Kern Roberts says more businesses will face the challenges of new accounting rules as acquisitions increase.

The accounting rules for corporate acquisitions for companies applying international financial reporting standards (IFRS) changed radically for accounting periods beginning on or after 1 July 2009.

Due to the low level of corporate acquisitions in the last couple of years, the full effects of these changes are yet to be felt by UK capital markets. However, acquisitions are starting to pick up, with purchases of UK businesses by other home-grown companies growing steadily throughout 2010, reaching a value of £3.8 billion in Q4 2010. This is the highest figure reported since Q1 2009 and, amazingly, a higher figure than was recorded even in Q4 2007. If this upward trend continues, the impact of the new rules for acquisition accounting will be increasingly widely felt.

The accounting changes result from a complete rewrite of IFRS 3, the accounting standard that deals with business combinations. The new standard, IFRS 3 Revised (IFRS3R), will pose significant challenges for businesses when they come to make their first corporate acquisitions under the new rules. In particular, businesses should be conscious of the following main points.

Acquisition costs

Under the revised standard, acquisition costs, which have historically been accounted for as part of the cost of the acquisition and added to the balance of goodwill, will be expensed in the income statement as incurred. Therefore, costs such as finder's fees, advisory, legal, accounting, valuation and other professional or consulting fees will result in immediate expenses for acquirers.

Contingent consideration

Contingent consideration is an important part of many business combinations and IFRS3R changes the way in which it is accounted for. From now on, contingent consideration will have to be valued at fair value at the acquisition date, regardless of whether settlement is probable, possible or remote. Furthermore, subsequent adjustments to the fair value of liabilities arising from contingent consideration will be taken through the income statement and not as a movement in goodwill.

Goodwill and non-controlling interests

The new standard offers a choice of how goodwill is calculated when the acquisition leaves a non-controlling interest in the hands of a minority shareholder. In these circumstances, goodwill can be calculated as:

  • the consideration paid, less the purchaser's share of the identifiable net assets, or
  • the consideration paid, plus the fair value of the non-controlling interest, less 100% of the identifiable net assets.

The latter method will result in a higher goodwill figure – with a consequential impact on any future impairment and balance sheet ratios – and will also require a process to calculate the fair value of the non-controlling interest.

Dealing with the changes

In addition, quoted businesses should be aware of two main themes arising from the revised standard. Firstly, a number of the changes are likely to result in increased income statement volatility. Secondly, there will be an increase in the number of situations where detailed valuations will be required, creating an actual cost for businesses.

Both these areas are real concerns for businesses and, increasingly, the accounting 'tail' may sometimes wag the commercial 'dog', as companies will be forced to consider the accounting treatment when determining how an acquisition should be structured.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.