A Comment on the Pre-acquisition Headroom Approach for Goodwill Impairment Tests

Transcription

1 A Commen on he Pre-acquisiion Headroom Approach for Goodwill Impairmen Tess Auhors: Niclas Hellman, Associae Professor, Sockholm School of Economics, Deparmen of Accouning* Tomas Hjelsröm, Assisan Professor, Sockholm School of Economics, Deparmen of Accouning *Corresponding auhor Address: Niclas Hellman Associae Professor Deparmen of Accouning P.O. Box Sockholm Sweden Tel: Fax: Version: November

2 A Commen on he Pre-acquisiion Headroom Approach for Goodwill Impairmen Tess SYNPOSIS: The recenly conduced pos-implemenaion review of he Inernaional Financial Reporing Sandards (IFRS) for business combinaions poined a significan deficiencies, poenially leading o goodwill impairmen losses being recognized oo lile, oo lae (IFRS Foundaion, 2015). In response o he review, Inernaional Accouning Sandards Board (IASB) saff have developed a new approach, he Pre-acquisiion Headroom (PH) Approach, which addresses one of he main facors (allocaion of acquired goodwill o a pre-exising cash-generaing uni wih economic, non-recorded goodwill) ha makes he goodwill impairmen es ineffecive. The curren paper provides an analyical evaluaion of he PH Approach by comparing i wih he curren IFRS approach which is based on he original heoreical framework behind he sandard (Johnson & Perone, 1998), and recen developmens of his framework (Johansson, Hjelsröm, & Hellman, 2016). We conclude ha he PH Approach resuls in a more effecive impairmen es compared o he curren IFRS approach. Compared o he Johansson e al. (2016) approach, considering growh scenarios, he PH Approach is more effecive in he shor run and less effecive in he long run. The reason behind is ha he PH Approach favors a form of inernal consisency (accouning value bases deermined a he acquisiion dae remain during he pos-acquisiion period) over he measuremen consisency where fair value measuremen is applied a all poins in ime (he Johansson e al., 2016 approach). Our analysis furher shows ha he use of a consan pre-acquisiion headroom from he acquisiion dae makes he PH Approach saic and overeffecive ( oo much, oo early ) in cerain siuaions where economic value decreases in pars of he cash-generaing uni no relaed o he acquisiion. Keywords: Goodwill, Acquisiion, Impairmen, IFRS 2

3 INTRODUCTION Inernaional Financial Reporing Sandard (IFRS) 3 (Business Combinaions) was issued in 2004 and implied a change from he so called dual approach for goodwill reporing (amorizaion over useful life plus addiional impairmen if required) o an impairmen-only approach. The change was riggered by he adopion of an impairmen-only approach in he Unied Saes a few years earlier [Saemens of Financial Accouning Sandards (SFAS) 141 (Business Combinaions) and SFAS 142 (Goodwill and Oher Inangible Asses), boh issued in 2001]. In June 2015, he Inernaional Accouning Sandards Board (IASB) published a repor and feedback saemen based on he pos-implemenaion review (PIR) of IFRS 3 (IFRS Foundaion, 2015). The issue considered mos imporan o deal wih was he accouning for goodwill during he pos-acquisiion period, where consiuens had raised concerns ha impairmen losses were no imely recognized and in oo small amouns, i.e. oo lile, oo lae (IASB, 2016b, C12). One of he main reasons why he goodwill impairmen es is ineffecive relaes o he allocaion of acquired goodwill o a pre-exising uni of he acquirer ha already has unrecorded economic goodwill (he economic value of he uni exceeds he carrying amoun). This unrecorded economic goodwill will work as a buffer ha proecs acquired goodwill from being impaired during he posacquisiion period (Johansson, Hjelsröm, & Hellman, 2016). In search of improvemens o he impairmen model, IASB saff have developed a new approach, he Pre-acquisiion Headroom (PH) Approach, which addresses his problem. The basic idea of he PH Approach is o firs measure he size of he buffer, referred o as he pre-acquisiion headroom (he unrecorded economic goodwill), a he ime of he acquisiion, and hen o add he buffer o he carrying amoun of he eniy when performing he goodwill impairmen es. The purpose of his paper is o evaluae he measuremen consisency and he expeced effeciveness of he PH Approach from an analyical poin of view. A numerical example will be used o illusrae he heoreically derived effecs. As benchmarks for he evaluaion we will use (i) he curren IFRS model based on IFRS 3 and Inernaional Accouning Sandard (IAS) 36 (Impairmen of Asses); and (ii) an approach which consisenly applies he Johnson & Perone (1998) axonomy (JP axonomy) boh a he acquisiion dae and during subsequen period, i.e., based on he framework developed by Johansson e al. (2016) (JHH Approach). Johnson & Perone idenified six componens of goodwill (1 and 2 relaed o accouning conservaism; 3 and 4 relaed o core goodwill; 5 and 6 relaed o measuremen of he consideraion). The JP axonomy was used by he Financial Accouning Sandards Board (FASB) and he IASB when applying he goodwill concep and he adopion of he impairmen-only approach in he new sandards (cf. IFRS 3, Basis for conclusions), however, no in a ime-consisen manner (Johansson e al., 2016). We find ha adopion of he PH Approach will, from an analyical poin of view, lead o improvemens compared o he curren IFRS model. The effeciveness of he impairmen es improves under he PH Approach compared o he curren IFRS model, as he accouning goodwill from he acquisiion is no longer proeced by pre-exising unrecorded economic goodwill (he PH). Concepually, he explici consideraion of he PH makes he subsequen measuremen of 3

4 accouning goodwill more logically inuiive, bu has a saic feaure ha follows from an inernal consisency argumen according o which he measuremen bases used a he acquisiion dae mus remain unchanged during he pos-acquisiion period (IASB, 2016b, C14), i.e., a consan PH from he acquisiion dae is used over ime because he carrying amouns of accouning goodwill and acquired asses and liabiliies are based on he values deermined a he acquisiion dae. We argue ha he JHH Approach (and he logic of he JP axonomy) provides a concepually more aracive soluion o he problem by applying he same perspecive on measuremen over ime, i.e., for he purpose of he impairmen es, idenifiable asses and liabiliies are remeasured a fair value. In addiion, he JHH approach addresses buffers agains goodwill impairmen in general, no only in he case of a pre-exising business wih unrecorded economic goodwill. Wih regard o he effeciveness of he impairmen es (for growh scenarios), we find ha he PH Approach is more effecive han he JHH Approach in he shor run and less effecive in he long run. For a sudden crisis scenario (preceded by a boom in acquisiion prices), he PH Approach can become over-effecive, i.e., impairmen losses may have o be recognized due o economic value decreases in pre-exising pars of he uni no relaed o he acquisiion. We propose ha he PH Approach is reconsidered in favor of using he same perspecive on goodwill measuremen over ime insead of using a consan hisorical amoun for a par of he impairmen es problem. I should be acknowledged ha he paper focuses on analyical aspecs whereas pracical aspecs and coss are only discussed briefly. We do believe ha consideraion of pracical aspecs and coss correspond well wih our analyical findings, bu hese opinions are only based on qualiaive argumens and no backed by evidence from he field. THE PH CONCEPT IFRS prescribes ha for he purpose of impairmen esing, goodwill acquired in a business combinaion shall be allocaed o he acquirer s cash-generaing unis (CGUs) or groups of CGUs, where a CGU is defined as he smalles idenifiable group of asses ha generaes cash inflows ha are largely independen of he cash inflows from oher asses or groups of asses (IAS 36, 80 and 6). Each uni o which acquired goodwill is allocaed shall, however, represen he lowes level a which he goodwill is moniored for inernal managemen purposes and no be larger han an operaing segmen. The reason for seing an upper limi on he level of he es (he operaing segmen level) is because of he non-recorded economic goodwill in he pre-exising CGU, referred o earlier. Thus, he problem mus have been known o he sandard seer alhough no receiving much aenion in prior sandard-seing (or research) lieraure (cf. Johansson e al., 2016). Preparers have also been well aware of his feaure of he impairmen es, as illusraed by he following quoaion from he lised muli-naional corporaion Sandvik reporing under IFRS: The esing of goodwill a a higher organizaional level obviously lessens he probabiliy of idenifying an impairmen loss (Source: Annual repor of Sandvik, 2009) 4

5 Economic goodwill represens he difference beween he economic value and he carrying value of an eniy s ne asses (Preinreich, 1939). GWE EV CV (1) GWE EV CV = Economic goodwill based on he carrying value of operaing ne asses measured a ime = Economic value of he eniy a ime = Carrying value of operaing ne asses excluding goodwill of he eniy measured a ime For he purpose of he analysis, we will refer o economic value as deermined by he presen value of fuure cash flows. We will assume ha he economic value is equal o he recoverable amoun. Noe ha he carrying value does no include accouning goodwill of he eniy and ha he economic goodwill will comprise componens of boh value creaion and conservaive accouning recogniion and measuremen (Johansson e al., 2016). Equaion 2 describes he relaionship beween he conceps of accouning goodwill, economic goodwill and he buffer proecing goodwill from impairmen. BUF GWE GWA 1 (2) BUF = buffer proecing goodwill from impairmen a he CGU level GWE = economic goodwill based on he carrying value of operaing ne asses measured a ime GWA = accouning goodwill recognized due o he acquisiion a ime In connecion wih a goodwill impairmen es, he economic value of he CGU will be compared o he accouning goodwill, which is defined as he consideraion ransferred for he acquired eniy minus he carrying value of he operaing ne asses in he acquired eniy measured a he consolidaed level for he CGU, i.e., idenifiable asses and liabiliies measured a fair value. A buffer proecing goodwill from impairmen will exis when he economic goodwill exceeds he accouning goodwill. For he purpose of illusraing he ideas behind he PH Approach, assume ha he consideraion ransferred equals he economic value of he acquired eniy and ha he fair value measuremen of ha eniy s idenifiable asses and liabiliies eliminaes all accouning conservaism relaed o recogniion and measuremen. The accouning goodwill in his case will solely perain o acquired, so called, core goodwill, consising of he economic value of fuure expeced excess reurns including synergies (JP componens 1 and 2). The core goodwill will be consumed as he excess reurns are realized, and under he condiions assumed here, here is no buffer proecing goodwill from impairmen a he acquisiion dae. These condiions are illusraed in he lef-hand par of Figure 1. {Inser Figure 1 abou here} 5

6 However, combining he acquired eniy wih a pre-exising eniy will creae a buffer for his combined CGU a he acquisiion dae if he economic value exceeds he carrying value (including accouning goodwill) of he pre-exising eniy. This is he pre-acquisiion headroom (PH) referred o in he saff paper (IASB, 2016b), which is illusraed in he righ-hand par of Figure 1. SOME THEORETICAL ARGUMENTS Core goodwill should ideally become impaired as he excess reurns are realized. Thus, he impairmen es effeciveness should be evaluaed in comparison wih his ideal. As described above, he PH represens a buffer ha proecs accouning goodwill from being impaired under he curren IFRS model. Adding he PH o he carrying value of eniy s ne asses, for he purpose of he impairmen es, should make he es more effecive. However, he buffer does no only consis of he PH. There are oher facors o consider, boh a he acquisiion dae and during he posacquisiion period. A he acquisiion dae, he recoverable amoun may differ from he acquisiion cos due o wo componens: expeced synergies ha he acquirer has no paid for and any measuremen error in he acquisiion cos. BUF BUF 0 (1 )EV0,synergies P0,adj EV0,pre CV0,pre GWA 0,pre (1 )EV0,synergies P0,adj BUF0,pre (3) 0,PH (1 )EV0,synergies P0,adj (1 )EV0,synergies P0,adj (4) BUF 0 = buffer proecing goodwill from impairmen a he acquisiion dae under curren IAS 36 EV 0, = economic value of he relevan componen a he acquisiion dae BUF 0,pre = buffer proecing goodwill from impairmen emanaing from he pre-exising eniy a he acquisiion dae P 0,adj = measuremen error in he purchase price of he acquired eniy BUF 0,PH = buffer proecing goodwill from impairmen according o he PH approach a he acquisiion dae CV 0, = carrying value of he relevan componen a he acquisiion dae α = proporion of expeced synergies paid for by he acquirer Noe ha he buffer from he pre-exising eniy is equal o he pre-acquisiion headroom as proposed by he IASB saff. PH BUF 0,pre (5) PH = Pre-acquisiion headroom as proposed 6

7 Equaion 3 shows ha, for he combined CGU (described in Figure 1) a he acquisiion dae (=0), he oal buffer proecing goodwill from being impaired consiss of he PH, expeced synergies no paid for and any measuremen error relaed o he consideraion ransferred and possible over- /underpaymen (JP componens 5 and 6 of accouning goodwill). Le us now urn o wha happens o he combined CGU during he pos-acquisiion period. In a growh scenario, he economic value of he eniy will increase whereas he carrying amouns of ne operaing asses will no increase as much due o conservaive accouning, including growh in unrecognized asses and measuremen below fair value (JP componens 1 and 2). This will lead o gradual increase of he buffer over ime. In his siuaion, an unexpeced unfavorable oucome (lower han expeced cash flows), will no resul in any repored impairmen of he accouning goodwill as long as his economic goodwill loss is less han he buffer (Johansson e al., 2016, pp 17-18). The failure o recognize economic losses makes he goodwill impairmen es under he curren IFRS model ineffecive. EL GWE E 1 GWE (6) IMP 0 if BUF -EL (7) EL IMP = Economic goodwill loss in period = Goodwill impairmen in period One furher aspec of he growh scenario is ha he increase in he economic value will include inernally generaed core goodwill during he pos-acquisiion period (aciviies afer he acquisiion ha give rise o expeced fuure excess reurns). This adds o he buffer and decreases he probabiliy of impairmen under he curren IFRS model (Johansson e al., 2016, pp 18-19). The PH Approach only considers a par of he oal buffer, i.e., he PH ha exiss a he acquisiion dae. During he pos-acquisiion period, he PH is held consan which means ha he dynamic feaures of accouning conservaism and inernally generaed goodwill, emphasized in he JHH framework, are no capured. The IASB saff offer he following explanaion for heir choice of a consan adjusmen (IASB, 2016b, C14): Concepually, i would be appropriae o remeasure he PH every ime an impairmen es is performed because over ime he uni s asses and liabiliies (upon which he PH was calculaed) could change significanly. However, he saff noe ha his would resul in remeasuremen of any inernally generaed goodwill included in he PH amoun. This would be inconsisen wih he accouning reamen of he recognised goodwill, which is being esed for impairmen. Three commens on his explanaion. Firs, he quoaion indicaes ha he uni only refers o he pre-exising eniy. Since he uni is a combined eniy afer he acquisiion, and goodwill can only be deermined as a residual for his combined uni, i is he changes in asses and liabiliies of he 7

8 combined uni ha should be considered. Second, he reference o inernally generaed goodwill indicaes a broad view of his concep, comprising boh inernally generaed core goodwill and accouning conservaism. As hese wo componens are concepually differen (differen componens in he JP axonomy), and as he IASB saff are also considering improvemens wih regard o cerain idenifiable asses in he acquisiion analysis, i.e., cusomer relaions (IASB, 2016a), here is good reason o analyically disinguish beween inernally generaed core goodwill and conservaive recogniion/measuremen in he CGU during he pos-acquisiion period. Third, i says in he quoaion ha i would be concepually more appropriae o remeasure he PH, bu also ha his would be inconsisen wih he accouning reamen of recognized goodwill. Wha does his seemingly conradicory saemen mean? This is our inerpreaion: When conducing an impairmen es a a dae subsequen o he acquisiion, he economic value of he CGU will be measured a his subsequen dae. However, he carrying amoun of he asses and liabiliies will be based on values deermined a he acquisiion dae (less any depreciaion of fair value adjusmens) plus wha remains of subsequen capialized invesmens in fixed asses and working capial. Since he carrying amouns of fair value adjusmens will sill be based on he acquisiion analysis a he acquisiion dae, he PH should be deermined in he same way. Any deviaion from his principle would lead o inconsisency (he inconsisen accouning reamen argumen in he quoaion). The JHH Approach addresses all of he hree above poins in a differen way compared o he IASB Saff Paper. A comprehensive approach is adoped where all aspecs of he buffer are incorporaed, boh a he acquisiion dae and during he subsequen period. Concepual disincions are made beween he differen componens of goodwill so ha issues relaed o conservaive accouning can be analyzed separae from inernally generaed core goodwill. Wih regard o hird poin, here is a form of inernal accouning reamen consisency behind he choice of keeping he PH consan over ime, however, he overall oucome is ha he impairmen es comprises a comparison beween he curren economic value of he CGU and pas values deermined a acquisiion dae. Changes in he buffer during he pos-acquisiion period are no capured by he consan PH. Under he JHH approach, a differen soluions is suggesed as a remedy o he ineffeciveness of he goodwill impairmen es under he curren IFRS model (Johansson e al., 2016, p. 19). Insead of comparing he economic value of he CGU o he carrying values of asses and liabiliies, he JHH approach suggess ha asses and liabiliies are subjec o he same crieria as in connecion wih he acquisiion analysis, i.e., he idenifiable ne asses are measured a fair value. This implies ha he same measuremen principles are applied boh a he acquisiion dae and he daes of subsequen impairmen ess. Please noe ha hese subsequen fair value adjusmens only perain o he impairmen ess and do no affec he reporing of asses and liabiliies on he consolidaed saemen of financial posiion. In he nex secion, we formally compare he PH approach he curren IFRS model and he JHH Approach and draw some general conclusions. 8

9 ANALYSIS: COMPARISON OF THE PH APPROACH TO THE TWO BENCHMARK MODELS This secion includes a comparison beween he hree approaches discussed above. As can be seen in equaions 8 and 9 below, he buffer proecing goodwill will always be less under he PH approach han under he curren IAS 36 approach. Since PH is a non-negaive consan, he buffer according o he saff proposal is always less han or equal o he buffer according o he curren impairmen es in IAS 36. BUF BUF BUF PH (8) 0, 0,PH 0, pre BUF BUF,PH GWE GWA 1 GWE GWA 1 PH PH (9) The comparison beween he JHH approach and he PH approach deserves more aenion. Firs we deermine he buffer under he JHH approach. An adjusmen o he economic goodwill under he IAS 36 approach is made based on he difference beween he fair value of he separaely idenifiable ne asses and heir carrying value on he consolidaed balance shee. The carrying value includes he depreciaed/amorized fair value adjusmens recognized a he acquisiion dae. This is labelled IMPADJ in equaion 10. This adjusmen makes he economic goodwill and he buffer smaller under he JHH approach compared o he curren IAS 36 approach. GWE,JHH GWE EVR ADJ GWE IMPADJ (10),JHH 1 GWA min GWE GWA (11) BUF,JHH GWE GWA GWE IMPADJ GWA (12),JHH 1, 1 EVR = economic value in excess of he carrying value of recognized asses and liabiliies excluding fair-value adjusmens a ime ADJ = fair-value adjusmen for recognizable asses and liabiliies of he acquired eniy a ime, which is assumed o equal he economic value adjusmen a he ime of he acquisiion Under condiions of growh and unchanged relaive recogniion conservaism IMPADJ increases over ime. During he iniial years subsequen o he acquisiion he iniial fair value adjusmens are reversed, increasing economic goodwill bu increasing also IMPADJ wih he same amoun. This means ha he developmen of he buffer under he JHH approach is only dependen on he measuremen bias of unrecognized ne asses, core goodwill from he acquisiion and any inernally generaed core goodwill subsequen o he acquisiion. Equaions 13 and 14 make he comparison beween he buffer and he JHH and he PH approaches. BUF,PH BUF,JHH GWE, GWA 1, PH GWE, IMPADJ GWA 1 (13) BUF,PH BUF,JHH IMPADJ PH (14) 9

10 Wih growh and consan relaive measuremen bias, IMPADJ increases over ime and PH is consan over ime. Since IMPADJ sars a 0 and increases over ime, while PH is a non-negaive consan, i is clear ha when any economic goodwill exiss in he CGU o which he acquired eniy is allocaed (PH is posiive), he saff proposal will iniially resul in a lower buffer han according o he JHH approach and he curren impairmen es. Thereafer, he speed of he increase in he recogniion conservaism in he CGU, in absolue erms, deermines a wha ime he JHH Approach akes over as he mehod wih he lowes goodwill impairmen buffer. Equaions 15 hrough 19 illusraes he effec of a special case. This is when he pre-exising par of he CGU suffers from a value decrease, an economic loss. Depending he relaive size of he pre-exising par and he newly acquired eniy, as well as he magniude o he economic loss, he PH approach will generae a siuaion where newly acquired goodwill will be impaired even hough no economic loss in ha eniy has occurred and he acquisiion progresses according o plan. GWE GWE GWE,acq,pre,pre GWE 0 E 1, acq (15) GWE 0 E 1, pre (16) E GWE GWE E GWE EL 0 1,pre,acq 1,acq (17) If GWE,pre GWE,acq PH GWA 1 (18) IMP 0 (19) The siuaion modelled above resembles he condiions afer he boom in he mid-2000s and he following credi crunch from 2007/08 onwards. When he economic loss due o he unexpeced decrease in he economic goodwill in he pre-exising par of he CGU in equaion 16 corresponds o he low economic goodwill adjused for he PH o defend all goodwill in he CGU in equaion 18, his causes a recognized impairmen. The effec is ha insead of seeing oo lile oo lae impairmens we migh experience oo much oo soon. Noe furher ha wha happens in he CGU is ha any buffer in he pre-exising par of he CGU, defending pre-exising accouning goodwill in he CGU, also disappears which makes boh new and pre-exising accouning goodwill more exposed o impairmens. The effec on pre-exising accouning goodwill is difficul o align wih he IASB saff argumen ha values deermined a he acquisiion dae mus always be used for he purpose of he impairmen es (see earlier discussion regarding IASB, 2016b, C14). Even hough he acquisiion analysis deermining he pre-exising accouning goodwill in he CGU has no changed, he PH Approach will make his goodwill less proeced from impairmen. ILLUSTRATIVE EXAMPLE In his secion we briefly show wo illusraive examples of he developmens analyzed above. The firs case presened in able 1 relaes o he numerical example used by Johansson e al. (2016). 10

11 Panel A of able 1 illusraes he siuaion under he curren IAS 36 approach wih large buffers making impairmens very rare and when hey occur hey are small. Panel B of able 1 presens he comparison wih he wo alernaive approaches. In he comparison beween, we observe he ime series developmen of he buffers and ha he buffer under he JHH approach becomes smaller afer 8 periods in he numerical example. The rade-offs beween he shor-erm vs long-erm gains are apparen. Inser Table 1 here Table 2 illusraes he case where we afer 1 year see a subsanial decrease in value for he par of he CGU ha exised prior o he acquisiion whereas he value of he acquired eniy develops according o plan. The exising par experiences a 10 % value decrease in he second year afer he acquisiion and an addiion 35 % decrease in he hird year afer he acquisiion. Then abou 75 % of he recognized goodwill a he ime of he acquisiion relaed o he newly acquired eniy is impaired even hough no value decrease has emerged for ha eniy. The homogeneiy of he businesses wihin he CGU could limi hese effecs bu wih reporing eniies wih for example geographical differences wihin CGUs his could occur. Noe furher ha no such effec is presen under he JHH approach. Inser Table 2 here DISCUSSION AND CONCLUSION This paper provides an analyical evaluaion of he PH Approach by comparing i wih (i) he curren IFRS approach, and (ii) a recenly developed framework (JHH Approach) which, in urn, builds on he concepual paper by Johnson & Perone (1998). We firs conclude ha he PH Approach resuls in a more effecive impairmen es compared o he curren IFRS approach. Second, we find ha, in comparison wih he Johansson e al. (2016) approach, considering growh scenarios, he PH Approach is more effecive in he shor run and less effecive in he long run. The reason behind his oucome is ha he PH Approach favors a form of inernal consisency (accouning value bases deermined a he acquisiion dae remain during he pos-acquisiion period) over consisen fair value measuremen a all poins in ime (he JHH Approach). Our analysis furher shows ha he use of a consan pre-acquisiion headroom from he acquisiion dae makes he PH Approach saic and over-effecive ( oo much, oo early ) in cerain siuaions where economic value decreases in pars of he cash-generaing uni no relaed o he acquisiion. This paper focuses on analyical aspecs whereas pracical aspecs and coss for preparers have no been discussed so far. An advanage of he PH Approach is ha he PH mus only be deermined 11

12 once, in connecion wih he acquisiion dae, when he acquired eniy is combined wih he acquirer. However, if he goodwill is allocaed o several CGUs, which is no uncommon in pracice, PHs for all hese CGUs will have o be deermined. A bigger problem may arise during he pos-acquisiion period. Consider he following saemen in a press release from he Finnish company Sora Enso: Sora Enso is reorganizing is operaions from he curren four divisions o eigh separae business areas: Fine Paper, Merchans, Consumer Board, Indusrial Packaging, Magazine Paper, News Prin, Norh America and Wood Producs. An impairmen charge oaling abou EUR will be accouned for as a non-recurring iem wihou cash impac in he hird quarer of 2007 The impairmen charge arises from a number of facors including he reorganizaion ino eigh separae business areas, increased wood coss mainly driven by expor duies on wood from Russia, he poor oulook for magazine papers, rising ineres raes and adverse currency movemens. (Source: Press release of Sora Enso, 5 Sepember, 2007, emphasis added) The quoaion suggess ha he impairmen was o some exen relaed o he reorganizaion. Why? In he annual repor for he same year (Annual repor of Sora Enso 2007, p. 152), i is furher saed ha he creaion of he new business areas resuled in new groups of cash-generaing unis o be esed for goodwill impairmen. Some of he impairmen loss referred o in he quoaion perained o goodwill. This example poins a a pracical problem wih regard o he PH Approach. Even hough he iniial PH is only deermined once, reallocaions of his amoun will have o be made in connecion wih changes of he CGUs. If he CGU for which he PH was originally deermined no longer exiss, he logic behind he approach will become less clear and he allocaion may be perceived as arificial. Wih regard o he JHH Approach, here are addiional coss for preparers in erms of making fairvalue adjusmens for he CGU for he purpose of he es; however, he coss should be somewha limied because preparers would already have experience of making such fair-value adjusmens as of he acquisiion dae. Based on our analysis, we acknowledge he improved effeciveness of he impairmen es as compared o he curren IFRS model. However, we propose ha he PH Approach is reconsidered in favor of using he same perspecive on goodwill measuremen over ime, as in he JHH Approach, insead of using a consan hisorical amoun as in he PH Approach. This would also address he ineffeciveness problems more comprehensively as he JHH Approach is no limied o he issue of pre-exising economic goodwill in he CGU. 12

13 REFERENCES IASB (2016a). Goodwill and Impairmen Projec. Progress Repor: Goodwill and Oher Inangible Asses in a Business Combinaion. Saff Paper prepared for IASB/FASB Meeing. IASB Agenda Ref 18A, June. IASB (2016b). Goodwill and Impairmen Projec. Progress Repor: Improving he Impairmen Requiremens. Saff Paper prepared for IASB/FASB Meeing. IASB Agenda Ref 18B, June. IFRS Foundaion (2015). Pos-implemenaion review of IFRS 3 Business Combinaions. Repor and Feedback Saemen. July. Johansson, S-E., Hjelsröm, T., & Hellman, N. (2016). Accouning for goodwill under IFRS: A criical analysis. Journal of Inernaional Accouning, Audiing & Taxaion, 27, Johnson, L. T., & Perone, K. R. (1998). Is goodwill an asse? Accouning Horizons, 12(3), Preinreich, G. A. D. (1939). Economic heories of goodwill. Journal of Accounancy, 68(3),

14 Table 1. Analysis of he developmen of he buffer proecing goodwill from impairmen under he IAS36, he JHH and he pre-acquisiion headroom approaches. Table 1 Panel A: Impairmen es according o curren IAS 36 EV,alone 121,5 127,8 133,9 139,9 145,8 151,6 157,3 162,9 168,3 173,6 178,8 EV ,6 267,8 279,8 291,6 303,2 314,6 325,8 336,6 347,2 357,6 GWE, , ,2 116,4 119,6 123,2 127,2 131,6 136,8 143 GWA 41,5 41,5 41,5 41,5 41,5 41,5 41,5 41,5 41,5 41,5 41,5 BUF 61,5 65,3 68,5 71,7 74,9 78,1 81,7 85,7 90,1 95,3 101,5 (1) Necessary drop in value o cause an impairmen loss N/A 51,10% 51,20% 51,30% 51,40% 51,50% 51,90% 52,60% 53,50% 54,90% 56,80% (2) Necessary drop in value o eliminae GWA N/A 83,60% 82,20% 80,90% 79,80% 78,90% 78,30% 78,10% 78,20% 78,80% 80,00% Panel B: Adjused impairmen es GWC,acq 21,5 18,8 15,8 12,8 9,8 6,9 4,5 2,4 0,9 0 0 GWC,pre 21,5 18,8 15,8 12,8 9,8 6,9 4,5 2,4 0,9 0 0 GWE , ,2 116,4 119,6 123,2 127,2 131,6 136,8 143 IMPADJ 20 25,6 31,2 36,8 42,4 47,8 53,2 58,2 62,8 67,4 71,5 GWA 41,5 41,5 41,5 41,5 41,5 41,5 41,5 41,5 41,5 41,5 41,5 BUF,JHH 41,5 39,7 37,3 34,9 32,5 30,3 28,5 27,5 27,3 27,9 30 CV,unadj 60 65,4 70,9 76,3 81,6 86,8 91,7 96,3 100,5 104,2 107,3 PH 61,5 61,5 61,5 61,5 61,5 61,5 61,5 61,5 61,5 61,5 61,5 BUF,PH 0 3,8 7 10,2 13,4 16,6 20,2 24,2 28,6 33,8 40 BUF,PH vs BUF -61,5-61,5-61,5-61,5-61,5-61,5-61,5-61,5-61,5-61,5-61,5 BUF, PH vs BUF,JHH -41,5-35,9-30,3-24,7-19,1-13,7-8,3-3,3 1,3 5,9 10 Change in IMPADJ from acquisiion dae 5,6 11,2 16,8 22,4 27,8 33,2 38,2 42,8 47,4 51,5 Panel A of he able presens he numerical illusraions of (1) he percenage drop in he economic value of he acquired eniy required o cause any goodwill impairmen loss and (2) he percenage drop in he economic value of he acquired eniy ha causes a complee impairmen of accouning goodwill under he curren IAS36 impairmen approach. Panel B of he able shows he same measures as in Panel A bu using he wo alernaive approaches, JHH and pre-acquisiion headroom, o impairmen ess. The acquired eniy becomes an inegraed par of he acquirer s operaions and his inegraed eniy is assumed o form a combined CGU. The acquirer s operaions in his CGU are assumed o be of he same size and have he same cash flows and accouning characerisics as does he acquired eniy. The able includes key variables relaing o goodwill and he buffer proecing goodwill from impairmen. Each number refers o he beginning of he year saed in he column heading. The explanaions of each variable are as follows: EV,alone Economic value of he enire acquired eniy. EV Economic value of he combined cash-generaing uni. GWC,acq Core goodwill of he acquired eniy according o he Johnson & Perone definiion. GWC,in Core goodwill of he pre-exising par of he cash-generaing uni according o he Johnson & Perone definiion. GWE Economic goodwill of he combined cash-generaing uni. This is he difference beween he economic value and he carrying value of he operaing ne asses. GWA Accouning goodwill for he combined cash-generaing uni, i.e., he goodwill repored on he consolidaed saemen of financial posiion. BUF Buffer proecing goodwill from being impaired in he cash-generaing uni. This buffer consiss of buffers from boh he acquired eniy and he par of he acquirer s pre-exising operaions allocaed o he cashgeneraing uni. The buffer for he combined cash-generaing uni, BUF, is he difference beween he economic goodwill, GWE, and he accouning goodwill, GWA. IMPADJ Adjusmens based on he difference beween he economic value of he recognized operaing ne asses and he carrying value of hese operaing ne asses. CV,unadj Carrying value of he operaing ne asses in he acquired eniy before any fair-value adjusmens for consolidaion purposes PH Pre-acquisiion headroom adjusmen o he impairmen es BUF,PH Buffer proecing goodwill under he pre-acquisiion headroom approach BUF,JHH Buffer proecing goodwill under he JHH approach 14

15 Table 2. Analysis of he developmen of he buffer proecing goodwill from impairmen under he JHH and he pre-acquisiion headroom approaches wih economic losses Table 2 EV,pre 121,5 127,8 115,0 86,3 89,9 93,5 97,0 100,4 103,8 107,0 110,3 EV,acq 60,75 63,9 66,95 69,95 72,9 75,8 78,7 81,5 84,2 86,8 89,4 EV 182,25 191,7 182,0 156,2 162,8 169,3 175,6 181,9 187,9 193,8 199,7 GWC,acq 10,75 9,4 7,9 6,4 4,9 3,45 2,25 1,2 0, GWC,pre 21,5 18,8 15,8 12,8 9,8 6,9 4,5 2,4 0,9 0 0 GWE 82,3 84,6 79,0 67,0 67,9 68,9 70,3 71,9 74,0 76,5 79,9 IMPADJ 20,0 23,7 23,7 20,4 23,6 26,8 29,8 32,7 35,3 37,8 39,9 GWA 20,8 20,8 20,8 20,8 20,8 20,8 20,8 20,8 20,8 20,8 20,8 BUF, 41,5 40,2 34,6 25,9 23,6 21,4 19,8 18,5 17,9 18,0 19,2 BUF,PH 0,0 2,3-3,2-15,2-14,3-13,3-11,9-10,3-8,3-5,7-2,4 Impairmen under PH 0,0 0,0-3,2-12,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 GWA under PH approach 20,8 20,8 17,5 5,5 5,5 5,5 5,5 5,5 5,5 5,5 5,5 The able presens he numerical effecs of a sudden decrease in value in he pre-exising par of he cashgeneraing uni and is effecs on he oal accouning goodwill in ha uni under he pre-acquisiion headroom approach. The acquired eniy becomes an inegraed par of he acquirer s operaions and his inegraed eniy is assumed o form a combined CGU. The acquirer s operaions in his CGU are assumed o be wice he size and cash flows of he acquired eniy bu hey share he same accouning characerisics. The able includes key variables relaing o goodwill and he buffer proecing goodwill from impairmen. Each number refers o he beginning of he year saed in he column heading. The explanaions of each variable are as follows: EV,pre Economic value of he pre-exising par of he cash-generaing uni. EV,acq Economic value of he acquired eniy. EV Economic value of he combined cash-generaing uni. GWC,acq Core goodwill of he acquired eniy according o he Johnson & Perone definiion. GWC,pre Core goodwill of he pre-exising par of he cash-generaing uni according o he Johnson & Perone definiion. GWE Economic goodwill of he combined cash-generaing uni. This is he difference beween he economic value and he carrying value of he operaing ne asses. IMPADJ Adjusmens based on he difference beween he economic value of he recognized operaing ne asses and he carrying value of hese operaing ne asses. GWA Accouning goodwill for he combined cash-generaing uni, i.e., he goodwill repored on he consolidaed saemen of financial posiion. BUF Buffer proecing goodwill from being impaired in he cash-generaing uni. This buffer consiss of buffers from boh he acquired eniy and he par of he acquirer s pre-exising operaions allocaed o he cashgeneraing uni. The buffer for he combined CGU, BUF,IAS36, is he difference beween he economic goodwill, GWE, and he accouning goodwill, GWA. Buffer proecing goodwill under he pre-acquisiion headroom approach BUF,PH 15

16 Figure 1. Illusraion of how pre-acquisiion headroom is incorporaed in a cash-generaing uni in connecion wih an acquisiion 16