IOSCO targets “hidden losses” in issuers’ financials

Amid concerns about the buildup of goodwill on corporate balance sheets, and the lack of timely disclosure to investors when that goodwill becomes impaired, the International Organization of Securities Commissions (IOSCO) launched a consultation on the issue.

The umbrella group of global regulators published a paper seeking feedback on financial reporting and disclosure practices for dealing with goodwill impairments.

According to the paper, the strong market for mergers and acquisitions (M&A) that has prevailed since the global financial crisis has been followed by an accumulation of goodwill — future economic benefits that are expected from an M&A deal — on corporate balance sheets.

For instance, among the companies in the S&P 500, accumulated goodwill has more than doubled from US$1.6 trillion in 2008 to US$3.7 trillion in 2021, it noted.

“In active M&A periods, acquisition prices tend to be higher, and as a result, the balance of goodwill has grown. Consequently, there is a risk that goodwill balances continue to accumulate over time even when the economics do not justify this,” the paper said.

As a result, regulators are concerned that companies are properly accounting for goodwill, and accurately disclosing when goodwill has become impaired.

“There is a risk that management may use optimistic assumptions in estimating the recoverable amount, which in some circumstances may be motivated by a reluctance to recognize impairment losses that will negatively impact profitability,” it said. As a result, IOSCO added, investors may not be aware that a company’s goodwill is being overvalued until its financial performance deteriorates significantly, and these losses are revealed.

“In this sense, it is sometimes said that goodwill carries ‘hidden losses’ that are not recognized until a dramatic decline in profitability or cash flows occurs,” it said.

IOSCO noted that the International Accounting Standards Board (IASB) is currently considering potential improvements to its standards for evaluating goodwill and disclosing the performance of corporate acquisitions.

Additionally, IOSCO said that a survey of securities regulators found that the disclosure of the assumptions that underpin goodwill impairment tests is among the top concerns of regulators.

To that end, IOSCO is now seeking feedback on the issue. It plans to use that feedback to develop recommendations for regulators, issuers, auditors and corporate directors, and to inform its work with the IASB.

In the meantime, the group said it’s critical for the application of financial reporting standards to result “in fair presentation of the financial position, performance and cash flows of the company for the benefit of investors, including that the goodwill is not stated at an amount in excess of its recoverable amount, and that impairment losses are recognized in a timely manner.”

James Langton

James is a senior reporter for Advisor.ca and its sister publication, Investment Executive. He has been reporting on regulation, securities law, industry news and more since 1994.