Re: Request for Information: Post-implementation Review: IFRS 3 Business Combinations

Transcription

1 Mr Hans Hoogervorst Chairman of the International Accounting Standards Board 30 Cannon Street London EX4M 6XH United Kingdom Our Ref. Phone Fax Date BS/HDF May, Re: Request for Information: Post-implementation Review: IFRS 3 Business Combinations Dear Hans, The Linde Group is a world-leading gases and engineering company with approximately employees working in more than 100 countries worldwide. In the 2013 financial year it achieved sales of EUR 16.7 billion. We offer a wide range of compressed and liquefied gases as well as chemicals and we are therefore an important and reliable partner for a huge variety of industries. Our engineering division is successful throughout the world, with its focus on promising market segments such as olefin plants, natural gas plants and air separation plants, as well as hydrogen and synthesis gas plants. The Linde Group is listed in the leading German share index (DAX) and prepares its consolidated financial statements in accordance with International Financial Reporting Standards as adopted by the European Union. The Linde Group welcomes very much to have the possibility to comment on the IASB s Post-implementation Review: IFRS 3 Business Combinations. We appreciate the efforts undertaken by the IASB to continuously improve the IFRS to develop a single set of high quality, understandable, enforceable and globally accepted financial reporting standards. If you have any questions or remarks, please do not hesitate to contact us. We would be happy to discuss any of our comments with you at your convenience. Yours sincerely, Bjoern Schneider Head of Group Accounting & Reporting Dr. Hans-Dieter Fladung Head of IFRS Competence Centre & External Reporting Linde AG, Klosterhofstraße 1, München Telefon , Telefax , info@linde.com Sitz der Gesellschaft: München, Registergericht: München, HRB Aufsichtsrat: Manfred Schneider (Vorsitzender), Vorstand: Wolfgang Reitzle (Vorsitzender), Aldo Belloni, Thomas Blades, Wolfgang Büchele, Georg Denoke, Sanjiv Lamba

2 Page 2 Appendix I: Answers to the questions raised in the PiR 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, standardsetter, academic, accounting professional body etc). (a) (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). (a) Type of user includes: buy-side analyst, sell-side analyst, credit rating analyst, creditor/lender, other (please specify). Ad 1(a): The Linde Group is a preparer of financial statements. Ad 1(b): German jurisdiction Ad 1(c): both Ad 1(d): (i) year of adoption was 2005, (ii) around 20 Ad 1(e): n/a

3 Page 3 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? Ad 2(a): The main benefit is that the management has to clearly render account for the business acquisition made and the value drivers behind. After a Purchase Price Allocation and the subsequent allocation of Goodwill to CGUs and the related disclosures to be made the motives of the management become apparent. This is very helpful in the period when the acquisition is made. So all excess of purchase price over book value of net assets acquired is explained and made transparent. This is helpful if one believes that the balance sheet is the primary bearer of financial information. In subsequent periods, the disadvantages seem to outweigh the advantages: The companies having undergone some acquisitions are hardly comparable with companies that have grown organically. Furthermore, the amortization of intangible assets and hidden reserves make the most important post-amortization KPIs meaningless and most profitability-related KPIs are barely helpful any more. One reason for this is that the amortization of PPA-related intangible assets comes in addition to the continuous treatment of investment in most intangible assets as current expense; this incongruence leads to a double charge of cost to the P+L and evokes the impression of an deterioration of profitability whereas the opposite might be the case. Also, in a multi-period perspective the decision usefulness of P+L information suffers because PPA-related amortization and depreciation does not appear in the same amount in all periods but may vary a lot in the passage of time; so, there might be an implied recovery effect on results built in the subsequent measurement when asset step-ups disappear over time. So, for an overview of the assets / liabilities acquired the provisions of IFRS 3 are helpful, for a multi-period comparison of profits it is counterproductive. The same limitation occurs with respect to company to company comparison. Neither balance sheets nor P+L information or ratios are comparable. Therefore there is need for disclosure of adjusted figures, a procedure that might raise suspicion (please refer also to the ESMA paper to Alternative Performance Measures which might be interpreted this way) in some jurisdictions and cultural environments. We have the impression that the IASB values higher the decision usefulness of the balance sheet than the decision usefulness of the comparability of P+L information. We experience the opposite in our day-to-day work with analysts and the recipients of financial information. We have never been questioned about the results of a purchase price allocation (except by enforcers who are eager to discuss this) but are frequently asked to explain the impacts of PPA-related expenses that have to be eliminated from the recipients calculation sheets and models. And this observation does not only apply for German investors but also for international ones. Ad 2(b): In most cases we endeavored so far, the decision was fairly clear. We only had problems in one or two cases. One common point of the problematic cases was that we acquired a group of assets and had to take over some of the vendor s employees and we were driven towards a treatment as business although we had the firm intention to replace the existing processes by our own ones that were substantially different. The question

4 Page 4 was if there was an integrated set of activities that was taken over or not. Sometimes it is hard to decide if such a set of activities is really taken over and recognized in the purchase price or not. 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. Ad 3(a): Please refer to our answer to question 2(a). The disclosures are exhaustive and enable all knowledgeable readers of financial statements to understand the relevant information. We can only underpin once more our observation that analysts seem not to be interested in the PPA results and rather focus on P+L information than on balance sheet information provided. We feel that the process is far too subjective to lead to useful information and that therefore the users of information tend to neglect the information rather than to question or use it. Ad 3(b): The most significant challenge is the application of the different types of asset valuation methods (multi-period excess earnings method, incremental cash flow method, relieve from royalty method) and the determination of the respective input parameters. The underlying problem is that the standards refer to a valuation model ( stand alone fair values defined as price paid in an arm s length transaction) that are hardly applicable in practice because it does not exist for most assets being too specific for having observable transaction or market prices. The isolation of the asset value as stand alone value in a transaction between knowledgeable and willing parties is very theoretical and little practicable. The consequence is that there are lot of presumptions and assumptions to be made and that those are hardly verifiable. The valuation itself is a good and profitable playground for highly specialized valuation experts who can argue all type of adjustments with regards to the overly complex valuations to be made. The preparer tends to lose control over the process. The enforcer and auditors have to set up their own policies what to accept and what not and the whole game becomes the fight of specialists where the preparer finally has no say any more. This is at least true in many cases not in all. We doubt if it needs such overly complex valuation concepts to achieve a sufficient degree of transparency about the value of assets acquired.

5 Page 5 Ad 3(c): The fair valuation of contingent considerations can be a real challenge because it often requires decisions about digital statuses: will one hurdle be exceeded or not? If yes, with which probability? This is definitely more complex than a business plan driven valuation where one can make suitable adjustments about uncertainty. The bad consequence: you are always wrong with your valuation since you never hit the final value and there is always a P+L impact. 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? Ad 4(a): We think that the separate valuation and recognition of intangible assets is useful for the period of acquisition. In subsequent periods, we consider it little helpful because it hinders transparency on the development of return and profit KPIs (please refer to Answer 2(a)). So we would prefer a PPA to be recognized rather as separate information in the notes than in the books. We would welcome if the excess purchase price (=purchase price minus carrying amount of equity acquired) and its allocation and therewith the intangible assets themselves would clearly be kept in separate line items of the balance sheet named as part of excess purchase price and the impact of subsequent measurement in separate line items of the P+L so that they can easily be extracted for analysis purposes of different kinds. Ad 4(b): The main problem is that the distinction between goodwill and intangible assets apart from goodwill is rather based on convention than on stringent logic. Both types of intangible assets deal with future economic benefits that are highly uncertain with a low degree of substantiation. So, major parts of goodwill consist of future assets (e.g. future customer relationships, IP etc.) or assets that cannot be controlled ( assembled workforce ). On the other hand also customer relationships being different from customer contracts are not controllable in the sense of really transferrable or protectable. So, we feel that the number and kind of intangible assets to be recognized apart from goodwill are artificial. We would in general increase the degree of evidence necessary for capitalization of intangible assets so that the rules for capitalization of internally generated intangible assets is more in line with the identification within a PPA. Furthermore, we would see no reason for more restrictive capitalization requirements in ongoing accounting than they apply in purchase accounting.

6 Page 6 Ad 4(c): We think that negative goodwill should not arise. But if it arose we would not recognize a gain through P+L but would head for offset with equity. 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? Ad 5(a): We do not consider this useful at all. It is again an overly complex exercise with only very limited informational content. We would be in favour of either making goodwill subject to regular amortization (leaving Purchase Price Allocations aside) that is charged against a separate OCI account and kept outside of P+L and therewith offsetting the excess purchase price against equity (either pro rata or at once). The main disadvantage of the impairment only approach is that the procedure is so much subject to judgment that it is hardly enforceable. The result is that impairment always comes too late and then fortifies the problems the company already has. Ad 5(b): The impairment test in the sense of an impairment only approach should be abolished not more and not less. We think that most additional information, especially more detailed information about the business plan underlying the test, is counterproductive in two ways: (1) it would inform competitors about the expectations in single markets and therefore negatively affect the constituent and (2) it would bias the market s expectation regarding business outlook. We think it should be under the responsibility of each individual to assess future prospects; to disclose a business plan does not foster this. Ad 5(c): The main issue is that most assumptions are so subjective that they cannot be meaningfully enforced without accounting rule setting by the enforcer or auditor. We would wish clear, easy rules well to apply and that can be enforced without any necessity of establishing a separate rule set in addition to the legitimate standard setter.

7 Page 7 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. Ad 6(a): After a purchase price allocation the value accounted for NCI is somewhere between the fair value of the NCI and fair value of net assets associated with the NCIs. This depends on the way the company exercised its choice with regards to full goodwill method or proportionate goodwill method. As to our understanding NCIs are not expected to represent claims ; if claims are intended to be accounted for it would be the correct way to account for them as liability which would come near to the interest theory/parent company theory and which has been abolished putting forth the entity theory. If one accepts that there is no necessity of fair value accounting because it over stresses the purpose of financial accounting and reporting, we would be in favour of accounting for NCIs at cost which would basically correspond with the basis of accounting for the remaining equity figures of the ultimate parent company. If in contrast one accepts fair value accounting as the best approximation of decision useful information, it might be considered imperative to value NCIs at fair value. In these cases we would nevertheless encourage to contemplate the fresh start method because this would enhance fair accounting furthermore and we would encourage contemplating to abolish cost accounting as such because there is nothing worse but a crude mixture of fair values and cost based accounting in one balance sheet. We think that sooner or later the IASB will have to choose either to pursue the full fair value approach or to remain with the cost basis. Actually, we have an incidental fair value approach but not a consequent one. The incidental fair value approach that we see now has the big disadvantage that companies showing incidents upon which a revaluation has to take place can hardly be compared with companies that have not shown such incidents. Furthermore, this approach leads to even stronger deterioration of comparable P+L information if the restriction for capitalization of intangible assets was kept in the course of on-going accounting (IAS 38). Therefore we would be in favour of a clear decision that comprises incidental accounting as well as on-going accounting. This would enhance inter- company comparability as well as inter-temporal comparability. Ad 6(b): Since we are in favour of cost accounting, we measure NCIs using the proportionate goodwill method. So they are measured at share in fair value of net assets acquired. This avoids the necessity to calculate fictitious goodwill amounts for NCIs which are not observable by transactions since no one has paid for them. We are hesitating taking such items on the balance sheet unless it is absolutely required.

8 Page 8 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. Ad 7(a): The actual rule set comes near to what we described earlier as incidental fair valuation, i.e. the first stake is revalued at fair value at the incident of getting control over an investee. This aims at the equal treatment of acquisition at once and step acquisition. The technical challenge in this context is then to determine the control premium incorporated in the transaction price in order to determine the NCI value. The basic question is why obtaining control is stipulated as incident for doing such revaluation. One could also do this upon all changes in ownership in an investee as such. A transaction price could also be observed in this context in many cases (if the transaction does not lead to control) the issue with a control premium would not apply. Not that we would favor such ruling but we do not understand the theoretical rationale behind. This would bring the balance sheet one step nearer to a fair value balance sheet without incurring much effort. Ad 7(b): As 7(a) but vice versa. 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? Ad 8(a): More relevant than the information provided would be an investee s normalized earnings and profit level based on the basic KPIs the investing company is measured against. This would meaningfully enhance the reporting about the value contribution expected from the investment.

9 Page 9 Ad 8(b): We would not consider it necessary to combine acquisitions individually immaterial since the meaningfulness of such combined information is very limited (IFRS 3.B65). We would consider it sufficient if only the important ones are required to be reported. We furthermore do not consider P+L data from the acquisition date onwards as well as pro forma data from the beginning of year useful because they are mostly distorted by extraordinary expenses. (IFRS 3.B64 (q)) Contingent Consideration accounting is also very burdensome and causes much work and has vast room for judgment. It would be better to adjust goodwill right away with the installments made. An estimated total purchase price could be disclosed but not be subject to hard book entries. (IFRS 3.B64 (g)) Transaction cost is normally immaterial compared with the total financials of a reporting entity. Therefore they should only be required if material. (IFRS 3.B64 (m)) Ad 8(c): Most burdensome is the Purchase Price Allocation, followed by the impairment only approach regarding goodwill. The rest is comparatively easy to handle. 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. Ad 9(a): Generally spoken, the more a standard leaves open for interpretation, the more difficult it is for the preparers, users, enforcers and auditors to cope with the standards. Furthermore, the more complex and judgmental the contents are, the more implicit interpretation there is with the consequences indicated above. IFRS 3 and IAS 36 are two standards which belong to the most difficult ones. The only way to improve this standard is to dramatically change the underlying concept. This change would be gratefully welcomed by preparers and users of financial reports. Ad 9(b): Some major findings:

10 Page 10 - Day 1 impairment risk on the basis of value in use concept where it is forbidden to take into account future synergies and restructuring work as well as of fair value less cost to sell concept since cost to sell would be a loss. - Application of DCF-based valuation techniques in the course of purchase price allocation which might lead to a dramatic overstatement of asset values. - The mere WACC / WARA-bridge in the course of purchase price allocation is a nightmare for appraisers and enforcers. - The concept of fair value is artificial in the light of a transaction which deals with businesses / entities. A business as such alters the quality of an asset and its valuation parameters which shows up in many valuation methods applied (e.g. relief from royalty method refers to the sales level of the target company although the asset would. Ad 9(c): It is easier to start standard setting from a clearly defined theoretical basis. Therefore, there must be a clear theory of decision usefulness. This can only exist if there is something like best practice decision making and a thorough analysis of the data necessary for this. Once this exists, it is doable to derive a consistent set of principles for providing such information taking into account all needs identified beforehand. Starting from this base and accompanied by empirical evidence, rule setting will leave the path of erratic investigation of wish lists (as actually done) and enter the stage of norm setting. Norms can only result from convictions. In a world that is driven by scientific evidence rather than believing, the creation of such evidence is key for all rules that proclaim credibility. And actually, we miss this crucial first step. 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)?

11 Page 11 Ad 10(a): The PPA and the necessity to disclose the composition of Goodwill enables users to get insights into the deal structure and the motivation of the deal and therefore enables user to mirror management s expectations against their own. Ad 10(b): We got acquainted to the cost (additional audit costs, PPA costs, additional internal administrative effort, etc.) in context with IFRS 3 so that they hardly occur unexpectedly. Ad 10(c): We try to avoid contingent considerations wherever possible. Those make the effects of an acquisition less predictable and increase the volatility of results.