The IASB’s project on business combinations is divided into Phase I and Phase II. An exposure draft of Phase I is expected to be published in early December together with proposals for consequential amendments to the standards on impairment and intangible assets. The proposals have been well trailed and the most controversial are set out below.
- The banning of merger accounting
Merger accounting is to be banned for any business combinations. All business combinations will have to use acquisition accounting with guidance proposed to identify the acquirer where one is not otherwise apparent. The driving force behind this proposed change is the goal of consistency. It is argued that having a choice of methods in accounting for business combinations will always permit at least some combinations to have a choice between methods of accounting which result in very different figures both at the date of the acquisition and for many years after. Merger accounting is already banned in the USA, Canada and Australia.
Under UK GAAP, acquisition accounting is required for the vast majority of business combinations but merger accounting is required as being more appropriate in certain restricted circumstances where there is a merger of equals and a whole new merged entity is created.
- Goodwill amortisation banned
The proposal that goodwill should not be amortised follows the new requirements in the USA. Companies in the UK are presently required by law to write off any goodwill arising on acquisition on a systematic basis. However, FRS 10 ‘Goodwill and intangible assets’ permits goodwill to be carried indefinitely under the true and fair override in special circumstances where there is evidence of the durability of the acquired business and the goodwill is capable of continued measurement so that annual impairment reviews are feasible.
No one would claim that acquired goodwill was actually dissipated in line with any pre-determined schedule of amortisation and certainly not the straight line model often used. However, the IASB proposal goes to the opposite position and, in effect, requires proof of the dissipation of goodwill through an impairment test before any diminution in acquired goodwill can be recognised. Whether such a proposal results in a more accurate description of how goodwill really behaves depends on the accuracy of the impairment test proposed. Banning amortisation rules out the possibility of acquirers using the simplest and the cheapest way of accounting for goodwill.
Some are concerned about the robustness of the impairment test proposed by the IASB and the conditions that trigger it. They fear that internal goodwill in the acquiring entity may be used to support the carrying value of acquired goodwill and that the lack of any retrospective test of assumptions used in the prospective tests for impairment will mean that there is no check on the reality of the assumptions used.
In the USA, the ban on merger accounting was regarded as likely to be politically acceptable only if the goodwill charge to the income statement was abolished through a policy of carrying goodwill unless there was evidence of impairment. On cost/benefit grounds, a simple trigger test was chosen to indicate impairment and only a simple impairment test was required.
- The basis on which intangible assets are recognised
The IASB is likely to propose revising the recognition criteria in IAS 38 Intangible Assets to relax substantially the recognition criteria to be met before an intangible asset is recognised separately. There will be a wide range of intangibles to be recognised. The argument is that better information is provided about an acquisition where as many of the acquired assets as possible, whether tangible or intangible, are specifically recognised rather than left unindentified in goodwill. However, the new recognition criteria for intangible assets will affect accounting by all entities and not just acquirers.
The ASB will publish the IASB’s exposure draft with explanations of how the new proposals differ from existing UK GAAP.
Phase II of the business combinations project will deal in more detail with the application of acquisition accounting to step-by-step purchases, minority interests, the fair value of the consideration and complex combination issues such as mutual entities, dual listed entities and entities under common control. A review of the use of “fresh start accounting“ for combinations with no clear acquirer has also been promised.
