The objective of asset impairment is mainly to describe the procedures that an entity applies to ensure that its assets are carried to no more than its recoverable amount. IAS 36 explains that an asset is carried at more than its recoverable amount if its carrying amount exceeds 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 means 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.
Examining the goodwill reporting practices adopted by a sample of 50 large Australian listed firms, which disclosed the existence of goodwill in each of the first two years (2007 and 2008) in which they produced financial statements pursuant to IFRS. These firms represented only a subset of the Australian listed firm population. This research employs a comparative methodology in which the content of a firm's impairment testing disclosure and a checklist of requirements derived from the text of AASB 136are categorised according to a dichotomous comply or non-comply taxonomy. The quality and technical accuracy of the goodwill disclosures produced by these organizations together with an assessment of evidence of variation in these over time provides an evidentiary basis for analysis.
Over the years, the domain and practice of goodwill accounting has exhibited considerable turmoil and change. Various controversies that relate to the improper use of pooling of interests approach to acquisition accounting in order to avoid goodwill recognition, excessive in-process research and development allocations and immediate post-acquisition write-offs, the use of aggressive expense deferral amortization techniques such as the inverse sum of the years' digits represent a small sample of the challenges which have arisen over time, Carlin and Finch, (2008) in (Gibson and Francis, 1975; Carnegie and Gibson, 1987, 1992; Wines and Ferguson, 1993; Carlin et al., 2007). When contemplating the current preference on the part of standard setters for impairment testing for goodwill, it is useful to recognize that formulations for goodwill reporting based on the IFRS -capitalize and test for impairment- should be adopted.
Carlin and Finch, (2008) in Ernst & Young, (2001) postulate that various technical articles published in Australia at the time FASB had approved 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 capacity of Australian domiciled businesses to effectively compete on price on internationally contested acquisition transactions. In spite of various domestic lobbying efforts, it was perhaps inevitable given the emphasis placed on international harmonization, that the USA move to an impairment regime coupled with the existence of a similar approach to goodwill accounting under the IFRS regime which was contemporaneously being promoted by the International Accounting Standards Board, would jolt 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 promulgation of an all encompassing applicable accounting standard dealing with all intangibles - irrespective of whether or not identifiable, embodied in AASB 138 - Intangible Assets Resisting compliance with IFRS 263
The continuation of the mandatory application of purchase accounting to corporate acquisition transactions - embodied in AASB 3 - Business Combinations.
The continuation of the prohibition on the recognition of internally generated goodwill, and by extension, the reversal of write-downs on purchased goodwill - embodied in AASB 136.
The abandonment of the traditional recognition and amortisation approach to accounting for goodwill and the replacement of this rubric with an impairment regime, embodied in AASB 136, pursuant to which purchased goodwill may beheld indefinitely at cost until impaired, with impairment devaluations 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 this new accounting architecture easy to comprehend in its broad dimensions, a close inspection to the provisions of AASB 136 reveals a "foundation of enormous 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 generates cash inflows that are largely 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. To equate the higher of fair value less disposal costs and value in use, the recoverable amount of the assets attributed to the selected cash-generated units must be appraised. To the extent that the carrying amount of assets within a CGU exceeds the recoverable amount, value impairment must be recognized. Another issue of concern was the extent to which these firms complied with the requirement balance sheet goodwill balances be reconciled to the level of goodwill disclosed as having been allocated to CGUs for the purposes of goodwill impairment testing. The CGUs aggregation phenomenon was another aspect addressed. Research illustrates that disclosures made by new IFRS adopters with goodwill were compliant to the hypothesis that reporting entities gave fourth lesser CGUs than required under the standard as a strategy to shun unwanted impairment fees. The proof upon which those deductions were agreed pertained to 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 in testing whether goodwill impairment decisions vary with financial characteristics that allow for discretion, we test for "agency based predictions as potential motives", pp. 16. More over, most scholars have alluded to the fact that a firm's reluctance to 'impair' its assets may result to an increase in the following factors:
The costs of violating debt covenants (CovDebt), defined as the ratio of current period debt to prior period assets and an indicator if the firm has net worth or net income based debt covenant.
Managers' accounting-based compensation (Bonus), an indicator for whether the firm's CEO received a cash bonus during the year in question. Ramanna and Watts, (2008) illustrate that accounting based compensation is paid out as a bonus and the contracts are written off on net income, implying that they include the effect of goodwill write-offs.
Managers' reputational concerns (Tenure). To avoid reputation costs, long tenure CEOs are less likely to take goodwill write-offs, since such CEOs are more likely to have been involved in the generation of that book goodwill.
The firm being traded on an exchange with accounting-based delisting requirements (Delist). Ramanna and Watts,(2008) illustrate that firms listed on the NASDAQ and AMEX are subject to goodwill inclusive accounting based delisting requirements while OTC listed firms do not have such delisting requirements. To capture exchange delisting concerns, we create a dummy variable set to one if the firm trades on NASDAQ or AMEX; zero otherwise, pp. 18.
Equity-asset-pricing concerns. In measuring capitalization of earnings in returns, the response coefficient (ERC) is used. If equity asset-pricing concerns affect managers' impairment decisions, non-impairment is likely to increase in ERC, Ramanna and Watts, (2008), pp. 18-19.
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, according to SFAS 142, if a firm reorganizes its reporting unit structure, it can reallocate goodwill from merged and disbanded units. Owing to the costs associated with this reorganization, a firm may not engage in reorganization but instead have the opportunity to "clean its books" by taking a goodwill write-off citing the restructuring even when that goodwill is not impaired. "This write-off, however creates a loss reserve for future years", (Ramanna and Watts, 2008, pp. 18).
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. 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 reliability and relevance 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 Statement of Financial Accounting Standards (SFAS) 142 and for the impairment or disposal of long-lived assets (SFAS 144). The adoption of IAS in 2006 in Australia resulted in intangible assets (IAS 38), goodwill from business combinations (IAS 3), 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 premise is that the reporting of asset values in line with market values increases the relevance and usability of financial accounts for financial statement users.