ACC201 Financial Accounting T219: Assessment 3- Australian Accounting Standards Analysis-Solution 3
Question 1
Wayne Upton (2001, p. 71) in his discussion of the lives of intangible assets noted that the formula for Coca-Cola has grown more valuable over time, not less, and that Sir David Tweedie, former chairman of the IASB, jokes that the brand name of his favourite Scotch whisky is older than the United States of America — and, in Sir David’s view, the formula for Scotch whisky has contributed more to the sum of human happiness.
Required:
Outline the accounting for brands under AASB 138/IAS 38 and discuss the difficulties for standard setters in allowing the recognition of all brands and formulas on statements of financial position.
Question 2
Gu and Lev (2011) argue that the root cause of many goodwill write-offs is that the shares of the buyer are overpriced at the acquisition date.
Figure 7.8 presents eBay’s cumulative stock return against the S&P 500 index from 2003. In mid-September 2005, eBay acquired the internet phone company Skype for $2.6 billion. On 1 October 2007, it announced a massive goodwill write-off of $1.43 billion (55% of the acquisition price) related to the Skype acquisition.
Gu and Lev argue that the root cause of this behaviour is the incentives of managers of overvalued firms to acquire businesses, whether to exploit the overpricing for shareholders’ benefit or to justify and prolong the overpricing to maintain a facade of growth. Goodwill write-offs are accordingly an important business event signalling a flawed investment strategy.
Required:
- a) Explain the circumstances under which goodwill is recognised and how any subsequent write-off occurs under AASB 136.
- b) Explain why a significant goodwill write-off may signal a ‘flawed investment strategy
Question 3
Tooth Ltd acquires Nail Ltd, effective 1 March 2020. At the date of acquisition, Tooth Ltd intends to close a division of Nail Ltd. As at the date of acquisition, management has developed and the board has approved the main features of the restructuring plan and, based on available information, best estimates of the costs have been made. As at the date of acquisition, a public announcement of Tooth Ltd’s intentions has been made and relevant parties have been informed of the planned closure. Within a week of the acquisition being affected, management commences the process of informing unions, lessors, institutional investors and other key shareholders of the broad characteristics of its restructuring program. A detailed plan for the restructuring is developed within 3 months and implemented soon thereafter.
Required
- a) Explain the accounting for restructuring provisions with reference to AASB137.
- b) Under AASB137, Should Tooth Ltd create a provision for restructuring as part of its acquisition accounting entries?
- c) How would your answer change if all the circumstances are the same as those above except that Tooth Ltd decided that, instead of closing a division of Nail Ltd, it would close down one of its own facilities?
Executive Summary
The report summarizes the three case questions in detail and shows how the Australian Accounting standards are implemented in specific situations. The case puts specific light on the standards for goodwill impairment, recognition of the restructuring provisions, and the accounting for the intangible assets of brand names. The report shows how there are fine lines between the situations in which the implementation of these standards may differ. Furthermore, it also shows how the resultant implementation can cause a change in the values of assets on the balance sheet of the firms.
Question 1: Wayne Upton
AASB 138/IAS38:
In the accounting of the brands under the Australian Accounting Standard of 138, it is required for the internally generated brands or intangibles to be must recognized as per the criteria established in the Para 57, while the Para 63 specifically excludes the recognition of the brands that are internally generated. While the Para 57 shows the requirement of recognizing the brands that arise during the development phase of the company, the Para 63 shows that expenditure spent on all internally generated brands cannot be distinguished from the date when the said intangible asset was first recognized as per the Para 57 as all the costs of an intangible asset which is internally generated comprises of all the costs that are needed to produce, create or prepare this asset in order to make it available for operations(AASB, 2018, p.13). Thus, the internally generated intangible assets are usually not recognized. Therefore, some companies might have very extremely valuable intangibles, however, these are not recorded on the balance sheets. Thus, even though the formulas for the Coca Cola or the Brand of Whisky have grown valuable over time, they cannot recognize it or grow its value on their balance sheets.
On the other hand, for the acquired brands, the brands need to be recognized at cost. While the brands are acquired as part of the business, then as per AASB 3, there is no need for any recognition criteria to be met. Given that the intangible assets acquired meet the definition of the intangible assets as per Para 33 of AASB 3. As per this standard, the intangible assets are acquired as a subsequent part of a business merger or combination which shows that there is a probability which is reflected in the measurement of the asset. This implies that the criteria for probability recognition are already met. These acquired brands which result in the form of business combinations are initially measured at cost, i.e. at their fair values. Afterward, they can be valued at a revalued amount or cost, however it needs to have an active market for its revaluation. Furthermore, the amortization of such assets is based on the useful life or else on the non-amortization on the basis of the indefinite life period.
Question 2: Gu and Lev
a) Circumstances under which goodwill is recognized
Good will occur after the attainment of any business combination and is measured by the surfeit of the consideration that is given over the fair value of these acquired net assets. After that, for each of the CGUs, or the combination of the CGUs, Goodwill is allocated as these all are expected to have gained value from the benefit of the synergy. In case any of the CGUs is considered or recognized as impaired, then this loss of the impairment is first assigned to the goodwill prior to its allocation to any of the other assets of that specific CGU. The writing off of the Goodwill as impaired results in permanent impairment and it cannot be ever reversed.
Goodwill is the premium which is paid by the acquiring firm over the fair valuation assigned to the net assets of the business combination that is being acquired. The greater is the amount of the premium paid by the acquiring firm on the acquired firm value above its fair value, and the more is the value of the acquired goodwill. When the carrying amount of the acquired business is lower than the recoverable amount of the business, then it results in the impairment recognition of the Goodwill (AASB, 2015).
b) Significant goodwill written-off
It is true that the impairment recognition and writing off of the goodwill value in the future of the acquired business may be considered as a flawed strategy of investment by the acquiring firm as the company was expecting higher future earnings of the acquired firm which did not pay off as expected, and the company paid a higher value for the business combination than its actual fair value (Gu & Lev, 2008).
Question 3: Tooth Ltd and Nail Ltd
a) Accounting for restructuring provisions
As per AASB 137, the provisions and other liabilities can be distinguished from all other liabilities like accruals and trade payables, as there is uncertainty about the amount and timing of the future expenses needed for its settlement. The provisions are needed to be recognized only when the business has a present requirement as a result of any past activity, and there is going to be an outflow of resources in the future of the settlement of the obligations and that an estimate which is reliable enough can be made. The provision for the restructuring costs is recognized only when the general criteria as defined above for the provisions are met as well. Furthermore, the gains on the disposal of the assets are not taken into consideration for the measurement of the restructuring provision even if the sale of these assets is part of the restructuring process (AASB, 2015).
b) Should Tooth Ltd Create a provision for restructuring
Tooth Ltd is not needed to create a provision of the restructuring as a component of the acquisition entries for accounting purposes. This is because of the reason that as per the standards requirements of AASB 137/IAS 37 and the AASB 3/IFRS 3, the acquired firm is not required to recognize the provision for the restructuring as part of the acquisition entry unless it is not already recognized as a liability by the acquired firm.
c) Changes if all the circumstances are the same
Pertaining to this scenario, even though the closing of the facility has raised from the reason for the proposal of the acquisition, the notion of considering if there is a present obligation as per the internal restructuring standards requirement of AASB 137 or not as opposed to the restructuring recognized as acquisition is still needed to be considered. This is because of the reason that the requirements under AASB 3 linked with the restructuring provisions are recognized as a component of the acquisition and is regarding the liabilities and assets of the acquired firm only (AASB, 2015). Still, as the acquiring firm is closing the facility, the restructuring provisions are not going to be recognized in the books of the acquiring firm, and thus this cost cannot be considered as a per of the cost of restructuring or acquisition (Loftus, 2018).
Conclusion and Recommendations:
The analysis of the impairment of the goodwill shows how the companies usually conduct improper valuations at the time of the acquisitions resulting in impairment of the goodwill later of the acquired assets showing the flawed investment strategy. It also showed how the companies need to conduct the implementation of the standards for the provisions of the restructuring for their own or acquired firm’s facility’s closure. The report also showed how the companies find it challenging to not value their internally generated brands even though when these brands are growing in value.
References:
AASB, 2015. AASB 136 – Impairment of Assets. [Online] Available at: legislation.gov.au/Details/F2017C00297 [Accessed 17 September 2018].
AASB, 2015. Business Combinations. [Online] Available at: https://www.aasb.gov.au/admin/file/content105/c9/AASB3_08-15.pdf [Accessed 17 September 2019].
AASB, 2015. Provisions, Contingent Liabilities and. [Online] Available at: https://www.aasb.gov.au/admin/file/content105/c9/AASB137_08-15.pdf [Accessed 09 September 2019].
AASB, 2018. Intangible Assets AASB 138. [Online] Available at: https://www.aasb.gov.au/admin/file/content105/c9/AASB138_08-15_COMPoct15_01-18.pdf [Accessed 17 September 2019].
Gu, F. & Lev, B., 2008. Investor Sentiments, Ill-Advised Acquisitions, and Goodwill Impairment.
Henderson, S. et al., 2017. Issues in Financial Accounting. 16th ed. Australia: Pearson.
Loftus, J., 2018. Financial Reporting. 2nd ed. Milton, QLD: John Wiley and Sons.
