Business Combinations II
Comparison of fair value measurements in IFRS and US GAAP
The staff reported on the results of an investigation undertaken at the request of the IASB and FASB about whether the different definitions of fair value (that in FAS 157 and the existing definition in IFRS) might result in different valuations of assets acquired and liabilities assumed in a business combination depending on whether it is accounted for in accordance with IFRSs or US GAAP.
The staff and a working group had identified areas in which GAAP differences might occur, depending on the facts and circumstances of the asset or liability. Some respondents commented that the following might result in differences in fair value:
- when an asset is acquired in a business combination for defensive purposes and market participants would similarly lock up the asset and that use would maximise the value of the group of assets in which asset is used (for example, brands or in-process research and development projects);
- potential differences in the settlement definition of fair value for liabilities under IFRSs and the transfer definition under US GAAP;
- references to different markets under IFRSs and US GAAP, particularly with regard to Level 3-type financial instruments;
- differences in the application of highest and best use concepts; and
- differences in guidance regarding non-performance risk and credit standing.
With only brief discussion, the Board:
- Affirmed that the measurement attribute in a business combination is fair value, as defined in IFRSs: Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's length transaction;
- Decided that the GAAP differences identified by participants, as above, should be addressed as part of the IASB's Fair Value Measurement Guidance project.
- Noted that some of the matters identified above were not GAAP differences, but were situations in which the IASB and FASB have consistent concepts, but have used different words to articulate those concepts. Board members asked the staff to investigate drafting IASB-specific application guidance that would explain this (the FASB would rely on FAS 157, for which there is currently no IASB equivalent).
Classification and designation of assets, liabilities and equity instruments acquired or assumed in a business combination
The Board agreed that the Standard should state that an acquirer should classify or designate the assets, liabilities, and equity instruments acquired or assumed at the acquisition date based on the conditions that exist at the acquisition date (for example, the contract terms, the economic conditions and the acquirer's intent and accounting policies).
However, the IASB will clarify that the classification of the following items shall be determined at the inception of the contract and shall not be reassessed, unless there has been a substantive modification in the original terms and conditions as a result of the combination):
- Insurance contracts
- Embedded derivatives
The staff noted that the FASB had tentatively decided to require reassessment of embedded derivatives, in accordance with existing guidance in FAS 133. This will be addressed as a sweep issue.
The Board confirmed the disclosure package in Observer Note 2C on IASB Website.
The effective date for the IASB standard was agreed as business combinations occurring in annual periods beginning on or after 1 January 2009. (The FASB statement will be effective for annual periods beginning on or after 15 December 2008. The Board discussed this, but concluded that the allowance in IAS 1 for a 52/53 week financial year should not result in a difference in practice.)
The Board agreed to permit early adoption of the new standard. It was noted that the FASB had voted to prohibit early adoption. IFRS preparers with a US GAAP reconciliation requirement could avoid a reconciling item by not adopting the standard early.
Replacement share-based payment awards
The Board agreed to modify the guidance in the BC ED to be consistent with the principles underpinning IFRS 2 and to require that excess fair value in the acquirer's replacement award over the acquiree's award be recognised over the post-combination requisite service period of the acquirer's replacement award along with any portion of the award attributable to future services. This will align the accounting for the excess fair value in the acquirer's replacement award over the acquiree's award with its treatment under US GAAP.
In order to clarify how an acquirer should allocate the remaining fair value of the acquirer award between consideration transferred in the business combination and compensation cost the Board agreed to modify the wording in A103(c) of the BC ED as follows:
Of the remaining fair value based measure of the replacement award the portion attributable to past services is equal to the remaining fair-value-based measure of the replacement award (or settlement) multiplied by the ratio of the portion of the vesting period completed to the greater of the total vesting period or the original vesting period of the acquiree award.The Board believes that the proposed wording is similar to the US GAAP requirement.
The Board agreed that an acquirer's replacement award be allocated between consideration transferred and post-combination expense in the same manner that awards classified as equity instruments would be.
The Board agreed not to address the accounting for share-based payment awards with graded vesting schedules as part of the business combinations phase II project.
The Board agreed that a forfeiture estimate be included in the fair value of unvested replacement awards deemed to be consideration transferred in a business combination.
The Board affirmed the guidance in the BC ED that post-combination forfeitures of awards considered to be consideration transferred in the business combination do not affect the purchase price.
The Board affirmed the guidance in the BC ED requiring an acquirer to account for the post-combination effects of replacement share-based payment awards classified as liabilities through adjustments to compensation cost and income tax expense in the period in which they arise.
The Board decided not to address the accounting for income tax effects arising from replacement awards as part of the business combinations phase II project. Instead it was agreed to point out in the Standard that income taxes on replacement awards should follow the existing guidance in IAS 12 Income Taxes and IFRS 2 Share-based Payment.
The Board discussed various issues related to insurance contracts acquired in a business combination (see IFRS 4 paragraphs 31-33).
The Board agreed that the expanded presentation described in paragraph 31 of IFRS 4 should continue to be optional.
The Board agreed that phase II of the business combinations project should not specify whether the acquirer should present pre-acquisition contract balances of the acquiree as a separate asset or should include them in the intangible assets presented using the expanded presentation.
The Board agreed that phase II of the business combinations project should not address contingent commissions, subsequent accounting for the fair value intangible asset and guarantees for adequacy of insurance liabilities.
The Board agreed that the following issues should not be revisited for insurance contracts acquired in a business combination as they are addressed by more general principles in phase II of the business combinations project:
- When does a reinsurance arrangement qualify as a business combination?
- Mutual insurance entities
- Fair value measurement
- Classification of an insurance contract
Board's tentative conclusion on the Amendments to IFRS 3 as a whole
The staff notified the Board that one FASB member had indicated an intention to dissent from the final FASB statement.
The staff summarised the most significant changes from the current version of IFRS 3 as follows:
- Acquisition costs would be expensed;
- Contingent consideration would be assessed at fair value at the date of acquisition; any subsequent changes would be reflected in profit or loss;
- In a step acquisition, goodwill would be assessed at the time control is acquired; any subsequent increases in ownership would be treated as transactions between equity participants [one IASB member has indicated an intention to dissent on this issue];
- Any historical holding (for instance, as an investment) in an entity for which control is later acquired would be re-measured at fair value at the date of acquisition of control, and a gain recognised in profit and loss;
- The measurement of non-controlling interests.
The IASB chairman addressed the measurement of non-controlling interests. At the March 2007 meeting, a possible compromise had been suggested of an exception to the measurement of non-controlling interest at fair value based on 'undue cost and effort.' It had since become evident that such an exception was not viable. Consequently, the Board was faced with three alternatives:
- Measure non-controlling interest at fair value (Alternative A)
- Measure non-controlling interest at the proportionate share of the interest in net assets (Alternative B)
- An explicit option of either Alternative A or B, available on an acquisition-by-acquisition basis (Alternative C)
The Board was asked who would dissent from a standard including each of the Alternatives. The votes were as follows:
- Alternative A: eight Board members indicated they would dissent;
- Alternative B: six Board members indicated they would dissent;
- Alternative C: four Board members indicated they would dissent.
Based on this vote, the IASB version of the final standard would contain an explicit option as explained above, because only Alternative C commanded the required majority of the IASB. A Board member asked the staff, when drafting the Basis for Conclusions, to make it very clear that the IASB had voted in this way as an expedient to approve the Standard; that there was no conceptual basis for the option; and that it was possible to avoid a reconciling item between IFRS and US GAAP by adopting Alternative A.
On a related issue, the Board was asked for an indicative vote on the amendments to IAS 27. Two Board members indicated an intention to dissent; two more reserved their position, pending review of the pre-ballot draft.
IASB/FASB Sweep issues
The staff reviewed various sweep issues to be discussed at the joint meeting with the FASB on 24 April. No decisions were taken at this meeting. (The joint meeting will be reported on www.iasplus.com.)
The staff reviewed the cost/benefit assessment prepared by the IASB and FASB staff. The overall conclusion is that the benefits of the amendments to IFRS 3 and IAS 27 outweigh the costs.
This assessment will be discussed at the joint meeting on 24 April. It will form part of the formal feedback report to be prepared for the IASB Trustees.
JOINT MEETING OF THE IASB AND THE FASB