PwC IFRS blog

Business combinations: Soon we will see the ‘new’ standard’s effects

It feels like a long time (approaching two years) since my posting on the subject of the IASB’s revised business combinations standard. It was probably the most controversial accounting topic of its day; but now, of course, the debate has moved on, and subjects such as fair value and financial instruments are taking centre stage.

There have been few high-profile deals since the revised versions of IFRS 3 on business combinations and IAS 27 on consolidated financial statements were issued in January 2008. However, there are signs in some parts of the world that M&A activity is starting to pick up, and the timing could not be better as the revised standards are effective for years beginning on or after 1 July 2009. Although many companies with calendar years will not apply the revised standards until 2010, some of the potential deals currently attracting media attention may not be completed until next year, and these may fall to be accounted for under the new approach. This could have an impact on earnings and may influence the way in which deals are structured

Here’s a reminder, at a very high level, of some of the revised standards’ implications:

• The cost of a business combination includes cash paid, shares issued and any payments that are contingent on future events. Items traditionally considered as part of the cost of the business combination may no longer be so. In particular, transaction costs, such as legal and accountants’ fees, will be written off as incurred.
• The consideration also, in effect, includes any previously held interest in the acquired business. When control is obtained, the previously held interest will in future have to be re-measured to fair value and a gain or loss recognised in the income statement. The converse is also true: when control is lost – for example, when a former subsidiary becomes an associate – the remaining interest is also fair valued through the income statement.
• Many acquisitions are made with an element of the payments being contingent on, for example, the future performance of the acquired business. Previously, contingent payments were accrued only when probable, and they were added to and adjusted against goodwill. Under the new approach, all contingent payments are measured at fair value at the time of the acquisition. They are subsequently re-measured to fair value through the income statement. So, if an acquired business does better than originally assumed and the fair value of the liability increases, it may, paradoxically, result in a debit in the income statement; on the other hand, if the opposite occurs it would be a credit.

Most companies follow a ‘parent-company’ approach to consolidation, which means that a purchase of a minority interest (or non-controlling interest, as it is now known) leads to goodwill, while a sale of shares to a minority results in a gain or loss. The new standards take the 'economic entity' view (a concept in my view that has yet to have the benefit of an adequate debate), whereby minorities are viewed in the same way as the parent shareholders, as just another class of equity. This means that transactions with them under the new standards will not result in goodwill or gains: all effects will be recorded in equity.

These are just some of the ways in which earnings may be impacted by the revised standards. There are many reasons why an acquisition makes economic sense, but will the potential for increased volatility in the income statement influence decisions? Good deals will remain good deals, but will the structure of transactions change?

As always, I am interested to hear your views, either by commenting here or by email.

Making the accountants more accountable

Consider the stakeholders, be more open about agenda-setting, accelerate the Board’s due process – these are some of the key recommendations arising from the IASCF’s consultation exercise aimed at improving the IASB’s accountability.

The points raised in the consultation paper, published on 9 September as part of the IASCF’s constitutional review could have far-reaching implications for the standard-setting process. Let’s look at some of the most important areas, which I also raised at the recent London roundtable.

Stakeholder perceptions

Many of the concerns that have been raised regarding the IASB’s accountability have been as much about behaviours and perceptions of the organisation’s willingness to listen and respond to input, as they have about the constitutional arrangements. There is evidence that the IASB and the IASCF have been better at listening to outside input recently. However, public perception to the contrary seems to  persist and can be difficult to overcome. Some constituents feel that the constitutional changes overall seem relatively modest as the end-product of an 18 month-process of deliberation. The IASB will need to demonstrate in its actions and behaviours that it is responsive to constructive input. 

Accountability, agenda-setting & due process

Many stakeholders argue that the process of setting the IASB’s technical agenda and work priorities should be more transparent, with clearly understood channels through which stakeholders can provide input and reactions, while not becoming overly bureaucratic.

The proposal to require the IASB to consult with the Trustees and the Standards Advisory Council (SAC) on agenda decisions is helpful, as is the proposal to enable the general public to provide input on papers on the Board’s agenda.

That said, there could be a greater emphasis on ‘feedback loops’, which would require the IASB to be accountable for its positions. Of course, the ultimate decision on the agenda should be made by the IASB itself; but if, for example, the SAC has provided advice on the IASB’s work priorities and the IASB has chosen not to follow that advice, it should explain and justify its reasons for doing so. A similar principle applies to other aspects of the IASB’s due process. If a sizeable proportion of comment letters on a draft pronouncement indicate that constituents are opposed to or have significant concerns about the IASB’s proposals, the IASB should be required to explain and justify its reasons for following a particular course.   

Accelerated due process

While it is important that the IASB should be permitted to consult quickly on emergency situations, it is also important that stakeholders have the opportunity to comment on proposed changes. There should still be due process, even if that process is accelerated. 

People can move quickly when the need arises, but it is unrealistic to expect stakeholder organisations to assess and comment on complex accounting proposals in anything less than 30 days.

It may be easy to put a subject such as constitutional review towards the bottom of the ‘to do’ list, as I have said before. After all, there will be little impact on the day jobs of most people, certainly in the shorter term. But the questions raised in this review are important and go to the heart of the future of standard setting on the global stage.

As always, I am interested to hear your views, either by commenting here or by email.

Digging around for an accounting solution

After 10 years of debate, discussion, and backroom musing, last month the IASB published its initial proposals on financial reporting for mining and oil & gas companies. Well, sort of. The IASB seems to be hedging its bets: it took an unusual step of issuing a draft discussion paper – prepared by the national standard-setters of Australia, Canada, Norway and South Africa – and releasing it deep within its website without any fanfare or formal public comment period. The formal release is scheduled for the first quarter of next year. It’s certainly quiet beginnings for an ambitious new accounting standard.

Even still, the draft proposals haven’t gone unnoticed in the energy and resources sector. Based on the conversations my colleagues and I have had with resources companies, after a decade of trying to get accounting for extractive industries on the ‘immediate’ agenda, they’re now nonplussed with where the IASB appears to be heading.

The IASB is proposing a new standard for accounting for extractive assets, which would replace the current guidance in IFRS 6, ‘Exploration for and evaluation of mineral resources’. It would strip out many of the accounting choices currently allowed in IFRS 6, in an attempt to create uniform accounting practice globally.

The draft discussion paper makes five key recommendations (albeit tentatively).

• A single financial reporting model should be available for all mining and oil & gas activities. This sounds logical and it seems to be supported by industry.
• Reserves and resources definitions for financial reporting should be consistent and developed by an overarching industry body. Again, this seems to be supported by industry, and it would make obvious inroads into achieving global consistency and comparability.
• Mineral and oil & gas assets should be recognised when an entity has acquired the legal right to explore. Under this approach, there would be more capitalisation of expenses, which would increase the risk of asset impairment. But unlike the impairment rules in IAS 36, ‘Impairment of assets’, entities would need to assess their assets for impairment whenever evidence suggests that full recovery of the carrying amount of an exploration asset is unlikely. Unsurprisingly, most entities don’t support this proposal. Many are questioning the merit in being ‘forced’ to capitalise something in one year, only to have to write it off at a later date.
• Mineral and oil & gas assets should continue to be measured at historical cost, supplemented by disclosure of the volume and current value of reserves.
• Significantly more detailed disclosures are proposed. By far the most contentious of them is the requirement to disclose information about either the current value or fair value measurement of proved and probable reserves, by major geographical region. This would present resources entities with significant disclosure challenges and may not substantially enhance comparability between entities. Other disclosures proposed relate to monies paid to governments, split by country. Many of the companies I’ve spoken to have questioned why such a burden should be imposed only on one industry.

Time will tell where the IASB ends up with this project. Its current plans involve issuing a formal discussion paper next year, but there has been no communicated timetable from that point on. Given accounting for the extractive industries has been a contested issue for as long as many can remember, I doubt it will be all smooth sailing from here.

As always, I would be interested in your thoughts, either by commenting here or by email.