FINANCIAL REPORTING DOSSIER

This article provides key recent updates in financial reporting in the global space; insights into an accounting topic, viz., subsequent accounting of goodwill tracing its roots, developments and upcoming changes; compliance aspects of tax reconciliation disclosure under Ind AS; and a peek at an international reporting practice in the Directors’ Remuneration Report

1.    KEY RECENT UPDATES

1.1     Audit quality in a multidisciplinary firm

The International Federation of Accountants (IFAC) released a publication, Audit Quality in a Multidisciplinary Firm – What the Evidence Shows, on 25^th September, 2019 aimed at contributing to the debate on multidisciplinary firms. A multidisciplinary firm provides audit and non-audit services under a single brand name. The publication strives to provide readers with a better understanding of how the multidisciplinary model is the most effective structure to serve the audit function and how the rules that have evolved over the past decades serve to mitigate risks associated with audit firms providing non-audit services to some audit clients.

1.2     USGAAP – Simplifying the classification of debt

The Financial Accounting Standards Board (FASB) issued an Exposure Draft (ED) on 12^th September, 2019 proposing changes to Topic 470, Debt, of USGAAP. The proposed accounting standards update – Simplifying the Classification of Debt in a Classified Balance Sheet (Current vs. Non-Current) – would shift the classification of certain debt arrangements between non-current and current liabilities.

The ED introduces a principle for determining whether a debt arrangement should be classified as non-current liability. The principle is that an entity should classify an instrument as non-current if either of the following criteria is met at the reporting date: (1) the liability is contractually due to be settled more than one year (or operating cycle, if longer) after the balance sheet date; (2) the entity has a contractual right to defer settlement of the liability for at least one year (or operating cycle, if longer) after the balance sheet date. As an example of the proposed changes, current USGAAP requires short-term debt that is refinanced on a long-term basis (after the balance sheet date but before issue of financial statements) to be classified as non-current liability. The amendment proposed prohibits an entity from considering a subsequent financing when determining classification of debt at the balance sheet date.

1.3     IFRS – Business Combinations Under Common Control

The International Accounting Standards Board (IASB) at its 22^nd October, 2019 meeting finalised its discussion on the scope of the project ‘Business Combinations Under Common Control’ and is exploring how companies should account for the same. It tentatively decided that a receiving entity should recognise and measure assets and liabilities transferred in a business combination under common control at the carrying amounts included in the financial statements of the transferred entity. A discussion paper is expected to be published in the first quarter of 2020.

2.    RESEARCH: DAY 2 GOODWILL ACCOUNTING

2.1     Introduction

The Day 2 (subsequent measurement) accounting for goodwill is a contentious issue in accounting literature. Over the years, different accounting models have been evaluated / mandated by global standard setting bodies. The FASB and the IASB are both currently working on projects involving research on goodwill and impairment.

Stakeholders continue their quest to seek answers to related questions that include (a) how is the consumption of economic benefits embodied in the asset ‘goodwill’ reflected in the financial statements? (b) whether an impairment of goodwill communicates its periodic consumption or erosion in value, etc.

2.2     Setting the context

Analysis of three sample companies’ data is provided below:

As can be seen from the table above, company 3 has goodwill that is 157.7% of its total equity. It may be noted that the company uses Alternate Performance Measures (APMs) in reporting business performance to stakeholders (in management commentary / presentations, etc.). In arriving at APMs, the company adjusts its IFRS results for some items that include amortisation of intangibles and impairment of goodwill. The resultant adjusted measures include ‘Adjusted Operating Profit’, ‘Adjusted PBT’ and ‘Adjusted EPS’. The objective of reporting APMs is to provide users with useful complementary information to better understand the financial performance and position of the company.

In the following sections (2.3 to 2.7), an attempt is made to address the following questions:

2.3     Goodwill

IFRS / Ind AS define goodwill as ‘an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognised’. The USGAAP definition of goodwill is in line.

AS has not specifically defined goodwill but explains as follows:

(a)     Goodwill arising on amalgamation represents a payment made in anticipation of future income and it is appropriate to treat it as an asset to be amortised to income on a systematic basis over its useful life. (Para 19, AS 14);

(b)     Goodwill arising on acquisition represents a payment made by an acquirer in anticipation of future economic benefits. The future economic benefits may result from synergy between the identifiable assets acquired or from assets that individually do not qualify for recognition in the financial statements. (Para 79, AS 28).

Goodwill is invariably an accounting plug as the quantum recorded is a function of the accounting model and the policy choices adopted on the date of acquisition. At the same time it is an accounting asset as it represents future economic benefits arising from other assets in a business combination that are not separately recognised.

2.4     Accounting models evaluated / mandated by standard setters

A summary of various approaches evaluated / mandated by standard setters over the years is summarised below:

2.5     Development of Goodwill Day 2 accounting

2.5.1 USGAAP

APB Opinion No. 17, Intangible Assets issued in August, 1970 by the Financial Accounting Standards Board (FASB), explained goodwill as the excess of the cost of an acquired company over the sum of identifiable net assets. Goodwill was required to be amortised to the income statement on a systematic basis over the period estimated to be benefited, not exceeding forty years.

In June, 2001 the FASB issued SFAS No. 142, Goodwill and Other Intangible Assets that prohibited amortisation of goodwill. Goodwill would instead be tested at least annually for impairment. The impairment of goodwill was based on a two-step approach. In Step 1, the fair value of a reporting unit (to which goodwill was assigned) was compared with its carrying amount and in case the carrying value exceeded the fair value, then the entity undertook Step 2. In Step 2, the impairment of goodwill was measured as the excess of the carrying amount of goodwill over its implied fair value. The implied fair value of goodwill was calculated in the same manner in which goodwill is recognised in a business combination.

The FASB issued ASU 2017-04 in January, 2017 Simplifying the Test for Goodwill Impairment (effective for public listed entities for fiscal years beginning after 15^th December, 2019) eliminating Step 2, thereby requiring the annual goodwill impairment test to be conducted by comparing the fair value of a reporting unit with its carrying amount.

At present, non-controlling interests (NCI), if any, need to be accounted in USGAAP by measuring the same at their fair value.

2.5.2 IFRS

The current standard governing the accounting for acquisitions and the resultant recognition of goodwill as an asset is IFRS 3, Business Combinations, issued in March, 2004 by the IASB. IFRS 3 treats goodwill as an asset akin to an indefinite-life intangible asset and permits an impairment-only approach. Para 90 of IAS 36, Impairment of Assets, states that a cash-generating unit to which goodwill has been allocated shall be tested for impairment annually and whenever there is an indication that the unit may be impaired. The carrying amount of a cash-generating unit (to which goodwill is allocated) is compared with its recoverable amount to determine the impairment loss.

Prior to the addition of IFRS 3 to the authoritative literature, its predecessor, IAS 22, Business Combinations, required goodwill to be amortised with a rebuttable presumption that its useful life did not exceed 20 years from the date of initial recognition. In case a reporting entity rebutted the presumption, goodwill was compulsorily required to be subject to annual impairment testing even if there was no indication that it was impaired.

IFRS 3 permits an accounting policy choice with respect to calculation of NCI at the date of acquisition. An entity can opt to measure NCI either at fair value (resulting in recording of ‘full goodwill’) or as its proportionate share in the acquiree’s identifiable net assets (resulting in recording of ‘partial goodwill’) per Para 19, IFRS 3. For the purposes of impairment testing, goodwill needs to be notionally grossed up in arriving at the carrying amount of the cash-generating unit to which goodwill has been assigned when the ‘partial goodwill’ method has been adopted (Appendix C, IAS 36).

2.6     Current positions under various GAAPs for goodwill accounting

2.7     Coming up next

(1) The IASB (that issues IFRSs) has planned to release a Discussion Paper (DP) in February, 2020 to present its preliminary views on ‘Goodwill and Impairment’ that inter alia include the following:

(2) The FASB (that issues USGAAP) in July, 2019 issued an Invitation to Comment – Identifiable Intangible Assets and Subsequent Accounting for Goodwill that includes invitation to comment inter alia on the project area ‘Whether to change the subsequent accounting for goodwill’.

Ind AS and IFRS preparers and auditors need to watch this space.

3.    GLOBAL ANNUAL REPORT EXTRACTS: ‘RELATIVE IMPORTANCE OF SPEND ON PAY’

3.1     Background

UK Company Law requires disclosures of ‘The Relative Importance of Spend on Pay’ in the Directors’ Remuneration Report.

The Large and Medium-sized Companies and Groups (Accounts and Reports) (Amendment) Regulations 2013 (effective 1^st October, 2013) require the Directors’ Remuneration Report to set out in a graphical or tabular form the actual expenditure for the financial year and the immediately preceding financial year and the difference in spend between those years on – (i) remuneration paid / payable to employees, (ii) distribution to shareholders by way of dividend and share buyback, and (iii) any other significant distributions / payments deemed by the directors to assist in understanding the relative importance of spend on pay.

3.2     Extracts from the ‘Directors’ Remuneration Report’ section of an Annual Report

Company: Burberry Group Plc, FTSE 100 Index constituent (2019 Revenues: GBP 2.7 billion)

Relative importance of spend on pay for 2018/19

The table below sets out the total payroll costs for all employees over FY 2018/19 compared to total dividends payable for the year and amounts paid to buy back shares during the year. The average number of full-time equivalent employees is also shown for context.

4.    COMPLIANCE: TAX RECONCILIATION DISCLOSURE (Ind AS)

Tax reconciliation disclosure

4.1     What is the disclosure requirement?

Ind AS requires a Tax Reconciliation Disclosure in the notes. The objective of the disclosure is to enable users understand whether the relationship between Tax Expense and profit before Tax (PBT) is unusual and to understand the significant factors that could affect the relationship in the future. The disclosure facilitates users to model a long-term forecast tax rate in valuation analysis.

4.2     Where are the disclosure requirements contained?

The disclosure requirements are contained in Para 81(c) of Ind AS 12, Income Taxes. An entity also needs to take into consideration paragraphs 84 to 86, 46 to 52B and Para 5 of the standard.

4.3     Is the disclosure mandatory?

This disclosure is mandatory for all entities preparing financial statements under the Ind AS framework.

4.4     What needs to be disclosed?

An explanation of the relationship between tax expense and accounting profit (PBT) is required to be disclosed and the same is summarised in the table given below:

5.    FROM THE PAST – ‘ROOT CAUSE ANALYSIS OF AUDIT DEFICIENCIES’

Extracts of remarks made by Mr. Brian T. Croteau (former Deputy Chief Accountant, US Securities Exchange Commission) before the American Accounting Association Annual Meeting in August, 2012 is reproduced below:

‘Consider for a moment the investigation of the tragic crash of the Air France flight on its way from Brazil to France in June, 2009. Like the National Transportation Safety Board does in conducting objective, precise accident investigations and safety studies in the United States, France’s Bureau of Investigation and Analysis studied this crash. Only recently, three years later and after careful study, it issued a report detailing its conclusions of the various contributors and the underlying root cause of the crash. Understanding the root cause in these circumstances included a challenging two-year relentless search for the black box and piecing together many pieces of evidence to develop the entire picture. Doing so has already resulted in changes to the way pilots are trained in an effort to reduce the risk of future accidents.

I believe with today’s audit documentation and technology, auditors, academics, standard setters, regulators and others can continually strive to do more to understand and assess the contributing factors and root causes of audit deficiencies so we can effect improvements in auditor performance and audit quality.’