Understanding the Pros and Cons of SoftBank Group's Investment and Acquisition Strategy from an Accounting Perspective

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More and more companies, including SoftBank Group, are adopting the International Financial Reporting Standards (IFRS) instead of the Japanese accounting standard, J-GAAP. One reason for this is that IFRS does not require the amortization of goodwill. To state the conclusion first, adopting IFRS allows a company to present higher operating profit at the time of an acquisition.

While summarizing the basics, such as what goodwill is and the significance of its amortization, I will outline the pros and cons of IFRS using SoftBank Group as an example.

Basics: What is "Goodwill" that arises during an acquisition?

Normally, when a company is acquired or merged, payment is made not only for tangible assets like the company's assets and liabilities, but also for intangible assets such as brands and know-how that serve as a source of future profit generation.

Therefore, at the time of an acquisition or merger, the payment exceeds the company's net assets, and that portion is recorded as "goodwill." Thus, "goodwill" is said to be the company's excess earning capacity.

Source: https://www.ycg-advisory.jp/knowledge/glossary/goodwill-2/

Basics: What is "Goodwill Amortization" under Japanese accounting standards?

Unlike IFRS, Japanese accounting standards require goodwill to be amortized systematically.

As mentioned earlier, goodwill is the power to generate excess earnings, but that power is not maintained permanently. Accounting standards for amortizing goodwill have been established based on the reasoning that if a company consumes goodwill and generates new earnings, it should be recorded as an expense, similar to depreciation for other capital investments.

Why IFRS does not require goodwill amortization

On the other hand, IFRS recognizes that "goodwill" as a power to generate excess earnings is something that management maintains through their efforts. Furthermore, it takes the position that the depreciation pattern and useful life of goodwill are not constant, and that arbitrarily determining an amortization method should be avoided.

For this reason, an accounting standard has been established where an impairment test is conducted every period, and impairment processing is performed only when impairment of the goodwill value is recognized, with no amortization taking place.

(Note): Japanese accounting standards state that while it is true that the value of goodwill can be maintained, it is not the excess earning power possessed by the acquired company, but rather the self-creation ability possessed by the acquiring company, and therefore it should not be treated in the same way. It also indicates the recognition that it is more rational to perform systematic amortization over a certain period than to use a method where depreciation might not be recognized at all in a given year.

Why SoftBank Group adopts IFRS

As mentioned earlier, if IFRS is adopted, there is no need to amortize goodwill. Therefore, there is the advantage of being able to suppress amortization expenses and make operating profit appear larger. It can also be interpreted that they actively engage in investments and acquisitions because it does not impair operating profit. Such advantages are considered one of the reasons why SoftBank Group, which wants to make active investments, adopts IFRS.

I found a table simulating what the operating profit would look like if they had actually amortized the goodwill to be interesting, so I will cite it here.

Source: https://diamond.jp/articles/-/180403

On the other hand, a disadvantage is that because amortization is not performed, impairment charges that must be recorded when corporate value is impaired become larger.

Due to the impact of the novel coronavirus, SoftBank Group expects an operating loss of 1.3 trillion yen. Although I have not calculated it myself, if they had performed goodwill amortization, the loss from impairment might have been smaller.

That said, I support SoftBank Group's strategy of aggressive investment and will continue to keep an eye on them in the future.

#SoftBankGroup #IFRS #AccountingStandards #Goodwill #GoodwillAmortization #Impairment