Navigating Goodwill and Impairment in Business Combinations: An Analysis

Goodwill and impairment are critical concepts in accounting for business combinations. Goodwill represents the excess payment made to acquire a company over the fair value of its identifiable net assets. It's an intangible asset not amortized but tested periodically for impairment. A qualitative assessment can indicate if a full (quantitative) test is needed. The quantitative test involves identifying reporting units, assigning assets/liabilities, and comparing the unit's fair value to its carrying amount. Recent rules removed the second step of comparing implied and carrying goodwill. Key factors include testing timing, trigger events, fair value methods, and links to other asset impairments.

Brief History of Project

The IASB issued IFRS 3 in 2004 and revised it in 2008, followed by a post-implementation review in 2013-2014, with findings published in 2015. To address concerns raised, the IASB launched the Business Combinations-Disclosures, Goodwill, and Impairment project, releasing a Discussion Paper in 2020 and conducting stakeholder outreach. Based on feedback, it developed new proposals and issued an Exposure Draft in March 2024 for public comment.

Background- Exposure Draft

The Exposure Draft proposes changes to IFRS 3 and IAS 36 to improve transparency and effectiveness. It aims to enhance disclosures on the performance of business combinations and refine the impairment testing of cash-generating units with goodwill, addressing issues identified in the post-implementation review of IFRS 3.

Proposed Amendments to IFRS 3

Rationale For Proposed Amendments

When one company acquires another, investors seek clarity on the goals of the management behind the acquisition and whether those goals are achieved in the subsequent years. This helps assess if the acquisition was effective, including pricing, integration, and expected benefits. Without such information, investors often rely on impairment tests, raising concerns that goodwill impairments are recognized too late. Preparers are concerned that the proposals may require disclosure of commercially sensitive information, increasing litigation risk. To address this, the IASB proposes an exemption allowing companies to withhold certain details if disclosure would seriously prejudice key acquisition objectives. The IASB also proposes limiting performance disclosures to strategic acquisitions to avoid disclosure overload.

The key proposed changes to IFRS 3 include:

1. New disclosure requirements:
   • Information about the entity's acquisition-date key objectives and related targets for strategic business combinations, and the extent to which those objectives and targets are being met.
   • Quantitative information about the synergies expected to arise from a business combination. Example, revenue synergies, cost synergies, and other types of synergies.
   • To require an entity to disclose for each category of synergies:
     • The estimated amounts or range of amounts of the expected synergies.
     • The estimated costs or range of costs to achieve these synergies.
     • The time from which the benefits expected from the synergies are expected to start and how long they will last.

1. Exempting entities from disclosing some of this information in specific circumstances where it could prejudice the achievement of the entity's key objectives.
2. Replacing the requirement to disclose the primary reasons for a business combination with a requirement to disclose the strategic rationale.

Strategic Business Combinations

The acquirer must disclose information about each strategic business combination as reviewed by key management personnel (as defined in IAS 24 Related Party Disclosures). The required disclosures include:

1. Year of Acquisition:
   • Key Objectives and Targets: Disclose acquisition-date key objectives and related targets, either as a range or point estimate.
2. Year of Acquisition and Subsequent Reporting Periods:
   • Performance Against Objectives: Disclose the extent to which acquisition-date key objectives and targets are being met. This includes:
     1. Actual performance data reviewed to assess whether objectives and targets are being met.
     2. A statement indicating whether actual performance meets the acquisition-date objectives and targets.
3. Duration of Disclosure:
   • The acquirer must continue to disclose this information as long as key management personnel review the actual performance against the acquisition-date objectives and targets.
4. Non-Review and Cessation of Review:
   • If key management personnel have not started and have no plan to review the achievement of the objectives and targets, disclose this fact and the reasons.
   • If the review stops before the end of the second annual reporting period after the year of acquisition, disclose this fact and the reasons. If key management personnel continue to receive information based on the original metric during this period, disclose that information as well.

The IASB proposes that acquisitions that meet any one of these thresholds would be strategic acquisitions:

Identifying Information to Disclose

Key disclosures required include:

Exemptions from Disclosure

• Commercially Sensitive Information: Entities are exempt from disclosing commercially sensitive or proprietary information to protect competitive advantage and confidential strategies.
• Litigation Risk: Entities may be exempt from disclosing information that could lead to legal risk or litigation, as such details might be used against them in legal proceedings.

To ensure transparency and accountability, entities claiming exemptions would be required to disclose:

1. The fact that an exemption has been applied.
2. The specific disclosure requirement(s) for which the exemption has been claimed.
3. The nature of the information omitted and the reasons for claiming the exemption.

Other Proposed Amendments to IFRS 3

Aligning with IFRS 19: Subsidiaries without Public Accountability- Disclosures

The proposed amendments aim to align IFRS 3 with the forthcoming IFRS 19 standard. Key disclosure requirements under the proposal include:

1. Disclosures about the strategic rationale for a business combination.
2. Information about the expected synergies from the business combination.
3. The contribution of the acquired business to the reporting entity's revenue and profit or loss.
4. The discount rate used in calculating the value in use for impairment testing purposes.

Effective Date and Early Application: The IASB will set the effective date after reviewing feedback, but early application is allowed to enhance disclosure transparency and adopt the new requirements sooner.

Proposed Amendments to IAS 36:

Rationale:

Stakeholders raised two main concerns regarding impairment testing:

• Impairment losses on goodwill are often not recognized promptly. This delay is frequently due to the shielding of goodwill from impairment by the headroom in an existing business with which an acquisition is integrated. Additionally, management's overoptimism can contribute to delayed recognition.
• The impairment test can be expensive and time-consuming.

To address these issues, the IASB proposes targeted changes to IAS 36 to improve goodwill impairment testing, aiming to reduce shielding and over-optimism, and enhance transparency and reliability.

The following example demonstrates how the proposed amendments impact the allocation of goodwill and the potential for shielding goodwill from impairment.

Fact Pattern:

Entity P operates a chain of fitness centers. It operates separate centers for gym facilities and yoga classes. It identifies two operating segments gym facilities and yoga classes. Each fitness center is identified as a Cash Generating Unit (CGU).

Entity P does not have any presence in City Y. To enter the market in City Y, in January 20Y1, it acquires a fitness center for yoga classes (Center Y) from Entity Q in City Y. It recognizes goodwill of INR 1.5 crore from the acquisition of Center Y. Center Y will be a part of the operating segment of yoga classes. Entity P's management does not monitor goodwill separately for internal management purposes. It monitors each center separately for internal management purposes.

The carrying amounts as of 31 December 20Y1 are as below:

• Net assets of Center Y (excluding goodwill) INR 8 crore
• Goodwill allocated to Center Y INR 1.5 crore
• Net assets of the operating segment yoga classes INR 60 crore

The recoverable amount (value in use) of Center Y is INR 9 crore. The recoverable amount (value in use) of the operating segment - yoga classes is INR 75 crore.

Analysis:

Under the existing requirements:

• Entity P does not monitor goodwill for internal management purposes. Therefore, under the current requirements, it can allocate the goodwill recognized on the acquisition of Center Y to the operating segment yoga classes as that is the highest level set by at which goodwill can be allocated.
• The carrying amount of the net assets of the operating segment - yoga classes as at 31 December 20Y1 is INR 60 crore.
• The carrying amount of the net assets of the operating segment - yoga classes, including goodwill recognized on the acquisition of Center Y, as at 31 December 20Y1 is INR 61.5 crore. The recoverable amount of this operating segment is INR 75 crore. Therefore, no impairment is recognized.

Under the proposed approach:

• The business associated with the goodwill that is monitored for internal management purposes is the CGU of Center Y. Therefore, the goodwill is allocated to the CGU of Center Y for impairment testing.
• The carrying amount of the CGU of Center Y, including goodwill, is INR 9.5 crore (i.e., INR 8 crore + INR 1.5 crore). The recoverable amount of the CGU of Center Y is INR 9 crore.
• Therefore, Entity P is required to recognize an impairment loss of INR 0.5 crore, which will be allocated to goodwill.

Thus, under the existing requirements, due to the headroom available in the operating segment - yoga classes, goodwill is shielded from impairment. Under the proposed requirements, this shielding is reduced.

The IASB has proposed amendments to address concerns about the cost and complexity of impairment testing, specifically relating to the calculation of value in use. The key impacts are:

1. Inclusion of Uncommitted Future Cash Flows:
   • Current Restrictions Removed: The proposed amendments remove the restriction on including cash flows from uncommitted future restructuring or asset enhancement. Previously, IAS 36.33 and IAS 36.44 prohibited these estimates in cash flow projections.
   • Impact: This change allows for a more realistic and internally consistent projection of cash flows, aligning impairment tests with the cash flow projections used for internal decision-making.
2. Reduction in Cost and Complexity:
   • Simplified Budget Adjustments: By allowing the inclusion of future restructuring and enhancement cash flows, the need to adjust management's financial budgets or forecasts specifically for impairment testing is reduced.
   • Impact: This simplification is expected to lower the cost and complexity associated with the impairment testing process.
3. Future Cash Flows:
   • Requirements Maintained and Expanded: Future cash flows must still be estimated based on the asset's current condition. However, estimates can now include:
     1. Cash outflows are necessary to maintain the asset's current economic benefits.
     2. Cash flows associated with potential restructurings, improvements, or enhancements.
   • Impact: This allows for a more comprehensive and accurate reflection of the asset's future economic potential.
4. Treatment of Restructuring Provisions:
   • Provisions Recognized in Accordance with IAS 37: When an entity becomes committed to a restructuring and recognizes a provision for it, the calculation of value in use should:
     1. Include future cash inflows and outflows reflecting the cost savings and benefits from the restructuring.
     2. Exclude future cash outflows for the restructuring itself.
   • Impact: This ensures that the value in use calculations reflect the economic benefits of restructurings without double-counting the associated costs.

The IASB has also proposed amendments to IAS 36.80 to enhance the accuracy of goodwill impairment testing:

Clarification of Allocation Level:

• Amend IAS 36.80(a) to specify that goodwill must be allocated to the lowest level at which the associated business is monitored for internal management purposes.

New Paragraphs:

• Paragraph 80A: Ensure entities first apply IAS 36.80(a) to determine the lowest monitoring level for the business associated with the goodwill.
• Paragraph 80B: Apply IAS 36.80(b) only after determining the lowest monitoring level, setting the highest permissible level for goodwill allocation.

Impact:

• Prevents defaulting to operating segment level allocation when goodwill is not separately monitored.
• Ensures more precise and stringent impairment testing, reducing the risk of shielding goodwill from impairment.

Value in Use Calculation

1. The proposed amendments to IAS 36 changes the value in use calculation, a key part of impairment testing, to better estimate the present value of future cash flows from an asset or CGU, including goodwill.

Removing Constraints on Cash Flow Projections:

• The current version of IAS 36 prohibits entities from including cash flows from future restructuring or asset improvements when calculating an asset's value in use.
• The proposed amendments remove this constraint, allowing entities to incorporate cash flow projections from planned future restructuring or asset improvements, provided they meet certain criteria.
• This change aligns the standard with common valuation practices and reflects the economic reality that entities often undertake restructuring or asset improvements to enhance future cash flows.

Eliminating the Requirement for Pre-Tax Inputs:

• Currently, IAS 36 requires entities to use pre-tax cash flows and pre-tax discount rates when calculating value in use.
• The proposed amendments remove this requirement, permitting entities to use either pre-tax or post-tax inputs, whichever is more consistent with their internal valuation practices.
• This change provides greater flexibility and aligns the standard with common valuation practices, where post-tax inputs are often used.

The proposed amendments to value in use aim to improve the relevance and reliability of impairment testing by aligning with common valuation practices, allowing post-tax inputs and future restructuring cash flows. To ensure transparency, entities must disclose key assumptions and judgments used in the calculation.

Implications and Next Steps

Conclusion

The evolving landscape of goodwill and impairment accounting in business combinations reflects the increasing need for transparency, reliability, and practicality in financial reporting. The IASB's proposed amendments to IFRS 3 and IAS 36 aim to address long-standing concerns related to the impairment testing process, including management over-optimism, goodwill shielding, and the cost and complexity of assessments. These changes not only improve financial statement disclosures but also align accounting practices with economic realities.

• Managerial Implications
  For corporate financial managers and decision-makers, the amendments reinforce the importance of strategic accountability in acquisitions. Enhanced disclosure requirements ensure that investors and stakeholders gain clearer insights into the rationale and performance of business combinations, leading to more informed decision-making. The adjustments to impairment testing, such as removing constraints on future cash flows and allowing post-tax inputs, provide greater flexibility in valuation and risk assessment. However, companies must also navigate the balance between transparency and the protection of commercially sensitive information.
• Contributions of the Study
  This study contributes to the broader discourse on financial reporting by critically evaluating how the IASB's amendments refine impairment testing and enhance disclosure quality. By analyzing these changes, the study provides a valuable reference for accountants, auditors, and regulators in understanding the implications of evolving accounting standards. The modifications to impairment testing criteria and disclosure requirements highlight a shift toward more investor-centric financial reporting.
• Current Developments and Next Steps
  In March 2024, the IASB published an Exposure Draft proposing amendments to IFRS 3 and IAS 36. As of February 2025, it continues redeliberating key areas, including improved disclosures, exemptions for sensitive information, and targeted changes to address goodwill shielding and over-optimism, reaffirming its focus on transparency and practical implementation.
• Scope for Further Investigation
  While the amendments show progress, future research should assess their real-world impact on reporting, investment decisions, and corporate behavior. Studies should also examine cost-benefit trade-offs and how companies adapt, helping refine standards to stay practical, transparent, and stakeholder-focused.

References

• Exposure Draft: Business Combinations- Disclosures, Goodwill and Impairment Snapshot: Exposure Draft Business Combinations-Disclosures, Goodwill and Impairment retrieved from https://www.ifrs.org/content/dam/ifrs/project/goodwill-and-impairment/exposure-draft-2024/iasb-ed-2024-1-bcdgi.pdf