HKFRS News 

Goodwill has always been the balancing figure, and few people have ever considered what it represents.  It still is the balancing figure, albeit a smaller one than under the previous regime, but now management must disclose what it represents.  Goodwill is likely to represent assets that do not meet the recognition criteria, (such as the workforce), synergies that the acquiring entity expects to achieve and overpayments.  No management team has ever disclosed an overpayment at the date of acquisition - or done so and survived the next Annual General Meeting.  However, their existence is not uncommon, hence the requirement in HKAS 36 to review goodwill arising on an acquisition as soon as possible after the acquisition date so that overpayments are identified and written off immediately.
 
The residual amount of goodwill, once established, must be allocated to the parts of the business expected to benefit from the acquisition.  The level of allocation must be the lowest level at which management monitors goodwill and cannot be larger than a segment (HKAS 36.80).  The goodwill impairment test is then performed at this level.
 
Practical issues
 
This sounds straightforward.  What are the practical issues?  Management will usually know which parts of the existing business are likely to benefit from the acquisition, as this will have been one of the considerations during the planning process.  It is less likely that management's expectations can be exactly mapped to the goodwill balance.  If the full value of expected synergies has been paid for, possibly as a result of a bidding war, demonstrating that the acquisition has been a success will be a challenge.
 
The value of the components of goodwill can usually be established to assist in the allocation process.  Management likes to quote synergy values to the media.  The value of the workforce and some other assets that do not meet the recognition criteria should be established in order to value the identifiable intangible assets.  These underlying 'assets' serve as a useful basis for allocating the components of goodwill to the cash-generating units (CGUs) or groups of CGUs expected to benefit from the deal.  The logic of doing so is clear.  If synergies paid for are expected to be achieved throughout the group, leaving the entire goodwill balance in the part of the group that has absorbed the acquired business is likely to lead to impairment.  The full value of the goodwill will be measured against less than the full value of the benefits.
 
At what level does management monitor goodwill?
 
Goodwill is not an asset that generates cash flows; management tends to regard it as a sunk cost.  Management will monitor whether an acquisition is performing as planned but will not typically monitor goodwill.  However, an appropriate level must be identified for the goodwill impairment test.  The allocation of goodwill discussed above will typically spread the goodwill balance quite widely across the group.  The monitoring of the acquired business' performance, in contrast, normally takes place at a more localised level.  Consider also the acquisitive company whose management is monitoring goodwill arising on a number of transactions.  It is impractical to consider separately the goodwill on each transaction.  In addition, each transaction is likely to affect the benefits expected from earlier deals; this makes an individual monitoring exercise of limited relevance for management and external users of the financial statements.
 
These practical considerations often lead to management teams allocating goodwill at segment level, the highest level permitted under HKAS 36.  However, this does not entirely solve their problems.  Segment reporting under HKAS 14 is a disaggregation of an entity's consolidated financial statements based on products and services or on geographical areas.  The segments may bear little relation to the way in which management runs the business; this could lead to practical difficulties in identifying the financial data necessary to perform the goodwill impairment test.
 
Following the IASB footsteps, the HKICPA has recently issued ED 8, Operating Segments, its proposed replacement for HKAS 14.  This exposure draft, part of the IASB's and FASB's convergence project, seeks to bring segment reporting under IFRS more closely in line with the practice under US GAAP.  The impact of the proposals in ED 8 on goodwill impairment testing is mixed.
 
Segment reporting under the proposals in ED 8 will be more closely aligned with the way in which the business is managed.  This should make the information reported more relevant to external users of the financial statements and easier for management to prepare.  However, the proposals are likely to result in management carrying out more goodwill impairment tests than at present.
 
The highest level at which goodwill can be allocated and reviewed for impairment under HKAS 36 is the reporting segment.  This is quite a high level within the business; most entities only have a few reporting segments.  A reporting segment under ED 8 may be an operating segment or a group of operating segments.  The consequential amendment proposed for HKAS 36 is that the level to which goodwill is allocated can be no higher than an operating segment - potentially one level below the current reporting segment.
 
It is likely that, if the proposals in ED 8 are approved, the impact on goodwill impairment testing will benefit both preparers and users.  Users will receive more relevant information, which will enhance their ability to determine the consequences of management actions on the goodwill balances.  Preparers are likely to be carrying out more goodwill impairment reviews but will benefit from the data required being more readily available to those who need to carry out the reviews.