Cash Generating Units (CGUs). Carlin and Finch, (2008) in AASB 136 define CGUs as "the smallest identifiable group of assets that creates cash inflows that are wholly independent of the cash inflows from other assets or groups of assets, to the lowest level at which management monitors goodwill within the group" pp. 264. It is necessary to appraise the recoverable amount attributed to specific CGUs in order to equalize fair value less disposal costs to the value in use. If the carrying amount of assets in a CGU surpasses the recoverable amount, then it is necessary to recognize value impairment. Another issue of concern was the extent to which these firms complied with the requisite of reconciling balance sheet goodwill balances to the level of goodwill disclosed as having been allocated to CGUs for the purpose of goodwill impairment testing. The CGUs aggregation phenomenon was another aspect addressed. Research illustrates that disclosures made by new IFRS adopters with goodwill were acquiescent to the hypothesis that reporting entities had lesser CGUs than dictated under the standard as a strategy to avoid redundant impairment fees. The underlying proof behind these deductions was based on the amounts of CGUs defined by reporting entities in comparison to the number of business segments they defined, and the ratio of CGUs to defined business segments.
Ramanna and Watts, (2008), postulate that to test the variability of financial characteristics and goodwill impairment decisions, use of "agency based predictions as potential motives", pp. 16 is necessary. With the adoption of a new accounting regime, scholars from within and outside Australia analyzed the effects with regard to discount rates, tax discount rates and cash flow projections.
Normally, discount rates are useful in predicting the prospective future cash flows. In accounting for intangibles, the discount rates were shown to differ depending on the risk profile of the asset in question. Whether a pre tax or a post tax discount rate is used, enough care should be applied to ensure that post tax discount rates are used for predicting only for post tax cash flows and vice versa.
Numerous researches on the effects of this change have elaborated the existing reports, the recommendations and their contents. According to the analyst's forecasts, share prices of the respective companies were found to adjust to accommodate the situation. With the asset impairment, however, some companies realised massive losses in their revenue. The analyst's position was that with time their share prices would change to accommodate the revaluation.
Previously, before the impairment, amortization was not considered value relevant; therefore differences in possible impairment and analyst's forecasts had little or no effect to the valuation process. As per IAS 36, the asset impairment should not be charged annually and permanently to the income statement; it has based on the management's discretion, making it difficult to approximate the amount and timing of the write off. With the adoption of this new regime in 2008, the Australian companies witnessed considerable changes in the carrying value of intangible assets and goodwill over the year. This is illustrated in the chart below:
Source: Brand Finance, December 2008, Australian intangible asset review: An evaluation of intangible asset disclosure in Australia [Online]. Available at: http://www.brandfinance.com/Uploads/pdfs/Australian%20Intangible%20Asset%20Review%20Dec08.pdf [Accessed: 29 Sept. 2010].
To make forecasts of companies within a given industry, analysts made accurate use of the valuation model to analyse comparables within the industry. This helped in giving a single forecast for specific industries and the whole nation at large. Researchers have also opted to use discounted cash flows in transactions involving huge cash.
As earlier noted, after a firm acquires goodwill, it must allocate that goodwill among reporting units likely to benefit from that acquisition. After this allocation, goodwill is tested for impairment within the reporting unit. However, SFAS 142 dictates that a firm can reallocate goodwill from disbanded and merged units if it restructures its reporting unit structure. Owing to the costs linked to this restructuring, a firm may opt to 'clean its books' via goodwill write-offs rather than engaging in the restructuring process. Ramanna and Watts, (2008) however postulate that the write-off may creates a loss reserve for future years.
This paper has accurately presented the situation that faced the top 50 Australian listed public companies. Faced with pressure to shift from the traditional accounting architecture in goodwill impairment and comply with the IFRS policy of fair value accounting, this paper has explored the reasons for the change; the comments from various scholars both in Australia and across the globe; and how these reasons conform to the American study of impairment by Ross L. Watts. Australian accounting standards demand that intangible assets should not appear in the balance sheet at a value more than their recoverable amount. In cases where an asset's carrying value is not exceeded by its recoverable value, an impairment test is required- which entails estimating the value of an asset. All impairment losses resulting from writing down the carrying value of an asset are reflected in the income statement as expenses. The current economic environment in Australia is facing a big hit, and as a result, many companies have shown up substantial impairment charges in their balance sheets. These losses have been a big blow especially to public companies; since they have depressed their share prices and scared investors. An analytical survey to the views of Ross L. Watts on asset impairment clearly reveals that Watts represents a break from the Historical accounting procedures to an impairment-based regime. It is worth noting that Watts sticks to the conventions embodied in IFRS 263, that the relevance and reliability of fair value based accounting numbers will be maximised when the assets concerned are being actively traded in liquid markets. The use of fair value, according to Watts, is not restricted to IAS. In the US for instance, fair value amounts are also used for goodwill and other intangible assets under SFAS 142 and for the disposal of long lived assets (SFAS 144). The adoption of IAS in 2006 in Australia resulted in goodwill from business combinations (IAS 3), intangible assets (IAS 38), and derivatives and financial instruments (IAS 39) being reported at fair value across Australia. Despite auditors and firms expressing fear in carrying these items at fair value, the underlying principle is that the reporting of asset values in line with market values increases the relevance and utilitarianism of financial accounts for financial statement users.