IAS: The latest word on mergers

On 31 March, bang on the deadline of its much vaunted, ‘stand-still period’, the IASB issued its seminal work on business combinations.

This standard, IFRS3, now forms the basis of how listed companies will have to account for takeovers once the UK moves into the IFRS regime in 2005.

But the IASB already had a business combinations standard, so why invest scarce resources on producing a new standard at such a crucial time?

The simple answer is that the world passed the old standard by and it became too simplistic for the modern business environment.

A number of countries, most significantly the US, had produced standards recognising this.

As such, IFRS3 represents the completion of the first phase of a joint project between the IASB and its US counterpart to converge their business combinations requirements.

The project has a second phase – with the possibility of more – but further change is not limited to future phases. Within a month of issuing the standard, the IASB issued an exposure draft proposing amendments to IFRS3’s scope. The pace and extent of change make for challenging times.

Although many of the requirements of IFRS3 are similar to existing GAAP, there are many significant changes to embrace, which will demand forward planning and the increased involvement of external valuation experts.

The biggest change in the standard is that merger accounting will no longer be permitted, although it will not affect many combinations.

Business combinations previously accounted for as mergers will not have to (but may) be restated. However, transactions occurring after 31 March 2004 cannot be so classified.

For those companies implementing IFRS3, as part of their first-time adoption of IFRS, this requirement will stretch back to their date of transition – commonly 1 January 2004.

Companies will need to identify an acquirer in each business combination, which will involve factors such as relative size and voting rights immediately after the transaction.

You cannot assume that the acquirer is the top company – this will not always be the case.

Of more pervasive impact is the fact that companies will no longer be required, or even permitted, to amortise goodwill. Under IFRS3 they will perform an annual impairment test.

This will involve a number of assumptions about future cashflows, discount rates and the like. It will be time consuming, and potentially costly to do – particularly if the company is unable to draw on internal expertise.

The annual impairment testing is likely to result in more ‘lumpy’ profit and loss figures compared to straight line amortisation; losses will be recognised in years with a bleak future outlook, and there will be no goodwill expense at all in years with positive future outlooks.

Negative goodwill can no longer be carried on the balance sheet. Any negative goodwill carried at the date of first applying IFR^S3 (for most UK entities, their date of transition in accordance with IFRS1) will be written off against retained profits.

For future business combinations any negative goodwill will be recognised immediately in profit or loss for the period.

The recognition criteria for intangible assets under IFRS3 are likely to result in separate recognition of intangible assets that would currently be subsumed within goodwill.

The examples given in IFRS3 are wide-ranging and include: internet domain names, customer lists, customer relationships, lease agreements, construction permits, computer software, databases and trade secrets.

In recognising these assets, companies may well need more actively involved valuation experts than has perhaps been the case in the past.

The company will need to ensure that each intangible has been identified, and where appropriate, assign an auditable fair value to that asset.

Companies will now need to identify all the contingent liabilities that may attach to the acquiree, and determine the fair value of those.

This fair value is the amount that the company would have to pay another entity to assume the liability. Such values must take into account the range of likely outcomes, rather than the single most likely.

The inclusion of contingent liabilities in acquisition accounting is a topic being reconsidered in phase two of the business combinations project.

However, it is scant comfort for those operating in highly litigious industries that the requirement for an onerous search for, and valuation of, contingent liabilities may be discontinued at some time in the future.

In completing the accounting, companies should also ensure that they understand the information their auditors need to audit the transaction, and make sure this information is compiled at the time of the acquisition.

They should also consider whether they need to appoint appropriately qualified independent experts. In many instances, ethical guidance will prevent the auditors and their associates from undertaking valuation activities for the company.

This of course is not the end of change in this area.

The IASB is continuing its joint project with FASB on business combinations.

IFRS3 currently scopes out a number of transactions, including those between entities under common control.

There are also other intriguing suggestions coming out – such as a proposal to gross up any goodwill for any minority interests.

Pleasures yet to come!

  • Ken Wild, global leader of Deloitte IFRS leadership team.


  • Implement systems for impairment testing of goodwill and other intangible assets
  • Identify external experts to be used in the course of business combination transactions
  • Identify the information requirements of auditors
  • Identify the likely impact on the results, and considering whether there is any need to start briefing shareholders or institutions.

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