HSBC 2006 Annual Report Download - page 407

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Goodwill, purchase accounting and intangible assets
IFRSs
• Prior to 1998, goodwill under UK GAAP was written off against equity. HSBC did not elect to reinstate this
goodwill on its balance sheet upon transition to IFRSs. From 1 January 1998 to 31 December 2003, goodwill
was capitalised and amortised over its useful life. The carrying amount of goodwill existing at 31 December
2003 under UK GAAP was carried forward under the transition rules of IFRS 1 from 1 January 2004, subject to
certain adjustments.
• IFRS 3 ‘Business Combinations’ requires that goodwill should not be amortised but should be tested for
impairment at least annually at the cash generating unit level by applying a test based on recoverable amounts.
• Quoted securities issued as part of the purchase consideration are valued for the purpose of determining the cost
of the acquisition at their market price on the date the transaction is completed.
US GAAP
• Up to 30 June 2001, goodwill acquired was capitalised and amortised over its useful life, which could not
exceed 25 years. The amortisation of previously acquired goodwill ceased with effect from 31 December 2001.
• Quoted securities issued as part of the purchase consideration are fair valued for the purpose of determining the
cost of acquisition at their average market price over a reasonable period before and after the date on which the
terms of the acquisition are agreed and announced.
Impact
• Total goodwill and shareholders’ equity are both higher under US GAAP than under IFRSs because, under US
GAAP, (i) pre-1998 goodwill is included on the balance sheet and (ii) the amortisation of goodwill ceased on
31 December 2001 compared with 31 December 2003 under IFRSs.
• However, goodwill on the acquisition of HSBC Finance in March 2003 is lower under US GAAP than under
IFRSs. This is principally the result of differences in the accounting for securitisations and intangibles. Under
IFRSs, previously recognised gains on the sale of assets to securitisation vehicles are eliminated and the
securitised assets are recognised on balance sheet. However, because HSBC elected not to restate business
combinations prior to 1 January 2004 on transition to IFRSs, a significant amount of intangible assets arising on
acquisition were not recognised for IFRSs purposes. Under US GAAP, recognition of these assets was required.
• Offsetting this was the recognition of a deferred tax liability under US GAAP in respect of these intangibles and
gains on sale of securitised assets.
• The effect of these items was further offset by the higher value under US GAAP of HSBC shares issued as part
of the purchase consideration. The HSBC share price fell between the time of the announcement of the
acquisition in November 2002 and its completion in March 2003, so the average price under US GAAP
exceeded the price on the date of acquisition under IFRSs.
Derivatives and hedge accounting
IFRSs
• Derivatives are recognised initially, and are subsequently remeasured, at fair value. Fair values of exchange-
traded derivatives are obtained from quoted market prices. Fair values of over-the-counter derivatives are
obtained using valuation techniques, including discounted cash flow models and option pricing models.
• In the normal course of business, the fair value of a derivative on initial recognition is considered to be the
transaction price (that is the fair value of the consideration given or received). However, in certain circumstances
the fair value of an instrument will be evidenced by comparison with other observable current market
transactions in the same instrument (without modification or repackaging) or will be based on a valuation
technique whose variables include only data from observable markets, including interest rate yield curves, option
volatilities and currency rates. When such evidence exists, HSBC recognises a trading gain or loss on inception
of the derivative. When unobservable market data have a significant impact on the valuation of derivatives, the
entire initial difference in fair value indicated by the valuation model from the transaction price is not recognised
immediately in the income statement but is recognised over the life of the transaction on an appropriate basis, or
when the inputs become observable, or the transaction matures or is closed out.