The International Accounting Standards Board (IASB) and the U.S.
Financial Accounting Standards Board (FASB) have agreed to work
separately and jointly toward convergence of accounting standards.
However, despite recent convergence activities significant differences
remain between U.S. and international standards in accounting for
impairment of goodwill and other intangible assets. These differences
are not currently scheduled for resolution.
Since 2000, there has been a rapidly accelerating movement toward
developing a single set of accounting standards that would be accepted
globally in financial markets. This movement has been marked by the
endorsement of International Financial Reporting Standards (IFRSs or
IFRS) for stock trading by the International Organization of Securities
Commissions (IOSCO); the reorganization of the International Accounting
Committee (IASC) into a more representative and aggressive body, called
the International Accounting Standards Board (IASB), with direct ties to
key national standards setters; the official agreement of the IASB and
the U.S. Financial Accounting Standards Board (FASB) to work, separately
and jointly, toward convergence of accounting standards; and, perhaps
most importantly, the adoption by the European Union (EU) of the
IASB's IFRSs for reporting by public companies, beginning January
1, 2005. Nearly 7,000 public companies in the 25 EU countries will be
required to use IFRS for the first time in 2005 in lieu of their
national standards. Consequently, other countries (such as Australia)
have determined to adopt IFRS as well, to the extent that the IASB
expects that over 90 countries will be following IFRS by 2005 .
To facilitate this widespread adoption of IFRS, the IASB committed
to arrive at a "stable platform" of standards by March, 2004,
so that the converting companies would be able to assimilate the new
standards for the 2005 financial reporting period. The constituents had
expressed concern that the IASB was promulgating changes so rapidly that
the standards would continue to be a moving target, which would
complicate and confuse the transition. Hence, the IASB determined that
only standards issued by March 2004 would have implementation dates in
2005. The "stable platform" of international standards to be
January 1, 2005, was completed (except for fine-tuning adjustments)
with the issuance of IFRS 3, Business Combinations (IFRS 3); IFRS 4,
Insurance Contracts (IFRS 4); IFRS 5, Non-current Assets Held for Sale
and Discontinued Operations (IFRS 5); and the amendments to
International Accounting Standards IAS 36, Impairment of Assets (IAS
36); IAS 38, Intangible Assets (IAS 38); and IAS 39, Financial
Instruments: Recognition and Measurement Fair Value Hedge Accounting for
a Portfolio Hedge of Interest Rate Risk (IAS 39).
The issuance of IFRS 3 completes only the first phase of the
business combinations project, which is an ongoing joint project of the
FASB and the IASB, and the reason for consequential amendments to IAS 36
and IAS 38 was to incorporate the changes relating to business
combinations made in IFRS 3, not to reconsider other existing
requirements of IAS 36 and IAS 38. Many of the changes adopted in IFRS 3
promote convergence with U.S. Statement of Financial Accounting
Standards 141, Business Combinations (SFAS 141) and SFAS 142, Goodwill
and Other Intangible Assets (SFAS 142), including: adopting the
exclusive use of the purchase method; recognition of more intangible
assets, separate from goodwill, at fair value at the acquisition date;
not amortizing goodwill and other intangible assets with indefinite
lives but testing them for impairment; and the recognition of negative
goodwill immediately in the income statement. Unfortunately, the
amendments to IAS 36 do not achieve the desired convergence with U.S.
generally accepted accounting principles (GAAP) that was anticipated in
the Exposure Draft (ED 3) stages of the project. Instead, they leave
significant differences between U.S. and international standards which
are not currently scheduled for resolution. This paper will discuss IAS
36 and the proposed and adopted amendments; the convergence achieved and
differences remaining; and the outlook for achieving convergence in the
accounting for impairment of goodwill and other intangible assets.
The Amendments to IAS 36
Because goodwill amortization was eliminated in IFRS 3, the IASB
felt that the impairment test in IAS 36 should be revised to accommodate
goodwill. The IASB's initial proposal included in ED3 was a
two-step impairment test for goodwill similar to that required under
SFAS 142. However, significant concerns arose among IASB constituents
about the practicality and complexity of the proposed impairment test
for goodwill. Moreover, there were still some constituents, including
two members of the U.S. Financial Accounting Standards Board and some of
the respondents to ED3, who opposed even the elimination of goodwill
amortization, regardless of the convergence objective.
SFAS 142's Two-step Goodwill Impairment Test
Under SFAS 142's two-step impairment test, the fair value of
goodwill in periods subsequent to the date of acquisition is estimated
in the same manner as it was at the date of the acquisition.
* The first step identifies a potential impairment by comparing the
estimated fair value of a reporting unit to its carrying amount,
including goodwill. If the fair value of the reporting unit is greater
than its carrying amount, goodwill is not considered impaired, and the
second step is not required. If the fair value of the reporting unit is
less than its carrying amount, the second step of the impairment test
must be performed to measure the amount of the impairment loss, if any.
* In the second step, the estimated fair value of the reporting
unit determined in Step 1 is allocated to all the assets and liabilities
of that unit (including any unrecognized identifiable intangible
assets). The excess of the estimated fair value over the amounts
assigned to assets and liabilities is the new estimated (or implied)
fair value of goodwill. If the carrying amount of goodwill exceeds its
estimated fair value amount, an impairment loss is recognized equal to
that excess and is reported as a charge to income from operations.
The amounts determined in the new purchase price allocation are
used for purposes of testing goodwill for impairment. That is, the
entity would not record a "step-up" in net assets or any
unrecognized intangible assets as a result of this process. Also, once
written down for impairment, no future recovery of goodwill value may be
If an impairment test of goodwill and any other asset occurs at the
same time, the goodwill impairment test should occur after the other
asset is tested for impairment. For example, if an asset group is being
tested for impairment under SFAS 144, Accounting for the Impairment of
Long-Lived Assets and for Obligations Associated with Disposal
Activities, that asset group should be tested for impairment before
conducting the two-step goodwill impairment test.
IAS 36's Goodwill Impairment Test
The goodwill impairment test in IAS 36 is quite different from that
in SFAS 142, as the proposed change to converge with U.S. principles was
not adopted. The European Financial Reporting Advisory Group (EFRAG) and
others proposed eliminating the second step proposed in ED3 for testing
goodwill impairment because they felt it was unnecessarily complex and
costly to implement. Consequently, the IASB decided to retain the
existing impairment testing approach in IAS 36 for measuring goodwill
impairment, which, rather that testing goodwill for impairment through a
direct method, requires the use of a residual approach.
Under IAS 36, for the purpose of impairment testing, goodwill
acquired in a business combination should, from the acquisition date, be
allocated by the acquirer to the lowest cash-generating units (CGU) or
group of CGUs that are expected to benefit from the combination, which
should be the level at which goodwill is to be monitored for internal
management purposes. At a minimum, an entity is required to allocate and
monitor goodwill at the segment level, based on either the primary or
the secondary reporting format determined in accordance with IAS 14,
Segment Reporting, but it need not coincide with the legal entity
approach at which goodwill may be allocated under IAS 21, The Effects of
Changes in Foreign Exchange Rates, for the purpose of measuring foreign
currency gains and losses, if goodwill is not monitored at that level.
The amendment specifies that goodwill should be carried at cost, not
amortized, and, at least annually, an assessment should be made as to
whether it has been impaired in accordance with the procedure
established in IAS 36.
To conduct an IAS 36 impairment test, the carrying amount of the
CGU is compared with its recoverable amount. The recoverable amount is
the higher of (1) the fair value, less costs to sell, or (2) its value
in use. Clearly, if the first of the two values calculated is higher
than the carrying amount, then goodwill impairment does not exist, and
the other value need not be determined. It is expected that most
entities will start the test by determining value in use, given the
absence of an active market for most CGUs. While fair value may be
estimated as the price that could be obtained for disposal in an
arm's length transaction between willing participants, it is
unlikely that this information is readily available, and its
determination might be costly. Value in use, on the other hand, can be
determined from internal cash flow projections. In fact, the cash flow
projections used in the valuation should be taken from the
management-approved budgets and forecasts, generally for up to a maximum
of the next five years, unless a longer period can be justified, and by
extrapolating, using a steady or declining growth rate for subsequent
periods. However, cash flow projections should relate to the CGU in its
current condition; future uncommitted restructurings and expenditures to
enhance performance should not be anticipated. The expected future cash
flows are then discounted to their net present value to determine value
in use, using a discount rate that will include the risk-free rate
adjusted by any risks specific to the CGU's future unadjusted cash
IAS 36 specifies that the test is applied to the CGU as a whole.
When the CGU's carrying amount exceeds its recoverable amount, it
must be written down to the recoverable value. The goodwill of the CGU
is written down first; any additional impairment amount that may be
required to be recognized once goodwill has been fully written off is
allocated on a pro rata basis to the other assets within the CGU, as
long as it does not reduce any asset below the higher of its fair value,
less cost to sell, or value in use. That is, because of this residual
method approach, once it has been determined that an impairment exists,
if the amount of goodwill allocated to that CGU does not cover the
difference between the recoverable amount and the carrying amount, the
test requires allocation of the impairment to other assets as well, even
though an indicator of impairment may not have existed for those assets.
Other Intangible Assets with Indefinite Lives
Like SFAS 142, IFRS 3 requires greater recognition of intangible
assets other than goodwill in a business combination than its
predecessor IAS 22, through amendments to the definition and
presumptions about the reliability of measurement. Moreover, as in SFAS
142, these intangible assets may be deemed to have indefinite lives if
there is no foreseeable time limit to their future cash flows. In this
case, the intangible assets are not amortized, but are subject to
impairment testing, like goodwill. While assets with finite lives are
only tested if there are indications of impairment, goodwill and
intangible assets with indefinite lives must be tested for impairment at
The impairment test for intangible assets is the same as that
applied to other assets under IAS 36. That is, the carrying amount of
the asset is compared with its recoverable amount, which is the higher
of (1) the fair value, less costs to sell, or (2) its value in use.
Impairment losses for intangible assets with indefinite lives,
other than goodwill, may be reversed under IAS 36. If the impairment
test indicates that there has been a recovery of value because the
difference between carrying value and recoverable amount has decreased,
the loss may be reversed, and the intangible asset written up. The
increase to the carrying amount cannot exceed what the depreciated
historical cost would have been if the impairment had not been
recognized. Moreover, changes caused by unwinding of the discount may
not be reversed. When indicated, the reversal of an impairment loss is
recognized in the income statement. The reversal of impairment losses
for goodwill is prohibited.
Remaining Differences in Accounting for Impairment
Despite the joint efforts of the IASB and the FASB to achieve
convergence in accounting for business combinations and related goodwill
and intangible assets, evidenced by the significant changes adopted by
the IASB in the issuance of IFRS 3 and the amendments to IAS 36 and IAS
38, some major differences remain, especially in the treatment of asset
impairment. Key areas of divergence in dealing with impairment are shown
in Exhibit 1.
The impairment testing models of the IASB and the FASB have
differing bases, in that the FASB compares the carrying value of an
asset to its fair value, and the IASB compares its carrying value to the
recoverable amount, which includes value in use. This difference may
diminish if the FASB adopts its current Exposure Draft: Fair Value
Measurement, because the draft incorporates a measure which is roughly
equivalent to the IASB's value in use. Hence, the adoption of this
draft would promote convergence by eliminating some of the remaining
differences between the IASB and FASB in accounting for impairment.
The impairment testing models differ considerably, however, with
respect to the application of the test to goodwill and intangible assets
with indefinite lives. The IASB has retained the impairment test in IAS
36 for testing goodwill impairment, rejecting the FASB's two-step
test. The result is that the IASB requires application of goodwill to a
CGU, and only tests its impairment at the level of the CGU or group of
CGUs, without computing the implied value of goodwill at the time of the
test. If impairment of the CGU is required, it is written down against
goodwill first, and any remaining impairment, once goodwill is written
off completely, is required to be applied on a pro rata basis to other
long-lived assets in the CGU. The FASB, on the other hand, associates
goodwill with a reporting unit (which may be different in description
from a CGU), and if impairment of the reporting unit is required, then
each of its assets is measured at fair value to determine the implied
value of goodwill before it is written down. In fact, it may not be
necessary to write down goodwill if the impairment is determined to be
caused by other assets in the reporting unit, for which a different
impairment model applies (that is, the two-step approach in SFAS 144).
Finally, a significant difference remains with respect to the
reversal of impairment losses. The FASB prohibits reversals entirely.
The IASB permits impairment losses to be reversed, up to the amount of
what the depreciated historical cost would have been without the
impairment loss, except if caused by unwinding of the discount rate.
However, at least both have agreed that reversals of goodwill impairment
should not be permitted.
These differences are substantive obstacles to convergence. They do
not appear on the IASB's agenda, but the IASB has asked the FASB to
reconsider them during its deliberations on the Phase II of the Business
With the recent pronouncements on business combinations, there has
been an increase in the number of intangible assets with indefinite
lives, including goodwill, that are not subject to amortization. Hence,
impairment testing has become increasingly important. Nonetheless,
despite their joint efforts to converge on new accounting
pronouncements, the IASB and the FASB still have significant differences
in their impairment testing models.
Resolving their differences and achieving convergence is important
to global capital markets. For some time, Australia, Germany and the
United Kingdom have permitted foreign companies that issue securities in
those countries to prepare their consolidated financial statements using
IFRS. After January 1, 2005, listed companies domiciled in those and
other EU countries are required to use IFRS. The primary countries that
still do not accept IFRS without reconciliation are Canada, Japan and
the United States. The U.S. Securities Exchange Commission (SEC) has
encouraged for several years the convergence of IASB and FASB standards
so that the current requirement to reconcile certain financial
information by Foreign Private Issuers for financial statements that
were prepared on a basis other than U.S. GAAP could be eliminated.
Because of the recent changes in the IASB and the EU adoption of IFRS,
the SEC has indicated that it will review the need for reconciliation
after 2005. The decisions taken as a result of this review will
undoubtedly depend upon the degree of convergence achieved. The SEC may
also face political pressure from the EU and the possibility of a
requirement for U.S. companies listed in the EU to reconcile to IFRS.
Both the IASB and the FASB are in the second phase of the Business
Combinations Project, which they are considering jointly. However,
current developments on the project indicate that convergence in this
area may not be accomplished in the short term.
Financial Accounting Standards Board. "Accounting for the
Impairment of Long-Lived Assets and for Obligations Associated with
Disposal Activities." Statement of Financial Accounting Standards
No. 141, Norwalk, CT: FASB, December 2001.
Financial Accounting Standards Board. "Business
Combinations." Statement of Financial Accounting Standards No. 141.
Norwalk, CT: FASB, June 2001.
Financial Accounting Standards Board. "Goodwill and Other
Intangible Assets." Statement of Financial Accounting Standards No.
141. Norwalk, CT: FASB, June 2001.
Gannon, D.J. and A. Ashwal. Financial reporting goes global.
Journal of Accountancy, September 2004.
http://www.aicpa.org/pubs/jofa/sep2004/gannon.htm, accessed February 10,
International Accounting Standards Board. "Accounting for
Business Combinations." International Accounting Standard No. 22,
London: IASB, November 1983. Revised September 1998 (Superseded in March
International Accounting Standards Board. "Business
Combinations," International Financial Reporting Standard No. 3,
IASB, London: March 2004.
International Accounting Standards Board. "Impairment of
Assets." International Accounting Standard No. 36. London: IASB,
Revised March 2004.
International Accounting Standards Board. "Intangible
Assets." International 4 Accounting Standard No. 38, London: IASB,
Revised March 2004.
1. www.iasb.org/about/faq.asp, accessed November 6, 2004.
Victoria Shoaf, The Peter J. Tobin College of Business, St.
Ignacio Perez Zaldivar, Deloitte & Touche LLP
EXHIBIT 1. DIFFERENCES IN ACCOUNTING FOR IMPAIRMENT
IASB (International) FASB (U.S.)
* Measurement of Compare carrying value Compare carrying
impairment recoverable amount (the value to fair value.
higher of to fair value
value in use and fair
value less costs to
* Level of testing for CGU, the lowest level to Reporting unit,
goodwill which goodwill can be either a business
allocated and for which segment or one
management monitors organizational level
goodwill. (Monitoring below
should be at least at
the Segment level.)
* Calculating impairment One step: compare Two steps: (1)
of goodwill recoverable amount of a Compare fair value
CGU to its carrying of the reporting
amount. unit with its
If FV is greater
step 2); and (2)
Compare implied FV
of goodwill with
* Calculating impairment Goodwill and intangible Goodwill and
of Intangible assets assets with indefinite Intangible assets
lives are not tested are tested directly.
directly; the CGU, to
which those assets have
been allocated, is
tested for impairment as
* Reversal of impairment Applicable to all Always prohibited
losses intangible assets, other