TÜV SÜD AG 80684 Munich Germany IFRS Foundation Publications Department 30 Cannon Street, London EC4M 6XH United Kingdom Our reference/name Tel.-Extension/E-Mail Date Page Andreas Gaar +49 89 5791-3043 2014-05-30 1 of 10 andreas.gaar@tuev-sued.de Dear Ladies and Gentlemen, TÜV SÜD Group appreciates the opportunity to participate in the Post-implementation Review: IFRS 3 Business Combinations. TÜV SÜD Group is a global technical services provider. Our range of services covers testing, inspection and certification, as well as consulting and training. As dedicated and responsible specialists with wide-ranging industry expertise, we develop made to-measure solutions for retail customers as well as for industry, trade and government. As consultants, we optimize technology, systems and know-how, while focusing on the entire value added chain. Headquartered in Munich, Germany, TÜV SÜD Group operates in some 50 countries around the world. At 800 locations on five continents, 20,000 employees increase safety and add economic value for our customers, thus generating revenues of 1.9bn in 2013. As a privately held company which prepares its consolidated financial statements in accordance with IFRS we concluded a total of 42 business combinations which fall under the scope of IFRS 3 since January 1, 2007. As a consequence, we were able to gather extensive experience in accounting for business combinations both under IFRS 3 (2008) and IFRS 3 (2004). Even though we believe that IFRS 3 conveys valuable information to users of financial statements, additional guidance on certain issues could contribute to improving the cost effectiveness of business combination accounting. Headquarters: Munich Trade Register Munich HRB 109 326 VAT ID No. DE129484275 Information pursuant to Section 2(1) DL-InfoV (Germany) at www.tuv-sud.com/imprint Supervisory Board: Prof. Dr.-Ing. Hans-Jörg Bullinger (Chairman) Board of Management: Dr. Axel Stepken (Chairman), Dirk Eilers, Dr. Matthias J. Rapp, Horst Schneider, Karsten Xander Phone: +49 89 5791-0 Fax: +49 89 5791-1551 www.tuv-sud.com TÜV SÜD AG Group Accounting Westendstr. 199 80686 Munich Germany
Page 2 of 10 In case of questions or if you wish to discuss our remarks in more detail, please do not hesitate to contact us. Kind regards, Stefan Lembert Head of Group Accounting Andreas Gaar Group Accounting / International Accounting
Page 3 of 10 Appendix 1: The following are TÜV SÜD Group s answers to the questions raised in the PiR IFRS Business Combinations request for information: Question 1: Please tell us: (a) 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). (b) your principal jurisdiction. If you are a user of financial statements, which geographical regions do you follow or invest in? (c) whether your involvement with business combinations accounting has been mainly with IFRS 3 (2004) or IFRS 3 (2008). (d) if you are a preparer of financial statements: (i) whether your jurisdiction or company is a recent adopter of IFRS and, if so, the year of adoption; and (ii) 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. (e) 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). TÜV SÜD is a preparer of financial statements, headquartered in Germany. Our scope of investment is worldwide, with a strong focus on industrialized and emerging markets. Having adopted IFRS as of January 1, 2007, we applied both IFRS 3 (2004) and IFRS 3 (2008). Overall, since that date we concluded 42 business combinations of which the majority of transactions have been accounted for under IFRS 3 (2008). All acquirees were from the technical services industry. Question 2: (a) Are there benefits of having separate accounting treatments for business combinations and asset acquisitions? If so, what are these benefits? (b) 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 4 of 10 M&A transactions concluded by TÜV SÜD in recent years all satisfied the requirements of a business combination. Given that under IFRS 3.B7 an organized workforce capable of following rules is considered sufficient to satisfy the need for processes, we believe that in the people driven services industry, asset acquisitions will be few and far between. Moreover, such transactions will likely not be material. This, however, might be different in other industries. Question 3: (a) To what extent is the information derived from the fair value measurements relevant and the information disclosed about fair value measurements sufficient? (a) If there are deficiencies, what are they? (b) 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? (c) Has fair value measurement been more challenging for particular elements: for example, specific assets, liabilities, consideration etc? (a) According to the Conceptual Framework information is relevant if it has predictive value, confirmatory value or both. We believe that the measuring assets and liabilities of the acquiree at fair value does convey valuable information to a user of financial statements. Based on the disclosed fair values, the reader of the financial statements has the opportunity to confirm as to whether the entity accounting for a business combination does share his views on the value drivers of the acquiree. We believe that this information has both confirmatory value and predictive value. However, limitations to the relevance of information apply to the valuation of specific intangible assets, if certain valuation methods are applied or if historic data is not available. Generally, the most significant challenges in valuing assets and liabilities within the scope of a business combination are: Measuring intangible assets at fair value to which cash flows cannot be attributed, either directly or indirectly, frequently causes the relevance of valuation results to be rather low. For measuring fair value of such assets, like accreditations to issue certifications or perform certain restricted services, preparers of financial statements regularly have to resort to apply reproduction or replacement cost methods. Due to the inherent limitations of these valuation methods, the appraised asset value might not reflect the ex ante value contribution of these assets considering the value driver analysis of the acquiree. The valuation of (non-contractual) customer relationships, especially determining certain parameters such as the remaining economic useful life of such relationships, can be challenging if no past statistical data, such as customer retention rates are available which can be used as a valid starting point for estimating certain valuation inputs. This often is the case for remaining useful life, if the acquiree is providing services on a per project basis or if the acquiree is a SME with limited controlling systems that did not keep track of such data in the past. One approach to adequately derive and document such parameters in absence of historical data is to use scoring models which consider a
Page 5 of 10 number of factors impacting the strength of the customer relationship such as the nature of the customer relationship, contract details, the market structure and competitive situation in the market. However, in absence of hard data substantial leeway remains for the entity accounting for a business combination in determining the economic useful life of customer relationships. This fact impedes the comparability of business combination accounting for transactions within the same industry. For TÜV SÜD Group, the global financial crisis did not lead to a significant increase in challenges encountered in measuring assets or liabilities identified at fair value. This is mainly due to the fact that our business model in the TIC (testing, inspection and certification) market is comparably stable and thus not susceptible to short-term economic fluctuations. Question 4 (a) 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? (b) 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? (c) 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? We believe that the separate recognition of intangible assets significantly enhances the relevance of business combinations accounting for the following reasons: By recording intangible assets separately from goodwill, the user of financial statements receives valuable information as to how the acquiring entity views and weighs the value drivers of the acquiree. Especially in the services industry which exhibits low equipment intensity and a high share of intangible assets in total value, separate recognition of intangible assets conveys a high degree of relevant information to the user of financial statements, even if there are inherent limitations to the valuation of intangible assets: i.e. as intangible asset valuations frequently require a large number of entity specific level 3 inputs, the supportable range of values often is larger than in an ordinary business valuation. We do not believe that changes to the current principles of accounting are required. Based on our experience, the challenges in implementing separate recognition criteria are correctly identifying value drivers of the acquiree and attributing these value drivers to particular intangible assets. Due to interdependencies between intangible assets and their impact on the business, this is not always straightforward: e.g. it is not clear at first sight, which impact a brand has on customer retention. Soft facts as the customers` prior experience of the quality of products and services offered by the acquiree must be considered. A deep understanding of
Page 6 of 10 the acquiree s business, market environment and industry practices is necessary to arrive at adequate results. With regards to negative goodwill, we do not think that recording negative goodwill directly within profit and loss provides a significant advantage as opposed to recording negative goodwill in the balance sheet and amortizing the amount over a pre-determined period. We believe however, that disclosures about the underlying reasons of a negative goodwill could be valuable to users of financial statements, if they are comprehensively made. Question 5 (a) How useful have you found the information obtained from annually assessing goodwill and intangible assets with indefinite useful lives for impairment, and why? (b) Do you think that improvements are needed regarding the information provided by the impairment test? If so, what are they? (c) What are the main implementation, auditing or enforcement challenges in testing goodwill or intangible assets with indefinite useful lives for impairment, and why? In general, we believe that the information conveyed by performing impairment tests on goodwill and intangible assets is useful to the user as well as for the preparer of financial statements: By way of the results and more importantly the disclosures of key assumptions employed by the accounting entity in its impairment tests, users of financial statements can receive additional information on management`s expectations for each CGUs future prospects. Annual impairment testing for goodwill and indefinite useful life intangible assets forces the accounting entity to put more focus on analyzing the potential outcomes of transactions, thus promoting the use of scenarios before and after conclusion of a transaction. In our view, this often is to the benefit of the acquirer. The main challenge in implementing impairment testing for goodwill and intangible assets is to utilize existing systems in a way to automate the process of impairment testing. By using standard models and standard reports, the effort required for impairment testing is manageable, even for medium-sized entities such as TÜV SÜD Group. Also, even if the impairment only approach was scrapped, a goodwill impairment test would still have to be performed in case of a triggering event. Thus, irrespective of the initial accounting treatment of goodwill, efficient impairment testing processes need to be maintained. As a consequence, in our view, savings in cost and effort would be limited while the quality of results would likely be lower due to lack of repetition. Further challenges encountered are: Allocating corporate assets to CGUs often requires substantial manual adjustments not only to the carrying amount of a CGU, but also to the business plan. If a Group charges
Page 7 of 10 the costs associated with corporate assets to its subsidiaries, these charges have to be reversed and replaced by operating costs and depreciation associated with corporate assets. In addition, reinvestments in corporate assets need to be considered. We thus encourage the IASB to provide clarifying guidance that an allocation of corporate assets is not required if costs associated with these assets are charged to CGUs at market rates (including an adequate profit margin). Determining the correct level of impairment testing for intangibles assets (with or without indefinite useful life) has been a matter of discussion in past and present. Whereas there are parties, that believe that a separate asset which was initially measured by using the income approach should also be tested for impairment on the level of a separate asset using the same valuation method, other parties have advocated the view that an impairment test should always be performed at the level of (a more aggregated) CGU. Further guidance on part of the IASB on this issue would be appreciated. Question 6 (a) 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? (b) 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. To date we have measured NCI for all acquisitions accounted for under IFRS 3 (2008) at the proportionate share of identifiable net assets (Proportionate share method). If a preparer of financial statements chooses to apply the proportionate share of net assets method, the amount of goodwill recognized depends on the percentage of shares acquired. Irrespective of further share purchases or disposals, the goodwill will not change. Thus, the goodwill recognized will not reflect the overall consideration paid. On the other hand, measuring the NCI at fair value permits the accounting entity with a wider margin for discretion in determining fair value. We do not believe that either option is clearly superior and in absence of a better approach, we agree with the notion that preparers should be able to choose which method to apply. Irrespective of the merits of the methods to measure NCI as of acquisition date, we believe that the option to choose on acquisition-by-acquisition basis between measuring NCI either with the proportionate share method or the fair value method might limit the information value of the financial statement of the accounting entity. We therefore suggest to compel preparers to choose one of the two methods and apply it consistently in all business combinations.
Page 8 of 10 Question 7 (a) 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. (b) 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. The main advantage of the accounting treatment of step acquisitions under IFRS (2008) is that it is comparably easy to apply and understand (especially compared to the guidance in IFRS (2004)). Generally, it is useful that the business combination accounting is based on the consideration transferred plus the fair value of the shares owned by the accounting entity prior to taking control over the acquiree (pre-existing investment). Recording a gain or loss from the revaluation of the pre-existing investment is consistent with the treatment of the remaining investment in the former subsidiary after a loss of control. The quality of information conveyed by this is somewhat limited if the basis is not disclosed on which the fair value of the pre-existing investment was determined. The same is true for the revaluation of shares retained after the loss of control. In order to better assess the revaluation gain or loss, it would be helpful to require additional disclosures on how the fair value of the pre-existing investment was calculated (e.g. whether the transaction price was deemed to be equal to fair value and if not, what factors led to the deviation). Question 8 (a) 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? (b) Is there information required to be disclosed that is not useful and that should not be required? Please explain why. (c) What are the main challenges to preparing, auditing or enforcing the disclosures required by IFRS 3 or by the related amendments, and why? In order to evaluate the effect the business combination accounting will have on future EBIT, getting an idea on the future impact of business combinations on EBIT is extremely valuable. Therefore, we suggest to require preparers of financial statements to disclose a schedule on how depreciation and amortization of fair value adjustments and other quantifiable p&l effects from business combinations are expected to impact profit and loss in future years. This would
Page 9 of 10 also be useful for third party stakeholders trying to assess the value of a publicly listed reporting entity by way of income or cash flow based valuation models. IFRS 3.B64q requires the disclosure of the amount the acquiree contributed to the consolidated profit and loss of the current financial year. As profit and loss is not clearly defined preparers are free to choose which profit they disclose (e.g. EBIT, or EBT or net profit). Thus, the ability of users of financial statements to compare the disclosures between entities of the same industry is limited. This could be avoided by either clarifying which definition of profit (or loss) should be disclosed. Alternatively, preparers of financial statements should at least be required to disclose which definition of profit has been presented in the Group notes. IFRS 3.B64q(ii) currently requires that revenue and profit and loss are to be disclosed as if all business combinations had taken place on the first day of the reported financial year. Acquirees that are small- and medium sized entities generally do not report according to IFRS and thus, for the period prior to the acquisition date revenue and profit and loss figures generally are only available based on local GAAP guidelines. We suggest that if for the period prior to acquisition date financial data is only available according to accounting rules other than IFRS and if this is likely to have material impact on the reported revenue and profit and loss, the preparer of financial statements should disclose this fact and the most likely impact on the figures disclosed. We further suggest to include in IFRS 3 Appendix A a clarification on the definition of acquisition related costs, most notably if and to what extent internal costs are part of acquisition related costs. 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: (a) understanding how useful the information that is provided by the Standard and the related amendments is, and whether improvements are needed, and why; (b) learning about practical implementation matters, whether from the perspective of applying, auditing or enforcing the Standard and the related amendments; and (c) any learning points for its standard-setting process. Implementation matters often arise in situations where IFRS 3 requires business accounting to be applied based on the preparers assessment of economic circumstances while the standard only provides very general guidance on how this economic circumstances should be assessed. One example for such a situation is the accounting guidance for determining whether a transaction is part of a business combination transaction, most notably the guidance for arrangements for contingent payments to employees or selling shareholders. Even we realize that there are limits to the level of detail the application guidance can provide, we suggest to include more practical examples in such application guidance sections appended to the standard.
Page 10 of 10 Question 10 From your point of view, which areas of IFRS 3 and related amendments: (a) represent benefits to users of financial statements, preparers, auditors and/or enforcers of financial information, and why; (b) have resulted in considerable unexpected costs to users of financial statements, preparers, auditors and/or enforcers of financial information, and why; or (c) have had an effect on how acquisitions are carried out (for example, an effect on contractual terms)? In contrast to not recording hidden reserves and losses separately, but amortizing goodwill over a period of no more than 20 years as required in IAS 22, we believe that the impairment only approach better reflects economic facts and circumstances. For entities that employ push down accounting and use KPIs which reflect both p&l and balance sheet numbers such as Economic Value Added (EVA) or Return on Capital Employed (ROCE) the impairment only approach leads to more useful results as both the p&l and the balance sheet (capital employed) are less affected by normalizations without economic basis (such as standardized scheduled goodwill amortization periods). Further we believe that the amendment in the accounting for step acquisitions in IFRS 3 (2008) increased both relevance and reliability of business combinations. Whereas the new rules provide more up to date information, the results are also likely to be more reliable. While in theory the approach of accounting for each share purchase step separately on a retrospective basis as required by IFRS 3 (2004) is appealing, the quality of data and information as of the date of past acquisition steps often was not good enough to produce relevant results. Even if sufficient data and information was available, the information generated by performing multiple steps of analysis as of different acquisition dates was not worth the time nor cost efficient. Additional costs of analysis and costs of internal communication have been caused by the implementation of the revised rules for the accounting of contingent consideration and for determining whether a transaction is part of a business combination transaction. Both rules impact the p&l and therefore require extensive explanation to different levels of management. It is necessary to anticipate potential p&l impacts so as to avoid management being surprised by adverse p&l effects after the closing of a transaction. This is especially true for the guidance on whether a transaction is part of a business combination, as the guidance included in the standard IFRS 3 is rather vague. Since IFRS 3 (2008) has become effective, we have observed that contingent payments to employees and selling shareholders are increasingly scrutinized due to potential adverse p&l impacts.