Research Paper No. 3
June 2017

Analyst Views on Financial
Information Regarding Goodwill

Accounting Standards Board of Japan

Key FindingsAll analysts interviewed by the ASBJ staff conducted their analyses based on cash
flow information.

Although the way they used cash flow information varied,

those who adjusted accounting profit to determine cash flows added backamortisation and impairment losses.
However, the fact that analysts added back amortisation and impairment losses did
not necessarily mean that their intention was to avoid using accounting profits thatamortised goodwill in their analyses. All analysts conducted analyses frommultiple perspectives; in addition to analyses based on cash flow information,
analysts considered accounting profit and net asset information.



Although how accounting profit and net asset information were used varied among
analysts, the ASBJ staff observed that the analysts could be classified broadly into
two groups: (i) those who placed more significant importance on analyses based on
cash flow information to achieve comparability at the global level, and (ii) those
who placed significant importance on analyses based on accounting profit and net
asset information as much as on analyses based on cash flow information,
considering the impact of such information on stock prices and the lending
behaviour of financial institutions.



Within the analysts who placed more significant importance on analyses based on
cash flow information, some supported the non-amortisation of goodwill because
the signal of the failure in the investment should be provided by recognising
goodwill impairment when the value of goodwill had become lower than the initialamount recognised as goodwill, whereas others were indifferent between
amortisation and non-amortisation of goodwill because neither affected cash flows.

Page 2Within the analysts who placed significant importance on analyses based on
accounting profit and net asset information as much as on analyses based on cash
flow information, some supported the amortisation of goodwill for the following
reasons:
 the value of goodwill cannot be maintained permanently;
 the non-amortisation of goodwill may induce imprudent businesscombinations; impairment losses better represent the failure in the investment when goodwill
impairment was recognised when the value of goodwill had become lower thanthe carrying amount of goodwill after amortisation; and the amortisation of goodwill achieves equal footing between growth by meansof business combinations and organic growth.

At the same time, other analysts supported the non-amortisation of goodwill due tothe costs to conduct their analyses because there was no alternative but to converge
with the approach that was most widely used internationally, for the purpose ofachieving comparability at the global level.

Some analysts thought that information regarding the management’s estimate of theperiod for which expected future cash flows would increase due to the businesscombination was useful.

These analysts thought that, by amortising goodwill

based on such period, profit or loss would be calculated by matching the increases
in income due to the business combination with the amortisation expense
determined based on the management’s estimates and thus provides useful
information.
Regardless of how cash flow information and accounting profit and net asset
information were used, many analysts thought that impairment losses on goodwill

Page 3

were recognised later than when they thought the deterioration in the value of
goodwill had occurred. These analysts said that they incorporated thedeterioration in the value of goodwill in their analyses before the impairment losses
on goodwill were recognised.
In recent international discussions regarding the subsequent accounting for
goodwill, arguments such as “analysts believe that goodwill amortisation would notprovide relevant information” or “all analysts ignore goodwill amortisation andadjust profit or loss in order to eliminate the effect of goodwill amortisation” areoften heard.

Based on the interviews, it was confirmed that the method ofanalyses varied among analysts, and how they conducted analyses based on cash
flow information and accounting profit and net asset information depended on theobjectives of their analyses.

It was also confirmed that their views on theamortisation of goodwill varied.

Page 4

Implications for standard setting The ASBJ staff thinks that, in order to reflect the analyst views in the process ofdeveloping accounting standards, it is necessary to interpret their views in thecontext of setting standards.

 As stated in the “Key Findings” section, the analysts interviewed by the ASBJ staff
can largely be classified into those who place more significant importance on cash
flow information, and those who place significant importance on accounting profit
and net asset information as much as on analyses based on cash flow information,and their views on the amortisation of goodwill varied.

 Within the various views expressed by the analysts, the ASBJ staff focuses on twoviews.

One view, expressed by more than one analyst from the perspective ofconducting analyses based on accounting profit and net asset information, is that
goodwill should be amortised.

The other view, expressed by more than one

analyst from the perspective of conducting analyses based on cash flow
information, is that they were indifferent between amortisation and nonamortisation of goodwill.

 The ASBJ staff thinks that these two views have different implications foraccounting standard setting.
The former view implies that accounting profit and net asset information,
which are determined in accordance with accounting standards that require theamortisation of goodwill, provide relevant information because information
provided under the amortisation and impairment approach is more informative than
the impairment only approach.

Page 5

The latter view implies that the relevance of financial information is basicallyunaffected, even if goodwill is amortised, because neither the amounts ofamortisation nor impairment losses are meaningful.
Taking these views into account, for the subsequent accounting for goodwill,
to reflect the analyst views in the process of developing accounting standards, therelevance of financial information for more analysts would be improved by placing
more significance on the views of analysts who support the amortisation andimpairment approach.

 The ASBJ staff hopes that the results and the implications of this Research Paper
contribute to the international discussions related to the accounting for goodwill.

Page 6

I. Objective of the Research Paper
1.

The objective of this Research Paper is to provide a basis for discussions regarding
the IASB’s research project on “Goodwill and Impairment” and the FASB’s
Research Agenda “Subsequent Accounting for Goodwill for Public Business
Entities and Not-for-Profit Entities.”

2.

The non-amortisation of goodwill was first introduced in U.S. GAAP by FASBStatement No. 142, Goodwill and Other Intangible Assets, issued in June 2001
(hereinafter referred to as “Statement 142”).

The Basis for Conclusions ofStatement 142 stated that “in addition to the many analysts that ignore goodwill
amortisation expense in their analyses, many entities ignore goodwill amortisation
expense in measuring operating performance for internal reporting purposes”(paragraph B90).
3.

In June 2015, the IASB published the Report and Feedback Statement, “Postimplementation Review of IFRS 3 Business Combinations” (hereinafter referred toas “the Report”). The Report indicated that investors held mixed views on thesubsequent accounting for goodwill; some investors supported the existing
requirements under IFRS (that is, the non-amortisation of goodwill) whereas otherinvestors supported the amortisation of goodwill.

4.

On the other hand, in recent international discussions regarding the subsequentaccounting for goodwill, arguments such as “analysts believe that goodwill
amortisation would not provide relevant information” or “all analysts ignore
goodwill amortisation and adjust profit or loss in order to eliminate the effect of
goodwill amortisation” are often heard.

5.

The staff of the Accounting Standards Board of Japan (hereinafter referred to as the“ASBJ staff”) conducted in-depth interviews with prominent analysts in Japan withthe aim of understanding their current views on goodwill and impairment morethoroughly.

This Research Paper summarises the results of those in-depth

interviews.
6.

It should be noted that this Research Paper intends to share the various views ofanalysts in Japan and, therefore, does not intend to provide analyses of the
proportion (or the number) of the different views.

Furthermore, it should be noted
Page 7

that this Research Paper summarises the views of analysts to assure the anonymityof their responses, although it might have been easier to understand the analyst
views had their views been described separately.

When the views of more than one

analyst was summarised as a single view, this Research Paper indicates such fact,
but it does not indicate the number of the analysts, because those views were notnecessarily identical.

The number of the views included in this Research Paper andthe number of the analysts who expressed those views do not necessarily match,because one analyst may have expressed more than one view from different
perspectives on the same subject.

Page 8

II. Scope and Methodology of the In-Depth Interview
7.

The ASBJ staff conducted in-depth interviews with eleven prominent analysts inJapan. The ASBJ staff selected analysts with outstanding experience and knowledge
in business valuation or credit quality assessment, with the assistance of the Securities
Analysts Association of Japan (SAAJ). The ASBJ staff also considered the balanceof views from buy-side equity analysts, sell-side equity analysts, and credit analysts.
When selecting analysts whose work focused on a specific industry, the ASBJ staff
selected industries where business combination transactions were more common.

8.

The analyst type, employer type, and industry focus of the eleven analysts who wereinterviewed can be summarised as follows1:
Analyst Type

Employer Type

Industry Focus

1

Buy-sideequityInvestment managementcompany2

Buy-sideequityAsset management company All industries

3

Buy-sideequityAsset management company All industries

4

Buy-sideequityAsset management company
All industries(Non-Japanese)5

Buy-sideequityAsset management company
All industries(Non-Japanese)

6Sell-side
equitySecurities company

All industries

7

Sell-side
equitySecurities company

Telecommunication
Services

8Sell-side
equitySecurities company

Food, Beverage, andTobacco9Sell-side
equitySecurities company

Retail10Sell-side
equitySecurities company (NonJapanese)

Health Care

11

CreditCredit agency

All industries

All industries

Page 99.

All eleven analysts analysed financial statements which were prepared in accordancewith three types of accounting standards, namely Japanese GAAP, IFRS, and U.S.
GAAP.

The ASBJ staff thought that it would be meaningful to report the views ofanalysts who analysed the financial statements of Japanese entities applying
Japanese GAAP, because such analysts were the only analysts who currently
analysed financial statements that were prepared in accordance with accounting
standards that required the amortisation of goodwill in addition to the impairment of
goodwill (Among the accounting standards used in major capital markets, only
Japanese GAAP currently requires the amortisation of goodwill).

All elevenanalysts had experience in analysing financial statements that were prepared inaccordance with IFRS or U.S. GAAP, when they conducted business valuations or
credit quality assessments of Japanese entities that have adopted IFRS or U.S.
GAAP, or when they analysed financial statements of non-Japanese peer entities.
10.

The ASBJ staff interviewed each of the eleven analysts using a common questionnaire.
The questionnaire included the following questions:

How do you use financial information regarding business combinations that isprovided in the entity’s financial statements when conducting businessvaluations or credit quality assessments?

What type of disclosures are useful as disclosures related to goodwill?

What is the most appropriate as the subsequent accounting for goodwill,
impairment only, systematic amortisation with impairment testing, or direct
write-off?

1

Some analysts had experience as a buy-side equity analyst as well as a sell-side equity analyst.
Regarding analysts who have experienced more than one analyst type or employer type, the listshows the analyst type or employer type when the interview was conducted (when the analyst
referred to a specific analyst type or employer type, the list shows that specific analyst type or
employer type). Moreover, some analysts expressed their own personal views while others
expressed collective views of analysts working for the same employer.
Page 10

III. Findings
Classification of the responses from analysts
11.

All eleven analysts the ASBJ staff interviewed stated that, in their process of businessvaluations or credit quality assessments, they conducted analyses based on cash flow
information in one way or another. Analysts calculated cash flow information byadding back amortisation and impairment losses to accounting profit.

12.

At the same time, all eleven analysts conducted analyses from multiple perspectives,and used accounting profit and net asset information in one way or another.

13.

How cash flow information and accounting profit and net asset information were usedin their analyses varied among analysts. The ASBJ staff observed that the responses
from equity analysts could be classified broadly into two groups:


Equity analysts who placed more significant importance on analyses based on
cash flow information; and

Equity analysts who placed significant importance on analyses based on
accounting profit and net asset information as much as on analyses based on cash
flow information.

14.

The credit analyst placed more significant importance on analyses based on
accounting profit and net asset information, although he also conducted analyses
based on cash flow information.

Views of equity analysts who place more significant importance on analyses
based on cash flow information
How financial information is used
15.

Some equity analysts stated that they placed more significant importance on analyses
based on cash flow information, although they also stated that they conducted analyses
based on accounting profit and net asset information.

16.

More than one buy-side equity analyst stated that they placed more significant
importance on analyses based on cash flow information.

These buy-side equity

analysts analysed financial statements of a relatively large number of entities toPage 11determine the composition of the portfolios of stocks they would hold. They raised
the following examples regarding how analyses were conducted in the context ofdetermining the composition of the portfolio of stocks they would hold:

Regarding the analyses based on cash flow information, the “fair” stock pricebased on the Discounted Cash Flows (DCF) method or the Return on Investment
Capital (ROIC) was calculated for each entity, and the prices or ratios werecompared among entities.

Regarding the analyses based on accounting profit and net asset information,
ratios such as the Price Earnings Ratio (PER), the Return on Equity (ROE) ratio,
and Earnings Per Share (EPS) were calculated for each entity, and the ratios werecompared among entities or with industry standards.

17.

Equity analysts gave the following reasons for placing more significant importanceon analyses based on cash flow information:More than one buy-side equity analyst stated that cash flow information wasnecessary for comparison among entities at the global level, because cash flow
information was unaffected by the differences in accounting standards.

One buy-side equity analyst stated that they used cash flow information
calculated by adjusting profits for the purpose of projecting the long-term
performance of the entity, because such information was more sustainable thanunadjusted profits for the year which might be affected by specific activities suchas restructuring.

Impact of business combinations on their analyses
18.

Many equity analysts who placed more significant importance on analyses based on
cash flow information stated that they analysed the appropriateness of the acquisition
price and the premium included in the acquisition price when they evaluated theimpact of a business combination on their analyses at the timing of announcement or
execution.

19.

One buy-side equity analyst stated that he made projections regarding the increase in
ROIC by the business combination at the timing of announcement or execution andcontinuously monitored whether the actual increase in ROIC met his projections.

Page 1220.

More than one equity analyst thought that impairment losses on goodwill wererecognised later than when they thought the deterioration in the value of goodwill had
occurred. Regarding how to reflect the risk of goodwill impairment in their analyses,
these equity analysts raised the following examples:One buy-side equity analyst stated that he would increase the hurdle rate to becompared with ROIC in order to reflect the risk of goodwill impairment.

One buy-side equity analyst stated that he would reflect the risk of goodwill
impairment in the determination of the final rating (for example, downgrading
the final rating from “buy” to “hold” to reflect the risk of goodwill impairment).

Subsequent accounting for goodwill
21.

Equity analysts who placed more significant importance on analyses based on cash
flow information were divided in their views on the subsequent accounting for
goodwill:

One buy-side equity analyst supported non-amortisation because, for analyses
based on ROIC, it was inappropriate to recognise expenses for the amortisationof goodwill based on a predetermined schedule, as it would distort the amount of
the original investment which was included in total assets (that is, thedenominator in the calculation of ROIC).

This analyst also thought that amechanical amortisation of goodwill made managements less conscious of thecapital cost and thus obscured the accountability of the results of businesscombinations assessed in the context of capital cost.


One buy-side equity analyst emphasised that amortisation of assets should be
required only when there was sufficient evidence for the amortisation period andargued that non-amortisation was better than mechanical amortisation over a
period without evidence. This analyst also noted that the signal of the failure in
the investment should be provided by recognising goodwill impairment when thevalue of goodwill had become lower than the initial amount recognised as
goodwill and that the amortisation of goodwill would weaken this effect.

One buy-side equity analyst stated that the amortisation of goodwill createdinconsistencies with cash flows, and the non-amortisation of goodwill would leadto recognising some value on the balance sheet permanently and, accordingly,
Page 13experience showed that both approaches have problems.

He thought that one

theoretical solution to resolve this contradiction was to directly write off goodwill.


One buy-side equity analyst stated that, from the perspective of conducting
analyses based on cash flow information, they were indifferent between
amortisation and non-amortisation because they did not affect cash flows.

Disclosures
22.

Some buy-side equity analysts who placed more significant importance on analyses
based on cash flow information stated the following views on disclosures related togoodwill:When an entity recognises goodwill impairment, disclosures of information
regarding how management determined when to recognise goodwill impairment(for example, how the business environment or management strategy has changed,
and how such changes affected the inputs for estimating the value in use,
including the expected future cash flows or discount rates, before and after therecognition of impairment losses) would be useful.

Views of equity analysts who place significant importance on analyses basedon accounting profit and net asset information as much as those based on
cash flow information
How financial information is used
23.

Some equity analysts stated that they placed significant importance on analyses basedon accounting profit and net asset information as much as those based on cash flow
information.

24.

Equity analysts who placed significant importance on analyses based on accounting
profit and net asset information as much as those based on cash flow information
included buy-side equity analysts who used financial statements to determine thecomposition of the portfolio of stocks they would hold as well as sell-side equity
analysts who analysed financial statements when they estimated stock prices of theirtarget entities in specific industries.

Page 14

25.

Examples raised by buy-side equity analysts regarding how to conduct the analyses
based on cash flow information and accounting profit and net asset information aresummarised in paragraph 16.

26.

Sell-side equity analysts raised the following examples regarding how analyses wereconducted in the context of conducting business valuations of their target entities:
Regarding the analyses based on cash flow information, stock prices were
estimated based on the DCF method or the Earnings before Interest, Taxes,
Depreciation and Amortisation (EBITDA) multiples.

Regarding the analyses based on accounting profit and net asset information,
ratios such as the PER, the ROE ratio, and EPS were calculated, and the trends inthe ratios were analysed, the ratios were compared among entities or with industry
standards, and the stock prices were estimated based on “fair” ratios.

27.

Equity analysts gave the following reasons for placing significant importance on
analyses based on accounting profit and net asset information as much as those basedon cash flow information:More than one equity analyst, including both buy-side and sell-side equity
analysts, stated that they placed significant importance on analyses based on
publicly reported financial information as a predictor of stock-price fluctuations,because such financial information had impact on the short-term stock-pricefluctuations.

More than one equity analyst, including both buy-side and sell-side equity
analysts, stated that they used accounting profit and net asset information in orderto predict future cash flows, because they thought such information affected
management behaviour (for example, management may be reluctant to make newinvestments considering the impact on accounting profit, or impairment maytrigger management to aggressively promote restructuring activities).

One sell-side equity analyst stated that the precision of future cash flow
predictions varied among industries and that, for business valuations of entities
in an industry where the precision of future cash flow predictions is low, it ismore likely that analyses would be based more on accounting profit informationsuch as using the PER.
Page 15More than one equity analyst, including both buy-side and sell-side equity
analysts, stated that they usually did not conduct analyses based on a single
method or a single index but conducted analyses from multiple perspectives using
multiple indices that were calculated using more than one method.

Impact of business combinations on their analyses
28.

Similar to those who placed more significant importance on analyses based on cash
flow information (see paragraph 18), many equity analysts who placed significant
importance on analyses based on accounting profit and net asset information as muchas those based on cash flow information stated that, when they evaluated the impactof a business combination on their analyses at the timing of announcement or
execution, they analysed the appropriateness of the acquisition price and the premiumincluded in the acquisition price and considered the impact of those transactions on
stock prices based on the DCF method or indices such as the PER or EPS.

29.

Similar to those who placed more significant importance on analyses based on cash
flow information (see paragraph 20), many equity analysts thought that impairment
losses on goodwill were recognised later than when they thought the deterioration in
the value of goodwill had occurred.

Equity analysts who placed significant

importance on analyses based on accounting profit and net asset information as muchas those based on cash flow information stated that they identified the deterioration in
the value of goodwill by observing reduced profitability and incorporated thedeterioration in the value of goodwill in their analyses before impairment losses on
goodwill were recognised.

They raised some examples of how to incorporate thedeterioration in the value of goodwill, such as reflecting the decrease in profitability
in the estimation of future cash flows (for example, reflecting the decrease in thegrowth rate) and reducing the amount of goodwill included in net assets or total assets
to be used in their analyses.
30.

Equity analysts shared the following implications of their understanding that
impairment losses on goodwill were recognised later than their analyses:More than one sell-side equity analyst stated that they placed little value on theinformation regarding the recognition of goodwill impairment and the amount of
the impairment losses, because they thought that the judgments made by

Page 16management that goodwill was impaired was arbitrary and that in many cases
they came later than when analysts had identified such impairment.
More than one sell-side equity analyst stated that their estimated stock prices may
be reduced when sufficient information necessary for their projections could not
be obtained. These equity analysts noted that they sometimes increased theirestimated stock prices or observed increases in actual stock prices in response to
the recognition of goodwill impairment or sufficient disclosure.

One sell-side equity analyst stated that the grouping used to perform impairment
tests was problematic.

This analyst stated that some entities avoided

recognising goodwill impairment by undergoing restructuring activities for the
purpose of enlarging the unit used to perform the impairment test.


One buy-side equity analyst thought that, as indicated by the fact that goodwill
impairment was often recognised at the timing of management changes, the laterecognition of goodwill impairment was a matter of management or audit and nota matter of accounting standards.

Subsequent accounting for goodwill
31.

Equity analysts who placed significant importance on analyses based on accounting
profit and net asset information as much as those based on cash flow information weredivided in their views on the subsequent accounting for goodwill:
Views in favour of the amortisation and impairment approach

32.

Some equity analysts stated views in favour of the amortisation and impairment
approach:One buy-side equity analyst emphasised that there was ambiguity in whether
goodwill met the definition of an asset.

This analyst thought that, if the valueof goodwill could not be maintained permanently, there needed to be amechanism that ultimately reduced the carrying amount of goodwill to zero.
This analyst also stated that non-amortisation of goodwill led to the recognitionof internally generated goodwill.
More than one equity analyst, including both buy-side and sell-side equity
analysts, stated that by amortising goodwill and recognising goodwill impairment
when the value of goodwill had become lower than the carrying amount ofPage 17

goodwill after amortisation, impairment losses better represented the failure in
the investment and thus provided more relevant information.
More than one equity analyst, including both buy-side and sell-side equity
analysts, mentioned that the non-amortisation of goodwill might induce an M&A
bubble, because an entity could achieve growth in both revenue and profit simply
by acquiring a profitable entity.

On the other hand, the amortisation of goodwill

would force management to set a higher target to earn more profit from theinvestment than the amortised amount.
One sell-side equity analyst thought that accounting profit that included
amortisation of goodwill had a higher information value, because the accounting
would be consistent with the accounting for investments in property, plant andequipment (that is, the amortisation of goodwill achieved equal footing between
growth by means of business combinations and organic growth).

One sell-side equity analyst placed significant value on the information regarding
the amortisation period for goodwill, because such information represented
management’s estimate of the period for which the amount of goodwill would berecouped by the increase in expected future cash flows due to the businesscombination.

Views in favour of the non-amortisation approach
33.

Some equity analysts stated views in favour of the non-amortisation approach:More than one sell-side equity analyst mentioned that, given that both U.S. GAAP
and IFRS require the non-amortisation of goodwill, there was no alternative but
to converge with the approach that was most widely used internationally inpractice for the purpose of achieving comparability at the global level. They
stated that the coexistence of the amortisation approach and the non-amortisation
approach incurred additional costs to conduct their analyses.

One sell-side equity analyst stated that, in some industries, business combinations
were essential for the sustainable growth of the entity operating in that industry
and thus it was undesirable for management to become hesitant to makeinvestments because the accounting required the amortisation of goodwill.

Neutral views
Page 18

34.

More than one sell-side equity analyst stated that, from the perspective of conducting
analyses based on cash flow information, they were indifferent between amortisationand non-amortisation because they did not affect cash flows.

Amortisation period
35.

Some equity analysts who placed significant importance on analyses based on
accounting profit and net asset information as much as those based on cash flow
information stated the following views regarding the amortisation period:More than one sell-side equity analyst stated that information regarding themanagement’s estimate of the period for which expected future cash flows would
increase due to the business combination was useful.

These equity analysts alsomentioned that, by amortising goodwill based on such period, profit or loss would
be calculated by matching the increases in income due to the businesscombination with the amortisation expense determined based on the
management’s estimates and thus provides useful information.
One buy-side equity analyst was in favour of determining the amortisation period
based on the management’s estimates of the period for which synergies wererealised and maintained.

This analyst further stated that goodwill may beamortised over a relatively long period when the synergies were expected to berealised over a long period of time.
Disclosures
36.

Some equity analysts who placed significant importance on analyses based on
accounting profit and net asset information as much as those based on cash flow
information stated the following views on the disclosures related to goodwill:More than one sell-side equity analyst stated that, in order to assess individual
business combinations, disclosures of the initial amount of goodwill recognised,
the carrying amount of goodwill, and the accumulated amortisation andimpairment amounts of goodwill are needed for each business combination.

More than one sell-side equity analyst stated that disclosures of the expected
growth rates and discount rates that management used for their estimates areimportant.

These equity analysts also mentioned that such disclosures arenecessary not only to analyse whether the amount of impairment losses
Page 19

recognised were sufficient but also to examine whether there were any differencesin the inputs analysts used for their analyses when the entity did not recognise
goodwill impairment.
More than one sell-side equity analyst stated that the processes of stress tests
conducted by the entity should be disclosed so that analysts could predict underwhat circumstances the entity would be recognising goodwill impairment.

More than one equity analyst, including both buy-side and sell-side equity
analysts, stated that the total of goodwill and intangible assets other than goodwill
should be disclosed because the two were inter-related. These equity analysts
also stated that it would be useful if the ratio of total intangible assets (that is, thetotal of goodwill and intangible assets other than goodwill) to net assets wasdisclosed, because the risk in the valuation of those assets would depend on thisratio.

Intangible assets other than goodwill
37.

Although there was no specific question in the questionnaire, some equity analysts
who placed significant importance on analyses based on accounting profit and net
asset information as much as those based on cash flow information stated their viewson the initial or subsequent accounting for intangible assets other than goodwill which
an entity acquired as part of a business combination:Sell-side equity analysts whose industry focus were in the telecommunication
services, foods, and pharmaceuticals industries stated that the valuation of
intangible assets acquired as part of a business combination at fair value was often
challenging.

Intangible assets which may be material in amount but difficult tomeasure at fair value included brands, trademarks, intellectual properties,
licensing agreements, and customer relationships.

Some of these equity

analysts further noted that it would be useful for entities to disclose how the fairvalues and values in use of the identified intangible assets were calculated.

Views of the credit analyst
How financial information is used

Page 20

38.

The credit analyst stated that, when he conducted credit quality assessments, he placed
more significant importance on analyses based on accounting profit and net asset
information, although he stated that he also conducted analyses based on cash flow
information.

39.

The credit analyst raised the following examples regarding how analyses wereconducted in the context of conducting credit quality assessments of the target entities:
Regarding the analyses based on accounting profit and net asset information,
ratios related to profitability and capital structure such as the capital adequacy
ratio or the net debt to equity ratio were calculated, and the trends in the ratios
were analysed and the ratios were compared among entities or with industry
standards.

Regarding the analyses based on cash flow information, future cash flows were
estimated in order to estimate the debt repayment period.

40.

The credit analyst stated the following reason for placing more significant importanceon analyses based accounting profit and net asset information:
Analyses based on financial information is important because financial
information such as accounting profit or net assets would significantly affect thecreditworthiness and financial stability of the entity through the lending behaviorof financial institutions.

Impact of business combinations on analyses
41.

The credit analyst stated that he focused on the impact of the acquisition on thecreditworthiness of the entity (for example, the impact on the amount of interestbearing debt, the debt repayment period, the capital structure, and the capital adequacy
ratio).

He also noted that large-scale acquisitions rarely had a positive impact on thecredit rating, because synergies or growth potentials were generally ignored in
evaluating the credit rating.
42.

The credit analyst stated that he paid particular attention to the recognition of goodwill
impairment, because it would deteriorate the value of net assets.

Similar to manyequity analysts, he thought that impairment losses on goodwill were recognised later
than when he thought the deterioration in the value of goodwill had occurred.

He

also stated that, when continuously monitoring the impact of a business combination,
Page 21

in some cases, the amount of goodwill included in the net assets or total assets foranalysis purposes was reduced before goodwill impairment was recognised, when heobserved that accounting profits or cash flows lagged behind the original target.
Subsequent accounting for goodwill
43.

The credit analyst supported the amortisation and impairment approach for thefollowing reasons:Because goodwill is initially recognised as a residual (rather than being measured
at fair value), it should be viewed as an acquisition cost and thus the carrying
amount of goodwill should ultimately be reduced to zero via amortisation.



Because it is difficult to measure the fair value of the goodwill accurately and theprocess for measuring the value of the goodwill would inevitably be subjective,
even if the impairment process is improved, goodwill should be systematicallyamortised from the viewpoints of financial soundness and the creditworthiness ofthe entity.

Amortisation period
44.

The credit analyst stated the following view regarding the amortisation period:The primary purpose of amortising goodwill is to ultimately reduce the carrying
amount of goodwill to zero.

The desirable amortisation period would be basedon the management’s estimate of the period for which the amount of goodwill
would be recouped by the increase in expected future cash flows due to thebusiness combination.
Disclosures
45.

The credit analyst stated the following view on the disclosures related to goodwill:The initial amount of goodwill recognised, the carrying amount of goodwill, andthe accumulated amortisation and impairment amounts of goodwill for eachbusiness combination were useful for the purposes of credit quality assessment.

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IV. Acknowledgements
This Research Paper was prepared by ASBJ staff members Tomoyuki Tani, Nami
Yamaguchi, Yuichi Yamane, and Satoshi Kasai, with Atsushi Kogasaka andYasunobu Kawanishi as the Board advisors.
The ASBJ greatly appreciates each of the eleven analysts, with sharing their pearls of
wisdom about their experiences and knowledge in business valuations or credit
quality assessments.
The ASBJ would also like to express its gratitude to Mr. Makoto Kaimasu, Executive
Vice President of the Securities Analysts Association of Japan, with his assistance inthis project.

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