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.’