IFRS 3 — Accounting for contingent consideration in a business combination
In May 2012, the IASB published Exposure Draft ED/2012/1 Annual Improvements to IFRSs 2010-2012 Cycle which proposed to amend IFRS 3 to clarify that:
- classification of contingent consideration in a business combination as either a liability or an equity instrument is based solely on the requirements of IAS 32 Financial Instruments: Presentation
- contingent consideration in a business combination that is not classified as an equity instrument is subsequently measured at fair value, with the corresponding gain or loss recognised either in profit or loss or other comprehensive income in accordance with IFRS 9.
At a previous meeting, the Committee discussed constituent feedback to the annual improvement proposal. The Committee, at that meeting, tentatively agreed:
- the wording of the requirement on non-equity contingent consideration subsequent measurement in paragraph 58(b) of IFRS 3 should be amended to ensure that it does not imply that contingent consideration can only be a financial instrument
- that the proposed amendment to IFRS 9 paragraph 4.1.2 should be deleted
- the wording of the transition and effective date paragraph should be amended to ensure that the proposed amendment to IFRS 3 could not be applied without also applying IFRS 9.
At that meeting, the Committee noted that the proposals would require the recognition of fair value changes relating to own credit risk in other comprehensive income for financial liability contingent consideration; a result inconsistent with the proposed requirements for the subsequent measurement of non-financial liability contingent consideration. Therefore, the Committee requested that the staff consider how the accounting for the subsequent change in the fair value of financial and non-financial liability contingent consideration could be made more consistent.
Considering feedback at the previous meeting, the staff analysed the subsequent measurement basis for three different types of liability contingent consideration; those being, trading financial liabilities, other financial liabilities and non-financial liabilities. As a result of its analysis, the staff presented the following proposal:
- Held for trading financial liability contingent consideration issued in a business combination should be subsequently measured at fair value through profit or loss (FVTPL)
- Other financial liability contingent consideration issued in a business combination should be required to apply the requirements for liabilities designated as at FVTPL in paragraph 5.7.7–5.7.9 of IFRS 9; and
- For non-financial liability contingent consideration issued in a business combination, the fair value changes attributable to the non-performance risk of that non-financial liability contingent consideration should be required to be presented in other comprehensive income, and the remaining amount of change in the fair value of that non-financial liability contingent consideration should be presented in profit or loss.
Several Committee members expressed concern with the staff proposals, particularly in the area of non-financial liability contingent consideration. Concerns included a view that the staff proposals were creating presentation inconsistencies between non-financial liability contingent consideration and other non-financial liabilities under IAS 37, while also limiting the usefulness and practicality of bifurcated non-performance risk from other fair value changes (which is not a requirement for any other non-financial liabilities in IFRS).
Another Committee member believed the Committee’s original intention was to eliminate the inconsistency between derivative financial liability contingent consideration (which goes to profit or loss) and non-derivative financial liability contingent consideration (which goes to other comprehensive income). He noted the staff proposal did not resolve this inconsistency. He expressed a preference that all contingent consideration in a business combination that is not classified as an equity instrument be subsequently measured at FVTPL. He saw this as a simplistic approach which promoted consistency in application but acknowledged that it resulted in some inconsistencies with IFRS 9.
The Committee Chair, listening to member views, outlined two alternatives:
- measure all contingent consideration in a business combination that is not classified as an equity instrument at FVTPL, or
- measure all contingent consideration in a business combination that is not classified as an equity instrument at FVTPL except for non-derivative financial instrument contingent consideration (which should be measured through other comprehensive income).
The Committee could not reach a super majority on these alternatives, with eight Committee members supporting (1) and six Committee members supporting (2). The Committee Chair then asked whether anyone would object to (1), to which no one objected. Therefore, the staff plans to bring the Committee recommendation to the IASB for its consideration.