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Goodwill is a non-current asset arising in consolidated financial statements when accounting for a business combination. It is a balancing figure representing, at the date of acquisition, the excess of the value of the business acquired over the net assets identified and recognised by the acquirer.

IFRS requires that goodwill must not be amortised but is tested for impairment, at least annually. According to IAS 36 Impairment of Assets, an asset is considered to be impaired if its carrying amount exceeds its recoverable amount, the latter being the higher of its fair value less disposals costs and its value in use (the present value of future cash flows expected to be derived from the asset). Because goodwill does not generate its own cash flows independently of other assets, it must be grouped with other assets and subsequently tested for impairment at the level of a cash-generating unit (CGU).

Value in use is frequently the basis of establishing recoverable amount, but this process has not been without criticism from both preparers and users of financial statements. As noted on IFRS.org: "Some companies that have been applying IFRS 3Business Combinationssince 2010, say that the requirements in IAS 36Impairment of Assetsfor testing impairment of goodwill are overly complex, time-consuming and expensive. Many companies also find it difficult to identify sufficiently reliable and observable data for measuring specified intangible assets that should be recognised separately from goodwill."

Further complaints include the concern that the information provided on goodwill and impairment is insufficient and that impairment of goodwill is not recognised until too late. The IASB has resisted the idea of re-introducing amortisation of goodwill or allowing some identifiable intangible assets acquired in a business combination to be included within goodwill.

The Board has however been considering ways of ensuring that impairment of goodwill is recognised in a more timely fashion, as well as making improvements to the value in use calculation. In the IASB's May 2018 podcast, the Chairman Hans Hoogervorst lamented that the Board is still not close to a solution. Issues discussed include effectiveness and cost, and Hoogervorst stated that part of the problem in finding a solution is that the two are contradictory.

"If you make impairment more effective, it easily becomes a costlier procedure. We have come to the conclusion that we need a fresh look to consider more options other than the updated headroom approach which was our first consideration," said Hoogervorst.

So what exactly is the "Updated Headroom Approach"? When you walk through a door, the space between the top of the frame and the top of your head is referred to as "headroom". It shields you from bumping your head. In business combinations, when goodwill is first recognised, investors believe that there is some unrecognised "headroom" that shields it from imminent impairment.

In a paper in March 2018, the European Financial Reporting Advisory Group (EFRAG) mentions three components of unrecognised headroom: 1) internally-generated goodwill, 2) any unrecognised assets such as internally generated intangibles that do not meet the recognition criteria and, 3) any difference between carrying amounts and recoverable amounts of other assets in the cash generating unit (CGU) that are not measured at current value.

For example, assume that the goodwill on acquiring a business and separately identified intangibles were allocated to a single CGU. Twelve months later, prior to impairment testing, the separate intangibles have been amortised for one year, and goodwill remains unchanged. Assuming that the value in use is the basis of recoverable amount, the present value of the future cash flows will reflect any internal goodwill generated since acquisition and changes in the value of intangible assets (say customer relationships). These increase the recoverable amount but are not reflected in the CGU's carrying amount. This represents unrecognised headroom.

Under the updated headroom approach, the unrecognised headroom in a CGU is recalculated every time the goodwill impairment test is performed and is compared to its previous level to determine whether impairment has occurred.

EFRAG provides this example: Company X tests goodwill for impairment regularly at the annual reporting date. Company X has a CGU Z that includes goodwill acquired in a past business combination. The recoverable amount and the carrying amount of the net assets of CGU Z at two reporting dates are as follows (assume that there is no change in the level of business activity):

Under current accounting, no impairment would result as the CGU's recoverable amount is still higher than the carrying amount. Under the updated headroom approach, the decrease in the unrecognised headroom of CU20 represents an impairment loss and is deducted from acquired goodwill "to the extent that it is attributable to the acquired goodwill". How to determine the latter may be problematic. Suggestions included always assuming that reduced headroom is attributable to acquired goodwill or introducing a rebuttable presumption to that effect.

This approach would result in recognising goodwill impairment earlier. Some contend that it would not add significantly to complexity or cost. The Board's latest view is that it does not solve all the issues raised by investors around goodwill impairment testing and further thinking is necessary.