Do Audit Committees understand Intangible Assets?

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Understanding Intangible assets has become more relevant in modern business due to digital/technology companies and goodwill recognition raising concerns around valuation and impairment calculations. Goodwill has got in the news following the liquidation of a number of entities.

Earlier this year it was reported, one of the UK government’s biggest contractors, filed for liquidation. At the date of its liquidation, the company had goodwill valued at £1.57bn on its statement of financial position. This was listed as the single biggest asset in the books, representing more than a third of the company’s total assets. This goodwill had initially been correctly calculated and had arisen from the acquisition of numerous entities over many years.

The following story is familiar to many companies in Sri Lanka! The intangible assets note in the financial statements shows an annual impairment review had been performed and there was deemed to be no impairment in goodwill. However, in the above instance an insolvent entity ends up with £1.57bn of goodwill, which is unimpaired?

On the other hand, does a large goodwill balance simply represent overpaying for an entity as opposed to an actual asset? How do minority shareholders establish fraudulent intent in such situations? In most cases, the CFO in collusion with majority shareholder Directors develops beautiful cash flows to justify higher recoverable amounts and hood wink the auditor and the audit committee. We of course know impairment tests involve subjective inputs that are too easy for management to manipulate.

Therefore, an impairment review of goodwill is an important task rather than simply preparing an excel worksheet. Depending on its size internal auditors should review this process and confirm appropriateness with IFRS and challenging sensitivity analysis based on relevance to the business. Audit committees should make it their business to understand why goodwill was not impaired or else when it is impaired it did not relate to an overpayment due to fraud.

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About surenraj

“Views expressed are my own”
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