IFRS3: Business Combinations
Elimination of merger accounting: Merger accounting was already difficult
because of the tight construction of the criteria. So the elimination of this
methodology seems sensible. Having only one business combination accounting
approach should enhance inter-company comparability in the future. The
elimination of merger accounting also means the attraction of using share
consideration has diminished.
Change in the definition of goodwill: IFRS3 marks a distinct change from the
previous approach, where goodwill was merely a residual difference between the
purchase consideration and the fair value of the net assets. Instead, the onus
will now be on the company to split any separately identifiable intangible
assets on future acquisitions. This means the amount allocated to goodwill on
future acquisitions will be lower.
No more goodwill amortisation: there is no longer any systematic amortisation
of goodwill. However, amortisation of other intangibles will be required.
Goodwill will instead be subject to an annual impairment test. Most companies
have applied this change prospectively so that existing goodwill has, in
essence, been frozen at its current value.
Less opportunity to manipulate post-acquisition results:Restructuring
provisions on acquisitions have been severely restricted, which should mean
fewer opportunities for management to manipulate post-acquisition results.
Financial analysis in M&A
Fair value: Establishing an initial estimate of the fair value of an asset
and any subsequent adjustment can have important implications for key
performance indicators. For example, if an initial fair value estimate for a
property were conservative, then depreciation would be understated, with
goodwill overstated. Any changes to these fair values from the initial estimates
could be significant.
Valuation and amortisation of intangibles: What separable intangibles have
been recognised? Does this reveal extra value in the target? Are the amounts
recognised unexpectedly high or low? Are the separable intangibles maintained?
If these assets do not have to be replaced, is amortisation a real economic cost
or merely double-counting?
Impairment disclosures: Extensive disclosure is required in impairment
disclosures, but may have significant value relevance. However, it is rarely
examined in any detail by investors.
Method of payment: The financing structure is one of the most important
discriminating factors between value enhancing and value destroying
acquisitions. The results suggest that acquirers that pay by cash enjoy a much
An equity-financed deal is associated with share price weakness as it is
often perceived as a signal that the acquirer s shares are overvalued and that
the buyer is not confident about synergy gains.
By contrast, a cash or debt-financed offer tends to send a positive signal to
the market about the buyer’s confidence in its ability to reload its cash
balance. Those cash offers that involve a debt issuance can provide a
significant additional incentive to make the merger work to realise synergy
Use of losses: One attractive aspect of a merger or acquisition target may be
that it has losses carried forward that can be used more efficiently.
However, this issue is fraught with complexity because most countries have
anti-avoidance rules that restrict or deny the use of tax losses by third
Deferred tax and business combinations: Assets are revalued to fair value for
financial reporting purposes at the point of their acquisition. This causes
temporary differences between the tax value (base) of the assets and their book
value. Therefore, there will be a disconnect between book and tax depreciation.
Tax deductibility of goodwill: The importance of the tax dimension of a
corporate takeover has been illustrated very clearly with the recent interest in
Spanish companies going on the acquisition trail. In Spain, goodwill inherent in
the purchase of the stock is tax-deductible. As a result, a Spanish business can
theoretically pay more for a target and get the same value for shareholders.
Capital structure: Interest is tax-deductible; dividends are not. This
encourages companies to allocate as much debt as possible to particular
subsidiaries. Generally, to maximise the value of the tax shield, the debt will
be allocated to higher tax regimes.
This is an edited version of an article that first appeared in Financial
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