- Application of the Purchase Method

Mutual Entities

An important objective of the IASB-FASB joint project is to achieve convergence on the accounting for business combinations. A remaining area of divergence is the accounting for combinations between two or more mutual entities. The FASB decided to include business combinations involving two or more mutual entities within the scope of its Business Combinations Exposure Draft arising from the Application of the Purchase Method project.

In June 2004, the Board considered whether the IASB's Exposure Draft arising from this project should propose that business combinations involving two or more mutual entities or by contract alone without the obtaining of an ownership interest should be accounted for in accordance with the Board's tentative decisions in this project, rather than in accordance with the interim approach set out in the Exposure Draft of Proposed Amendments to IFRS 3 Combinations by Contract Alone or Involving Mutual Entities (Mutual Entities Exposure Draft).

The Board tentatively decided that the Exposure Draft should propose that such business combinations be accounted for in accordance with the proposals in the Application of the Purchase Method project. However, the Board agreed that before proceeding with this tentative decision, it should consider the issues that the FASB considered in respect of mutual entities to the extent that those issues have not already been dealt with by the IASB.

With this objective in mind, FASB staff gave an overview of the issues that had been considered by the FASB and noting that although differences do exist in the manner that business combinations affect mutual entities when compared to other entities, such differences did not warrant different accounting. Furthermore, the particular difficulty of identifying an acquirer would not be unique to such entities only.

FASB staff also indicated that it did not appear that the FASB had intentions to explore 'fresh start accounting' for 'true mergers' which were agreed to be rare / seldom occurred, as this would create another form of accounting (in addition to purchase method accounting). A Board member suggested that the IASB should still explore fresh start accounting as this was an area that had not been explored before and therefore could not be ruled out as not providing appropriate accounting in such cases.

After some deliberation, the Board re-affirmed some of its previous decisions and made consequential decisions as follows:

• re-affirmed the Phase I 'in-principle' decision to require the purchase method of accounting for combinations of two or more mutual entities.
• that difficulties in identifying the acquirer are not a sufficient reason to justify a different accounting treatment and that no further guidance is necessary for identifying the acquirer for combinations of two or more mutual entities.
• reject the phase I Mutual Entities Exposure Draft's proposed 'modified' purchase method of accounting and propose in the forthcoming Exposure Draft that the accounting for goodwill should be the same for combinations of mutual entities as for combinations of other entities.
• require the acquiring mutual entity to measure and recognise the business combination as the fair value of the acquired mutual entity.
• add additional guidance for measuring the fair value of an acquired mutual entity.
• require that in an acquisition in which the acquirer exchanges member interests for the member interests of the acquired mutual entity, the fair value of the acquired mutual entity be recognised as a direct addition to a properly labelled capital or equity account, which would be consistent with the accounting for combinations in which any other entity issues equity instruments in exchange for equity instruments of the acquired entity.
• provide detailed guidance for the valuation of acquired loans, deposits, or intangible assets in the forthcoming Exposure Draft.
• Not modify the tentative decisions in this project for possible regulatory impacts but consider using the invitation to comment to ask constituents to identify any regulatory concerns that might exist in their jurisdictions.
• Include an additional disclosure requirement for mutual entities to disclose the accounting for the member interests transferred.

Implications of introducing fair value hierarchy into IFRSs

The FASB and IASB have in the past, tentatively decided in this project to use fair value as the measurement objective for the business acquired in a business combination. The Boards also tentatively decided to adopt additional guidance for measuring fair value in the form of a hierarchy (the fair value hierarchy) to ensure consistent application of the fair value measurement requirement.

However, the FASB subsequently amended the fair value hierarchy to reflect decisions made by the FASB as part of its Fair Value Measurements project. Therefore, the FASB plans to include in its forthcoming Business Combinations Exposure Draft the fair value hierarchy agreed in its Fair Value Measurements project. The IASB has not considered all of the issues that the FASB has considered as part of its Fair Value Measurements project and that resulted in the FASB amendments.

The Board deliberated on how best to proceed considering the overall objective of this project was convergence, the desire not to delay the Phase II project, but also considering that the IASB had not deliberated on the specific issues that led to the FASB making amendments to the hierarchy. Some of the options discussed:

• append the FASB document with a 'wrap-around' from the IASB stating that these issues are still to be debated by the IASB with a view to producing a single pronouncement in the future with all necessary fair value guidance that would be applicable under IFRS.
• to debate the issues in the FASB document as part of Phase II, on the understanding that a 'high hurdle' (a 'dissentable' issue) would be used during these deliberations in making wording suggestions.

The latter option was selected and the Board proceeded to list the issues that it would like to include in the Phase II fair value document that would be applicable to fair value measurement in the context of business combinations only. These issues will be discussed at the next meeting:

• definition of an active market;
• guidance on market inputs;
• guidance on valuation techniques

The Board requested that IFRIC consider reviving the IAS 41 fair value issue that it had been working on in light of the above.