IFRS update December 2005 – Intangibles

The introduction of international financial reporting standards has had
implications for the fast-moving world of corporate finance and deal making.

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Before IFRS3 and
, the standards for business combinations and intangible assets, any
premium a company paid for an acquisition was lumped into goodwill and
amortised. The purchaser was not required to specify exactly what was being paid
for. Under the new regime, businesses have to be far more precise and
transparent when making an acquisition.

‘The new standards improve the rigour of the acquisition process,’ says
PricewaterhouseCoopers partner Richard Winter. ‘Businesses will not proceed with
acquisitions without justification for what they are buying in terms of how it
will be reflected in the balance sheet.’

The new standards require companies to recognise intangible assets separately
on their balance sheets after an acquisition. Everything from trademarks and
brands to patented technology and customer contracts will have to be valued and
reflected individually.

Nick Rea, director of valuation and strategy at PwC, says this might slow
down the progress of deals, but would encourage thorough decision making in the
acquisition process. ‘Some deals are taking longer to complete,’ he says, ‘but a
business will have a better idea of what it is buying and why it is doing the
deal. The standard is not going to change deal fundamentals but it is going to
increase transparency.’

There are, though, some details in the standards that could affect the
valuations of firms.

Under IAS38, companies conducting in-house research have to capitalise any
development spend if it meets certain criteria. But in the event of an
acquisition, the purchasing group has to capitalise the research spend as well
as the development costs of the target company.

Rea says this anomaly needs to be taken into account when investors are
comparing a company that has developed its technology in-house to a business
that has taken on its R&D through acquisition.

And Sarpel Ustunel, director of valuation boutique Global View Advisors, says
directors will have to think more carefully about how they invest their
development budgets because they can no longer expense development costs.

‘Under new standards, any capitalised development expenditures have to be
written off for unsuccessful projects at a future date, which may lead to
criticisms of directors who are accountable for these investments,’ he says.
‘The new standard will provide more transparency to investors in assessing the
recovery of the development costs through economic benefits upon completion of
projects or new products.’

Big R&D spenders take it in their stride

Biotech and pharmaceutical businesses have been at the forefront of the
changes to accounting for intangible assets because of the importance of
research and development in their businesses.

These companies used to be able to write off or capitalise their development
expenses, but under IAS38 only the capitalisation option is available.

Ian Dixon, a director in the assurance practice at PwC and a biotech
specialist, says: ‘Biotech and pharmaceutical companies have to start thinking
carefully about when a product is sufficiently developed to start capitalising
costs and how to amortise those costs over the product’s useful life.

Dixon adds that the new standard has not caused the problems that might have
been expected. ‘R&D is in the lifeblood of what these companies do,’ he
says. ‘They have a very good handle on the prospects of products in their

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