To the International Accounting Standards Board (IASB)
Committee on Financial Capital Markets
Keidanren
Comments on the IASB Discussion Paper
"Business Combinations—Disclosures, Goodwill and Impairment"
Keidanren welcomes the opportunity to submit comments on the IASB Discussion Paper "Business Combinations—Disclosures, Goodwill and Impairment" (hereinafter the "DP"). Our comments are as follows:
General comments
Based on market participants' feedback to the Post-implementation review of IFRS 3, the IASB recognized the issue that the recognition of impairment losses on goodwill is "too little, too late" (hereinafter the "too little, too late" issue) and prioritized the "subsequent accounting for goodwill". However, the DP does not provide any specific solution to improve the subsequent accounting for goodwill. Instead, the DP focuses on the "improvement of disclosures about acquisitions" which is not a priority issue in the Post-implementation review. Such objective of the DP is in general significantly contrary to the business objective of increasing corporate value, and market participants' expectations. The IASB should reconfirm that the project's top priority is to resolve the "too little, too late" issue and modify the course of the project so that it works on fundamental improvement of the subsequent accounting for goodwill including reintroduction of amortisation as the first priority. (Question 1)
As the "improvement of disclosures about acquisitions" does not resolve the "too little, too late" issue, it is not an issue to consider on a priority basis. Among the specific proposals, we are strongly concerned about the disclosures of monitoring metrics and synergies about an acquisition as most of these disclosures are commercially sensitive. If other companies obtain and use these disclosures as reference information, competitive disadvantage could be caused while synergies initially expected might not realize, leading to serious impairment of corporate value. As a result, as preparers cannot disclose most of the monitoring metrics and synergies, information which can be disclosed is significantly restricted and we do not believe such disclosures are useful for investors. In addition, it is impossible to identify and verify items and amounts of the synergies of the combined business (including accurate understanding of whether those synergies came from business combinations or were achieved regardless of business combinations), empirically ex-post facto. We also believe that it is difficult to audit the validity of the amounts. Therefore, the disclosures of monitoring metrics and synergies are not appropriate as the notes to the financial statements.
There is also a proposal to expand the disclosure of pro forma information. We cannot accept this proposal as pro forma information is not subject to audit in the first place, and there are doubts about the usefulness of such information. (Questions 2-5)As to the subsequent accounting of goodwill, the DP does not provide any specific measures that will contribute to resolve the "too little, too late" issue and only presents a preliminary view that the "impairment-only approach" should be retained. As we believe the only reasonable solution to resolve the "too little, too late" issue is the "amortisation and impairment approach", we do not agree with the IASB's preliminary view and strongly request that amortisation of goodwill be reintroduced for many reasons described in our response to Question 7.
There is an argument against amortisation as "investors are adding back the amortisation expenses." The investors simply add back amortisation, which is a non-cash expense, of each fiscal year for their cash flow-based analysis. In their cash flow-based analysis, as they add back the impairment cost as well, it does not form a ground for an argument against the reintroduction of amortisation. As there are investors who find importance in accounting profit as well, it is not appropriate to deny the validity of amortisation as an accounting standard simply because there are some investors who find importance in cash flow-based analysis. (Questions 6 and 7)We recognize the "simplification of the impairment test" as one of the important themes, but as there is a concern that it might lead to a delay in recognizing impairment losses, careful consideration should be required. If amortisation of goodwill is reintroduced, we agree with the proposal to abolish the annual impairment test from a cost-benefit perspective. (Questions 9 and 10)
It is not desirable that IFRS and US GAAP reach different conclusions on important themes like accounting treatment of goodwill. We strongly request that IASB and FASB closely work together and that convergence between IFRS and US GAAP on the accounting treatment of goodwill including reintroduction of goodwill amortisation be achieved. (Question 13)
Our responses to each question
(Question 1)
(a) We strongly oppose to set the objective of the project as "to help investors to assess performance and more effectively hold management to account for its decisions to acquire those businesses."
(Reasons)
Based on market participants' opinions that the "too little, too late" issue in the Post-implementation review of IFRS 3 needs to be addressed, the IASB prioritized the "subsequent accounting for goodwill."
However, the DP does not provide any effective solution to the "too little, too late" issue. Instead, the DP has substituted the issue by setting the objective of the project as "to help investors to assess performance and more effectively hold management to account for its decisions to acquire those businesses" and made many proposals on the "improvement of disclosures about acquisitions." Such objective of the DP is significantly contrary to the business objective of increasing corporate value, and market participants' expectations.
The IASB should narrow the objective of the project down to address the "too little, too late" issue and focus on the subsequent accounting for goodwill as a solution to the issue. The "improvement of disclosures about acquisitions" should be treated as a separate project after completing the improvement of the subsequent accounting for goodwill.
(b) If amortisation of goodwill is reintroduced, abolition of the annual impairment test should simultaneously be proposed from a cost-benefit perspective.
(Question 2)
(a)(b) We strongly oppose the disclosure requirements about the subsequent performance of an acquisition in paragraphs 2.4-2.44 generally.
(Reasons)
As explained in our response to Question 1, the "improvement of disclosures about acquisitions" to resolve "investors' need for better information on the subsequent performance of an acquisition" is not an urgent issue nor a project to be prioritized. Matters related to business strategies and KPIs should be disclosed as management's view in the non-financial information section such as MD & A at the discretion of a company and not in the notes to the financial statements.
The new disclosure proposals lack consideration for disclosure costs. As detailed disclosure is already required for business combinations, it is excessive, when compared to disclosures of other items, to require further detailed disclosure at the time of, and subsequent to an acquisition. In addition, the new proposals are not feasible for preparers because of the following points:
We strongly oppose the disclosures of management's (CODM's) monitoring metrics about an acquisition described in (b) (ii) & (iv) as it is highly likely that they contain a large amount of commercial sensitivity. If other companies obtain and use these disclosures as reference information, competitive disadvantage could be caused while synergies initially expected might not realize, leading to serious impairment of corporate value. As a result, such disclosures would become disadvantageous not only for companies but for investors as well, forcing companies to significantly restrict information actually disclosed. We also believe that it is clearly over-disclosure if disclosure of the reasons why management (CODM) does not monitor an acquisition ((b) (iii)) or why management (CODM) stops monitoring ((b) (v)) is required or if disclosure of the new metrics is required when management (CODM) changes them ((b) (vi)).
In the first place, requiring disclosure of matters related to commercial sensitivity or metrics only used within a company deviates from the role of the notes that supplement financial information. In addition, as it would be difficult to audit the validity of the numbers in the monitoring metrics, the monitoring metrics should not be treated as a note to the financial statements.
Furthermore, an acquired business is often integrated with other businesses, making it impossible to follow the performance after acquisition.
(c) We disagree that the information provided should be based on the information a company's CODM reviews.
(Reasons)
The IASB requires under IFRS 8 "Operating Segments" to disclose segment information that reflects the judgements made by management (CODM). Based on the management approach, the IASB requires in this DP to disclose the information the CODM reviews. However, while the former disclosure rarely infringes on commercial sensitivity, the latter disclosure contains commercial sensitivity and internal information only used within a company that is difficult to audit. Therefore, the characteristics of disclosed information are entirely different, and the requirements in the IFRS 8 and this DP cannot be treated in the same way.
(d) We agree that concerns about commercial sensitivity could inhibit companies from disclosing information.
(Reasons)
If information that contains commercial sensitivity eventually becomes disadvantageous for companies and impair corporate value, it will also become disadvantageous for investors. Therefore, information that contains commercial sensitivity should not obviously be subject to disclosure. In the first place, it is inappropriate to require disclosure of information that may contain commercial sensitivity in the notes to the financial statements.
(e) Disclosed information about the metrics that management (CODM) monitors at the time of the acquisition is highly likely to be misunderstood as forward-looking information even though the information just reflects management's (CODM's) targets. We are concerned that investors may mistakenly expect high commitment if the metrics that management (CODM) monitors are disclosed in the notes to the financial statements that are subject to audit.
(Question 3)
As we oppose the disclosure requirements about the subsequent performance of an acquisition in general in our response to Question 2, we also oppose the proposals to add disclosure objectives in Question 3.
(Question 4)
We strongly oppose the proposal to disclose a description of the synergies, etc.
(Reasons)
The main reasons are the same as our response to Question 2(a).
It is impossible to identify and verify items and amounts of the synergies of the combined business (including accurate understanding of whether those synergies came from business combinations or were achieved regardless of business combinations), empirically ex-post facto. We also believe that it is difficult to audit the validity of the amounts.
As the synergies contain a large amount of commercial sensitivity, if the synergies become subject to disclosure and customers and competitors obtain such information, synergies initially expected may not realize while corporate value may significantly be impaired. We are strongly concerned that disclosure of the synergies may become disadvantageous for investors as a result. If commercially sensitive information is excluded, we believe it is almost impossible to disclose quantitative and specific information about the synergies which will contribute to investor's decision.
We are concerned that investors may require high commitment to those synergies which can be realized by the efforts of companies such as cost improvement, as the investors mistakenly interpret and use them as forward-looking information rather than just management's (CODM's) targets.
As to the proposal "to specify that liabilities arising from financing activities and defined benefit pension liabilities are major classes of liabilities", these two types of liabilities are disclosed if they are material under the current disclosure requirement (IFRS 3 B64(i): disclosure of each major class of assets acquired and liabilities assumed). So, there is no need to change the current disclosure requirement.
(Question 5)
We strongly oppose the proposal to expand disclosure related to pro forma information.
(Reasons)
We oppose to the proposal to replace "the amount of profit or loss since the acquisition date and the pro forma profit or loss" with "operating profit before acquisition-related transaction and integration costs". Calculation of the numbers based on the "operating profit before acquisition-related transaction and integration costs" is very complicated and the numbers are difficult to understand. In the first place, we do not agree with the definition of operating profit in the IASB Exposure Draft "General Presentation and Disclosures", and we oppose disclosure of pro forma information based on operating profit.
We strongly oppose the disclosure of the cash flows from operating activities of the acquired business after the acquisition date, and of the combined business on a pro forma basis as the usefulness of this information is highly questionable and the burden of preparers is extremely heavy. In the first place, there are opinions which doubt the usefulness of the current pro forma information as described in paragraph 2.74, and we oppose the proposal to expand the current disclosure requirements.
(Question 6)
(a) We agree that it is not feasible to design an impairment test that is significantly more effective at the timely recognition of impairment losses on goodwill at a reasonable cost. It should be noted that the headroom approach of the impairment test which the IASB previously considered was rejected as it was practically impossible.
(b) Not applicable.
(c) We believe that the second point (shielding) is particularly important as a reason for a delay in recognizing impairment losses on goodwill.
(d) We do not believe the IASB should consider any other aspects.
(Question 7)
(a) We strongly oppose the IASB's proposal that amortisation of goodwill should not be reintroduced. The only reasonable solution to resolve the "too little, too late" issue is the reintroduction of amortisation. Specific reasons why goodwill should be amortised (including the resolution of the "too little, too late" issue and our counterargument to the "impairment-only approach") are as follows:
(Reasons)
Impairment losses on goodwill are not recognized on a timely basis with the current "impairment-only approach". The main reason is that the shield effect of the headroom makes it difficult to identify part of goodwill which should be impaired. By reintroducing amortisation, it will become possible to expense an appropriate amount of goodwill on a timely basis. (Resolution of the "too little, too late" issue)
As goodwill is a part of investment costs and is mainly composed of technological capabilities, know-how, customer base and human resources, its value depreciates due to technological innovation, market changes and retirement or transfer of personnel, etc. If part of goodwill lasts indefinitely, it should normally be recorded as an intangible asset with indeterminable useful life. (Depreciation of goodwill)
As goodwill is a cost incurred to acquire businesses, it should be allocated over the period when the benefits of the acquisition (such as revenue and cost reduction) are recognized. By amortising goodwill, net profit of a company after acquisition is more appropriately reflected, leading to appropriate understanding of the results of the investment. (Appropriate understanding of investment results)
The "amortisation and impairment approach" enables business management which comprehensively takes into account profit, cost and future impairment risk while keeping in mind the recovery of the investment. This will impose certain discipline on management and contribute to sustainable growth of a company. (Securement of disciplined corporate management)
As the "amortisation and impairment approach" considers the necessity of impairment by comparing the book value of goodwill, which reflects aged depreciation of goodwill, with the recoverable value, more appropriate amount of impairment is recognized on a timely basis. (Timeliness of impairment recognition)
Paragraph 3.83 presents an argument that reintroduction of amortisation is unlikely to reduce the cost of impairment testing significantly. However, amortisation reduces risk and probability of impairment, which reduces the cost of impairment testing. Additionally, by combining simplification of the impairment test proposed in the DP with amortisation, the cost of the impairment test will be further reduced. The "amortisation and impairment approach" is an approach with excellent cost-benefit. (Cost-benefit perspective)
Paragraph 3.90 states "for amortisation it is difficult to estimate the useful life of goodwill and the pattern in which it diminishes", but it does not present any analysis or grounds. It is possible to recognize the useful life of goodwill and the patterns in which goodwill diminishes, and the difficulty of the recognition is not so different from that of depreciation of tangible fixed assets. (Estimate of useful life and the pattern)
(b) Regarding goodwill amortisation, Keidanren has consistently maintained the importance of the reintroduction of amortisation. According to quantitative surveys conducted by the Accounting Standards Board of Japan in 2016 and 2020, the outstanding amount of goodwill has been increasing since the "impairment-only approach" was applied by international standards. Given this trend, we recognize that there is a growing need to reintroduce amortisation in order to expense an appropriate amount of goodwill on a timely basis.
(c) The reintroduction of amortisation will eliminate most of the concerns that companies do not recognize impairment losses on goodwill on a timely basis. In particular, we believe the issue that impairment losses on goodwill are not recognized on a timely basis due to the shield effect of the headroom under the "impairment-only approach" will be largely resolved.
(d) Acquired goodwill is distinct from goodwill subsequently generated internally (internally generated goodwill). Due to the shield effect of the headroom, the "impairment-approach" would prevent identification of part of goodwill which should be impaired and would replace it with internally generated goodwill without being impaired. As a result, the "impairment-only approach" records internally generated goodwill on the balance sheets which is contrary to the fundamental principle of accounting standards.
(e) If amortisation of goodwill is reintroduced, some managements may add back the amortisation expense as one of the performance measures for investors (Of course, others may not). Even if amortisation is added back for management's performance indicators, it is simply one indicator and should be separated from discussions as to whether amortisation should be reintroduced as an accounting treatment. Many Japanese companies support amortisation of goodwill from corporate management perspective, and if amortisation of goodwill is reintroduced, they will consider numbers after amortisation important and utilize them for corporate management.
There is an argument against amortisation as "investors are adding back the amortisation expenses." The investors simply add back amortisation, which is a non-cash expense, of each fiscal year for their cash flow-based analysis. In their cash flow analysis, as they add back the impairment cost as well, it does not form a ground for an argument against the reintroduction of amortisation. As there are investors who find importance in accounting profit as well, it is not appropriate to deny the validity of amortisation as an accounting standard simply because there are some investors who find importance in cash flow-based analysis.
(f) The useful life of goodwill and its amortisation pattern to be used should be those reasonably estimated by management. However, considering the response to the "too little, too late" issue, fixed installment of up to 10 years should be the basis for consideration.
(Question 8)
We strongly oppose to present on the balance sheets the amount of total equity excluding goodwill.
(Reasons)
If the amount of total equity excluding goodwill is required on the main part of the financial statements, it could send a false message that goodwill is not recognized as an asset. Therefore, it is not useful information for investors as well.
If goodwill is amortised, the value of goodwill as an asset can be more rigorously determined, and an irresponsible proposal can be saved.
(Question 9)
If amortisation of goodwill is reintroduced, we agree with the proposal to remove the requirement to perform a quantitative impairment test every year. When goodwill is amortised, even if an impairment test is performed only when there is an indication of impairment, cases where the recognition of impairment losses is delayed will be limited. In addition, the cost and workload to conduct impairment tests will be significantly reduced, which will contribute to cost-benefit.
When assuming the current "impairment-only approach" is retained, some still favour removing the requirement for an annual impairment test. However, we believe careful consideration should be required as there remain concerns that the recognition of impairment losses might be delayed.
(Question 10)
As to the proposal to remove the restriction that prohibits companies from including some cash flows in estimating value in use, some agree with it as management's plans can be reflected in the calculation of value in use by incorporating cash flows arising from a restructuring or from improving or enhancing the asset's performance into the calculation of value-in-use. However, as there is a concern that the recognition of impairment losses of goodwill might be further delayed than it currently is, careful consideration should be required. In addition, it should be noted that this proposal has an influence on accounting treatments of impairment losses other than goodwill.
We agree with the proposal to allow companies to use post-tax cash flows and post-tax discount rates in estimating value in use for the impairment test. As the relevant practice has already been established, the proposal contributes to the smooth practice if it is clarified in the standards. In addition, it is desirable to improve the guideline on the treatment of temporary differences.
(Question 11)
We agree that this project does not pursue the proposals for simplifications as described in paragraph 4.55(a)-(d).
(Question 12)
We agree with the IASB's preliminary view that the current recognition standard of identifiable intangible assets should not be changed as the current accounting standards for intangible assets are working effectively.
(Question 13)
It is not desirable that IFRS and US GAAP reach different conclusions on important themes like accounting treatment of goodwill. We strongly request that IASB and FASB closely work together and that convergence between IFRS and US GAAP on the accounting treatment of goodwill including reintroduction of goodwill amortisation be achieved.