Allocating goodwill to cash-generating units

Allocating goodwill to cash-generating units

On this page we discuss how to allocate goodwill to CGUs.

Identifying CGUs is a critical step in the impairment review and can have a significant impact on its results. That said, the identification of CGUs requires judgement. The identified CGUs may also change due to changes in an entity’s operations and the way it conducts them.

After the entity identifies its CGUs, it must determine which assets belong to which CGUs, or groups of CGUs. The basis of allocation differs for:

  • operational assets
  • corporate assets, and
  • goodwill.

The below diagram summarises the different allocation bases for goodwill:

the different allocation bases for goodwil

It is not possible to determine the recoverable amount of goodwill independently from other assets because goodwill does not generate cash flows of its own; rather it contributes to the cash flows of individual CGUs or multiple CGUs.

As such, goodwill must be allocated to individual CGUs (or groups of CGUs) for the purpose of impairment testing. The guidance in IAS 36 requires the goodwill acquired in a business combination to be allocated to each of the acquirer’s CGUs or groups of CGUs that are expected to benefit from the synergies of the combination. Further, the level to which the goodwill is allocated must:

  • represent the lowest level within the entity at which the goodwill is monitored for internal management purposes, and
  • not be larger than an operating segment before aggregation as defined by IFRS 8 ‘Operating Segments’.

What is an operating segment based on IFRS 8?

An operating segment is a component of an entity:

  • that engages in business activities from which it may earn revenues and incur expenses (including revenues and expenses relating to transactions with other components of the same entity)
  • whose operating results are regularly reviewed by the entity’s chief operating decision maker to make decisions about resources to be allocated to the segment and reassess its performance, and
  • for which discrete financial information is available.

An operating segment may engage in business activities for which it has yet to earn revenues, for example, start-up operations may be operating segments before earning revenues.

How to do it – Allocating goodwill acquired in a business combination

IAS 36 sets out requirements on the level of allocation and the basis of allocation of goodwill to CGUs or groups of CGUs.

Level of allocation

IAS 36 offers some flexibility on the level to which goodwill is allocated. The allocation can be to CGUs, or to groups of CGUs, provided the level of allocation:

  • represents the lowest level within the entity at which the goodwill is monitored, and
  • is not larger than an operating segment.

In general, the first condition rarely has a practical effect because few entities separately monitor goodwill outside the impairment review and external financial reporting process. The impact of the second condition is more varied. In some entities, an operating segment may comprise many CGUs while in others, the CGUs and operating segments might be similar or even identical. In general, this is possible in theory but rare in practice.

The basis of allocation

The basis of allocation (the expected synergies from the combination) requires considerable judgement in practice. One approach is to perform a ‘pre-combination’ and ‘post-combination’ valuation and use this analysis as a basis to allocate the goodwill. Such an analysis may identify the factors that contribute to the synergies expected to arise from the acquisition (eg cost savings from economies of scale and reduced overheads or increased revenues from cross-selling opportunities to new markets). Others may use the relative carrying values of the CGUs to allocate the goodwill to impacted CGUs.

In general, the entity should take a practical approach while aiming to arrive at the most representative allocation of goodwill to those CGUs that are expected to benefit from the combination. If the requirements in IAS 36 are overlooked, and goodwill is allocated entirely to the acquired business, this can sometimes lead to unnecessary future impairment losses and complications (eg when the CGUs are subsequently reorganised or disposed of).

Case – Limit on the level at which goodwill can be allocated

Entity A manufactures and sells widgets. In year 20X1, it purchases Entity B, Entity C, and Entity D which also produce widgets, each in a different part of the world. Entity A recognised goodwill of CU1M with respect to the acquisition of Entity B, CU2M with respect to the acquisition of Entity C and CU4M with respect to Entity D, all attributable to the cost-savings opportunities from using Entity A’s established centralised functions (purchasing, marketing, human resources).

Management has identified several CGUs, each of which is a component of one of entities A, B, C and D. The operating segments before aggregation for the purposes of IFRS 8 are Entities A, B, C and D as management reporting and resource allocation decisions are based on the corporate structure. Goodwill is not separately monitored.

What does it look like?

Management can choose whether to allocate goodwill among individual CGUs that are expected to benefit from the synergies of each combination, or at the level of its four operating segments. If management determines it cannot allocate goodwill among its individual CGUs except on an arbitrary basis it should allocate it at the operating segment level.

Allocating goodwill to cash-generating units = Reallocation of goodwill

Various circumstances may necessitate a reallocation of goodwill among CGUs (or groups of CGUs) including:

  • the disposal of an operation to which goodwill has been allocated, and
  • the reorganisation of an entity’s reporting structure.

Disposal of an operation within a CGU to which goodwill has been allocated

When goodwill has been allocated to a CGU and the entity disposes of an operation within that unit, the goodwill associated with the disposed operation must be:

  • included in the carrying amount of the operation when determining the gain or loss on disposal, and
  • measured on the basis of the relative values of the operation disposed of and the portion of the CGU retained (unless another method better reflects the goodwill associated with the disposed operation).

Case – Disposal of an operation to which goodwill has been allocated

An entity sells for CU100 an operation that was part of a CGU to which goodwill has been allocated. The goodwill allocated to the CGU cannot be identified or associated with an asset group at a level lower than that CGU, except arbitrarily. The recoverable amount of the portion of the CGU retained is CU300.

What does it look like?

Because the goodwill allocated to the CGU cannot be non-arbitrarily identified or associated with an asset group at a level lower than that CGU, the goodwill associated with the operation disposed of is measured on the basis of the relative values of the operation disposed of and the portion of the unit retained. Therefore, 25 per cent of the goodwill allocated to the CGU is included in the carrying amount of the operation that is sold.

Reorganisation of the reporting structure

When an entity reorganises its reporting structure in a way that changes the composition of one or more CGUs to which goodwill has been allocated, the goodwill must be:

  • reallocated to the units affected, and
  • measured using a relative value approach (again, unless another method better reflects the goodwill associated with the reorganised units).

Case – Reorganisation of the reporting structure

Goodwill had previously been allocated to CGU A. The goodwill allocated to CGU A cannot be identified or associated with a lower-level asset group, except arbitrarily. CGU A is to be divided and integrated into three other CGUs: B, C and D.

What does it look like?

Because the goodwill allocated to CGU A cannot be non-arbitrarily identified or associated with an asset group at a lower level, it is reallocated to CGUs B, C and D on the basis of the relative values of the three portions of CGU A before those portions are integrated into CGUs B, C and D.

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Allocating goodwill to cash-generating units

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