Response to Exposure Draft of Proposed Amendments to IFRS 3, 'Business Combinations'

Transcription

1 Our ref: smk 28 October 2005 Alan Teixeira Esq. Senior Project Manager International Accounting Standards Board 30 Cannon Street London EC4M 6XH Chiltern pic 3 Sheldon Square London W2 6PS T: D: F: E: kennedys@chilternplc.com Letter of Comment No: 101 't File Reference: Dear Alan Response to Exposure Draft of Proposed Amendments to IFRS 3, 'Business Combinations' Introduction I am writing to set out comments from Chiltern pic regarding the Exposure Draft of Proposed Amendments to IFRS 3, 'Business Combinations'. Chiltern pic is a major tax-led professional services organisation and we have a team providing advice regarding IFRS and valuation issues. I am pleased to have the opportunity to send you the Chiltern team's views in connection with the Exposure Draft. We note that the Exposure Draft places significantly more emphasis on fair value measurement than the existing IFRS 3. We support this emphasis on fair value measurement, as fair value is a much more relevant measure than cost, but consider it essential that this emphasis is supported by more substantial guidance on, and codification of, valuation methodology. The approach taken in the Exposure Draft is to provide a certain amount of guidance regarding some of the valuation issues that could arise in implementation of the proposals. We consider, however, that there is now so much emphasis on fair value determination - both in this Exposure Draft and other standards - that valuation in the context of financial reporting must be addressed as a separate issue. Valuation is a discipline and specialism with its own experts. It is not a discipline in which the majority of preparers of accounts have sufficient experience that, following a few guidance paragraphs in an IFRS, would enable them to produce a robust valuation. We propose, REG ISTERED " 1 THE ASOV E AOD ~ ESS I,. ENGlAND. CDrIlPANY NIJMIlER

2 26 October 2005 Page 2 of 13 therefore, that valuation matters in financial reporting be addressed by valuation specialists, who should declare their credentials. The necessary guidance should be set out in a separate valuation standard or standards and should be written so that it can be followed by valuation specialists rather than by laymen. We note that the process of formally recognising the credentials of a valuation specialist is currently evolving. For instance, the body to which many valuation specialists in the UK belong is the Society of Share & Business Valuers ("SSBV"). This body has set its own admission procedures to ensure that members have appropriate skills and experience and has representatives from all the "Big 4" accountancy practices as well as a number of medium-sized and small professional services organisations. We consider that the IASB should support and recognise the development of such organisations. We understand that the International Valuation Standards Committee ("IVSC"), currently the only global valuation body, is involved in discussions with the IASB in connection with a proposed project to be undertaken by the IVSC to draft valuation standards for financial reporting purposes. We strongly support the proposed IVSC project - as noted above, we consider it essential that valuation standards are prepared, endorsed and followed by valuation experts. We would expect that such an IVSC standard would incorporate and build upon the draft guidance already issued by the: FASB in its Proposed Statement of Financial Accounting Standards, June 2004, 'Fair Value Measurements'; and AICPA in its Exposure Draft, March 2005, 'Proposed Statement on Standards for Valuation Services'. We do not consider that either of these documents provides sufficient guidance by themselves. We are of the view that the IASB should take global soundings on this important issue rather than relying on input from the USA only. With these general points in mind, I have set out below our responses to the questions raised in the Exposure Draft.

3 28 October 2005 Page 3 of 13 Question 1 Are the objective and definition of a business combination appropriate for accounting for all business combinations? If not, for which business combinations are they not appropriate, why would you make an exception, and what alternative do you suggest? We consider that the objective and definition of a business combination are appropriate for accounting for all business combinations. Question 2 Are the definition of a business and the additional guidance appropriate and sufficient for determining whether the assets acquired and the liabilities assumed constitute a business? If not, how would you propose to modify or clarify the definition or additional guidance? We consider that the definition and additional guidance are appropriate for determining whether the assets acquired and the liabilities assumed constitute a business. Question 3 In a business combination in which the acquirer holds less than 100% of the equity interests of the acquiree at the acquisition date, is it appropriate to recognise 100% of the acquisition-date fair value of the acquiree. including 100% of the values of identifiable assets acquired, liabilities assumed and goodwill, which would include the goodwill attributable to the non-controlling interest? If not, what alternative do you propose and why? We support the proposal to recognise 100% of the acquiree including the goodwill attributable to the non-controlling interest even when less than 100% has been acquired. We consider that this has intellectual appeal and results in goodwill being treated consistently with the acquired assets and liabilities in the consolidated accounts.

4 28 October 2005 Page 4 of 13 Question 4 Do paragraphs A8-A26 in conjunction with Appendix E provide sufficient guidance for measuring the fair value of an acquiree? If not, what additional guidance is needed? Paragraph 19 of the Exposure Draft proposes that the acquirer measures the fair value of the acquiree as a whole. Paragraph 20 clarifies that, in some situations, the consideration paid for the acquisition does not provide the best evidence of the acquisition-date fair value of the acquirer's interest in the acquiree and refers the reader to paragraphs A8-A26 for guidance in such situations. We consider that having guidance in paragraphs A8-A26 with only one reference to Appendix E - paragraph A22 refers to the definition in E6(b) - is confusing to the reader. We think it would be clearer if all fair value guidance were gathered together in one appendix. Currently, Appendix E appears to be something of an afterthought. As set out in the introduction to this response, we consider that all valuation guidance should be set out in a separate valuation guidance standard(s) written by valuation specialists for valuation specialists. Our views in respect of Appendix E, which we note is based on the FASB proposed statement issued in June 2004 and may be updated when the FASB finalises this statement, are that it attempts to cover the valuation of too many different assets simultaneously. The valuation of financial instruments is a topic in its own right, as are the valuations of of businesses, shares and intangible assets. In particular, it is confusing to amalgamate the valuation of instruments traded in an active market, e.g. certain types of financial instrument, with those which are not traded in an active market, e.g. all businesses and virtually all intangible assets. Whilst Appendix E might be suitable as a summary introduction to valuation approaches, it must be supported by detailed guidance on the approaches taken by valuation specialists when valuing different types of asset. Paragraphs 8-26 of Appendix A are too specific to sit comfortably in the middle of an IFRS. As noted in our introduction, the majority of preparers of accounts do not have in-depth valuation expertise. Attempting to provide guidance to such 'laymen' as an integral part of an IFRS could mislead preparers of accounts into thinking that they have the ability and technical toolkit to prepare robust valuations. We consider that this approach is both dangerous and imprudent and could lead to highly unreliable financial reporting.

5 28 October 2005 Page 5 of 13 Much of A8-A26 is devoted to specific situations where a holding of less than 100% is acquired and how the value of a notional 100% purchase should be derived in such cases. Three examples are given. We consider that inclusion of these examples is particularly dangerous as it could lead laymen to think that, by drawing analogies with the guidance provided, they have the skills to determine the value of a 100% holding by reference to the purchase price of a smaller stake. We consider that an experienced valuation specialist would be required to determine the value of a 100% holding in such situations. In our view, the guidance which we have requested above should be drafted by the lyse and should refer to the approaches taken by valuation specialists in such situations including, in particular, research undertaken into prices paid for different stakes in different industries. We note that the three examples given do not differentiate between the powers of holders of more than 25% of an entity, who are likely to be able to block a special resolution if acting in concert, and those of very small minorities who have nothing more than minimal nuisance va lue to the majority holders. Example 2, paragraph A 14, is helpful only because it demonstrates that the Exposure Draft has been worded in a misleading fashion in paragraphs 21 (b) and 56. Both these paragraphs propose that the acquisition-date fair value of a non-controlling interest is revalued to its fair va lue immediately before the acquisition date, if such an interest is to be increased to a controlling interest as part of a step-by-step acquisition. A valuation practitioner would interpret such a requirement as meaning that the stake is revalued to its current fair value in the context of it being a minority holding. Thus, if a 1 % stake were held as an 'Available for Sale' financial asset in accordance with las 39, it would be required to be revalued to the acquisition date value of a 1 % stake. The example in paragraph A14 describes the revaluation of a 1% stake from its purchase price of CU 850k to eu 1m. The CU 1m, however, is based not on the revaluation of the 1% stake in the context of it being a 1 % stake but in the context of it being a part of the deemed value for a 100% stake. Thus, it is valued as 1 % of a 100% stake rather than as a 1 % stake. This example and the proposals in paragraphs 21(b) and 56 omit to discuss the issue of the control premium attaching to a controlling stake. In our view, the fact that this incorrect approach has been taken, which omits to identify the difference between the value of a 1 % stake per se and the calculation of 1 % of a 100% stake, highlights the dangers of laymen drafting and applying valuation guidance for financial reporting purposes.

6 28 October 2005 Page 6 of 13 The general guidance regarding the market approach, set out in paragraphs A20-A21, is consistent with current best practice as adopted by valuation practitioners but would not be sufficient for a layman to apply the market approach to value a business. The general guidance regarding the income approach, set out in paragraphs A22-23, is brief. It is not adequate to address the key issues of differentiating fair value and value in use through different approaches to both forecasting cash flows and determining appropriate discount rates. Question 5 Is the acquisition-date fair value of the consideration transferred in exchange for the acquirer's interest in the acquiree the best evidence of the fair value of that interest? If not, which forms of consideration should be measured on a date other than the acquisition date, when should they be measured and why? We address the issue of contingent consideration in our response to Question 6 below. In other respects, we consider that consideration should be measured at the acquisition date. Question 6 Is the accounting for contingent consideration after the acquisition date appropriate? If not, what alternative do you propose and why? We do not agree with the proposed approach of detennining contingent consideration at the acquisition date. The approach in the existing IFRS 3 is that contingent consideration is trued up to the final amount payable through the fair value balance sheet. We consider that this is the appropriate approach. We note that there are some similarities between the payment of contingent consideration in a business combination and the vesting of performance conditions under IFRS 2, 'Share-based Payment'. We would support, therefore, an approach for IFRS 3 that is consistent with IFRS 2. Thus, contingent consideration: that is dependent upon achievement of a specific share price would be measured at the date of acquisition and not subsequently adjusted (similar to IFRS 2 market-based performance conditions); and

7 28 Oclober 2005 Page 7 of 13 that is not dependent upon achievement of a specific share price would be trued up, as the contingent conditions are or are not satisfied, through the fair value balance sheet - this would include situations in which satisfaction of the consideration is through the issue of additional equity, provided the contingent condition was not of the type that the equity had to achieve a certain price. We note, with regard to our proposed approach, that contingent consideration is often dependent upon events that cannot be reliably estimated at the date of acquisition and that that is why the consideration is contingent. We cannot see any benefit to making a once-and-for-all estimate of Ihis in the fair value balance sheet, with laler adjustments not being recognised if they are paid through equity or being reflected in the post-acquisition results if they are settled through cash or other asset payments. If contingent consideration were payable in cash and dependent upon future profits, under the Exposure Draft proposals, this would be reflected in the fair value balance sheet as a liability, based upon the assumption that a specific profit level is reached. If this level were not reached, some of the liability would be released as a credit 10 the post-acquisition profit and loss account and there should, in theory at least, be a corresponding impainnent of goodwill debited to the profit and loss account. This matching could be ensured through further guidance in IFRS 3 and las 36, 'Impairment of Assets' - but we consider that it would be much simpler and more appropriate for the fair value balance sheet to continue to be adjusted until the final amount of contingent consideration had been detennined. Question 7 Do you agree that the costs that the acquirer incurs in connection with a business combination are not assets and should be excluded from the measurement of the consideration transferred for the acquiree? If not, why? We support the view taken in the Exposure Draft that costs incurred by the acquirer are not assets, as they do not provide future economic benefits, and hence should be accounted for in accordance with other IFRS's separately from the business combination. We note that this approach also has the benefit of providing better accountability to shareholders for such costs.

8 28 October 2005 Page 8 of 13 Question 8 Do you believe that these proposed changes to the accounting for business combinations are appropriate? If not, which changes do you believe are inappropriate, why, and what alternatives do you propose? We consider that the proposed changes in respect of receivables are appropriate. It is the fair value of the receivable at the date of acquisition that is relevant, not its historical cost with an associated valuation allowance. We consider that the symmetry between accounting for contingencies that are assets and those that are liabilities improves the accounting compared with that in the current version of IFRS 3, which recognises contingent liabilities only. We also consider that the proposed approach of treating contingencies that are assets as intangible assets following initial recognition is appropriate and provides helpful clarification of how the intangible asset definition in las 38, 'Intangible Assets', should be applied. We also agree with the proposed treatment of contingencies that are liabilities. Question 9 Do you believe that these exceptions to the fair value measurement principle are appropriate? Are there any exceptions you would eliminate or add? If so, which ones and why? We agree with the proposed exceptions to the fair value measurement principle and note that these arise either from specific requirements in other IFRS's or because the scope of the Exposure Draft is not sufficient to consider amendments to accounting for complex issues such as employee benefit plans or deferred tax.

9 28 October 2005 Page 9 of 13 Question 10 Is it appropriate for the acquirer to recognise in profit or loss any gain or loss on previously acquired non-controlling equity investments on the date it obtains control of the acquiree? If not, what alternative do you propose and why? We have set out in our response to Question 4 above our reservations regarding the drafting of this proposal. For the purpose of responding to this question, we have assumed that the intention in the Exposure Draft is as set out in Example 2, paragraph A 14, namely that the revaluation should be to the minority pro rata value of a 100% stake (as opposed to the acquisition date fair value of a minority stake). Whilst such a revaluation would have no meaning in valuation terms, it is one way of ensuring that the total deemed price payable can be reconciled to the fair value of a 100% interest. To be consistent with the requirements for 'Available for Sale' financial assets under las 39, we consider that any gain on this 'revaluation' should be recognised in equity not profit and loss account. It should be recognised in profit or loss account only to the extent that it is ultimately realised through disposal. It would, for instance, be inappropriate to pay dividends based on this 'revaluation'. Question 11 Do you agree with the proposed accounting for business combinations in which the consideration transferred for the acquirer's interest in the acquiree is less than the fair value of that interest? If not, what alternative do you propose and why? We agree that it would be inappropriate to recognise goodwill in the balance sheet in a situation in which the consideration transferred is less than the fair value of the interest obtained. Also, making this adjustment is consistent with the premise of the Exposure Draft generally that fair value is best represented by the consideration transferred. Thus, we agree with the proposed approach to reduce to zero any goodwill arising as the difference between fair value and net recognisable assets acquired prior to recognising any remaining excess of the fair value of the interest acquired over the price paid for it in the profit and loss account.

10 28 October 2005 Page 10 of 13 Question 12 Do you believe that there are circumstances in which the amount of an overpayment could be measured reliably at the acquisition date? If so, in what circumstances? Whilst we consider that there are many instances in practice of overpayments being made for acquisitions, we consider that the practicalities involved in identifying them are too great to make it feasible to recognise them at the acquisition date. We consider that, in practice, the only way of accounting for such overpayments is through robust application of the impairment test in accordance with las 36, 'Impairment of Assets'. Question 13 Do you agree that comparative information for prior periods presented in financial statements should be adjusted for the effects of measurement period adjustments? If not, what alternative do you propose and why? We agree with the proposed approach in respect of adjustment of comparative information in respect of measurement period adjustments. Question 14 Do you believe that the guidance provided is sufficient for making the assessment of whether any portion of the transaction price or any assets acquired and liabilities assumed or incurred are not part of the exchange for the acquiree? If not, what other guidance is needed? We consider that it is very helpful to provide this guidance. Problems can arise in practice - for instance with regard to payments to some but not all owners of the acquiree company in the case that some are employed by the acquirer.

11 28 October 2005 Page 11 of 13 Question 15 Do you agree with the disclosure objectives and minimum disclosure requirements? If not, how would you propose amending the objectives or what disclosure requirements would you propose adding or deleting and why? We consider that disclosure is particularty important when fair value measurements are used in accounts. One way of ensuring that valuation procedures are robust is to require disclosures in respect of them. Whilst we note that the basis of measurement of fair value for both the consideration and the acquisition date fair value of the acquiree are required, it is not clear exactly what would be required to be disclosed. We consider that a description of the techniques applied should be disclosed, whether greater emphasis was placed on one technique rather than another and also some analysis of the way in which the consideration transferred is related to the fair value of a 100% interest. Reference should also be made to how the approach taken is consistent with the Fair Value Hierarchy set out in Appendix E. No disclosures appear to be required regarding the method by which the fair values of assets and liabilities including both contingencies and intangible assets had been determined. We consider that it is important that such disclosures are made. Methodologies applied should be disclosed together with key assumptions, in a similar fashion to the required disclosures for goodwill and indefinite-lived intangible assets under las 36. jf there were a body of valuation experts drafting valuation guidance, our view IS consideration of the disclosures required should be part of their remit. that Question 16 Do you believe that an intangible asset that is identifiable can always be measured with sufficient reliability to be recognised separately from goodwill? If not, why? Do you have any examples of an intangible asset that arises from legal or contractual rights and has both of the following characteristics: a. the intangible asset cannot be sold, transferred, licensed, rented or exchanged individually or in combination with a related contract, asset or liability: and

12 28 Odobe< 2005 Page 12 of 13 h. cash flows that the intangible asset generates are inextricably linked with the cash flows that the business generates as a whole? We concur with the view that an intangible asset that is identifiable can always be measured with sufficient reliability to be recognised separately from goodwill. We note that the limited guidance regarding intangible asset valuations currently included in paragraphs of las 38, 'Intangible Assets', would be removed if the Exposure Draft proposals were adopted. We also note that there is no specific guidance regarding the valuation of intangible assets in Appendix E of the Exposure Draft. We note, however, that the guidance in paragraphs 36 and 37 of las 38, which would not be deleted by the Exposure Draft, provides a practical way ot ensuring that intangible assets are not analysed into unnecessarily small components. As stated earlier, we consider that guidance regarding, inter alia, valuation of intangible assets should be provided by a body of valuation experts working in collaboration with the IASB. It is also important that intangible asset valuations in accounts are prepared only by valuation experts who can support their credentials, for instance through membership of a body such as the SSBV. We do not have any examples of intangible assets with both the characteristics described in Question 16(a) and (b) above. Question 17 Do you agree that any changes in an acquirer's deferred tax benefits that become recognisable because of the business combination are not part of the fair value of the acquiree and should be accounted for separately from the business combination? If not, why? We agree that such changes should be accounted for in the post-tax results of the combined entity and are not part of the fair value of the acquiree at the acquisition date.

13 28 October 2005 Page130f13 Question 18 Do you believe it is appropriate for the IASB and the FASB to retain those disclosure differences? If not, which of the differences should be eliminated, if any, and how should this be achieved? We have not reviewed in detail the differences in disclosure between the IASB Exposure Draft and the FASB Exposure Draft. However, we agree that differences resulting from remaining differences in other standards are inevitable. Question 19 Do you find the bold type-plain type style of the Exposure Draft helpful? If not, why? Are there any paragraphs you believe should be in bold type, but are in plain type, or vice versa? We are happy with the style, which is consistent with other IASB documents. If you wish to discuss any matters arising from this response. please contact me on (mobile ) or by Kind regards Yours sincerely Shan Kennedy Director, IFRS & Valuation