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MADJ
ISSN: 2789-9470
Goodwill recognition
47
Goodwill recognition in Malawian Banking Industry – Fair
Value Based Approach
By
Brian Phiri Kampanje
Abstract
Very often than not, business acquisition results in recognition
of goodwill as the consideration paid to gain control of the
acquiree is higher than the fair value of the net assets acquired
to compensate for synergies which acquirer benefits from the
business combination. Negative goodwill is a rare
phenomenon and must be justified and so is impairment of
goodwill which requires proper disclosures. The results of this
study indicate that auditors failed to make proper
pronouncements for incorrect recognition of full impairment
loss on goodwill, negative goodwill and adoption of full
goodwill which includes non-controlling interest in the
business acquisition transaction. There is need for regulators
to look into the results of this study and make necessary
directives on recognition of goodwill to comply with
appropriate International Financial Reporting Standards
(IFRSs) embedded in 2013 Malawi Companies Act.
Type of Paper: Research
Key words: Acquisition; Goodwill; Banking; Malawi.
1.0 Introduction
Mergers, Acquisitions & Disposals Journal
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Mergers, Acquisitions & Disposals Journal Vol. 2 Special Issue 1. Aug 2021
In an ideal banking acquisition transaction and indeed any
business combination, goodwill has to be recognised either
positive or negative to reflect the intrinsic perceptions of both
the acquirer and acquiree embedded under the Fair Value
Principles. This is so because the expectations of both the
acquirers and acquires are often different and therefore the
final price paid or received arising out of negotiations or
bargaining is not exactly the same which the counterparty to
the business combination transaction originally had. The three
underlined accounting standards under this study were
Revised International Financial Reporting Standard (IFRS) 3
– Business Combination, International Financial Reporting
Standard (IFRS) 13 – Fair Value and International Accounting
Standard (IAS) 36 – Impairment Loss.
The study focussed on the Malawian banking acquisition
transactions which took place between 2010 and 2020 in view
of readily available high quality data.
1.1 Problem Statement
IFRS 3 requires recognition of goodwill arising out of
business combination if consideration paid is in excess of the
value of the percentage of the net assets acquired and this
must be subjected to annual impairment test. The impairment
review must be objective and indeed fair. The reporting entity
does not have the option to decide whether to recognise
goodwill or not. If impairment loss is recognised, there must
be genuine reasons to do so and full disclosures made to assist
users of the financial statements make informed decisions.
1.2 Research Objectives
Goodwill recognition in Malawian Banking Industry
49
a) To evaluate the mechanisms of recognising goodwill in
financial year in which business combination occurred in
the Malawian banking industry.
b) To assess the auditor’s report regarding the matters of
goodwill in the financial year of business combination of
Malawian banks.
1.3 Research Questions
a) What are mechanisms of recognising goodwill in
Malawian Banking Industry?
b) How do auditors’ reports deal with matters of goodwill
recognition in the year of acquisition in Malawian
banking industry?
2.0 Literature Review
2.1 What is goodwill?
The first definition describing goodwill was emerged in the
1880s whereas goodwill considered being the difference
between the purchase price and the book value of an acquired
company’s assets Johnson and Tearney (1993) cited in Al-
Khadash and Salah (2009:24)
Kampanje (2012) postulated the following:-
[Goodwill has been a controversial subject since early 1900s as
narrated by Dunse et al (2004:237) in quoting Lord MacNaghten in
the House of Lords who delivered the leading judgement on the
meaning of the term “goodwill” on 20 May 1901[It is a thing very
easy to describe, very difficult to define. It is the benefit and
advantage of the good name, reputation and connection of a
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business. It is the attractive force which brings in custom. It is the
one thing which distinguishes an old-established business from a
new business at its first start.]. It is more likely that in business
combination under IFRS 3, acquirer is likely to pay higher
consideration than percentage of net assets acquired as a token of
appreciation for the established business as noted by Scott (2008:61)
who postulates as follows [If asked to describe goodwill, traditional
aspects such as product reputation, skilled force, site location,
market share and so on, spring to mind].
Association of Chartered Certified Accountants (2004:383) defines
goodwill as follows; [Future economic benefits arising from assets
that are not capable of being individually identified and separately
recognised – IFRS 3. Goodwill is any excess of the cost of
acquisitions over the acquirer’s interest in the fair value of the
identifiable assets and liabilities acquired as at the date of the
exchange transaction – IAS 22.......Negative goodwill arises when
the acquirer’s interest in the net fair value of the acquiree’s
identifiable assets, liabilities and contingent liabilities exceeds the
cost of the business combination. IFRS 3 refers to negative goodwill
as the excess of acquirer’s interest in the net fair value of acquiree’s
identifiable assets, liabilities and contingent liabilities over cost.]
Blaug and Lekhi (2009:28) observed as follows; [.....Essentially, it is
the premium paid on the combination. Goodwill, is however one of
the most fragile intangible assets and can be eroded quickly. For this
reason goodwill from business combinations is not amortised but
subject to annual impairment testing].
Justification for payment of goodwill is that it is a purchase
for future stream of superior earnings because goodwill
attracts customers thereby increases both revenue and profit
Umale et al (2013).
2.2 Recognition and measurement of Goodwill
Goodwill recognition in Malawian Banking Industry
51
Goodwill is an intangible asset accounted for under IAS 38 –
Kampanje (2012). For goodwill to be recognised, it must meet
the criteria of asset recognition by guaranteeing that it is
probable that future economic benefits will flow to the entity
and that the asset has value or cost which can be measured
reliably – IASB (2010). ACCA (2014:19) stated that
paragraph B64(e) of IFRS 3 requires an acquirer to disclose a
qualitative description of factors that make up the goodwill
recognised and examples of such qualitative description could
be synergies from combining the operations of the acquiree
and acquirer or intangible assets that do not qualify for
separate recognition other factors. ACCA (2014:19) further
notes that there is no prescribe practice and therefore leaving
too much discretion to the preparers of the financial
statements. Yaremko et al (2015:2) noted that the economic
nature of goodwill is determined by the factors that cause it
such that scientists and experts include the following; business
reputation of the acquiree (target firm); brand, trademarks,
patents of the acquired entity; customer base and customer
loyalty to the brand or the company acquired; developed
software, other technical or technological development;
management culture, business model and well-established
business process, personal qualification etc and these are
grouped together to form goodwill as they are not accounting
objects to be individually valued or costs assigned to them and
therefore just termed “all-in-one-pot” approach in goodwill
recognition.
Holt (2010) avers that goodwill can be measured in two
different ways: goodwill is the difference between the
consideration paid and the purchaser's share of identifiable net
assets acquired. This is a 'partial goodwill' method because the
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Mergers, Acquisitions & Disposals Journal Vol. 2 Special Issue 1. Aug 2021
non-controlling interest (NCI) is recognised at its share of
identifiable net assets and does not include any goodwill.
Secondly, goodwill can also be measured on a 'full goodwill'
basis, which means that goodwill is recognised for the non-
controlling interest in a subsidiary as well as the controlling
interest. ACCA (2014:19) provided latest developments as
follows:
[Additionally, one of the main changes introduced in IFRS 3 is the
measurement of non-controlling interests. This also has an impact
on the values of goodwill recognised during a business combination
(through what are commonly known as the full goodwill or partial
goodwill methods). More specifically, paragraph 19 of IFRS 3
requires that, for each business combination, the acquirer shall
measure any non-controlling interest in the acquiree either at fair
value or at the non-controlling interest’s proportionate share of the
acquiree’s identifiable net assets.
Along these lines, for each business combination in which the
acquirer holds less than 100% of the equity interest in the acquiree
at the acquisition date, paragraph B64(o) requires an acquirer to
disclose: (i) the amount of the non-controlling interest in the
acquiree recognised at the acquisition date and the measurement
basis for that amount, and (ii) for each non-controlling interest in an
acquiree measured at fair value, the valuation technique(s) and
significant inputs used to measure that value.].
Victor et al (2012:1121) provides three approaches to
goodwill which are accounting, legal and auditing. However
of particular interest in this part is the legal approach
expounded below:
[The purchasing of companies and of businesses has raised many
juridical problems concerning the transfer of the goodwill from
Goodwill recognition in Malawian Banking Industry
53
seller to buyer. This transfer is difficult to be stipulated in the
purchasing contract because some elements of the goodwill remain
bound to the business (location, reputation, products, competition,
employees) and other elements remain to the seller consisting in his
personal qualities (management, relation with the clients and with
the authority (etc). In general the seller commits through contract to
not develop the same business in that region and to not attract his
previous clients and employees. However nobody can stop those to
follow their employer in other region or business.].
The legal approach above indicates that seller of the business
might still compete with the buyer in one way or another and
possibly erode expected future economic benefits from the
business combination.
Goodwill in banking industry is also recognised if the future
benefits associated with the business acquisition are more
probable to the flow to the entity in line with general
classification of the assets by IASB (2010) above.
2.3 Goodwill impairment and write offs
IFRS Staff Paper (2016) observed that key change introduced
by IFRS 3 when it was first introduced in 2004 was to
eliminate amortisation of goodwill and instead require
goodwill to be to be tested annually for impairment. ACCA
(2008:15) avers that purchased goodwill is measured at cost
rather than fair value and that amortisation of goodwill was
replaced by impairment testing, which should be prudent
although it does not include a subsequent cash-flow test of
impairment value which is asymmetric and not neutral in its
application to purchased goodwill. KPMG (2020b) explains
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that as goodwill does not itself generate independent cash
inflows, the acquirer must assess the goodwill together with
other related net assets for impairment purposes.
There is growing interest in the treatment of purchased
goodwill as IFRS 3 prohibits amortisation of goodwill but that
it should be subjected to annual impairment tests. Yaremko et
al (2015) and IFRS Staff Paper (2016) highlights three
possible approaches which are being discussed for possible
amendment of IFRS 3 and these are:
a) Goodwill’s immediate write off after the acquisition of an
entity model;
b) Capitalisation as an intangible asset or other special asset
with annual amortisation model; and
c) Capitalisation as an intangible asset or other special asset
with without further amortisation but subjected to annual
impairment test model.
The discussion about the three possible models above are
ongoing and way forward will be known in due course.
Full or partial write off is currently permissible where there is
evidence that carrying amount of goodwill is higher than its
recoverable amount (value in use or current market value). Al-
Khadash and Salah (2009), Yaremko et al (2015) and IFRS
Staff Paper (2016) noted that goodwill might be overvalued
due to speculation or other factors. This should either be
written off immediately or written down (partial write off) by
a reporting entity once it is made aware of it – Al-Khadash
and Salah (2009) who also presented a goodwill write-off
model developed by Hayn and Hughes (2005) resting on two
Goodwill recognition in Malawian Banking Industry
55
main parts which are bankruptcy (deteriorating financial
condition of a firm) on one part and explanatory variables on
the other part as depicted below:
The subscripts i and A denotes the firm and the acquisition
year respectively, while the subscript t represents the write-off
year if there are any. The dependent variable in the model is
the goodwill write-off. This variable is a dichotomous that
receives the value 1 if the firm experienced the write-off of
goodwill and if there is no write-off, the variable receives the
value 0. Consequently, if the firm takes writeoff then t is the
year of the write-off and n ranges from A+1 to t, years
following the write-off are eliminated from the sample.
ACCA (2014) prohibits reversal of impairment loss on
goodwill if any conditions which resulted in write-off have
been expunged or improved.
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KPMG (2020b) provides a set of questions which boards of
acquirers must always try to answer in an effort to find out the
relevance of the goodwill as presented hereunder:
[
Can you identify the value underlying the goodwill through the
disclosures made in the financial statements, especially in the
case of new acquisitions or impairment testing?
How important is goodwill for the company and is this
importance taken into account accordingly in the financial
statements? If goodwill is one of the main assets in the
consolidated financial statements, we expect the notes on
goodwill to play a prominent role.
How does the company measure whether past acquisitions have
been successful or not? Does your company use specific
benchmarks to assess the success of an acquisition and if so, are
they appropriate?
How does the company account for past acquisitions
externally?].
2.4 Asset or business acquisition?
BDO (2020:8) stated that International Accounting Standard
Board amended IFRS 3 in October 2018 to distinguish asset
acquisition from business acquisition and one of the
distinguishing factors between the two is that goodwill is not
recognised under asset acquisition but these amendments were
effective for periods beginning 1st January 2020. Inputs and
processes differentiates assets from businesses. Crowe
Soberman LLP (2017) provides details regarding inputs,
processes and outputs as follows:
Goodwill recognition in Malawian Banking Industry
57
[Input: are economic resources, such as intellectual property, access
to necessary materials, employees and non-current assets such as
intangible assets or the rights to use non-current assets.
Process: is any system, standard, protocol, convention or rule, such
as strategic management processes, operational or resource
management processes. Administrative processes are specifically
excluded.
Output: is a return in the form of dividends, lower costs or other
economic benefits
… If the transaction does not include both inputs and processes then
it is not a business combination. ..
… Some processes must be included in the transaction, but all
processes used by the vendor need not be included. Some necessary
processes may be provided by the acquirer on integrating the
business with their own operations. ..].
2.5 Fair Value Principles
Fair Value Principles are accounted for under IFRS 13 – IFRS
Foundation (2012). Škoda and Bilka (2012) stated that Fair
Value was originally defined in IAS 20 as below:
[The first definition of fair value was introduced in 1982 in a
contemporary issue of IAS 20 published by the IFRS. This
definition has not changed much within years and is almost identical
to the most recent version, according to which Fair value is ´the
amount for which an asset could be exchanged between
knowledgeable, willing parties in an arm’s length transaction´.].
Two incorrect points noted with the above definition are that
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liability part was omitted (that it could be settled) and IASC
(International Accounting Standards Committee) not IFRS
was the one which published IAS 20. The proper definition of
Fair Value was the amount for which an asset could be
exchanged or liability settled between knowledgeable and
willing parties in an arm’s length transaction – Kaur (2013:1).
Kaur (2013:1) provided further definition which included
equity as so the definition of fair value was an amount for
which an asset could be exchange or liability settled or an
equity instrument granted could be exchanged knowledgeable
and willing parties in an arm’s length transaction.
The main emphasis was that there was no duress to buy or
sell, both parties had sufficient information on the pricing or
quality aspects of the product and that consideration to be paid
or received was adequate in that regard (no bias perceptions
when determining the pricing).
KPMG (2020a:7) defines fair value as price that would be
received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the
measurement date. KPMG (2020a:7) further states that fair
value is an exit price (e.g. price to sell an asset and not price
to buy an asset).
2.6 Fair value inputs and bank’s assets and liabilities
Prior to formulation of IFRS 13, Fair Value, there were four
Fair Value Inputs namely; Level 1determinable by direct
reference to observable market failing that; Level 2 required
for accepted model for estimating market price; Level 3 was
based on the actual price paid (assuming no persuasive
Goodwill recognition in Malawian Banking Industry
59
evidence that it was not unrepresentative); and Level 4 based
on the entity’s specific data that could be estimated reliably
and not inconsistent with market expectations – International
Valuation Standards Committee (2004). KPMG (2020a:62)
states that IFRS 13 fair value is based on hierarchy with three
level inputs which are briefly discussed below:
[The fair value hierarchy is made up of three levels, with Level 1
being the highest level.
Level 1 inputs. Unadjusted quoted prices in active markets for
identical assets or liabilities that the entity can access at the
measurement date.
Level 2 inputs. Inputs other than quoted prices included within
Level 1 that are observable for the asset or liability, either
directly (i.e. as prices) or indirectly (i.e. derived from prices).
Level 3 inputs. Unobservable inputs for the asset or liability.].
KPMG (2020a:95) defines an active market as one in which
transactions for the asset or liability take place with sufficient
frequency and volume to provide pricing information on an
ongoing basis. KPMG (2017:11) however earlier noted that
although there is a clear definition of active market under
IFRS 13, the assessment of whether the market is active could
be challenging particularly in borderline cases.
IFRS Foundation (2012) stated that there are three valuation
approaches under Fair Value vis-à-vis:
Market Value Approach (based on transaction price paid
for an identical or a similar instrument. Can also be
comparable company valuation multiples);
Income Approach (based on discounted cash flow
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method, dividend method, or capitalisation model); and
Cost Approach
A typical commercial bank has more assets in form of loans
and advances as its assets and depositors’ funds as liabilities
on its balance sheet (statement of financial position). These
are categorised as financial instruments and accounted for
under IFRS 7 (Financial Instruments – Disclosures) and IFRS
9 (Financial Instruments) with embedded fair value principles
outlined in IFRS 13 – Kasyan et al (2017).
Knott et al (2014:8) provides fair value of loans and deposits
as follows:
[The market value of loans is seldom observable. In this sense, loans
are similar to assets of non-financial firms, such as property, plant
and equipment, that affect the value of those firms but do not
actively trade in secondary markets (Flannery, Kwan and
Nimalendran (2004)). But a loan, like any other risky financial asset,
is a future stream of uncertain cash flows. And the theory of pricing
financial assets all stems from one simple concept: price equals
expected discounted payoff (Cochrane (2001)). This concept can be
applied to loans regardless of whether they are traded.
… The fair value of banks’ liabilities can be calculated in a similar
way but the interpretation of these values is not straightforward
…..Banks are required to disclose the fair value of liabilities that are
held at amortised cost. Accounting standards define the fair value of
deposits available on demand as the amount repayable, so the
disclosed fair value would be expected to equal the amortised cost
value.].
KPMG (2020a) however stipulates that some loans can be
valued using a market approach (e.g. if there are secondary
market transactions and prices for identical or similar assets).
Goodwill recognition in Malawian Banking Industry
61
2.7 Fair value and Basel (II and III)
ACCA (2009:6) noted that fair value principles had
significant impact on banks especially on capital adequacy as
follows:
[The banks have complained that fair value has combined
unacceptably with the Basel 2 capital adequacy rules to increase
pro-cyclicality. ACCA would argue that this is an issue for banking
regulators to thrash out with standard-setters. IFRS financial
statements and the fair values contained within them may not,
however, be the ideal basis for prudential supervision of financial
institutions. ACCA’s view is that accounts are intended to inform
shareholders on the affairs of the company, not provide a financial
stability tool for regulators].
International Valuation Standards Committee (2004) however
noted that it was Basel Committee which requested for
appropriate accounting standards that reflect well on asset
valuation as highlighted below:
[In July, the Basel Committee on Banking Supervision published
guidance for national supervisors and banks planning the transition
to Basel II. Among the key requirements are "the adoption of
internationally accepted accounting standards, asset valuation rules
which are consistent, realistic and prudent, and loan loss provisions
that reflect realistic repayment expectations". “All necessary," says
the Committee, "to ensure that capital ratios – computed under the
1988 or new Framework - will reflect meaningfully the capital
adequacy of the bank.”].
Temim (2016) provided a vivid interaction between IFRS 9 –
Financial Instruments which is based on fair value and Basel
III adapted hereunder:
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[… Most banks subject to IFRS 9 are also subject to Basel III
Accord capital requirements and, to calculate credit risk-weighted
assets, use either standardized or internal ratings-based
approaches…..The data, models, and processes used today in the
Basel framework can in some instances be used for IFRS 9
provision modeling, albeit with significant adjustments. Not
surprisingly, a Moody’s Analytics survey conducted with 28 banks
found that more than 40% of respondents planned to integrate IFRS
9 requirements into their Basel infrastructure.
… Depending on whether the standardized or advanced Basel
approach is used, the bank will be able to leverage some of the data
used by the Basel models to model IFRS 9 expected credit loss and
encourage easier reconciliation of inputs for capital requirement and
impairment calculations….
…. An IFRS 9 implementation will involve a shift from often
siloed-function data with no coordination, a lack of organizational
oversight, and a fragmented IT structure, to a crossfunctional
approach to data with clearly defined data ownership and
segmentation across the bank….].
2.8 Relationship of fair value and goodwill recognition
IFRS 13 was formulated to reduce arbitrary valuation
techniques which had no concrete bases. Reporting entities
can now clearly show how they determined value attached to
specific assets and users can assess the suitability of such
determinations to make well informed investment decisions,
risk analysis and determine the net-worth of the reporting
entity.
KPMG (2020) however notes that even if the acquiree’s
shares are publicly traded and therefore subjected to Level 1
Goodwill recognition in Malawian Banking Industry
63
Input (those with an active market), the consideration paid to
acquire equity stake in such companies is usually higher than
the quoted price. KPMG (2020:55) highlights the following:
[Acquisitions of public companies frequently involve payment of a
premium to the pre-announcement share price, primarily because of
synergies and other benefits that flow from control over another
entity. In these circumstances, the quoted market price of an
individual equity security may not be representative of the fair value
of the reporting unit as a whole. Therefore, a control premium (or
market participant acquisition premium) adjustment may be
appropriate.].
It can therefore be concluded that goodwill is much dependent
on the perception of future benefits to be accrued to the
acquirer and not necessarily the fair value of the net assets at
the date of the acquisition. This therefore entails that fair
value principles do not cover intrinsic values in synergies and
bargaining and negotiations processed take significant role in
determination of consideration for business acquisition but the
starting point is the unbiased determination of the net assets
from perceived future synergies are added up to come up with
goodwill.
3.0 Methodology
Archival data was adopted as source of data collection and it
consisted of Malawian banks’ annual reports from 2010 to
2020 as well as Reserve Bank of Malawi Annual Banking
Supervision Reports. The study was thus independent from
the data subjects and there was collaboration of data from
different reports – Yin (2003) and Vaivio (2008).
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The study used census sampling technique in view of the
small number of the data subjects as Malawi had eleven banks
in 2010 - Reserve Bank of Malawi Bank Supervision Report
Annual Report (2010) and eight banks in 2020 - Registrar of
Financial Institutions (2020). It is acceptable sampling method
as noted by Cosmin (2010) as well as Gupta and Kumar
(2020).
3.1 Table 1: Descriptive data
Acquistion 1 Acquistion 2
Acquistion 3
Acquistion 4
1 CP/PAEA 0.2433 5.0868 0.1508 0.0029
2 CP/POEA 0.2167 1.5527 0.1239 0.0024
3 CP/PAEG 0.2144 0.7988 0.1490 0.0018
4 CP/POEG 0.1879 0.4544 0.1202 0.0017
5 CP/PANAA 0.1697 1.9733 0.1430 0.0022
6 CP/PONAA 0.1563 0.3404 0.1239 0.0020
7 CP/PANAG 0.1551 1.0480 0.1414 0.0015
8 CP/PONAG 0.1407 0.2297 0.1198 0.0015
9 GW/PAEA 0.0820 1.5753 0.0918 -0.0017
10 GW/POEA 0.0731 0.4808 0.0754 -0.0014
11 GW/PAEG 0.0723 0.2474 0.0907 -0.0010
12 GW/POEG 0.0634 0.1407 0.0732 -0.0010
13 GW/PANAA 0.0572 0.6111 0.0870 -0.0013
14 GW/PONAA 0.0527 0.1054 0.0754 -0.0012
15 GW/PANAG 0.0523 0.3245 0.0860 -0.0009
16 GW/PONAG 0.0475 0.0711 0.0729 -0.0009
17 PAIAA/GW 0.0000 0.0000 0.9279 -71.3518
18 PAIAG/GW 0.0000 0.3059 0.9279 -105.5692
19 POIAA/GW 0.0000 0.0000 1.1862 -74.2496
20 POIAG/GW 0.0000 1.4165 2.2473 -102.0956
21 IGW/POEA -0.0731 0.0000 0.0000 0.0000
22 IGW/POEG -0.0634 0.0000 0.0000 0.0000
Goodwill recognition in Malawian Banking Industry
65
Key
4 Findings and discussions
Four out of six Malawian Commercial Banks acquisitions
were evaluated in view of the availability of the data. The
response rate was thus 66.67% which is deemed appropriate –
Bryman and Bell (2007).
4.1 Goodwill recognition in business acquisitions
75 percent of the results reported positive goodwill indicating
that a premium was paid for the acquisition. 25 percent
indicated negative goodwill and this rather peculiar in the
Malawian banking sector. Further commentary regarding the
goodwill recognition is presented below.
4.1.1 Recognition of Full Goodwill
1 CP - Consideration Paid
2 FGW - Full Goodwill
3 PAEA - Pre-acquisition Equity of Acquirer
4 PAEG - Pre-acquisition Equity of the Group
5 POEA - Post-acquisition Equity of Acquirer
6 POEG - Post-acquisition Equity of the Group
7 PANAA - Pre-acquisition Net Assets of Acquirer
8 PANAG - Preacquisition Net Assets of the Group
9 PONAA - Post-acquisition Net Assets of Acquirer
10 PONAG - Post-acquisition Net Assets of the Group
11 PAIAA - Pre-acquisition Intangible Assets of Acquirer
12 PAIAG - Pre-acquisition Intangible Assets of the Group
13 POIAA - Post-acquisition Intangible Assets of Acquirer
14 POIAG - Post-acquisition Intangible Assets of the Group
15 IGW - Impaired Goodwill
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Full Goodwill is the one which accounts for both portion
attributable to the acquirer and the acquiree by recognising
that when business combination occurs, it is not only the
acquirer who enjoys the benefits of the synergies but the
acquiree too.
Full Goodwill was recognised in Acquisition-3 only and was
ignored in the other three. Revised IFRS 3 – Business
Combination requires recognition of Full Goodwill in line
with IFRS 13 Fair Value which requires that Non-Controlling
Interest must be measured at Fair Value. This indicates that
there was violation of accounting standard in seventy five
percent of the acquisitions under review.
4.1.2 Consideration paid against equity of acquirer/group
Descriptive data from 1 to 4 in the table above (CP÷PAEA;
CP÷POEA; CP÷PAEG; CP÷POEG) shows that consideration
paid for Acquisition-2 was 5.0868 times the equity of the
acquirer and 1.5527 of the group. The acquisition was for
bigger entity bigger than itself. This is not usual phenomenon
as Nolop (2007) noted that in research conducted by Bain &
Company of more than 1,700 firms over 15 years period
shown that success of the acquisition was influenced by the
size of the target relative to market capitalization of the
acquirer and that the economic returns were greatest from
acquisitions that represented 5 per cent or less of acquirer’s
market capitalization.
4.1.3 Consideration against net assets of acquirer/group
Descriptive data from 5 to 8 in the table 1 above
Goodwill recognition in Malawian Banking Industry
67
(CP÷PANAA; CP÷PONAA; CP÷PANAG; CP÷PONAG)
indicates that consideration paid for Acquisition-2 was greater
than the net assets of the acquirer and even that of its group.
This mirrors 4.1.2 above.
4.1.4 Goodwill paid against equity of acquirer/group
Recognised Goodwill against Pre-acquisition Equity of
Acquirer ratio for Acquisition-2 was 1.5753 as shown in
number 9 through 12 (GW÷PAEA; GW÷POEA; GW÷PAEG;
GW÷POEG) of the table 1 above. This indicates the
willingness of the acquirer to sacrifice substantial investment
in of form of consideration paid in exchange for long term
benefits. Alternatively, it indicates the boldness of a small
company to acquire a bigger entity and this might demonstrate
quest for rapid growth through acquisition (financed by a
series of external financing) rather than organic growth.
Acquisition-2 requires special attention as recognition of
goodwill requires significant modelling to verify that
substantial tangible benefits will accrue to the acquirer from
the impending or completed business combination. It can be
construed that acquirers of Acquisition-2 put it all to achieve
it all and this can be regarded as the “Big Project” whose
failure would be catastrophic. Alternatively, it might indicate
of significant undervaluation of the acquiree resulting in
massive benefits derived by the acquirer once the acquisition
is completed. Second theory of undervaluation of acquiree
appears to be more plausible.
Acquisition-1 and Acquisition-3 appear to be similar in range
on these ratios and also under consideration paid against the
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equity (CP÷PAEA) discussed under section 4.1.2 above. This
can be proved using correlation coefficient whose formula is
presented below:-
The correlation coefficient is 0.9996 for (CP÷PAEA) over
(GW÷PAEA) showing very strong relationship indicating that
the higher the consideration paid in relation to acquirer’s
equity the higher will be goodwill in relation to the equity of
the acquirer. This probably indicate that the acquirers were
not under pressure to take over the equity of acquirees as
noted by Nolop (2007) who said one of the best rules in
acquisition is “Do not shop when you are hungry” which
simply means one can purchase things not a priority or being
price insensitive when desperate and therefore conform to Fair
value principles. Acquisition-2 however does not however
necessarily mean there was desperation in the acquisition
because it appears acquiree was undervalued and acquirer
took that opportunity.
4.1.5 Goodwill paid against net assets of acquirer/group
Recognised Goodwill against Pre-acquisition Net Assets of
Acquirer ratio for Acquisition-2 was 0.6111 as shown in
number 13 through 16 (GW÷PANAA; GW÷PONAA;
GW÷PANAG; and GW÷PANAG) which in another
Goodwill recognition in Malawian Banking Industry
69
expression we can say recognised goodwill was 61.11 per cent
of the acquirer’s pre-acquisition net assets and this is difficult
to justify unless the acquirers were aware that acquiree’s net
assets were greatly undervalued so that enormous benefits
would ensue once the business combination was achieved.
4.1.6 Relationship of Goodwill and Intangible Assets
Recognised goodwill is part of the intangible assets. Four
ratios were used to find out the relationship between total
intangible assets and goodwill from 17 through 20 of table 1
above (PAIAA÷GW; PAIAG÷GW; POIAA÷GW; and
POIAG÷GW). The results indicate 0 for Acquisition-1 and so
are for Acquisition-2 on acquirer but not on its group. This
might confirm earlier observation by Kampanje (2012) that
intangible assets are not properly recognised in the financial
statements of the Malawian public companies and this might
be the trend for the whole economy. Acquisition-3 had the
highest ratio indicating the importance of goodwill as part of
the intangible assets of the acquirer. Acquisition-4 indicated
negative relationship culminating from recognised negative
goodwill. IFRS Community (2020) highlighted that reasons
for realising negative goodwill should be disclosed in the
financial statements for example seller was under pressure due
to liquidity issues but more importantly, gains on bargain
purchases are rare in real life because if the consideration paid
is higher than the value of the net assets acquired, fair value of
the assets is decreased or alternatively liabilities ought to be
increased. Critical review of the acquisition resulting in
negative goodwill indicates that 20% of the net assets
acquired were due to Deferred Tax arising out of the assessed
cumulative tax losses. The acquirer stated that the recognition
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of the Deferred Tax Asset would be subject to Malawi
Revenue Authority prior approval. Paragraph 12.35 of IAS 12
– Income Tax specifically emphasises that the existence of
unused tax losses is strong evidence that future taxable profit
may not be available and that an entity with history of recent
recognises a deferred tax asset arising from unused tax losses
or tax credits only to the extent that the entity has sufficient
temporary differences or there is convincing evidence that
sufficient taxable profit will be available. Section 43 of the
Malawi Taxation Act provides a vivid explanation on the
treatment of unused tax losses as follows:-
[43.-(1) If during any year of assessment there is a change in the
shareholding of a company with an assessed loss or in the
shareholding of a company which directly or indirectly controls any
company with an assessed loss and the Commissioner is satisfied
that such change has been affected solely or mainly in pursuance of
or in connexion with any scheme for taking advantage of such
assessed loss no assessed loss incurred prior to that change shall be
deductible.
(2) For the purposes of this section a company shall be deemed to be
controlled by another company if the majority of the voting rights
attaching to all classes of its shares are held directly or indirectly by
such other company.].
It can therefore be argued that recognition of Deferred Tax
Asset in the calculation of the negative goodwill was
conditional on receiving approval from the tax authorities.
Contingent consideration could have been a better alternative.
4.1.7 Impaired goodwill against post acquisition equity
IGW÷POEA and IGW÷POEG from 21 through 22 of table 1
Goodwill recognition in Malawian Banking Industry
71
above indicate that Acquisition-1 recognised a full
impairment of the goodwill without giving any reasons for
doing so contrary to IFRS 3. IFRS Community.com (2020)
provides astounding revelation regarding impairment of
goodwill as follows:
[All assets and liabilities acquired should be recognised irrespective
of whether they were recognised by the target (IFRS 3.10-13) or
whether the acquirer intends to use them. Assets that the acquirer
does not intend to use or intends to use in a ‘suboptimal’ way should
still be measured at fair value assuming their highest and best use.
They also cannot be written-off immediately after the acquisition, as
the impairment loss under IAS 36 can be recognised only when both
value in use and fair value less costs of disposal are below the
carrying value of the asset (IFRS 3.B43).]
The bar for impairing goodwill appears to be too high
possibly to enhance consistency and avoid profit smoothing in
the financial statements.
4.2 Auditors’ reports concerning goodwill recognition
The auditors’ reports usually include a commentary of
material transactions which we have taken place during the
reporting period. IASB Conceptual Framework (2010:17)
states the following:
[Information is material if omitting it or misstating it could
influence decisions that users make on the basis of financial
information about a specific reporting entity. In other words,
materiality is an entity-specific aspect of relevance based on the
nature or magnitude, or both, of the items to which the information
relates in the context of an individual entity’s financial report.
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Consequently, the Board cannot specify a uniform quantitative
threshold for materiality or predetermine what could be material in a
particular situation.].
Auditors peg materiality at 5 per cent by stating that if an item
in the financial statements are understated or overstated by
more greater than 5 per cent, that item is materially misstated
as per the Audit Risk Model which is generally used across
the global – Law (2008). Basing on Consideration Paid
against Pre-acquisition Equity of Acquirer (CP÷PAEA) of
Acquisition-1 was 24.33 per cent, Acquisition-2 was 508.6
per cent, Acquisition-3 was 15.08 per cent and Acquisition-4
was 0.29 per cent. Vouching through the auditors’ reports of
the acquirers in this study, only Acquisition-4 was covered in
the auditor’s report under emphasis matter and auditor was
satisfied with the way negative goodwill was recognised
despite the shortfalls noted in 4.1.6 above where the bar for
negative goodwill is too high. All in all it appears that external
auditors could have done in better in reviewing the
acquisitions as they are considered to have inherent risk as fair
valuation of the acquiree might be materially misstated and
affect the financial statements of the acquirer.
5.0 Conclusions and recommendations
The study has revealed substantial disparities of acquisitions
in Malawian banking industry between 2010 and 2020.
Acquisitions 1 and 3 depict fair value principles in the
recognition of goodwill. Acquisition-2 probably indicates
undervaluation of the assets of the acquiree and therefore
much as the goodwill was over 500 times the pre-acquisition
equity of the acquirer, the consideration paid ought to have
been much higher than the one paid and therefore no fair
Goodwill recognition in Malawian Banking Industry
73
value principles followed. Negative goodwill recognised on
Acquisition-4 was not based on fair value principles a big
component of the assets of about 20 per cent was deferred tax
asset for accumulated tax losses which both International
Accounting Standard (IAS) 12 and Malawi Taxation Act
would require significant motivation to be included in the
calculation of goodwill and therefore fair value principles
were not followed in that regard.
Impairment of goodwill should only be done with substantial
evidence to suggest that it has to be written down and full
disclosures made in the financial statements. That was not the
case with Acquisition-1. Appendix 1 provide more details.
Only Acquisition-3 recognised full goodwill in which the
value of the Non-Controlling Interest was factored in in order
to calculate goodwill with full understanding that business
combination benefits both acquiree and acquirer.
Auditors have duty to ensure that reporting entities comply
with the tenets of the international financial reporting
standards on matters dealing with impairment of goodwill and
recognition of negative goodwill but results of this study
suggest that external auditors failed to make appropriate
comments in the auditors’ reports as they were supposed to
have qualified the audit reports as the treatment of the
goodwill appeared to have been irregular for Acquisition-1
(impairment of goodwill) and Acquisition-4 (recognition of
negative goodwill). It can be deduced that financial statements
for both Acquisition-1 and Acquisition-4 did not comply with
applicable accounting standards and auditors ought to have
qualified the audit reports.
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Acquisition-2 appears to stem out of the grossly understated
net assets of the acquiree despite substantial goodwill being
recognised but not based fair value valuation principles.
Auditors ought to have flagged this transaction and qualify the
financial statements.
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Appendix 1: Impairment Test of Goodwill
Source: pwc.com (2017) “Navigating the new goodwill
impairment testing guidance (ASU 2017-04”
Accessed from http://www.pwc.com/us/en/services/audit-
ssurance/accounting-advisory/goodwill-impairment.html