Constituents generally agreed that IFRS 3 is conceptually sound, but that it is often difficult to apply in practice, in New Zealand.

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1 30 May 2014 Mr Hans Hoogervorst Chairman The International Accounting Standards Board 30 Cannon Street London EC4M 6XH United Kingdom Dear Hans Post-implementation Review of IFRS 3 Business Combinations We have obtained information about the application of IFRS 3 from some New Zealand constituents, including accounting firms and preparers of financial statements for some listed entities that have undertaken business combinations. IFRS 3 Business Combinations (2008) was applied to all the business combinations undertaken by those preparers. The responses to the questions raised in the Request for Information is a summary of the feedback received from New Zealand constituents and do not necessarily represent the views of the New Zealand Accounting Standards Board (NZASB). Constituents generally agreed that IFRS 3 is conceptually sound, but that it is often difficult to apply in practice, in New Zealand. Despite the level of judgement needed and the difficulties sometimes encountered in applying its requirements, there was a strong view that a substantial review of IFRS 3 is not needed. However, additional guidance would be helpful. The main concerns raised by New Zealand constituents are briefly outlined below. Scope There is a concern that the scope of IFRS 3 excludes business combinations under common control. Many of the business combinations undertaken in New Zealand are combinations under common control, and the lack of guidance means that there can be diversity of accounting for these types of transactions. Assessing whether a transaction is a business combination or an asset acquisition An area of practical difficulty, in many instances, is assessing whether a transaction is a business combination or an asset acquisition. The particular difficulty is determining whether or not a process has been acquired (which is a necessary element of a business combination), because this

2 determines whether the transaction is a business combination or an asset acquisition. Investment property and forestry are two industries where there is a fair amount of uncertainty. Use of fair value Although the use of fair value for recognising the net assets acquired in a business combination is supported, sometimes there are practical difficulties encountered when determining fair values. Often fair value is determined by applying valuation models, which can be very subjective. The use of such models is also associated with increased costs of reviewing and auditing those values. This consequently increases the overall costs incurred in undertaking a business combination. Impairment testing The concerns noted above about subjectivity and auditing costs also apply to the annual testing of impairment for indefinite life intangible assets and goodwill. Comments on the specific questions asked in the Request for Information are attached to this letter. If you have any queries or require clarification about the issues raised in this letter, please contact Vanessa Sealy-Fisher (vanessa.sealy-fisher@xrb.govt.nz) or me. Yours sincerely Michele Embling Chairman New Zealand Accounting Standards Board michele.embling@xrb.govt.nz Page 2 of 9

3 Post-implementation Review of IFRS 3 Question 1 Please tell us: (d) (e) about your role in relation to business combinations (ie preparer of financial statements, auditor, valuation specialist, user of financial statements and type of user, regulator, standard-setter, academic, accounting professional body etc). your principal jurisdiction. If you are a user of financial statements, which geographical regions do you follow or invest in? whether your involvement with business combinations accounting has been mainly with IFRS 3 (2004) or IFRS 3 (2008). if you are a preparer of financial statements: (i) (ii) whether your jurisdiction or company is a recent adopter of IFRS and, if so, the year of adoption; and with how many business combinations accounted for under IFRS has your organisation been involved since 2004 and what were the industries of the acquirees in those combinations. if you are a user of financial statements, please briefly describe the main business combinations accounted for under IFRS that you have analysed since 2004 (for example, geographical regions in which those transactions took place, what were the industries of the acquirees in those business combinations etc). Type of user includes: buy-side analyst, sell-side analyst, credit rating analyst, creditor/lender, other (please specify). The New Zealand Accounting Standards Board (NZASB) is the standard-setting body in New Zealand. IFRS was adopted in New Zealand for annual reporting periods beginning on or after 1 January 2007, with early adoption permitted for annual reporting periods beginning on or after 1 January The responses to the questions is a summary of feedback received from accounting firms in New Zealand and preparers of the financial statements of some New Zealand listed entities that have undertaken business combinations. IFRS 3 (2008) was applied to all the business combinations undertaken by those preparers. The responses from preparers relate to nine business combinations in total. The industries of the acquirees were building products, property investment and software. Definition of a business Question 2 Are there benefits of having separate accounting treatments for business combinations and asset acquisitions? If so, what are these benefits? What are the main practical implementation, auditing or enforcement challenges you face when assessing a transaction to determine whether it is a business? For the practical implementation challenges that you have indicated, what are the main considerations that you take into account in your assessment? Page 3 of 9

4 Constituents generally agreed that it is appropriate to have separate accounting treatments for business combinations and asset acquisitions. Constituents commented on the challenge, in many instances, of assessing whether a transaction is a business combination or an asset acquisition. They noted that judgement is required in determining whether a process, and hence a business, has been acquired, which in turn makes the process time consuming and costly Constituents expressed concern about the different treatment of acquisition costs in an asset acquisition (some can be capitalised) and a business combination (all are expensed in the year of the business combination). Both the Financial Reporting Standards Board (FRSB) (the predecessor to the NZASB) and the New Zealand constituent who commented on the proposed amendments to IFRS 3 (2008) expressed a concern that the expensing of acquisition costs relating to a business combination is inconsistent with the treatment to capitalise those costs for an asset acquired. Both parties believed that the capitalisation or expensing of acquisition costs should be considered as a separate project. It was noted that while there may be a conceptual reason behind expensing the costs of acquiring a business, the requirement does not make sense when trying to determine the ongoing operating performance of a business.. Fair value Question 3 To what extent is the information derived from the fair value measurements relevant and the information disclosed about fair value measurements sufficient? If there are deficiencies, what are they? What have been the most significant valuation challenges in measuring fair value within the context of business combination accounting? What have been the most significant challenges when auditing or enforcing those fair value measurements? Has fair value measurement been more challenging for particular elements: for example, specific assets, liabilities, consideration etc? According to the Conceptual Framework information is relevant if it has predictive value, confirmatory value or both. Constituents generally agreed that measuring the acquired net assets at fair value is conceptually correct but can be difficult to apply in practice. The definition of fair value in IFRS 13 Fair Value Measurement is an exit price and focuses on the price in an orderly transaction between market participants. The assumption of a market participant s view of fair value ignores the value that the acquirer may ascribe to the assets acquired and liabilities assumed based on the reason(s) for the acquirer undertaking the business combination. For example, the acquirer may acquire a business with the sole intention of subsequently closing that business down in order to reduce competition. In these circumstances, the acquirer may be prepared to pay a premium for that business that other market participants would not be prepared to pay. Page 4 of 9

5 New Zealand is a relatively small market with infrequent purchases and sales of businesses in the market place. As a result, valuation models are often used to determine fair value. Some constituents have concerns about the broad range of fair values that can be determined using different valuation models, and the subsequent difficulties and costs of auditing them. Determining the fair value of intangible assets is a particular concern as this is often a time-consuming and expensive exercise. A significant valuation challenge is determining the fair value of intangible assets that are recognised separately from goodwill. Preparers of financial statements question the benefits of these valuations, particularly when users of the financial statements have little or no understanding of intangible assets other than brands and goodwill. Additional audit and assurance costs are also incurred because business combinations often require a technical review in addition to the usual audit procedures regarding the fair values of the net assets acquired. Separate recognition of intangible assets from goodwill and the accounting for negative goodwill Question 4 Do you find the separate recognition of intangible assets useful? If so, why? How does it contribute to your understanding and analysis of the acquired business? Do you think changes are needed and, if so, what are they and why? What are the main implementation, auditing or enforcement challenges in the separate recognition of intangible assets from goodwill? What do you think are the main causes of those challenges? How useful do you find the recognition of negative goodwill in profit or loss and the disclosures about the underlying reasons why the transaction resulted in a gain? Some preparers expressed the view that the recognition of separately identifiable intangible assets is very challenging and, in their view, of limited use. Also, some preparers noted that users do not really distinguish, or seek to understand, the difference between goodwill, brands and other intangible assets (that is, they become synonymous), and so question whether there is any value in recognising those separate intangible assets as it is simply a purchase price allocation. These preparers considered that it is a costly exercise with limited value creation. Constituents noted the subjectivity of negative goodwill (as a consequence of the subjectivity of determining fair values), but also noted that acquirers do go back and check the appropriateness of the asset and liability valuations. Constituents thought that negative goodwill could be a reflection of the business environment at the time of the business combination. Page 5 of 9

6 Non-amortisation of goodwill and indefinite-life intangible assets Question 5 How useful have you found the information obtained from annually assessing goodwill and intangible assets with indefinite useful lives for impairment, and why? Do you think that improvements are needed regarding the information provided by the impairment test? If so, what are they? What are the main implementation, auditing or enforcement challenges in testing goodwill or intangible assets with indefinite useful lives for impairment, and why? The concerns raised included those previously mentioned in response to questions 3 and 4, that is, subjectivity and costs. Assessing goodwill and intangible assets with indefinite useful lives annually for impairment is subjective, because the amount determined is sensitive to the assumptions applied. In some cases this can result in impairment testing being an expensive exercise because of its inherent subjectivity and difficulties with auditing the amounts determined. Some preparers thought that entities should report on the judgements made. However, they also thought that on the whole the disclosures required are voluminous and therefore counterproductive, as it becomes hard for users to see through the noise. Commercial sensitivity is almost always intension with the aim of providing enhanced disclosures and this can lead to boiler-plate narratives. Non-controlling interests Question 6 How useful is the information resulting from the presentation and measurement requirements for NCIs? Does the information resulting from those requirements reflect the claims on consolidated equity that are not attributable to the parent? If not, what improvements do you think are needed? What are the main challenges in the accounting for NCIs, or auditing or enforcing such accounting? Please specify the measurement option under which those challenges arise. To help us assess your answer better, we would be grateful if you could please specify the measurement option under which you account for NCIs that are present ownership interests and whether this measurement choice is made on an acquisition-by-acquisition basis. In New Zealand, NCI is measured at the proportionate share in the recognised amounts of the acquiree s net identifiable assets. Page 6 of 9

7 Step acquisitions and loss of control Question 7 How useful do you find the information resulting from the step acquisition guidance in IFRS 3? If any of the information is unhelpful, please explain why. How useful do you find the information resulting from the accounting for a parent s retained investment upon the loss of control in a former subsidiary? If any of the information is unhelpful, please explain why. Constituents commented that determining the fair value of an investment retained on the loss of control of a former subsidiary can sometimes be problematic. Constituents also noted that there are no disclosures regarding the revenue and expenses (and profit or loss) attributable to the loss of control of a former subsidiary. Disclosures Question 8 Is other information needed to properly understand the effect of the acquisition on a group? If so, what information is needed and why would it be useful? Is there information required to be disclosed that is not useful and that should not be required? Please explain why. What are the main challenges to preparing, auditing or enforcing the disclosures required by IFRS 3 or by the related amendments, and why? All constituents disagreed with the requirement to disclose the revenue and profit or loss of the combined entity for the current reporting period as though the business combination took place at the beginning of the annual reporting period (paragraph B64(q)(ii)). The disclosure is costly and of limited use. In light of the relatively small size of the New Zealand economy, there are concerns regarding the commercial sensitivity of some of the information required to be disclosed. There was a general feeling that the disclosure requirements are excessive, and result in boilerplate disclosures being made that are not useful. Page 7 of 9

8 Other matters Question 9 Are there other matters that you think the IASB should be aware of as it considers the PiR of IFRS 3? The IASB is interested in: understanding how useful the information that is provided by the Standard and the related amendments is, and whether improvements are needed, and why; learning about practical implementation matters, whether from the perspective of applying, auditing or enforcing the Standard and the related amendments; and any learning points for its standard-setting process. Scope Business combinations under common control are scoped out of IFRS 3. Many of the business combinations in New Zealand are combinations under common control, consequently there can be diversity of accounting for these types of transactions. Purchase consideration When the purchase consideration comprises listed equity instruments, and the price of those instruments changes as a consequence of the business combination, those price changes can have a significant impact on the amounts recognised for the business combination. Application of IFRS 3 generally Some constituents agreed that the technical theory of IFRS 3 is good but the practical application of the requirements is often difficult. These constituents thought that a better link between the theory and the practice would be useful, as would more detailed examples, including marginal examples. Effects Question 10 From your point of view, which areas of IFRS 3 and related amendments: represent benefits to users of financial statements, preparers, auditors and/or enforcers of financial information, and why; have resulted in considerable unexpected costs to users of financial statements, preparers, auditors and/or enforcers of financial information, and why; or have had an effect on how acquisitions are carried out (for example, an effect on contractual terms)? The response to these questions was from a preparer perspective: Fair valuation of existing acquired assets and liabilities represents benefits to users of financial statements. Page 8 of 9

9 Identification and measurement at fair value of intangible/off-balance sheet assets acquired has resulted in considerable cost because primarily this becomes a purchase price allocation exercise and does not lead to benefit for users of the financial statements. IFRS 3 and the related amendments have had limited effect on how acquisitions are carried out. Page 9 of 9