Tel +44 (0)20 7694 8871 8 Salisbury Square mark.vaessen@kpmgifrg.com London EC4Y 8BB United Kingdom Mr Hans Hoogervorst International Accounting Standards Board 1 st Floor 30 Cannon Street London EC4M 6XH Our ref Contact MV/288 Mark Vaessen Dear Mr Hoogervorst Request for Information We appreciate the opportunity to comment on the Request for Information Post-implementation Review: IFRS 3 Business Combinations (RFI). We have consulted with, and this letter represents the views of, the KPMG network. In responding to this RFI, for each issue that we highlight we have provided what we believe is sufficient information for the Board to assess its next steps: retain IFRS 3 as issued; continue to monitor the implementation of IFRS 3; or revise IFRS 3. We have not sought to provide specific solutions to individual issues in all cases, which will emerge as part of any subsequent projects. In compiling this response, we have sought to highlight practical issues that we believe can be actioned by the Board in the short to medium term through targeted projects. We also encourage the Board to seek out practical solutions that provide relevant and useful information, but which also increase consistency in the application of the standards and lower the cost of preparing financial information. This covering letter discusses the four major areas that we believe require further consideration by the Board. Our points are discussed more in-depth in the Appendix, in which we answer the specific questions asked in the RFI. In addition, we welcome the IASB s openness to identifying learning points about its standardsetting process. We think that the processes in question should be viewed not only as the Board s formal due process, but also the internal processes that turn the Board s decisions into finished standards. We believe that it would be of great benefit to the Board and its stakeholders if the Board carried out a critical analysis of the following: the underlying reasons why new standards can be found to require a series of fixes, and the process of achieving buy-in from stakeholders for new standards before they are issued., a UK company limited by guarantee, is a member of KPMG International Cooperative, a Swiss entity. Registered in England No 5253019 Registered office: 8 Salisbury Square, London, EC4Y 8BB
Regarding fixes to new standards, in the case of IFRS 3 (2008) these have included the annual improvements in 2010 and 2013. In addition, similar issues noted in this comment letter remain to be dealt with, e.g. related to NCI. Turning to the external due process, we see signs that it is not always achieving buy-in from stakeholders. We understand that transparency and the presentation of relevant information is a key driver of the standard-setting process, balanced against cost and operability. Sometimes it becomes apparent that users do not desire the level of transparency that is achieved in the final standard. In other cases, users desire the information but the issue is whether the benefits really did outweigh the costs. An example in the case of IFRS 3 of both situations is the granular recognition of intangible assets. There are also cases where important implications, and the reasons for them, are not apparent to preparers during the consultation process and come as something of a surprise on adoption of the standard. The remuneration-vs-consideration test in IFRS 3.B55(a) is an example. We readily appreciate the challenge of drafting a long and complex standard with multiple layers of guidance the standard itself, application guidance, illustrative examples, the basis for conclusions, and in some cases educational material (IFRS 3 runs to 650+ paragraphs). We also acknowledge the efforts that the Board has been making to improve its due process, such as the greatly increased outreach activities. However, we trust that the Board would agree that the above issues around the quality of drafting and cost-benefit balance are of concern, and that it would be of great benefit to the Board and its stakeholders if further steps were taken to identify and address the underlying root causes. We do not claim to have a ready-made solution to put forward, but we believe that areas to be revisited include the nature of outreach activities, with whom they are conducted and at what stage(s) of the standard-setting process, the advantages and disadvantages of having multiple layers of guidance, brevity and clarity in drafting, as well as drafting, review and editorial protocols within the IASB. The definition of a business We see a conceptual difference between the acquisition of a business and the acquisition of a group of assets. A business should be able to create further value in addition to the sum of the values of the individual elements acquired. For that reason, the acquirer is expected to pay a premium over these set of assets and activities acquired. Therefore, we believe that only an acquisition of a business should be capable of triggering the recognition of goodwill. However, the current definition of a business in IFRS 3 does not draw a clear dividing line between what is a business and what is an asset or group of assets. For some sectors, such as real estate and energy and natural resources, the current requirements are particularly challenging and application of the standard requires a significant degree of judgement. In addition, we do not expect the recent amendment to IAS 40 Investment Property (Annual MV/288 2
Improvements to IFRSs 2011 2013 Cycle) in respect of the acquisition of property as a business or as investment property to make the task easier. Issues arise in practice because the application guidance in Appendix B of the standard uses terminology different from the definition in Appendix A; it introduces the idea that a business does not need to contain all its elements, such as to create a second definition that is sometimes vague and appears all-embracing. The impact is that Appendix B appears to imply that a business could merely be an asset, leaving several questions open. As a result, the standard does not provide a consistent basis on which to decide if a business has been acquired. In our response to Question 2(b) of the RFI (see Appendix) we provide examples of questions that often arise in applying the current guidance under IFRS 3, mainly relating to processes. In our experience, the practical outcome of these issues is that in many cases too much time is spent in this area relative to the benefits, there is diversity in practice, and there is significant risk of an entity s judgement being second-guessed, for example by a regulator. The recognition of intangible assets and the subsequent accounting for goodwill and indefinite-lived intangible assets We believe that the threshold for the separate recognition of intangible assets in a business combination should be moved. It is not clear that the current approach has broad support amongst users, and it is well known that companies, in many cases supported by users, back out the amortisation of intangible assets via non-gaap measurements. In part this may be because some of the intangible assets seem like a sub-classification of the goodwill e.g. some customer-related intangible assets and we endorse that concern. We are also aware that at least some investors do not want brands separately recognised as they view them, unlike, for example, wireless spectrums or patents, as continually replaced assets. In addition, this is one of the areas in applying IFRS 3 that requires significant time and resources on both identification and measurement. For example, the lack of any thresholds in terms of control or measurement reliability means that the search for intangible assets to recognise separately is at a very granular level, as well as their measurement being highly judgemental. Taken together, these points imply that a substantial amount of time and resources is spent on an area that does not appear to be worthwhile. We believe that a revised threshold should be determined based on a consensus of preparers and users, forged by the IASB s formal outreach. This is a difficult accounting matter e.g. what is or is not a recognition criterion for intangible assets has long been controversial for which we believe a practical solution is appropriate. MV/288 3
We also believe that the subsequent accounting for goodwill and indefinite-lived intangible assets should be reconsidered. A recent KPMG report 1 based on stakeholder interviews, which was focused on goodwill impairment testing under IFRS, highlighted the high number of judgements and assumptions that make the goodwill impairment testing a complex and timeconsuming exercise. It is not clear that the benefits of mandatory annual impairment testing outweigh the related costs. Our report indicates that the value relevance of impairment testing is in confirming rather than predicting value, and that goodwill impairment charges do not act as a major signalling event for the market. These appear to be strong arguments for simplifying the accounting model; and although some argue that impairment testing ensures management accountability for investments made, this could still be achieved in a simplified model of evaluating the return against the cost over a reasonable period of time. Overall, our report indicated considerable support for a return to an amortisation-based model of accounting for goodwill. With regards to accountability, it is also not clear whether this is achieved by the current model. This is because the integration of the business acquired in effect co-mingles the acquired goodwill with the unrecognised internally generated goodwill from the existing business. Therefore, the current impairment testing model does not completely work as signalling recoverability of the business actually acquired. We support an amortisation-based accounting model with indicator-based impairment testing. We also support investigation into ways in which the impairment testing model could be simplified. A key benefit of an amortisation-based model of accounting for goodwill (and indefinite-life intangible assets) is that it would reduce pressure on the identification of intangible assets (because both goodwill and intangible assets would be amortised), with the amortisation charge at least facilitating some form of accountability over a payback period. While we understand that many analysts would reverse the amortisation charge in assessing an entity s earnings, such an adjustment is easy to make and therefore does not outweigh the benefits of an amortisation charge. Disclosure requirements We support the Board s current initiative to revisit and rethink disclosure requirements under IFRS. We believe that the requirements under IFRS 3 should also be revisited as part of this broader project. We understand that in general a business combination is a complex and relevant transaction that requires specific disclosures. However, the current requirements are too detailed, which creates a risk of useful information being obscured. Rather than suggesting tweaks to the current requirements, we believe that the Board should start with a clean slate and build a vision of the 1 Who cares about goodwill impairment? A collection of stakeholder views, April 2014 MV/288 4
type of information that should be disclosed based on an understanding of the purpose that the disclosure is designed to serve. We outline one potential vision in our response to Question 8 (see Appendix), which has the following components: aggregation of what was acquired; information required when a number in the statement of financial position is not enough to understand the transaction; assumptions and judgements in subjective areas; and information to provide transparency of the adjustments made by management as a part of the acquisition accounting. Common control transactions We continue to support the Board undertaking a specific project on common control transactions. This is a continuous area of challenge, the current practice is diverse and we are aware of different interpretations by accounting standard setters and regulators from different jurisdictions. Please contact Mark Vaessen or Mike Metcalf at +44 (0)20 7694 8871 if you wish to discuss any of the issues raised in this letter. Yours sincerely MV/288 5
Appendix: Questions in the RFI Question 1 Your background and experience KPMG is a global network of professional firms providing audit, tax and advisory services. We have extensive experience in the interpretation and application of IFRS 3 (2004 and 2008) in our roles as auditors and advisors. Question 2 Definition of a business (a) Are there benefits of having separate accounting treatments for business combinations and asset acquisitions? If so, what are these benefits? Yes, we believe that there are benefits to having separate accounting treatments for business combinations and asset acquisitions. We see a conceptual difference between the acquisition of a business and the acquisition of a group of assets. A business should be able to create further value in addition to the sum of the values of the individual elements acquired. For that reason, the acquirer is expected to pay a premium over these set of assets and activities acquired. Therefore, we believe that only an acquisition of a business should be capable of triggering the recognition of goodwill. In addition, it is not clear how the accounting for asset acquisitions in IFRS 3.2(b) interacts with other standards. This is because allocating the purchase price based on relative fair values is inconsistent with the requirements in, for example, IAS 39 Financial Instruments: Recognition and Measurement and IAS 12 Income Taxes; in such cases, is a day 2 remeasurement required? (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? The current definition of a business in IFRS 3 does not draw a clear dividing line between what is a business and what is an asset or group of assets. For some sectors, such as real estate and energy and natural resources, the current requirements are particularly challenging and application of the standard requires a significant degree of judgement. In addition, we do not expect the recent amendment to IAS 40 Investment Property (Annual Improvements to IFRSs 2011 2013 Cycle) in respect of the acquisition of property as a business or as investment property to make the task easier. Issues arise in practice because the application guidance in Appendix B of the standard uses terminology different from the definition in Appendix A; it introduces the idea that a business does not need to contain all its elements, such as to create a second definition that is sometimes vague and appears all-embracing. The definition is based on the presence of three elements MV/288 6
inputs, processes and outputs but Appendix B further indicates that it can still be a business even if it does not contain some (or all) of them provided that the entity can source the missing elements itself or in the market (which is almost always the case). The impact is that Appendix B appears to imply that a business could merely be an asset, leaving several questions open. As a result, the standard does not provide a consistent basis on which to decide if a business has been acquired. The following are examples of questions that often arise in applying the current guidance under IFRS 3, mainly around processes. What is the required level of sophistication of the processes acquired in order to trigger the definition of a business? How is IFRS 3.B8 applied when most of the processes and inputs are missing because the acquirer has other inputs and processes already in place so as to be able to conduct and manage the acquired set? Can IFRS 3.B8 be read as implying that a business has been acquired even if the acquired set has no processes? To what extent does the retention of staff imply that processes are acquired? What if those staff will apply the acquirer s operating protocols? How should the requirements be interpreted when the acquired set has no employees and all processes are outsourced to a third party? How should the requirements be interpreted when a project in development stage is acquired? In our experience, the practical outcome of these issues is that in many cases too much time is spent in this area relative to the benefits, there is diversity in practice, and there is significant risk of an entity s judgement being second-guessed, for example, by a regulator. Question 3 Fair value (a) 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? We believe that the fair value measurement principles under IFRS generally provide relevant information for users. However, we see deficiencies in two areas: the cost vs benefit of recognising and valuing certain intangible assets (see valuation challenges below); and a disconnect between the day 1 vs day 2 measurement of provisions. MV/288 7
Provisions measured at fair value in the acquisition accounting are subsequently remeasured in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets. Since IAS 37 is based on a best-estimate model, this implies that a provision assumed in a business combination will be remeasured on day 2 with the change in carrying amount recognised in profit or loss. In our experience, the primary example of this disconnect is in the accounting for decommissioning liabilities, which are often material. We recommend introducing a further measurement exception into IFRS 3 so that provisions in the scope of IAS 37 are measured under that standard in the acquisition accounting. (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? In our experience, fair value measurement in a business combination is a complex and costly exercise, which generally requires the involvement of valuation specialists. This is inherent in the fact that fair value is a complex area in general and a business combination involves the recognition of many assets and liabilities for which market prices are not available, together with other fair value measurements e.g. for contingent consideration arrangements that are often used to bridge valuation differences between buyers and sellers who cannot agree a cash equivalent price. However, in our experience the valuation of intangible assets is particularly challenging and requires significant time, especially when there are multiple intangible assets with potentially overlapping benefits e.g. a revenue stream generated from overlapping customer, brand and/or technology assets. The challenges range from identifying the most appropriate valuation methodology to making appropriate assumptions. For example, intangible assets are generally only acquired as part of business combinations so acquirers often do not use and are not familiar with the methods used to value individual intangible assets. In particular, acquirers often focus their commercial quantitative analysis of acquisitions on the overall business i.e. when evaluating a transaction commercially, they do not generally seek separately to value the identifiable intangible assets. Moreover, because such assets tend to be relatively unique and rarely traded except as part of acquisitions of overall businesses, market prices do not exist against which the reasonableness of value estimates or assumptions can be assessed. Against these valuation difficulties, it is not always clear whether the benefits of the identification and recognition of certain intangible assets outweigh the related costs (see our response to Question 4). Regarding the general point of fair value measurement being a complex area, we support the recent agreement of the IFRS Foundation and the International Valuation Standards Council on MV/288 8
a joint statement of protocols for co-operation. We believe that practical application guidance on fair value measurement would reduce diversity in practice and may also reduce the cost of acquisition accounting. Question 4 Separate recognition of intangible assets from goodwill and the accounting for negative goodwill (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? We find some, but not all, of the separate recognition of intangible assets useful. We believe that the threshold for the separate recognition of intangible assets in a business combination should be moved. It is not clear that the current approach has broad support amongst users, and it is well known that companies, in many cases supported by users, back out the amortisation of many intangible assets via non-gaap measurements. In part this may be because some of the intangible assets seem like a sub-classification of the goodwill e.g. some customer-related intangible assets and we endorse that concern. We are also aware that at least some investors do not want brands separately recognised as they view them, unlike, for example, wireless spectrums or patents, as continually replaced assets; the alternative argument is that a brand may be a driver of the combination, so transparency supports its recognition. In addition, this is one of the areas in applying IFRS 3 that requires significant time and resources on both identification and measurement. For example, the lack of any thresholds in terms of control or measurement reliability means that the search for intangible assets to recognise separately is at a very granular level, as well as their measurement being highly judgemental. Taken together, these points imply that a substantial amount of time and resources is spent on an area that does not appear to be worthwhile. We believe that a revised threshold should be determined based on a consensus of preparers and users, forged by the IASB s formal outreach. This is a difficult accounting matter e.g. what is or is not a recognition criterion for intangible assets has long been controversial for which we believe a practical solution is appropriate. (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? The main implementation challenges in the separate recognition of intangible assets relate to the time spent in identifying such assets at such a granular level (see usefulness above), and the difficulty in measuring fair value (see our response to Question 3). Taking these two issues together with the preparers not seeing the benefit of recognising these intangible assets, in many MV/288 9
cases supported by investors, it is not uncommon to experience significant resistance to the identification, measurement and recognition of certain intangible assets, which creates challenges for auditors and regulators. We also believe that an alternative approach for the subsequent accounting for goodwill would remove some of the pressure from this area (see our response to Question 5). (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 recognition of negative goodwill in profit or loss is a better approach than the previous one that required a credit balance in the statement of financial position. It is also consistent with the overall principle of measuring and recognising assets acquired and liabilities assumed at fair value. Question 5 Non-amortisation of goodwill and indefinite-life intangible assets (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? We believe that the subsequent accounting for goodwill and indefinite-lived intangible assets should be reconsidered. A recent KPMG report 1 based on stakeholder interviews, which was focused on goodwill impairment testing under IFRS, highlighted the high number of judgements and assumptions that make the goodwill impairment testing a complex and time-consuming exercise. It is not clear that the benefits of mandatory annual impairment testing outweigh the related costs. Our report indicates that the value relevance of impairment testing is in confirming rather than predicting value, and that goodwill impairment charges do not act as a major signalling event for the market. These appear to be strong arguments for simplifying the accounting model; and although some argue that impairment testing ensures management accountability for investments made, this could still be achieved in a simplified model of evaluating the return against the cost over a reasonable period of time. Overall, our report indicated considerable support for a return to an amortisation-based model of accounting for goodwill. With regards to accountability, it is also not clear whether this is achieved by the current model. This is because the integration of the business acquired in effect co-mingles the acquired goodwill with the unrecognised internally generated goodwill from the existing business. Therefore, the current impairment testing model does not completely work as signalling recoverability of the business actually acquired. MV/288 10
We support an amortisation-based accounting model with indicator-based impairment testing. We also support investigation into ways in which the impairment testing model could be simplified. A key benefit of an amortisation-based model of accounting for goodwill (and indefinite-life intangible assets) is that it would reduce pressure on the identification of intangible assets (because both goodwill and intangible assets would be amortised), with the amortisation charge at least facilitating some form of accountability over a payback period. Whilst we understand that many analysts would reverse the amortisation charge in assessing an entity s earnings, such an adjustment is easy to make and therefore does not outweigh the benefits of an amortisation charge. (c) What are the main implementation, auditing or enforcement challenges in testing goodwill or intangible assets with indefinite useful lives for impairment, and why? There are two separate areas of concern related to impairment testing: the degree of judgements and assumptions, and interpreting the requirements of the standard. In our experience, the degree of judgements and assumptions makes impairment testing on an annual basis an extremely time-consuming exercise. Over a third of companies who were interviewed as part of KPMG s goodwill report 1 indicated that they spend a significant amount of time on this area relative to other areas of external financial reporting, and regulators also indicated that they spend considerable time reviewing impairment disclosures. On the issue of interpretation, there are many areas of IAS 36 Impairment of Assets that give rise to difficult interpretive questions 2, but we believe that the key concern is around cashgenerating units from identifying cash-generating units and allocating goodwill following a business combination, through to reallocating goodwill following a restructuring or disposal. For example, in accordance with IAS 36.80, goodwill is allocated to the lowest level in the entity at which goodwill is monitored internally by management, but not larger than an operating segment pre-aggregation. While this allocation ceiling provides an anti-abuse mechanism in identifying impairment losses (IAS 36.BC146), it also means that preparers may need to prepare additional reporting systems simply for the purpose of goodwill impairment testing. However, as noted above, it is not clear that the benefits of mandatory annual impairment testing outweigh these costs, and we support simplifying goodwill impairment testing. Question 6 Non-controlling interests (a) How useful is the information resulting from the presentation and measurement requirements for NCI? 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? 2 These include, but are not limited to, the treatment of income taxes in estimating value in use, and the interaction of goodwill impairment testing with the accounting for non-controlling interests. MV/288 11
(b) What are the main challenges in the accounting for NCI, or auditing or enforcing such accounting? Please specify the measurement option under which those challenges arise. We believe that the information resulting from the presentation and measurement of NCI is useful, but could be enhanced (see below). In our experience, most entities choose the proportionate interest approach to measurement and apply this approach on a consistent basis. Therefore, we support maintaining the accounting policy choice for the measurement of NCI on initial recognition. However, we believe that the current standards lack a clear, comprehensive framework in terms of what NCI is supposed to represent. This lack of a framework, combined with the accounting policy choice on initial recognition, creates challenges in accounting for certain subsequent transactions, which has led to diversity in practice. Prior to 2008, the definition of minority interests was based on the minority s share of net assets of the group; this was an easy concept to understand and apply, because the statement of financial position number could always be proved. However, the current requirement based on equity not attributable to the parent is more difficult what does that mean in practical terms? Questions arise because the accounting for subsequent transactions may result in the balance of NCI being just an accumulation of the results of several transactions, but not a meaningful balance with an intrinsic relevance. The following are examples (not exhaustive): In a subsequent sale of interests to NCI while retaining control, IFRS 10.23 and B96 require the NCI to be adjusted. However, it is not clear how this adjustment should be made, especially when an entity elected to measure NCI using the proportionate interest approach. A straightforward approach is to base the change on subsidiary equity (net assets?) but this means that the re-allocation deduction includes an element of goodwill whereas the initial measurement did not. In an extreme case, this can lead to a negative balance of NCI. An alternative approach is to base the change on a proportion of the reported NCI balance, with or without an analysis of whether the underlying transactions that gave rise to the NCI includes an element of goodwill. Under IFRS 3.19, the proportionate basis of NCI measurement is limited to those that represent present ownership interests and entitle the holder to a share of net assets in the event of liquidation ( ordinary NCI). It is not clear whether this should be interpreted as only a test for limiting the application of the proportionate approach, or whether it is also an instruction as to how to apply the proportionate approach i.e. that it is the liquidation proportion. MV/288 12
This issue is particularly relevant when there is also other NCI measured at fair value. In arriving at the net assets to multiply by the ordinary NCI percentage, is other NCI deducted at its fair value or at its liquidation amount? The latter can result in the parent s and the two NCI interests amounting to more than the total net assets of the subsidiary. A parent may make a non-reciprocal (capital) contribution to a subsidiary that does not result in a change in the relative ownership percentages. We understand that IFRS 10 requires a change in the NCI balance as a result of such a change in overall equity. This is, however, subject to occasional question because the NCI did not put in any equity at this point: it is queried why its equity interest (which also remains at its previous percentage) should change in accounting terms. In addition, we wish to see the Board complete its project on the accounting for put options written on NCI, as this continues to be a challenging area of diverse application in practice. Question 7 Step acquisitions and loss of control (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. We are not sure that the information resulting from the step acquisition guidance in IFRS 3 is useful, because it is counter-intuitive. The requirement to remeasure previously held interests results in the recognition of gain or loss for an interest that was not actually sold. However, we believe that the current remeasurement approach is straightforward and therefore we believe that there is benefit to retaining it. It is an improvement over the previous approach under IFRS 3 (2004), which resulted in a complex and not always meaningful result (albeit a third approach might be possible). (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. Similarly as for a step acquisition, the remeasurement of the retained interests and the recognition of a gain or loss is counter-intuitive the gain or loss arises from something that is retained and not only from the part actually sold. However, we do not believe that this information entirely lacks relevance (e.g. consistency on all occasions of onset of equity accounting) and therefore we believe that there is some benefit in retaining the current requirements. Question 8 Disclosures (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? MV/288 13
(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? We support the Board s current initiative to revisit and rethink disclosure requirements under IFRS. We believe that the requirements under IFRS 3 should also be revisited as part of this broader project. We understand that in general a business combination is a complex and relevant transaction that requires specific disclosures. However, the current requirements are too numerous and unfocused, which creates a risk of useful information being obscured. Rather than suggesting tweaks to the current requirements, we believe that the Board should start with a clean slate and build a vision of the type of information that should be disclosed based on an understanding of the purpose that the disclosure is designed to serve. As an alternative vision, we have identified four main areas of disclosure. Disaggregation/aggregation. Sometimes items need to be broken down or put together in order to communicate an entity s position or transactions. For a material business combination, the effects of which are spread throughout the financial statements, the latter is necessary i.e. bringing together in one place a statement of what various asset and liabilities have been acquired and the various elements of the consideration transferred a table showing an acquisition statement of financial position etc. Information required when a number in the statement of financial position is not enough to convey qualitative matters. For example, the terms of the contingent consideration with the purpose of explaining to users the risks associated with the consideration agreed to be transferred and identifying possible future outflows. Assumptions and judgements in subjective areas. For example, related to the recognition of intangible assets and fair value measurements. Information to provide transparency of the adjustments made by management as a part of the acquisition accounting. For example, the fair value adjustments compared to the book values of the assets acquired and liabilities assumed. As a part of this exercise, an assessment should be made of the cost of preparing the disclosures compared to the purpose that they achieve. For example, while the current detailed requirements for business combinations that occurred after the reporting date achieve a useful purpose, in terms of communicating some relevant context to the year-end results and position, is that commensurate with the cost? Another example is the preparation of pro forma information, which may require a costly exercise involving the use of many assumptions e.g. what the fair MV/288 14
value of the assets acquired and liabilities assumed would have been at the start of the year and it is not clear what the disclosure is trying to achieve. Similarly, we believe that the disclosures related to the impairment testing of goodwill (and indefinite-lived intangible assets) should be revisited from a clean slate. In that case, a key hurdle will be to distinguish between users needs related to understanding the subjectivity of the results of impairment testing, and the general desire amongst some users to have as much value-based information as possible to use as inputs in their own valuation models. A fresh start and new vision for disclosure would ask whether the latter is something that financial statements should aim at. This issue was noted in KPMG s goodwill report 1. Question 9 Other matters 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. Common control transactions As noted in our covering letter, we continue to support the Board undertaking a specific project on common control transactions. This is a continuous area of challenge, the current practice is diverse and we are aware of different interpretations by accounting standard setters and regulators from different jurisdictions. Measurement period adjustments Adjusting comparative information On the assumption that provisional fair values were established on a reasonable basis, we believe that measurement period adjustments should be recognised in the current period as changes in accounting estimates. This is because they are not prior period errors under IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. Our concern is that the requirement to adjust comparative information diminishes the distinction between changes in estimates and true errors, and dilutes the alerting effect to the public of restatements for corrections of errors. Ability to adjust observable market data A degree of tension exists between the general requirement in IFRS 3 to measure amounts recognised in the acquisition accounting at fair value and the requirement to amend acquisition accounting retrospectively for measurement period adjustments. MV/288 15
In our view, additional information that becomes available during the measurement period that, had it been known, might have affected observable market data on which the measurement of an item included in the acquisition accounting is based should not give rise to a measurement period adjustment. This is because such information does not affect the basis of estimation of the fair value of an asset or liability at the acquisition date i.e. the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Identifying an acquirer Reverse acquisitions IFRS 3.7 requires IFRS 10 to be used to identify the acquirer in a business combination, with the further guidance in B14 B18 being considered when IFRS 10 does not clearly identify the acquirer. The practical issue is that in many reverse acquisitions, IFRS 10 would indicate that the legal acquirer is the parent entity, which defeats the purpose of identifying, in a reverse acquisition, the legal acquiree as the acquirer. In our view, IFRS 10 should not be the sole focus of identifying an acquirer even if it appears that the acquirer can be identified; the additional guidance in IFRS 3 should also be taken into account. Otherwise there is a risk that the analysis of which party is the acquirer may lead to an answer that conflicts with what we believe is the intention of IFRS 3. For example, only applying the IFRS 10 guidance on control would mean that a reverse acquisition could not arise, because the investor that controls all of the voting rights of an investee will always be assessed to have power if the investee is controlled by means of voting rights. Relative sizes In order to assess who is the acquirer in certain circumstances, one of the indicators in IFRS 3.B16 is the fact the acquirer is usually the entity whose relative size is significantly greater than that of the other combining entity or entities. B16 indicates that size may be compared with reference, for example, to assets, revenues or profit, but is not clear which measurement basis should be used for this comparison e.g. carrying amount or fair value. We believe that relative sizes should be based on the fair value of the entities, instead of revenues or assets. This is because the fair value would capture other elements of the size of an entity, e.g. the level of liabilities. (b) learning about practical implementation matters, whether from the perspective of applying, auditing or enforcing the Standard and related amendments; and (c) any learning points for its standard-setting process. MV/288 16
We welcome the IASB s openness to identifying learning points about its standard-setting process. We think that the processes in question should be viewed not only as the Board s formal due process, but also the internal processes that turn the Board s decisions into finished standards. We believe that it would be of great benefit to the Board and its stakeholders if the Board carried out a critical analysis of the following: the underlying reasons why new standards can be found to require a series of fixes, and the process of achieving buy-in from stakeholders for new standards before they are issued. Regarding fixes to new standards, in the case of IFRS 3 (2008) these have included the annual improvements in 2010 and 2013. In addition, similar issues noted in this comment letter remain to be dealt with, e.g. related to NCI. Turning to the external due process, we see signs that it is not always achieving buy-in from stakeholders. We understand that transparency and the presentation of relevant information is a key driver of the standard-setting process, balanced against cost and operability. Sometimes it becomes apparent that users do not desire the level of transparency that is achieved in the final standard. In other cases, users desire the information but the issue is whether the benefits really did outweigh the costs. An example in the case of IFRS 3 of both situations is the granular recognition of intangible assets. There are also cases where important implications, and the reasons for them, are not apparent to preparers during the consultation process and come as something of a surprise on adoption of the standard. The remuneration-vs-consideration test in IFRS 3.B55(a) is an example. We readily appreciate the challenge of drafting a long and complex standard, with multiple layers of guidance the standard itself, application guidance, illustrative examples, the basis for conclusions, and in some cases educational material (IFRS 3 runs to 650+ paragraphs). We also acknowledge the efforts that the Board has been making to improve its due process, such as the greatly increased outreach activities. However, we trust that the Board would agree that the above issues around the quality of drafting and cost-benefit balance are of concern, and that it would be of great benefit to the Board and its stakeholders if further steps were taken to identify and address the underlying root causes. We do not claim to have a ready-made solution to put forward, but we believe that areas to be revisited include the nature of outreach activities, with whom they are conducted and at what stage(s) of the standard-setting process, the advantages and disadvantages of having multiple layers of guidance, brevity and clarity in drafting, as well as drafting, review and editorial protocols within the IASB. Question 10 Effects 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; MV/288 17
(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? We have no additional comments in response to this question, save to observe that we believe that accounting standards do not aim at providing benefits for auditors (or enforcers). They provide benefits for users and preparers, through facilitating the stewardship relationship between shareholders and companies. MV/288 18