LAX is a European manufacturing equipment supplier, offering installation, training, maintenance and other services. The firm is divided into eight business groups (BGs) that serve different geographical areas. LAX has been very successful. The firms founders developed the LAX creed, which states the firms philosophy of innovation, creativity, work ethic, and commitment to firm values. Top management has always stressed the importance of business ethics and corporate social responsibility. Three years ago, the firm initiated annual sustainability reporting to stakeholders.

LAX made an acquisition of a major US competitor [Eagles Inc.] earlier this year, which became LAXs eighth BG and the first in the US. This acquisition resulted in Goodwill being recorded of $20,000,000 in February 2018. At December 2018, there is no indication that this Goodwill is impaired because the expected benefits are on target. This acquisition increased the firms Goodwill on the balance sheet to $180,000,000.

LAX is a private company, and it uses local GAAP. However, it plans to become a public firm on the Borsa Stock Exchange. Consequently, the accounting professionals at LAX are dealing with the challenge of first time adoption of IFRS in preparation for the initial offering. Darby Good, CGMA was assigned the task of identifying the firms cash generating units, and she prepared the firms position statement for the auditors after the firms CFO (Connor Remhild) agreed with her conclusions. A cash generating unit (CGU) is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets.

Within the eight BGs smaller business units (BUs) exist. A BU is identified for each country where a BG operates, but some countries are combined into a regional BU. Eagles, Inc. has 9 BUs.

LAXs customers are often multinational customers with subsidiaries in different countries. When one BG enters into a major sales agreement with a multinational customer in one region/country, this agreement will typically also create income opportunities for other BGs through referral sales from the customers subsidiaries in the different countries. When customer subsidiaries are referred to other BGs, background information is provided on the customers operations; and the other BG usually negotiates prices, quality and other features independently. However, for some deals, a BG may seek consultation from the sales team making the original sale at the referring BG. The sales team making a referral sale does not share the sales commissions with the sales team at the BG making the referral. On average 55% of all sales will lead to a referral sale in another BG.

The firm uses the Balanced Scorecard as a performance measurement system. The Balanced Scorecard contains a set of performance measures (PM) carefully chosen to represent important aspects of a business unit in the four areas critical to the business units short term and long-term performance. These are financial performance, customer relations, internal business processes, and learning and growth. A description of each type of measure is below:

Financial measures indicate how well a business unit is doing in meeting profitability and other economic targets during the previous period.

Customer-related measures indicate a business units success in obtaining and retaining the targeted customers. These measures are intended not only to relate to the profitability of the previous period but, more importantly, also to the units profitability in the long term.

Internal business process measures indicate a business units performance on activities critical to meeting the customer, i.e., longer term, and financial, i.e., short term, targets.

Learning and growth measures indicate a business units success in developing the personnel and systems necessary for the units long-term growth and improvement.

The Balanced Scorecard is cascaded down from the firm level to Business Groups and then to Business Units. The cascading process provides for alignment of the Business Groups and Business Units with firm strategy. Thus, there is a Balanced Scorecard for each Business Group and each Business Unit. Selected PMs from the Balanced Scorecard are used in the incentive bonus formulas. While the firm believes in decentralization, the Balanced Scorecard is used to communicate and implement firm strategy and variances from targets are monitored.

The company is managed on a group wide basis where strategic decisions are made for example product development and range and business development, as well as selection of the customer management team. BG management is focused on the successful delivery of systems and relationship management for the key global clients in their territory. Forecasts and budgets exist for each BG, which are treated as investment centers for management control systems purposes. Diagnostic control systems are used to motivate, monitor, and reward achievement of objectives. The incentive (bonus) system for BG managers uses one financial and 4 non-financial performance measures (PM). Two of the non-financial PMs are common to all BGs number of customer referrals to other BGs and customer satisfaction rating) and two non-financial PM are unique to BG strategy. Targets are set for each PM. Residual income is weighted 70% in the incentive bonus formula.

Local sales, installation and maintenance are carried out at the BU level. Forecasts and budgets exist for each BU, which are treated as profit centers for management control system purposes. Diagnostic control systems are used to motivate, monitor, and reward achievement of objectives. The incentive system for BU managers uses one financial and 4 non-financial PM. Two of the non-financial PMs are common to all BUs and two non-financial PM are unique to BU strategy. Targets are set for each PM. BU profit is weighted 80% in the incentive bonus formula. If a BU is trending toward under-performing (mainly focusing on trend toward large unfavourable quarterly target profit variances), the BGs CFO takes a closer look at weekly BU income statements. If the CFO has ideas to share with the BUs management, they will offer to make a field visit with the BU manager in an effort to support improvement. If large unfavourable quarterly target profit variances become a reality, a meeting with the CFOs staff is required.

Connor Remhild, LAXs CFO, is of the opinion the CGUs cannot be identified at a lower level than the firm level (one CGU). Your role is the audit manager, and the CGU decision is important for the first time adoption of IFRS and subsequent years. The audit partner is interested in your recommendations.

At what level should LAX identify CGUs? Clearly state your reasoning for selecting one of the following alternatives: Firm wide (one CGU), Business Groups (eight CGUs), Business Units (multiple CGUs). OR, you may identify another alternative. Your argument for your chosen CGU level should be strong, and it should be clear why other alternatives are inferior. Clearly state any assumptions that you are making in your recommendation. Cite relevant IFRS standards or guidance or other credible sources (eg. Deloitte IAS Plus). Use citations.