The Hindu Business Line : Impairment in the goodwill party

Goodwill impairment is a technical accounting point but it can be viewed as an unavoidable admission of the fact that not all went as planned within a merger/acquisition.- MS NANDINI CHOPRA, VALUATIONS SERVICES HEAD, KPMG.

The current generation of CFOs (chief financial officers) could be set for a sobering experience with a slew of goodwill impairment announcements looming large on the horizon, says Ms Nandini Chopra, Valuations Services Head at KPMG in India.

The grim scenario she foresees is of a number of C-class executives having to admit that their company overpaid for acquisitions during the bull market times of recent years; or that their newly merged business has not performed as expected.

“The value of goodwill — classed as the difference between the total price paid for an acquisition and the value of the tangible and identified intangible assets purchased — is assessed on an annual basis for companies reporting under the US GAAP and the IFRS, and a large number of balance sheet write-downs (called goodwill impairment) could be inevitable,” explains Ms Chopra, during the course of an email interaction with Business Line.

Excerpts from the interview:

We wouldn’t be talking about this if only there were no market downturn…

True. At the height of the bull market, companies may have been prepared to overpay somewhat for an acquisition; effectively paying a premium to secure the acquisition they craved.

The fact that they overpaid — or that the newly merged business struggled to perform as had been anticipated — was masked by share prices which continued to rise regardless of the effectiveness of the acquisition.

Now that the market has taken a downturn, the recognition of any overpaying or underperforming cannot be avoided thanks to the accounting rules around goodwill impairment.

Owning up to this can be a chastening experience. Sadly, current market conditions mean that it is something which more and more CFOs are likely to be experiencing for the first time in their professional lives.

What are the implications of goodwill impairment?

Goodwill impairment is a technical accounting point but it can be viewed as an unavoidable admission of the fact that not all went as planned within a merger/acquisition.

The saving grace, however, is that the announcement of goodwill impairment rarely hurts the company still further. Because by then the damage may have already been done as share prices may have fallen and confidence may have been dented.

In this way, the goodwill announcement simply acts as the final confirmation of culpability — but it rarely triggers any further downward share price movements of its own. By the time it comes around, shareholders, analysts and other market-watchers already know what’s coming — so there is less of an element of being on the wrong end of a nasty surprise.

Would an opposite argument hold true — that goodwill is automatically impaired if the stock market falls?

A tempting argument. And we may further argue that the value of a company is diminished so, in accounting terms, something needs to be reduced and this is when goodwill is impaired.

However, this does not necessarily follow — as a newly merged company which performs well (and which made its acquisition at the right price) can still buck the stock market trend and thus protect its goodwill value.

What are the differences between the Indian AS and the US GAAP and IFRS, on the treatment of goodwill impairment?

Our AS (Accounting Standard) 28 on ‘Impairment of Assets’ is very similar to the IFRS.

There are no material differences between the two — in fact a substantial portion of the standard is an exactly copy of IFRS. However, there are a few subtle differences.

One, the Indian GAAP permits reversal of impairment of goodwill when certain conditions are met; the IFRS does not permit this reversal. And two, there is also a difference for types of assets to be tested at least annually (under the Indian GAAP, all intangible assets with a useful life of more than 10 years, under the IFRS only the intangible assets with indefinite useful life).

With preparation for IFRS convergence in progress, what corrections will be necessary for goodwill?
In India, whenever we do any business combinations, we account for goodwill/capital reserves in the year of business combination which is the difference between the purchase consideration and fair value of assets.
Post-AS 28, it has become necessary to test the goodwill impairment every year. Also there is no concept of capital reserve under the IFRS. In case the fair value of net assets taken over in a business combination exceeds the purchase consideration, such excess after reassessment of the fair values is credited to the income statement.
When the IFRS convergence happens, AS 14 (Accounting for Amalgamations) will change and IFRS 3 on Business Combination will apply. As a result, all the goodwill already accounted for in the balance sheet before the IFRS transition will have to be restated.
With no notifications yet about the conversion to IFRS, we don’t know when such transition period will start. Any acquisition made after the date of transition will have to be allocated over intangibles as well.
During IFRS transition, there are certain exemptions available to companies in IFRS 1 for the first-time adoption. One of these exemptions is on business combinations. IFRS 1 specifies that in relation to acquisitions that are made prior to the date of transition, an entity may elect:
To restate all historical acquisitions in accordance with the requirements of IFRS 3, Business Combinations; or
Not to restate any historical acquisitions; or
To restate all historical acquisitions after a particular date (for example, say, two years prior to the date of transition).
Thus, if the company chooses not to restate historical acquisitions, there will be no impact on the carrying amount of goodwill on the transition date. If the company does not choose this exemption, it will need to follow the IFRS for the past acquisitions.
One key difference will be that the asset acquired will have to be recorded at its fair value (also the deferred tax impact will have to be considered), with a corresponding reduction in goodwill. Understandably, this will change the amortisation charge in the future periods.
In sum, therefore…
Plenty of goodwill impairment announcements are just around the corner. Is it ‘just’ a technical accounting point? I think it is, yes. Is it going to hurt the company still further? No. However, is it going to be a decidedly uncomfortable experience for the newer recruits to the CFO ranks who have been traditionally used to enjoying healthy stock market returns for the past five years? Yes, it will. Rather like a rite of passage, this is something which has to be endured at some point. That time appears to be now.

D. MURALI

(Portrait by R. Rajesh) InterviewsInsights.blogspot.com

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