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- Operating Segments – how AASB 8 can impair your goodwill
Operating Segments – how AASB 8 can impair your goodwill
- By Rob Mackay
- Published 25/02/2010
- February 2010
- Unrated
What are the results that are reviewed?
The results that are ‘regularly reviewed’ by the CODM could take many forms and will depend upon the nature of the businesses activities. For instance, in a service business, the CODM may receive information of a components revenues and staff productivity to make decisions, whereas in a manufacturing business, the CODM may review sales, cost of sales, inventory levels, and overhead allocations. The point is, the degree of detail contained in the results being reviewed is of little consequence as long as that information is used to by the CODM to make decisions. Hence, the format of the management reports will impact on the identification of operating segments and hence goodwill allocations.
For those entities directly applying AASB 8, this information will also form the basis of operating segment disclosures in the financial statements. It is this ‘management approach’ to reporting that AASB 8 is intended to capture since it provides readers with insight into the internal workings of management’s governance. Unfortunately, the mechanics of this approach to reporting has also led to entities redesigning their management reporting practices in order to control the information that ends up in the financial statements of the entity.
What is discrete information?
There is no guidance as to the application of this requirement, however the literal interpretation is simply that separate identifiable information in relation to a component of the business is reported to the CODM.
I have determined my segments, but the CODM can only assess the recoverability of goodwill at a higher level. Is this OK?
Management must compare the carrying amount of goodwill with it's recoverable amount. Since goodwill does not produce cash flows on its own, it must be allocated to the cash generating units of the business where the value of the business can then be ascertained and compared against the carrying value of the net assets of the business.
Management may have valued the company as a whole (or valued components of the business) and intends on relying upon such valuation models for the purpose of assessing the carrying value of goodwill in the accounts. This is a scenario which presents problems for management since management will be in breach of the requirements of AASB 136 for impairment testing purposes.
Example: XYZ Manufacturing Pty Ltd is an international business with 3 Australian business units comprising (A) Manufacturing, (B) Distribution and (C) Retail. The company is valued at $50m, and the carrying value of net assets in the accounts is $40m, including goodwill at $10m. The goodwill can be attributable to each of the units but the board has not actually allocated the goodwill since it reviews goodwill at the Australian group level. Last year, XYZ reported the Australian group operations as the reporting segment in the financial statements. The board receives operating results in its monthly board pack with respect to units A, B & C for the purposes of reviewing profitability of each unit, adjusting unit strategy and assessing future funding needs. Given that the value of the company exceeds net assets, the board believe no impairment is evident and propose to sign off that goodwill is recoverable.
At the group level, goodwill would appear to be recoverable. However, it is evident that business units A, B & C represent 3 separate operating units. In this example, goodwill must be allocated to at least the level of each operating segment since it has been determined that each of the segments would benefit from the goodwill originally acquired. (Goodwill acquired should be allocated to each of the acquirer’s cash generating units or groups of cash generating units that is expected to benefit from the synergies of the combination, irrespective of whether other assets or liabilities of the acquiree are assigned to those units or groups of units. In this example it is presumed that if there were multiple CGUs within an operating segment of XYZ, goodwill is allocated to that group of CGU’s but the size of that group of CGUs must be capped at the level of the operating segment).
Goodwill should be initially allocated to each segment using a method that best reflects the value that is assumed by each segment in the form of goodwill from the acquisition. Possible allocation methods might include specific valuations of goodwill components acquired, allocating goodwill based on the relative fair values of net assets or profit margins of each operating segment, or valuations of each segment using forecast cash flows post business combination.
XYZ must then ascertain the recoverable amount of each operating segment which will generally be based on a value-in-use model. In this example, this will represent more work for management since they do not have valuation information below the whole-of-entity level. If such information cannot be furnished to the entity’s auditors, this may result in a qualification to the accounts.
The results that are ‘regularly reviewed’ by the CODM could take many forms and will depend upon the nature of the businesses activities. For instance, in a service business, the CODM may receive information of a components revenues and staff productivity to make decisions, whereas in a manufacturing business, the CODM may review sales, cost of sales, inventory levels, and overhead allocations. The point is, the degree of detail contained in the results being reviewed is of little consequence as long as that information is used to by the CODM to make decisions. Hence, the format of the management reports will impact on the identification of operating segments and hence goodwill allocations.
For those entities directly applying AASB 8, this information will also form the basis of operating segment disclosures in the financial statements. It is this ‘management approach’ to reporting that AASB 8 is intended to capture since it provides readers with insight into the internal workings of management’s governance. Unfortunately, the mechanics of this approach to reporting has also led to entities redesigning their management reporting practices in order to control the information that ends up in the financial statements of the entity.
What is discrete information?
There is no guidance as to the application of this requirement, however the literal interpretation is simply that separate identifiable information in relation to a component of the business is reported to the CODM.
I have determined my segments, but the CODM can only assess the recoverability of goodwill at a higher level. Is this OK?
Management must compare the carrying amount of goodwill with it's recoverable amount. Since goodwill does not produce cash flows on its own, it must be allocated to the cash generating units of the business where the value of the business can then be ascertained and compared against the carrying value of the net assets of the business.
Management may have valued the company as a whole (or valued components of the business) and intends on relying upon such valuation models for the purpose of assessing the carrying value of goodwill in the accounts. This is a scenario which presents problems for management since management will be in breach of the requirements of AASB 136 for impairment testing purposes.
Example: XYZ Manufacturing Pty Ltd is an international business with 3 Australian business units comprising (A) Manufacturing, (B) Distribution and (C) Retail. The company is valued at $50m, and the carrying value of net assets in the accounts is $40m, including goodwill at $10m. The goodwill can be attributable to each of the units but the board has not actually allocated the goodwill since it reviews goodwill at the Australian group level. Last year, XYZ reported the Australian group operations as the reporting segment in the financial statements. The board receives operating results in its monthly board pack with respect to units A, B & C for the purposes of reviewing profitability of each unit, adjusting unit strategy and assessing future funding needs. Given that the value of the company exceeds net assets, the board believe no impairment is evident and propose to sign off that goodwill is recoverable.
At the group level, goodwill would appear to be recoverable. However, it is evident that business units A, B & C represent 3 separate operating units. In this example, goodwill must be allocated to at least the level of each operating segment since it has been determined that each of the segments would benefit from the goodwill originally acquired. (Goodwill acquired should be allocated to each of the acquirer’s cash generating units or groups of cash generating units that is expected to benefit from the synergies of the combination, irrespective of whether other assets or liabilities of the acquiree are assigned to those units or groups of units. In this example it is presumed that if there were multiple CGUs within an operating segment of XYZ, goodwill is allocated to that group of CGU’s but the size of that group of CGUs must be capped at the level of the operating segment).
Goodwill should be initially allocated to each segment using a method that best reflects the value that is assumed by each segment in the form of goodwill from the acquisition. Possible allocation methods might include specific valuations of goodwill components acquired, allocating goodwill based on the relative fair values of net assets or profit margins of each operating segment, or valuations of each segment using forecast cash flows post business combination.
XYZ must then ascertain the recoverable amount of each operating segment which will generally be based on a value-in-use model. In this example, this will represent more work for management since they do not have valuation information below the whole-of-entity level. If such information cannot be furnished to the entity’s auditors, this may result in a qualification to the accounts.
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Article Series
This article is part 1 of a 2 part series. Other articles in this series are shown below:
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Operating Segments – how AASB 8 can impair your goodwill