We’ve already considered a couple of the issues raised by the EFRAG discussion paper Goodwill impairment test: can it be improved?, which was published last June.

Here’s another topic:

• In accordance with IAS 36, estimating value in use involves estimating the future cash flows to be derived from continuing use of the CGU and from its ultimate disposal. The cash flow projections should be based on reasonable and supportable assumptions and the most recent budgets and forecasts.
• The cash flow projections should relate to the asset in its current condition. Thus, the VIU should not reflect cost saving or benefits that are expected to arise from enhancements or future restructurings but to which an entity is not yet formally committed.

The possible problem here is that excluding such future restructurings “does not reflect how acquirers price the busi­ness. Typically, a buyer would incorporate future restructurings and changes in the processes when determining the maximum purchase price to be paid.” The paper therefore proposes that the measurement of VIU “should be changed to allow the effect of planned future restructurings (in­flows and outflows) to be incorporated in the cash flow projection, even when the threshold to recognize a provision for restructuring costs has not yet been met.” It notes:

• To mitigate these risks, an entity could be allowed to take into account future restructuring only if it has a formal plan (al­though not yet made public) and/or the restructuring is expected to be completed in the foreseeable future. In addition, an entity may be required to demonstrate the technical feasibility of completing the restructuring plan and the availability of adequate financial and other resources to complete the plan (similar to the guidance in paragraph 57 of IAS 38 to recognize an intangible asset arising from development).

It might seem that this only extends a conceptual murkiness in the current standard – when do restructurings actually create new sources of value, rather than preserve the carrying value of existing goodwill? And whatever the answer is, does it matter? This is how the Austrian Financial Reporting and Auditing Committee sees it:

• While we believe that the simple inclusion of future restructurings in the calculation is not in line with the concept of the VIU, the special situation concerning goodwill may justify a broader view for two reasons: on the one hand the special nature of goodwill as an aggregate item, on the other hand the prohibition of reversing an impairment loss.

Most other respondents also support the idea. Mazars for instance argues that such changes “would reduce costs, since entities would have to build one single business plan of the CGU for management and impairment purposes. At the same time we believe they would enhance the relevance of the impairment test, which would be based on how the entity intends to run the business.” Some, like the Dutch Accounting Standards Board, would support going further: “we are of the opinion that future capital enhancements – under similar conditions – have to be added to the calculation method for determination of the value in use as well.”

Perhaps there’s a subtext here that ties back to my recent comments on how only 20% of companies’ market value is typically represented by the tangible assets recognized in the financial statements. If you stick to a rigid view that only purchased goodwill is recognized and measured, and that those calculations should be untainted by the incursion of subsequently-created internally-generated goodwill, then it likely leads you to a more spartan view of what the value in use calculation encompasses. But since any such division between the two types of goodwill will be judgmental at best, perhaps it’s not so conceptually offensive if the lines between the two kinds of goodwill are allowed to blur. Especially as a strict approach to isolating the purchased goodwill will only persistently reduce the effectiveness of the statements at representing an entity’s market value.

But of course, such pragmatism only points to the broader folly of the whole thing – if internally-generated goodwill can in effect be recognized to some degree, why should that recognition stop at the cost amount of a past goodwill purchase? After all, the more time passes, the more this limit becomes essentially arbitrary, unrelated to the company’s current economics or to the basis on which it may generate value in the future. If we’re happy with taking future restructurings and future capital enhancements into account in maintaining the carrying value of past assets, why wouldn’t they be an equally reliable input into identifying and recognizing new assets? Once you start thinking along those lines, you might conclude that any such tweaks to the goodwill impairment test will be merely the smallest of first steps in a long conceptual journey. Even though, as I wrote before, that journey already seems to be seriously overdue…

The opinions expressed are solely those of the author