Finch, Nigel --- "Intangible Assets and Creative Impairment - An Analysis of Current Disclosure Practices by Large Australian Listed Firms" [2006] JlLawFinMgmt 7; (2006) 5(2) Journal of Law and Financial Management 18

• Abstract
• 1. Introduction
• 2. Intangible Assets in Australian Listed Companies
• Table 1 – Composition of intangible assets for all listed firms in 2005
• Table 2 – Relative value of intangible assets for all listed firms in 2005
• 3. Sample and Method
• Table 3 – Ten Australian ‘high user’ firms with 2006 reporting
• 4. Results & Discussion
• Table 4 – Analysis of goodwill disclosures
• Table 5 – Analysis of intangible (ex. Goodwill) disclosures
• Table 6 – Description of major intangible (ex. Goodwill) asset classes
• 6. Conclusion
• References

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Intangible Assets and Creative Impairment - An Analysis of Current Disclosure Practices by Large Australian Listed Firms

Nigel Finch
Macquarie Graduate School of Management

Abstract

This paper examines the disclosure of intangible assets by ‘high user’ industrial firms in the Australian market subsequent to the introduction in 2005 of AASB 136 and AASB 138. Using a sample of ten large industrial firms with combined intangible assets of $37,758 million as at 2006, the paper analyses the disclosure of goodwill and 18 other distinct intangible assets classes of these firms, and examines their implied effective life by probing the impairment expense detailed in the profit and loss statement. While a high degree of uniformity in disclosure practices pertaining to intangible assets is evident, questions are raised in relation to factors motivating impairment decisions for intangible assets under the new financial reporting regime.

1. Introduction

The reporting framework in Australia that deals with the disclosure of intangible assets is predominantly governed by two accounting standards: AASB 138 – Intangible Assets and AASB 136 – Impairment of Assets. Both of these accounting standards came into effect for Australian firms with reporting periods beginning on or after 1 January 2005 – the point in time when Australia formally adopted International Financial Reporting Standards (IFRS).

In Australia, the move to IFRS had particularly significant consequences for the accounting and financial reporting treatments relating to intangible assets – whether identifiable or unidentifiable. Prior to the adoption of IFRS, the chief applicable accounting standard dealing with the question of accounting for and reporting of intangibles was AASB 1013 – “Accounting for Goodwill”. In combination with AASB 1015 “Accounting for the Acquisition of Assets”, which required corporate acquisitions to be accounted for using the purchase method, AASB 1013 set the framework for the treatment of this important class of intangible.

In essence, it required that purchased goodwill arising from acquisition transactions be recognised in the consolidated balance sheet of the acquiring group and subsequently amortised against earnings on a straight line basis over a period not exceeding 20 years. While AASB 1013 dealt comprehensively with the appropriate treatment of goodwill, there was no holistic standard which set out the accounting and reporting requirements which pertained to identifiable intangible assets such as brands, patents, licences, mastheads and the like. In consequence, recognition and subsequent treatment of these items was inconsistent between firms.

As indicated above, two standards chiefly set out the rules relating to accounting for intangible assets in Australia under the IFRS regime. The first, AASB 138 – Intangible Assets deals with the definition, recognition and disclosure of intangible assets and requires financial statements to disclose for each distinct class of intangible asset:

(a) the useful life, amortisation rate and method.

(b) the gross carrying amount and accumulated amortisation at the beginning and end of the period.

Next, AASB 136 – Impairment of Assets deals with the definition, recognition and disclosure of asset (including intangible asset) impairment and requires financial statements to disclose for each distinct class of asset:

(a) The amount of impairment losses recognized in the profit and loss statement and under which heading the losses are included.

(b) The amount of any reversals of impairment loses.

The adoption of IFRS rules in Australia has changed the state of play in relation to accounting for intangibles considerably. A comprehensive suite of rules dealing with both identifiable and unidentifiable intangible assets now exists. In some cases, this has resulted in materially different accounting treatment becoming the norm – the most obvious example of which is a move away from an amortisation based regime for accounting for goodwill, to an impairment based approach.

Gaining a better understanding of the impact of this change is the key motivation for this paper, which is set out as follows. Section 2 provides a general discussion of the nature of intangible assets and of the significance of this class of assets to the total asset base of listed Australian corporations. Section 3 sets out details of the research methodology and data sample employed for the purposes of the study, while section 4 sets out the results of the study and provides a discussion of the key findings. Finally, conclusions are set out in Section 5.

2. Intangible Assets in Australian Listed Companies

For an increasing proporition of businesses the principal assets they own and employ in business are ‘intangible’ in their character., They tend to be are long-lived assets, and despite their lack of physical presence, they represent the ‘infrastructure’ on which, and by which, such businesses earn their future cash flows and profits. One meaning of intangible is ‘not cognizable by the sense of touch’ and this implies that they cannot be touched, but the meaning implied by accountants is more realistically interpreted as ‘difficult to value’ (Tiffin, 2005 p. 66).

IAS 38 - Intangible Assets defines an intangible asset as an identifiable non-monetary asset without physical substance held for use in the production or supply of goods and services, for rental to others, of for administrative purposes. This definition may not be a very good one as many intangibles do have a physical substance - e.g. patents and related drawings and licence agreements (Tiffin, 2005 p. 67)

. While this definition may be inadequate, the real issue regarding intangible assets, and the surrounding controversy about their recognition (Godfrey & Koh, 2001), is that intangibles, by their very definition, are difficult to value and as such, attempts to measure any accretions to or impairments of their problem can be plagued with problems and many vagaries. It is this uncertainty about the value of assets and changes to this value that makes then highly susceptible to creative accounting and reporting practices.

Despite complexities in valuing intangible assets, they nonetheless represent a significant repository of value for Australian listed firms. During the 2005 financial year, the total value of intangible assets for listed Australian firms was $149,294 million, which represented 5.7% of their total assets for that year^[1]. Tables 1 and 2 below summarise the composition and relative value respectively of intangible assets for listed Australian firms in 2005.

Table 1 – Composition of intangible assets for all listed firms in 2005

Intangible asset type	Amount ($ million)	% of total intangible assets
Intangible assets excl. goodwill	68,541	45.9%
Goodwill	80,753	54.1%
Total intangible assets	149,294	100.0%

Source: Aspect Financial Analysis

In 2005, goodwill comprised the largest component with 54.1% of total intangible assets. Other intangible assets (excluding goodwill) comprised 45.9% of total intangible assets consisting of an eclectic variety of distinct asset classes including, but not limited to, computer software, patents, copyrights, trade marks, brand names, publishing titles, motion picture films, customer lists, mortgage servicing rights, fishing licences, import quotas, franchises, customer and supplier relationships, customer loyalty, market share and marketing rights (CPA, 2006 p. 929).

Table 2 – Relative value of intangible assets for all listed firms in 2005

Intangible asset type	Amount ($ million)	% of total assets
Intangible assets excl. goodwill	68,541	2.60%
Goodwill	80,753	3.1%
Total intangible assets	149,294	5.7%
Total assets	2,638,681	100.0%

Source: Aspect Financial Analysis

In a relative sense, total intangible assets comprised approximately 5.7% of total assets for listed Australian firms in 2005 with goodwill comprising 3.1% of total assets and other intangible assets (excluding goodwill) comprising 2.6% of total assets.

3. Sample and Method

While the figures in Table 1 and 2 above show the aggregate value of intangible being 5.7% of total assets across the entire market in 2005, this result is unlikely to be representative of all market sectors. Therefore, to avoid possible result obfuscation, this paper focuses on the ‘top end of town’ and examines the disclosure practices of some of Australia’s largest industrial firms and the choices made with respect to impairment charges in relation to their intangible asset base.

To facilitate this goal, a selection of ten (10) industrial firms listed on the Australian Stock Exchange that have released their 2006 annual reports was obtained using Aspect Financial Analysis^[2]. The selection was further refined by identifying firms who were: (a) in the S&P/ASX Top 100 listed firms in 2006; and (b) were ‘high users’ of intangible assets, in that they had identified significant amounts of intangible assets separately on their balance sheet. This sample, along with other descriptive information, is shown in Table 3 below.

Table 3 – Ten Australian ‘high user’ firms with 2006 reporting

No.	Company	ASX Code	Total assets (million)	Intangible assets (million)	% of total assets
1	A.B.C. Learning Centres Limited	ABS	$2,044.1	$1,688.7	82.6%
2	The Australian Gas Light Company	AGL	$10,487.6	$2,402.4	22.9%
3	Amcor Limited	AMC	$10,155.5	$1,888.4	18.6%
4	DCA Group Limited	DVC	$2,368.3	$1,471.4	62.1%
5	John Fairfax Holdings Limited	FXJ	$4,087.1	$2,899.6	70.9%
6	Publishing and Broadcasting Limited	PBL	$8,351.1	$3,072.3	36.8%
7	Singapore Telecommunications Limited	SGT	$33,606.2	$10,115.6	30.1%
8	Telstra Corporation Limited	TLS	$36,175.0	$6,123.0	16.9%
9	Toll Holdings Limited	TOL	$14,670.0	$6,627.0	45.2%
10	Wesfarmers Limited	WES	$7,515.1	$1,470.2	19.6%
TOTALS			$129,460.0	$37,758.6	29.2%

A visual inspection of the data in Table 3 shows the enormity of the intangible assets employed by these ten firms. These ‘high user’ firms account for $37,758 million in intangible assets which represents 25.3% of the total intangible assets reported by all industrial firms in 2005. These ‘high user’ firms also account for $129,460 million in total assets, which represents 4.9% of total assets for the whole market during 2005. This clearly demonstrates the disproportionate importance of intangible assets to the selected sample organisations, and underlines the degree to which the choices made in relation to accounting and reporting for intangible assets by this group is a matter of significant research interest.

The annual reports for 2006 of the sample companies were reviewed, in particular the disclosures made regarding intangible assets. Firstly, the disclosures were examined to determine if they complied broadly with the requirements of the relevant accounting standards to determine the consistency and uniformity of disclosure.

Next, the amount of goodwill was isolated from total intangible assets and the impairment charge (if any) for 2006 was identified. This was compared to an estimate of the level of amortisation expense which would have been booked by each sample organisation pursuant to the pre IFRS accounting regime. Finally, the other intangible assets were also identified and catalogued along with the 2006 impairment charge and an estimate was made of the effective life of these assets. These results are summarised in Tables 4, 5 and 6 below.

4. Results & Discussion

The first observation is that that all the firms in the sample provided consistent presentation and disclosure on intangible assets which comprised:

• An explanation of the accounting polices used to define intangible assets and record their impairment, including the useful life, amortisation rate and method. This was contained within the notes to the accounts along with a summary of other accounting policies.

• The gross carrying amount and accumulated amortisation at the beginning and end of the period was also included for each distinct asset class.

• The amount of impairment losses recognised in the profit and loss statement for each distinct asset class was also disclosed.

• The amount of any reversals of impairment losses, acquisitions, disposals and other adjustments was also disclosed.

This disclosure is consistent with the requirements of AASB 136 and AASB 138 and is uniform across the entire sample providing evidence of a high degree of uniformity among the firms with respect to their presentation.

Table 4 – Analysis of goodwill disclosures

Company	Goodwill (million)	Total assets (million)	Goodwill as % of total assets	Annual impairment (million)
A.B.C. Learning Centres Limited	$313.7	$2,044.1	15%	-
The Australian Gas Light Company	$1,766.8	$10,487.6	17%	-
Amcor Limited	$1,743.6	$10,155.5	17%	-
DCA Group Limited	$1,305.6	$2,368.3	55%	-
John Fairfax Holdings Limited	$654.1	$4,087.1	16%	-
Publishing and Broadcasting Limited	$413.9	$8,351.1	5%	-
Singapore Telecommunications Limited	$9,553.2	$33,606.2	28%	-
Telstra Corporation Limited	$2,073	$36,175.0	6%	$1.0
Toll Holdings Limited	$5,659	$14,670.0	39%	$2.0
Wesfarmers Limited	$1,470.2	$7,515.1	20%	$3.0
TOTALS	$24,953.1	$129,460.0	19%	$5.0

As identified earlier in Table 2 above, goodwill represented 3.1% of total assets in 2005 across the entire market. Table 4 above shows these ‘high user’ firms have accumulated goodwill equivalent to 19% of their total assets in 2006, which is due to the high levels of mergers and acquisitions undertaken by Top 100 firms (Carlin, Finch & Ford, 2006). Curiously, the total amount of goodwill impairment in 2006 represents just 0.02% of total goodwill value.

Recall that AASB 136 was introduced from 1 July 2005 to replace the superseded goodwill accounting standard AASB 1013 - Accounting for Goodwill. Under AASB 1013, goodwill was required to be amortised over a period of not greater than 20 years (Deegan, 2005 p. 276). The replacement standard, AASB 136, requires goodwill not to be amortised, instead tested annually for impairment.

By comparison, under the old AASB 136 regime, the amortisation expense for the sample firms in 2006 would have been at least $1,247.6 million (being $24,953.1 million in goodwill divided by a maximum 20 year life). The amount of $5 million in total annual goodwill impairment actually expensed in 2006 represents an enormous boost to profitability for the sample firms of some $1,242.6 million.

It seems arguable that this boost to profitability represents a key motivation for impairment choices made by the sample of firms studied. Current accounting standards require a plethora of choices and assumptions to be made by managers and auditors in making determinations as to whether asset carrying values have been impaired. Some of the variables drawn upon by mangers in undertaking this task including the estimated future cash flow likely to be derived from the asset, an estimate of the likely future disposal value of the asset, and estimates regarding discount rates, growth rates and inflation rates. It is the exercise of these choices by management that ultimately determines the impairment expense and remaining asset value. Where managers have any degree of choice in determining values for assets, expenses and ultimately and profits of their firms, this accentuates the risk that creative or aggressive accounting choices are employed (Dean & Clarke, 2004; Griffiths, 1986; Schilit, 2002; Smith, 1996).

Table 5 – Analysis of intangible (ex. Goodwill) disclosures

Company	Intangibles ex goodwill (million)	Total assets (million)	Intangibles ex goodwill as % of total assets	Annual impairment (million)	Implied effective life (years)
A.B.C. Learning Centres Limited	$1,375.00	$2,044.1	67%	$14.1	97.5
The Australian Gas Light Company	$635.60	$10,487.6	6%	$3.9	163.0
Amcor Limited	$144.80	$10,155.5	1%	$21.4	6.8
DCA Group Limited	$165.80	$2,368.3	7%	$3.2	51.8
John Fairfax Holdings Limited	$2,245.50	$4,087.1	55%	$14.4	155.9
Publishing and Broadcasting Limited	$2,658.40	$8,351.1	32%	$18.1	146.9
Singapore Telecommunications Limited	$562.40	$33,606.2	2%	$51.1	11.0
Telstra Corporation Limited	$4,050.00	$36,175.0	11%	$904.0	4.5
Toll Holdings Limited	$968.00	$14,670.0	7%	$23.0	42.1
Wesfarmers Limited	NIL	$7,515.1	0%	nil	n/a
TOTALS	$12,805.5	$129,460.0	10%	$1,053.2	avg. 75.5

As shown in Table 2 above, intangible assets (ex. goodwill) represented 2.6% of total assets in 2005 across the entire market. These ‘high user’ firms have identified intangible assets (excluding goodwill) equivalent to 10% of their total assets, with the exception of one firm (Wesfarmers) reporting no intangible assets other than goodwill.

Based on the intangible value and the 2006 impairment expense, the implied effective life was calculated and shown in Table 5 above. Across the sample, the average of the effective lives for these intangible assets is 75.5 years, with four firms having an implied effective life greater than the mean. While it is impossible to determine if the effective lives are appropriate, given the non-specific high-level nature of disclosure made in the financial accounts, an examination of the asset classes in Table 6 below might be useful in forming a view on the reasonableness of the impairment assumptions.

Impairment losses for non-goodwill intangibles may be driven by many factors such as changes in general business conditions, changes in technology, declining market values, changing interest rates, or changes in how a company employs its assets (Mulford & Comiskey, 2002 p. 223).

From the data in Table 5, three firms are assuming their intangible assets will have an effective life less of than 20 years, and the remainder are making assumptions from 42.1 to 163.0 years. Because longer amortisation periods permit larger book values to accumulate on the balance sheet (and larger profits), then would be the case under shorter periods, the likelihood of an impairment-related write-down due to the myriad events identified by Mulford & Comiskey (2002) increases as amortisation periods increase. As such the quality of the profit disclosed by the firms with long amortisation periods might be questionable as it is likely to be overstated.

Table 6 – Description of major intangible (ex. Goodwill) asset classes

Company	Description of major intangible asset classes
A.B.C. Learning Centres Limited	Childcare licences
The Australian Gas Light Company	Licences, emission rights, natural gas conversion,
Amcor Limited	Internal development, internally developed software, externally developed software
DCA Group Limited	Bed licences, customer relationships, business names, licences, software development
John Fairfax Holdings Limited	Mastheads, tradenames, software
Publishing and Broadcasting Limited	Program rights, mastheads, licences
Singapore Telecommunications Limited	Licences, program rights, customer relationships
Telstra Corporation Limited	Software, mastheads, patents, trademarks, licences, brand names, customer bases, deferred expenditure
Toll Holdings Limited	Software, right of way, customer relationships
Wesfarmers Limited	No intangible ex. goodwill assets

In all, a total of 18 distinct asset classes (excluding goodwill) were identified across the sample of large industrial firms. These asset classes are shown in Table 6 above and comprise: bed licences; brand names; business names; childcare licences; customer bases; customer relationships; deferred expenditure; emission rights; externally developed software; internal development; internally developed software; licences; mastheads; natural gas conversion; patents; program rights; right of way; and tradenames.

Reflecting upon the descriptions for each of the above asset class, it seems highly pertinent to ask if it is reasonable to assume that any of these assets, for example software and customer relationships, could have an effective life greater than the mean of 75.5 years? This is a prudent question in helping a reader to determine the quality of the financial disclosure by the firms, because this apparent assumption of long-life will have a material and positive impact on the resulting continuing asset value, impairment expense and consequently the profit for these firms in the current year.

6. Conclusion

Australian firms have entered a new era in intangible asset disclosure with the introduction from 2005 of AASB 138 – Intangible Assets and AASB 136 – Impairment of Assets. Together, these two new accounting standards govern the recognition and disclosure of intangible assets and the treatment of their inevitable impairment.

By examining a sample of 2006 ‘high users’ of intangible assets, it is apparent that there is great uniformity and consistency in the disclosure practices of these firms. This may in part be attributable to the size and maturity of the these firms, with all of the firms in the sample sitting within the top 100 firms listed on the Australian Stock Exchange. Each firm provided concise information on accounting policies relating to intangible assets and impairment, and provided reconciliations of asset values, acquisitions, disposals and impairment across all significant intangible asset classes. The presentation of this disclosure was designed to meet the expectation of the standards.

Perhaps the most interesting aspect of the intangible asset disclosure was the determination of impairment expense. Using the analysis provided in Tables 4 and 5 above, it is apparent that these firms are taking a very conservative (creative?) approach to the calculation of impairment, with a goodwill impairment of just 0.02% and an average implied effective life across all firms of 75.5 years for intangible asset (ex. goodwill) impairment. While this approach may lower impairment expense in the short term and bolster profits, what is less obvious is there is also an affect on asset book values, leaving greater asset book values on the balance sheet.

Inevitably changes in general business conditions, changes in technology, declining market values, changing interest rates and myriad other internal and external factors will mean that the intangible assets with eventually be impaired and result in a significant write-down of these over-valued assets. It would seem from the analysis that the sample firms may be engaged in creative accounting by taking a very ‘conservative’ approach to impairment testing which is increasing both profits and the book values of intangible assets in the short term. Perhaps this deferral of impairment expense will one day be forced to raise its head, and take many unsuspecting shareholders by surprise.

References

Carlin, T., Finch, N and Ford, G., (2006), “Misadventure and the Form of Payment in Corporate Acquisitions” in G. N. Gregoriou. & K. Neuhauser (eds.), Mergers, Palgrave McMillan, New York.

CPA Australia, (2006), Accounting Handbook 2006 Volume 1, Pearson Education, Melbourne.

Dean, G. & Clarke, F., (2004), 'Principles Vs Rules: True And Fair View and IFRS', Abacus, vol. 40, no.2, pp. i-iv.

Deegan, C. M., (2005), Australian Financial Accounting, McGraw-Hill, Sydney.

Godfrey, J, & Koh, P., (2001), "The relevance to firm valuation of capitalising intangible assets in total and by category", Australian Accounting Review, vol. 11 no.2, pp. 39-48.

Griffiths, I., (1986), Creative Accounting, Waterstone & Co, London.

Mulford, C. & Comiskey, E., (2002), The Financial Numbers Game: Detecting Creative Accounting Practices, John Wiley, New York.

Tiffin, R., (2005), The Complete Guide to International Financial Reporting Standards, Thorogood, London.

Schilit, H., (2002), Financial Shenanigans, McGraw-Hill, New York.

Smith, T., (1996), Accounting for Growth: Stripping the Camouflage from Company Accounts, Random House, London.

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^[1] Data obtained from Aspect Financial Analysis for all listed firms with disclosure in 2005.

^[2] At the time of writing, not all firms had released their disclosures in 2006, and as such, a whole-of-market comparison for the year is not available. Therefore, any relative comparison made in this paper will be based on 2005 data.