Exceptions to the fair value measurement principle - Assets held for sale

The Business Combinations Exposure Draft (BC ED) proposes an exception to the fair value measurement principle for acquired non-current (long-lived) assets that are classified as held for sale as of the acquisition date.

At the January 2006 meeting, The Board asked the staff to bring the proposed accounting for assets held for sale back to the Board because:

• the staff was concerned about the justification for the proposal as an exception to the fair value measurement principle; and
• it was not clear to the staff whether the Boards intended the measurement exception to relate to assets that the acquiree classified as assets held for sale before the acquisition date or whether the Board intended the measurement exception to relate to any assets acquired in the business combination that the acquirer intends to hold for sale.

The Board agreed that the final standard make it clear that the designation by an acquiree of an asset as being held for sale is not relevant when recognising and measuring assets acquired in a business combination. In addition, the Board agreed with the staff view that an acquirer should be allowed to recognise an asset as being held for sale at the date of acquisition if it can meet the criteria in IFRS 5. However, it is unlikely that the acquirer would be able to meet those criteria as of the acquisition date.

The Board agreed to go a step further and amend IFRS 5 to replace 'fair value less cost to sell' with 'fair value'. It was reported that the FASB had indicated its intention to take the same extra step. However, some Board members noted that this extra step should be taken as a separate project as it will involve a fundamental review of impairment accounting.

Accounting for employee benefits in a business combination

The Board affirmed the fair value measurement exception for employee benefit obligations in the scope of IAS 19. Therefore, an acquirer will measure the assets or liabilities of the acquiree that are related to its employee benefit schemes in accordance with IAS 19 rather than at fair value.

Operating leases

The staff believes that without additional guidance, different interpretations of the application of the recognition principle to an acquiree's operating leases might result. For example, constituents might interpret the recognition principle as requiring recognition of an intangible asset (liability) for the acquiree's interest in a net beneficial (onerous) contract and:

• separate recognition of the assets and liabilities related to an acquiree's operating leases. For example, if the acquiree is the lessee of an operating lease, the acquirer would recognise a separate asset for the acquiree's rights to use assets according to the lease agreement, including related renewal options and other rights, and a separate liability for its obligations to make required lease payments.
• no recognition of assets and liabilities related to an acquiree's operating leases because IAS 17 Leases and FASB Statement No. 13 Accounting for Leases do not require separate recognition of assets and liabilities related to operating leases.

Operating leases in which the acquiree is the lessee

The Board affirmed the proposal in the business combinations ED that acquirers only should be required to recognise an intangible asset (liability) for the acquiree's interest in a net beneficial (onerous) contract, rather than being required to recognise separately an asset and related liability.

Operating leases in which the acquiree is the lessor

The staff proposed that the final business combinations standard should clarify that the fair value of the asset subject to the operating lease is not affected by the terms of the operating lease contract associated with the asset. The fair value of the asset subject to the operating lease will reflect the effects of leasing the asset at market terms at the measurement date. The effects of the terms of the existing operating lease contract should be considered separately from the fair value measurement of the asset subject to the operating lease. If the lease is not at market terms, the lessor would recognise separately an intangible asset (beneficial contract) or liability (onerous contract). The concern is that without this clarification some constituents might believe that the fair value of an asset subject to an onerous operating lease contract is lower than the fair value of the same asset leased at market terms.

Some Board members disagreed with the staff proposal on the basis that a building that is subject to lease agreements is different to one that is not subject to lease agreements. Furthermore, IAS 40 and IAS 41 are inconsistent on this issue. The Board decided to wait for the outcome of the FASB's deliberations before deciding on how to proceed.

Can an operating lease at market terms have a greater net value than zero?

The business combinations ED guidance on operating leases describes only two types of assets and liabilities that might be recognised in relation to operating lease contracts:

• an intangible asset or liability if the terms of the operating lease are favourable or unfavourable relative to market terms; and
• the asset subject to an operating lease in which an acquiree is the lessor.
• The Board agreed with the staff recommendation that the final business combinations standard should clarify, that operating lease contracts at market terms might have value for reasons other than terms that are favourable relative to market prices. For example, an operating lease contract might have value because an entity is willing to pay more than the market rate to gain entry into a market with limited access or to obtain access to existing customer relationships. In such circumstances the intangible asset to which that value is attributable should be recognised separately. That is to say, even if an acquiree's operating lease contract is at market terms, the acquirer still must recognise any intangible assets which create value in the at-market contract.

It was not clear whether the Board decided to characterise the above clarification as an exception to the recognition principle or as additional application / implementation guidance.