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The U.K.’s Financial Reporting Council said that merger and acquisition accounting standards need to be improved because companies do not understand the reporting requirements.
The FRC, an independent regulator that promotes corporate reporting and governance, said on January 7, 2010, that M&A activities are likely to increase significantly with better economic conditions. But according to a study it conducted in late 2009 of 20 acquisitions that were completed in 2008, companies said that M&A accounting is “costly and difficult.”
Investors say the information they get is not useful.
The FRC study suggested that one reason may be because IFRS 3, Business Combinations, “has been poorly applied by companies due to unfamiliarity with its requirements and the complexity of valuing intangible assets such as brands and customer relationships.”
The study found that companies provided insufficient or inconsistent information about acquisitions in audited financial statements when they are compared to the rationale for such acquisitions in their business reviews.
“The FRC considers that there is a need for improved compliance with the disclosure requirements of IFRS, so that investors and other stakeholders can better relate the intangible assets recorded for material acquisitions to the account of the transaction given in the business review,” the FRC study said. “A high level of consistency between the information in the business review and the audited accounts would improve the quality and transparency of the information about acquisitions.”
“I view this as more of a problem of application of the standard IFRS 3 than a problem with the standard itself,” said Charles Mulford, Invesco chair and professor of accounting at Georgia Institute of Technology in Atlanta and director of the GT Financial Reporting & Analysis Lab.
Moreover, “I think that the [FRC] comments made about IFRS 3 would also apply to U.S. accounting,” he said, in reference to the standards that are converged with the international guidance, SFAS 141(R), Business Combinations, (FASB ASC 805) and SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, (FASB ASC 810-10-65).
But Mulford said that he was “generally pleased” with the accounting and disclosure requirements of SFAS 141(R) and found the requirements of IFRS 3 consistent with those in U.S. GAAP.
“Identifying fair values of all acquired assets and assumed liabilities can be difficult, especially with intangibles, but it’s not impossible,” Mulford said. “Moreover, this is information that investors need to be able to better assess the prudence of an acquisition. Finally, while it is difficult for management to estimate these fair values, management is certainly in a much better position to do so than outside investors.”
However, he said that he took exception to reporting negative goodwill as a gain on the date of the acquisition, a provision in both IFRS 3 and SFAS 141(R).
“This is the only situation in accounting of which I’m aware where a company records a gain at the time of a purchase, with no outside verification of the gain's realization. Treating the bargain purchase amount as a component of accumulated other comprehensive income would make more sense to me,” Mulford said.
And what investors need is information that would allow them to determine an entity’s “organic growth,” one that excludes the effects of the acquisition.
He said he would add operating cash flow to the disclosure requirements in both IFRS 3 and SFAS 141(R), which deal with pro-forma revenues and net income for the two parties as though they were combined for all periods presented.
The FRC said it will continue to monitor M&A reporting in the next 18 months to assess whether the information about acquisitions has improved in quality and whether such information is useful. The agency expects improvements in part from recent amendments to the fair value guidance and the increasing practical experience of estimating fair values for intangible assets.
“In addition, recent amendments to IFRS 3 ...mean that, in future, more intangibles will be recognised for accounting purposes,” said Ian Wright, FRC's director of corporate reporting. “This may help ensure a greater degree of consistency between what is disclosed about acquisitions in the accounts and the rationale for acquisitions set out in business reviews.”
The FRC said it will provide feedback to the IASB as part of its planned post-implementation review of a revised IFRS 3.
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