GOODWILL

Question 1

GOODWILL

Answer 1

IFRS 3 Appendix A:
Future economic benefit from assets that are not capable of being individually identified and separately recognised.
Can be internally generated or purchased

Question 2

Difference between internal and purchased goodwill

Answer 2

Purchased goodwill is based on transaction with third party at arm’s length.
Internally generated goodwill is based on Directors’ valuation of internal goodwill by valuing
-business as a whole
-separable assets

Question 3

Is goodwill really an asset?

Answer 3

Goodwill is not controlled by the entity; cannot be separately identified/sold.

Question 4

How do we deal with goodwill?

Answer 4

IAS 38
33 In accordance with IFRS 3 Business Combinations, if an intangible asset is acquired in a business combination, the cost of that intangible asset is its fair value at the acquisition date

IAS 36
10 Irrespective of whether there is any indication of impairment, an entity shall also:
a)…
b) test goodwill acquired in a business combination for impairment annually in accordance with paras 80-99

Question 5

Carrying amount is..

Answer 5

The lower of:
Carrying amount
AND
Higher of
Net selling price
Value in use

Question 6

How is impairment recorded?

Answer 6

For goodwill impairment:
Dr Impairment expense (IS)
Cr Goodwill
CANNOT BE REINSTATED

Question 7

How do we deal with goodwill?

Answer 7

Immediate write off against reserves
Carry as an asset and amortise
Capitalisation with annual impairment review:
-“after initial recognition, the acquirer shall measure goodwill acquired at cost less any accumulated impairment losses”
-IFRS 3 prohibits amortisation & instead requires goodwill to be assessed for impairment in accordance with IAS 36

Question 8

EFFECT OF IMMEDIATE WRITE OFF OF GOODWILL

Answer 8

No hit to earnings

Big hit to net assets

Question 9

EFFECT OF CAPITALISATION & AMORTISATION OF GOODWILL

Answer 9

Gradual hit to earnings

Gradual hit to assets

Question 10

EFFECT OF CAPITALISATION & IMPAIRMENT REVIEW OF GOODWILL

Answer 10

No regular hit to earnings, but risk of major hit.

No regular hit to assets but risk of major hit.

Question 11

What is an impairment review?

Answer 11

-An attempt to test the carrying amount of an asset to see if it is overstated.

Question 12

IMPAIRMENT LOSS

Answer 12

The amount by which the carrying amount of an asset or a cash generating unit exceeds its recoverable amount. (IAS 36)

Question 13

CARRYING AMOUNT

Answer 13

The amount at which an asset is recognised after deducting any accumulated depreciation (amortisation) and accumulated impairment losses thereon. (IAS 36)

Question 14

RECOVERABLE AMOUNT

Answer 14

The higher of its fair value less cost to sell and its value in use (IAS 36)

Question 15

Calculating fair value less cost to sell

Answer 15

“The best evidence of an asset’s fair value less cost to sell is a price in a binding agreement in an arms length agreement…” IAS36 para 25

“If there is no binding sale agreement but an asset is traded in an active market, fair value less cost to sell is the asset’s market price less the costs of disposal..” IAS 36 para 26

“If there is no binding sale agreement or active market for an asset, fair value less cost to sell is based on the best information available…” IAS36 para 27

Question 16

Calculating value in use

Answer 16

IAS 36 para 30:
The following elements shall be reflected in the calculation of an asset’s value in use:
a) an estimate of the future cash flows the entity expects to derive from the asset;
b) expectation about possible variations in the amount or timing of those future cash flows;
c) the time value of money, represented by the current market risk free rate of interest.
d) the price for bearing the uncertainty inherent in the asset; and
e) other factors, such as illiquidity, that market participants would reflect in pricing the future cash flows the entity expects to derive from the asset.

Question 17

Steps to follow for impairment

Answer 17

Annual tests for impairment are not always necessary.
In general the steps to follow are:
1: Asses, at each accounting reference date, whether there is any indication that an asset may be impaired
2: if any such indication exists, the enterprise should estimate the recoverable amount of the asset.

BUT

For goodwill acquired in a business combination
Irrespective of whether there is any indication of impairment, the entity shall also:
-test goodwill acquired in a business combination for impairment annually in accordance with paras 80-99

Question 18

What do we do when there is an impairment?

Answer 18

An impairment loss should be recognised immediately as an expense in the income statement, unless the asset is carried at revalued amount under another standard.

Question 19

How should individual assets be tested for impairment according to IAS 36?

Answer 19

Individually
However, where cash flows do not arise from the use o a single non-current asset, impairment is measured for the smallest group of assets which generates income that is largely independent of the company’s other income streams. This smallest group is referred to as a cash generating unit (GCU)

Question 20

What are some indications of impairment?

Answer 20

A review for impairment is required when there is an indication that an impairment has actually occurred.
EXTERNAL INDICATORS:
-A fall in the market value of an asset
-Material adverse changes in regulatory environment
-Material adverse changes in markets
-Material long term increases in market rates of return used for discounting

INTERNAL INDICATORS:

• Material changes in operations
• Major reorganisation
• Loss of key personnel
• Loss or net cash outflow from operating activities if this was expected to continue or is a continuation of a loss making situation.

If there is such an indication, it is necessary to determine the depreciated historical cost of a single asset, or the net assets employed if a GCU, and compare this with the net realisable value and value in use.

Question 21

INTERNALLY GENERATED GOODWILL

Answer 21

Falls within the scope of IAS 38 Intangible assets Which states that “Internally Generated Goodwill shall not be recognised as an asset”. If companies were allowed to include IGG as an asset in the SoFP, it would boost total assets and produce a more favourable view of the SoFP.

Question 22

PURCHASED GOODWILL

Answer 22

Purchased goodwill has an identifiable cost, being the difference between the fair value of the total consideration that was paid to acquire the business and the fair value of the identifiable net assets acquired. This is the initial cost reported in the statement of financial position.

Question 23

IFRS 3 TREATMENT OF GOODWILL

Answer 23

Prohibits the amortisation of goodwill. It treats goodwill as if it has an indefinite life with the amount reviewed annually for impairment. If the carrying value is greater than the recoverable value of the goodwill, the difference is written off.
Whereas goodwill amortisation gave rise to an annual charge, impairment losses will arise at irregular intervals. This means that the profit for the year will become more volatile.

Question 24

Critical comment on reporting goodwill unchanged at cost.

Answer 24

Probably wrong to keep goodwill unchanged in the SoFP, as its value will decline with time. Its value may be maintained by further expenditure.

Question 25

Critical comment on writing off the cost of the goodwill directly to reserves in the year of acquisition

Answer 25

A buyer pays for goodwill on the basis that future profits will be improved. It is wrong, therefore, to write it of in the year of acquisition against previous years in the reserves. The loss in value of the goodwill does not occur at the time of acquisition but occurs over a longer period. The goodwill is losing value over its life, and this loss in value should be charged to the statement of comprehensive income each year. Making the charge direct to reserves stops this charge from appearing in the future income statements.

Question 26

Critical comment on amortising the goodwill over its expected useful life

Answer 26

Amortising goodwill over its life could achieve a matching under the accrual concept with a charge in the statement of comprehensive income. However, there are problems in determining the life of goodwill and choosing the amortisation method.