In the following chapter a theoretical framework is presented. The concepts necessary for the analysis of the empirical data are explained. The authors begin by defining some of the key concepts and the accounting standards associated with the study’s topic. The authors then move into a presentation of institutional theories underlying accounting practices. First part aim to improve the readers understanding of the topic and the second part is brought into the study to provide a base for analysis.
To perform its business, a firm uses a number of resources. Some of these resources are classified as assets and they constitute the visual building blocks of the firm’s balance sheet. Some resources are not distinctively acknowledged as assets such as a loyal staff or good relations with the bank (Smith, 2006). The aggregated value of all the firm’s assets is the firm’s value2. With this in mind one can easily see the importance of a clear definition of an asset. A generally agreed upon definition of an asset can be found in ISBS’ Framework for the preparation and presentation of financial statements paragraph 53- 59 (IFRS, 2009). Below you find IASB’s definition.
‘An asset is a resource which is controlled by a firm as a result of an occurred event and is expected to generate future economic benefits for the firm’ (IFRS, 2008)
There are two types of assets, tangible and intangible assets. Intangible assets are becoming increasingly important as their share of the total assets is growing. Two trends have made intangible assets more common and important in today’s accounting. One is the development towards a more service oriented and knowledge intensive economy. The second reason is the international effort to harmonize the accounting standards worldwide which is highly influenced by the Anglo-Saxon tradition that emphasizes a ”true and fair view” (Smith, 2006). According to the IASB’s definitions of accounting items one find a definition of intangible assets in IAS 38, “an identifiable non-monetary asset lackingphysical form” (IFRS, 2009). An intangible asset is recognized on the same grounds as tangible but with one important additional criterion, it has to be identifiable. The intangible asset counts as identifiable if:
- The asset is separable and/or
- If the asset arises from a contract or other legal rights (Smith, 2006).
There are many different opinions on what goodwill really is and the word is used in various situations. Some say all intangible assets should be lumped together under the post goodwill. Some like to distinguish different intangible assets as much as possible from each other such as intellectual capital, good costumer relation’s etcetera (Artsberg, 2005). The authors will only address the existing accounting definition of goodwill, which can be found in IRFS 3 appendix A.
‘An asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized’ (IFRS, 2009).
Goodwill could be described as a clash between two different time perspectives of a firm’s value, which result in a residual post in the balance sheet. The classic accounting tradition is to see the firm’s value as the aggregated value of the assets stated in the balance sheet, that is denominated in historical costs. Investors and financial analysts on the other hand are more interested in the future cash flows that a firm is predicted to generate. A firm’s value derived from a discounted cash flow (DCF)3 evaluation does almost exclusively not yield the same value compared to the value of the aggregated assets in the balance sheet. However, in an acquisition situation the most interesting value for the buyer is obviously the DCF value as it shows the predicted economic benefits the buyer can expect from the firm (Baxter, 1996). When a company acquires another company it thus usually pays a purchase price above the net asset value of the acquired companies, which results in a residual value called Goodwill. The higher price is usually motivated by the expected ynergy effect formed by the merger or in other cases it is ascribed to the acquired companies brand value (Smith, 2006).
Impairment test of Goodwill
According to IRFS 3 paragraph 55 Goodwill will no longer be amortized over time but instead Goodwill should be impairment tested at least once a year. The impairment test should be done in accordance with IAS 36, Impairment of Assets. The Goodwill should already during the acquisition be allocated to cash-generating units (CGU) or the smallest group of cash-generating units4 from which the expected synergy effect is likely to come from. The impairment test should then be done on every one of these CGUs or groups of CGUs in order to determine if a write-down of the Goodwill is necessary.
The Goodwill should be written-down if the recoverable amount5 is less than the carrying amount6 (IAS 36 p.6). The recoverable amount is defined as the higher of the assets fair value less the cost to sell it and the value in use of the asset (IAS 36 p.18). Fair value less the cost to sell should reflect the market price of the assets or an estimated sales price. The value in use however is more difficult to arrive at. It should be calculated by estimating the future cash flow, which the asset is expected to generate and its future terminal value (IAS 36 paragraph 31). These cash flows should be discounted with a discount rate before tax and reflect the current time value of money and the risk associated with the asset (IAS 36 paragraph 55). If either the fair value or the value in use is higher than the carrying amount there is no need to write-down the Goodwill. If both of the values are less than the carrying amount the Goodwill should be written-down with the value of the difference so the carrying amount becomes equal to either the fair value or the value in use. Whether a write-down is necessary or not the firm should every year give account for the assumption made in connection with the impairment test (IAS 36 paragraphs 126-137). Of special interest is paragraph 134 where all the disclosure requirements for an impairment test of the Goodwill entry are found.
1.2 Previous research
1.3 Problem discussion
1.4 Research Questions
2 Research Method
2.1 Research approach
2.2 Quantitative or Qualitative
2.3 Analyzes of the collected data
2.4 Data gathering
2.7 Critical review of the study
3 Theoretical Framework
3.2 International Standards
3.3 Institutional impact on the goodwill accounting
3.4 Qualitative characteristics of financial statements
4 Empirical Findings
5.1 Continental versus Anglo-Saxon accounting traditions
5.2 Qualitative characteristics
5.4 Agency theory
8 Suggestions for further research .
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IAS 36 Paragraph 134Why do companies fail to fulfill the disclosure requirements?