Allocation of Goodwill to CGU’s as per Ind AS 36 & IAS 36: Impairment of Assets

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Many entities are growing their business and market share through acquisition of other entities. They acquire entities in the same industry they are in, to increase their market share and the portfolio of products. They also acquire entities from different industries to enter into new sector of business and diversify their business portfolio.

In accounting for most of these acquisitions’ goodwill comes in to the picture as per the provisions of Ind AS 103 & IFRS 3: Business Combinations.

Goodwill recognized in a business combination is an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized.

Goodwill does not generate cash flows independently of other assets or groups of assets, it contributes to the cash flows of multiple Cash Generating Unit’s (“CGU”).

For the purpose of impairment testing, goodwill acquired in a business combination is to be allocated to the acquirers CGU’s (or a group of CGUs).

Goodwill will be allocated to those CGU’s which benefit from the synergy of the particular business combination, whether net assets acquired are being allocated to the CGU or not.

As per Ind AS 36 & IAS 36, each CGU or group of CGUs to which the goodwill is so allocated shall:

• 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 as defined by Ind AS 108 & IFRS 8: Operating Segments before aggregation.
  

The initial allocation of goodwill acquired in a business combination is to be completed before the end of the annual period in which the business combination is affected. If not, initial allocation shall be completed before the end of the first annual period beginning after the acquisition date.

As per the provisions of Ind AS 36 & IAS 36, a CGU to which goodwill is allocated, should be tested for impairment at least annually. This impairment test is to be done whether there are indicators for impairment or not.

A case study:

• ABC Limited manufactures and sells chewing gums for human consumption. ABC Ltd has been in business for the last fifteen years and has an extensive and effective supply chain. Through its robust supply chain, it could ensure that its products reach all the retails outlets all-round the country, even the remote areas. It also reduces the transport cost, both during dispatching its products and purchase of its raw materials.

• PQR Limited manufactures and sells an array of “FMCG” products. The products are pens, pencils, books, processed chocolates and bakery products. PQR Limited is in existence for the last 5 years and is looking to increase its market share by making sure that its products “visibility” increases and are placed in all the retail stores in the country.
  

• At this juncture PQR Limited decided to acquire ABC Limited. The rationale is to not only increase one more product i.e. chewing gums in its portfolio, but also leverage the robust supply chain to increase its existing products “visibility”. This will increase the revenue of each of existing products materially. The synergy of this business combination would be received by the existing CGU’s of PQR Limited as well.  

• As per the provision of Ind AS 103 & IFRS 3: Business Combinations, a goodwill of INR 50 million was recorded in the books of PQR Ltd.  

• Post-acquisition the CGU’s identified in PQR Limited, for the purpose of impairment testing, are:

  • Assets used to manufacture books.

  • Assets used to manufacture pens.

  • ­Assets used to manufacture pencils.

  • ­Assets used to manufacture processed Chocolates.

  • ­Assets used to manufacture bakery products.

  • ­Assets used to manufacture chewing gums.
    

This is because the entity has only one set of process and assets for each of the products. So, these are the smallest group of assets which can generate cashflows independently from other assets in the entity.

• The assets which are acquired from ABC Limited are allocated to the “Chewing Gums” CGU and no other CGU.
  

• The synergy of this acquisition is enjoyed by all the CGU’s, through an increased revenue and reduction in transport cost. Based on the proportion of benefits received by each of the CGU’s the goodwill will be allocated to each of these CGU’s.  

This article has been published in the Chartered Accountant Study Circle ("CASC") Bulletin.