Analysis of the comments received on the screening test — Agenda paper 13

Background

The Board continued its deliberation of the feedback received on the exposure draft (ED) Definition of a Business and Accounting for Previously Held Interests. The ED proposes a screening test that conclusively determines that a set of activities and assets is not a business if substantially all the fair value of the gross assets acquired is concentrated in a single identifiable asset or group of similar identifiable assets. The purpose of this session was to discuss whether the screening test should be modified in light of comments received.

The Staff will analyse the comments received on the other proposals in the ED at a future Board meeting.

Staff analysis and recommendation

The Staff made the following recommendations based on their analysis of feedback received, meetings held with the Accounting Standards Advisory Forum and the Capital Markets Advisory Committee, as well as the FASB’s related amendments to US GAAP published in January 2017.

1. Make the screening test optional on a transaction-by-transaction basis

Some respondents were concerned that the screening test could result in inappropriate conclusions in some circumstances. They were also concerned that applying the screening test would be inefficient in cases where it is clear that the acquired assets constitute a business.

The Staff acknowledged these concerns and recommended that an entity be given an option to apply the screening test on a transaction-by-transaction basis. This would allow entities the flexibility to assess whether a substantive process has been acquired if this assessment would be more efficient or result in a conclusion that better reflects the economics of a particular transaction. The proposed option to apply the screening test on a transaction-by-transaction basis would be different from the FASB’s January 2017 amendment.

The Staff also considered but rejected re-characterising the screening test into a mandatory indicator or a rebuttable presumption. This is because both these suggestions would require an entity to carry out a full assessment to see whether there are contrary evidence that would rebut the asset presumption, even if the screening test concluded that the transaction is an asset acquisition. The Staff believed that this extra step would defeat the purpose of having the screening test in the first place, which is to reduce the cost and complexity of applying the business definition guidance.

2. Confirm that the screening test is determinative

In keeping with the objective of reducing the cost of applying the business definition guidance, the Staff recommended that the screening test continue to be determinative. In other words, if an entity chooses to apply the screening test and concludes that the transaction is an asset purchase, it should not carry out further assessment that might change that conclusion.

This recommendation is consistent with the FASB’s related decision.

3. Exclude deferred tax balances and goodwill resulting from deferred tax adjustments from the screening test

Some respondents sought clarity on whether deferred tax balances should be considered in the screening test. The Staff believed that the tax effects of the assets and liabilities acquired should not affect the determination of whether an acquired set is a business. Excluding deferred tax balances from the screening test (i.e. from both the fair value of the gross assets acquired and the fair value of the single asset or group of similar assets) would also circumvent the potential circular assessment of whether goodwill arises on acquisition, which is itself dependent on whether the acquired set constitutes a business and the deferred tax balances that result from the fair value adjustments on acquisition.

This recommendation is consistent with the FASB’s related decision.

4. Clarify that a tangible asset and an IFRS 16 right-of-use asset may be considered ‘a single asset’

This proposed clarification was made in response to questions about whether a leasehold land and a building attached to that land should be considered a single identifiable asset for the screening test. This question arose because paragraph B11B of the ED gives an example of two tangible assets being regarded as a single asset, and paragraph B11C states that separately identifiable tangible and intangible assets should not be combined into a single asset. In this case, the building is tangible, yet the leasehold land is a right-of-use asset of unspecified nature (IFRS 16 does not specify whether a right-of-use asset is tangible or intangible).

The Staff believed that this is a drafting issue and that paragraph B11B is intended to apply to the case at hand. The proposed clarification to cover right-of-use assets is consistent with the FASB’s related amendment.

5. Clarify the meaning of ‘similar assets’

Many respondents sought additional guidance on what constitutes similar assets.

The Staff agreed that parameters should be set to restrict instances of when assets could be described as similar, as this would reduce the risk of reaching an inappropriate ‘asset’ conclusion from applying the screening test. Accordingly, the Staff recommended that an entity consider the nature of each single asset and the risks associated with managing and creating outputs from the assets when considering whether the assets are similar. This is consistent with the related FASB clarification.

6. Clarify the interaction with existing guidance

Some respondents noted that IAS 16, IAS 38 and IFRS 7 contain guidance on what constitutes a class of property, plant and equipment (PPE), intangible assets and financial instruments respectively. IAS 38 also describes how an intangible asset might be separable only with other related items. These respondents asked how the proposed notion of a single asset or a group of similar assets for the purpose of the screening test interacts with the existing guidance.

The Staff believed that the existing guidance is also applicable to the screening test. They recommended that the Board clarify that the proposed guidance on what assets may be considered a single asset or a group of similar assets does not modify the existing guidance in IAS 16, IAS 38 and IFRS 7.

Discussion

The Board approved the Staff’s recommendations. The Board debated only recommendations 1 and 2 above. The other recommendations were approved without discussion.

There was significant debate on whether having an optional screening test would be beneficial. Some Board members even considered scrapping the test on grounds that it might create more risks than resolve problems that might not even have been there in the first place. A Board member noted that the screening test was introduced partly to align with US GAAP requirements, yet the problems encountered in the US as regards the identification of a business are different from those experienced by those applying IFRS. Accordingly, a few Board members questioned whether it is really necessary for IFRS to introduce the screening test, especially on an optional basis which departs from the mandatory nature of the test in the equivalent FASB requirements.  The Vice-Chair was also particularly concerned about cases of false asset acquisitions arising under the test. She believed that by making the test optional, the Board is effectively giving blessing to entities to abuse the test to circumvent business combination accounting. 

The Staff defended the screening test on the following grounds:

1. The risk of the test is only a false asset acquisition;
2. The risk of a false asset acquisition is small. This is because by definition, as substantially all the fair value of the gross assets acquired is concentrated in a single asset or group of similar assets, the likelihood of the acquired set containing a substantive process (with a substantive fair value) is small; and
3. The financial impact of a false asset acquisition is likely to be insignificant. Consistent with the reasoning above, the value of any unrecognised goodwill would be small by definition. Furthermore, as indicated in feedback received on various occasions, the Staff believed that the differences in accounting treatment between a business combination and an asset acquisition do not have any substantial meaning and do not reflect the substance of the transaction.

The Staff said that they could narrow the qualifying criterion of the screening test further to reduce cases of false asset acquisitions. All in all, the Staff believed that the small risk as identified above is worth running in light of the cost-saving benefits that the screening test is expected to bring. The Staff also agreed to reword the test as ‘can be determinative’ as opposed to ‘is determinative’ to remove the oddity in cases where an entity abandons the screening test because a full assessment would indicate that the set acquired is a business.

One Board member preferred having the screening test as a rebuttable presumption and believed that the perceived burden associated with it is unjustified. He reasoned that if an entity eventually concludes that an acquisition is a business combination, management would need to determine the fair value of the assets acquired and liabilities assumed anyway, and performing the screening test would simply require them to compare these fair values with the consideration paid/payable, which is straightforward in his opinion. Nevertheless, most Board members believed that the test should not be re-characterised as a rebuttable presumption for the reasons given in the staff paper. Another Board member was concerned that there was no clear concept of what is meant by ‘similar assets’ and ‘concentration’. There was no uptake on his concerns around the table.