UK: Financial Reporting - IFRS - Business Combinations – A New Model

Last Updated: 20 March 2008
Article by Yvonne Lang

Recent revisions to IFRS 3 and IAS 27 mean that changes will be required to long-established accounting treatments and could affect the structure of future acquisitions.

The revised versions of IFRS 3 ‘Business combinations’ and IAS 27 ‘Consolidated and separate financial statements’ were issued at the beginning of the year. They are set not only to change long-established accounting practice, but also the shape of future acquisitions. The revisions mark the culmination of a joint project between the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) and, while there is considerable convergence, some differences remain. As a consequence there could still be significantly different financial reporting between companies applying IFRS and US GAAP.

Both standards come into effect for periods that begin on or after 1 July 2009. While it is possible to adopt for earlier periods, both standards must be adopted together and the revised standards cannot be implemented for periods beginning before 30 June 2007.

Measuring the cost of the business combination

As with the existing version of IFRS 3, consideration in a business combination is measured at fair value at the acquisition date. However, the revised version concentrates on what the vendor receives rather than what the acquisition costs the acquirer. Acquisition costs, such as legal and advisory fees, which have historically been included as part of the purchase consideration and, therefore, within the calculation of goodwill, will, in future, be recognised in the income statement in the period they are incurred.

Contingent consideration arrangements, such as earn-outs, are common to many acquisition agreements. While the fair value of such arrangements will continue to be included as part of the cost of the business combination, subsequent adjustments will be accounted for very differently. Adjustments are currently applied by amending the goodwill figure but, in future, they will need to be dealt with in the income statement.

Provisional fair values

At the date of acquisition, companies need to assess the fair value of the assets and liabilities acquired. Where it is not possible to make a definite assessment, companies can attribute provisional values and agree final figures within 12 months from the date of acquisition. None of this is new. However, whereas previously any adjustments to fair values were accounted for as adjustments in the period in which they were identified, under the revised IFRS 3, they will have to be treated as prior period adjustments and comparatives restated.

Non-contractual customer relationships

What might seem to be a small change in wording within the illustrative examples could have significant implications with respect to the recognition of intangible assets. Intangible assets are recognised if they arise either from a contract or are separable for non-contracted customer relations. The current wording in IFRS 3 implies that evidence of separability exists where there has been an exchange transaction for the same or similar assets. In the revised version, extension of this criteria to evidence that "other entities" have sold or transferred such assets significantly widens the scope and hence the likelihood that such relations will need separate recognition.

The demise of minority interests

Once the new standard comes into effect, the term ‘minority interest’ will be banished to the history books in so far as IFRS is concerned and will be replaced by ‘non-controlling interests’.

It is not only the name that is changing, but potentially the accounting treatment as well. Currently, at acquisition, the non-controlling interest is calculated by reference to the proportionate share of the identified net assets of the acquired entity. In what may seem an unusual move, the IASB is now offering companies a choice of how they account for their noncontrolling interests at the point control is obtained. As part of the convergence with US GAAP, the revised IFRS 3 introduces the option, on a transaction by transaction basis, to measure the non-controlling interest at fair value (US GAAP permits only fair value). In circumstances where the shares are actively traded, this fair value would be measured by reference to market value. Otherwise, a valuation technique would need to be applied.

Step acquisitions

The majority of business combinations arise in circumstances where the interest goes from 0% to 100% in one go. However, this is not always the case and accounting for so-called ‘step acquisitions’ has always left preparers reaching for their textbooks. However, the position is set to become easier as the IASB has sought to simplify the requirements. Where an entity goes from having an interest in a company (whether investment, associate or joint venture) to a position of obtaining control of that company, it will be required to re-measure to fair value its original investment. This fair value will form part of determining the total consideration given for the acquisition. To the extent that there is a gain or loss on the re-measurement, it will need to be included within the income statement.

However, once control has been obtained, further increases or decreases in ownership interest are treated as transactions with shareholders and recorded in equity. It will not be necessary to re-measure to fair value each time.

Consequential amendments to IAS 27

Certain amendments have also been made to IAS 27, primarily to reflect the new approach to changes in controlling and non-controlling interests.

Changes in a parent entity’s interest that do not result in a change of control are dealt with within equity and no adjustment is made to goodwill. When control is lost, all assets, liabilities and non-controlling interests are derecognised. Any interest that remains is recognised at its fair value on the date that control was lost.

There are also consequential amendments to both IAS 28 ‘Investments in associates’ and IAS 31 ‘Interests in joint ventures’. Where an entity ceases to have significant influence over an associate, it derecognises the associate. It also includes in the income statement the difference between the proceeds received and any retained interest and the carrying amount of the associate at the date significant influence was lost.

Smith & Williamson commentary

With the revised IFRS 3, we see a number of areas that will make understanding the cost and effect of acquisitions more difficult. In addition, greater volatility of reported earnings is highly likely, particularly in very acquisitive companies. For example, take the position of a company that makes acquisitions on a regular basis. If it also usually attributes provisional fair values, then there is the very real prospect of year upon year of prior period adjustments.

As well as introducing volatility in earnings, the change in treatment of contingent consideration is likely to lead to some interesting discussions between entities and their auditors. Companies will want to avoid unpredictable ‘costs’ in the income statement and this could lead to conflict with the requirement that deferred consideration be reflected at fair value.

Equally, the writing off of often substantial acquisition costs before the company has the benefit of the associated business activity, could result in not only volatility of results, but also impact on distributable profits.

All of these issues are likely to lead companies to look long and hard at the way in which deals are structured and their professional advisers are remunerated.



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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions