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Comments from ACCA
April 2003

The Association of Chartered Certified Accountants (ACCA) is pleased to have this opportunity to comment on the above exposure draft which has been considered by ACCA�s Financial Reporting Committee.

Question 1 - Scope

We agree that the proposed scope exclusions for entities under common control and for joint ventures are appropriate, because the ED is promoting an acquisition accounting only model which would not be appropriate for such cases. These topics are, however, potentially significant and should be addressed. We understand the accounting for business combinations of entities under common control will be dealt with in Phase II of the project. It is therefore difficult for us to consider this ED as adequate when important aspects of business combinations remain to be dealt with. We hope that the two phases of this project will eventually be merged together to form a single standard.

The definition of joint control in IAS28 and IAS31 should be left as it is for now. The proposal in ED3 could represent a significant change and seems to imply a rather narrower definition of joint control than at present. The risk is that certain entities or arrangements that are in substance joint ventures could avoid inclusion within the ambit of those standards.

Question 2 - Method of accounting for business combinations

We agree that the pooling method of accounting should be discontinued, even for the limited circumstances where it could be currently applied.

The case for applying acquisition accounting where no acquirer can be identified is less persuasive. In most business combinations it will be evident which is the acquiring company. In some, however, it will not be clear-cut. Paragraph 20 of the ED lists some examples of indicators. It seems quite possible that these indicators could point (in rare cases) at neither of the combining parties. More commonly perhaps, they could point in more than one direction. For example, Company A�s fair value is greater than B�s and the shareholders of A will predominate, while at the same time the management of B might be the dominant force in the new business. The ED gives no guidance on how to judge the various factors and indicators in paragraph 20, nor what other sorts of factors might be relevant. The impression given is that in some cases the choice of which to nominate as the acquirer might be arbitrary. This does not seem a satisfactory outcome for an accounting standard, especially when the choice could have a material effect on the post-combination accounts.

For cases where no acquirer could be identified satisfactorily we consider that fresh start accounting would be the best solution. The standard should set out a series of key indicators to identify the acquiring party. If these are reasonably conclusive, then the purchase accounting method should be followed. If the indicators are inconclusive (that is they do not identify either party or might identify either one), then the fresh start method should be used. We note that fresh start accounting may be included in Phase II of the business combinations project. As with the matters raised in Question 1 above, we find it unsatisfactory to comment definitively on what is only a partial standard.

If fresh start accounting is not going to be available, then we would prefer to see that there was an objective test for determining the acquirer in these cases of difficulty - for example whichever entity had the higher market capitalisation before the combination.

Question 3 � Reverse acquisitions

We support the idea of accounting for reverse acquisitions, based on the substance of the transaction. We believe, however, that the proposed description of the circumstances in which a business combination should be accounted for as a reverse acquisition, should be amended. Paragraph 21 would identify as the acquirer whichever of the combining entities obtains control over the other. In a typical reverse acquisition, however, the legal subsidiary will not obtain control over the legal parent. The shareholders of the legal subsidiary may obtain control, but not the subsidiary itself.

The Board should consider whether IAS27 adequately deals with reverse acquisitions. In these cases the parent company for the purposes of IAS27 would be the acquired entity as far as ED3 is concerned and vice versa. We are not clear that all the consolidation procedures in paragraph 15 of IAS27 will work properly.

We regard the proposed additional guidance together with the illustrative examples as likely to be helpful.

Question 4 � Identifying the acquirer when a new entity is formed to effect a business combination

We agree with the general principle that the acquirer should be identified on the basis of the evidence of the substance of the transaction. As noted in answer to Question 2, we support fresh start accounting in cases where it is difficult to identify the acquirer. Failing that, there should be an objective test to avoid the choice of acquirer being entirely arbitrary in these cases.

Question 5 � Provisions for terminating or reducing the activities of the acquiree

We agree with the IASB proposal. The conditions for recognising provisions on a business combination should be consistent with those in IAS 37. There must be an obligation in the acquired company at the date of acquisition.

Question 6 � Contingent liabilities

We consider that the recognition of contingent assets and liabilities on a business combination should remain consistent with their recognition under IAS 37, and so we do not support the proposal.

There does, however, seem a case for IASB reconsidering IAS37 in these areas. It does not seem right that the probabilities of future transfers of economic benefits should affect the initial recognition tests of liabilities; they should affect their measurement only. A number of anomalies arise under the current system as a consequence. For example, if there was a single claim for a $1 million with a 40% probability then no liability at all would be recognised. If, however, there was a series of claims adding up to the same sum and with the same overall probability, a provision of $400,000 would be recognised. If in the case of the single claim the probability was 60%, then $600,000 would be included as a liability because an outflow would now be more likely than not.

Equally we find illogical that the recognition criteria for a contingent assets includes virtual certainty of inflow of benefits, even though IAS39 when dealing with financial assets sets no such threshold and probabilities affect their measurement only.

Question 7 � Measuring the identifiable assets acquired and liabilities and contingent liabilities assumed

We agree with the proposal to value any minority interest at their proportion of the net fair values ascribed on acquisition, and to eliminate the alternative currently allowed in IAS22 (i.e. to use pre-acquisition carrying values).

Question 8 � Goodwill

We agree that goodwill acquired in a business combination should be treated as an asset. We are not convinced that the ED is right to prohibit amortisation and allow impairments to be the only way in which the value of goodwill is diminished.

We note that there are a number of arguments in favour of amortisation on the one hand and a number in favour of an impairment-only regime on the other. These are set out in paragraphs BC106 and 107 in the Basis for Conclusions and in the dissenting opinions of two IASB members.

The critical argument put forward in the ED concerns the relevance and usefulness of the information provided. The usefulness of goodwill write down information may be limited whichever option is chosen. This is because of

the inherent difficulties in identifying acquired entities some years later, after they have been restructured and reorganised the impairment tests being subjective and so capable of producing a wide range of answers amortisation periods being arbitrary and the annual charge consequently being selected from a wide range of possible values.

While we agree that the information provided by an impairment regime might be more relevant than that from an amortisation charge, the majority of cases of significant impairments will be recognised because the alternative regime is not just one of amortisation, but also of impairment (when there are indications that impairment may have taken place). We conclude, therefore, that on the relevance of information there is little to choose between the two methods, with the impairment only approach having a slight advantage.

Turning to other criteria than relevance, we find a similar position, but with the advantage reversed in favour of amortisation.

Comparability between entities is not likely to be accomplished very satisfactorily by either method (i) because of the measurement difficulties noted above and (ii) because impairment only creates new anomalies on the recognition of internally generated intangibles between entities growing organically and those growing by acquisition.

If the informational benefits of an impairment only regime are marginal at best, the costs of compliance are certainly higher where there has to be an annual impairment test for all goodwill.

Conceptually, amortised cost is a measurement basis more consistent with other long life non-monetary assets than impaired cost. Impairment tests are almost inevitably not going to discriminate between the loss in value of the purchased goodwill and the replacement by internally generated goodwill.

Our preference is therefore that a choice should remain for now between the two approaches. We normally favour the elimination of alternative treatments in accounting standards on the grounds of greater comparability. In this case, however, we are not sure that comparability is going to be improved by adopting one or the other methods. Where one of the options is not demonstrably better than the other, then the standard would have to make an arbitrary choice between them. This does not seem a very satisfactory position. An option would still leave those companies wanting to converge more closely with US GAAP the ability to do so. An optional regime has worked reasonably well in the UK over the last few years.

Question 9 � Excess over the cost of a business combination of the acquirer�s interest in the net fair value of the acquiree�s identifiable assets, liabilities and contingent liabilities

We do not agree with this proposal to recognise negative goodwill immediately as a profit.

We agree, however, that the valuation of the assets and liabilities acquired should be reconsidered very carefully if it appears that their fair value exceeds the consideration paid for them. There should be a presumption that this situation should not generally arise, and therefore that their fair value should be reduced to reflect, for example, the need to incur future costs. Even when reassessed, negative goodwill may still occasionally remain. We accept, for example, that if contingent liabilities are not recognised (see Question 6 above) and if restructuring provisions will be able to be recognised less frequently (see Question 5 above), the probability of negative goodwill emerging is increased. We favour continuing the existing treatment for negative goodwill under IAS22.

Negative goodwill would not meet the definition of a liability itself, although it may (as noted above) represent unrecognised obligations or future costs inherent in the valuation of the assets of the business. Where positive goodwill exists, then any negative goodwill should be netted against that amount. If that is not the case, then any balance should be a separate category included with liabilities.

Question 10 � Completing the initial accounting for a business combination and subsequent adjustments to that accounting

We agree with the proposals in the ED in this respect.

Other comments

Determining fair values of assets and liabilities (Paragraphs B15 and 16 on pages 72 to 74)

Guidance on reaching fair values for assets and liabilities acquired would be better stated by setting out a basic principle of recognition and measurement according to the relevant IAS/IFRS, and then providing additional guidance on any exceptions. The guidance in ED3 is much less comprehensive compared to the guidance in IAS39 on reaching the fair value of financial instruments. Derivatives, for instance, are not specifically referred to, nor are executory contracts specifically excluded (as they are in the scope of IAS37).

Transitional arrangements (paragraphs 77 to 83)

We agree that a full restatement should not be required in this case. We note that the treatment of a business combination as a uniting of interests up to the date of application of the IFRS, will be allowed and not required to be restated as an acquisition. Negative goodwill, however, will have to be credited to income by way of a prior year adjustment. This seems inconsistent and in our view, if the rules are changed on negative goodwill, then any inherited balances should be written off according to the existing rules.

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