Journal of International Accounting, Auditing and Taxation 27 (2016) 1325

Contents lists available at ScienceDirect

Journal of International Accounting,

Auditing and Taxation

Accounting for goodwill under IFRS: A critical analysis

Sven-Erik Johansson (Professor Emeritus), Tomas Hjelstrm (Assistant
Professor), Niclas Hellman (Associate Professor)
Stockholm School of Economics, Department of Accounting, P.O. Box 6501, 113 83 Stockholm, Sweden

a r t i c l e i n f o a b s t r a c t

Article history: In 2005, the International Financial Reporting Standards (IFRS) for goodwill accounting
Available online 1 August 2016 replaced the previously used two-component approach (i.e., goodwill amortization plus
additional impairment when required) with an impairment-only approach. There has been
renewed interest in this issue since the ndings of the post-implementation review of IFRS
3. This paper develops a theoretical model of the initial and subsequent accounting for
Keywords: goodwill, that is usable for evaluating the relevance of different standard-setting solutions
Goodwill in this area. The model indicates that the current impairment-only approach creates a buffer
Impairment that protects accounting goodwill from impairment. The buffer is created as a result of both
Intangible assets
internally generated core goodwill and the fair value of assets/liabilities not recognized on
Acquisitions
Business combinations
the statement of nancial position. In turn, the impairment test will understate the eco-
nomic loss and serve as a weak indicator of acquisition success/failure. Based on our model,
we propose changing the impairment test procedure so that the same measurement and
recognition criteria are employed as at initial recognition. Consequently, the representa-
tion of goodwill on the statement of nancial position, and the effectiveness of goodwill
impairment losses as an indicator, would improve.
2016 Elsevier Inc. All rights reserved.

1. Introduction

Accounting for goodwill has historically been the subject of much controversy among scholars and policy makers, and
has been associated with considerable variation in accounting practice across countries over time (Bloom, 2008, 2009).
One milestone in this development was when the United States Statements of Financial Accounting Standards (SFAS) 141
and 142 were adopted, followed by the transition to a similar approach under International Financial Reporting Standards
(IFRS) [IFRS 3 in combination with International Accounting Standard (IAS) 36]. According to the new approach, acquisition
premiums should be allocated to the acquired entitys identiable net assets to a greater extent than before, and goodwill
should no longer be amortized but subjected to periodic impairment tests. These standards have now been in force for a
decade and the International Accounting Standards Board (IASB) has recently undertaken a post-implementation review
of IFRS 3, aiming to identify, any unintended consequences following the introduction of the standard (IFRS Foundation,
2014). One conclusion of the post-implementation review was a need to identify ways to improve the goodwill impairment
test (IFRS Foundation, 2015). Based on a theoretical evaluation of the current accounting standards for goodwill employed by
the IASB, this paper proposes a revised and more effective goodwill impairment test which is consistent with the recognition
and measurement criteria applied by the IASB at initial recognition.

Corresponding author.
E-mail address: Niclas.Hellman@hhs.se (N. Hellman).

http://dx.doi.org/10.1016/j.intaccaudtax.2016.07.001
1061-9518/ 2016 Elsevier Inc. All rights reserved.
14 S.-E. Johansson et al. / Journal of International Accounting, Auditing and Taxation 27 (2016) 1325

This paper develops a theoretical model of accounting for goodwill using the prevailing IASB solution as a benchmark,
which can be used when evaluating the costs and benets of different standard-setting solutions. The model consistently
applies to both initial and subsequent accounting for goodwill. First, we analyze the composition of accounting goodwill
based on the components proposed by Johnson and Petrone (1998), and by applying valuation theory and Preinreichs (1939)
work on economic goodwill. Second, we evaluate the theoretical reasoning underlying the design of the goodwill impairment
test. This part of the analysis focuses on the extent to which the core goodwill (i.e., excess returns and synergies) becomes
impaired as the expected excess returns and synergies are realized and on the extent to which outcomes below expected
protability levels will trigger impairment. In more practical terms, this means that we are investigating the extent to which
the design of the goodwill impairment test generates impairment charges in the income statement that accurately inform
nancial statement users of the outcome of the acquisition.
Our analysis demonstrates two important implications of the IASB model of accounting for goodwill. First, a buffer will
be created that protects accounting goodwill from impairment during the post-acquisition period. The buffer is created from
the fair values of assets and liabilities not recognized in the consolidated statement of nancial position and from internally
generated core goodwill. Growth and conservative accounting (i.e., low valuation of net assets on the statement of nancial
position) for assets and liabilities are important determinants of the size of the buffer after the acquisition date. For an
acquired entity that is integrated into a larger cash-generating unit (CGU) of the acquirer, a buffer may already exist as of the
acquisition date due to internally generated core goodwill, measurement and recognition conservatism in the pre-existing
part of the CGU, and unpaid expected synergies.
Second, when a buffer protecting accounting goodwill is present, the impairment test will understate the economic loss
and serve as a weak indicator of the acquisition success/failure of the CGU. This implies that goodwill will not be expensed
in the income statement as the economic benets of an acquisition are realized. Furthermore, it will not allow the nancial
statement users to distinguish between successful and failed acquisitions.
The underlying theoretical explanation for the creation of the buffer relates to the different perspectives adopted as of
the acquisition date and in the post-acquisition period. As of the acquisition date, the aim is to recognize and measure all the
assets and liabilities of the acquired entity at fair value, recognizing only core goodwill (i.e., excess returns and synergies)
as accounting goodwill. During the post-acquisition period, however, this logic is not maintained. In the nal part of our
analysis, we propose changing the current impairment test procedure so that the same measurement and recognition criteria
are employed as at initial recognition. Consequently, the representation of goodwill on the statement of nancial position,
and the effectiveness of goodwill impairments as a signal of acquisition performance, would improve.
The contribution of this paper lies in the value of the theoretical model developed for evaluating standard-setting solutions
for goodwill accounting and in the offering of an improved goodwill impairment test. One of the major changes in IFRS 3 was
to replace the two-component (dual) approach (i.e., amortization with an additional impairment test when required) with
an impairment-only approach (i.e., non-amortization but with annual, or more frequent if necessary, impairment tests).
The reasoning underlying this change was discussed in the basis for the conclusions of IFRS 3. Acquirers generally expect
excess returns to be generated from acquisitions and tend to pay premiums over acquired net asset values, often resulting in
goodwill. As these excess returns are realized during the post-acquisition period, goodwill values should decline. According
to the accounting regime preceding the adoption of IFRS 3, i.e., the dual approach (IAS 22/IAS 36), the value decline was
divided into two components: (i) goodwill amortization reecting the gradual realization of expected excess returns and (ii)
impairment losses in the case of poor outcomes relative to expectations. One advantage of this model was that it ensured
that acquired goodwill would be expensed over the income statement and that post-acquisition internally generated core
goodwill would not be recognized as an asset in its place. This was acknowledged in the basis for conclusions (IFRS 3, BC 139a,
BC 140). However, a major problem with the dual approach was that the useful life of acquired goodwill and the pattern in
which it diminishes generally are not possible to predict, so the board concluded that straight-line amortisation of goodwill
over an arbitrary period fails to provide useful information (IFRS 3, BC 140). In the tradeoff between the two models, the IASB
nally opted for the impairment-only approach and referred to striking some balance (IFRS 3, BC 140) between different
perspectives: (1) refraining from amortization could result in a risk of recognizing internally generated core goodwill as an
asset and (2) the income statement would provide more useful information without the arbitrary goodwill amortization
provided that a rigorous and operational impairment test could be devised (IFRS 3, BC 142). Regarding the latter point, the
test prescribed by IAS 36 was considered adequate.
The Johnson and Petrone (1998) components of goodwill were explicitly used by the IASB (e.g., IFRS 3, BC 130131) and
the standard setter was already well aware of key tradeoffs between the alternatives. So what is the benet of the analysis
presented here? Recently, the debate concerning the dual versus impairment-only approaches has re-emerged, and the IASB
decided to add two projects to their research agenda, concerning (1) the effectiveness and complexity of testing goodwill for
impairment, and (2) subsequent accounting for goodwill, i.e., the impairment-only approach versus the dual approach (IFRS
Foundation, 2015). Problems with the impairment test have been identied during the post-implementation period, though
the alternative solutions are by and large the same as before. The analysis presented here provides a coherent theoretical
benchmark that claries the necessary conditions for the impairment-only model to work satisfactorily with regard to
relevance. In other words, the paper identies the nancial reporting implications of the theoretical view advocated in the
IFRS 3 basis for conclusions (i.e., the Johnson and Petrone framework) as to what accounting goodwill represents, if this view
is applied consistently to both initial and subsequent accounting for goodwill.
 S.-E. Johansson et al. / Journal of International Accounting, Auditing and Taxation 27 (2016) 1325 15

Table 1
Six Components of Goodwill.

Components of Goodwill Comment

1. Measurement conservatism Fair value in excess of book value (acquired entity)

2. Recognition conservatism
3. Going-concern element of core goodwill
4. Synergy element of core goodwill
5. Measurement error of consideration paid
6. Overpayment or underpayment by the acquirer
Fair value of net assets not recognized (acquired entity)
Ability of the acquired entity (stand-alone) to earn excess return on net assets
Fair value of expected synergies from combining acquired entity and acquirer

Note: These six components of goodwill are referred to by the IASB in IFRS 3. The terminology has been adapted to the terminology applied in the current
paper. Original Source: Johnson and Petrone (1998).

The theoretical framework for analyzing various components of goodwill, and the design of the impairment test, are
developed in Section 2. Theoretical results are derived and presented as six propositions, including the proposed amendment
of the impairment test currently used under IFRS. In Section 3, the sensitivity and effects of the theoretical results are
discussed and illustrated using a numerical example. A discussion and concluding remarks are presented in Section 4.

2. Theoretical analysis of goodwill and the goodwill impairment test

2.1. Links between goodwill concepts and IFRS 3

In IFRS 3 (BC 313), the IASB describes six components of goodwill used by both the IASB and FASB during the preparation
of IFRS 3 and SFAS 142, respectively (Table 1). The six components were rst presented in an article by Johnson and Petrone
(1998).
Both boards observe that the rst two components are not considered part of goodwill from a conceptual standpoint
(BC 314). The rst component represents the excess of fair values over carrying values in the acquired entity, whereas the
second component represents the fair values of assets and liabilities not previously recognized (BC 313). The rst component
addresses the measurement of assets and liabilities already recognized in the acquired entity, here referred to as measurement
conservatism. The second component addresses unrecognized operating net assets in the acquired entity and refers to assets
and liabilities that fulll the asset/liability denition criteria but not the recognition criteria, referred to here as recognition
conservatism. In IFRS 3, these components of goodwill are actively reduced at initial recognition by measuring identiable
net assets at fair value and by having less demanding recognition criteria for all acquired intangible assets than usual.
Applying widely used terminology, component 1 and parts of component 2 will be captured by the fair-value adjustment
as of the acquisition date. We assume that component 1 (i.e., measurement conservatism) will be completely captured by
the fair value adjustments made as of the acquisition date. Note that although IFRS 3 adopts relatively weak recognition
criteria, some assets will still not be recognized (e.g., research, marketing, and training investments). We refer to this part
of component 2 as unrecognized net assets. The fair value of such assets will initially constitute part of accounting goodwill
under IFRS 3.
The third component of IFRS 3 (BC 313) is referred to as the going-concern element and represents the ability of the
acquired entity, on a stand-alone basis, to earn a higher rate of return on its net assets than if these assets had been held
separately. The fourth component refers to the fair value of the expected synergies and other benets that arise from incor-
porating the acquired entity into the acquirer. The IASB describes these two components collectively as core goodwill (BC
316), denoted here as GWCt . Still, we analyze them separately because synergies are dependent on the degree of integration
into the acquirers existing business, while the going-concern component is not dependent on integration. The fth com-
ponent relates to measurement errors associated with the consideration transferred (BC 313); these are not considered an
asset (BC 315). The sixth component is referred to as overpayment or underpayment by the acquirer (BC 313).
The components presented by Johnson and Petrone (1998) are used as reference points in our analysis. The decompo-
sition of the various goodwill components and the concept of core goodwill combined with measurement and recognition
conservatism are central to obtaining a fundamental understanding of the representation of goodwill.

2.2. Ex ante analysis of goodwill development and impairment losses over time

The determination of goodwill is directly dependent on the concept of economic value, also known as fundamental value.
This is a theoretical concept based on a value derived from a valuation model (e.g., Ashton, Peasnell, & Wang, 2011; Skogsvik
& Juettner-Nauroth, 2013). The IASB uses the concept of economic value in that the value to be derived for the goodwill
impairment test according to IAS 36 is based on a discounted cash ow model. We will refer to economic value as the value
16 S.-E. Johansson et al. / Journal of International Accounting, Auditing and Taxation 27 (2016) 1325

determined by performing a valuation based on discounted future cash ows. The economic value of an entity at time 0
(EV0 ) is then dened as:


T
  CFT +1
EV0 = CF t (1 + r)t + (1 + r)T (1)
rg
t=1

EVt = economic value of the entity in period t

CFt = expected cash ow generated by the entity in period t
r = cost of capital for the cash ows generated by the entity
g = expected growth rate of cash ows in the steady state

We now introduce the carrying value of the operating net assets in the cash-generating unit (CGU) on the consolidated
statement of nancial position at the end of period t, CVt,CGU . According to IAS 36, a cash-generating unit is the smallest
identiable group of assets that generates cash inows that are largely independent of cash inows from other assets or
groups of assets. In accordance with Preinreich (1939), we dene economic goodwill as the difference between the economic
value and the carrying value of an entitys net assets excluding accounting goodwill. Note that this concept of goodwill
consists of components of both value creation and accounting measurement.

GWEt = EVt,CGU CVt,CGU (2)

GWEt = economic goodwill based on the carrying value of operating net assets measured at time t
EVt,CGU = economic value of the entire CGU at time t
CVt,CGU = carrying value of operating net assets excluding goodwill measured at time t, for the entire CGU at the consoli-
dated level

The carrying value of the operating net assets in the CGU consists of the sum of the carrying values of the pre-existing
part of the CGU and the newly acquired entity, also including any fair-value adjustments due to the acquisition. Meanwhile,
the economic value of the CGU consists of the sum of the stand-alone economic values of the pre-existing part and the newly
acquired entity, and the economic value of the synergies expected to be generated as a result of the acquisition.

CVt,CGU = CVt,pre + CVt,acq (3)

EVt,CGU = EVt,pre + EVt,acq + EVt,synergies (4)

CVt,acq = carrying value of the operating net assets in the acquired entity measured at the consolidated level in the CGU
excluding goodwill at time t
CVt,pre = carrying value of the operating net assets in the pre-existing part of the acquirers operations in the CGU, excluding
goodwill at time t
EVt,pre = economic value of the pre-existing part of the CGU at time t
EVt,acq = economic value of the acquired entity as a stand-alone entity at time t
EVt,synergies = economic value of the expected synergies in the CGU at time t

As stated above, the economic value is the discounted expected cash ows related to the CGU. The consideration trans-
ferred may differ from this value in two respects. First, the consideration transferred for the acquired entity as a stand-alone
entity might differ from the economic value of that entity. This is related to components ve and six of the Johnson & Petrone
framework. Second, the acquirer pays for only part of the expected synergies.

P0 = EV0,acq + P0,adj + EV0,synergies (5)

P0 = consideration transferred for the acquired entity at time 0 in its integrated form with synergies
P0,adj = over/underpayment by the acquirer and measurement error of the consideration transferred at the time of the
acquisition
= proportion of the economic value of synergies paid by the acquirer to the seller of the acquired entity

The accounting goodwill at the time of the acquisition is then dened as the difference between the consideration
transferred and the carrying value of the operating net assets as dened above.
 
GWA0,acq = P0 CV0,acq ND0,acq (6)

GWA0,acq = accounting goodwill recognized due to the acquisition at the time of the acquisition
P0 = consideration transferred for the acquired entity at the time of the acquisition
ND0,acq = net debt in the acquired entity taken over by the acquirer at the time of the acquisition
 S.-E. Johansson et al. / Journal of International Accounting, Auditing and Taxation 27 (2016) 1325 17

Eqs. (7) and (8) capture the relationship between accounting goodwill and economic goodwill in the newly acquired
entity and the pre-existing part of the CGU, respectively, at the time of the acquisition. Eq. (9) aggregates these two parts
into the complete CGU.

GWA0,acq = GWE0,acq (1 )EV0,synergies P0,adj (7)

GWA0,pre GWE0,pre = EV0,pre CV0,pre (8)

GWA0 = GWA0,acq + GWA0,pre GWE0 (1 )EV0,synergies P0,adj (9)

Having dened the above relationships at the time of the acquisition, the level of accounting goodwill in each period
after the acquisition becomes straightforward. The accounting goodwill is the lower of last periods accounting goodwill
and the economic goodwill determined in this period. If the economic goodwill is lower than the previous periods carrying
value of accounting goodwill, there will be an impairment charge. Expressions 10 through 13 give the relationship between
economic goodwill, accounting goodwill, and impairments.

GWAt = min(GWEt , GWAt1 ) (10)

IMPt = GWAt GWAt1 (11)

IMPt = goodwill impairment in period t

If GWEt GWAt1 > 0 IMPt = 0 (12)

otherwise GWEt GWAt1 < 0 IMPt = GWEt GWAt1 (13)

For analytical purposes, we may then introduce the concept of a buffer that protects accounting goodwill from impairment.
The buffer is dened as the difference between economic goodwill and lagged accounting goodwill at any point in time for
the CGU under consideration. When applying conservative accounting principles, the buffer is non-negative.

BUFt = GWEt GWAt1 (14)

BUFt = buffer protecting goodwill from impairment at the CGU level

By combining Eqs. (9) and (14), the buffer at the time of the acquisition comprises (1) the buffer in the pre-existing part
of the CGU, (2) the proportion of the synergies for which the acquirer has not paid the seller, and (3) the measurement errors
related to the consideration transferred (Eq. (15)).

BUF0, = (1 )EV0,synergies + P0,adj + EV0,pre CV0,pre GWA0,pre = (1 )EV0,synergies + P0,adj + BUF0,pre (15)

Proposition 1. For a stand-alone acquired entity with no measurement error in the consideration transferred, the buffer as of
the acquisition date is zero, i.e., economic goodwill equals accounting goodwill.

In this case, all the right-hand-side variables of Eq. (15) equal zero.

Proposition 2. For an integrated acquired entity, a buffer protecting the newly acquired goodwill exists starting from the
acquisition date due to the pre-existing part of the CGU and expected unpaid synergies.

Let us now turn to the case with an unexpected unfavorable outcome. Let us assume that the unexpected outcome
occurs in period t and that the carrying value of the operating net assets in the CGU will decrease due to reduced working
capital (e.g., inventory write-downs), impaired xed assets, and/or delayed investments. The economic value of the acquired
company forming the CGU will decrease as a result of the lower expectations of future cash ows. This reduction is likely
to be greater than the reduction in the carrying value because the value decline in unrecognized assets is not part of the
carrying value. This implies that the economic goodwill will also decrease because of the negative change in the expected
outcomes, generating an unexpected loss in economic goodwill (ELt ).

GWEt < Et1 [GWEt ] (16)

ELt = GWEt Et1 [GWEt ] (17)

ELt = economic goodwill loss in period t

From these arguments and from expressions 11, 12, 13, 14, and 17 we can conclude the following regarding impairment
of goodwill: as long as the economic goodwill loss is less than the buffer in period t, no impairment loss will be reported.
The acquirer will report an impairment loss only if the economic goodwill loss is greater than the buffer. Furthermore, as
long as the buffer is positive, the impairment of goodwill will underestimate the economic goodwill loss suffered by the
shareholders. This is captured in expressions 18 through 20.

IMPt = 0 if BUFt -ELt (18)

IMPt > 0 if BUFt < -ELt (19)

18 S.-E. Johansson et al. / Journal of International Accounting, Auditing and Taxation 27 (2016) 1325

IMPt > ELt if BUFt > 0 (20)

Proposition 3. Goodwill impairment understates the economic loss and serves as a weak indicator of the acquisition suc-
cess/failure of the CGU when there is a buffer present.

2.3. Content of accounting goodwill and the buffer over time using IFRS 3 and IAS 36

In this section, we analyze the representation of accounting goodwill over time and the components of the buffer. We
use the components from the Johnson and Petrone (1998) framework.
We start with the theoretical concept of core goodwill (GWC0 ), which comprises the expected excess prots from the
underlying business of the acquired entity together with any synergies that the acquirer has paid for at the time of the
acquisition. Note that the competitive forces in a market economy mean that both of these components would be expected
to decline over time.

GWCt = GWCt,acq + GWC t,int (21)

GWCt1,acq GWCt,acq 0 (22)

GWCt. = core goodwill for the entire CGU at time t, consisting of the economic value of future expected excess returns
including synergies
GWCt.acq = acquired core goodwill of the acquired entity at time t, consisting of the economic value of future expected
excess returns including synergies
GWCt.int = internally generated core goodwill for the entire CGU at time t, consisting of the economic value of future
expected excess returns

We then consider the value of the unrecognized assets and liabilities at the time of the acquisition, FVU0 . These assets
and liabilities will not be separately recognized on the statement of nancial position at any point in time. These assets and
liabilities will form part of accounting goodwill at the time of the acquisition, but as Johnson and Petrone (1998) point out,
they are not conceptually part of core goodwill. If the acquired entity continues with its operations in a similar manner as
before the acquisition, the value of these unrecognized assets and liabilities would be expected to increase over time.

EVUt > EVUt1, (23)

EVUt = economic value of individually unrecognized assets and liabilities of the CGU at time t

Finally, we consider the fair value of recognized assets and liabilities in excess of the carrying value recorded on the
consolidated statement of nancial position. This value is the fair-value adjustment at the time of the acquisition (ADJ0 ), and
we assume that it is equivalent to the economic value of the adjustment. The fair-value adjustments for individual assets are
recognized in the consolidated nancial statements and are depreciated and amortized over their useful lives in accordance
with the applicable IFRSs. This procedure is represented by expressions 24 and 25 below.
 t

ADJt = ADJ0 1 if t <= n (24)
n
ADJt = 0 if t > n (25)

ADJt = fair-value adjustment for recognizable assets and liabilities of the acquired entity at time t, which is assumed to
equal the economic value adjustment at the time of the acquisition

The economic value of the fair-value adjustment is expected to increase over time, as represented by expression 26. This
contrasts with the development over time of the carrying value on the consolidated statement of nancial position according
to expressions 24 and 25.

EVRt > EVRt1 (26)

EVRt = economic value in excess of the carrying value of recognized assets and liabilities excluding fair-value adjustments
at time t

By combining the characteristics of core goodwill, fair-value adjustments, and the economic value of unrecognized oper-
ating net assets from expressions 21 through 26 with expression 2, we obtain an expression for accounting and economic
goodwill in terms of their different components. Accounting goodwill consists of the economic value of the unrecognized
assets and liabilities and core goodwill, which are the second, third, and fourth components, respectively, of the Johnson and
Petrone (1998) framework. Economic goodwill (for the CGU without a pre-existing part) consists of the difference between
the economic value and the combination of the unadjusted carrying value of the acquired entity and the recognized fair-value
adjustment.

GWEt = EVt CVt,unadj ADJt = GWCt + EVUt + EVRt ADJt = GWAt + BUFt (27)
 S.-E. Johansson et al. / Journal of International Accounting, Auditing and Taxation 27 (2016) 1325 19

GWEt = GWCt + EVUt + EVRt ADJt = GWAt + BUFt (28)

CVt,unadj = carrying value of the operating net assets of the CGU, excluding fair-value adjustment

Finally, we separate core goodwill into two parts, the acquired and the internally generated core goodwill. The acquired
core goodwill is specic to the conditions present in the acquired entity and the expected synergies from the acquisition.
The internally generated core goodwill captures all activities in the pre-existing part of the CGU and activities after the
acquisitions that give rise to expected future excess returns.

GWCt = GWCt,acq + GWCt,int (29)

GWCt,acq = core goodwill from the acquisition still remaining at time t

GWCt,int = internally generated core goodwill at time t

We enter Eq. (29) into Eq. (28) to obtain a representation of the changes in accounting goodwill and the buffer over time.
The resulting Eq. (30) contains four components. The rst one, the acquired core goodwill, is expected to decrease over time.
The sign of the change in the second component, internally generated core goodwill, is not predetermined, though it is likely
to grow in response to, for example, innovation. The last two components, measurement and recognition conservatism, are
expected to increase over time in absolute terms due to conservative accounting practices. Hence, the size and growth of
the buffer depend on the relative development of the four components.

GWCt0,acq + GWCt0,int + (EVRt0 ADJt0 ) + EVUt0 = BUFt0 + GWAt0 (30)

Proposition 4. The size of the buffer after the acquisition date depends on the growth in accounting conservatism related to
both unrecognized and recognized assets and liabilities in absolute terms and on internally generated core goodwill.

Proposition 5. When acquired core goodwill decreases over time, accounting goodwill will, after the acquisition, subsume a
combination of internally generated core goodwill and fair-value changes not recognized in the consolidated statement of nancial
position.

2.4. A remedy to the impairment test dilemma

The content of accounting goodwill on the statement of nancial position (propositions 4 and 5) and the outcome of the
impairment test affecting prot measurement (proposition 3) call the relevance of the information into question. The reason
for this is the design of the impairment test. By redening the impairment test, some or all of the concerns could be remedied.
IFRS 3 uses a method of determining goodwill (i.e., based on fair values of identiable assets and liabilities) differing from
that adopted in the IAS 36 impairment test (i.e., based on carrying value of assets and liabilities). As goodwill is determined
as a residual, it is important that the assets and liabilities used to calculate the residual be appropriately determined. A
time-consistent approach would be to use the IFRS 3 approach to calculate goodwill as the way to determine the recoverable
amount of accounting goodwill for the impairment test. This would not affect the measurement of the identiable assets and
liabilities on the consolidated statement of nancial position but only change how the recoverable amount is determined.
The effects are shown below.

GWEt,IFRS3 = GWEt (EVRt ADJt ) = GWEt IMPADJt (31)

 
GWAt,IFRS3 = min GWEt,IFRS3 ,GWAt1,IFRS3 (32)

GWCt0,acq + GWCt0,int + EVUt0 = BUFt0,IFRS3 + GWAt0,IFRS3 (33)

BUF t0,IFRS3 BUF t0 BUF t,IFRS3 BUF t GWAt,IFRS3 GWAt (34)

Variablet,IFRS3 = indicates the value taken by the variable using the IFRS 3 measurement and recognition criteria in the
impairment test calculations in period t
IMPADJt = adjustment made for the impairment test using the IFRS 3 measurement and recognition criteria in period t

Using the IFRS 3 approach when measuring goodwill for the impairment test makes the buffer smaller than or equal to
the buffer according to IAS 36. Consequently, the effectiveness of the impairment test in measuring economic value losses
will be higher, as will the likelihood of an impairment loss, due to the lower buffer.

Proposition 6. By changing the impairment test to employ the same measurement and recognition criteria as at initial recog-
nition, the representation of goodwill and the effectiveness of goodwill impairments as a signal of acquisition performance will
improve.

3. Model sensitivity and numerical example

This section provides some deeper and more applied insights into the effects of the model and the content of the goodwill
item on the statement of nancial position.
20 S.-E. Johansson et al. / Journal of International Accounting, Auditing and Taxation 27 (2016) 1325

3.1. The sensitivity of the model to key assumptions

The effectiveness of the impairment test hinges on the measurement and recognition rules applied. The size of the buffer
in each period when the test is performed is crucial. In the above model, the two major drivers are the useful life of the
fair-value adjustments recognized at the time of the acquisition (acquired entity) and the growth in the unrecognized fair
value of net assets (acquirer and acquired entity). The useful life is most relevant immediately after the acquisition because
the impact of this component stops growing at the end of the useful life of the fair-value-adjusted net assets. In the long term,
the growth in the unrecognized fair value of net assets becomes increasingly important. Companies with large unrecognized
net assets, for example, research- and brand-intensive companies, particularly in the growing service sectors, are therefore
the ones most exposed to this phenomenon.
According to the impairment-test procedure of IAS 36, the reported consolidated value of net assets is used when calcu-
lating accounting goodwill as a residual. However, the general result of the analysis in Section 2 is that it is the size of the
buffer when performing the impairment test that matters. If values other than reported consolidated values are used, as in
Section 2.4, the relevance of goodwill and goodwill impairments could be increased without affecting any other reported
numbers. Note that this is not the same as proposing a fair-value model for nancial reporting; it is merely a revision of the
impairment test in which fair values instead of reported values are used in calculating the residual.

3.2. The numerical example

To illustrate the propositions made, we have constructed a numerical example intended to capture the prevailing and
proposed conditions in a common acquisition situation. An overview of the assumptions made and the numbers used in the
numerical example appears in the Appendix A. The acquired entity is expected to generate excess returns based on a favorable
market position until steady state is attained. The acquired entitys nancial statements are affected by both measurement
and recognition conservatism. Accounting goodwill as a result of the acquisition amounts to about one-third of the total
consideration transferred, which itself corresponds to about two times the operating net assets. These gures are consistent
with levels observed in previous research (Higson, 1998). The example is based on growing cash ows and decreasing core
goodwill. Moreover, there is a constant relative level of measurement and recognition conservatism, meaning that there is a
constant ratio between the conservatively measured components and the reported book value of net assets of the acquired
entity. The example also illustrates the development of the buffer, the effects on goodwill impairment tests during the rst
ten years after the acquisition, and the effects of a revised impairment test.
Panels A of Tables 2 and 3 present the case with impairment tests according to IAS 36, while panels B present the case
with the proposed adjusted impairment tests using initial measurement and recognition in accordance with IFRS 3. Table 2
presents the outcome when the acquired entity forms a separate CGU and Table 3 presents the outcome when the acquired
entity is part of a CGU already containing an entity identical to the acquired one. We focus on the impairment test at the end
of year 3. This means that there are six years of explicit forecasts of future cash ows and thereafter a steady-state projection
in line with IAS 36.33b,c. Note that year 10 appears in the tables only to indicate that the company is in steady state according
to the impairment criteria. Also, according to IAS 36, a period exceeding ve years is accepted if an explanation is provided as
to why the longer period is justied. For purposes of the numerical example, a ten-year period was considered appropriate
in order to clearly illustrate the effects.
Table 2 shows rapid and considerable buffer growth, although in this case the newly acquired entity forms a CGU of
its own. At the end of year 3 the buffer is 5.7 percent of the economic value, requiring a signicant decrease in economic
value compared with the initial forecast in order to trigger goodwill impairment losses. For all the accounting goodwill to
be impaired, an economic value loss of 35.4 percent is required relative to the original cash ow expectations.
The adjusted impairment test provides a completely different view of the acquisition. Accounting goodwill is impaired
during each of the rst eight years. Despite this observation, it is inaccurate to claim that this is an alternative amortization
model. First, an amortization model is predetermined. Second, in an amortization model the depreciable amount would
then be amortized to the residual value, which is not the case here. This test is performed each year ex post with the
outcome determining the pattern. Third, the example outcome is dependent on the pattern of the core goodwill, the amount
of unrecognized values, and growth in general. Stated differently, the specic impairment pattern is dependent on the
conditions in each case. However, using the numerical example assumptions, all economic value losses at the end of year
3 are immediately mirrored in corresponding impairments of goodwill. Irrespective of case dependencies, the proposed
alternative impairment test will result in an overall lower buffer for growing rms and, on average, more timely reporting
of economic losses.
Panel A of Table 3 reveals the dramatic development of the buffer when the acquired entity forms a CGU together with
a pre-existing part of the acquirers operations. The rst observation is the size of the buffer at the time of the acquisition.
In our example, where the pre-existing and the acquired operations are identical, the buffer is 25 percent of the economic
value of the CGU. The drop in value of the acquired entity required to incur any impairment loss is then 51.3 percent at the
end of year 3, or half of what we would assume if the entire CGU decreased in economic value. The necessary drop in value
remains relatively stable throughout the simulation period.
Panel B illustrates the effects of an adjusted impairment test. Although no goodwill impairments occur when the outcome
is as planned, the economic value loss necessary to cause an impairment is much less substantial than in panel A. At the
 S.-E. Johansson et al. / Journal of International Accounting, Auditing and Taxation 27 (2016) 1325 21

Table 2
Analysis of Unexpected Economic Losses Required to Cause Goodwill Impairment Losses. The case of an acquired entity forming a separate CGU.

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10

Panel A: Impairment Test According to IAS 36

EVt,alone 121.5 127.8 133.9 139.9 145.8 151.6 157.3 162.9 168.3 173.6 178.8
GWCt,alone 21.5 18.8 15.8 12.8 9.8 6.9 4.5 2.4 0.9 0.0 0.0
GWEt,alone 41.5 44.4 47.0 49.6 52.2 54.8 57.6 60.6 63.8 67.4 71.5
GWAt,alone 41.5 41.5 41.5 41.5 41.5 41.5 41.5 41.5 41.5 41.5 41.5
BUFt,alone 0.0 2.9 5.5 8.1 10.7 13.3 16.1 19.1 22.3 25.9 30.0
(1) Drop in value required to cause an impairment loss N/A 2.3% 4.0% 5.7% 7.3% 8.8% 10.2% 11.7% 13.2% 14.9% 16.7%
(2) Drop in value required to eliminate GWA N/A 34.7% 35.0% 35.4% 35.7% 36.1% 36.6% 37.1% 37.8% 38.8% 39.9%

Panel B: Adjusted Impairment Test

GWCt 21.5 18.8 15.8 12.8 9.8 6.9 4.5 2.4 0.9 0.0 0.0
GWEt 41.5 44.4 47.0 49.6 52.2 54.8 57.6 60.6 63.8 67.4 71.5
IMPADJt 0 3.8 7.6 11.4 15.2 18.9 22.6 26.1 29.4 32.7 35.7
GWAt 41.5 40.6 39.4 38.2 37 35.9 35 34.5 34.4 34.4 34.4
BUFt,IFRS3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.3 1.4
(1) Drop in value required to cause an impairment loss N/A 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.2% 0.8%
(2) Drop in value required to eliminate GWA N/A 31.8% 29.4% 27.3% 25.4% 23.7% 22.3% 21.2% 20.4% 20.0% 20.0%

Panel A of the table presents, in the case of an acquired entity forming a separate CGU, the numerical illustrations of (1) the percentage drop in the
economic value required to cause any goodwill impairment loss and (2) the percentage drop in the economic value that causes a complete impairment of
accounting goodwill. Panel B of the table shows the same measures as in Panel A, but using the adjusted impairment test applying the same measurement
and recognition criteria as in the initial purchase price allocation. Decreases in the economic value may occur if the realized protability is below the
expected outcome and/or because of decreased protability and growth expectations. The table includes key variables relating to goodwill and the buffer
protecting goodwill from impairment. Each number refers to the end of the year stated in the column heading. The explanations of each variable are as
follows:
EVt,alone Economic value of the entire acquired entity.
GWCt,alone Core goodwill, which captures the excess protability expected to be generated by the acquired entity.
GWEt,alone Economic goodwill of the acquired entity from the acquirers perspective. This is the difference between the economic value and the carrying
value of the operating net assets.
GWAt,alone Accounting goodwill, i.e., the goodwill reported on the consolidated statement of nancial position.
BUFt,alone Buffer protecting goodwill from impairment. The buffer is the difference between the economic goodwill, GWEt,alone , and the accounting goodwill,
GWAt,alone .

end of year 3 over half of the buffer is removed and at the end of year 10 about 70 percent of the buffer is removed. Only a
24.9 percent loss in the economic value of the acquired entity is required to cause a goodwill impairment at the end of year
3, or 12.5 percent for the entire CGU; the corresponding numbers at the end of year 10 are 16.8 percent and 8.4 percent,
respectively.
Table 4 shows the buffer components and their development over time. Panel A illustrates the case in which the acquired
entity forms a separate CGU and panel B the case in which the acquired entity forms a CGU together with part of the acquirers
existing operations. In the rst case, there is no internally generated core goodwill. Note that all components have changed
in value from their values at the time of the acquisition and that the value of the unrecognized net assets and acquired core
goodwill constitutes accounting goodwill of 41.5. Panel A indicates that even though we assume decreasing core goodwill,
the effects of the value of the unrecognized net assets combined with increases in the fair value of recognized net assets
are sufcient to generate an increasing buffer for the accounting goodwill. This clearly indicates that a buffer is created
without the existence of new internally generated core goodwill. Panel B further emphasizes the magnitude and effects of
conservative accounting. In this case, internally generated core goodwill partly creates the initial buffer, the high level of
which is then supported by the increase in measurement and recognition conservatism. In addition, if the operations in the
CGU create new internally generated core goodwill, the probability of goodwill impairments becomes extremely small.

4. Discussion and concluding remarks

The revised model for accounting for goodwill under IFRS has now been in force for about a decade and the IASB has
recently undertaken a post-implementation review to identify unintended consequences, implementation challenges, etc.
(IFRS Foundation, 2015). A growing body of literature on the application of the relevant standards for purchase price allocation
and impairment tests reveals extensive use of management opportunism (e.g., Glaum, Schmidt, Street, & Vogel, 2013;
Ramanna & Watts, 2012). This paper, however, aims to contribute to the literature by developing a model that is theoretically
consistent for both initial and subsequent accounting for goodwill, irrespective of the latitude for management opportunism.
When the IASB decided to change from the dual approach to the impairment-only approach, preparers incurred some
additional costs due to more frequent tests and disclosures. However, the IASB believed the benets would outweigh the
costs as users would nd the information more relevant. In contrast to arbitrary goodwill amortization, it seemed that an
impairment loss would reect an actual value decline due to expected cash ows being realized and/or whenever cash
ow outcomes being below expectations. Our paper demonstrates that these anticipated benets of increased relevance are
not fully realized because a buffer emerges that protects accounting goodwill from impairment during the post-acquisition
22 S.-E. Johansson et al. / Journal of International Accounting, Auditing and Taxation 27 (2016) 1325

Table 3
Analysis of Unexpected Economic Losses Required to Cause Goodwill Impairment Losses. The case of an integrated acquired entity forming a combined
CGU with a pre-existing part of the acquirers operations.

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10

Panel A: Impairment Test According to IAS 36

EVt,alone 121.5 127.8 133.9 139.9 145.8 151.6 157.3 162.9 168.3 173.6 178.8
EVt 243.0 255.6 267.8 279.8 291.6 303.2 314.6 325.8 336.6 347.2 357.6
GWEt, 103.0 106.8 110.0 113.2 116.4 119.6 123.2 127.2 131.6 136.8 143.0
GWAt 41.5 41.5 41.5 41.5 41.5 41.5 41.5 41.5 41.5 41.5 41.5
BUFt 61,5 65.3 68.5 71.7 74.9 78.1 81.7 85.7 90.1 95.3 101.5
(1) Drop in value required to cause an impairment loss N/A 51.1% 51.2% 51.3% 51.4% 51.5% 51.9% 52.6% 53.5% 54.9% 56.8%
(2) Drop in value required to eliminate GWA N/A 83.6% 82.2% 80.9% 79.8% 78.9% 78.3% 78.1% 78.2% 78.8% 80.0%

Panel B: Adjusted Impairment Test

GWCt,acq 21.5 18.8 15.8 12.8 9.8 6.9 4.5 2.4 0.9 0.0 0.0
GWCt,int 21.5 18.8 15.8 12.8 9.8 6.9 4.5 2.4 0.9 0.0 0.0
GWEt 103.0 106.8 110.0 113.2 116.4 119.6 123.2 127.2 131.6 136.8 143.0
IMPADJt 20 25.6 31.2 36.8 42.4 47.8 53.2 58.2 62.8 67.4 71.5
GWAt 41.5 41.5 41.5 41.5 41.5 41.5 41.5 41.5 41.5 41.5 41.5
BUFt,IFRS3 41.5 39.7 37.3 34.9 32.5 30.3 28.5 27.5 27.3 27.9 30.0
(1) Drop in value required to cause an impairment loss N/A 31.1% 27.9% 24.9% 22.3% 20.0% 18.1% 16.9% 16.2% 16.1% 16.8%
(2) Drop in value required to eliminate GWA N/A 63.5% 58.8% 54.6% 50.8% 47.4% 44.5% 42.4% 40.9% 40.0% 40.0%

Panel A of the table presents, in the case of an integrated acquired entity, the numerical illustrations of (1) the percentage drop in the economic value of
the acquired entity required to cause any goodwill impairment loss and (2) the percentage drop in the economic value of the acquired entity that causes a
complete impairment of accounting goodwill. Panel B of the table shows the same measures as in Panel A, but using the adjusted impairment test applying
the same measurement and recognition criteria as in the initial purchase price allocation. The acquired entity becomes an integrated part of the acquirers
operations and this integrated entity is assumed to form a combined CGU. The acquirers operations in this CGU are assumed to be of the same size and
have the same cash ows and accounting characteristics as does the acquired entity. The table includes key variables relating to goodwill and the buffer
protecting goodwill from impairment. Each number refers to the beginning of the year stated in the column heading. The explanations of each variable are
as follows:
EVt,alone Economic value of the entire acquired entity.
EVt Economic value of the combined cash-generating unit.
GWEt Economic goodwill of the combined cash-generating unit. This is the difference between the economic value and the carrying value of the operating
net assets.
GWAt Accounting goodwill for the combined cash-generating unit, i.e., the goodwill reported on the consolidated statement of nancial position.
BUFt Buffer protecting goodwill from being impaired in the cash-generating unit. This buffer consists of buffers from both the acquired entity and the
part of the acquirers pre-existing operations allocated to the cash-generating unit. The buffer for the combined CGU, BUFt , is the difference between the
economic goodwill, GWEt , and the accounting goodwill, GWAt,comb .
IMPADJt Adjustments based on the difference between the economic value of the recognized operating net assets and the carrying value of these operating
net assets.

Table 4
Decomposition of Buffer Components Over Time.

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10

Panel A: The Acquired Entity as a Stand-Alone Entity

(1) GWCt-0,acq 0.0 2.7 5.7 8.7 11.7 14.6 17.0 19.1 20.6 21.5 21.5
(2) GWCt-0,int 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
(3) EVU t-0 0.0 1.8 3.6 5.4 7.2 8.9 10.6 12.1 13.4 14.7 15.7
(4) EVR t-0 ADJ t-0 0.0 3.8 7.6 11.4 15.2 18.9 22.6 26.1 29.4 32.7 35.7
BUFt 0.0 2.9 5.4 8.0 10.6 13.3 16.0 19.0 22.2 25.8 29.9

Panel B: The Acquired Entity as an Integrated Entity

(1) GWCt-0,acq 0.0 2.7 5.7 8.7 11.7 14.6 17.0 19.1 20.6 21.5 21.5
(2) GWCt-0,int 0.0 2.7 5.7 8.7 11.7 14.6 17.0 19.1 20.6 21.5 21.5
(3) EVU t-0 0.0 3.6 7.2 10.8 14.4 17.9 21.1 24.2 26.9 29.4 31.5
(4) EVR t-0 ADJ t-0 0.0 5.6 11.2 16.8 22.4 27.9 33.1 38.2 42.9 47.4 51.5
BUFt 61.5 65.3 68.5 71.7 74.9 78.1 81.7 85.7 90.1 95.3 101.5

The table shows the numerical illustration of the four components (1, 2, 3, and 4) affecting the buffer that protects goodwill from impairment (see expression
30). The numbers presented for each component in the table (1, 2, 3, and 4) pertain to the cumulative change in the components from the time of the
acquisition, year 0, to the specic year. In turn, the total buffer, BUFt , is the sum of the four components. Each number refers to the end of the year stated
in the column heading. The explanations of each variable are as follows:
(1) GWCt -0,acq Change in acquired core goodwill from the time of the acquisition to the time under consideration. This is the only component recognized
by the IASB as a legitimate component of goodwill.
(2) GWCt -0,int Change in internally generated core goodwill in the cash-generating unit from the time of the acquisition to the time under consideration.
(3) EVU t -0 Change in the economic value of unrecognized operating net assets. At the time of the acquisition, the economic value of unrecognized
operating net assets is part of the accounting goodwill, but thereafter, any change affects the size of the buffer.
(4) EVR t -0 ADJ t -0 Part of the measurement conservatism of the recognized operating net assets that is not adjusted for at the end of each specic year.
Because the fair-value adjustments, ADJ t , are depreciated, the difference between the economic value and the underlying carrying value of the recognized
operating net assets of the acquired entity increases rather quickly over time.
BUFt Buffer protecting goodwill from impairment. The buffer is the difference between the economic goodwill and the accounting goodwill. This is the sum
of components 1, 2, 3, and 4.
 S.-E. Johansson et al. / Journal of International Accounting, Auditing and Taxation 27 (2016) 1325 23

period. The buffer is created from the fair values of assets and liabilities not recognized in the consolidated statement of
nancial position and from internally generated core goodwill. Growth and conservative accounting for assets and liabilities
are important determinants of the size of the buffer after the acquisition date. For an acquired entity integrated into a larger
CGU of the acquirer, a buffer may already exist as of the acquisition date due to the buffer present in the pre-existing part of
the CGU and expected synergies not paid for. The basis for conclusions indicates that the IASB was, at least to some extent,
aware of these obstacles to achieving improved relevance. However, as indicated by the model developed in this paper, when
the impairment test is consistently applied within the full context of IFRS, the test will understate the incurred economic
loss. This implies that goodwill will not be expensed in the income statement as the economic benets of an acquisition are
realized, which will in turn make it difcult for users to distinguish between successful and failed acquisitions.
The decision to replace the previously used dual approach with an impairment-only approach was a major departure
from prior practice. The former had advantages in terms of separating the goodwill decline into (1) amortization capturing
the expected value decline as excess returns were realized and (2) impairment losses representing unfavorable outcomes.
The post-implementation review of IFRS 3 also concludes that there is a need to re-evaluate the comparison between
the dual and impairment-only approaches and to identify ways to improve the impairment test (IFRS Foundation, 2015).
However, although there is some theoretical support for returning to the dual approach, erce criticism would be voiced in
response to such a change in the standards (e.g., criticism against the arbitrary nature of goodwill amortization). Based on
our theoretical analysis, and without reverting to the dual model, we propose changing the impairment test procedure so
that the same measurement and recognition criteria are employed as at initial recognition (note that this would only apply
to the impairment test procedure whereas the measurement and recognition of assets and liabilities on the statement of
nancial position would be unchanged). Consequently, the representation of goodwill on the statement of nancial position
and the effectiveness of goodwill impairment losses as a signal of acquisition performance, i.e., relevance, should improve.
This would lead to additional costs for preparers in terms of making fair-value adjustments for the CGU for the purpose of
the test; however, the costs should be somewhat limited because preparers would already have experience of making such
fair-value adjustments as of the acquisition date.

Acknowledgements

We honor the memory of our valued co-author, Sven-Erik Johansson, who sadly passed away in May 2015. Further, we
thank the two anonymous reviewers and the editors for their insightful comments and suggestions. Finally, we gratefully
acknowledge the nancial support provided by Handelsbankens Forskningsstiftelser.

Appendix A.

The numerical exampleassumption overview

The numerical example referred to in Section 3 is used to illustrate the theoretical results. An overview of the numbers
and methods used in the numerical example is provided below. We have replaced the discounted cash ow model with
the residual income model (e.g., Ohlson, 2005; Skogsvik & Juettner-Nauroth, 2013; Zhang, 2000) in order to directly link
accounting-based concepts, such as return measures and reported growth, to cash ows and values. Note that this is a
mathematical restatement of the discounted cash ow model prescribed in IAS 36, so everything is consistent with the
impairment test requirements. According to the model, the economic value can also be expressed in terms of the carrying
value of the underlying operating net assets and the expected return on those operating net assets through the residual
income model; see expression (A.1).


T
 
EV0 = CV0 + (RONAt - r) CVt 1 (1 + r)t + (EVT CVT ) (1 + r)T (A.1)
t=1

RONAt = return on operating net assets in period t dened as operating earnings after tax over the beginning of period
carrying value of the operating net assets. CVt = carrying value of operating net assets at the end of period t

We then set up the following assumptions linking cash ows to accounting-based return measures:

The consideration transferred corresponds to a market-to-book ratio of 2.02.

The expected RONA in both the acquired entity and in all other parts of the CGU is 19 percent in the rst year after the
acquisition.
The expected RONA converges linearly to its steady-state level, which is dependent on the expected accounting conser-
vatism in the steady state.
Measurement conservatism is 33.33 percent and recognition conservatism is 33.33 percent of the carrying value of the
operating net assets in the acquired entity.
The growth in identiable operating net assets is determined by expected protability and a xed nancing policy. Both
the nancial policy and the protability are assumed to converge linearly to the steady-state level, which implies that the
24 S.-E. Johansson et al. / Journal of International Accounting, Auditing and Taxation 27 (2016) 1325

growth rate converges almost linearly to its steady-state level. g = RONA (1pr), where pr is a payout ratio for all capital
providers determining the xed nancing policy and the growth convergence is almost linear for reasonable levels of RONA
and pr. Decreasing the RONA levels and increasing the payout ratios, which is probably a common scenario, would imply
a slightly convex g function with a more rapid decrease in growth early in the period before the steady state is reached.
No core goodwill is expected in the steady state, i.e., GWCT = 0.
The fair value and the acquired entitys carrying value of operating net assets grow at identical rates.
The payments to capital providers are set to 0 for all loss years in the numerical examples.
The fair-value adjustment as of initial recognition is depreciated over ten years.
The cost of capital is set to 10 percent.
The acquired entity has 60 in operating net assets at time 0 (based on conservative accounting), i.e., CV0,alone,unadj .
The period from the acquisition date to the attainment of the steady state is 10 years. We use 10 years to better illustrate
the effects, although the impairment test according to IAS 36 prescribes 5 years.
Impairment tests are conducted ex ante at the end of each year during the post-acquisition period, based on a comparison
between the economic value and the accounting value of goodwill as of the testing date.

Appendix Table A.1

This table provides an overview of the assumptions and components needed for the conclusions presented in Section 3
of the paper. If the acquired entity forms a CGU with an existing part of the acquirers operation, the basic gures, except for
fair-value adjustments and accounting goodwill, are doubled.
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10

CFt 6.0 6.7 7.4 8.0 8.8 9.5 10.2 10.9 11.5 12.2
EVt 121.5 127.8 133.9 139.9 145.8 151.6 157.3 162.9 168.3 173.6 178.8
GWCt, 21.5 18.8 15.8 12,8 9,8 6,9 4,5 2,4 0.9 0.0 0.0
RONAt 19.0% 18.5% 18.0% 17.6% 17.1% 16.6% 16.1% 15.7% 15.2% 14.7%
Prt 52.6% 54.6% 57.8% 60.4% 62.% 66.0% 68.9% 72.1% 75.7% 79.8%
Gt 9.0% 8.4% 7.6% 6.9% 6.4% 5.6% 5.0% 4.4% 3.7% 3.0%
CVt,unadj 60.0 65.4 70.9 76.3 81.6 86.8 91.7 96.3 100.5 104.2 107.3
ADJt 20.0 18.0 16.0 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0
CVt 80.0 83.4 86.9 90.3 93.6 96.8 99.7 102.3 104.5 106.2 107.3
GWEt 41.5 44.3 46.9 49.5 52.1 54.8 57.5 60.5 63.7 67.3 70.4
GWAt 41.5 41.5 41.5 41.5 41.5 41.5 41.5 41.5 41.5 41.5 41.5
BUFt 0.0 2.9 5.4 8.0 10.6 13.3 16.0 19.0 22.2 25.8 29.9
All values are as of the end of the year and all ows are during the year specied in the column heading. The explanations
of each variable are as follows:
CFt Cash ows generated by the acquired entity; these cash ows can be regarded as free cash ows.
EVt Economic value, which equals the present value of future cash ows annually discounted by 10 percent.
GWCt Core goodwill generated by the acquired entity. Core goodwill includes the excess expected prots to be generated
by the acquired entity discounted to the relevant point in time. No core goodwill remains in the steady state.
RONAt Acquired entitys return on operating net assets. This measure is calculated as operating earnings divided by
opening operating net assets (disregarding fair-value adjustments at the consolidated level).
Prt Proportion of operating earnings distributed to the capital providers of the entity. If this measure is divided by RONAt ,
then gt is obtained.
Gt Growth rate of operating net assets for the acquired entity.
CVt,unadj Carrying value of the acquired entitys operating net assets before the acquisition-related adjustments are made.
ADJt Fair-value adjustments attributable to accounting conservatism in the acquired entity. These adjustments are depre-
ciated over 10 years in the example.
CVt Carrying value of the acquired entity from the acquirers perspective, i.e., the sum of CVt,unadj and ADJt .
GWEt Economic goodwill of the acquired entity from the acquirers perspective. This is the difference between EVt and
CVt . As of the acquisition date, the accounting goodwill, GWAt , equals the economic goodwill, GWEt .
GWAt Accounting goodwill. As of the acquisition date, the accounting goodwill is calculated as the difference between
the economic value, EVt , and the carrying value of the acquired entity from the acquirers perspective, CVt .
BUFt Buffer protecting goodwill from impairment. The buffer is the difference between the economic goodwill, GWEt ,
and the accounting goodwill, GWAt .
 S.-E. Johansson et al. / Journal of International Accounting, Auditing and Taxation 27 (2016) 1325 25

Appendix Table A.2

This table shows the effects of applying fair-value accounting to all items, except for core goodwill, when performing the
impairment test. In this situation, no buffer emerges and accounting goodwill is impaired in line with the development of
the acquired core goodwill. There is no internally generated core goodwill in this example.
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10

ADJt 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
CVt 100.0 109.0 118.1 127.1 136.0 144.7 152.8 160.5 167.4 173.6 178.8
EVUt 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
EVRt 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
GWCt 21.5 18.8 15.8 12,8 9,8 6,9 4,5 2,4 0.9 0.0 0.0
EVt 121.5 127.8 133.9 139.9 145.8 151.6 157.3 162.9 168.3 173.6 178.8
GWEt 21.5 18.8 15.8 12,8 9,8 6,9 4,5 2,4 0.9 0.0 0.0
GWAt 21.5 18.8 15.8 12,8 9,8 6,9 4,5 2,4 0.9 0.0 0.0
BUFt 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
The table presents the numerical illustration of the development of goodwill components over time and the resulting
value buffer protecting accounting goodwill from impairment. Each number refers to the end of the year stated in the column
heading.
The consideration transferred at the acquisition date is the economic value (EVt ) of 121.5. In this case, no accounting
conservatism exists, meaning that ADJt , EVUt , and EVRt all take values of 0. The acquired companys operating net assets in
the consolidated report (CVt ) then take the value of 100 and the accounting goodwill (GWAt ) takes the value of 21.5. From
an economic perspective, the economic value of 121.5 consists of the carrying value of the acquired companys operating
net assets of 100 and the economic goodwill of 21.5. The economic goodwill consists solely of core goodwill (GWCt ) of 21.5.
The explanations of each variable are as follows:
ADJt Fair-value adjustments attributable to accounting conservatism in the acquired entity. These adjustments are depre-
ciated over 10 years in the example.
CVt Carrying value of the acquired entity from the acquirers perspective in the consolidated reports.
EVUt Economic value of unrecognized operating net assets in the acquired company. This component is not part of the
carrying value but is included in accounting goodwill, GWAt .
EVRt Difference between the economic value of the recognized operating net assets and their carrying values in the
acquired entity. As of the acquisition date, EVRt equals the fair-value adjustments, ADJt .
GWCt Core goodwill, which captures the excess protability expected to be generated by the acquired entity.
EVt Economic value of the entire acquired entity.
GWAt Accounting goodwill. As of the acquisition date, the accounting goodwill is calculated as the difference between
the economic value, EVt , and the carrying value of the acquired entity from the acquirers perspective, CVt .
GWEt Economic goodwill of the acquired entity from the acquirers perspective. This is the difference between EVt and
CVt . As of the acquisition date, the accounting goodwill, GWAt , equals the economic goodwill, GWEt .
BUFt Buffer protecting goodwill from impairment. The buffer is the difference between the economic goodwill, GWEt ,
and the accounting goodwill, GWAt .

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