Term Paper on "Switch to IAS IFRS the Challenge Presented by Goodwill"

Term Paper 38 pages (10455 words) Sources: 30

[EXCERPT] . . . .

Switch to IAS/IFRS: The Challenge presented by Goodwill

As the months go by, European listed companies are discovering the upheavals involved in implementing IAS/IFRS from the FY 2005. The controversy surrounding IAS 39 (recognising and measuring financial instruments) has been a case of missing the forest for the trees; although there is no doubt that this standard is likely to have a major impact on companies in the financial sector, other IAS/IFRS standards are likely to impact just as much on the balance sheets of large industrial or retail groups. For example, there is IAS 22 (business combinations) and IAS 36 (impairment of assets) which will completely overhaul the way goodwill is treated - depreciation is replaced with the impairment test, which means a strict definition of a model for valuing assets acquired, which will make it possible to monitor the assets over several years. Both standards issue a series of recommendations, for the most part indicative, certain aspects of which may be somewhat baffling to valuation experts, but which most importantly are likely to usher in significant changes in the relationship between a company and its auditors.

The aim of this study was to analyse the scope of the methodology recommended by these two standards in terms of valuation, and the implications of the imminent introduction thereof for the various actors involved (finance and accounts department within companies, auditors, market authorities, financial analysts, etc.) and their relationships with each other. To this end, a critical review of the relevant peer-reviewed, scholarly and organizational literature concerning how things have changed for listed European companies now that they must disclose their financial statements according to international financial reporting standards, with special emphasis on goodwill, is followed by a summary of the research and salient findings in the conclusion.

Review and Discussion

Background and Overview.

In recent years, policymakers at all levels of the European Commission have encountered some unexpected and costly problems in their efforts to achieve convergence and harmony across the board. In this regard, Radig and Loudermilk (1998) reported early on that, "Business expansion beyond national boundaries is widespread today, and companies must function in countries where cultures and laws are different from our own. There is a need for uniformity in accounting principles used within multinational companies" (22). To this end, the International Accounting Standards Committee (IASC) was created in 1973 to achieve this goal, but the organization has encountered problems based on nationalistic pride and preference, different models in place and a dearth of authority when dealing with governmental bodies (Radig and Loudermilk 22).

Likewise, in her study, "Large Firms Envision Worldwide Convergence of Standards," Street (2002) reports that, "Currently, the largest accounting firms' are working diligently in conjunction with their partners in the International Forum on Accountancy Development (IFAD) to achieve their vision of raising national accounting and auditing standards worldwide to meet or exceed internationally recognized benchmarks. An awareness of the ongoing activities of the firms and their IFAD partners to improve financial reporting, accountability, and transparency worldwide is crucial if other members of the accounting community, including educators, are to support and, more importantly, actively participate in these efforts" (215).

The IFAD was created in 1999 based on.".. The premise that the expertise of the accounting profession and the financial resources of the World Bank and other international financial institutions when combined... could be harnessed in the interests of enhancing accounting capacity and capabilities in developing and emerging nations" (Street 214). Over time, IFAD's objectives were expanded to include common global issues as well, and today, more than 30 international institutions, including:

The International Monetary Fund (IMF), International Federation of Accountants (IFAC);

The International Accounting Standards Board (IASB);

The International Organization of Securities Commissions (IOSCO);

The Organization for Economic Cooperation and Development (OECD); and,

The International Association for Accounting Education and Research (IAAER) (Street 215).

All of these organizations and agencies are collaborating with the member firms to support reform programs intended to improve the quality of financial reporting and auditing around the world (Street 215). The large firms and their partners agree that a framework for reforms in individual countries involves three steps:

Determine the standards that should apply;

Assess the extent to which the standards have been adopted and arrangements for ensuring compliance; and,

Implement an action plan to address identified gaps in performance (Street 215).

The large firms' "Vision" holds that "all general purpose financial information must be prepared using a single world-wide framework using common measurement criteria and fair and comprehensive disclosure." The Vision asserts that the national standards of many countries should be raised with the IASB's International Accounting Standards (IAS)/International Financial Reporting Standards (IFRS) and IFAC's International Standards of Auditing (ISA) serving as the benchmarks. In addition, the Vision emphasizes the importance of implementing IFAC's new global ethics standards and the significance of other issues that must be addressed if change is to materialize; these initiatives include (a) corporate governance, (b) financial accountability and reporting laws, and - education. In addition, the Vision concerns all countries, all companies, and all accountants and auditors (Street 215).

During this effort, the firms and their partners have also been actively addressing the need and manner for compliance with international standards. Analyses by Cairns (1999) and a study by Street and Gray (2001) identified instances of companies that claimed to have prepared IAS financials that clearly diverge from IAS in some cases. To address this issue, effective for 1999-year-end financial statements, the IASB revised IAS No. 1 to require that "financial statements should not be described as complying with International Accounting Standards unless they comply with all the requirements of each applicable standard." Additionally, the large firms have worked with IFAC to launch the Forum of Firms, an organization of international firms that perform audits of financial statements that may be used across national borders. Members agree to several requirements, including undergoing a global independent quality review. Commitment to all the obligations of membership contributes to raising the standards of the international practice of auditing (Street 216).

To further address compliance, the large firms are developing training programs, and several are proceeding on the premise that staff must pass an internal test before working on audits of IAS/IFRS financial statements. Additionally, the large firms are initiating quality controls for IAS/IFRS audits. These are similar to controls developed several years ago for non-U.S. companies that report according to U.S. GAAP, as compliance problems also initially existed here. Currently, there are fewer compliance problems as the quality control system requires reviews by U.S. GAAP experts. In combination with ongoing efforts to raise auditing standards in all countries to the international benchmark, the new quality control reviews should yield the same improvement for IAS/IFRS companies. Commenting on the efforts of the large firms, IASB Chairman Sir David Tweedie stated: "The IASB's objective of having one single set of high-quality global standards to meet the worldwide aim of comprehensible, transparent and reliable financial statements would be rendered pointless if the auditing firms did not apply rigorous, high-quality global auditing standards to ensure that a fair presentation is given in these statements" (quoted in Street at 216).

The Challenge Presented by Goodwill.

While "goodwill" may appear to be an ephemeral and nebulous concept, there are some definitions and tests available to help place a dollar figure on it. According to Black's Law Dictionary (1990), goodwill is, "The favor which the management of a business wins from the public. The favorable consideration shown by the purchasing public to goods or services known to emanate from a particular source.... The excess of cost of an acquired firm or operating unit over the current or fair market value of net assets of the acquired unit. Informally used to indicate the value of good customer relations" (694). By contrast, the term "consolidated goodwill" is used to refer to the difference between the fair value of the consideration given by an acquiring company when buying a business and the aggregate of the fair values of the separable net assets acquired; in this regard goodwill is generally a positive amount that should be eliminated by writing it off immediately to the reserves or alternatively by amortization to the profit and loss account over its useful life, to comply with "Statement of Standard Accounting Practice 22, Accounting for Goodwill" (Pallister et al. 118).

In addition, the term "purchased goodwill" is used to describe the difference between the fair value of the price paid for a business and the aggregate of the fair values of its separable net assets. According to Butler, Butler and Isaacs (1997), purchased goodwill.".. may be written off to reserves or recognized as an intangible asset in the balance sheet and written off by amortization to the profit and loss account over its useful economic life. Internally generated goodwill should not be recognized in the financial statements of an organization. The treatment of goodwill is governed by 'Statement of Standard Accounting Practice 22, Accounting for Goodwill'" (157). In their essay, "Accounting… READ MORE

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