By John Filar Atwood
Japan’s decision to let its companies decide whether or not to adopt international financial reporting standards (IFRS) was a fascinating economic experiment and provided a new way forward for countries that have not yet adopted IFRS, according to IASB chairman Hans Hoogervorst. Companies representing more than 30 percent of the market capitalization of the Tokyo Stock Exchange have chosen to adopt IFRS, he noted, which proves that given a choice companies are willing to incur the costs of the transition to enjoy the benefits of IFRS reporting.
In remarks at a conference hosted by the Accounting Standards Board of Japan, Hoogervorst noted that three-fourths of the G20 countries have now fully adopted IFRS, while other countries like China and India have achieved substantial convergence between their national accounting standards and IFRS. In Japan, 200 companies have chosen to fully adopt IFRS, he added.
Japan’s approach created a viable third path to IFRS adoption in addition to the existing full-adoption and convergence-of-standards approaches, Hoogervorst said. Japan allowed larger, more international companies to apply IFRS without forcing all Japanese companies to switch. In his view, this option could work for other jurisdictions for whom IFRS adoption for all companies in one step might be challenging because they may need time to build up IFRS expertise. He noted that some other Asian countries are seriously considering the Japanese model of IFRS adoption.
Accounting for goodwill. In the speech, Hoogervorst also discussed why the IASB is reconsidering the use of amortization of goodwill. With the adoption of IFRS 3 Business Combinations in 2004, the IASB abolished the amortization of goodwill, relying instead on the impairment-only approach. He said that based on a post-implementation review of IFRS 3, the IASB initially decided not to revisit the idea of re-introducing amortization of goodwill based on its determination that there was insufficient new evidence to justify the idea.
Hoogervorst said that the IASB now has decided to include a comprehensive analysis of the accounting for goodwill in an upcoming discussion paper, including an examination of the possibility of re-introducing amortization. The change of heart, he said, was due to staff research that highlighted the shortcomings of the impairment-only approach.
Some of the problems with the impairment-only approach to goodwill were already well known, he said. The annual impairment test is costly and subjective, and overly optimistic projections of future cash flows from cash generating units can cause impairment losses to be identified too late.
Staff research. Hoogervorst said that IASB staff research also showed convincingly that goodwill tends to be shielded by a buffer of internally generated goodwill. The staff found that even if a company makes a terrible acquisition, as long as the value of the original part of the business remains high enough, the value of the combined business may stay above its book value, protected by the buffer of the internally generated goodwill from the old business. In those cases, the staff noted, no goodwill impairment will be recognized.
Hoogervorst said that in practice, a company must burn through all of the buffer before the acquired goodwill becomes visibly impaired. Since the buffer can be substantial, the staff research made it clear that it is almost inevitable that the results of the impairment test will be "too little, too late." Given that IFRS 3 relies completely on the impairment test to ensure that goodwill really exists, Hoogervorst said that this is an unacceptable situation.
Goodwill may keep accumulating over time even when the economics do not justify it, he noted, and the balance sheet may give an overly optimistic representation of a company’s financial health. Hoogervorst believes that sophisticated investors will be able to see through inflated goodwill numbers, but others may not. As a result, the IASB will raise the question of re-introduction of amortization of goodwill in a forthcoming discussion paper.
No better alternative. Hoogervorst warned that it is not a foregone conclusion that the discussion paper will lead to a re-introduction of amortization. There were compelling reasons behind the 2004 decision to get rid of it, he said. Whatever the outcome, he believes that the discussion paper will serve to make stakeholders better aware of the shortcomings of the impairment-only approach. There may be no better alternative, he said, in which case stakeholders will have to accept the flaws of IFRS 3.