Advanced Financial Accounting - Example

Advanced Financial Accounting Name Institution Affiliation Table of Contents Page Executive Summary 3 Background on Accounting Requirements for Goodwill Impairment 3 Core-More Group Limited Accounting for Goodwill 5 Review of Accounting for Goodwill Impairment 7 Recommendations and Conclusions 8 References 9 Executive Summary This report aims to inform the Chief Finance Officer and the Board of Directors in Core-More Group Limited of the accounting standards on impairment of goodwill. It will discuss in detail the implications the standards have on the company’s process of preparing financial statements. The views of the company regarding consistency, adequacy and other issues brought by goodwill impairment will be examined. Background of goodwill impairment before and after the introduction of IFRS and some ideas that the IASB can use to improve the standard will be highlighted. The procedure of impairment testing of goodwill has some benefits and challenges according to the views of different organizations. Furthermore, the report intends to advise the International Accounting Standards Board (IASB) on the changes and improvements that businesses would want in relation to the impairment of goodwill. They suggest providing of application guidance, giving more disclosures and aligning the cash-generating units with the operating segments in a business. This report will assist the company as a whole to understand how goodwill is recognized in the financial statements. Background on Accounting Requirements for Goodwill Impairment Goodwill is considered as an intangible asset gained from company’s business activities such as customer loyalty, employee happiness and brand recognition. This intangible asset is hard to quantify, but the IASB has developed guidelines and accounting procedures for its recognition in the financial statements. Before the introduction of IFRS, treatment of goodwill by businesses followed the Generally Accepted Accounting Principles (GAAPs). IFRS and GAAPs have some similarities in how they treat goodwill though they also differ in various ways. Both standards outline that goodwill be reassessed annually for impairment or more regularly if there is a presence of impairment indicators. Moreover, both the IFRS and GAAP entail the recognition of impairment loss asset and writing down of the impaired asset. Under the GAAPs, goodwill is apportioned to a unit, which is described as an operational segment. In settling on the method of impairing goodwill, organizations have the alternative to consider qualitatively whether it is more probable, the fair value of a carrying amount is more than its reporting unit. If this is the case, an approach that has two steps is performed. The first step is performing a recoverability test, which is done at the level of the reporting unit (Ernst & Young, 2011). The fair value, as well as the reporting unit's carrying amount, are compared (KPMG:UK, 2014). An impairment test is usually carried out if the carrying amount is found to be more than the reporting unit's fair value. In addition, impairment loss from goodwill is calculated. This is the total the carrying amount surpasses the implicit fair value within goodwill‘s reporting unit. The IASB introduced IFRS later, which accounts for goodwill differently. IFRS has an approach with only one step through which testing of impairment should be done so long as there are impairment indicators. Unlike under GAAPs, allocation of goodwill is done by distributing it to a cash-generating unit, which refers to the lowest level in an entity. The internal management of any organisation monitors goodwill through these units. Additionally, the cash-generating units (CGU) should be smaller than the operating segment (Barton, 2009). A company that needs the impairment carried out on its goodwill should do it at the level of the CGU. The carrying amount is compared to the recoverable amount of the goodwill. If the carrying amount is more than the recoverable amount, the difference is known as the impairment loss. The loss is distributed first to decrease goodwill to zero, after that, subject to some limitations, other assets' carrying amount of a CGU is decreased pro rata, depending on the carrying value of every asset. Most organizations prefer amortisation of goodwill to the impairment since it is simpler and more realistic. Impairment testing of goodwill is considered subjective, more complex thus time-consuming. Companies will be more comfortable with amortisation it decreases the goodwill balance. On the other hand, an impairment loss causes fluctuations in the financial statements. Core-More Group Limited Accounting for Goodwill In our company, we follow the IFRS to accounting for the goodwill in the financial statements. We carry out a compulsory impairment testing on the goodwill annually. Goodwill amortisation is not done at all. As such, the impairment loss is calculated by getting the recoverable amount related to the CGU that the goodwill is apportioned. Core-More Group Limited has found impairment of product to be very complex. The process needs critical judgement and uncertain estimating while preparing the financial records for the company. Implementation,auditing and enforcement challenges in testing the impairment There are a number of complexities that our company faces as it uses the impairment testing. Firstly, subjecting goodwill to the impairment testing sometimes affects the performance of the company’s shares in the stock exchange market. The lagging behind of the performance of the stocks can be as long as a period of two years. Poor performance will undoubtedly reduce the business developments significantly. Impairment testing only confirms the value instead of predicting it. Most of the times, the impairment charges are reflected in the prices of the shares even before it are recognized on the organization’s balance sheet. Therefore, the impairment test is generally done when it is too late. Secondly, the testing requires high degrees of subjectivity to get the results. It is very hard to decide when the accounting department recognises any impairment charge. The results largely depend on the estimation of the accountant thus; it is almost impracticable to get unbiased opinions (Hake, 2005). Even if one uses the best model around the globe to calculate the impairment loss, the analysis will depend on the inputs that he or she uses in the model. Moreover, the accounting department spends more time on impairment of goodwill more than areas of accounting while preparing the financial statements. One of the hardest areas is coming up with the discount rate. It is also challenging to describe to people who are not familiar with accounting how the impairment is done as well as the results. It takes a lot of time and patience informing the employees in the other departments in Core-More Group Limited. The accounting department has realised that the technical requirements related to the impairment only model may cause impairment losses. Determining a cash-generating unit is a complex process that the company has been experiencing since it adopted the IFRSs in the accounting department. The procedure of apportioning the goodwill to these units causes a detachment between the operating segments and the goodwill impairment in the company (KPMG:UK, 2014). The finance department has tried to comprehend the reasons distributing goodwill to these units never reflects how the high-level management runs the company. Furthermore, regulators of the industry are using considerably long periods looking at how the company has recognised the analysis and disclosures related to testing of goodwill impairment. Since the impairment procedures are highly subjective, enforcing high accounting standards is often impossible. Review of Accounting for Goodwill Impairment The financial statements of a company aims to provide information that is valuable to current and potential investors, donors, creditors as well as other users in making wise credit, investment and related resource distribution decisions. Nevertheless, the advantages of offering information for that intention should substantiate the associated costs. This is not the case with goodwill impairment procedure, which is sometimes very costly outweighing the benefits the business gets from the process. A majority of the organizations had assumed that most of the expenses associated with undertaking the first stage of the goodwill impairment test could be incurred during the first year of adoption. After that, they were expected to decrease drastically in future years following the company’s assigning of their goodwill to each cash-generating unit and creating its fair value model to finish the impairment test. According to (Bens, 2006) if raised, impairment charges decrease equity to levels, which trigger loan defaults. The majority of lenders expect organizations who have borrowed funds to promise to retain certain operational ratios. If a business does not follow these obligations, it can be considered as defaulting the loan contract. This may possibly have an unfavourable effect on the organization's capacity to refinance its debts, in particular if it has a significant debt and is still in need of extra funds. Therefore, recognizing goodwill in the financial statements by impairment test may not be the best procedure. Usefulness of the information obtained from annual impairment of goodwill Consequently, some professionals are of the view that annual impairment testing will be beneficial to investors since the organizations then will not want to take huge goodwill slash in one year and not do something for years. The annual tests would assist investors in reviewing whether the amount rewarded by businesses in acquiring another organization was justified or not. If done appropriately, this will offer investors with further valuable information. Most balance sheets are stuffed with goodwill that the companies gained in the bubble years when they overpaid for assets with overpriced stock. Over-inflated financial records misrepresent not only the examination of an organization but also that which investors ought to pay for the stock (Schaeffer & Robins, 2008). Impairment testing of goodwill forces businesses to revalue the bad investments. Recommendations (Improvements on impairment test) Based on the different views of companies and users of financial statements, the IASB should consider the subsequent recommendations: a) Align the cash-generating units with the operating segments thus reflecting better how the management views the company. b) Provide more application guidance that will assist in improving consistency in how goodwill impairment testing is applied. c) It should increase disclosures related to the procedure of goodwill impairment testing to make it more understandable to the accountants and other users of financial statements. Conclusions According to many businesses that perform the impairment tests, they find the procedure very complicated, time-consuming and more costly compared to the old method of amortisation. Some even suggest doing away totally with impairment. However, it has some benefits from providing information that is more valuable to investors. References Media Release Cover-More Group Limited is of the view that impairment of goodwill is complex though the accounting rule can be modified to suit the simplicity that most organizations require. The company is concerned about the persistent cost as well as the difficulties encountered when calculating a reporting unit’s fair value. This is more common in the first stage of the goodwill impairment test that has two steps. The company is suggesting that the IASB allow businesses to apply qualitative approaches during impairment test for goodwill. The procedure is also costly especially to small businesses, which have a smaller number of resources required for calculating the goodwill as compared to large public organizations. IASB should consider alternative methods of estimating the value of goodwill apart from allocating the diminishing goodwill to the lowest level units in an organization. The costs of preparing financial statements should always be far much lesser than the benefits gained from relying on such records. Calculating the goodwill of a company relies on units of the lowest level called the cash-generating unit that the accountant of the company must determine. Goodwill is required to be distributed to these groups. Cover-More Group Limited is recommending the possibility of testing the impairment of goodwill at higher levels of reporting units instead of lower level cash-generating units. Shifting to these units will reduce the confusion most accounting departments across the globe experience in recognizing goodwill in their financial statements. The company feels that amortisation of goodwill (the old method of dealing with goodwill) was better than the current method called impairment testing of goodwill. Amortisation could only cause slight effects on the company that acquires another one. However, the new method may cause unpredictability of a company’s earning through a loss called the impairment losses. Moreover, our company believes that auditors are forced to deal with a lot of difficulties and complexities in relation to the allocation of fair value. They are required to confirm that the units, computation of the exchange price, as well as the recoverable amount using discounted cash flows estimates. Auditors will have to utilize their professional judgement in addition to depending on the management’s integrity to get the reasonable value of the goodwill. The management would favour recognizing goodwill as an intangible asset in the balance sheet (the financial record that summarises the assets and liabilities of a company) with no writing off (reduction). This is because it will reduce negative implications on the price of the shares. Finally, the IASB should provide the companies that perform impairment of goodwill with more guidelines on how to calculate it. The guidelines will make the computations and preparing of financial statements easier and less complicated. If the suggestions made to the board are not considered to improve how organizations treat goodwill, the impairment should be eliminated. A majority of organizations including our company would prefer amortising of goodwill to the impairment procedure. In brief, the impairment of goodwill is a very confusing topic not only to non-accountants but also among accountants. It has been a controversial debate among professionals around the world. Some are arguing against the procedure while others support it with reasons such as the procedure being beneficial to investors. The debate about the issue will continue as long as the IASB does not consider recommendations from various stakeholders. Read More